January 28, 2020

January 27, 2020

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Federal Court Rules Maryland Scheme to Promote Investment in In-State Generation Unconstitutional

On September 30, a Federal District Court Judge for Maryland declared that the state’s incentive scheme to encourage the construction of new gas-fired generation capacity violates the Supremacy Clause of the Constitution.  By requiring incumbent utilities to supplement PJM’s market-clearing prices with payments to the developer of a new gas-fired generator, the Judge determined that Maryland’s incentive scheme impermissibly sets a wholesale rate.  The Judge’s ruling may complicate states’ efforts to ensure that FERC-jurisdictional electricity markets meet the goals of individual states.

In 1999, Maryland restructured its electricity industry, requiring its investor-owned utilities to divest their generation assets and purchase electricity in federally regulated, regional wholesale markets. In 2007, at the direction of the Maryland General Assembly, the state’s Public Service Commission (PSC) published a report that concluded that the state faced a critical shortage of generation capacity.   According to the PSC, Maryland was located in a highly congested portion of the regional PJM market and therefore paid higher than average prices for wholesale energy.  The PSC found that while the PJM markets are “structured ostensibly to create price incentives for [investment in] new generation and transmission,” the markets had not responded to the state’s “looming capacity shortage.”

Following several proceedings at the PSC, including the issuance of an RFP to construct new gas-fired capacity in Maryland, in April of 2012 the PSC issued an order directing the state’s three incumbent utilities to enter into contracts for differences (CfDs) with a developer that would construct 661 megawatts of new in-state generation capacity. Under the CfDs, the utilities would pay the developer the difference between set contract prices and the PJM clearing prices for energy and capacity.  When the PJM prices were lower than the contract prices, the utilities would pay the developer.  When PJM prices were higher than the contract prices, the developer would pay the utilities.

The plaintiffs – primarily existing generators – complained that the PSC’s order impermissibly regulated the price of wholesale energy sales.  Such sales, they argued, may not be regulated by states because the “scheme of federal regulation . . . [is] so pervasive as to make reasonable the inference that Congress left no room for the states to supplement it.”  The Judge agreed, concluding that the PSC is “establish[ing] the price ultimately received [by the developer] for its physical energy and capacity sales to PJM . . . under field preemption principles, the PSC is impotent to take regulatory action to establish the price for wholesale energy and capacity sales.”  In other words, the Judge concluded that the PSC set the rate and not merely that its order affected the rate by inducing the developer to bid into the PJM markets.

The Judge rejected the defendant’s argument that the CfDs merely finance construction and therefore do intrude on FERC’s ratemaking.  First, to get paid under the CfDs the developer’s bids had to clear the PJM market.  Payment required delivery of energy and not just construction of the facility.  Second, the Judge found that the developer considered a similar set of factors in determining its offer price into PJM and the contract price under the CfDs.  The Judge therefore found that the revenue from selling to PJM and revenue from the CfDs serve the same function: they enable the developer to operate the facility and dispatch electric energy in the regional wholesale market.  Because the contract price is based on ongoing operations, the Judge concluded that it is not a financing mechanism, as the defendant contended.  The Judge also differentiated the CfDs from “purely financial agreements,” such as swaps, because those agreements do not involve physical delivery of energy while the CfDs require physical delivery. 

The Judge’s ruling equates market-clearing prices in an interstate wholesale market with a subsequent adder paid or received by in-state utilities pursuant to state regulation.  According to the Judge, a state incentive expressed in real dollars and explicitly added to the price cleared in an interstate market impermissibly invades the field of federal ratemaking.  The Judge’s ruling should not have any effect on a state incentive that implicitly affects an interstate market price.

A Renewable Portfolio Standard (RPS) is a state incentive scheme that does not explicitly add a dollar amount to wholesale prices.  Instead, an RPS typically requires each in-state utility to hold renewable energy credits (REC), which represent energy generated by eligible renewable generators.  State regulators often set a ceiling price for RECs by specifying a per-REC fine that a utility must pay if it fails to hold sufficient RECs.  Following that model, Maryland could require its incumbent utilities to hold “new capacity credits” and set a ceiling price for those credits and eligibility guidelines for sellers of new capacity credits.  Although an in-state requirement for new capacity may raise dormant Commerce Clause concerns, a broader requirement that focuses on reducing congestion or lowering in-state wholesale prices could achieve the same goal without offending federal supremacy.  This “new capacity credits” incentive scheme may not pay the developer precisely the same amount as the CfDs, but it would not invade Federal ratemaking under this Judge’s ruling.

A similar case is pending in Federal district court in New Jersey.  An incentive scheme in that state, approved by the state legislature and administered by the Board of Public Utilities, induced the construction of new capacity by requiring developers to bid into PJM’s capacity auctions as price takers and then supplementing the payments from PJM with state money.  If the New Jersey court follows the Maryland Judge’s logic, that adder by the state will be deemed an impermissible intrusion into Federal ratemaking, and New Jersey may then have to consider an incentive scheme that does not add a specific dollar amount to a price set in a PJM auction.  

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