Blumenthal v. F.E.R.C.

• Decision Date: 23 January 2009
• Docket Number: No. 07-1130.,07-1130.
• Citation: 552 F.3d 875
• Parties: Richard BLUMENTHAL, Attorney General for the State of Connecticut, Petitioner v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent NEPOOL Industrial Customer Coalition, et al., Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

552 F.3d 875

Richard BLUMENTHAL, Attorney General for the State of Connecticut, Petitioner v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent

NEPOOL Industrial Customer Coalition, et al., Intervenors.

No. 07-1130.

United States Court of Appeals, District of Columbia Circuit.

Argued November 17, 2008.

Decided January 23, 2009.

On Petition for Review of Orders of the Federal Energy Regulatory Commission.

Michael C. Wertheimer, Assistant Attorney General, Attorney General's Office of State of Connecticut, argued the cause for petitioner. With him on the briefs was John S. Wright, Assistant Attorney General.

Robert A. Weishaar Jr. and Vasiliki Karandrikas were on the brief for intervenor NEPOOL Industrial Customer Coalition in support of petitioner.

Jennifer S. Amerkhail, Attorney, Federal Energy Regulatory Commission, argued the cause for respondent. With her on the brief were Cynthia A. Marlette, General Counsel, and Robert H. Solomon, Solicitor.

Mark E. Nagle, William R. Derasmo, Anne K. Dailey, and Kenneth R. Carretta were on the brief for intervenors Dominion Energy Marketing, Inc., et al. in support of respondent.

Theodore J. Paradise, Sherry A. Quirk, and Debra A. Palmer were on the brief for intervenor ISO New England Inc. in support of respondent.

Before: SENTELLE, Chief Judge, GRIFFITH, Circuit Judge, and EDWARDS, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge GRIFFITH.

GRIFFITH, Circuit Judge:

The Federal Energy Regulatory Commission (FERC) rejected Connecticut's challenge to the structure of the state's electricity market. FERC concluded that the current "hybrid" market, in which some electricity generators sell power at regulated rates and others at market rates, is lawful, and that Connecticut's proposed alternative would not be. We hold that FERC's denial of Connecticut's complaint was not arbitrary and capricious and thus deny the petition for review.

I.

A.

Just over a decade ago, the New England electricity market was highly regulated and relatively uncomplicated. Generators sold electric energy wholesale at a regulated price based on the cost of production to entities that transmitted that energy for consumer use. In 1998, the market became less regulated and more complicated when FERC approved a proposal by the New England Power Pool— an alliance of electric utilities—to move the market toward greater competition. The proposal established ISO New England Inc. (ISO-NE), a "private, non-profit entity to administer New England energy markets and operate the region's bulk power transmission system," NSTAR Elec. & Gas Corp. v. FERC, 481 F.3d 794, 796 (D.C.Cir.2007), and created markets for the sale of several products provided by generators: energy, capacity (that is, the option of buying a particular amount of energy in the future), and ancillary services that ensure the availability of sufficient electricity at all times to meet fluctuating levels of demand. Most importantly, under the new regime, the range of electricity rates is set based on the market and not on the generators' costs alone. Individual generators offer electricity to the market at a particular price. ISO-NE determines the amount of electricity needed to meet demand for a particular time period and sets the "market-clearing price" at which there is no excess demand. This market-clearing price, which all generators must use, is equal to the bid price of the least expensive megawatt of power not needed to meet demand—that is, the next unit of supply that would be employed if demand were any higher.

Following the 1998 reforms, the New England electricity market encountered problems with infrastructure weaknesses, outdated generating units, and insufficient supply to meet increasing demand. In some areas, including Connecticut, the resulting transmission constraint often made it difficult to transmit the available electricity supply to where it was needed. Additionally, the inability of many high-cost (and typically older) generating units to earn a profit in the competitive markets threatened the reliability of the already overburdened system. These units were needed to maintain a reliable supply of energy during times of high demand, but were infrequently used because their bids usually exceeded the market-clearing price during times of low or normal demand.

To address these problems, in 2002 FERC approved a new set of operating rules, including Market Rule 1, for New England. To respond to the problem of transmission constraint, Market Rule 1 adopted "locational marginal pricing." ISO-NE had previously set the market-clearing price using offers of electricity based only on meeting demand at the least possible cost. Under locational marginal pricing, the decision to use a particular offer also depends on the feasibility of transmitting that power to where it is demanded. The market-clearing price thus includes the additional cost of dispatching power that is more expensive but which can be transmitted to where it is needed. Market Rule 1 also authorized the use of Reliability-Must-Run (RMR) agreements to prevent high-cost generators from shutting down for lack of profitability. An RMR agreement entitles the generator to recover a full cost-of-service rate rather than the rate it could obtain on the market. In turn, the generator must offer all of its capacity into the energy markets at a predetermined price representing actual marginal cost, and any revenue from these market sales directly reduces the cost-based payments made under the RMR agreement. RMR agreements are available only to those generators that are unable to supply their needed electricity without the cost-ofservice compensation of the agreements.

Market Rule 1 is a temporary and imperfect solution to particular problems in the New England electricity market. By ensuring the availability of sufficient power to meet demand, Market Rule 1 meets a primary goal of system reliability. That it does so by interfering with the efficient operation of a purely competitive market is a problem. Recognizing that, FERC encouraged ISO-NE to develop a new market structure for New England to achieve the benefits of Market Rule 1 without the drawbacks. After extensive proceedings, including a settlement agreement between ISO-NE and more than one hundred interested parties, FERC approved a plan for a new Forward Capacity Market. See Me. Pub. Utils. Comm'n v. FERC, 520 F.3d 464 (D.C.Cir.2008) (affirming FERC's approval order). Under the new scheme, ISO-NE will hold annual capacity auctions three years before the capacity is needed. The advance time will allow potential new generators to compete in the auctions and plan for market entry. The Forward Capacity Market will also continue locational marginal pricing through separate auctions held in "capacity zones" that are designated based on relative transmission constraint.

Because of the three-year lead time, the Forward Capacity Market will not take effect until June 1, 2010. In the meantime, FERC has approved several interim measures to ensure reliability of the electricity system in New England as a whole and Connecticut specifically. It approved temporary transition payments to New England generators between 2006, when the Forward Capacity Market was finalized, and 2010, when it will take effect. Additionally, FERC approved more RMR agreements than anticipated under Market Rule 1. This proliferation of RMR agreements was prompted by ISO-NE's determination in 2003 that all electric generation in Connecticut is necessary for reliability—meaning all Connecticut generators satisfy the first half of the RMR eligibility test. Finally, FERC authorized the use of Peaking Unit Safe Harbor (PUSH) bidding. PUSH bidding allows generators in constrained areas that are operating at only 10% of their capacity to offer supply into the markets at a higher price than they otherwise could under prevailing market rules. PUSH-eligible units tend to be those that only go into operation during peak demand periods, and PUSH bidding was supposed to enable them to earn sufficient revenue from those periods to stay in the market. In January 2007, however, FERC eliminated PUSH bidding, finding that it had not worked as anticipated.

B.

These interim strategies did not meet with universal support. On September 12, 2005, Connecticut Attorney General Richard Blumenthal and other interested entities¹ filed a complaint against ISO-NE with FERC. The complaint charged that FERC's changes to the electricity market structure in Connecticut violate the requirement of the Federal Power Act that all rates for the sale of electric energy, and all rules and regulations affecting those rates, "shall be just and reasonable," 16 U.S.C. § 824e(a) (2006). The complainants argued that what they termed the "hybrid" market—under which some generators are compensated through RMR agreements, others receive market rates, and still others (at the time) operated under PUSH bidding rules—inherently produces unjust and unreasonable rates.

The complainants' theory was that high-cost generators, which generally earn lower revenues in the market because they cannot match the lower bid prices of more efficient generators, were opting out of the market and into RMR agreements that guaranteed they would recoup their costs. Then, because these units must bid their (necessary) energy supplies into the market at marginal cost, the market-clearing price was set based on the cost of service for these high-cost units. Low-cost generators, on the other hand, continued to collect market-based rates, reaping excessive rewards because of the difference between their marginal costs and the inflated market-clearing price. PUSH bidding exacerbated the problem by further inflating the market-clearing price in much the same way RMR agreements did. As a result, according to Connecticut, "electric consumers in Connecticut are forced to pay the higher of either...