Amicus Curiae Brief — Fed. Energy Regulatory Comm'n v. Elec. Power Supply Ass'n, 135 S. Ct. 2049 (2015) (No. 14-840)

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FiLE:?

JUL 1S 7

Nos. 14-840 and 14-841 aE TES Sem

IN THE

Supreme Court of the United States

Federal Energy Regulatory Commission,

Petitioner,

Vv.

Electric Power Supply Association, et al.,

Respondents.

EnerNOC, Inc., et al.,

Petitioners,

Vv.

Electric Power Supply Association, et ai.,

Respondents.

On Writ of Certiorari to the United States Court

of Appeals for the District of Columbia Circuit

BRIEF OF STANFORD ECONOMICS

PROFESSOR CHARLES D. KOLSTAD AS

AMICUS CURIAE IN SUPPORT OF

PETITIONERS

Daniel Cullenward Wendy B. Jacobs

UNIVERSITY OF Counsel of Record

CALIFORNIA, BERKELEY Ari Peskoe

452 Sutardja Dai Hall EMMETT ENVIRONMENTAL

Berkeley, CA 94720 LAW & POLICY CLINIC

HARVARD LAW SCHOOL

6 Everett St., Suite 4119

Cambridge, MA 02138

(617) 496-2058

wjacobs@law.harvard.edu

i

TABLE OF CONTENTS

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INTEREST OF AMICUS CURIAE ...........c...0cccccc00000 l

SUMMARY OF ARGUMENT .....00000.0....ccccccecceeeeeeeees 2

TED astcsiinisahintinnsticiiininiiimeiitenieacicimpiginiinmniinnstianiins 3

I. Encouraging Demand Response in Wholesale

Electricity Markets Benefits All Consumers.....3

Il. FERC Received Conflicting Comments from

Leading Economists Regarding the Appropriate

Demand Response Resource Compensation

Level and Made a Carefully Reasoned Choice...7

A. FERC Received Conflicting Comments

from Leading Economists Regarding the

Appropriate Compensation Level............... )

B. FERC’s Decision to Adopt LMP

Compensation for Demand Response

Resources is Carefully Reasoned and

STITT iiscshisohistiandidnnenenieinniciinisatidintivdeiaiendemneees 12

III. FERC’s Net Benefits Test Reflects the Debate

about LMP Compensation and Ensures That

Consumers Benefit from Demand Response

Resources Paid at LMP....................ssssccssssssserees 15

Eee 19

‘

TABLE OF AUTHORITIES

Cases

Am. Gas Ass'n v. FERC,

693 F.3d 14 (D.C. Cir. 2010) .................ccccecccceseseees 8

Statutes

Administrative Procedure Act,

4 2 (8 | —_ EARS UCM mee eae snes 8

Federal Power Act,

Eo ee 8

Regulations and Administrative Materials

18 C.F.R.

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§ B5.28(b)(5)......-cceccecsescesscsseseccsccsessessessucsessucssecneeneee 4

§ 35.28(g)(1)(V)......-ceccecoecoscoecoecsesceccessecseccessuecnecaeensee 7

§ 35.28(g)(1)(V)(A).....ecceccecsecoescecsecssecseesecsesneceees 15, 16

§ 35.28(g)(1)(V)(B).....cecccesccecsecsecssesseessecsvecseesseeeveee 16

1

INTEREST OF AMICUS CURIAE'

Professor Charles D. Kolstad of Stanford Univer-

sity is an internationally known environmental econ-

omist with a focus on industrial organization, public

economics, and energy markets. He is a former pres-

ident of the Association of Environmental and Re-

source Economists (AERE). Prior to joining Stanford

in 2012, he was on the faculty of the University of

California, Santa Barbara, where he was Chair of

the Department of Economics and a Bren Distin-

guished Professor of Environmental Management.

Professor Kolstad is also a University Fellow at Re-

sources for the Future (Washington, DC), a Fellow of

CESifo (Munich, Germany) and a Research Associate

at the National Bureau of Economic Research (Cam-

bridge, MA).

As an academic economist concerned with the de-

sign of energy markets, Professor Kolstad has an in-

terest in the use of economic analysis in FERC’s Or-

der 745 and in the subsequent judicial review of that

order. Accordingly, this brief addresses only the se-

cond of the two questions presented to this Court:

whether the Court of Appeals erred in holding that

the rule issued by the Federal Energy Regulatory

Commission is arbitrary and capricious.

! All parties have consented to the filing of this brief and copies

of their consent letters have been filed with the Clerk. Pursuant

to Rule 37.6, counsel certifies that this brief was not authored

in whole or in part by counsel for any party, and that no person

other than amicus or his counse] made a monetary contribution

to its preparation or submission.

2

SUMMARY OF ARGUMENT

Properly enabling demand response resources to

compete with electricity generators in wholesale

markets benefits all consumers. It also requires eco-

nomically complex market design choices.

In developing Order 745, entitled Demand Re-

sponse Compensation in Wholevale Energy Markets,

the Federal Energy Regulatory Commission (FERC)

invited and received comments from leading energy

economists regarding the appropriate compensation

level for demand response resources. Although the

experts did not agree, FERC explicitly addressed the

conflicting comments it received and made a careful-

ly reasoned choice: Order 745 requires wholesale

markets to pay demand response resources using lo-

cational marginal prices (LMP), rather than LMP

minus the retail price of electricity (LMP-G) or some

other measure.

Acknowledging the conflicting testimony it re-

ceived on this question, FERC included a net benefits

test that makes Order 745’s compensation level

(LMP) conditional on delivering net benefits to con-

sumers. This test helps mitigate concerns that LMP

overcompensates demand response resources by en-

suring that Order 745’s application results in net

benefits to consumers as a class.

The administrative record confirms that FERC

thoroughly reviewed conflicting expert opinions in a

highly technical regulatory process, provided a de-

tailed and logical rationale for adopting one compen-

sation level rather than another, and added a pre-

cautionary net benefits test to ensure consumer ben-

efits in light of conflicting expert opinion. In short,

3

Order 745 is well reasoned and neither arbitrary nor

capricious.

ARGUMENT

I. Encouraging Demand Response in

Wholesale Electricity Markets Benefits All

Consumers

On a muggy August afternoon in Washington,

D.C., people across the nation’s capital turn up their

air conditioning systems to escape the sweltering

heat. Demand for electricity skyrockets. Wholesale

electricity market operators—who have the task of

balancing supply and demand in real-time, literally

at the speed of light—respond by calling on addition-

al suppliers to generate sufficient energy to meet

demand. Because market operators dispatch electric-

ity resources based on their relative costs, with the

lowest-cost resources dispatched first, wholesale

electricity prices can rise quickly as demand for elec-

tricity increases.

During the worst summer heat, all available low-

cost power plants are already running at full output,

requiring market operators to call on the most ineffi-

cient and expensive generation resources to match

rising demand. These so-called peaker plants sit idle

for much of the year and are activated only in mo-

ments of peak electricity demand. They require more

fuel (and often generate more pollution) per unit of

electric output than do power plants engineered to

operate on a more frequent basis, leading to higher

operating costs. In turn, market operators rarely call

on them, so their owners must recoup the entire cap-

ital cost of their investment through high-priced

sales made in a handful of hours, during a few days

4

each year. As a result, peaker plants are the most

expensive suppliers of electricity.

In a wholesale market without demand response

resources, market operators have no choice but to

call on expensive peaker plants to meet peak de-

mand. This raises prices for all consumers because of

the way wholesale electricity markets work. All gen-

erators, including peaker plants, submit bids to the

market operator that reflect the lowest price they

would be willing to accept to generate energy; peak-

ers submit comparatively high bids that reflect their

high operating costs. Critically, all dispatched re-

sources are paid the same market-clearing price—

known as the locational marginal price (LMP), which

varies by location according to generation costs and

transmission constraints.

Thus, on that hot afternoon in August when

peaker plants are needed to meet demand, the

wholesale market price spikes to induce peaker

plants to operate. The resulting high market price is

a boon for more efficient generators, but is costly to

electricity consumers.

Enter demand response, which FERC regulations

define as a “reduction in the consumption of electric

energy by customers from their expected consump-

tion in response to an increase in the price of electric

energy or to incentive payments designed to induce

lower consumption of electric energy.” 18

C.F.R. § 35.28(b)(4). Similarly, a demand response

resource is a “resource capable of providing demand

response.” Id. at § 35.28(b)(5).

Rather than dispatching expensive peaker plants

to generate more electricity, market operators can

5

call on demand response resources to reduce system-

wide consumption. If demand response resources are

willing to accept a lower price than peaker plants,

the resulting market price will be lower than in a

market without demand response, thereby saving

consumers money.

Under ideal market conditions, economic theory

states that a consumer’s voluntary choice to buy a

product indicates he is willing to pay at least as

much as the price he paid. But wholesale electricity

markets are far from perfect. Many wholesale mar-

ket customers, such as electric utilities, pass their

full costs on to their ultimate customers via average,

time-invariant prices; this pricing regime reduces the

potential for consumers to rationally respond to the

real-time prices available in wholesale electricity

markets. As FERC noted in Order 745, “demand re-

sponsiveness to price changes is relatively inelastic[{?]

in the electric industry and does not play as signifi-

cant a role in setting the wholesale energy market

price as in other industries.” Pet. App. 96a (§ 57).

Thus, FERC chose to encourage a more dynamic re-

sponse from wholesale electricity market consumers

and, in turn, to achieve a more economically efficient

outcome.

If permitted, demand response resources can bid

into wholesale markets in one of two ways. First,

some large firms that consume significant quantities

of electricity are able to reduce demand at a scale big

enough to sell directly into the wholesale market.

Consider a large commercial retailer that has in-

2 Demand for a certain product is said to be “inelastic” if a

change in price leads to little or no change in demand.

6

store refrigerated storage for food and other perisha-

bles. The retailer could anticipate sweltering tem-

peratures and pre-cool its well-insulated refrigera-

tion systems before power prices spike in the after-

noon heat, allowing the company to reduce its power

demand when air conditioning at homes and offices

is needed most.

Second, although many firms (and most residen-

tial consumers) are too small to generate significant

demand response resources on their own, they can

participate in wholesale electricity markets via a

demand response aggregator—a third party that ag-

gregates individual customers’ savings and bids

them as a block into the wholesale market. With a

proper market design in place, demand response ag-

gregators can develop innovative business models to

coordinate such demand response resources using

internet-enabled appliance controls and other ad-

vanced technologies. For example, a demand re-

sponse aggregator could conceivably pre-cool the re-

frigerators of many willing individual homeowners,

delivering a significant demand response resource by

coordinating many smaller actions.

Allowing demand response resources to compete

with generators in wholesale electricity markets can

help correct for market failures present in today’s

electricity system, reduce peak prices, and enable a

more economically efficient overall outcome. These

are the fundamental goals of Order 745, which estab-

lishes a standard market design that opens all orga-

nized wholesale electricity markets to competition

from qualified demand response resources. Id. at

54a-55a (4 2). Notably, dissenting FERC Commis-

sioner Moeller himself acknowledged the benefits of

7

a well-designed demand response policy in wholesale

electricity markets:

While the merits of various methods for com-

pensating demand response were discussed at

length in the course of this rulemaking, no-

where did I review any comment or hear any

testimony that questioned the benefit of hav-

ing demand response resources participate in

the organized wholesale electricity markets.

On this point, there is no debate.

Id. at 156a.

Thus, when reviewing the technically complex

features of Order 745’s market design—and in par-

ticular, the compensation level awarded to demand

response resources—the Court should be mindful

that FERC’s overarching goal of encouraging addi-

tional demand response activity in wholesale mar-

kets met with remarkably broad support in the ad-

ministrative record. Leading experts (and FERC

Commissioners) differ only as to how best to imple-

ment that goal.

Il. FERC Received Conflicting Comments from

Leading Economists Regarding the

Appropriate Demand Response Resource

Compensation Level and Made a Carefully

Reasoned Choice

Order 745 requires wholesale electricity market

operators? to compensate qualified demand response

resources that successfully bid into the market at the

standard wholesale market price. 18 C.F.R.

3 These entities are known as Regional Transmission Organiza-

tions (RTOs) and Independent System Operators (ISOs).

8

§ 35.28(g)(1)(v). In industry parlance and throughout

the record, this price is called LMP, a technical term

that refers to the time-variant, location-specific pric-

es found in wholesale auction markets regulated by

FERC.‘

The D.C. Circuit vacated Order 745 chiefly be-

cause it found that FERC lacks jurisdiction to regu-

late demand response in wholesale electricity mar-

kets and, in the alternative, because the Order was

arbitrary and capricious for failing to provide a “di-

rect response” to questions raised by dissenting

Commissioner Moeller. Pet. App. 16a (citing Am. Gas

Ass'n v. FERC, 593 F.3d 14, 20 (D.C. Cir. 2010)).

Specifically, the lower court criticized FERC for not

addressing the argument that LMP “overcompen-

sat{es]’ demand response resources.” Jd. at 15a (quot-

ing id. at 273a). Finding that an overcompensating

rate can never be “just and reasonable” as required

under the Federal Power Act, 16 U.S.C. § 824d(a),

the D.C. Circuit indicated that if it needed to reach

the question, it would find Order 745 arbitrary and

capricious under the Administrative Procedure Act.

Pet. App. 15a-17a (citing 5 U.S.C. § 706(2)(A)).

On this point, the lower court erred. In its final

order, FERC did directly address Commissioner

Moeller’s concerns in the course of analyzing both

sides of an expert debate over the appropriate com-

pensation level for demand response resources. The

4 Wholesale auction markets are the markets run by RTOs and

ISOs under FERC’s supervision. FERC also regulates bilateral

wholesale transactions, which operate under different pricing

arrangements. Order 745 does not apply to these bilateral

transactions.

9

Commission explicitly responded to comments that it

should adopt alternative compensation levels, includ-

ing the one Commissioner Moeller preferred, and

based its final selection of LMP as “just and reasona-

ble” on evidence in the record submitted by credible

experts.

A. FERC Received Conflicting Comments

from Leading Economists Regarding the

Appropriate Compensation Level

Although FERC received over 3,800 pages of

comments and hosted a technical conference on its

proposed regulation, the D.C. Circuit undertook only

a cursory, two-paragraph analysis of the administra-

tive record. Compare Pet. App. 53a-54a (J 1) with Jd.

at 15a-16a. A thorough review of the final rulemak-

ing reveals the very elements the D.C. Circuit

thought to be missing. Specifically, the Commission

prepared a lengthy summary of the major issues, in-

cluding significant deliberation over the appropriate

compensation level to award demand response re-

sources and how to ensure that the outcome benefits

consumers. Jd. at 67a-119a (4 18-85).

The heart of the debate concerns the compensa-

tion level Order 745 sets for qualified demand re-

sponse resources. On this question the Commission

received and considered conflicting testimony abcut

demand response compensation from multiple par-

ties, including two of the world’s leading authorities

on regulatory economics—Professors Alfred E. Kahn

and William W. Hogan.

Dr. William W. Hogan, the Raymond Plank Pro-

fessor of Global Energy Policy and Director of the

Electricity Policy Research Group at the John F.

10

Kennedy School of Government at Harvard Universi-

ty, submitted comments on behalf of respondent

Electric Power Supply Association.

Dr. Hogan’s primary concerns with Order 745’s

compensation level reflect the complex relationship

between wholesale and retail electricity markets. A

consumer who curtails her consumption benefits by

avoiding payment of the retail price of electricity (G).

Under Order 745, the consumer—or the demand re-

sponse aggregator with whom she is under con-

tract—also receives the wholesale market price

(LMP) for providing a demand response resource, re-

sulting in a total compensation of LMP+G. Dr. Ho-

gan refers to this outcome as “double-payment.” /d.

at 73a-74a (4 24). Because this price level would en-

courage a consumer to avoid consumption that she

values at more than LMP but less than LMP+4G, it

could cause the inefficient curtailment of economical-

ly beneficial electricity consumption. Jd. Accordingly,

Dr. Hogan expressed his preference for establishing

alternative compensation levels. For example, he

suggested FERC could set compensation at LMP-G,

a level that would ensure that the wholesale price for

demand response (LMP-G) plus the avoided retail

costs (G) would equal the marginal] wholesale price

(LMP) awarded to generators. Jd. at 76a (§ 27).

Commissioner Moeller cites these same concerns in

his dissent, expressing a strong preference for com-

pensating demand response resources at LMP-G ra-

ther than LMP. /d. at 163a (citing Dr. Hogan’s “dou-

ble-payment” critique as evidence of overcompensa-

tion and therefore a failure to establish “just and

reasonable” rates under the Federal Power Act); id.

at 172a (expressing a preference for LMP-G).

11

Taking the opposite position, the late Dr. Alfred

E. Kahn, formerly the Robert Julius Thorne Profes-

sor Emeritus of Political Economy at Cornell Univer-

sity, commented on behalf of demand response pro-

viders in support of LMP compensation.

The fundamental premise of Dr. Kahn’s argument

is that when balancing supply and demand in a

wholesale electricity market, increasing supply by

generating one additional megawatt-hour is no dif-

ferent than reducing demand by the same amount.

Viewing demand-side resources as economically

equivalent to supply-side resources, Dr. Kahn argued

that both demand response providers and power

plant generators should receive equal compensation

at LMP. Id. at 69a-70a ({ 20).

Dr. Kahn also addressed Dr. Hogan’s concerns

about “double-counting” consumer benefits under

LMP compensation, pointing out that a similar phe-

nomenon affects producers. He agreed that although

consumers avoid the cost of retail power (G), produc-

ers also save money since they no longer face the cost

of generating the electricity consumption avoided

through demand response. Jd. at 78a (§ 31). Fur-

thermore, Dr. Kahn disputed the argument that gen-

erators are “incomparably saddled” with the costs of

generating power under FERC’s formulation, as the

D.C. Circuit later concluded. Id. at 16a. While gener-

ators who receive LMP compensation face costs re-

lated to generating power—such as purchasing fuel

and paying for the capital costs of their power

plants—so too do demand response aggregators, who

expend labor and capital costs developing sophisti-

cated business models and deploying advanced tech-

nologies to deliver demand response resources. /d. at

12

78a (¥ 31) (“successful bidders for the opportunity to

induce [demand response] are compensated for the

cost of those efforts”). Like supply side resources,

demand response resources incur costs.

B. FERC’s Decision to Adopt LMP

Compensation for Demand Response

Resources is Carefully Reasoned and

Rational

As evidenced by the debate between these two

world-class experts, FERC received conflicting testi-

mony on the best mechanism for compensating de-

mand response resources in wholesale markets. In-

deed, this was the first observation FERC made in

its final determination. Jd. at 89a (4 45) (“The Com-

mission acknowledges the diverging opinions of

commenters regarding the appropriate level of com-

pensation for demand response resources”). After re-

viewing the issues raised by Dr. Kahn, Dr. Hogan,

and other commenters, the Commission then offered

three valid reasons for selecting LMP instead of

LMP-G.5

First, FERC concluded that paying demand re-

sponse resources LMP “will compensate those re-

sources in a manner that reflects the marginal value

of the resource to each [wholesale market operator].”

Id. The Commission also cited:Dr. Kahn’s argument

that LMP compensates demand response resources

“on a competitive par” with generators. Jd. at 10la

(¥ 61). Under this view, LMP provides equal treat-

ment to demand response resources and traditional

5 The Commission's determination discussed a number of other

technical issues in Order 745, which are omitted here for brevi-

ty. See Pet. App. 89a-104a (FJ 45-67).

13

generation resources. Just as it would be wrong for

FERC to provide one level of compensation to natu-

ral-gas-fired power plants and another to coal-fired

generators, the Commission reasoned that would it

be equally wrong to compensate supply- and de-

mand-side resources at different levels. Jd. at 101a-

102a (§ 62) (citing FERC’s existing policy of award-

ing LMP to all generators whose bids clear the mar-

ket, regardless of technology or fuel source).

Second, FERC identified the presence of market

barriers that reduce the contribution of demand re-

sponse below its theoretical economic potential—

notably, the inability of many wholesale market con-

sumers to pass real-time costs on to retail consum-

ers. Id. at 96a-99a (99 57-59) (discussing market

barriers in detail). FERC concluded that compensat-

ing demand response resources at LMP “can address

the identified barriers to potential demand response

providers.” Jd. at 99a (§ 58). In turn, “[r]jemoving

barriers to demand response will lead to increased

... participation of demand response resources” and

achieve wholesale market prices that are “closer to

the levels that would result if all demand could re-

spond to the marginal cost of energy.” Jd. at 99a

(4 59).

Third, FERC concluded that Order 745 ensures

more consumer benefits than costs by conditioning

payment of LMP to demand response resources on a

net benefits test. Jd. at 90a-91a (4 47). Section III of

this brief, below, describes the test and its effects in

detail; as designed, the test guarantees that consum-

ers derive an overall benefit from compensating de-

mand response resources at LMP.

14

Ultimately, FERC’s decision to compensate de-

mand response resources at LMP levels is a carefully

reasoned decision, not an arhjtrary and capricious

one. As the discussion above indicates, if one is will-

ing to “delve ... into the dispute among experts,” a

review of the record in FERC’s Order 745 provides a

“direct response” to Commissioner Moeller’s con-

cerns. Jd. at 16a (citations omitted). Indeed, as Judge

Edwards pointed out in his dissent below,

“[w]hatever policy disagreements one might have

with Order 745’s decision to compensate demand re-

sponse resources at the LMP (and there are legiti-

mate disagreements to be had), the rule does not fail

for want of reasoned decisionmaking.” Jd. at 47a

(Edwards, J., dissenting).

Given the divide in the record over the correct

compensation level for demand response in wholesale

markets, FERC had reasonable grounds to require

either LMP or LMP-G, or to explore other compensa-

tion arrangements. The Commission’s selection of

LMP is based on a careful review of the arguments

for and against this level and reflects a logically valid

view of the hkely impacts of Order 745 on wholesale

electricity markets. Consistent with Judge Edwards’s

view, one need not agree with FERC’s decision to

find it well reasoned. Had FERC selected LMP-G, as

respondent Electric Power Supply Association and

dissenting Commissioner Moeller would have pre-

ferred, one could imagine an equally vigorous dissent

from another Commissioner highlighting the benefits

of full LMP See id. at 73a (§ 24, n.57) (citing Electric

Power Supply Association’s comment supporting

LMP-G); id. at 172a (indicating dissenting Commis-

sioner Moeller’s preference for LMP—G over LMP).

15

Order 745 raised technically complex issues, in-

cluded extensive deliberation over the appropriate

compensation level for demand response resources,

and offered a carefully articulated set of reasons to

support FERC’s decision. It therefore exemplifies ex-

actly the kind of detailed energy market design deci-

sions that should be made by the Commission, not

the courts.

III. FERC’s Net Benefits Test Reflects the

Debate about LMP Compensation and

Ensures That Consumers Benefit from

Demand Response Resources Paid at LMP

Recognizing divergent points of view among

commenters on the appropriate compensation level

for demand response resources, FERC conditioned

payment of LMP to demand response resources on

satisfaction of a “net benefits test” submitted by each

wholesale electricity market operator and approved

by the Commission. 18 C.F.R. § 35.28(g)(1)(v)(A).

Under the test, Order 745 requires that demand re-

sponse resources receive LMP only when the market-

clearing price is sufficiently high to ensure that

payments for demand response resources are smaller

than the corresponding reduction in consumer ex-

penditures. Pet. App. 114a-115a (4 79).

Although at first glance the net benefits test

might seem complicated, it is actually quite simple.

Demand response lowers the demand for electricity

from a relatively high amount (Q®) to a relatively

lower amount (QPF), with a net reduction in con-

sumption (AQ = QH — QP®). Due to lower demand,

the market-clearing price falls from a relatively

higher price (LMP#) to a relatively lower price

(LMP°®), with a net reduction in price (ALMP =

16

LMP — LMP). But demand response resources

must be paid, too. Order 745 requires that wholesale

market consumers compensate demand response re-

sources at the market-clearing price. 18 C.F.R.

§ 35.28(g)(1)(v)(B). As a result, demand response re-

sources cost consumers LMP?F x AQ but save con-

sumers ALMP x QDR.

FERC’s net benefits test requires that the total

reduction in consumer expenditures exceeds the total

cost of compensating demand response resources:

ALMP x QDR > LMPDR x AQ

See Pet. App. 115, n.162. In turn, FERC’s methodol-

ogy requires each wholesale market operator to iden-

tify the threshold market-clearing price above which

this inequality holds true, based on the specific con-

ditions of each market. Jd. at 114a-117a (¥ 79-81).

Conversely, when market-clearing prices are below

the threshold price identified by the net benefits test,

Order 745’s requirement to compensate demand re-

sponse resources at LMP does not apply. 18 C.F.R.

§ 35.28(g)(1)(v)(A). When demand response passes

the net benefits test, demand response resources are

compensated at LMP and reduce wholesale market

prices. Consumers benefit from reduced expendi-

tures, resulting in an increase in their overall eco-

nomic welfare.

As with the choice of compensation level, there is

also some debate in the record over FERC’s use of

the net benefits test. This debate is best understood

in the light of the conflicting viewpoints articulated

by Dr. Kahn and Dr. Hogan. By choosing LMP coni-

pensation, FERC aligned itself with Dr. Kahn for the

reasons discussed above. But others, including Dr.

17

Hogan, argued that LMP-G is the economically op-

timal price signal and therefore compensation at

LMP would be economically inefficient. As FERC

acknowledged, those who prefer LMP-G argue that

under their approach there would be no need for a

net benefits test because LMP-G would send the

economically optimal price signal to market partici-

pants without additional policy safeguards. Pet. App.

117a (¥ 82). Having established its rationale for

awarding full LMP compensation, however, FERC

noted that it saw “no reason to reduce that compen-

sation simply to avoid the use of the net benefits

test.” Id.

A net benefits test is a sensible way of dealing

with the conflicting testimony the Commission re-

ceived over the proper compensation level for de-

mand response resources. Notably, combining a net

benefits test with LMP compensation addresses and

mitigates FERC’s critics’ most pressing concerns. In

short, the net benefits test is designed to ensure that

consumers are made better off under Order 745.

It is worth noting that although FERC refers to

its approach as a “net benefits test,” it would be more

accurate to describe it as a “static consumer expendi-

ture test.” This is because the test focuses exclusively

on consumers’ expenditures—in economic terms, a

sufficient condition to ensure that consumers’ welfare

is enhanced, but an incomplete picture of how the

welfare of all market participants, including produc-

ers, is affected. The test is static, as opposed to a dy-

namic, in that the test methodology is based on his-

torical market conditions. See id. at 116a-117a

(J 81). Recognizing the limitations of a static analy-

sis, FERC wisely required wholesale market opera-

18

tors to study implementation of dynamic methods to

integrate demand response resources into the mar-

kets’ electricity dispatch algorithms. Jd. at 118a-119a

(J 84). While a static expenditure-based test cannot

guarantee that compensating demand response re-

sources at LMP optimizes overall social welfare, it

safeguards against the possibility of overcompensat-

ing demand response resources to the detriment of

consumers as a group.

The net benefits test is designed to guarantee

lower market prices, resulting in ber efits to consum-

er welfare. Producers receive less income due to low-

er market prices, reducing their welfare. Demand re-

sponse aggregators welfare increases, however, due

to compensation at LMP under Order 745. Without

additional information about market conditions, the

expenditure analysis in FERC’s net benefits test

cannot tell us whether the gains in consumer and

demand response aggregators’ welfare are greater

than or less than the loss in producer welfare; how-

ever, we can be confident that this approach will in-

crease consumer welfare, so long as it is properly ex-

ecuted by wholesale market operators.

Because the net benefits test is designed to en-

sure that consumers save more money from lower

wholesale market prices than they pay to compen-

sate demand response resources and because the

Commission relied on this finding, FERC’s decision

to compensate demand response resources with LMP

is rational and carefully reasoned.

19

CONCLUSION

For the foregoing reasons, the judgment of the

court of appeals should be reversed.

Respectfully submitted,

Wendy B. Jacobs

Counsel of Record

Ari Peskoe

EMMETT ENVIRONMENTAL

LAW & POLICY CLINIC

HARVARD LAW SCHOOL

6 Everett St., Suite 4119

Cambridge, MA 02138

(617) 496-2058

wjacobs@law.harvard.edu

Daniel Cullenward

BERKELEY ENERGY AND

CLIMATE INSTITUTE

UNIVERSITY OF CALIFORNIA,

BERKELEY

425 Sutardja Dai Hall

Berkeley, CA 94720

Counsel for amicus curiae

Charles D. Kolstad

JULY 16, 2015