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Article: December 2017: Energy Litigation Update

Business Litigation Reports

Recent Federal Decisions on the Constitutionality of State Power-Plant Subsidies. Given an absence of a federal scheme to subsidize power plants that may provide certain benefits (like low carbon emissions) that are not fully valued in the existing interstate wholesale markets, several states have enacted such schemes. Federal courts—so far, the Supreme Court of the United States, and two subsequent federal district courts—have evaluated challenges to such state programs. In Hughes v. Talen Energy Marketing, LLC, 136 S. Ct. 1288 (2016), the Supreme Court held that the Federal Power Act, 16 U.S.C. § 791a et seq., preempted a Maryland regulation subsidizing new in-state electricity generation that effectively set the wholesale rate that a new generator would be paid. Although the Court held that the Maryland program impermissibly “disregard[ed] an interstate wholesale rate required by FERC [the Federal Energy Regulatory Commission],” it stressed that its “holding [was] limited.” Id. at 1299. Two subsequent district court decisions, Coalition for Competitive Electricity, Dynegy Inc. v. Zibelman, -- F. Supp. 3d --, 2017 WL 3172866 (S.D.N.Y. July 25, 2017), and Village of Old Mill Creek v. Star, 2017 WL 3008289 (N.D. Ill. July 14, 2017), dismissed challenges to state programs that subsidize renewable energy production through so-called zero emission credits (“ZECs”). The decisions are summarized below.

In Hughes, Maryland electricity regulators sought to encourage the development of new in-state generation because the State’s location in a particularly congested part of the regional grid makes importing enough electricity difficult. 136 S. Ct. at 1294. Concerned that the generally applicable wholesale rates were too low to incentivize adequate new development, regulators required utilities that deliver electricity to retail consumers in Maryland to enter into a “contract for differences” with a new power plant. Id. at 1294-95. The order required the plant to sell its power to PJM, the regional transmission organization that oversees the Pennsylvania-New Jersey-Maryland region’s wholesale market, at a “clearing price” PJM set through an auction, and required the Maryland utilities to buy their power from PJM at the same price. Id. at 1293, 1297. The contract for differences, however, effectively replaced PJM’s auction-based clearing price—so long as the plant sold its power through the auction, if the clearing price was lower than the rate set in the contract, the utilities paid the difference to the plant; and if the clearing price was higher, the plant paid the difference to the utilities. Id. at 1295 & n.5.

The Supreme Court, assuming without deciding that plaintiffs could seek declaratory relief under the Supremacy Clause, Id. at 1296 n.6, held that the Maryland program “invade[d] FERC’s regulatory turf,” Id. at 1297. By requiring the plant to participate in the auction but guaranteeing CPV a different rate than PJM’s auction-based clearing price, Maryland had “adjust[ed] an interstate wholesale rate,” a power exclusive to the federal government. Id. The Court rejected Maryland’s argument that the regulation served the permitted goal of encouraging new power plant construction, holding that “States may not seek to achieve ends, however legitimate, through regulatory means that intrude on FERC’s authority over interstate wholesale rates.” Id. at 1298. The Court also rejected analogizing the scheme to a direct bilateral contract for the sale of power between the plant and the utilities, pointing out that “[t]he contract for differences does not transfer ownership” of energy capacity, but instead “operates within the auction.” Id. at 1299.

Although the Hughes Court struck down Maryland’s regulation, it limited the effect of its ruling. The Court’s opinion expressly did not “address the permissibility of various other measures States might employ to encourage development of new or clean generation,” so long as such measures were “untethered to a generator’s wholesale market participation” and did not “condition payment of funds on capacity clearing the auction.” Id. (internal quotation omitted).

This summer, the District Courts for the Northern District of Illinois and Southern District of New York considered whether two similar state subsidy programs were among those allowed under Hughes. The Illinois program challenged in Village of Old Mill Creek creates zero emission credits, or ZECs, awards them to qualifying facilities (in effect, two Illinois nuclear power plants) for each megawatt hour of energy produced, and requires Illinois utilities to purchase all of the ZECs conferred each year. 2017 WL 300828 at *1, *3-4. The price of ZECs “decreases if wholesale market prices increase, up to a limit, and it increases if wholesale market prices decrease.” Id. at *5. The New York program at issue in Coalition for Competitive Electricity similarly requires utilities to purchase ZECs from nuclear generators, although only to those plants that are deemed to be at risk of closure absent the ZECs. 2017 WL 317866 at *3. As in Illinois, the price of New York ZECs varies with “a forecast of wholesale electricity prices.” Id. at *4.

In Old Mill Creek, the district court rejected the merits of a challenge to Illinois’s subsidies (after ruling that plaintiffs largely lacked standing and could not seek to enjoin a state regulation on the basis of a preemption claim). See 2017 WL 3008289 at *5-10. Although the ZECs substantially affect the quantity and terms of wholesale electricity sales by subsidizing nuclear energy, the court held that they do so indirectly and thus, according to the court, without running afoul of Hughes’ holding. Id. at *12. The court explained that, even if the plants receiving ZECs have to sell their power in the auction as a practical matter, Illinois’s ZEC program itself neither required them to do so nor conditioned their receipt of ZECs on joining the auction. Id. at *13. Accordingly, the court ruled that the challenged scheme does “not impos[e] a condition directly on wholesale transactions,” passing muster under Hughes, which preempts programs in which “a tether to wholesale rates is indistinguishable from a direct effect on wholesale rates.” Id.

The Coalition district court, after similarly ruling that it lacked equity jurisdiction to hear preemption claims, 2017 WL 3172866 at *5-7, adopted similar reasoning in upholding New York’s ZEC program on the merits. Because “nuclear generators receive ZECs for their zero-emissions production of energy, and not for the sale of that energy into the wholesale market,” the court held the “direct and concrete tie (or tether)” between the challenged scheme and the generator’s participation in the wholesale interstate market that was fatal in Hughes is absent. Id. at *10-11. Like the Illinois challengers, the New York plaintiffs were unable to explain why the ZEC program’s substantial but indirect market distortions should be preempted while other state incentives, like tax exemptions, land grants, or direct subsidies are not. Id. at *12. As a result, the Coalition court ruled that by separating the ZEC subsidy from its recipients’ participation in the auction, “New York has successfully threaded the needle left by Hughes that allows States to adopt innovative programs to encourage the production of clean energy.” Id. at *14.

The plaintiffs in Old Mill Creek and Coalition have appealed the district courts’ decisions to the Seventh and Second Circuits, respectively. See Village of Old Mill Creek v. Star, 7th Cir. Case No. 17-2433 (Consolidated with 17-2445); Coalition for Competitive Elec. v. Zibelman, 2d Cir. Case No. 17-2654. Briefing in both appeals is ongoing, and the anticipated decisions by the Courts of Appeals may shed further light on the line between permissible and impermissible state programs to subsidize particular power plants.