# Amicus Curiae Brief — 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%3A24 ## Record - **Collection:** Supreme Court brief - **Document type:** Amicus Curiae Brief - **Published:** January 1, 2015 ## Text . ne ~~ FILED = 2013 IN THE OFFICE OF THE CLES” Supreme Court of the Anited States Nos. 14-840, 14-841 FEDERAL ENERGY REGULATORY COMMISSION, Petitioner, v. ELECTRIC POWER SUPPLY ASSOCIATION, ET AL., Respondents. ENERNOC, INC., ET AL., Petitioners, v. ELECTRIC POWER SUPPLY ASSOCIATION, ET AL., Respondents. On Writs of Certiorari to the United States Court of Appeals for the District of Columbia Circuit BRIEF OF ROBERT L. BORLICK, JOSEPH BOWRING, JAMES BUSHNELL, AND 19 OTHER LEADING ECONOMISTS AS AMICI CURIAE IN SUPPORT OF RESPONDENTS JOHN LEE SHEPHERD, JR. JEFFREY A. LAMKEN SKADDEN, ARPS, SLATE, Counsel of Record MEAGHER & FLOM LLP MOLOLAMKEN LLP 1440 New York Ave., NW The Watergate, Suite 660 Washington, D.C. 20005 600 New “oe Ave., NW (202) 371-7338 W C. 20037 (202) Counsel for Amici Curiae WILSON-EPES PRINTING Co., INC. — (202) 789-0096 — WasnincTon, D.C. 20002 QUESTIONS PRESENTED The questions presented for the Court’s review in this case are: 1. Whether the Federal Power Act, 16 U.S.C. §§791a et seq., authorizes the Federal Energy Regulatory Com- mission (FERC) to induce retail reductions in electricity consumption and to recoup those payments through ad- justments to wholesale rates. 2. Whether FERC’s rule establishing the amount paid to induce those reductions in electricity consumption is arbitrary and capricious or otherwise unsupported by reasoned decisionmaking. This brief of amici curiae addresses only the second question presented. (i) TABLE OF CONTENTS I. FERC’s Rule Imposes Inefficient Distortions Without Reasoned A. The Need for Proper Price Signals To Regulate Supply and Demand in Electricity Markets .....................cccec-esce00es 1. The Critical Role of Price in 2. The Wholesale-Retail Disconnect 3. Aligning Wholesale and Retail ) Vantasutatee Subsidy That 1. Paying LMP Without Accounting for Input Cost Is Inconsistent with Basic Economics ...................-+.-+- 2. FERC’s Rule Creates Irrational Incentives To Cease or Defer Socially Valuable Production............. 3. The Rule Offers Arbitrary and Uneconomic Rewards Based on the Meter’s Location. .............c0ccs00-. (iii) iv TABLE OF CONTENTS—Continued II. Efficient Demand-Response Mechanisms Replicate the Market .................c:sssceceseseereees III. Contrary Arguments Are Unfounded.......... A. FERC’s Own Arguments Show That Paying Full LMP Effects an Unjustified Subsidy ...............ccs-0000s0-. B. Reliance on the Net-Benefits Test Underscores the Irrationality of FERC’s Approach.............csc-scsceeceseesreseees C. Petitioner and Its Amici Seek Subsidies Not Supported by the (| TAEeseeeere e e Addendum — List of Amici CUuriae...........ccccccceeeeee v TABLE OF AUTHORITIES . Page(s) CASES Delaware Dep't of Natural Res. v. EPA, No. 13-1093, slip op. (D.C. Cir. May 1, it hcshjeineinantinnisnashpianaeaaiaaidaiitiinseinmnsees 20 FPC v. Conway Corp., 426 U.S. 271 (1976)......... 24 FPC v. Hope Natural Gas Co., 8 30 Morgan Stanley Capital Grp. Inc. v. Pub. Util. Dist. No. 1, 554 U.S. 527 (2008) .............. 30 Nat'l Soc’y of Prof'l Eng’rs v. United States, 435 U.S. 679 (1978) .........cccccccsee sceeseerees 7 New York v. FERC, 535 U.S. 1 (2002) ................. 7 Permian Basin Area Rate Cases, BOO U.S. TET (19GB) ..ccccececcevesscscssseccsccsosscscceccsosses 30 Sacramento Mun. Util. Dist. v. FERC, 616 F.3d 520 (D.C. Cir. 2010) 20.0.0... ccccceeeseeees 8 SEC v. Chenery Corp., 332 U.S. 194 (1947)......... 31 ADMINISTRATIVE MATERIALS kf ee 10 Cal. Indep. Sys. Operator Corp., 116 FERC 961,274 (2006) .........cc-cccecessesecsessersereesenes 8 Md. Pub. Serv. Comm’n v. PJM Interconnection, L.L.C., 127 FERC ice alicmreernntccams 8 Milford Power Co., LLC, 119 FERC a 29 PJM Indus. Customer Coal. v. PJM Interconnection L.L.C., 121 FERC eB cccentcsscesseccssannesemnnsennnecnmamenaocsaces 22, 23 vi TABLE OF AUTHORITIES—Continued Page(s) PJM Interconnection, L.L.C., 99 FERC , SENT NR Sao ee 22 OTHER AUTHORITIES Borenstein, Time-Varying Retail Electricity Prices: Theory and Practice, in E Deregulation: Choices and Challenges 317 (Griffin & Pe hs i attitiecarnieinirentnsnenniemantmerernccee 8,9 Borlick, Paying for Demand-Side Response at the Wholesale Level: The Small Consumers’ Perspective, 24 Elec. J. 8 Borlick, Pricing Negawatts, 148 Pub. Utils. Fort. 14 (2010)...................0000- 9 12,21, 26 Chao, Price-Responsive Demand Management for a Smart Grid World, ee 29 Cicchetti & Hogan, Including Unbundled Demand-Side Options in Electric Utility Bidding Programs, Pub. Utils. i REET 30 Electric Energy Market Competition Task Force, Report to Congress on Competition in Wholesale and Retail Markets for Electric Energy (2007) ..............+- 7 Faruqui & Palmer, Dynamic Pricing and Its Discontents, 34 Regulation 16 (2011)........ 23 Griffin & Puller, /ntroduction to Electricity Deregulation: Choices & Challenges (Griffin & Puller eds., 2005) ...............ccccccceeseeees 4 vii TABLE OF AUTHORITIES—Continued Page(s) Hilke & Wise, Who Turned Out the Lights? Competition and California’s Power Crisis, 15 Antitrust 76 (2001) ..............ccseeeeeee 9 Hogan, Providing Efficient Incentives for Demand Response (Oct. 29, 2009), http-//elibrary ferc.gov/idmws/common/ OpenNat.asp?fileID = 12228734 SERRE SC ee 9, 21, 33 Newell, DR Distortion, 148 Pub. Utils. | See 19, 21, 33 IN THE Supreme Court of the Anited States Nos. 14-840, 14-841 FEDERAL ENERGY REGULATORY COMMISSION, Petitioner, V. ELECTRIC POWER SUPPLY ASSOCIATION, ET AL., Respondents. ENERNOC, INC., ET AL., Petitioners, Vv. ELECTRIC POWER SUPPLY ASSOCIATION, ET AL., Respondents. On Writs of Certiorari to the United States Court of Appeals for the District of Columbia Circuit BRIEF OF ROBERT L. BORLICK, JOSEPH BOWRING, JAMES BUSHNELL, AND 19 OTHER LEADING ECONOMISTS AS AMICI CURIAE IN SUPPORT OF RESPONDENTS INTEREST OF AMICI CURIAE Amici curiae (listed in the Addendum) are leading economists and educators who have designed, studied, and written about the electricity markets affected by the 2 decisions under review here.’ FERC’s Final Rule estab- lishes the rate paid for reducing purchases of electricity (called “demand response”). FERC now requires market participants to pay the full “locational marginal price” of electricity that is not consumed, treating non-consump- tion as equivalent to selling energy one owns or gener- ates. See U.S. Br. 45-61. Although amici’s views may diverge on other issues, they agree that FERC’s decision cannot be reconciled with the economic principles FERC has repeatedly en- dorsed. FERC’s pricing methodology overcompensates reduced consumption by compensating demand response as if parties that reduce consumption sell electricity they generate, or resell into the market energy they pur- chased. But demand-responders do neither: They de- cline to buy electricity at a particular rate; they do not provide electricity they own to others. Requiring that ’ Pursuant to this Court’s Rule 37.6, counsel for amici curiae states that no counsel for a party authored this brief in whole or part or made a monetary contribution to the preparation and submission of this brief. Counsel’s fees and expenses incurred to prepare this brief were paid by American Electric Power Service Corp., the Independ- ent Power Producers of New York, Inc. and the New England Power Generators Association, Inc. No other person or entity made a mon- etary contribution intended to fund the preparation or submission of this brief. Robert Borlick, William Hogan, and Roy Shanker were compensated experts in FERC proceedings below. James Bushnell, Seott Harvey, and Benjamin Hobbs were compensated as members of the Market Surveillance Committee of the California Independent System Operator, Inc., which filed comments before FERC. Paul Centolella was a Commissioner on the Ohio Public Utilities Commis- sion and, as part of his official duties, participated in submitting comments before FERC. All parties consented to the filing of this brief. Copies of the letters granting consent have been filed with the Clerk. 3 demand-responders be paid as if they contributed and sold their own electricity into the market creates exces- sive incentives to curtail demand. It induces the cessa- tion of productive activity even when that harms social welfare. And it creates bizarre incentives by compensat- ing those who operate their own (typically dirtier and more costly) generation “behind the meter” for self- consumption more generously than generators who sup- ply electricity to the interstate grid for everyone’s use. FERC’s methodology harms social welfare and the long- term health of electricity markets. If FERC has legiti- mate reasons for imposing those costs, it never articulat- ed them. SUMMARY OF ARGUMENT I.A. FERC has regulated wholesale electricity mar- kets to promote efficient competition, mandating the use of a locational marginal price (LMP) that incorporates all costs of delivering the electricity necessary to meet real- time demand at each location. However, because end-use consumers in state-regulated retail markets often pay fixed rates, their energy consumption may be relatively inelastic, regardless of real-time changes in wholesale prices. To make retail consumption more responsive to whole- sale price changes, FERC mandated “demand-response” payments of full LMP to customers for not consuming electricity. Although FERC attempted to justify pay- ment of full LMP on efficiency grounds, its analysis de- fies the economic principles FERC purported to follow. B. Under FERC’s rule, everyone actually supplying electricity to market at LMP must bear the cost of ob- taining the electricity they sell. Generators must pro- duce energy, and traders must buy it, to sell it at LMP. But not demand-responders. They are paid full LMP, as 4 if they “sold” electricity into the market, even though they do not own (or buy) electricity and supply it to mar- ket. They simply decline to consume electricity. Basic math shows that paying full LMP encourages purchasers to forgo electricity consumption and produc- tive activity even when it harms overall social welfare. FERC previously employed that math to conclude that paying full LMP would be an unjustified subsidy for de- mand response, as did the Federal Trade Commission in these proceedings. FERC’s rule also compensates users more handsome- ly for generating electricity solely for their own “behind- the-meter” use, discriminating against generators that offer electricity into the grid. That favors less efficient self-supply over public generation—even when self- supply costs more than prevailing LMP FERC never attempted to justify that result. II. FERC offered no economically plausible rationale for rejecting the more efficient alternative of LMP- minus-G (where G is the full retail price). FERC had previously approved that workable formula for compen- sating demand-responders. III. FERC relies on the “net-benefits test,” which re- quires RTOs to perform a complex calculation using “his- torical data” and an indeterminate list of factors. The necessity of superimposing a net-benefits test demon- strates that FERC’s pricing rule is flawed. If paying full LMP produced appropriate pricing signals, FERC would not need to superimpose another test as a precondition for demand response. By its terms, moreover, the test merely precludes de- mand-response payments unless those payments lower the total amount consumers pay for electricity. But arti- +) ficially lowering prices can impede efficiency and deter necessary investment in new facilities. This Court and FERC have recognized that pricing must look to the in- terests of the market as a whole, including generators and customers. Any economist seeking to maximize ben- efits to society will measure total social welfare, not just the consumer side of the ledger. FERC never justified its exclusive focus on lower short-term prices and point- edly ignored the harm to social welfare its pricing scheme imposes. Regulators sometimes depart from ef- ficiency to pursue other goals. But damaging efficiency while purporting to pursue it is arbitrary and capricious rather than reasoned decisionmaking. ARGUMENT FERC’s Final Rule defies the basic economic princi- ples upon which FERC established organized electricity markets. Declaring that it “is not limited to textbook economic analysis,” FERC urged that it “may account for the practical realities of how [electricity] markets oper- ate.” Pet. App. 89a-90a. But FERC’s decision defies both economic theory and the practical realities alike. FERC’s formula for compensating decisions to reduce retail consumption exceeds what a competitive market would provide; systematically provides greater incentives to reduce consumption than to generate energy for useful purposes; and creates perverse incentives that injure consumers in the long run. Notwithstanding the many post-hoc rationalizations now asserted for that rule, FERC gave no rationale that makes theoretical or prac- tical economic sense. Amici find FERC’s order disturbing. FERC purports to promote efficiency but instead undermines efficiency by creating obvious subsidies while denying that any subsidy exists. Regulators may sometimes depart from 6 efficiency to pursue other legitimate goals. Here, howev- er, FERC departed from efficiency while purporting to pursue it, without acknowledging the costs of that depar- ture. I. FERC’s RULE IMPOSES INEFFICIENT DISTORTIONS WITHOUT REASONED JUSTIFICATION There is a well-acknowledged disconnect between wholesale and retail energy markets. Wholesale prices for electricity, which are set in competitive, organized markets, reflect minute-to-minute fluctuations in demand and supply. But the retail rates paid by electricity con- sumers are often fixed in advance; purchasers pay a flat rate for each additional megawatt consumed regardless of real-time changes in supply and demand. As a result, real-time price signals are not transmitted to retail elec- tricity consumers, whose demand remains highly inelas- tic to fluctuations in wholesale prices. Here, FERC attempted to give retail customers incen- tives to curtail usage in response to wholesale price changes. But FERC created incentives that depart dra- matically from proper competitive outcomes and any sen- sible notion of economic efficiency. By overcompensating reductions in demand, FERC discourages socially valua- ble, productive activity, without acknowledging that con- sequence. It likewise compensates self-generation more handsomely than generation for the public’s benefit. At bottom, FERC has chosen to subsidize demand response without offering economic reasoning for that subsidy—or the corresponding burden on generators and small con- sumers who must fund it. 7 A. The Need for Proper Price Signals To Regulate Supply and Demand in Electricity Markets 1. The Critical Role of Price in Energy Markets “Price is the ‘central nervous system of the economy.’” Nat'l Soc’y of Prof’l Eng’rs v. United States, 435 U.S. 679, 692 (1978). “[Tyhe influence of prices on the behavior of consumers and producers is crucial for how a market economy allocates scarce resources.” Mankiw, Princi- ples of Economics 7 (5th ed. 2008). In efficient markets, rising prices signal the need to increase production (and trigger decreased consumption); falling prices signal the need to decrease production (and trigger greater con- sumption). The resulting buyer and seller conduct “natu- rally move{s] markets toward the equilibrium of supply and demand.” /d. at 77. Those bedrock principles apply to electricity markets. On the demand side, “[{p}rice changes signal to customers in wholesale and retail markets that they should change their decisions about how much and when to consume electric power.” Electric Energy Market Competition Task Force, Report to Congress on Competition in Wholesale and Retail Markets for Electric Energy 47 (2007). Suppliers respond as well. “If the cost of increas- ing [electricity] production is small, a relatively small price increase may * * * encourage producers to increase production in response to increased demand.” /d. at 50. But if production costs are high, “suppliers will not in- crease production unless the price increases enough to cover the higher costs.” [bid. FERC has recognized the importance of price signals to balance supply and demand. It restructured organized wholesale electricity markets to ensure accurate price signals. See New York v. FERC, 535 US. 1, 45 (2002). And it has used price signals by establishing auctions for 8 long-term supply. See, eg., Md. Pub. Serv. Comm'n v. PJM Interconnection, L.L.C., 127 FERC 961,274 (2009). 2. The Wholesale-Retail Disconnect on Pricing Although electricity markets are subject to the princi- ples of supply and demand, there is a gulf between wholesale pricing (regulated by FERC) and retail pricing (regulated by States). That separation impedes the criti- cal signaling function of price—an impediment FERC’s rule here was supposed to overcome. Wholesale rates are generally efficient. Most whole- sale electricity in orgenised markets is priced according to “locational marginal pricing,” or “LMP.” Under LMP, “prices are designed to reflect the least-cost of meeting an incremental megawatt-hour of demand at each loca- tion on the grid, and thus prices vary based on location and time.” Sacramento Mun. Util. Dist. v. FERC, 616 F.3d 520, 524 (D.C. Cir. 2010). LMP incorporates each cost component for delivering electricity to its destina- tion—the cost of generating it, the cost of transmitting it from the generator, and “line losses” (energy losses that occur during transport). /bid) LMP “communicate[s] the true market value of electricity at each location”; “create[s] financial incentives to dispatch the lowest cost energy”; and “encourage{s] transmission and generation investment at appropriate locations.” Cal Indep. Sys. Operator Corp., 116 FERC 961,274 at 62,126 (2006). And LMP is dynamic: Because it “reflect{[s] the supply- demand interaction,” it “varies constantly,” with prices changing in minute-by-minute increments. Borenstein, Time-Varying Retail Electricity Prices: Theory and Practice, in Electricity Deregulation: Choices and Chal- lenges 317, 317 (Griffin & Puller eds., 2005). Wholesale market participants thus have an incentive to respond to 9 increased prices, triggered by peak-demand or supply shortfalls, by reducing purchases. By contrast, retail rates typically do not reflect real- time price fluctuations. Borenstein, supra, at 317. Ra- ther, the retail price “typically is constant for months at a time.” Ibid. As a result, moment-to-moment or day-to- day wholesale price signals are not transmitted to most consumers. The wholesale price during a peak-usage pe- riod thus might increase dramatically, but retail consum- ers paying fixed rates have no economic incentive to de- crease consumption in response. See Pet. App. 96a-98a. Consumer demand is thus rendered “inelastic” with re- spect to wholesale price. The lack of incentives to reduce demand during peak periods was one of the “most obvi- ous culprit{s]” for the 2000-2001 California energy crisis. Hilke & Wise, Who Turned Out the Lights? Competition and California’s Power Crisis, 15 Antitrust 76, 76 (2001). One way to ensure appropriate incentives is dynamic pricing—charging retail customers the “relevant real- time or day-ahead LMP” of the electricity they consume. Hogan, Providing Efficient Incentives for Demand Re- sponse 12 (Oct. 29, 2009) (“Whitepaper”), http://elibra- ry ferc.gov/idmws/common/OpenNat.asp?fileID = 12228734 (Attach. A). Exposing consumers to market-driven, real- time price fluctuations requires consumers to consider the real-time cost of consumption—encouraging con- sumption during low-demand periods, and discouraging it during peak-demand periods. Borlick, Pricing Nega- watts, 148 Pub. Utils. Fort. 14, 16 (2010). But real-time pricing is not always feasible, because of customer or leg- islative resistance and the costs of real-time metering equipment. Griffin & Puller, /ntroduction to Electricity Deregulation: Choices & Challenges 26 (Griffin & Puller 10 eds., 2005). As a result, wholesale and retail prices rarely converge in real time. 8. Aligning Wholesale and Retail Incentives Through Demand-Response Payments To overcome the fact that many retail consumers do not receive real-time price signals that would inform con- sumption decisions, see J.A.293-294, regulators have at- tempted to recreate otherwise missing market incentives through “demand-response” policies. “Demand response means a reduction in the consumption of electric energy by customers from their expected consumption in re- sponse to an increase in the price of electric energy” or, more commonly, “incentive payments designed to induce lower consumption of electric energy.” 18 C.F.R. § 35.28(b)(4). Properly structured incentives can increase social wel- fare. Excessive incentive payments for demand re- sponse, however, are problematic. They encourage busi- nesses not to produce when it would be more efficient— and socially valuable—for them to continue production. They encourage large consumers to self-supply, even when their self-generated electricity is more costly to so- ciety. And they deter and distort investment in genera- tion by artificially suppressing consumption and prices. The key demand-response question thus asks how much to pay a retail customer to forgo purchasing elec- tricity at a fixed price when wholesale prices climb. The obvious answer is to replicate market forces by asking what a fixed-price customer would earn by purchasing energy at retail and reselling it at the prevailing whole- sale market price (7e., LMP). In that case, the custom- er’s profit would be the difference between the price at which it sold electricity, and the contract price at which it could buy electricity. That difference provides an incen- ll tive to forgo consumption only when doing so is more profitable than using the electricity to produce goods and services (~e., when non-production is more efficient than production). Here, FERC instead required that retail customers be paid the market price for wholesale electricity—the full LMP—without subtracting the price the customer would have paid to buy it. See Pet. App. 100a-101a, 210a. The customer is thus compensated as if it acquired or gener- ated electricity for free and sold electricity it owned to others in the market. As explained below, that result is neither justified nor justifiable. B. FERC’s Pricing Produces an Unacknowledged Subsidy That Harms Social Welfare Throughout the rulemaking, FERC claimed that pay- ing full LMP for demand response was justified by eco- nomic efficiency. FERC announced at the outset that “paying demand response resources the LMP will com- pensate those resources in a manner that reflects the marginal value of the resource.” Pet. App. 91a; accord J.A.35. Doing so, FERC stated, “will improve the com- petitiveness of the organized wholesale energy markets and * * * help to ensure that energy prices in those mar- kets are just and reasonable.” J.A.35. FERC maintained that focus in its Final Rule. It ex- plained that pursuing these goals will “balance supply and demand,” Pet. App. 96a, “caus{ing] wholesale and re- tail prices to converge on a price level reflecting de- mand’s ability to respond to the marginal cost of energy,” Pet. App. 216a. While purporting to pursue economic ef- ficiency, however, FERC adopted an approach that dis- torts rather than reflects market forces and fundamental economic principles, creating implicit subsidies FERC cannot explicitly justify. 12 1. Paying LMP Without Accounting for Input Cost Is Inconsistent with Basic Economics Any demand-response mechanism must account for the costs the consumer avoids by not purchasing electric- ity. In a competitive market, a consumer who receives electricity at a favorable rate might resell that electricity instead of using it. But the customer must buy electricity to resell it. The consumer who forgoes using electricity, and makes that electricity available to others for a price, thus receives the difference between the price at which he can sell electricity and the price he paid for it. Here, FERC required demand-responders to be paid the full value of electricity they decline to purchase with- out accounting for what they would have paid for it—they get full LMP. That pays demand-responders as if they actually sell electricity to the market, having somehow generated or acquired it for free. But that erroneously assumes that not buying electricity is the same as pro- ducing it. A company that does not use electricity can in some loose sense be said to make that unused electricity available to others. But to make electricity available to others, it needs another input: It needs someone to pro- duce the electricity that it has a right to use, does not use, and thereby leaves available for others. FERC’s meth- odology ignores that essential input. For that reason, FERC erred in assuming that not us- ing one megawatt-hour of electricity (the so-called “neg- awatt-hour”) is economically equivalent to producing one megawatt-hour of electricity. See U.S. Br. 49-50. That “assumption is wrong.” Borlick, Pricing Negawatts, su- pra, at 14. “The characteristics of a megawatt and a ‘negawatt’ are different, both in terms of physics and in economic impact.” Pet. App. 160a (Moeller, Comm’r, dis- senting). In terms of physics, a megawatt exists and can 13 be measured; a “negawatt” is an imputed quantity calcu- lated by comparing what the customer might have used to what it actually used. In terms of economics, a mega- watt and a negawatt are not equivalent, because a nega- watt does not include the costs the consumer avoided by not purchasing electricity. That is, the negawatt is not the costless generation of electricity. It is the non-use of energy that someone else generated, and built expensive facilities to create. See C.A. App. 483 (Hogan, Demand Response Pricing in Organized Wholesale Markets). The fallacy of FERC’s approach becomes evident if one imagines that this case concerned automobiles rather than energy. If a particular automobile is in high de- mand but short supply, the wholesale price might sky- rocket to, for example, $50,000 per car (yielding profits for the manufacturer). A car dealer who has obligated himself to sell those cars to certain consumers at $40,000 might be willing to pay those consumers not to buy a car (this might be called a “naughtomobile”). But no one would say the dealer should pay each potential buyer $50,000—the full cost of a new car—for merely declining to purchase one at $40,000. The dealer would at most of- fer the potential buyer $10,000—the amount the dealer would lose if the consumer insisted on making the pur- chase. FERC’s approach gives the customer a windfall. He gets paid $50,000, as if he himself manufactured and sold an additional car. Compare that to the treatment of a consumer who has already bought a car for $40,000, but has not taken deliv- ery. No one would object to his reselling that car at the market rate of $50,000. He sells that car, which he paid for and owns, to others for the same $50,000 the manu- facturer gets for selling an identical car. But then the consumer’s profit is $10,000, not $50,000. Under FERC’s 14 approach, however, that seller gets /ess profit for bring- ing an actual car to market than would someone who simply declined to buy one in the first instance. FERC never explains why the market price for selling an actual product into the market (that the seller owns or made) would be the same price the market pays others who of- fer nothing they own or paid for but who simply decline to make purchases.” Even if a customer were deemed to “supply” some- thing he never purchased or generated, FERC’s rule still makes no sense. In energy markets, diverse generation sources compete: Coal-powered plants compete with hy- droelectric dams, which compete with gas turbines. If FERC decreed that coal-powered plants need not pay for inputs needed to generate electricity—for example, that coal mines must provide coal for free—coal-powered generators receiving LMP would become more profita- ble. The same would be true if FERC ordered that coal- plants could take electricity from other generators, and resell it at LMP, without paying the original generator. In both situations, coal-plants would be paid for power that, by decree, they acquire for little or nothing. LMP would fall, as electricity sold by coal-plants—subsidized by free inputs—displace unsubsidized energy sources. That might (initially) benefit consumers. But it distorts the market in favor of one source that may not be the most efficient. Allowing lower-cost subsidized power * This is no mere hypothetical: Companies that profit by buying in day-ahead markets and reselling at LMP in real-time markets would now do better by not buying at all and receiving LMP. See, e.g., Mo- tion to Intervene and Comments of the California Department of Water Resources State Water Project at 4, FERC Dkt. No. RM10- 17-000 (May 13, 2010). 15 drives down prices for other, potentially more efficient sources, deterring investment in power plants that might be socially desirable. FERC’s approach is almost indistinguishable from that hypothetical coal-plant subsidy. It directs that all resources that putatively make electricity “available” be paid LMP Under that rule, everyone actually supplying electricity (nuclear plants, solar generators, and even traders importing energy from adjacent markets) must bear the cost of obtaining the electricity they make avail- able. But not demand-response providers. They are deemed to have “sold” electricity into the market even though they have not generated or purchased any. FERC thus subsidizes demand response at the expense of other suppliers and the markets’ long-term health. Pet. App. 170a (Moeller, Comm’r, dissenting). It does not matter, as FERC urges (at 53-54), that demand-response providers incur some costs (e.g., costs of shutting down factories, shifting production times, or organizing demand-responders), or that competing gen- erators incur some costs in ramping down to stop provid- ing electricity. The point is that FERC’s order gives de- mand-responders one critical input for free—they effec- tively sell electricity they do not own without bearing the cost of generating or acquiring it. If the hypothetical coal order excused coal-plants from paying for only some of their inputs, it still would be a subsidy and it still would distort the market. The result is no different if one sub- stitutes the word “demand-responders” for “coal power- plant.” Thus, even if demand response and generatior were said to provide the same “marginal value,” Pet. App. 91a, FERC’s order allows one to obtain an input—the elec- tricity it purports to make available—without paying for 16 it. There is a simple way to eliminate the subsidy. De- mand-responders can be required to “pay” for the elec- tricity they purport to offer. Demand-responders can start with a payment of LMP for the electricity they of- fer; but FERC must deduct the retail rate demand- responders would pay for the electricity if they were to buy it before reselling it at LMP. 2. FERC’s Rule Creates Irrational Incentives To Cease or Defer Socially Valuable Production FERC’s approach produces irrational incentives that FERC never acknowledges. Basic math shows that pay- ing demand-responders full LMP encourages productive facilities to cease operations even when that damages so- cial welfare. An example makes that clear. If a widget-maker must spend $.30 for electricity at retail to produce each widget, and it must spend $.10 per widget in other costs, the widget-maker ordinarily will produce widgets whenever the market price for widgets exceeds $.40. If the market price is $1.00, the widget-maker will make widgets at a $.60 profit. Society gains handsomely: The widget- maker converts $.40 worth of inputs into a product con- sumers value at $1 (or more). Nonetheless, society is better off if the widget-maker stops production once LMP for electricity reaches $.91. At that point, the real cost of making a widget (labor and materials at $.10 per widget plus the $.91 per-widget electricity cost, totaling $1.01) exceeds the $1.00 market price. But a demand-response payment of LMP will in- duce the widget-maker to stop production earlier—when LMP reaches $.61. At that point, the widget-maker earns more by doing nothing: It avoids $.30 in electricity costs (at retail) and $.10 in production costs per widget (assuming production costs fall to zero when production 17 ceases). And it collects $.61 in demand-response pay- ments, more than the net profit of $.60 it would earn from making widgets. Society, however, is worse off. Society would benefit from production—it gets widgets worth $1 from inputs costing $.71 ($.61 in electricity and $.10 in other costs). Yet FERC’s rule would cause the widget-maker to stop production. See J.A.193-194 (Hogan, Implications for Consumers of the NOPR’s Proposal To Pay the LMP for All Demand Response). The pro-competition, consumer- protective Federal Trade Commission made precisely that point: Paying full LMP would “give the wrong in- centives” by “creatiing] situations in which a demand- response provider would find it more profitable to sell its power rights (z.¢., provide demand response) than to con- sume that power, even though the value to society of con- suming that power exceeds the power’s cost to society.” J.A.282-283.5 The suggestion that widget-makers may defer produc- tion (rather than ceasing production), Priv. Pet. Br. 54, is no answer. Overcompensating demand response encour- ages curtailed consumption even when the social cost— whether of shifting or ceasing production—exceeds the social benefit. Changing the subject cannot change the calculation. * If LMP declines because of demand response, the calculations be- come more complex, but the result is unchanged: Demand- responders curtail consumption even when that harms social welfare. The same is true for behind-the-meter generation, discussed pp. 18- 20, infra. See J.A.193-194 (Hogan, Implications, supra). 18 3. The Rule Offers Arbitrary and Uneconomic Rewards Based on the Meter’s Location A proper pricing rule should provide the same incen- tive—to consumers and generators alike—to invest in generation facilities. In other words, the incentives “should be the same with respect to placing the genera- tor on the consumer side of the [electricity] meter versus [the grid] side of the meter.” C.A. App. 484 (Hogan, De- mand Response Pricing, supra). But FERC arbitrarily compensates users more handsomely for generating elec- tricity solely for their own behind-the-meter use, discrim- inating against plants that offer electricity into the grid. Returning to the widget-maker: Assume he can avoid drawing power from the public grid by building or oper- ating his own generator. In an efficient market, he would self-supply only when it costs less than purchasing elec- tricity. Thus, if self-generation costs $.60 per widget, he should not self-supply until LMP exceeds $.60. But un- der FERC’s approach, he would self-supply sooner. If his retail electricity rate is $.30 per widget, the widget- maker will self-supply when LMP hits $.31 per widget. He spends $.60 running his own generator instead of pay- ing $.30 retail, which would result in a net loss of $.30 per widget. But he then collects a demand-response payment of LMP, or $.31 per widget, for not buying the electricity from the grid. So he ends up $.01 ahead for each widget. Thus, even though the economic cost of self-generating electricity is almost double the grid price—$.60 per widget rather than LMP of $.31—the widget-maker will self-supply. And, under FERC’s rule, that self-supply would appear as a “reduction in electricity consumption” even though the demand-response payment “has merely moved the consumption somewhere where it is not visible to the RTO.” J.A.198 (Hogan, /mplications, supra). 19 The absurdity of that result crystalizes if one com- pares what would happen if the widget-maker offered the output of his generator into the market, rather than us- ing it himself. If (once again) self-generation costs $.60 per widget, and LMP is $.31 per widget, the widget mak- er cannot profit by selling self-generated electricity: It costs him $.60 to make something he can sell for only $.31. Plus he must still pay for any electricity he draws from the grid for his own use (at the retail rate of $.30 assumed above). But if he moves the generator behind the meter and keeps it for his own use, he does better. He gets paid $.31 per widget in demand-response pay- ments for not using electricity from the grid (instead generating it himself); and he saves the $.30 per widget he would have paid for the electricity he now generates for himself. Thus, even though total consumption in each example is identical, the result changes depending on who generates electricity and where it is metered or “seen.” Paying full LMP thus provides a subsidy for self- supply. Indeed, “whether full LMP constitutes a subsidy isn’t a serious economic question.” Newell, DR Distor- tion, 148 Pub. Utils. Fort. 36, 41 (2010). That behind-the-meter problem also provides “the: seeds of [the Final Rule’s] own demise.” J.A.200 (Ho- gan, Implications, supra). Inefficient demand-response payments “must be recouped somewhere.” /d. at 199. Under FERC’s approach, “every dollar of benefit gained by the wholesale buyers is expropriated” in the short- term “from the generators.” Borlick, Paying for De- mand-Side Response at the Wholesale Level: The Small Consumers’ Perspective, 24 Elec. J. 8, 16 (2011). That windfall for demand-responders will, in turn, “induce others to leave the [grid] system” and go behind-the- meter, creating an unsustainable inefficiency spiral. 20 J.A.200 (Hogan, Implications, supra). And that spiral will disproportionately affect “residential and small commercial consumers whose operations are not of suffi- cient size and scope” to warrant behind-the-meter self- generation, but who will ultimately pay the price for un- derinvestment in common generation units. /d. at 203. Rather than address that concern, FERC “assum/[ed] that consumers would not respond to these incentives to move generators behind the meter or operate inefficient backup equipment.” J.A.205. But large, industrial con- sumers often have that option, mostly through “diesel units that lack emissions controls.” J.A.1149 n.58 (Com- petitive Power Supplier Ass’ns). FERC agrees that de- mand-responders will self-supply using “standby genera- tor{s),” touting that as a “cost” they incur. U.S. Br. 54. And FERC offered no “evidence to support [a contrary] assumption.” J.A.205 (Hogan, /mplications, supra). Favoring behind-the-meter generation is thus “nothing less than a subsidy for dirty’"—and more costly— “generating resources.” Delaware Dep't of Natural Res. v. EPA, No. 13-1093, slip op. at 23 (D.C. Cir. May 1, 2015) (quotation marks omitted). And the disparity in compen- sation based on the meter’s location demonstrates the defect in FERC’s approach: It facially discriminates, and distorts the market, by favoring behind-the-meter ac- tions, including demand response, over in-front-of-the- meter activity like generation for public use. Il. EFFICIENT DEMAND-RESPONSE MECHANISMS REP- LICATE THE MARKET In an efficient market, real-time pricing would require consumers to pay for their marginal consumption. See C.A. App. 482 (Hogan, Demand Response Pricing, su- pra). If our widget-maker were required to pay LMP for his electricity, he would continue making widgets until 21 LMP brought his total costs—for energy and other in- puts—above the market price for widgets. He would not need demand-response payments to encourage him to decrease consumption when wholesale prices rise; he would do so whenever increasing input prices drive prof- its to zero. Absent real-time pricing, however, demand response can provide a second-best solution—if one avoids creat- ing subsidies. “Payments based on the LMP minus retail rate structure eliminate these subsidies.” C.A. App. 1143 (Dr. Shanker). That mechanism is known as “LMP- minus-G,” where “G” is the full retail rate the consumer would have paid for electricity. That methodology gives demand-response providers incentives that parallel those in competitive, real-time electricity markets. See C.A. App. 1139 (Shanker, supra); Newell, supra, at 37. For example, if a consumer has a contract right to purchase electricity at a particular rate, it might pur- chase electricity and, in turn, sell it to others at LMP. If our widget-maker had a retail contract allowing him to purchase electricity at $.30 per unit, and LMP rose to $.91 per unit, he could stop production, exercise the im- plicit option to buy electricity for $.30, and sell the elec- tricity at $.91, yielding a profit of $.61 per unit. “The net transaction for the customer would be the LMP minus the fixed price of the contract.” Hogan, Whitepaper, su- pra, at 13. LMP-minus-G mimics that result for demand re- sponse. It recognizes that “[e]conomic demand response isn’t a sale of energy; rather, it’s a sale of a call option on energy.” Borlick, Pricing Negawatts, supra, at 14. Like other call options, its value is measured by the value of the underlying good, less the cost of exercising the option (the strike price)—here, the retail rate for electricity. If 22 the retail price is lower than LMP, buyers can sell for a profit (LMP less the retail rate). Failing to subtract the retail rate, however, allows the consumer to sell its elec- tricity at full rates without exercising the option and thus without buying a key input. That induces demand- responders to sell load reductions, or self-supply, even when it is more efficient for them to purchase electricity from the grid. FERC previously recognized as much. See PJM In- terconnection, L.L.C., 99 FERC 961,227 at 61,941 (2002). Indeed, FERC refused to mandate payment of full LMP because it would create an excessive incentive to curtail demand. See PJM Indus. Customer Coal. v. PJM Inter- connection, L.L.C., 121 FERC 961,315 at P26 & n.20 (2007). The RTO, it explained, already “reimburses [de- mand-responders} for the difference between the whole- sale rate and their retail rate,” ie., LMP-minus-G. /d. at P26. “That payment provides customers under retail rates with the same economic incentive to curtail load as if they were paying the wholesale rate itself.” bid FERC did the math to prove that conclusion: It showed that LMP-minus-G gives demand-responders the same incentives as efficient wholesale rates—and why paying full LMP creates excessive incentives.‘ FERC thus la- * FERC stated: “The financial benefit [of reduced consumption] is comprised of two components: (i) the retail rate that is avoided by not consuming, and (ii) the payment received under the program, which is equal to the difference between the LMP and the retail rate.” PJM Indua., 121 FERC 161,315 at P26 n.19. Thus, “if the LMP is $600/MWh and the retail rate is $50/MWh, the customer who would receive a payment under the program of $550/MWh (ie., $600- $50), for a total financial benefit of $600/MWh, which is the value of the LMP.” /bid. Paying LMP, by contrast, would produce excessive 23 beled the payment of full LMP a “subsidy” that “could lead [consumers] to curtail cost-effective production.” /d. at P26 n.20. Today, FERC identifies no error in its for- mer math or economic analysis. Instead, it imposes pre- cisely the subsidy it previously rejected. The irony is that, by overcompensating demand re- sponse, FERC may doom truly efficient real-time pric- ing. The “technical barrier to dynamic pricing”— availability of time-sensitive metering for retail users— “should be lifted in the next five to 10 years.” Faruqui & Palmer, Dynamic Pricing and Its Discontents, 34 Regu- lation 16, 17 (2011). But overcompensated demand- responders have little incentive to change to a more effi- cient model that eliminates their windfall subsidies. Ill. CONTRARY ARGUMENTS ARE UNFOUNDED Petitioners and supporting amici offer several eco- nomic justifications for FERC’s full-LMP rule. None has merit. FERC did not rely on many of them. And many are naked requests for subsidies FERC never admitted providing, in never-justified amounts, to overcome barri- ers FERC never found. A. FERC’s Own Arguments Show That Paying Full LMP Effects an Unjustified Subsidy FERC and its amici urge that FERC’s pricing mech- anism is efficient, while LMP-minus-G is not. But that consists mostly of assertion—not analysis. incentives: “{TJhe financial benefit for reducing consumption would exceed the LMP. That is, with the subsidy payment, the customer would receive a payment of $600/MWh (ie., the LMP) and in addi- tion would avoid the $50/MWh retail rate, for a total financial benefit of $650.” Ibid. 24 1. Critically, there is much FERC and its amici do not say. They nowhere deny that FERC’s pricing regime favors those who self-supply behind the meter over those who supply electricity to the grid for all. See pp. 18-20, supra. As the only economists to submit a brief below, we made precisely that point. C.A. Amicus Br. of Lead- ing Economists 20-23. We made that point before FERC. See, e.g., J.A.196-205; see also pp. 2, 18-20, su- pra. No one offers an answer; none exists. Likewise, no economist seriously addresses the skewed incentives that paying LMP produces. See pp. 16-17, supra.° Ine vad, FERC relies almost exclusively on a submis- sion by Dr. Alfred Kahn, see Pet. App. 97a-98a, 101a, 214a, 217a-218a, which posits that demand response “is in all essential respects economically equivalent to supply response” (i.e., increased generation) and should be com- pensated accordingly. Pet. App. 69a-70a. As FERC characterizes that theory, “reduction in demand provides the same benefits to a wholesale system as an equivalent increase in supply” and should “be compensated equiva- lently.” U.S. Br. 47-48, 52-53 (invoking Dr. Kahn). * At times, FERC seems to embrace its refusal to address these costs. The “Final Rule does not attempt to measure what would have happened in a retail program,” FERC declares, because the sole focus was “the net price effect of paying the demand response resources the LMP in the wholesale market.” Pet. App. 238a (em- phasis added); see Cicchetti Br. 30; ECDRP Br. 26. But neither eco- nomics nor precedent allows FERC to wreak havoc on retail incen- tives—ignoring damage to total social welfare—by myopically focus- ing on FERC-regulated wholesale markets in isolation. FPC v. Conway Corp., 426 U.S. 271, 272-278 (1976). FERC must consider “the entire factual context in which the proposed wholesale rate will function,” which “will naturally include those related to nonjurisdic- tional transactions.” Jd. at 280 (quotation marks omitted). 25 The late Dr. Kahn was one of the great economists of his time. Nonetheless, the arguments now imputed to him do not withstand economic scrutiny, and he never had or took the opportunity to address the critique of his initial analysis. The cited submission ignores the fact that retail customers who curtail consumption in ex- change for demand-response payments receive two bene- fits. First, they benefit by avoiding the cost of purchas- ing electricity (a benefit generators do not receive). And they receive demand-response payments as well. When determining the compensation necessary to induce ap- propriate conduct, the effect of both benefits must be considered—as FERC previously recognized. See pp. 22 & n.4, supra. Professor Kahn’s submission ignores the cost avoided by not buying electricity at retail. Genera- ters, moreover, surrender electricity they own so others may use it, receiving full LMP for it. Traders buy elec- tricity on the market, pay for it, and sell that paid-for electricity at full LMP. But demand-responders do not offer electricity they own. They surrender the right to buy and use electricity generated by others. Yet FERC insists they be paid the same rate as someone who sells electricity he bought, paid for, and owns. No right-thinking economist would urge the market should pay a consumer who gives up a car he bought and owms the same price that would be paid to a consumer who never paid for or acquired a car but merely surren- ders the unexercised option of buying it. FERC’s order does just that. That difference makes the overcompensa- tion—and the subsidy—clear. Because a generator must produce electricity, its profit is not LMP. It is LMP mi- nus the costs incurred to deliver power, including all in- puts to its generation. As a result, “[tJhere is no need to deduct costs from the LMP payments made to genera- 26 tors because,” when they receive LMP, “they earn the net amount equal to LMP minus” the cost of creating the power they sell. C.A. App. 651 (NEPGA). 2. The government responds (at 54) that, because FERC “does not ordinarily take into account the costs of production when paying generators LMP, it would not take into account a demand-response provider’s costs ei- ther.” See also Priv. Pet. Br. 52-53; ECDRP Br. 21. If demand-responders were selling electricity they owned, as generators do, that would make sense. But demand- responders do not sell electricity they own. They sur- render only an option to buy electricity. By compensat- ing demand-responders as if they owned electricity and were reselling it, FERC makes them owners of electrici- ty for free. It is no different than if FERC decreed that coal-powered plants may sell electricity at full rates without paying for certain inputs. See pp. 14-16, supra. It is incongruous for a regulator like FERC to order the creation of a subsidy by giving one set of suppliers an in- put for free—treating them as owning electricity they did not buy—and then defend its order by saying it should never take costs into account. By doing so, FERC subsi- dizes demand response, forcing the system to “dispatch excessive and inefficient amounts” instead of generated electricity. Borlick, Pricing Negawatts, supra, at 17. 3. FERC’s purported concerns about “practical diffi- culties” are unfounded (even FERC conceded LMP- minus-G was “perhaps feasible,” Pet. App. 102a). Not one ISO or RTO—the entities that would implement this mechanism—suggested that LMP-minus-G would be problematic. PJM and the Midcontinent ISO already offset avoided retail costs with little practical difficulty. J.A.1173 n.117 (Competitive Power Supplier Ass’n). FERC cited the New York PUC’s assertion that sub- 27 tracting retail rates would be “an administrative burden” that could engender “confusion.” Pet. App. 76a; see U.S. Br. 58-59. But the New York ISO, which would imple- ment it, supported LMP-minus-G because it “avoids the need for [FERC’s] complicated and contentious net- benefits test and cost allocation rules.” C.A. App. 1153. B. Reliance on the Net-Benefits Test Underscores the Irrationality of FERC’s Approach Ultimately, virtually every defense of FERC’s orders falls back on FERC’s “net-benefits” test. That test re- quires each RTO or ISO to use “historical data,” and an indeterminate list of factors bearing on supply conditions (e.g., fuel prices and generator unit availability), to calcu- late the point at which consumer benefits from reduced LMP exceed the cost of paying LMP to demand-response providers. Pet. App. 56a-57a. 1. FERC’s need to overlay a net-benefits test repre- sents an admission that its basic pricing methodology is flawed. If paying full LMP produced appropriate pricing signals, FERC would not need to superimpose another test as a precondition for demand response. As the Fed- eral Trade Commission explained, “there is no need for a net benefits test so long as FERC utilizes efficient prices in compensating demand response providers”; “[tlhe proposal to implement a net benefits test *** arises *** only if FERC sets inefficiently high compensation levels for demand response.” C.A. App. 1180. FERC ignores the practical problems with its net- benefits test. That test assumes an omniscient regulator who can accurately predict when demand response is ap- propriate, rather than allowing rational price signals to achieve that result. To replicate the effects of price sig- nals, regulators would have to apply the net-benefits test for each proposed demand-response provider for each 28 transaction. It is far from clear that could be accom- plished accurately. Thus, a “clear majority of the wit- nesses (representing a spectrum of interests that includ- ed demand response advocates, economists, generators, and the RTOs and ISOs)” opposed the test, characteriz- ing it as exceedingly difficult to administer. Pet. App. 164a (Moeller, Comm’r, dissenting). And FERC’s reli- ance on unsubstantiated “practical difficulties” to reject LMP-minus-G, while simultaneously imposing a complex and difficult net-benefits test to mitigate the impact of its erroneous rule, is not reasoned decisionmaking. 2. Even if perfectly administered, FERC’s net- benefits test is fundamentally flawed. By its terms, the test precludes demand-response payments unless those payments lower the amount consumers pay for electrici- ty. See U.S. Br. 55-56; Priv. Pet. Br. 43; Cicchetti Br. 29- 30. FERC acknowledges that “[t]he cost allocation methodology required in the Final Rule is based upon the benefits of demand response to wholesale load”—e., customers. Pet. App. 248a (emphasis added); see id. at 234a (“net benefits test” met when demand-response “payment is a cost-effective purchase from the custom- er’s standpoint,” ie., “[wJhen reductions in LMP from implementing demand response results in a reduction in the total amount consumers pay * * * greater than the money spent acquiring those demand-response resources at LMP”) (emphasis added). The net-benefits test thus focuses exclusively on benefits to buyers, without looking to the impact on industry or society. That erroneously assumes that lower prices are al- ways beneficial. Manipulating markets to force prices below competitive rates may seem desirable for consum- ers in the short-run. But FERC has repeatedly held that artificially suppressed prices “deter investment in new 29 generation” and harm consumers in the long-run by “broadly hinder[ing] market development and perfor- mance.” Milford Power Co., LLC, 119 FERC 961,167 at P31 & nn.48-51 (2007) (listing cases). The net-benefits test, by myopically focusing solely on whether prices are lower rather than whether they are efficient, ignores that wisdom. Perhaps more important, the net-benefits test ignores half the societal benefits of economic activity. Any econ- omist examining pricing and production to maximize benefits to society will measure total social welfare. So- cial welfare consists of the sum of the consumer surplus (the difference between how much the consumer values a good and what he pays for it), plus the producer surplus (the difference between the cost of production and the price). Mankiw, Principles of Macroeconomics 148 (5th ed. 2009). Social welfare—societal benefit—is maximized when that sum is maximized. [bid. But FERC’s test looks only to consumer welfare— whether consumers end up paying less. See, e.g., Pet. App. 234a-235a (“When demand response produces a suf- ficient reduction in LMP to cover the increased billing costs imposed on remaining customers, it is beneficial to customers; when the reduction does not cover costs, the demand response is not beneficial.”); p. 28, supra. By do- ing that, FERC approves demand-response payments even where it lowers total social welfare (such as where the consumer benefit is merely a wealth transfer from producers). See Chao, Price-Responsive Demand Man- agement for a Smart Grid World, 23 Elec. J. 7, 17 (2010). Dr. Kolstad, while purpc:tiny to support the order, thus concedes that “the test focuses exclusively on consumers’ expenditures” and thus “cannot guarantee that compen- sating demand response at LMP optimizes overall social 30 welfare.” Kolstad Br. 17-18. That test thus contradicts both FERC’s understanding of its mandate, see pp. 7-8, 22, supra, and this Court’s as well: For more than half a century, this Court has emphasized that “FERC must choose a method that entails an appropriate ‘balancing of investor and consumer interests.” Morgan Stanley Capital Grp. Inc. v. Pub. Util. Dist. No. 1, 554 U.S. 527, 532 (2008) (quoting FPC v. Hope Natural Gas Co., 320 U.S. 591, 608 (1944)) (emphasis added); accord Permian Basin Area Rate Cases, 390 U.S. 747, 776 (1968). Because the net-benefits test looks at only half of that balance—the consumer interest in lower prices— Professor Cicchetti’s brief studiously avoids addressing total social welfare. Instead, he states that “economic efficiency [is] improved” in various situations “because buyers would pay less” despite the cost of “compen- sat{ing] providers” for demand response. Br. 25-26 (em- phasis added). The net-benefits test, he asserts, “prohib- its the dispatch of DRR that is not cost-effective from a buyer’s perspective.” Jd. at 27 (emphasis added). But efficiency is not the same as lower prices. Total social welfare is not the same as buyer welfare. And “balanc- ing” the interests of generators and consumers is not the same as ensuring consumers always pay less. Professor Cicchetti’s publications (unlike his brief) recognize that. Professor Cicchetti cites (at 2) a paper he co-authored with Dr. William Hogan, amicus here. That paper concludes that demand-response payments “equal to the utility’s marginal cost” of buying from the grid at LMP “would obviously be overkill. The conserver would be paid twice for the same decision, once when his/her bill was reduced [by the amount he conserved], and again when receiving a subsidy equal to avoided [wholesale] cost.” Cicchetti & Hogan, Including Unbundled De- 31 mand-Side Options in Electric Utility Bidding Pro- grams, Pub. Utils. Fort., June 8, 1989, at 9, 10. Critiqu- ing the payment of full LMP, he urged that the “incentive given the [demand-responder] is wrong. He is paid twice: once by giving him the dollars for the conservation *** again by providing a free service. This misplaced incentive could result in inefficient over-investment in conservation.” Jd. at 11; see pp. 16-17, supra.® Dr. Cicchetti may now believe that social goals justify inefficient pricing that lowers total welfare. But he never purports to pursue a goal other than efficient pricing. The same thing is true of FERC. Its stated goal was to “improve the competitiveness of the organized wholesale energy markets,” J.A.35, so as to “balance supply and demand,” Pet. App. 96a. With respect to that goal, Dr. Cicchetti’s scholarship, not his brief, is correct. * Dr. Cicchetti now offers a theory FERC never relied on, precluding its consideration here. See SEC v. Chenery Corp., 332 U.S. 194, 196 (1947). Nonetheless, his new theory shows why LMP-minus-G, not full LMP, produces efficient results. Because utilities pay end-users for the right to limit their consumption at key moments—allowing the utility to limit its purchases—itilities incur some costs. But that does not speak to the rate utilities should be paid. Where utilities are saving money by not buying expensive wholesale electricity for customers who would pay lesser retail rates, they save LMP simply by reducing their purchases. Dr. Cicchetti would have them receive a demand-response payment of LMP on top of that, making the ben- efit twice LMP, less forgone retail revenue. Moreover, Dr. Cicchetti concedes that “large industrial end-users” (or demand-response ag- gregators) who sell demand response directly into wholesale mar- kets “are an exception to” his critique. Cicchetti Br. 33 n.21. But Dr. Cicchetti does not explain why those suppliers should receive double payments. Moreover, if industrial end-users would receive only LMP-minus-G in an efficient market, the same should be true for other demand-responders. 32 3. FERC and its amici make various efforts to shore up FERC’s leaky economics, but they fail for similar rea- sons. For example, Professor Cicchetti and others assert that demand response “should enter the wholesale mar- ket whenever its marginal cost is less than the marginal cost of supplying electricity.” Cicchetti Br. 21; see EC- DRP Br. 22; U.S. Br. 48; Priv. Pet. Br. 47. True. But Dr. Cicchetti (and the others) ignore how FERC has distort- ed the concept of marginal cost. If demand-responders and generators were both bringing electricity to the market so others could use it, they each would bear the marginal cost of obtaining or generating that electricity; they would account for that cost when deciding when to enter the market. Under FERC’s order, generators and traders do that—they are not relieved of paying the costs of the electricity they generate (or buy) and then sell. But demand-responders receive full price for electricity they never buy. The marginal cost of demand response is thus effectively subsidized by FERC’s decree that they be treated as if they are selling electricity they own when they never buy or pay for it. Those subsidies for non-consumption significantly re- duce demand and lower prices. But “every dollar of ben- efit gained by the wholesale buyers is expropriated” in the short-term “from the generators.” Borlick, Paying for Demand-Side Response, supra, at 16. “[MJost of the parties advocating such a net benefits calculation explicit- ly base it on the ‘benefits’ of such price suppression.” C.A. App. 1141-1142 (Shanker, supra). If there are non- economic, policy reasons for artificially suppressing pric- es and establishing a one-sided test that ignores total so- cial welfare, regulators should acknowledge them and balance them against the resulting costs. Here, FERC did not do that. “[Ijn the long run,” the burden of its fail- 33 ure will not befall generators, RTOs or ISOs, or FERC. The costs will eventually be passed along to “residential and small business consumers,” which cannot provide demand response, but end up paying demand-responders to displace otherwise more efficient generation. Borlick, Paying for Demand-Side Response, supra, at 8. That “is inefficient for the economy as a whole, distorts produc- tion and consumption decisions, and raises prices in the long run.” C.A. App. 1142 (Shanker, supra); see Newell, supra, at 38. C. Petitioner and Its Amici Seek Subsidies Not Supported by the Record Finally, some parties urge that overcompensation is necessary to overcome putative “barriers to full demand response participation,” Priv. Pet. Br. 46-47, or to cover “the cost of technology” and “infrastructure” “necessary to participate in wholesale markets,” U.S. Br. 53-54, 55. Those are, at bottom, requests for a subsidy. Nothing in the record establishes the extent of any putative “barri- ers.” There is no finding that paying full LMP is cali- brated to overcome those “barriers.” And there is no analysis suggesting that demand-response providers face more significant “barriers” than new generators, who must invest in multi-year, multi-billion-dollar plants. Undoubtedly, FERC effected a subsidy for demand re- sponse. It just refused to admit or justify it. That is ar- bitrary and capricious." ’ Paying too much for demand response likewise is not calibrated to address any particular externality. See Borlick, Paying for De- mand-Side Response, supra, at 11. It “dof{es) nothing to induce elec- tricity suppliers to reduce the environmental externalities they im- pose on others.” Hogan, Whitepaper, supra, at 7. It merely induces generators to supply less energy—period. And because it encour- 34 The government also suggests (at 53-54) that FERC decided that higher payments were warranted to offset certain demand-responder costs, such as the cost of “ob- taining power from another source” (e.g., “standby gen- erators”) or the costs of “going without the foregone power in its production of goods.” See also Priv. Pet. Br. 55 (overcoming increased labor costs). Demand-responders do encounter costs when they curtail demand. See U.S. Br. 53-54; Priv. Pet. Br. 52-53; ECDRP Br. 22; Kolstad Br. 11. But they should consider those costs when deciding whether to curtail consump- tion. If those costs exceed the available payment for de- mand response, demand-responders should continue production (or should continue using electricity from the grid rather than switching to self-generation). Only if total benefits exceed total costs will curtailing production or shifting to self-generation benefit society as a whole. The problem with FERC’s position is that it establishes an incentive to move to behind-the-meter, stand-by gen- eration even when that costs more than electricity at market rates, or to cease or defer production when doing so damages total social welfare. See pp. 16-20, supra. FERC’s failure to confront those distortions dooms its order. CONCLUSION The judgment of the court of appeals should be af- firmed. ages unregulated behind-the-meter generation, overcompensating demand reduction may increase pollution. Respectfully submitted. JOHN LEE SHEPHERD, JR. JEFFREY A. LAMKEN SKADDEN, ARPS, SLATE, Counsel of Record MEAGHER & FLOMLLP MOLOLAMKEN LLP 1440 New York Ave.,N.W. The W: Suite 660 Washington, D.C. 20005 § 600 New Hampshire Ave., N.W. (202) 371-7338 Washington, D.C. 20037 (202) 556-2000 jlamken@mololamken.com Counsel for Amici Curiae September 2015 ADDENDUM la ADDENDUM LIST OF AMICI CURIAE' Robert L. Borlick is a Managing Director at Borlick Associates. He has more than 35 years’ experience in the electric power industry, and recently served as a con- sultant to the Demand Response Working Group of the Midcontinent Independent System Operator. He has held a number of positions at the United States Depart- ment of Energy, including Chief of the Economic and Financial Analysis Branch and Director of the Electric Power Analysis Division. Joseph Bowring is the President of Monitoring Ana- lytics, LLC, and the Independent Market Monitor for PJM Interconnection. He is the former Chief Economist for the New Jersey Department of the Public Advocate’s Division of Rate Counsel. He has taught economics as a member of the faculty at Bucknell University and Villa- nova University. James Bushnell is a Professor in the Department of Economics at the University of California, Davis. He is also a Research Fellow at the National Bureau of Econ- omic Research and a member of the Market Surveillance Committee of the California Independent System Oper- ator. He serves as an Associate Editor of the journal Operations Research. Paul A. Centolella is President of Paul Centolella & Associates, LLC. He is a member of the Secretary of Energy’s Electricity Advisory Committee, the National Institute of Science and Technology's Smart Grid Advisory Committee, and the National Academy of Sciences Committee on Adoption of Advanced Energy ' Institutional affiliations are listed for identification purposes only. 2a Efficiency & Clean Energy. He previously served as a Commissioner of the Public Utilities Commission of Ohio. Hung-po Chao is President of Energy Trading Ana- lytics, LLC. Previously, he served as Director of Market Monitoring and then Director of Market Strategy at ISO New England. Before that, he held various research management positions at the Electric Power Research Institute, and was a Consulting Professor at Stanford University. Ahmad Farugqui is a Principal at The Brattle Group. Formerly, he was Vice President of CRA International. He has edited or co-edited four books and authored or co- authored more than a hundred papers on energy effi- ciency, demand response, tariff design, and load fore- casting. His work has been cited in The Economist, The New York Times, USA Today, The Wall Street Journal, and The Washington Post, and he has appeared on Fox News and National Public Radio. Michael Giberson is Associate Professor of Practice, in the area of Energy, Economics, and Law, at the Rawls College of Business, Texas Tech University. Before that, he was a consultant at Potomac Economics, Ltd. He has worked with the Critical Infrastructure Protection Pro- ject and the Interdisciplinary Center for Economic Sci- ence at George Mason University. Dinos Gonatas is a Principal at CPG Advisors. He has worked extensively in the area of electric transmis- sion for wind power. Previously, he was a business devel- opment manager at Oxford Instruments, and a licensing officer at the Massachusetts Institute of Technology. He holds six U.S. patents in the area of synthetic fuel tech- nologies for coal and gas conversion. 3a Scott Harvey is a Consultant at FTI Consulting, Inc. He is currently a member of the California Independent System Operator’s market surveillance committee. He has consulted with the New York Independent System Operator on market design and performance issues since its inception. Benjamin F. Hobbs is the Theodore K. and Kay W. Schad Professor of Environmental Management at the Johns Hopkins University and Director of the Johns Hopkins Environment, Energy, Sustainability & Health Institute. He currently serves as the Chairman of the Market Surveillance Committee of the California Inde- pendent System Operator. William W. Hogan is the Raymond Plank Professor of Global Energy Policy at the John F. Kennedy School of Government, Harvard University, and Research Di- rector of the Harvard Electricity Policy Group. He has been actively engaged in the design and improvement of competitive electricity markets in many regions of the United States, as well as around the world. In the past, he was President of the International Association for Energy Economics. Joseph P. Kalt is the Ford Foundation Professor (Emeritus) of International Political Economy at the John F. Kennedy School of Government, Harvard Uni- versity. He is also Co-Director of the Harvard Project on American Indian Economic Development, and has pub- lished widely in the area of natural resources economics and policy. Robert J. Michaels is Professor of Economics at the California State University, Fullerton; Senior Fellow at the Institute for Energy Research; Adjunct Scholar at the Cato Institute; and an independent consultant. His 4a research on electricity markets frequently appears in academic and industry media. He has testified before state regulatory commissions, FERC, and Committees of Congress. Shmuel S. Oren is the Earl J. Isaac Professor in the Science and Analysis of Decision Making at the De- partment of Industrial Engineering and Operations Re- search, University of California at Berkeley. He is a for- mer member of the California Independent System Operator Market Surveillance Committee, and served as Senior Advisor to the Market Oversight Division of the Public Utility Commission of Texas. He has consulted on market design issues with ISO New England, Pacific Gas & Electricity, and other companies. David B. Patton is President of Potomac Economics. He currently serves as the Independent Market Monitor for Midcontinent Independent System Operator, the New York Independent System Operator, [SO New Eng- land, and the Energy Reliability Council of Texas. He is also a former Senior Economist at FERC, where he worked on issues such as transmission pricing. Craig Pirrong is Professor of Finance and Director of the Global Energy Management Institute at the Bauer College of Business, University of Houston. In the past, he has consulted for the New York Mercantile Exchange, the Chicago Board of Trade, the Chicago Stock Ex- change, and several electric utilities. Susan Liese Pope is Managing Director at FTI Con- sulting, Inc. She has more than 20 years’ experience in the electric power sector, and has worked with the New York Independent System Operator, PJM Interconnec- tion, the California Independent System Operator, the Midcontinent Independent System Operator, and other 5a RTOs to design rules for the operation of wholesale elec- tricity markets. Larry E. Ruff is an independent consultani. He was formerly Senior Vice President at National Economic Research Associates. He has advised governments and utilities in the United States, Canada, Europe, the Asia- Pacific region, and Latin America on competitive restruc- turing of electric and gas utilities. Richard Schmalensee is the Howard W. Johnson Professor of Management, Emeritus; Professor of Ap- plied Economics, Emeritus; and Dean, Emeritus at the Sloan School of Management, Massachusetts Institute of Technology. He is a fellow of the American Academy of Arts and Sciences. He is a former member of the Presi- dent’s Council of Economic Advisors. Roy J. Shanker is an independent consultant in ener- gy markets with over 40 years’ experience. He has been actively involved in the design, development, and conduct of the PJM and New York Independent System Operator markets since approximately 1995 when design efforts began. He also has had engagements involving the design and ongoing development of the Midcontinent Independent System Operator and ISO New England. He has been an invited speaker and frequently testifies before FERC. Vernon L. Smith is the George L. Argyros Endowed Chair in Finance and Economics at Chapman University and Professor of Economics and Law at the Dale E. Fowler School of Law at Chapman University. He was awarded the Nobel Memorial Prize in Economic Sciences in 2002. He is a founding member and President of the International Foundation for Research in Experimental Economics and a Senior Fellow at the Cato Institute. He 6a served as a consultant on the privatization of electric power in Australia and New Zealand and has partici- pated in numerous private and public discussions of ener- gy deregulation in the United States. Richard D. Tabors is President at Tabors Caramanis Rudkevich, and was previously President and Principal at Across the Charles. In the past, he was a senior lec- turer in technology and policy at the Massachusetts In- stitute of Technology. He received his Ph.D. from Syra- cuse University and holds an honorary D.Sc. from the University of Strathclyde, Glasgow, Scotland, where he was a visiting professor. --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0317%3A24. Public record. Not legal advice.