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Can We Return to Cooperative Federalism?

Randolph Elliott, Regulatory Counsel, NRECA

The National Rural Electric Cooperative Association has petitioned for review of the FERC order on wholesale market participation by electric storage resources. FERC's final rule on wholesale market rules for aggregating distributed energy resources is pending.

In its May order denying rehearing, the Federal Energy Regulatory Commission declared that "states cannot directly prohibit electric storage resources from participating in the wholesale market." Thus, in regions where the six FERC-regulated regional transmission organizations (RTOs) and independent system operators (ISOs) operate wholesale electricity markets, storage resources now have a federal right to participate directly in these markets and states cannot stand in their way. It does not matter whether the storage is located on the FERC-regulated transmission grid, on a state-regulated distribution facility, or even behind a retail customer's meter. "The owner of a resource has a choice between participating in the retail market or wholesale market," FERC stated, and "states may not take away that choice by broadly prohibiting all retail customers from participating in RTO/ISO markets."

What began in 2016 as a rulemaking to modernize RTO and ISO wholesale market rules by removing barriers to participation by electric storage resources has broadened into a regulation preempting states from harnessing distributed and behind-the-meter storage for the benefit of retail customers. FERC's target is not just outdated RTO and ISO tariffs, but also state and local policy governing how electric storage resources may be used on local distribution systems and by retail consumers. 

FERC Commissioner Bernard McNamee, who joined FERC after the storage order was issued in May 2018, vigorously dissented from the order, writing that FERC lacks this authority under the Federal Power Act and is infringing on state authority to regulate retail service and local distribution facilities.

FERC's storage orders are subject to judicial review. A federal appeals court and possibly the Supreme Court will determine whether FERC may preempt state

retail regulation and whether the agency has justified that sweeping action.

In assessing the implications of FERC's action, it is useful to look at how FERC previously approached this issue in the context of "demand response" and to look ahead at what FERC has proposed for distributed energy resources.

Demand Response: cooperative federalism

In 2008, FERC required RTOs and ISOs to accept wholesale-market bids from aggregations of retail customers participating as wholesale demand response resources, "unless the law or regulations of the relevant electric retail regulatory authority do not permit a retail customer to participate." Specifically, the commission's "intent was not to interfere with the operation of successful demand response programs, place an undue burden on state and local retail regulatory entities, or raise new concerns regarding federal and state jurisdiction ...." 

Accordingly, FERC directed the RTOs and ISOs to defer to the decisions of the relevant electric retail regulatory authority, such as a city council for a municipal utility, the governing board of an electric cooperative, or a state public utility commission.  To further minimize the regulatory burden on small utilities, FERC ruled that aggregation of retail customers for purpose of wholesale demand response participation would not be permitted unless the retail regulator affirmatively opted in. For large utilities, the retail regulator could opt out of wholesale market participation. 

Citing these provisions, the Supreme Court's 2016 opinion in FERC v. Electric Power Supply Association upheld FERC's statutory authority to set the compensation that RTOs and ISOs must pay to these wholesale demand response resources. First, the court held that the Federal Power Act gives FERC authority over the rates in RTO and ISO wholesale electricity markets, and over RTO and ISO rules and practices that "directly affect" these rates, such as the compensation paid for demand response. 

Second, the court ruled that FERC was not setting rates for retail electricity sales, a role that the Power Act reserved for the states. "Wholesale demand response as implemented in the Rule is a program of cooperative federalism, in which the states retain the last word," the court wrote. 

Paradoxically, FERC relies on the first part of the court's analysis as the basis for its electric storage rules, even though FERC refused to let the states retain the last word on whether retail customers' storage resources may participate in wholesale markets. In its order denying rehearing, FERC asserts that "the court's jurisdictional conclusion ... did not rest upon the fact that states were granted an opt-out," and the court's discussion of the opt-out "was not a determinative part of its analysis."  

Time will tell whether FERC's truncated reading of the court's opinion will prevail in the courts. But it undoubtedly will prompt a re-examination of the limits to the commission's authority. 

DER aggregation: raising the stakes on federalism

FERC is considering a proposal requiring the RTOs and ISOs to change their wholesale market rules even further to enable participation by "aggregations" of all kinds and varied sizes of DERs, including generation, storage and electric vehicles. The basic idea is that multiple, small resources can be amassed and participate in wholesale markets as if they were a single, larger resource. FERC proposes that the aggregator could be the local distribution utility or a third party. 

The legal and factual analysis used to support FERC's storage rule cannot support the DER aggregation proposal. There are multiple reasons why FERC should follow its demand response precedent and allow state and local regulatory authorities to determine whether to allow DER aggregations-particularly non-utility, third-party DER aggregations-to participate directly in wholesale markets. 

First, FERC is now looking at a much broader class of distributed resources. FERC proposed to define DER to mean "a source or sink of power that is located on the distribution system, any subsystem thereof, or behind the customer meter," including storage, distributed generation, and electric vehicles and their charging equipment. This definition includes every potential storage and generation resource at a home and business, and every EV and related equipment in the RTO and ISO regions. This includes smaller storage resources that are ineligible to participate in RTO or ISO markets as individual resources under FERC's storage rule. Thus, the reach of FERC's DER proposal is much broader than its storage rule.

Second, FERC is proposing a much more substantial interference with state and local utility regulation. Unlike the storage rule, FERC is proposing to authorize non-utility, third-party aggregators of retail customers' DER. If FERC rules that states cannot prohibit non-utility DER aggregation, then FERC would be substantially interfering with-essentially rewriting-the rules for state retail electricity regulation.  Moreover, non-utility DER aggregation would impose new burdens on state and local regulators charged with overseeing distribution utility operations, reliability, safety, costs and rates. Non-utility DER aggregation would impose additional direct costs on distribution utilities for metering, communication, and possible distribution line upgrades as well as administrative costs. Distribution utilities would also have to pay indirect costs such as the loss of efficiency in distribution system planning and operation. 

Third, FERC would be interfering with many state and local DER policies. In its storage order, FERC claimed that states "do not have a longstanding history of managing and regulating programs for electric storage resources within their boundaries."  In contrast with states' demand response policies in 2008, "fewer states have policies that involve electric storage resources, and those policies that exist were implemented fairly recently." This logic does not hold for the broader class of DERs. Most states have a set of established DER policies, including net metering, value-of-solar tariffs, community solar programs, EV charging, and retail and distribution charges to fairly allocate costs between DER and non-DER customers. Moreover, states are continually developing new policies to deal with DER.  

In February, the National Association of Regulatory Utility Commissioners and the National Association of State Energy Offices formed a Task Force for Comprehensive Electricity Planning in which 16 states are working "to develop new approaches to better align distribution system and resource planning process." FERC's DER aggregation proposal would undermine this planning effort.

If FERC were to hold that retail customers must have the choice between retail and wholesale markets, and states cannot deprive them of that choice, then FERC could not insist that it is accommodating, much less assisting, state DER policies. Instead, FERC effectively would be finding that an advanced energy economy spearheaded by non-utility DER aggregators, with free rights of entry and exit into federally regulated RTOs and ISOs and into retail markets and local distribution systems, will do a better job than state and local regulators in determining how best to deploy DER for the benefit of the public.  (For electric cooperatives, the federal intrusion, if anything, would be even more direct: FERC would give the retail member-consumers of a distribution cooperative a federal right to exit the cooperative's DER programs in favor of the FERC-regulated wholesale market.)

Decisions on DER deployment and use should be made first and foremost at the local level, because that is where DERs derive their primary value.  As a group of MIT researchers recently explained in "Why Distributed?" by Scott Burger et al in IEEE Power and Energy Magazine, (March-April 2019). DERs provide unique benefits because they can be located on distribution systems near the point of consumption. This is not to deny that DERs may have value in wholesale markets; but it suggests that most of their value lies elsewhere-in providing services beyond FERC's jurisdiction. 

FERC may well conclude that RTO and ISO wholesale markets should be modernized to facilitate participation by DER aggregations. But it should allow state and local regulatory authorities to determine whether their retail customers should be allowed to take advantage of the opportunities presented by these modernized wholesale markets. It should not force its vision of the future of DERs on the states.