# Appendix — Fed. Energy Regulatory Comm'n v. Elec. Power Supply Ass'n, 135 S. Ct. 2049 (2015) (No. 14-840) > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0317%3A03 ## Record - **Collection:** Supreme Court brief - **Document type:** Appendix - **Published:** January 1, 2015 ## Text Supreme Court, US. 14-8 4 {) JAN 15-208 OFFICE OF THE CLERK No. In the Supreme Court of the United States FEDERAL ENERGY REGULATORY COMMISSION, PETITIONER Vv. ELECTRIC POWER SUPPLY ASSOCIATION, ET AL. ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT APPENDIX TO THE PETITION FOR A WRIT OF CERTIORARI DONALD B. VERRILLI, JR. Solicitor General Counsel of Record DAVID L. MORENOFF EDWIN S. KNEEDLER General Counsel Deputy Solicitor General ROBERT H. SOLOMON JOHN F. BASH Solicitor Assistant to the Solicitor HOLLY E. CAFER General A P a ar as a) a Federal Energy Regulatory ashington, D.C. 20530-0001 Commission SupremeCtBrie{s@usdoj.gov Washington, D.C. 20426 (202) 514-2217 TABLE OF CONTENTS Appendix A — Court of appeals opinion | ee la Appendix B — Order of the Federal Energy Regulatory Commission (Mar. 15, 2011)... ‘ieeneieenaetnenand 49a Appendix C — Order of the Federal Energy. Regulatory Commission on rehearing and clarification ee 173a Appendix D — Order of the Federal Energy Regulatory Commission denying rehearing (Feb. 29, 2012)..............--.. 276a Appendix E — Court of appeals order denying rehearing (Sept. 17, 2014).................. 282a Appendix F — Court of appeals order denying rehearing (Sept. 17, 2014).................. 284a (I) APPENDIX A UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT Nos. 11-1486, 11-1489, 12-1088, 12-1091, 12-1093 ELECTRIC POWER SUPPLY ASSOCIATION, PETITIONER Vv. FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT MADISON GAS AND ELECTRIC COMPANY, ET AL., INTERVENORS Argued: Sept. 23, 2013 Decided: May 23, 2014 Before: BROWN, Circuit Judge, and EDWARDS and SILBERMAN, Senior Circuit Judges. Opinion for the Court by Circuit Judge BROWN. Dissenting opinion filed by Senior Circuit Judge Ep- WARDS. BROWN, Circuit Judge: Electric Power Supply Association and four other energy industry associations (“Petitioners”) petition this court for review of a final rule by the Federal Energy Regulatory Commission (“FERC” or “the Commission”) governing what FERC calls “demand (la) 2a response resources in the wholesale energy market.” The rule seeks to incentivize retail customers to re- duce electricity consumption when economically effi- cient. Petitioners complain FERC’s new rule goes too far, encroaching on the states’ exclusive jurisdic- tion to regulate the retail market. We agree and vacate the rule in its entirety. I Under the Federal Power Act (“FPA” or “the Act”) the Commission is generally charged with regulating the transmission and sale of electric power in inter- state commerce. The FPA “split([s] [jurisdiction over the sale and delivery of electricity] between the federal government and the states on the basis of the type of service being provided and the nature of the energy sale.” Niagara Mohawk Power Corp. v. FERC, 452 F.3d 822, 824 (D.C. Cir. 2006). Section 201 of the Act empowers FERC to regulate “the sale of electric en- ergy at wholesale in interstate commerce.” 16 U.S.C. § 824(b)(1) (emphasis added). Thus, “FERC’s juris- diction over the sale of electricity has been specifically confined to the wholesale market.” New York v. FERC, 535 U.S. 1, 19, 122 S. Ct. 1012, 152 L. Ed. 2d 47 (2002). The Commission concedes that “demand response is a complex matter that lies at the confluence of state and federal jurisdiction.” See Demand Response Compensation in Organized Wholesale Energy Mar- kets, 134 FERC 9% 61,187, 2011 WL 890975, at *30 (Mar. 15, 2011) [hereinafter Order 745]. For more than a decade, FERC has permitted demand-side re- sources to participate in organized wholesale markets, 3a allowing Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs) to use demand-side resources to meet their systems’ needs for wholesale energy, capacity, and ancillary services. As this court has noted, Congress in 2005 declared “the policy of the United States that time-based pric- ing and other forms of demand response shall be encouraged and unnecessary barri- ers to demand response participation in energy, ca- pacity and ancillary service markets shall be eliminat- ed.” Ind. Util. Reg. Comm’n v. FERC, 668 F.3d 735, 736 (D.C. Cir. 2012) (citing 16 U.S.C. § 2642). The Commission has issued dozens of orders on demand- side resource participation, and ISOs and RTOs main- taining economic demand response programs could file tariffs with the Commission and accept bids for ancil- lary services and from aggregators of retail customers directly into the wholesale energy markets. See Whole- sale Competition in Regions with Organized Electric Markets, 73 Fed. Reg. 1 64,100, 64,101 (Oct. 28, 2008) (to be codified at 18 C.F.R. pt. 35) [Order 719]. Order 745 establishes uniform compensation levels for suppliers of demand response resources who par- ticipate in the “day-ahead and real-time energy mar- kets.” Order 745, 2011 WL 890975, at *1. The order directs ISOs and RTOs to pay those suppliers, includ- ing aggregators of retail customers, the full locational marginal price (LMP), or the marginal value of re- sources in each market typically used to compensate generators. The Commission conditioned the pay- ment of full LMP on the ability of a demand response resource to replace a generation resource and required demand response to be cost effective. Cost effec- 4a tiveness would be determined by a newly devised “net benefits test,” which FERC directed ISOs and RTOs to implement. FERC acknowledged that the cost of payments to retail customers to encourage reduced energy consumption would have to be subsidized by load-serving entities participating in the wholesale market. Jd. 1 99, 2011 WL 890975, at *27; see also id. 7102. Finally, the rule allocated the costs of demand response payments proportionally to all entities that purchase from the relevant energy markets during times when demand response resources enter the mar- ket. Commissioner Moeller dissented, arguing the Commission’s retail customer compensation scheme conflicted both with FERC’s efforts to promote com- petitive markets and with its statutory mandate to ensure supplies of electric energy at just, reasonable, and not unduly preferential or discriminatory rates. See id., 2011 WL 890975, at *34-39. Requests for rehearing and clarification were filed by ISOs, RTOs, state regulatory commissions, trade associations, publicly owned utilities, transmission owners, suppliers, and others. The Commission, in another 2-1 decision, confirmed its approach and Peti- tioners filed timely petitions for review. II The Administrative Procedure Act (APA) directs us to “hold unlawful and set aside agency action in excess of statutory jurisdiction, authority, or limita- tions.” 5 U.S.C. § 706(2)(C). “FERC is a creature of statute” and thus “has no power to act unless and until Congress confers power upon it.” Cal. Indep. Sys. Operator Corp. (CAISO) v. FERC, 372 F.3d 395, 398 5a (D.C. Cir. 2004) (citing La. Pub. Serv. Comm'n v. FCC, 476 U.S. 355, 374, 106 S. Ct. 1890, 90 L. Ed. 2d 369 (1986)). If FERC lacks authority under the Federal Power Act to promulgate a rule, its action is “plainly contrary to law and cannot stand.” See Michigan v. EPA, 268 F.3d 1075, 1081 (D.C. Cir. 2001). We address FERC’s assertion of its statutory au- thority under the familiar Chevron doctrine. See City of Arlington, Tex. v. FCC, —U.S.—, 133 S. Ct. 1863, 1870-71, —L. Ed. 2d— (2013). The question is “whether the statutory text forecloses the agency’s assertion of authority.” Jd. at 1871. If, however, the statute is silent or ambiguous on the specific issue, we must defer to the agency’s reasonable construction of the statute. /d. at 1868. FERC claims when retail consumers voluntarily participate in the wholesale market, they fall within the Commission’s exclusive jurisdiction to make rules for that market. Petitioners protest that retail sales of electricity are within the traditional and “exclusive jurisdiction of the States” and regulating consumption by retail electricity customers is a regulation of retail, not wholesale, activity. Reply Br. 11-12. The prob- lem, Petitioners say, is the Commission has no author- ity to draw retail customers into the wholesale markets by paying them not to make retail purchases. Initially, we note the regulations have a single defi- nition of “demand response”—a “reduction in the con- sumption of electric energy by customers from their expected consumption in response to an increase in the price of electric energy or to incentive payments designed to induce lower consumption of electric 6a energy.” 18 C.F.R. § 35.28(b)(4) (emphasis added); see also Order 745, 2011 WL 890975, at *1n.2. High retail rates will reduce demand. Conversely, if con- sumers are paid to reduce demand, prices fall. FERC acknowledges the first case, “price-responsive demand” is a “retail-level” demand response. See Order 745, 2011 WL 890975, at *1-3 & n.2 (citing 18 C.F.R. § 35.28(b)(4)). In contrast, FERC dubs a reduction in the consumption of energy in response to incentive payments a “wholesale demand response.” See FERC Br. 5, 34; see also Order 745, 2011 WL 890975, at *1-3 & n.2 (citing 18 C.F.R. § 35.28(b)(4)). The Commis- sion draws this distinction between “wholesale demand response” and “retail demand response” in an attempt to narrow the logical reach of its rule. See, e.g., FERC Br. 5 (“{T]he Commission has made plain that its focus is narrow and that it addresses only wholesale demand response.”); id. (“States remain free to au- thorize and oversee retail demand response pro- grams.”); id. at 14-15. Yet FERC acknowledges “wholesale demand response” is a fiction of its own construction. See Oral Arg. Tape, No. 11-1486, at 27:31 (Sept. 23, 2013) (conceding “selling” demand response resources in the wholesale market “is a bit of a fiction”). Demand response resources do not actu- ally sell into the market. Demand response does not involve a sale, and the resources “participate” only by declining to act. As noted, and as the Commission concedes, demand response is not a wholesele sale of electricity; in fact, it is nota sale atall. See Order 745, 2011 WL 890975, at *18 (“[T]he Commission does not view demand re- sponse as a resale of energy back into the energy mar- 7a ket.”). Thus, FERC astutely does not rely exclusive- ly on its wholesale jurisdiction under § 201(b)(1) for authority. See Niagara Mohawk Power Corp., 452 F.3d at 828 & n.7. Instead, FERC argues §§ 205 and 206 grant the agency authority over demand response resources in the wholesale market. These provisions task FERC with ensuring “all rules and regulations affecting rates” in connection with the wholesale sale of electric energy are “just and reasonable.” 16 U.S.C. § 824d(a) (emphasis added); see also id. § 824e(a). Thus, the Commission argues it has jurisdiction over demand response because it “directly affects wholesale rates.” FERC Br. 32-34; see also Order 745, 2011 WL 890975, at *30. We agree with the Commission that demand re- sponse compensation affects the wholesale market. Because of the direct link between wholesale and retail markets, compare FERC Br. 32, with Pet’rs Br. 11-14 (describing the “direct” relationship between whole- sale and retail rates), and Reply Br. 12 (“(T]here is undeniably a link between wholesale rates and retail sales”), a change in one market will inevitably beget a change in the other. Reducing retail consumption— through demand response payments—will lower the wholesale price. See Oral Arg. Tape, at 33:13. De- mand response will also increase system reliability. FERC Br. 33. Because incentive-driven demand re- sponse affects the wholesale market in these ways, the Commission argues §§ 205 and 206 are clear grants of agency power to promulgate Order 745. 8a The Commission’s rationale, however, has no limit- ing principle. Without boundaries, §§ 205 and 206 could ostensibly authorize FERC to regulate any num- ber of areas, including the steel, fuel, and labor mar- kets. FFERC proposes the “affecting” jurisdiction can be appropriately limited to “direct participants” in jur- isdictional wholesale energy markets. See FERC Br. 37. But, as this case demonstrates, the directness of participation may be a function of the richness of the incentives FERC commands. The commission’s au- thority must be cabined by something sturdier than creative characterizations. See Altamont Gas Trans- mission Co. v. FERC, 92 F.3d 1239, 1248 (D.C. Cir. 1996) (noting FERC cannot “do indirectly what it could not do directly”). The “direct participant” theory also assumes FERC can “lure” non-jurisdictional resources into the wholesale market in the first place to create jurisdiction, see Oral Arg. Tape, at 29:52, which is the heart of the Petitioners’ challenge. The limits of §§ 205 and 206 are best determined in the context of the overall statutory scheme. See FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 132-33, 120 S. Ct. 1291, 146 L. Ed. 2d 121 (2000). Congressional intent is clearly articulated in § 201’s text: FERC’s reach “extend{s] only to those matters which are not subject to regulation by the States.” 16 U.S.C. § 824(a). States retain exclusive authority to regulate the retail market. See Niagara Mohawk Power Corp., 452 F.3d at 824. Absent a “clear and specific grant of jurisdiction” elsewhere, see New York, 535 U.S. at 22, 122 S. Ct. 1012, the agency cannot reg- ulate areas left to the states. The broad “affecting” language of §§ 205 and 206 does not erase the specific 9a limits of § 201.’ See generally RadLAX Gateway Ho- tel, LLC v. Amalgamated Bank, —U.S.—, 182 S. Ct. 2065, 2071, 182 L. Ed. 2d 967 (2012); sections 205 and 206 do not constitute a “clear and specific grant of jurisdiction.” Indeed, the Commission agrees its jur- isdiction to regulate practices “affecting” rates does not “trump|| the express limitation on its authority to regulate non-wholesale sales.” FERC Br. 34-35. Otherwise, FERC could engage in direct regulation of the retail market whenever the retail market affects the wholesale market, which would render the retail market prohibition useless. Cf Morpho Detection, Inc. v. TSA, 717 F.3d 975, 981 (D.C. Cir. 2013) (declin- ing to “adopt a reading that would render the general rule a nullity”). ' The Dissent focuses extensively on § 201(b)(1), positing that the “jurisdictional issue turns on a rather straightforward question of statutory interpretation: whether a promise to forgo consumption of electricity that would have been purchased in the retail electricity market unambiguously constitutes a “sale of electric energy” under section 201(b)(1).” Dissenting Op. at 227. The jurisdictional issue is not quite so narrow. In fact, even the Commission does not char- acterize the challenge this way and never offers an interpretation of § 201(b)(1), arguing instead that demand response resources are direct participants in wholesale markets. See FERC Br. 3440. Though our review is deferential, even if we reached Chevron step two, we could not defer to an interpretation the agency has not offered. In any event, we do not base our conclusion on the “any other sales” language of § 201(b)1). Rather, we look to the statutory scheme as a whole and find that demand response, while not neces- sarily a retail sale, is indeed part of the retail market, which, as the statute and case law confirm, is exclusively within the state’s juris- diction. 10a In addition, if FERC’s arguments are followed to their logical conclusions, price-responsive demand response—retail demand response in “FERC speak”— would also affect jurisdictional rates in the same way as the type of demand response at issue in FERC’s rule here, and FERC’s authority regarding demand re- sponse would be almost limitless. Although the cur- rent rule leaves price-responsive demand untouched, nothing would stop FERC from expanding this regula- tion and encroaching further on state authority in the future. Thus, FERC can regulate practices affecting the wholesale market under §§ 205 and 206, provided the Commission is not directly regulating a matter subject to state control, such as the retail market. Cf Conn. Dep't of Pub. Util. Control v. FERC, 569 F.3d 477, 479 (D.C. Cir. 2009) (finding FERC could regulate the in- stalled capacity market under its affecting jurisdiction because FERC did not engage in direct regulation of an area subject to exclusive state control).’ * Connecticut Department of Public Utility Control v. FERC, 569 F 3d 477 (D.C. Cir. 2009), does not sanction FERC’s rule. In Con- necticut, FERC raised the capacity requirement and incidentally in- centivized construction of more generation facilities, which are sub- ject to state control; here, the Commission’s rule reaches directly in- to the retail market to draw retail consumers into its scheme. Here, FERC’s incentive is not merely a logical by-product of the rule; it is the rule. According to the Dissent, “FERC can indirectly incentiv- ize action that it cannot directly require so long as it is otherwise acting within its jurisdiction.” Dissenting Op. at 234. We agree Connecticut cannot control where FERC has directly incentivized action it cannot directly require. lla The fact that the Commission is only “luring” the resource to enter the market instead of requiring en- try does not undercut the force of Petitioners’ chal- lenge. The lure is change of the retail rate. Demand response—simply put—is part of the retail market. It involves retail customers, their decision whether to purchase at retail, and the levels of retail electricity consumption. If FERC had directed ISOs to give a credit to any consumer who reduced its expected use of retail electricity, FERC would be directly regulating the retail rate. At oral argument, the Commission conceded crediting would be an impermissible intru- sion into the retail market. See Oral Arg. Tape, at 27:15. Ordering an ISO to compensate a consumer for reducing its demand is the same in substance and effect as issuing a credit.’ Thus, while it is true de- mand response can occur in two ways—through a re- sponse to either price change or incentive oayments— nothing about the latter makes it “wholesale.” A buyer is a buyer, but a reduction in consu:nption can- not be a “wholesale sale.” FERC’s metaphysical dis- tinction between price-responsive demand arid incentive- based demand cannot solve its jurisdictional quandary. Nor does FERC’s reliance on a statement of con- gressional policy from the Energy Policy Act of 2005 save its rule. FERC insists its actions “ar2 consistent with Congressional policy requiring federal level facil- itation of demand response, because this ‘inal rule is * The agency’s concession contradicts the Dissert’s contention that FERC can regulate demand response here »ecause “non- consumption [does not] constitute an ‘other sale,” Dissenting Op. at 233. 12a designed to remove barriers to demand response par- ticipation in the organized wholesale energy markets.” Order 745, 2011 WL 890975, at *30. FERC’s reliance on this language is perplexing; if anything, the policy statement supports the opposite conclusion, that Con- gress intended demand response resources to be reg- ulated by states, as part of the retail market. The Energy Policy Act of 2005 confirms the nation- al policy of encouraging and facilitating “the deploy- ment of [time-based pricing and other demand re- sponse] technology and devices that enable electricity customers to participate in such pricing and demand response systems and [eliminating] unnec- essary barriers to demand response participation in energy, capacity and ancillary service markets.” Pub. L. No. 109-58, § 1252(f), 119 Stat. 594, 966 (2005). As an initial matter, even if § 1252(f) supports FERC’s authority, the Commission cannot rely on the section for an independent source of power. Policy state- ments like § 1252(f) “are just that—statements of pol- icy. They are not delegations of regulatory authori- ty.” See Comcast Corp. v. FCC, 600 F.3d 642, 654 (D.C. Cir. 2010); cf New York, 535 U.S. at 22, 122 S. Ct. 1012 (finding that a “mere policy declaration cannot nullify a clear and specific grant of jurisdiction”). Thus, the relevant sections of the Energy Policy Act of 2005 can only be used to “help delineate the contours of statutory authority.” Com- cast Corp., 600 F.3d at 654. And here, those contours do not encompass federal regulation of demand re- sponse. 13a FERC latches onto the language in § 1252(f) re- quiring elimination of “unnecessary barriers to de- mand response participation in energy ser- vice markets” to support its claim that Order 745 ad- vances congressional! policy. See FERC Br. 40. In Order 745, however, FERC went far beyond removing barriers to demand response resources. Instead of simply “removing barriers,” the rule draws demand response resources into the market and then dictates the compensation providers of such resources must receive. We think the title of the section is noteworthy: “Federal Encouragement of Demand Response De- vices.” (emphasis added). Pub. L. No. 109-58, § 1252(f), 119 Stat. 594, 966. “To encourage” is not “to regulate.” Although the title is “not dispositive of the provision’s meaning,” “it is not too much to expect that it has something to do with the subject matter” of the section. See CAISO, 372 F.3d at 399. And here, “review of the statutory text reveals that [the title} has everything to do with the subject matter.” See id. The section dictates demand response is to be “encouraged” and “facilitated,” not directly regulated as Order 745 proposes. This is obvious when § 1252(f) is read in tandem with § 1252(e), “Demand Response and Regional Co- ordination,” which declares it the “policy of the United States to encourage States to coordinate, on a regional basis, State energy policies to provide reliable and affordable demand response services to the public.” Pub. L. No. 109-58, § 1252(e), 119 Stat. 594, 966. This language underscores that states, not the Commission, l4a regulate demand response. Indeed, § 1252(e) goes on to note FERC should “provide technical assistance to States and regional organizations in developing plans and programs to use demand response to respond to peak demand or emergency needs.” Jd. The Commission is also to prepare an annual report, assessing demand response resources. Id. Thus, the Energy Policy Act clarifies FERC’s authority over demand response resources is limited: its role is to assist and advise state and regional pro- grams. Even more importantly, the Energy Policy Act statements show Congress understood the importance of demand response resources to the wholesale market —an importance Petitioners do not dispute. Yet, de- spite this significant impact on the wholesale market, Congress left regulation of this aspect of retail demand up to the states, rather than to the federal govern- ment. Because the Federal Power Act unambiguously re- stricts FERC from regulating the retail market, we need not reach Chevron step two. But even if we assumed the statute was ambiguous—as Judge Ed- wards argues, we would find FERC’s construction of it to be unreasonable for the same reasons we find the statute unambiguous. Because FERC’s rule entails direct regulation of the retail market—a matter exclu- sively within state control—it exceeds the Commis- sion’s authority. 15a IV Alternatively, even if we assume FERC had statu- tory authority to execute the Rule in the first place, Order 745 would still fail because it was arbitrary and capricious. Under the APA, we must set aside orders that are “arbitrary, capricious, an abuse of discretion, or other- wise not in accordance with law.” 5 U.S.C. § 706(2)(A). In particular, “it most emphatically remains the duty of this court to ensure that an agency engage the ar- guments raised before it,” NorAm Gas Transmission Co. v. FERC, 148 F.3d 1158, 1165 (D.C. Cir. 1998), including the arguments of the agency’s dissenting commissioners, Am. Gas Ass’n v. FERC, 593 F.3d 14, 19 (D.C. Cir. 2010); see also Kamargo Corp. v. FERC, 852 F.2d 1392, 1398 (D.C. Cir. 1988) (“We recognize that this case presents a difficult problem for the Com- mission, but we think it has no alternative but to con- front the questions raised by the [commissioner’s] dis- sent.”). A review of the record reveals FERC failed to properly consider—and engage—Commissioner Moel- ler’s reasonable (and persuasive) arguments, reiterat- ing the concerns of Petitioners and other parties, that Order 745 will result in unjust and discriminatory rates. Moeller argued Order 745 “overcompensatjes}” demand response resources because it “requires that demand resource[s] be paid the full LMP plus be al- lowed to retain the savings associated with [the pro- vider’s}] avoided retail generation cost.” Demand Re- sponse Compensation in Organized Wholesale Energy Markets: Order on Rehearing and Clarification, 137 16a FERC {4 61,215, 2011 WL 6523756, at *38 (Dec. 15, 2011) [hereinafter Order 745-A] (Moeller, dissenting); see also Pet’rs Br. 45-50. The Commission then re- sponded that demand response resources are compa- rable to generation resources and should therefore re- ceive the same level of compensation. Order 745-A, 2011 WL 6523756, at *14-15. Yet comparable contri- butions cannot be the reason for equal compensation, when generation resources are incomparably saddled with generation costs. Nor can FERC justify its cur- rent overcompensation by pointing to past under- compensation.‘ Although we need not delve now into the dispute among experts, see, e.g., Br. of Leading Economists as Amicus Curiae in Support of Pet’rs, the potential windfall to demand response resources seems troubling, and the Commissioner’s concerns are cer- tainly valid. Indeed, “overcompensation cannot be just and reasonable,” Order 745-A, 2011 WL 6523756, at *38 (Moeller; dissenting), and the Commission has not adequately explained how their system results in just compensation. The Commission cannot simply talk around the ar- guments raised before it; reasoned decisionmaking re- quires more: a “direct response,” which FERC failed to provide here. See Am. Gas Ass’n, 593 F.3d at 20. Thus, if FERC thinks its jurisdictional struggles are its only concern with Order 745, it is mistaken. We ‘ Similarly, the hope that demand response resources will use the expected windfall for “capital improvements,” see Dissenting Op. at 237, does not respond to Petitioner’s concerns that the overcompen- sation is unfair and discriminatory. 17a would still vacate the Rule if we engaged the Petition- ers’ substantive arguments. V Ultimately, given Order 745’s direct regulation of the retail market, we vacate the rule in its entirety as ultra vires agency action. For the reasons set forth above, we vacate and re- mand the rulings under review. So ordered. EDWARDS, Senior Circuit Judge, dissenting: Under the Federal Power Act, regulatory authority over the nation’s electricity markets is bifurcated between the States and the federal government. In simplified terms, the Federal Energy Regulatory Commission (“FERC” or “Commission”) has authority over wholesale electricity sales but not retail electrici- ty sales, with the latter solely subject to State regula- tion. See 16 U.S.C. § 824(a), (b)(1). The consolidat- ed petitions before the court call on us to parse this jurisdictional line between FERC’s wholesale jurisdic- tion and the States’ retail jurisdiction—a line which this court and the Supreme Court have recognized is neither neat nor tidy. See New York v. FERC, 535 U.S. 1, 16, 122 S. Ct. 1012, 152 L. Ed. 2d 47 (2002) (“(TJhe landscape of the electric industry has changed since the enactment of the [Federal Power Act], when the electricity universe was ‘neatly divided into spheres of retail versus wholesale sales.’” (quoting Transmission Access Policy Study Grp. v. FERC, 225 F.3d 667, 691 (D.C. Cir. 2000))). 18a Petitioners challenge Order 745, a rule imposing certain compensation requirements on the administra- tors of the nation’s wholesale electricity markets. See Order 745, Demand Response Compensation in Orga- nized Wholesale Energy Markets, 134 FERC 4 61,187, 2011 WL 890975, at *1 (Mar. 15, 2011). The rule re- quires these wholesale-market administrators—called Regional Transmission Organizations (“RTOs”) and Independent System Operators (“ISOs”)—to compen- sate so-called “demand response resources” at a speci- fied price when certain conditions are met. As rele- vant here, “demand response resources” are essen- tially electricity consumers, often bundled together by a third-party aggregator, who agree to reduce their electricity consumption in exchange for incentive pay- ments. See 18 C.F.R. § 35.28(b)(4)-(5). The pun scattered throughout the record is that while genera- tors produce megawatts, consumers produce “nega- watts.” In effect, Order 745 requires that, at certain times, megawatts and negawatts receive the same amount of payment in wholesale markets, an amount called the “locational marginal price” or “LMP.” Although the challenged rule requires ISOs and RTOs to pay demand response resources a specified compensation (LMP), this requirement is applicable only when two conditions are met: (1) when the de- mand response resource is capable of balancing supply and demand in the wholesale market, and (2) when compensating the demand response resource is cost- effective under a “net benefits test” prescribed by the rule. The specific mechanics of these conditions and of the “net benefits test” are less important than what they accomplish. The critical point here is that, be- 19a cause of the specified conditions, Order 745 requires compensation of demand response resources only when their participation in a wholesale electricity mar- ket actually lowers the market-clearing price for wholesale electricity. With these basics in hand, it is easy to see why FERC stated in its rulemaking that “jurisdiction over demand response is a complex matter that lies at the confluence of state and federal jurisdiction.” Order 745, 2011 WL 890975, at *30. On one view, the de- mand response resources subject to the rule directly affect the wholesale price of electricity. That is, the final rule’s conditions operate to ensure that every negawatt of forgone consumption receiving compensa- tion reduces both the quantity of electricity produced and its wholesale price. Focusing on this direct effect —direct, it bears repeating, because under the rule’s conditions all demand response resources receiving compensation reduce the market-clearing price—it is easy to conceive of Order 745 as permissibly falling on the wholesale side of the wholesale-retail jurisdictional line. On another view, however, the electricity not consumed thanks to the rule’s compensation payments would have been consumed first in a retail market. Focusing on the market in which the consumption would have occurred in the first instance, one can conceive of Order 745 as impermissibly falling on the retail side of the jurisdictional line. The task for this court, of course, is not to divine from first principles whether a demand response re- source subject to Order 745 is best considered a matter of wholesale or retail electricity regulation. Rather, 20a our task is one of statutory interpretation within the familiar Chevron framework. See Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-44, 104 S. Ct. 2778, 81 L. Ed. 2d 694 (1984); see also Cal. Indep. Sys. Operator Corp. (CAISO) v. FERC, 372 F.3d 395, 399-400 (D.C. Cir. 2004). The Commission has interpreted the Federal Power Act to permit it to issue Order 745. And it falls to this court to determine whether the Act unambiguously “sp[{eaks] to the precise question,” 467 U.S. at 842, 104 S. Ct. 2778 (Chevron step one), and, if not, whether the Com- mission’s interpretation is a permissible construction of the statute, zd. at 843, 104 S. Ct. 2778 (Chevron step two). Though the rule and its operation are highly tech- nical, the primary jurisdictional issue raised in these consolidated petitions turns on a rather straightfor- ward question of statutory interpretation: whether a promise to forgo consumption of electricity that would have been purchased in a retail electricity market un- ambiguously constitutes a “sale of electric energy” under section 201(b)(1) of the Federal Power Act. 16 U.S.C. § 824(b)(1). If so, the Commission lacked jurisdiction to issue Order 745 because section 201(b)(1) of the Act states, in relevant part, that the “provisions of this subchapter shall apply to the sale of electric energy at wholesale in interstate commerce, but shall not apply to any other sale of elec- tric energy.” Id. (emphasis added). The statute, to my mind, is ambiguous regarding whether forgone consumption constitutes a “sale” under section 201(b)(1). Because of this ambiguity, 2la the Act is also ambiguous as to whether a rule requir- ing administrators of wholesale markets to pay a spec- ified level of compensation for such forgone consump- tion constitutes “direct regulation” of retail sales that would contravene the limitations of section 201. Conn. Dep't of Pub. Util. Control v. FERC, 569 F.3d 477, 481-82 (D.C. Cir. 2009) (holding that FERC’s approval of an Installed Capacity Requirement was not “direct regulation” of electrical generation facilities and, thus, did not violate section 201 (emphasis added)). Be- cause the Act is ambiguous regarding FERC’s author- ity to require ISOs and RTOs to pay demand response resources, we are obliged to defer under Chevron to the Commission’s permissible construction of “a stat- utory ambiguity that concerns the scope of the agen- cy’s statutory authority (that is, its jurisdiction).” City of Arlington v. FCC, —U.S.—, 133 S. Ct. 1863, 1868, 1874-75, —L. Ed. 2d— (2013). Absent an affirmative limitation under section 201, there is no doubt that demand response participation in wholesale markets and the ISOs’ and RTOs’ market rules concerning such participation constitute “prac- tice[s]} affecting” wholesale rates under sec- tion 206 of the Act. 16 U.S.C. § 824e(a); see also id. § 824d(a) (providing that “all rules and regulations affecting or pertaining to [wholesale] rates or charges shall be just and reasonable”). Petitioners’ argu- ments to the contrary ignore the direct effect that the ISOs’ and RTOs’ market rules have on wholesale elec- tricity rates squarely within FERC’s jurisdiction. The Commission has authority to “determine the just and reasonable practice” by setting a level of compensation for demand response resources that, in 22a its expert judgment, will ensure that the rates charged in wholesale electricity markets are “just and reasona- ble.” Jd. § 824e(a). It was therefore reasonable for the Commission to conclude that it could issue Order 745 under the Act’s “affecting” jurisdiction. See id. §§ 824e(a), 824d(a). In addition to challenging FERC’s jurisdiction, Pe- titioners argue that its decision to mandate compensa- tion equal to the LMP was arbitrary and capricious. Petitioners believe that the LMP overcompensates de- mand response resources since they also realize sav- ings from not having to purchase retail electricity. The Commission, Petitioners insist, should have set the compensation level at the LMP minus the retail cost of the forgone electricity. But the Commission’s decision in this regard was reasonable and adequately explained. For these reasons, explained below in greater de- tail, I respectfully dissent. I BACKGROUND A. The Problem To understand this case, one must appreciate the scope and significance of the problem FERC sought to address in Order 745. Three characteristics of the nation’s electricity market go a long way toward fram- ing the problem. First, electricity, unlike most com- modities, cannot be stored for later use. There must instead be a continual, contemporaneous matching of supply to meet current electricity demand. Second, not all power plants are created equal: some are effi- cient and cheap; others, inefficient and expensive. 23a Third, most retail consumers are charged a fixed price for electricity that does not adjust in the moment to temporary spikes in the cost of producing electricity. The first two characteristics, in tandem, cause sig- nificant fluctuations in the cost of supplying electricity at different times of day. During periods of regular electricity consumption, only the efficient and cheap power plants need be deployed. But at hours of peak usage (¢.g., a summer afternoon in Washington, D.C. when countless air conditioners toil against the humid- ity and heat), the suppliers of electricity must marsha) the least efficient and most costly power plants to match the soaring demand for electricity. It is be- cause electricity cannot be efficiently stored that these periods of peak demand must be met with new genera- tion and not stockpiled supply. In a perfect market, or even in a well-functioning market, the skyrocketing cost of producing additional electricity at hours of peak usage would be reflected in temporarily higher prices charged to consumers. In turn, this increased price would reduce the megawatts of electricity demanded, as some individuals and busi- nesses would, for example, turn off their air condi- tioners to save money. The market would thereby reach an efficient equilibrium. But here is where the third characteristic of elec- tricity markets comes in. Retail electricity prices are generally regulated to remain constant over longer periods of time. That is, consumers do not pay dif- ferent amounts during different hours of the day, not- withstanding the sharply vacillating cost of producing electricity. Electricity demand thus does not respond 24a to time-sensitive price signals. As a result, there are times when people and businesses consume electricity that costs more to produce than it is worth to them to consume. This is inefficient. Wholesale electricity markets, which are under FERC’s jurisdiction, suffer the same inefficiency. Since retail demand is not price-responsive, the aggregate amount of electricity demanded in the wholesale mar- ket by the entities that serve retail customers is also uncoupled from the time-specific price of supplying electricity. In economic terms, the demand for elec- tricity in the wholesale market is inelastic. See Order 745-A, Demand Response Compensation in Organized Wholesale Energy Markets, 137 FERC 9% 61,215, 2011 WL 6523756, at *9 (Dec. 15, 2011). The Commission recognizes the problem. As it ob- served in its order denying requests for rehearing of Order 745, [a] properly functioning market should reflect both the willingness of sellers to sell at a price and the willingness of buyers to purchase at a price. In an RTO- or [SO-run market, however, buyers are generally unable to directly express their willing- ness to pay for a product at the price offered. As discussed later, RTOs and ISOs cannot isolate indi- vidual buyers’ willingness to pay which results in extremely inelastic demand. Id.; see also Order 745, 2011 WL 890975, at *1 (“[A] market functions effectively only when both supply and demand can meaningfully participate.” (emphasis added)). 25a B. FERC’s Solution Having identified a problem in the wholesale elec- tricity market, the Commission has a statutory obliga- tion to do what it can to fix it. That is because FERC is charged under the Federal Power Act with ensuring that wholesale electricity rates are “just and reasona- ble.” 16 U.S.C. §§ 824d(a), 824e(a). It must ensure that all “rates and charges made, demanded, or re- ceived by any public utility for or in connection with the sale of electric energy subject to the jurisdiction of the Commission” are “just and reasona- ble.” Jd. § 824d(a) (emphasis added); see also id. § 824(a). And when FERC determines that a “prac- tice affecting” such a rate is unjust or un- reasonable, it must itself determine and fix “the just and reasonable practice to be thereafter observed.” Jd. § 824e(a). Consistent with its statutory duty and in view of the market distortions caused by inelastic wholesale demand, the Commission has initiated a series of re- forms to open wholesale markets to “demand response resources.” For our purposes, “demand response resources” are resources that are capable of reducing “the consumption of electric energy by customers from their expected consumption in response to incentive payments designed to induce lower consump- tion of electric energy.” 18 C.F.R. § 35.28(b)(4)-(5). Put simply, demand response resources agree not to purchase electricity in exchange for payment. The basic premise of FERC’s demand-response re- forms is that there are two ways that wholesale- market administrators (i.e., ISOs and RTOs) can bal- 26a ance wholesale supply and demand: by increasing the supply of electricity or by decreasing the demand for it. See Order 745-A, 2011 WL 6523756, at *14. An ISO or RTO reduces wholesale demand when it pays a demand response resource because that resource will forgo electricity consumption in the retail market, which, in turn, will lead to fewer megawatts of elec- tricity being demanded in the aggregate in that ISO’s or RTO’s wholesale market. At certain times (e.g., summer afternoons in Washington, D.C.), paying in- centive payments to induce consumers not to consume electricity may be cheaper than paying generators to produce more power; negawatts, in such circumstanc- es, are the cheaper alternative. And because, func- tionally, there is little difference to wholesale-market administrators between a megawatt and a negawatt (both assist equally in the administrator’s task of bringing wholesale demand and supply into equipoise), demand response resources are capable of competing directly with traditional generation resources so long as the appropriate market rules are in place. For some years now, FERC has recognized that the direct participation of demand response resources in wholesale markets improves the functioning of these markets in several respects. First, it lowers whole- sale prices because “lower demand means a lower wholesale price.” Order 719-A, Wholesale Competi- tion in Regions with Organized Electric Markets, 128 FERC 4% 61,059, 2009 WL 2115220, at *12 (July 16, 2009). Second, it mitigates the market power of sup- pliers of electricity because they have to compete with demand response resources and adjust their bidding strategy accordingly. See id. (“[T]he more demand 27a response is able to reduce peak prices, the more down- ward pressure it places on generator bidding strate- gies by increasing the risk to a supplier that it will not be dispatched if it bids a price that is too high.”). Third, demand response “enhances system reliability,” for example, by “reducing electricity demand at criti- cal times (e.g., when a generator or a transmission line unexpectedly fails).” Jd. at *12 & n.76; see also Order 745-A, 2011 WL 6523756, at *6 (“[D]jemand response generally can be dispatched by the [ISO or RTO] with a minimal notice period, helping to balance the electric system in the event that an unexpected contingency occurs.”). The benefits of demand response participating in wholesale markets are beyond reproach. Commis- sioner Moeller, who dissented in Order 745, put it best: While the merits of various methods for compen- sating demand response were discussed at length in the course of this rulemaking, nowhere did I review any comment or hear any testimony that questioned the benefit of having demand response resources participate in the organized wholesale energy mar- kets. On this point, there is no debate. The fact is that demand response plays a very important role in these markets by providing significant economic, reliability, and other market-related benefits. Order 745, 2011 WL 890975, at *34 (emphasis added) (Moeller, dissenting). It is no surprise, then, that FERC has initiated a series of reforms to open up its markets to demand response, on the theory that doing so helps to ensure 28a “just and reasonable” wholesale rates by improving how these markets function in the three ways just mentioned. See Order 890, Preventing Undue Dis- crimination and Preference in Transmission Service, 72 Fed. Reg. 12,226, 12,378 (Mar. 15, 2007); Order 719, Wholesale Competition in Regions with Orga- nized Electric Markets, 73 Fed. Reg. 64,100 (Oct. 28, 2008); see also Br. for Resp’t at 11-13 (providing over- view of these rulemakings); id. at 12 (noting that, be- fore Order 719, FERC had approved proposals by various ISOs and RTOs “to allow demand response participation in their ancillary services markets” (cita- tions omitted)). In particular, in Order 719 FERC required ISOs and RTOs to “accept bids from demand response re- sources in RTOs’ and ISOs’ markets for certain ancil- lary services on a basis comparable to other resources” and, in certain circumstances, to “permit an aggrega- tor of retail customers to bid demand re- sponse on behalf of retail customers directly into the organized energy market.” Order 719-A, 2009 WL 2115220, at *1. But FERC placed an important con- dition on this requirement; ISOs and RTOs were re- quired to accept bids from demand response “unless not permitted by the laws or regulations of the rele- vant electric retail regulatory authority.” 18 C.F.R. § 35.28(g)(1)(iA), (iii); Order 719-A, 2009 WL 2115220, at *13. Finally, recognizing that “further reforms may be necessary to eliminate barriers to demand response in the future,” FERC further ordered ISOs and RTOs to “assess and report on any remaining barriers to comparable treatment of demand response 29a resources that are within the Commission’s jurisdic- tion.” Order 719-A, 2009 WL 2115220, at *1. And further reforms were indeed necessary. Prior to issuing Order 745, ISOs and RTOs had differing practices concerning the level of compensation to be paid to demand response resources in their markets. Order 745, 2011 WL 890975, at *4. The Commission found that many [ISOs and RTOs undercompensated demand response resources in certain circumstances. See id. at *16. It reached this finding in light of ex- isting barriers to demand response participation in wholesale markets, including “the lack of market in- centives to invest in enabling technologies that would allow electric customers and aggregators of retail customers to see and respond to changes in marginal costs of providing electric service as those costs change.” Id.; see also id. (“[T]he inadequate compensation mechanisms in place today in wholesale energy mar- kets fail to induce sufficient investment in demand response resource infrastructure and expertise that could lead to adequate levels of demand response pro- curement Without sufficient investment in the devel- opment of demand response, demand response re- sources simply cannot be procured because they do not yet exist as resources. Such investment will not occur so long as compensation undervalues demand response resources.” (emphasis added) (quoting a commenter)). Order 745 sought to correct the under-compensation problem by mandating that ISOs and RTOs pay de- mand response resources the same market price that they pay to generators, i.e, LMP. But it limited this compensation requirement to circumstances where two 30a specific conditions are met. LMP-compensation would be required only when (1) “the demand response re- source [is} able to displace a generation resource in a manner that serves the RTO cr ISO in balancing sup- ply and demand,” and (2) “the payment of LMP [is] cost-effective, as determined by [a] net benefits test.” Jd. at *13; see also 18 C.F.R. § 35.28(g)(1)(v)(A). FERC understood that it had authority to correct the under-compensation problem because, in the ab- sence of adequate compensation, too few demand re- sponse resources affirmatively bid into the wholesale markets. And such participation is necessary for the market to function rationally and reach “just and rea- sonable” rates. As FERC stated: We find, based on the record here that, when a de- mand response resource has the capability to bal- ance supply and demand as an alternative to a gen- eration resource, and when paying LMP to that demand response resource is shown to be cost-effective as determined by the net benefits test described herein, payment by an RTO or ISO of compensation other than the LMP is unjust and unreasonable. When these conditions are met, we find that payment of LMP to these resources will result in just and reasonable rates for ratepayers. Order 745, 2011 WL 890975, at *13 (emphasis added). Il. ANALYSIS A. Jurisdiction Petitioners argue that Order 745 is “in excess” of FERC’s “statutory jurisdiction.” Br. of Pet’rs Elec. 3la Power Supply Ass’n, et al. (“Br. of Pet’rs”) at 27 (citing 5 U.S.C. § 706(2)(C)). We evaluate this contention under Chevron and defer to FERC’s permissible con- struction of its authorizing statute, regardless of “whether the interpretive question presented is ‘juris- dictional.’” City of Arlington, 133 S. Ct. at 1874-75; see also Connecticut, 569 F.3d at 481. The proper question is thus whether the Act unambiguously fore- closes FERC from issuing Order 745 under its “af- fecting” jurisdiction. See 16 U.S.C. § 824e; Chevron, 467 U.S. at 842, 104 S. Ct. 2778. FERC’s explanation of its jurisdiction under the Federal Power Act is straightforward and sensible. FERC has the authority and responsibility to correct any “practice affecting” wholesale electricity rates that the Commission determines to be “unjust” or “unreasonable.” 16 U.S.C. § 824e(a); see also id. § 824d(a). In its view, the ISOs’ and RTOs’ rules governing the participation of demand response re- sources in the nation’s wholesale electricity markets are “practices affecting [wholesale electricity] rates.” Order 745-A, 2011 WL 6523756, at *10 (quoting 16 U.S.C. §§ 824d, 824e). That is, an ISO’s or RTO’s market rules governing how a demand response re- source may compete in its wholesale market, including the terms by which 2 demand response resource is to be compensated in the market, are “practices affect- ing” that wholesale market’s rates for electricity. And FERC has determined that an ISO’s or RTO’s “practice” is unjust and unreasonable to the degree that it inadequately compensates demand response re- sources capable of supplanting more expensive gener- ation resources. See id. at *36. As explained above, 32a FERC has found that demand response improves the functioning of wholesale markets by (1) lowering the wholesale price of electricity, (2) exerting downward pressure on generators’ market power, and (3) en- hancing system reliability. FERC’s explanation is consistent with our case law. In Connecticut, we considered whether FERC has jur- isdiction to review an ISO’s capacity charges. 569 F.3d at 478-79. Capacity is not electricity but the ability to produce it when needed, and in Connecticut the ISO had established a market where capacity providers—generators, prospective generators, and demand response resources—competitively bid to meet the ISO’s capacity needs three years in the future. Id. at 479-81. Generation, like retail sales, is expres- sly the domain of State regulation under section 201, 16 U.S.C. § 824(b)(1), and the petitioners argued that by increasing the overall capacity requirement the ISO was improperly requiring the installation of new gen- eration resources. 569 F.3d at 481. We disagreed and held that FERC had “affecting” jurisdiction under section 206 because “capacity decisions af- fect FERC-jurisdictional transmission rates for that system without directly implicating generation facili- ties.” Jd. at 484. That the capacity requirement helped to “find the right price” was enough of an effect to satisfy section 206. Jd. at 485. Petitioners’ specific arguments against FERC’s exercising jurisdiction are unpersuasive. First, Peti- tioners note that section 201 of the Act establishes a clear jurisdictional line between “the sale of electric energy at wholesale in interstate commerce,” which is 33a properly the subject of FERC’s jurisdiction, and “any other sale of electric energy.” Br. of Pet’rs at 27-28 (citing 16 U.S.C. § 824(a), (b)(1)). According to Peti- tioners, the Commission has transgressed this line because it “has ordered ISOs and RTOs to pay retail customers for reducing their retail purchases of elec- tricity.” Id. at 28. But this argument mischaracterizes the rule and papers over a key ambiguity. First, the mischarac- terization: Petitioners are wrong inasmuch as they imply that FERC requires ali ISOs and RTOs to pay demand response resources a minimum level of com- pensation (LMP). The compensation requirement promulgated in Order 745 does not apply unless an ISO or RTO “has a tariff provision permitting demand response resources to participate as a resource in the energy market.” 18 C.F.R. § 35.28(g)(1)(v). And the regulation’s requirement that ISOs and RTOs accept bids from demand response resources comes with a key caveat: the requirement applies “unless not per- mitted by the laws or regulations of the relevant elec- tric retail regulatory authority.” Jd. § 35.28(g)(1)(iXA); see also id. § 35.28(g)(1)(iii). In other words, there is a carve-out from the compensation requirement for ISOs and RTOs in States where local regulatory law stands in the way. Thus, the Order preserves State regula- tion of retail markets. This is hardly the stuff of grand agency overreach. More fundamentally, Petitioners’ argument found- ers on a statutory ambiguity they ignore. Section 201 makes clear that FERC may regulate “the sale of electric energy at wholesale in interstate commerce” 34a but not “any other sale of electric energy.” 16 U.S.C. § 824(b)(1) (emphasis added). The demand response at issue here is forgone consumption, which is no “sale” at all. Perhaps the phrase “any other sale of electric energy” could be interpreted to include non- sales that would have been sales in the retail market, but it certainly does not require such a reading. It is reasonable to categorize demand response as neither a retail sale nor wholesale sale under the Federal Power Act. And on this understanding, section 201 “says nothing about” FERC’s power to review compensation rates for demand response in wholesale electricity markets. Connecticut, 569 F.3d at 483. Nor is Petitioners’ argument under section 201 made any stronger by reference to subsection (a). This prefatory subsection states that while “Federal regulation of electric energy in interstate commerce and the sale of such energy at wholesale in interstate commerce is necessary in the public inter- est,” federal regulation should “extend only to those matters which are not subject to regulation by the States.” 16 U.S.C. § 824(a). But the Supreme Court has made clear that “the precise reserved state powers language in § 201(a)” is a “mere policy declaration that cannot nullify a clear and specific grant of juris- diction, even if the particular grant seems inconsistent with the broadly expressed purpose.” New York, 535 U.S. at 22, 122 S. Ct. 1012 (emphasis added) (interna! quotation marks omitted). And, as I discuss below, section 206’s specific grant of “affecting” jurisdiction quite clearly authorized FERC to issue Order 745. 35a The most that can be said of section 201 is that it commits regulation of retail sales to the States and regulation of wholesale sales to the Commission. And while it is true that the forgone consumption would have been purchased in the first instance in the retail market, it does not follow from this fact that non- consumption constitutes an “other sale” under section 201(b). There was no sale, period. And the statute does not give a clear indication that Congress intended to foreclose FERC from regulating non-sales that have a direct effect on the wholesale markets under FERC’s jurisdiction. Even assuming that the Federal Power Act re- quires demand response resources to be considered inextricably part of retail “sales” subject solely to State regulation, Order 745 does not engage in the type of “direct regulation” that would violate section 201. See Connecticut, 569 F.3d at 481. Order 745 does not require anything of retail electricity consum- ers and leaves it to the States to decide whether to permit demand response. Al) Order 745 says is that if a State’s laws permit demand response to be bid into electricity markets, and if a demand response resource affirmatively decides to participate in an ISO’s or RTO’s wholesale electricity market, and if that de- mand response resource would in a particular circum- stance allow the ISO or RTO to balance wholesale sup- ply and demand, and 7f paying that demand resource would be a net benefit to the system, then the ISO or RTO must pay that resource the LMP. That is it. This requirement will no doubt affect how much elec- tricity is consumed by a small subset of retail consum- ers who elect to participate as demand response re- 36a sources in wholesale markets. But that fact does not render Order 745 “direct regulation” of the retail mar- ket. Authority over retail rates and over whether to permit demand response remains vested solely in the States. In this respect, Order 745 is similar to the capacity rule in Connecticut that we found did not directly reg- ulate generation facilities. 569 F.3d at 482. Even though increasing the capacity requirement incentiv- ized the procurement of additional resources, including new generation facilities, to meet the higher require- ment, we recognized that States retained their ulti- mate authority over the construction of new genera- tion facilities. /d. at 481-82. And because the ca- pacity requirements could be met in other ways aside from building new generators (e.g., through demand response or capacity contracts), it was irrelevant that “public utilities overwhelmingly responded to [increased capacity requirements] by choosing to allow construction of new facilities over other alterna- tives.” Id. at 482. The lesson of Connecticut is that FERC can indirectly incentivize action that it cannot directly require so long as it is otherwise acting within its jurisdiction—and that doing so does not constitute impermissible direct regulation of an area reserved to the States. So too here: Order 745 may encourage more demand response, but States retain the ultimate authority to approve the practice. Second, Petitioners argue that the FERC’s “affect- ing” jurisdiction under sections 205 and 206 of the Act “does not extend so far as to allow the Commission to regulate directly the retail services that are expressly 37a carved out from the scope of its jurisdiction.” Br. of Pet’rs at 30-31 (citing 16 U.S.C. § 824(a), (b)(1)). To a large degree, this argument simply rehashes Petition- ers’ erroneous reading of section 201 and fails for the reasons just described. Demand response resources are promises to forgo consumption of electricity and therefore are not retail “sales.” This is not changed by the fact that forgone consumption would have taken place in the first instance in a retail market. Because of this, the Commission’s asserting “affecting” juris- diction over demand response does not, as Petitioners suggest, “nullify[]” a limitation set forth in section 201. Id. at 32. To.be sure, section 206 cannot be read to displace unambiguous jurisdictional limits imposed by section 201(b). Suppose, for example, that FERC issued a rule requiring ISOs and RTOs to condition all whole- sale sales of electricity on load-serving entities’ agree- ing to charge retail customers with real-time pricing that adjusted hourly for variations in the cost of pro- ducing electricity. Such a rule would unambiguously regulate each retail “sale” because it would mandate a particular form of compensation for actwal—not counter-factual—retail sales. Thus, while price- responsive retail pricing would no doubt “affect” the wholesale rate, FERC could not claim jurisdiction under sections 205 and 206 because the subchapter which includes these sections “shall not apply to any other sale of electric energy.” 16 U.S.C. § 824(b)(1) (emphasis added). This example plainly differs from the present case because demand response resources are forgone sales or non-sales, and therefore it is at best ambiguous whether the limitation in section 201(b) 38a applies. See Connecticut, 569 F.3d at 483 (“Section 201 prohibits the Commission from regulating genera- tion facilities but says nothing about its power to re- view the capacity requirements that an [ISO] imposes on member [utilities].”). To bolster their case, Petitioners invoke the specter of limitless federal authority if FERC is permitted to exercise “affecting” jurisdiction to issue Order 745. They caution that “the Commission’s expansive inter- pretation of its ‘affecting’ jurisdiction would allow it to regulate any number of activities—such as the pur- chase or sale of steel, fuel, labor, and other inputs influencing the cost to generate or transmit electricity —merely by redefining the activities as ‘practices’ that affect wholesale rates.” Br. of Pet’rs at 33. This argument cannot carry the day be-cause it ig- nores at least two important limits. It first ignores section 201’s limit proscribing any “direct regulation” of retail sales (which would bar the hypothetical rule, discussed above, in which FERC tries to mandate that retail sales have dynamic, time-responsive pricing). See Connecticut, 569 F.3d at 481. It also ignores the limitations we announced in CA/SO, 372 F.3d 395. There, we held that FERC exceeded its jurisdiction when it replaced the board members of an ISO on the theory that the composition of the ISO’s board was a “practice affecting [a] rate” under section 206(a). Jd. at 399. We held that “section 206’s em- powering of the Commission to assess the justness and reasonableness of practices affecting rates of electric utilities is limited to those methods or ways of doing things on the part of the utility that directly affect the 39a rate or are closely related to the rate, not all those remote things beyond the rate structure that might in some sense indirectly or ultimately do so.” /d. at 403 (emphasis added). These limits foreclose the parade of horribles mar- shaled by Petitioners. Like replacing the ISO's board of directors in CAJSO, FERC could not, consistent with Circuit precedent, regulate markets in steel, fuel, labor, and other inputs for generating electricity, which constitute “remote things beyond the rate struc- ture that might in some sense indirectly or ultimately” affect the wholesale rate of electricity. Jd.; see also Calpine Corp. v. FERC, 702 F.3d 41, 47 (D.C. Cir. 2012) (affirming FERC’s determination that it lacked “affecting” jurisdiction over station power, which is a necessary input to energy production, because there ‘was not a “sufficient nexus with wholesale transac- tions” (internal quotation marks omitted) (citing City of Cleveland v. FERC, 773 F.2d 1368, 1376 (D.C. Cir. 1985))); City of Cleveland, 773 F.2d at 1376 (“[T]here is an infinitude of practices affecting rates and service. The statutory directive must reasonably be read to require the recitation of only those practices that affect rates and service significantly. ” (emphasis added)). Order 745 passes the CAISO test quite comfortably because the demand response resources subject to the rule have a quintessentially “direct” effect on whole- sale rates. The rule’s compensation requirement ap- plies only when an ISO or RTO can use the demand response resource in lieu of a generation resource to balance supply and demand, and only when paying a 40a demand response resource is cost-effective under the rule’s net benefits test. 18 C.F.R. § 35.28(g)(1)(v)(A). Order 745 thus does not purport to regulate demand response writ large; its compensation requirement applies only when the demand response by definition alters the wholesale electricity price. That is about as “direct” an effect and as clear a “nexus” with the wholesale transaction as can be imagined. See Cal- pine Corp., 702 F.3d at 47; CAIJSO, 372 F.3d at 403; City of Cleveland, 773 F.2d at 1376. There can be little doubt that FERC has the authority to review the justness and reasonableness of rates that are so close- ly connected with the healthy functioning of its juris- dictional markets; this, as we said in Connecticut, is the “heartland of the Commission’s section 206 juris- diction.” 569 F.3d at 483. Third, Petitioners argue that the Commission’s or- ders exceed its jurisdiction because “they unreasona- bly interfere with existing state and local programs addressing retail customer ‘demand response.’” Br. of Pet’rs at 41. Any such effect, however, is merely incidental. As the Commission correctly observed, Order 745 “does not directly affect retail-level demand response programs, nor does it require that demand response resources offer into the wholesale market only. Indeed, the organized wholesale energy mar- kets can and do operate simultaneously with retail- level programs. ”" Order 745-A, 2011 WL 6523756, at *19. FERC’s reforms in Order 745 run on a parallel track with State-level reforms. And to the degree that FERC’s reforms incidentally affect parallel State-level initiatives, that does not render FERC’s actions improper. See Natl Ass'n of Regula- 4la tory Util. Comm'rs v. FERC, 475 F.3d 1277, 1280 (D.C. Cir. 2007) (observing that FERC’s authority to act within its statutory scope of jurisdiction “may, of course, impinge as a practical matter on the behavior of non-jurisdictional” entities). * * * To summarize: FERC’s jurisdiction turns on two issues: (1) whether demand response is a retail “sale” or is otherwise unambiguously committed to State reg- ulation under the Federal Power Act, and (2) whether sections 205 and 206 clearly grant jurisdiction to FERC to regulate how wholesale-market administra- tors compensate demand response resources that “directly affect” wholesale prices. Unless we inject quasi-philosophy into our Chevron analysis (what is the sound of one hand clapping? what is the true na- ture of a sale that was never made? of megawatts never consumed?), I think it clear that the Federal Power Act does not precisely address the first ques- tion; forgone consumption is not unambiguously a “sale,” nor does the statute dictate that demand re- sponse be treated solely as a matter of retail regula- tion. And the second question is resolved, in my view, by the terms of Order 745 which narrowly apply only to demand response resources that by definition di- rectly affect the wholesale rates of electricity. This falls squarely within the Commission’s “affecting” jur- isdiction. See 16 U.S.C. §§ 824d, 824e. The proper course for this court is to defer to the Commission's well-reasoned and permissible interpretation of its authority under the statute. 42a B. Level of Compensation Petitioners also argue that Order 745 is arbitrary and capricious under 5 U.S.C. § 706(2)(A). In re- viewing such claims, we consider whether FERC “examine[d] the relevant data and articulate[d] a sat- isfactory explanation for its action including a rational connection between the facts found and the choice made.” Motor Vehicle Mfrs. Ass’n of the U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43, 103 S. Ct. 2856, 77 L. Ed. 2d 443 (1983) (internal quotation marks omitted). We also afford significant deference to FERC in light of the highly technical regulatory land- scape that is its purview. Indeed, “the Commission enjoys broad discretion to invoke its expertise in bal- ancing competing interests and drawing administra- tive lines.” Am. Gas Ass’n v. FERC, 593 F.3d 14, 19 (D.C. Cir. 2010). And we “afford great deference to the Commission” in cases involving ratemaking deci- sions as the “statutory requirement that rates be ‘just and reasonable’ is obviously incapable of precise judi- cial definition.” Morgan Stanley Capital Grp. Inc. v. Pub. Util. Dist. No. 1, 554 U.S. 527, 532, 128 S. Ct. 2733, 171 L. Ed. 2d 607 (2008). Finally, to the extent that the Commission bases its actions on factual find- ings, such findings are conclusive if supported by sub- stantial evidence. 16 U.S.C. § 8251 (b). Petitioners’ chief complaint is that Order 745 sets the required compensation level for demand response at the LMP (recall: locational marginal price). LMP equals “the marginal value of an increase in supply or a reduction in consumption at each node within” an ISO’s or RTO’s wholesale market, and is the compen- 43a sation generation resources generally receive. Order 745-A, 2011 WL 6523756, at *20. Petitioners com- plain that demand response resources already get the benefit of the forgone expense of retail electricity (abbreviated in the record as “G”). Therefore, Peti- tioners contend that, under FERC’s rule, demand re- sponse resources effectively receive a “double pay- ment”: LMP plus G. Br. of Pet’rs at 47. According to Petitioners, requiring LMP compensation thus re- sults in unjust and discriminatory overcompensation of demand response resources. /d. at 45-50; see also Order 745-A, 2011 WL 6523756, *38 (Moeller, dissent- ing). It is of course true, as the majority observes, that FERC is “bounded by the requirements of reasoned decision making.” Am. Gas Ass’n, 593 F.3d at 19. Therefore, FERC was required to provide a “direct response” to the Petitioners’ and the dissenting Com- missioner’s concerns about overcompensation. Jd. at 20. This is precisely what the Commission did in carefully explaining how Order 745’s setting compen- ation at the LMP was neither discriminatory nor unjust. _ To begin with, FERC provided a thorough explana- tion for why compensating demand response at the LMP (and not LMP-G) was neither unjust nor over- Compensatory. It explained that such compensation Was necessary to encourage an adequate level of de- mand response participation in wholesale markets in light of existing market barriers. See Order 745-A, 2011 WL 6523756, at *15 (noting that Petitioners “fail to acknowledge the market imperfections caused by 44a the existing barriers to demand response”). That last part—the market barriers—is the key. The Commis- sion has identified numerous barriers preventing ade- quate participation of demand response in wholesale markets. Order 745, 2011 WL 890975, at *16 & n.122 (citing study). Indeed, citing record evidence, the Commission explained that “the inadequate compensa- tion mechanisms in place today in wholesale energy markets fail to induce sufficient investment in demand response resource infrastructure and expertise that could lead to adequate levels of demand response pro- curement.” Jd. at *16 (quoting a commenter). FERC further explained that “a lack of incentives to invest in enabling technologies can be addressed by making additional investment resources available to market participants” and that paying LMP “to demand re- sponse will provide the proper level of investment re- sources available for capital improvements.” Order 745-A, 2011 WL 6523756, at *16. In view of these barriers, and the value of demand response participa- tion to ensuring “just and reasonable” wholesale rates, the Commission concluded that LMP was the appro- priate level of compensation. FERC sums it up well: The Commission acknowledged that noted experts differed on whether paying LMP in the current cir- cumstances facing the wholesale electric market is a reasonable price. In determining that LMP is the just and reasonable price to pay for demand re- sponse, the Commission examined some of the pre- viously recognized barriers to demand response that exist in current wholesale markets. These 45a barriers create an inelastic demand curve in the wholesale energy market that results in higher wholesale prices than would be observed if the de- mand side of the market were fully developed. The Commission found that paying LMP when cost- effective may help remove these barriers to entry of potential demand response resources, and, thereby, help move prices closer to the levels that would re- sult if all demand could respond to the marginal price of energy. Id. at *17. This is a “direct response” to the points raised by the Petitioners. Am. Gas Ass’n, 593 F.3d at 20. With respect to the argument that utilizing the LMP is somehow discriminatory because incomparable resources are paid comparable amounts, the Commis- sion offered reasonable grounds for treating demand response as comparable to generation resources. The Commission observed that, from the perspective of an ISO or RTO, a demand response resource was compa- rable to a generation resource inasmuch as demand response is equally capable of balancing wholesale supply and demand. Order 745-A, 2011 WL 6523756, at *14. This is not the sum total of the explanation, however. In the same section of its order, the Com- mission explained that “examining cost avoidance by demand response resources is not consistent with the treatment of generation. In the absence of market power concerns, the Commission generally does not examine each of the costs of production for individual resources participating as supply resources in the organized wholesale electricity markets.” /d. at *17; 46a see also id. at *21. FERC continued: “we note that certain generators may receive benefits or savings in the form of credits or in other forms. In these cases, the generators realize a value of LMP plus the credit or savings, but ISOs or RTOs do not take such benefits or savings into account in determining how much to pay those resources.” /d. at *17n.122. The point is that the comparability of compensation is assessed without regard to outside costs and credits; just as two generators are both compensated at the LMP even though only one might be receiving a tax credit for producing energy, so too with comparing demand re- sponse resources to generation resources. This was clearly explained, and it is reasonable. This court has no business second-guessing the Commission’s judgment on the level of compensation. See La. Pub. Serv. Comm’n v. FERC, 551 F.3d 1042, 1045 (D.C. Cir. 2008) (noting that “[wJhere the subject of our review is a predictive judgment by FERC about the effects of a proposed remedy , our deference is at its zenith”); Pub. Serv. Comm'n of Ky. v. FERC, 397 F.3d 1004, 1009 (D.C. Cir. 2005) (holding that “more than second-guessing close judgment calls is required to show that a rate order is arbitrary and capricious” (citation omitted)); Envtl. Action, Inc. v. FERC, 939 F.2d 1057, 1064 (D.C. Cir. 1991) (“{I]t is within the scope of the agency’s expertise to make a prediction about the market it regulates, and a reasonable prediction de- serves our deference notwithstanding that there might also be another reasonable view.”). 47a Whatever policy disagreements one might have with Order 745 ’s decision to compensate demand re- sponse resources at the LMP (and there are legitimate disagreements to be had), the rule does not fail for want of reasoned decisionmaking. FERC’s judgment is owed deference because it has put forth a reasonable multistep explanation of its decision to mandate LMP compensation. First, responsive demand is a neces- sary component of a well-functioning wholesale mar- ket, and FERC understood that its obligation to en- sure just and reasonable rates required it to facilitate an adequate level of demand response particivation in its jurisdictional markets. See Order 745, 2011 WL 890975, at *16. Second, FERC concluded that market barriers were inhibiting an adequate level of demand response participation. See id. Third, FERC con- cluded that mandating LMP would provide the proper incentives for demand response resources to overcome these barriers to participation in the wholesale market. See id.; see also Notice of Proposed Rulemaking, De- mand Response Compensation in Organized Whole- sale Energy Markets, reprinted in J.A. 208, 220-21 (stating that “demand response resources react cor- fespondingly to increases or decreases in payment” and citing study showing that switching from LMP to LMP-G compensation resulted in a 36.8% decrease in demand response participation in the ISO being stud- ied). III. CONCLUSION FERC had jurisdiction to issue Order 745 because demand response is not unambiguously a matter of re- tail regulation under the Federal Power Act, and be- 48a cause the demand response resources subject to the rule directly affect wholesale electricity prices. See 16 U.S.C. §§ 824d, 824e. And the Commission’s deci- sion to require compensation equal to the LMP, rather than LMP-G, was not arbitrary or capricious. The majority disagrees on both points. The unfortunate consequence is that a promising rule of national significance—promulgated by the agency that has been authorized by Congress to address the matters in issue—is laid aside on grounds that I think are incon- sistent with the statute, at odds with applicable prec- edent, and impossible to square with our limited scope of review. I therefore respectfully dissent. 49a APPENDIX B UNITED STATES OF AMERICA FEDERAL ENERGY REGULATORY COMMISSION 18 C.F.R. Part. 35 [Docket No. RM10-17-000; Order No. 745) Demand Response Compensation in Organized Wholesale Energy Markets (Issued Mar. 15, 2011) AGENCY: Federal Energy Regulatory Commission. ACTION: Final Rule. SUMMARY: In this Final Rule, the Federal Energy Regulatory Commission (Commission) amends its reg- ulations under the Federal Power Act to ensure that when a demand response resource participating in an organized wholesale energy market administered by a Regional Transmission Organization (RTO) or Inde- pendent System Operator (ISO) has the capability to balance supply and demand as an alternative to a gen- eration resource and when dispatch of that demand re- sponse resource is cost-effective as determined by the net benefits test described in this rule, that demand response resource must be compensated for the ser- vice it provides to the energy market at the market 50a price for energy, referred to as the locational marginal price (LMP). This approach for compensating de- mand response resources helps to ensure the competi- tiveness of organized wholesale energy markets and remove barriers to the participation of demand re- sponse resources, thus ensuring just and reasonable wholesale rates. EFFECTIVE DATE: This Final Rule will become effective on [INSERT DATE 30 DAYS AFTER DATE OF PUBLICATION IN THE FEDERAL REGIS- TER]. Dates for compliance and other required fil- ings are provided in the Final Rule. FOR FURTHER INFORMATION CONTACT: David Hunger (Technical Information) Office of Energy Policy and Innovation Federal Energy Regulatory Commission 888 First Street, NE, Washington, DC 20426 (202) 502-8148 david. hunger@ferc.gov Dennis Hough (Legal Information) Office of the General Counsel Federal Energy Regulatory Commission 888 First Street, NE, Washington, DC 20426 (202) 502-8631 dennis. hough@ferc.gov SUPPLEMENTARY INFORMATION: 5la 134 FERC 4 61,187 UNITED STATES OF AMERICA FEDERAL ENERGY REGULATORY COMMISSION Demand Response Compensation in Organized Wholesale Energy Markets ITI. Docket No. RM10-17-000 ORDER NO. 745 TABLE OF CONTENTS (Issued Mar. 15, 2011) Paragraph Numbers III i scacreseceeeneinmnesiinnsiehlinibiapilanieeeaneeaised 1. Sun i iaitiecchansinionceiiipeiunbbidabianiouaticnddtte 8. ET II ss crencsaeeeneseseinotetpenianeienmassis 15. iii cdactereerrneenseinniaininancenimiaiinaigia 17. Be, CRBROMBREESR LGUOL..n.ccccccccesccccscscescescsees 18. i, I Sisccnicciinninenicioneniinderosomenadligs 18. Be Si diniinidiscnciiniiicnnsistsiinsimnnicnienased 20. a) Capability of Demand Response and Generation Resources to Balance Se TIED seireesisenicnsssitcnenslcsiiteiiendsenid 20. b) Appropriateness of a Net Benefits p ERE eee een eee ae 38. c) Standardization or Regional Variations in Compensation................. 43. 3. Commission Determination ................. 45. B. Implementation of a Net Benefits Test....68. is A cite iticinitniiis pnieniimesiamnatiie 68. 52a C. Measurement and Verification.................. 86. DFR ee FE cccccsicrsicsterenninesaiiteail 86. a aticsininsciicnietctictancineccdenin 88. 3. Commission Determination ................. 93. BO CR Bl cninttiiitineniintinenedemennensaninn 96. eg fg 96. GS Soin cinsiivsetiieone 97. 3. Commission Determination ................. 99. E. Commission Jurisdiction ...............s0eceee 103. 5. GER cnn 103. 2. Commission Determination ............... 112. V. Information Collection Statement................ 116. VI. Environmental Analysis....................:c.sseeees 121. VII. Regulatory Flexibility Act 0.0.0.0... 122. RT 130. IX. Effective Date and Congressional I sicicccnsteccitbuiciasiactialinabiiieiiitmiiuaiadaehal 133. Regulatory Text APPENDIX: List of Commenters 53a UNITED STATES OF AMERICA FEDERAL ENERGY REGULATORY COMMISSION Before Commissioners: Jon Wellinghoff, Chairman; Mare Spitzer, Philip D. Moeller, John R. Norris, and Chery! A. LaFleur. Demand Response Compensation in Organized Wholesale Energy Markets Docket No. RM10-17-000 FINAL RULE ORDER NO. 745 (Issued Mar. 15, 2011) I. Introduction 1. This Final Rule addresses compensation for de- mand response in Regiona) Transmission Organization (RTO) and Independent System Operator (ISO) orga- nized wholesale energy markets, i.e., the day-ahead and real-time energy markets. As the Commission has previously recognized, a market functions effec- tively only when both supply and demand can mean- ingfully participate. The Commission, in the Notice of Proposed Rulemaking (NOPR) issued in this pro- ceeding on March 18, 2010, proposed a remedy to con- cerns that current compensation levels inhibited mean- ingful demand-side participation.' After nearly 3,800 pages of comments, a subsequent technical conference, Notice of Proposed Rulemaking, 75 FR 15362 (Mar. 29, 2010), FERC Stats. & Regs. 1 32,656 (2010) (NOPR). 54a and the opportunity for additional comment, we now take final action. 2. We conclude that when a demand response’ re- source’ participating in an organized wholesale energy market‘ administered by an RTO or ISO has the capa- bility to balance supply and demand as an alternative to a generation resource and when dispatch of that de- mand response resource is cost-effective as deter- mined by the net benefits test described herein, that demand response resource must be compensated for the service it provides to the energy market at the market price for energy, referred to as the locational * Demand response means a reduction in the consumption of elec- tric energy by customers from their expected consumption in re- sponse to an increase in the price of electric energy or to incentive payments designed to induce lower consumption of electric energy. 18 CFR 35.28(b)(4) (2010). * Demand response resource means a resource capable of pro- viding demand response. 18 CFR 35.28(b)(5). ‘ The requirements of this final rule apply only to a demand re- sponse resource participating in a day-ahead or real-time energy market administered by an RTO or ISO. Thus, this Final Rule does not apply to compensation for demand response under programs that RTOs and ISOs administer for reliability or emergency condi- tions, such as, for instance, Midwest ISO’s Emergency Demand Re- sponse, NYISO’s Emergency Demand Response Program, and P.JM’s Emergency Load Response Program. This Final Rule also does not apply to compensation in ancillary services markets, which the Commission has addressed — eg No. 719, 73 FR 64100 (Oct. 28, 2008), FERC Stats. & Regs. ¥ aie (2008) (Order No. 719). 55a marginal price (LMP).° The Commission finds that this approach to compensation for demand response resources is necessary to ensure that rates are just and reasonable in the organized wholesale energy markets. Consistent with this finding, this Final Rule adds section 35.28(g)(1)(v) to the Commission’s regula- tions to establish a specific compensation approach for demand response resources participating in the orga- nized wholesale energy markets administered by RTOs and ISOs. The Commission is not requiring the use of this compensation approach when demand response resources do not satisfy the capability and cost- effectiveness conditions noted above.*® 3. This cost-effectiveness condition, as determined by the net benefits test described herein, recognizes that, depending on the change in LMP relative to the size of the energy market, dispatching demand re- sponse resources may result in an increased cost per unit ($/MWh) to the remaining wholesale load associ- ated with the decreased amount of load paying the bill. This is the case because customers are billed for en- ergy based on the units, MWh, of electricity consumed. We refer to this potential result as the billing unit * LMP refers to the price calculated by the ISO or RTO at partic- ilar locations or electrical nodes or zones within the ISO or RTO footprint and is used as the market price to compensate generators. There are variations in the way that RTOs and ISOs calculate LMP; however, each method establishes the marginal value of resources in that market. Nothing in this Final Rule is intended to change RTO and ISO methods for calculating LMP. .* The Commission’s findings in this Final Rule do not preclude the Commission from determining that other approaches to compen- gation would be acceptable when these conditions are not met. 56a effect of dispatching demand response. By contrast, dispatching generation resources does not produce this billing unit effect because it does not result in a de- crease of load. To address this billing unit effect, the Commission in this Final Rule requires the use of the net benefits test described herein to ensure that the overall benefit of the reduced LMP that results from dispatching demand response resources exceeds the cost of dispatching and paying LMP to those re- sources. When the net benefits test described herein is satisfied and the demand response resource clears in the RTO’s or ISO’s economic dispatch, the demand re- sponse resource is a cost-effective alternative to gen- eration resources for balancing supply and demand. 4. To implement the net benefits test described herein, we direct each RTO and ISO to develop a mechanism as an approximation to determine a price level at which the dispatch of demand response re- sources will be cost-effective. The RTO or ISO should determine, based on historical data as a starting point and updated for changes in relevant supply conditions such as changes in fuel prices and generator unit availability, the monthly threshold price corresponding to the point along the supply stack beyond which the overall benefit from the reduced LMP resulting from dispatching demand response resources exceeds the cost of dispatching and paying LMP to those re- sources. This price level is to be updated monthly, by 57a each ISO or RTO, as the historic data and relevant supply conditions change.’ 5. This Final Rule also sets forth a method for allo- cating the costs of demand response payments among all customers who benefit from the lower LMP result- ing from the demand response. 6. The tariff changes needed to implement the com- pensation approach required in this Final Rule, in- cluding the net benefits test, measurement and verifi- cation explanation and proposed changes, and the cost allocation mechanism must be made on or before July 22,2011. All tariff changes directed herein should be submitted as compliance filings pursuant to this Final Rule, not pursuant to section 205 of the Federal Power Act (FPA).* Accordingly, each RTO’s or ISO’s com- pliance filing to this Final Rule will become effective prospectively from the date of the Commission order addressing that filing, and not within 60 days of sub- mission. 7. In addition, we believe that integrating a deter- mination of the cost-effectiveness of demand response resources into the dispatch of the ISOs and RTOs may be more precise than the monthly price threshold and, therefore, provide the greatest opportunity for load to benefit from participation of demand response in the organized wholesale energy market administered by an RTO or ISO. However, we acknowledge the posi- "In its compliance filing an RTO or ISO may attempt to show, in whole or in part, how its proposed or existing practices are con- sistent with or superior to the requirements of this Final Rule. ® 16 U.S.C. 824d (2006). 58a tion of several of the RTOs and ISOs that modification of their dispatch algorithms to incorporate the costs related to demand response may be difficult in the near term. In light of those concerns, we require each RTO and ISO to undertake a study examining the requirements for and impacts of implementing a dy- namic approach which incorporates the billing unit effect in the dispatch algorithm to determine when paying demand response resources the LMP results in net benefits to customers in both the day-ahead and real-time energy markets. The Commission directs each RTO and ISO to file the results of this study with the Commission on or before September 21, 2012.° Il. Background 8. Effective wholesale competition protects custom- ers by, among other things, providing more supply op- tions, encouraging new entry and innovation, and spur- ring deployment of new technologies.” Improving the competitiveness of organized wholesale energy markets is therefore integral to the Commission ful- filling its statutory mandate under the FPA to ensure * We note that this report is for informational purposes only and will neither be wane nor nn rorya action, 10 a — Ban Order No. 719, 73 FR 64100 (Oct. 28, 2008), FERC Stats. & Regs. 7 31,281, at P 1 (2008) (Order No. 719); see also Re- gional Transmission Organizations, Order No. 2000, FERC Stats. & Regs. 7 31,089, at P 1 (1999), order on reh’g, Order No. 2000-A, FERC Stats. & Regs. 1 31,092 (2000), aff'd sub nom. Pub. Util. Dist, No. 1 of Snohomish County, Washington v. FERC, 272 F.3d 607, 348 U.S. App. D.C. 205 (D.C. Cir. 2001). 59a supplies of electric energy at just, reasonable, and not unduly discriminatory or preferential rates." 9. As the Commission recognized in Order No. 719, active participation by customers in the form of de- mand response in organized wholesale energy markets helps to increase competition in those markets.” De- mand response, whereby customers reduce electricity consumption from normal usage levels in response to price signals, can generally occur in two ways: (1) customers reduce demand by responding to retail rates that are based on wholesale prices (sometimes called “price-responsive demand”); and (2) customers provide demand response that acts as a resource in organized wholesale energy markets to balance supply and demand. While a number of states and utilities are pursuing retail-level price-responsive demand ini- tiatives based on dynamic and time-differentiated re- tail prices and utility investments in demand response enabling technologies, these are state efforts, and, thus, are not the subject of this proceeding. Our focus here is on customers or aggregators of retail customers providing, through bids or self-schedules, demand response that acts as a resource in organized wholesale energy markets. 10. As the Commission stated in Order No. 719," and emphasized in the NOPR,” there are several ways in " 16 U.S.C. 824d (2006); Order No. 719, FERC Stats. & Regs. 31,281 at P 1. » See Order No. 719, FERC Stats. nthe 4 31,281 at P 48. Markets, Order No. 719-A, FERC ute & Regs. 1 31,292, at P 48 (2009). 60a which demand response in organized wholesale energy markets can help improve the functioning and compet- itiveness of those markets. First, when bid directly into the wholesale market, demand response can facil- itate RTOs and ISOs in balancing supply and demand, and thereby, help produce just and reasonable energy prices.“ This is because customers who choose to re- spond will signal to the RTO or ISO and energy mar- ket their willingness to reduce demand on the grid which may result in reduced dispatch of higher-priced resources to satisfy load.” Second, demand response can mitigate generator market power.’ This is be- cause the more demand response that sees and re- sponds to higher market prices, the greater the com- petition, and the more downward pressure it places on generator bidding strategies by increasing the risk to ‘* NOPR, FERC Stats. & Regs. 9 32,656 at P 4. ‘* For example, a study conducted by PJM, which simulated the effect of demand response on prices, demonstrated that a modest three percent load reduction in the 100 highest peak hours corre- sponds to a price decline of six to 12 percent. ISO-RTO Council Re- port, Harnessing the Power of Demand How RTOs and ISOs Are In- tegrating Demand Response into Wholesale Electricity Markets, found at http://www.isorto.org/atf/cf/*%7B5B4E85C6-7EAC-40A0 -8DC3-003829518EBD®%7D/IRC DR Report 101607.pdf. ‘© Id. (“Demand response tends to flatten an area’s load profile, which in turn may reduce the need to construct and use more costly resources during periods of high demand; the overall effect is to lower the average cost of producing energy.”). 'T See Comments of NYISO’s Independent Market Monitor filed in Docket No. ERO9-1142-000, May 15, 2009 (Demand response “con- tributes to reliability in the short-term, resource adequacy in the long-term, reduces price volatility and other market costs, and miti- gates supplier market power.”). 6la a supplier that it will not be dispatched if it bids a price that is too high.” Third, demand response has the potential to support system reliability and address re- source adequacy’ and resource management chal- lenges surrounding the unexpected loss of generation. This is because demand response resources can pro- vide quick balancing of the electricity grid.” 11. Congress has recognized the importance of de- mand response by enacting national policy requiring its facilitation.** Consistent with that policy, the iF] Id. ® See ISO-RTO Council Report, Harnessing the Power of De- mand How RTOs and ISOs Are Integrating Demand Response into Wholesale Electricity Markets at 4, found at http://www. isorto.org/ atf/cf/%7B5B4E85C6-7E AC-40A0-8DC3-003829518E BD%7D/IRC _DR_Report_101607.pdf (“Demand response contributes to main- taining system reliability. Lower electric load when supply is es- pecially tight reduces the likelihood of load shedding. Improve- ments in reliability mean that many circumstances that otherwise result in forced outages and rolling blackouts are averted, resulting in substantial financial savings. ™ For instance, in ERCOT, on February 26, 2008, through a com- bination of a sudden loss of thermal! generation, drop in power sup- plied by wind generators, and a quicker-than-expected ramping up of demand, ERCOT found itself short of reserves. The system opera- tor called on all demand response resources, and 1200 MW of Load acting as Resource (LaaRs) responded quickly, bringing ERCOT back into balance. OAK RIDGE NATL LAB., NATL RENEWABLE ENERGY LAB., TECH. REP. NREL/TP-500-43373, ERCOT EVENT ON FEB. 26, 2008: LESSONS LEARNED (JUL. 2008). "™ See Energy Policy Act of 2005, Pub. L. No. 109-58, § 1252(f), 119 Stat. 594, 965 (2005) (“It is the policy of the United States that :; unnecessary barriers to demand response participation in energy, capacity, and ancillary service markets shall be eliminat- ed.”). 62a Commission has undertaken several reforms to sup- port competitive wholesale energy markets by remov- ing barriers to participation of demand response re- sources. For example, in Order No. 890, the Commis- sion modified the pro forma Open Access Transmission Tariff to allow non-generation resources, including de- mand response resources, to be used in the provision of certain ancillary services where appropriate on a comparable basis to service provided by generation re- sources.~ Order No. 890-A further required trans- mission providers to develop transmission planning processes that treat all resources, including demand response, on a comparable basis.” 12. In Order No. 719, the Commission required RTOs and ISOs to, among other things, accept bids from de- mand response resources in their markets for certain ancillary services on a basis comparable to other re- sources.“ The Commission also required each RTO and ISO “to reform or demonstrate the adequacy of its existing market rules to ensure that the market price for energy reflects the value of energy during an op- erating reserve shortage,”"” for purposes of encour- = ndue Discrimination and Preference in sion Service, Order No. 890, FERC Stats. & Regs. 4 31,241, at P 887-88 (2007), order on reh’g, Order No. 890-A, FERC Stats. & Regs. 4 31,261 (2007), order on reh’g and clarification, Order No. 890-B, 123 FERC 4 61,299 (2008), order on reh’g, Order No. 890-C, 126 FERC 4 61,228 (2009), order on clarification, Order No. 890-D, 129 FERC 4 61,126 (2009). “ Order No. 890-A, FERC Stats. & Regs. 31,261 at P 216. * Order No. 719, FERC Stats. & Regs. 131,281 at P 47-49. % Order No. 719, FERC Stats. & Regs. 131,281 at P 194. 63a aging existing generation and demand resources to continue to be relied upon during an operating reserve shortage, and encouraging entry of new generation and demand resources.” 13. Additionally, in recent years several RTOs and ISOs have instituted various types of demand response programs. While some of these programs are admin- istered for reliability and emergency conditions, other programs allow wholesale customers, qualifying large retail customers, and aggregators of retail customers to participate directly in the day-ahead and real-time energy markets, certain ancillary service markets and capacity markets.” 14. To date, the Commission has allowed each RTO and ISO to develop its own compensation methodolo- gies for demand response resources participating in its day-ahead and real-time energy markets. Asa result, * Order No. 719, FERC Stats. & Regs. 1 31,281 at P 247. * Other demand response programs allow demand response to be tused as a capacity resource and as a resource during system emer- gencies or permit the use of demand response for synchronized re- serves and regulation service. See, e.g., PJM Interconnection, LL.C., 117 FERC 1 61,331 (2006); Devon Power LLC, 115 FERC 4 61,340, order on reh’g, 117 FERC 1 61,133 (2006), appeal pending sub nom. Maine Pub. Utils. Comm’n v. FERC, No. 06-1403 (D.C. Cir. 2007); New_York Indep, Sys. Operator, Inc., 95 FERC 1 61,136 (2001); NSTAR Services Co. v. New England Power Pool, 95 FERC ‘T 61,250 (2001); N P P d ISO N Inc,, 100 FERC 1 61,287, order on reh’g, 101 FERC 1 61,344 (2002), order on reh’g, 103 FERC 9 61,304, order on reh’g, 105 FERC ‘1 61,211 (2003); PJM_Interconnection, L.L.C., 99 FERC 4 61,227 (2002); California Independent System Operator Corp., 132 FERC 1 61,045 (2010). 64a the levels of compensation for demand response vary significantly among RTOs and ISOs.” For example, PJM Interconnection, L.L.C. (PJM) pays the LMP minus the generation and transmission portions of the retail rate.” ISO New England Inc. (ISO-NE) and New York Independent System Operator, Inc. (NYI- SO) pay LMP when prices exceed a threshold level, with the levels differing between the RTOs.” The Midwest Independent Transmission System Operator, Inc.’s (Midwest ISO) demand response programs” pay * See New England, Inc., Docket No. ER09-1051-000; ISO New England, Inc., Docket No. ER08-830-000; Midwest Indep. Transmis- sion Sys. Operator, Inc., Docket No. ER09-1049-000. *“ See sections 3.3A.4 and 3.34.5 (Market Settlements in the Real- Time and Day-Ahead Energy Markets) of the Appendix to Attach- ment K of the PJM Tariff. *® For example, under ISO-NE’s Real-Time Price Response Pro- gram, the minimum bid is $100/MWh and a demand response re- source is paid the higher of LMP or $100/MWh. For the Day- Ahead Load Response Program, the minimum offer level is calcu- lated on a monthly basis and is the Forward Reserve Fuel Index ($/MM 8tu) multiplied by an effective heat rate of 11.37 MMBtu/ MWh. The maximum offer level is $1,000/MWh. See sections IIL.E.2.1 and III.E.3.2 of Appendix E of the ISO New England Transmission, Markets and Services Tariff. NYISO implements a day-ahead demand response program by which resources bid into the market at a minimum of $75/MWh and can get paid the LMP. See section 4.2.2.9 (“Day-Ahead Bids from Demand Reduction Pro- viders to Supply Energy from Demand Reductions”) of NYISO’s Market Services Tariff. Midwest ISO FERC Electric Tariff characterizes Demand Re- sponse Resources (DRR) as either DRR-Type I or DRR-Type IL. DRR-Type I are capable of supplying a specific quantity of energy or contingency reserve through physical load interruption. DRR-Type 65a LMP for demand response resources in the day-ahead and real-time energy markets.” The California Inde- pendent System Operator Corporation (CAISO) pays LMP at pricing nodes, or sub-load aggregation points (Sub-LAP) in its Proxy Demand Resource program that allows qualifying resources to provide day-ahead and real-time energy.” CAISO also provides for de- mand response resources to participate in its Partici- pating Load program, which enables certain resources to provide curtailable demand in the CAISO market. CAISO pays nodal real-time LMP for its Participating Load program. The Southwest Power Pool, Inc. (SPP) has filed revisions to its tariff to facilitate de- mand response in the Energy Imbalance Service Mar- ket.™ II are capable of supplying energy and/or operating reserves over a dispatchable range. See sections 39.2.5A and 40.2.5 of the Tariff. -® See Charges and Payments for Purchases and Sales for De- mand Response Resources. Midwest ISO FERC Electric Tariff, section 39.3.2C. -™ See section 11.2.1.1 IFM Payments for Supply of Energy, CAISO FERC Electric Tariff. CAISO notes that for a Proxy De- mand Resource that is made up of aggregated loads, the Resource is paid the weighted average of the LMPs of each pricing node where the underlying aggregate loads reside. See CAISO, 182 FERC 1 61,045, at P 26 n.14 (2010). ';™ The Commission has directed SPP to report on ways it can incorporate demand response into its imbalance market. Southwest Power Pool, Inc., 128 FERC 1 61,085 (2009). As of September 1, 2010, SPP has submitted seven informational status reports regard- ing its efforts to address issues related to demand response re- sources. In orders addressing SPP’s compliance with Order No. 719, the Commission also directed SPP to make another com- pliance filing addressing demand response participation in its orga- 66a lil. P Hi 15. As noted above, the Commission issued the NOPR in this proceeding on March 18, 2010.” The NOPR proposed to require RTOs and [SOs to pay the LMP in all hours for demand reductions made in re- sponse to price signals. The Commission sought com- ments on the compensation proposal and, in particular, on the comparability of generation and demand re- sponse resources; alternative approaches to compen- sating demand response in organized wholesale energy markets; whether payment of LMP should apply in all hours, and, if not, any criteria that should be used for establishing hours when LMP should apply; and whether to allow for regional variations concerning approaches to demand response compensation.” 16. After receiving the first round of comments, the Commission issued a Supplemental Notice of Proposed Rulemaking and Notice of Technical Conference (Sup- plemental NOPR) in this proceeding on August 2, 2010." The Supplemental NOPR sought additional comment on: whether the Commission should adopt a nized markets. Southwest Power Pool, Inc., 129 FERC 4 61,168, at P 51 (2009). On May 19, 2010, SPP submitted revisions to its Open Access Transmission Tariff in Docket Nos. ERO9-1050-004 and ER09-748-002 to comply with the Commission’s requirements estab- lished in Order Nos. 719 and 719-A. These filings are pending be- fore the Commission. * NOPR, FERC Stats. & Regs. 11 32,656. * See Appendix for a list of commenters. * Supplemental Notice of Proposed Rulemaking and Notice of Technical Conference, 75 FR 47499 (Aug. 6, 2010), 1832 FERC " 61,094 (2010) (Supplemental NOPR). 67a net benefits test for determining when to compensate demand response providers, and, if so, what, if any, requirements should apply to the methods for deter- mining net benefits; and what, if any, requirements should apply to how the costs of demand response are allocated. The Commission further directed Staff to hold a technical conference focused on these two is- sues, which occurred on September 13, 2010.* IV. Discussion 17. Based upon the record in this proceeding, the Commission herein requires greater uniformity in com- pensating demand response resources participating in organized wholesale energy markets. This Final Rule also addresses the allocation of costs resulting from the commitment of demand response, directing that such costs be allocated among those customers who benefit from the lower LMP resulting from the demand response. A. Compensation Level 1. NOPR Proposal 18. The NOPR proposed to require RTOs and ISOs to pay the LMP in all hours for demand reductions made in response to price signals. The NOPR sought to provide comparable compensation to generation and demand response providers, based on the premise that both resources provide a comparable service to RTOs and ISOs for purposes of balancing supply and demand and maintaining a reliable electricity grid.” Also as * See Notice of Technical Conference (Aug. 27, 2010). * NOPR, FERC Stats. & Regs. 9 32,656 at P 15. 68a stated in the NOPR, the proposed compensation level was designed to allow more demand response re- sources to cover their investment costs in demand response-related technology (such as advanced meter- ing) and thereby facilitate their ability to participate in organized wholesale energy markets.“ The Commis- sion sought comments on the compensation proposal and, in particular, on the comparability of generation and demand response resources; alternative ap- proaches to compensating demand response in orga- nized wholesale energy markets; whether payment of LMP should apply in all hours, and, if not, any criteria that should be used for establishing hours when LMP should apply; and whether to allow for regional varia- tions concerning approaches to demand response com- pensation. 19. In the Supplemental NOPR, the Commission sought additional comments and directed staff to hold a technical conference regarding various net benefits tests. In particular, the Commission sought comment on: whether the Commission should adopt a net ben- efits test applicable in all or only some hours and what the criteria of any such test would be; how to define net benefits; what costs demand response providers and load serving entities incur and whether they should be included in a net benefits test; whether any net benefits methodology adopted should be the same for all RTOs and ISOs; proposed methodologies for implementing a net benefits test and the advantages and limitations of any proposed methodologies.“ The ” Id. at P 16, * Supplemental NOPR, 132 FERC 1 61,094 at P 8-9. 69a September 13, 2010 Technical Conference included an eleven-member pane! discussion of net benefits tests representing a wide range of interests and viewpoints.” The Commission subsequently received additional writ- ten comments addressing these issues. 2. Comments a) Capability of Demand Response and Gen- eration Resources to Balance Energy Markets 20. Various commenters address the comparability of demand response and generation resources for pur- poses of compensation in the organized wholesale en- ergy markets. To begin, numerous commenters ad- dress the physical or functional comparability of de- mand response and generation, agreeing that an incre- ment of generation is comparable to a decrement of load for purposes of balancing supply and demand in the day-ahead and real-time energy markets.* Equat- ing generation and demand response resources, Dr. Alfred E. Kahn states: [Demand response] is in all essential respects eco- nomically equivalent to supply response [so] economic efficiency requires that it should be rewarded with the same LMP that clears the market. Since [demand response] is actually— and not merely metaphorically—equivalent to sup- ply response, economic efficiency requires that it be regarded and rewarded, equivalently, as a resource ® See Sept. 13, 2010 Tr. * DR Supporters Aug. 30, 2010 Comments (Kahn Affidavit at 2); Verso May 13, 2010 Comments at 3-4; Occidental May 13, 2010 Comments at 11; Viridity June 18, 2010 Comments at 5. 70a proffered to system operators, and be treated equivalently to generation in competitive power markets. That is, all resources—energy saved equivalently to energy supplied— should receive the same market-clearing LMP in remu- neration.“ Indeed, some commenters believe that, from a physicai standpoint, demand response can provide superior services to generation, such as providing a guick re- sponse in meeting system requirements and service without having to construct major new facilities.“ Occidental asserts that the fungibility of demand re- sponse and generation output creates greater opera- tional flexibility that, in turn, offers hTOs and ISOs multiple options to solve system issues both in energy and ancillary service markets, and that the fungible nature of demand response and generation supports comparable compensation for each as proposed in the NOPR.* 21. Viridity states that attempts to distinguish the physical characteristics of generation and demand re- sponse ignore bid-based security-constrained economic dispatch as the foundation for LMP and are based on the assumption that the value of load management on the grid is limited to periods when the system is stressed, i.e., traditional “super peak shaving.” Vi- “ DR Supporters August 30, 2010 Reply Comments (Kahn Affi- davit at 2 (footnote omitted)). * Verso May 13, 2010 Comments at 3-4; Alcoa May 13, 2010 Comments at 9. “ Occidental May 13, 2010 Comments at 11. Tla ridity states that, while these arguments might have been valid 15 years ago, today competitive markets can offer proactively-managed load control and compara- ble and non-discriminatory treatment of load-based energy resources. Therefore, Viridity asserts that all resources should be paid LMP if the grid operator accepts their bid to achieve grid balance.” 22. At the same time, other commenters argue that generation and demand response are not physically equivalent, pointing out that demand response reduces consumption, whereas generators serve consumption.“ They argue that a MW reduction in demand does not turn on the lights.“ EPSA adds that a load reduction does not provide electrons to any other load and, in- stead, allows the marginal electron to serve a different customer.” Some commenters assert that a power system can function solely and reliably on generating plants and without any reliance on demand response, while the system cannot rely exclusively on demand response because demand response by itself cannot keep the lights on. Ultimately, some commenters point out, megawatts produced by generators need to be placed on the system in order for power to flow.” Battelle additionally argues that a reduction in con- " Viridity June 18, 2010 Comments at 5 * ISO-NE May 13, 2010 Comments at 3. * See, e.g., APPA May 13, 2010 Comments at 12; Capital Power May 13, 2010 Comments at 2. ® EPSA May 13, 2010 Comments at 72. “= See, e.g., PSEG May 13, 2010 Comments at 8. 72a sumption is not exactly the same as an increase in pro- duction, because elastic demand often comes with attendant future consequences, such as rebound, by virtue of substitution in time.” 23. Some commenters who argue that the physical characteristics of demand response are not comparable to generation frame their arguments in terms of the ability of the system operator to call on demand re- sponse and generation resources to provide balancing energy. They argue that generation resources pro- vide superior service to demand response providers, positing that demand response is not intended for long periods of balancing needs,” and that, moreover, con- tracts with demand response providers limit the num- ber of hours and times a customer may be called upon to curtail. For example, ODEC asserts that the de- gree of physical comparability depends on the extent to which demand response resources can be dispatched similar to a generator.” Calpine adds that traditional generators provide system support features that de- mand response cannot, such as ancillary services in- cluding governor response or reactive power voltage support, which are necessary for reliable operation of the electric system.” 24. Numerous commenters also address the compa- rability of demand response and generation in eco- nomic terms. For example, EEI states that, in fi- * Battelle May 13, 2010 Comments at 3. “AEP May 13, 2010 Comments at 7-8. * ODEC May 13, 2010 Comments at 12. *® Calpine May 13, 2010 Comments at 4-5. T3a nance terms, the demand response product is, unlike generation, essentially an unexercised cal] option on spot market energy, and the value of that option is well-established in finance theory as the value of the resource (LMP) minus the “strike price,” which EEI contends in this case is the retail tariff rate.” EEI and like-minded commenters support, therefore, al- ternative compensation for demand response to equal LMP minus the generation (or G) component of the re- ‘tail rate.” They posit that payment of LMP without an offset for some portion of the retail rate does not send the proper economic signal to providers of de- mand response, because it fails to take into account the retail rate savings associated with demand response, and thereby overcompensates the demand response provider. As described by Dr. William W. Hogan on behalf of EPSA, this is sometimes called a double- ® EEI May 13, 2010 Comments at 4-5. See also Robert L. Bor- lick May 13, 2010 Comments at 4. Mr. Borlick argues that the correct price is LMP minus the Marginal Foregone Retail Rate (MFRR), describing the economically efficient price that should be paid to a demand response provider as “its offer price minus the price in its retail tariff at which it would have purchased the curtailed energy.” Mr. Borlick asserts that this amount accurately repre- gents the forgone opportunity costs that result when a demand response provider reduces its load. Id. " See May 13, 2010 Comments of: APPPA; AEP; The Brattle Group; Calpine; ConEd; Consumers Energy; CPG; Detroit Edison; Direct Energy; Dominion; Duke Energy; Edison Mission; EEI; EPSA; Exelon; FTC; GDF; NYISO on behalf of the ISO RTO Coun- dil; ICC; IPPNY; Indicated New York TOs; IPA; ISO-NE; Midwest TDUs; Mirant; Midwest ISO TOs; NEPGA; NYISO; ODEC; OMS; PJM; PJM IMM; P3; Potomac Economics; PG&E; Ohio Commis- sion; Robert L. Borlick; Roy Shanker; and RRI Energy. 74a payment for demand reductions, because demand re- sponse providers would “receive” both the cost savings from not consuming an increment of electricity at a particular price, plus an LMP payment for not con- suming that same increment of electricity.” Viewing LMP as a double-payment, these commenters argue that paying LMP will result in more demand response than is economically efficient.” For example, Dr. Hogan states that paying LMP might motivate a com- pany to shut down even though the benefits of con- suming electricity outweigh the cost at LMP® In- deed, P3 argues that compensation in excess of LMP-G is unjust and unreasonable, because such a payment level imposes costs on customers that are not com- mensurate with benefits received.” 25. ISO-NE argues that paying full LMP to demand response providers without taking into account the bill savings produced by demand response provides a sig- * See Attachment to Answer of EPSA, Providing Incentives for Efficient Demand Response, Dr. William W. Hogan, Oct. 29, 2009, submitted in Docket No. EL09-68-000. ® EPSA May 13, 2010 Comments at 23. See also May 13, 2010 Comments of APPA at 13; FTC at 9; Midwest TDUs at 14; Mirant at 2; New York Commission at 5; PJM at 6; PSEG at 5; and Potomac Economics at 6-8. ® Attachment to Answer of EPSA, Providing Incentives for Effi- cient Demand Response, Dr. William W. Hogan, Oct. 29, 2009, sub- mitted in Docket No. EL09-68-000. In Dr. Hogan’s view, supply should produce when the price of electricity exceeds its cost of pro- duction and demand should decline to consume when the costs in terms of convenience of delaying use are jess than the price of elec- tricity. t P3 June 14, 2010 Comments at 2, 7-8. 75a nificant financial incentive to dispatch demand re- sponse with marginal costs exceeding LMPs. By dis- patching higher-cost demand response, ISO-NE as- serts, lower-cost generation resources are displaced.” At the same time, ISO-NE argues, generation is not dispatched and paid for only when the generation re- duces LMP—generation is dispatched and paid for when it is cost-effective.™ 26. Dr. Hogan further disputes arguments equating a MW of energy supplied to a MW of energy saved on economic grounds. Dr. Hogan draws a distinction be- tween reselling something that one has purchased, and selling something that one would have purchased with- out actually purchasing it. Dr. Hogan argues that from the perspective of economic efficiency and wel- fare maximization, the aggregate effect of demand re- sponse is a wash producing no economic net benefit. Dr. Hogan asserts that Commission policy citing the benefits of price reduction in support of demand re- sponse compensation would amount to no less than an application of regulatory authority to enforce a buyers’ cartel. He states that the Commission has been vigi- lant and aggressive in preventing buyers and sellers from engaging in market manipulation to influence prices, and it would be fundamentally inconsistent for the Commission to design demand response compen- sation policies that coordinate and enforce such price manipulation. ® ISO-NE May 13, 2010 Comments at 3-4. ® Id. at 28. 76a 27. Dr. Hogan argues that the ideal and economically efficient solution regarding demand response compen- sation is to implement retail real-time pricing at the LMP, thereby eliminating the need for demand re- sponse programs. Realizing that this is unattainable at the present time, Dr. Hogan goes on to propose a next-best solution, which he believes is to pay demand response compensation in the amount of LMP-G, or some amount that simulates explicit contract demand response (such as “buy-the-baseline” approach discus- sed below). These options, he argues, more than pay- ing LMP, better support notions of comparability be- tween demand response resources and generation.™ 28. The New York Commission, however, argues that requiring payment of LMP-G would result in an ad- ministrative burden of tracking retail rates for the multiple utilities, ESCOs and power [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0317%3A03. Public record. Not legal advice.