On September 13, 2018, the Court of Appeals for the Seventh Circuit affirmed the trial court’s dismissal of claims that the zero-emission credit (ZEC) program enacted by the Illinois legislature in 2016 violated the U.S. Constitution’s dormant Commerce Clause and was preempted by the Federal Power Act. The Court took the unusual step of requesting an amicus brief from the Federal Energy Regulatory Commission (FERC). FERC and the Department of Justice jointly filed a brief in response, arguing that the Illinois’ program neither interferes with interstate auctions nor is otherwise preempted by federal law. Once FERC weighed in on the side of Illinois, a result in favor of the State was a likely conclusion.
Similar to the framework used for or “RECs,” Illinois’ ZEC program directs state regulators, based on defined criteria, to select certain nuclear plants to generate ZECs and then requires utilities to purchase those ZECs for a predetermined purchase price. The state-developed ZEC price is derived from the social cost of carbon, but is adjusted based on an index tied to wholesale power prices. The Electric Power Supply Association (EPSA), the national trade association comprised of many of the large, non-nuclear competitive power producers in the U.S., brought suit. The lower court dismissed those claims and the appeal ensued.
The crux of EPSA’s preemption argument rested on the premise that: (1) by propping up uneconomic nuclear units with ZECs, the state’s program impermissibly altered the total supply within the wholesale market, thus decreasing the amount ultimately paid to all generators in the annual capacity auction; and (2) that because the ZEC payments are made in connection with energy sales in the wholesale markets, over which FERC has exclusive jurisdiction, states may not interfere with that regulation. The court, however, rejected EPSA’s preemption argument, concluding instead that, “a state policy that affects price only by increasing the quantity of power available for sale is not preempted by federal law.” In reaching this result, the court distinguished the Illinois law from the state program rejected by the U.S. Supreme Court in Hughes v. Talen Energy Marketing. In upholding the ZEC program, the Seventh Circuit joined the Second Circuit in Klee, along with the Third Circuit’s pre-Hughes decision in Solomon, to rule that federal law does not preempt state policies that provide incentives to new or existing capacity.
Nor, according to the court, was the fact that the Illinois law tied the price for ZECs to capacity prices in FERC-regulated auctions a fatal flaw. Unlike the state program rejected in Hughes, which incentivized new natural gas-fired generation facility by “tethering” state contract payments to the unit’s participation in the federally-regulated wholesale market auction, the receipt of the ZEC is not dependent on wholesale market participation. Moreover, because, under the Illinois’ statute, every producer of power receives the same price for the ZEC, it did not impermissibly intrude on federal jurisdiction over the markets, even if that price may adjust based on market auction rates. The Court determined that, “’[S]o long as a State does not condition payment of funds on capacity clearing the [interstate] auction, the State’s program [does] not suffer from the fatal defect that renders Maryland’s program unacceptable.’”
Neither was the court swayed by EPSA’s argument that the Illinois’ program violated the Constitution’s dormant Commerce Clause. The Court stated that the “Commerce Clause does not ‘cut the States off from legislating on all subjects…[just because] the legislation might indirectly affect the commerce of the country.’” Instead, the court determined that the Federal Power Act calls for a balancing of federal and state interests with respect to the regulation of electricity. Because the ZEC program did not overtly discriminate against out-of-state power producers, and the effects of the statute would be felt wherever power is used, the court concluded that the statute did not violate the dormant Commerce Clause.
The effect of the Seventh Circuit’s decision should not be underestimated. One day following the release of the Seventh Circuit’s decision, the Ninth Circuit determined that Oregon’s low-carbon fuel standard did not unconstitutionally favor in-state versus out-of-state power producers. So far, every decision since Hughes has distinguished Hughes and upheld such state regulatory programs.
Moreover, while not binding, the decision will likely play heavily into the case currently pending before the Second Circuit evaluating New York’s ZEC program. While EPSA has not announced whether it will appeal the Seventh Circuit’s decision to the U.S Supreme Court, given FERC’s participation in the proceeding, and the fact that that the impact of state-sponsored programs can be mitigated through changes to the wholesale market rules, any appeal will face an uphill battle. Indeed, the more interesting developments from the Seventh Circuit’s decision will not likely come from the federal courts, but will be what, if any, market reforms related to price formation FERC will institute as a result.