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A Sensible Decision On Regulatory Power

Electricity is more or less the most difficult commodity to manage.

Supply and demand must be matched on a minute-by-minute basis. Unlike oil, natural gas or steel, electricity cannot readily be stockpiled for future use. Instead, producers must generate the exact amount of power necessary to meet the grid’s demand, which varies in real time.

Federal law lets the Federal Energy Regulatory Commission regulate wholesale electricity prices in order to keep the electricity supply stable. This creates a pretty sweet deal for power producers. On a given day, the grid needs a certain amount of available power to meet the anticipated demand. Wholesalers bid to provide the lowest price. Each wholesaler can only deliver a finite amount of power, so the grid operators start at the lowest bid and work their way upward, at successively higher prices, until they have enough committed power to meet the day’s expected needs.

The wholesaler who bids lowest gets a big benefit in this arrangement, because all the wholesalers whose bids are accepted are paid the same amount as the seller with the highest accepted bid. This means consumers do not benefit from the fact that some wholesalers were willing to provide power at a lower price than the one ultimately set.

One way to put consumers on an even playing field is to try to reduce total demand for electricity. If you reduce demand enough that you no longer need the producer that offered the highest accepted price, and all the remaining power producers will take less. The more you can reduce demand overall, the lower the highest accepted price for the supply will be, since you will need fewer producers in order to provide it.

To reduce demand, then, FERC developed a framework that approaches big, usually industrial electricity customers and asks how much it will cost to get the customers to reduce their load that day. Or, more accurately, FERC asks, “How much can you reduce your electricity load, and what would we have to pay you to get you to reduce it that amount?” The answers become “bids,” added into the existing auction system.

In effect, FERC has offered big consumers the same deal available to producers. They pay all consumers the equivalent price for a commitment to reduce their energy consumption, saving them from having to pay producers to meet heavier demand. From the regulator’s standpoint, this arrangement represents the best deal for everybody: Pay higher and higher prices to reduce the electricity load until it reaches a point where it would be cheaper to just buy more power to meet demand.

This looks like a textbook scenario to an economist. The best possible outcome is one where all needs are met at an optimal price. And consumers have increasingly embraced the opportunity; the North American Electric Reliability Corp. projected that the efforts to reduce demand through this mechanism will reduce overall electricity consumption by more than 17,000 megawatts nationally this winter.

But the energy industry did not like this solution. A coalition of several major power generators challenged the FERC rule regulating “demand response” as outside the scope of the commission’s powers. The producers argued, in effect, that FERC lacked the legislative authority to try to encourage demand to adjust to meet supply, rather than the other way around.

This case made it before the Supreme Court, which reached a fairly logical conclusion by ruling that the FERC’s actions fall within the agency’s authority to regulate interstate wholesale power sales under the Federal Power Act. The law prohibits FERC from regulating “any other sale” of electricity.

The court’s majority opinion found the regulating wholesale demand falls within the scope of regulating wholesale power sales generally, and so FERC acted within its scope. Justice Elena Kagan wrote the 6-2 majority decision, with Justices Antonin Scalia and Clarence Thomas dissenting. Justice Samuel Alito recused himself from the case.

Even the dissenting justices agreed that FERC has the authority to regulate practices affecting wholesale prices, but disagreed as to where to draw the line. In effect, the dissent said that government agencies have only the discretion that Congress explicitly gave them; in this case, the fact that the demand response rule does not regulate retail prices or sales was not enough on its own to convince the dissenting justices the rule was within FERC’s authority. While in many cases I would agree with this view of governmental agencies’ power, in this one, I believe the dissenters missed the point. FERC’s actions did not regulate retail transactions, and by definition, any sale that is not retail is wholesale. Therefore it was within the regulatory scope lawmakers granted.

FERC’s approach of balancing the teeter-totter of supply and demand from both sides, rather than only one, benefits the whole American power grid. It will prevent overinvestment in supply capacity, and instead allows us to manage demand to the extent it is economic to do so. If all energy regulation was as sensible - I’m looking at you, ethanol - the country would be even better off.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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