FERC on Feed-in Tariffs:

States' Incentive Prices for Alternative Energy Must Fall Within Federal Caps

On July 15, 2010, the Federal Energy Regulatory Commission (FERC) partly invalidated a California law that is designed to encourage energy efficiency. See Cal. Pub. Util. Comm'n, 132 FERC ¶ 61,047 (2010). The California law requires electric utilities to establish feed-in tariffs under which the utility must offer to purchase the electrical output of small-scale generators that meet specified fuel use, efficiency and environmental standards. The law authorizes the California Public Utilities Commission (CPUC) to establish offering prices under the feed-in tariffs, at levels that (1) reflect system-wide demand at the time of delivery, (2) are relative to the cost of natural gas, and (3) leave the utility's customers indifferent to the purchase. See Cal. Pub. Util. Code § 2841(b) (2010). The CPUC sought FERC's determination that the CPUC may set the offering prices notwithstanding FERC's authority to regulate rates for wholesale sales of electricity.

FERC held that federal law leaves the CPUC limited room to set offering prices under feed-in tariffs. 132 FERC ¶ 61,047 at P 64-65. FERC reasoned that the Federal Power Act establishes exclusive federal jurisdiction over wholesale sales of electricity in interstate commerce, that offering prices under feed-in tariffs are rates for the wholesale sale of electricity in interstate commerce, and that, therefore, the CPUC may act only when a sale is specifically exempted from federal oversight or when federal law specifically authorizes the states to act.

Accordingly, the CPUC may set offering prices under feed-in tariffs when the generator is publicly owned or publicly financed. Id. at P 71 Publicly-owned and publicly financed sellers are exempt from FERC's ratemaking authority. 16 U.S.C. § 824(f). The CPUC also may set offering prices when the generator is a "qualifying facility" under the Public Utility Regulatory Policies Act (PURPA) – but only if the offering price is within limits established by PURPA. Under PURPA, electric utilities must purchase the electrical output of qualifying generators at rates that reflect the utility's "avoided cost," i.e., the utility's cost of securing supply from other sources. PURPA authorizes the states to determine avoided cost, using FERC-approved methodologies. 16 U.S.C. §§ 824a-3(a), (b) and (f). FERC suggested that the states' authority to determine avoided cost includes authority to set rates for qualifying facilities at a level up to avoided cost. 132 FERC ¶ 61,047 at P 67. For all other generators, the CPUC may compel utilities to offer to purchase the generator's output, but the associated rate is subject to approval solely by FERC. Id. at P 69.

On one hand, FERC's decision seems unremarkable. The decision echoes a series of decisions by FERC since 1988, when FERC held that New York could not compel electric utilities to purchase from qualifying facilities at a rate that exceeded the avoided-cost rate. FERC reasoned that Congress had chosen to encourage cogeneration and small power production – but only to the extent that projects would be viable under avoided-cost pricing – and that this choice preempted the states from using higher prices to encourage cogeneration and small power production. See Orange & Rockland Util., Inc., 43 FERC ¶ 61,067 (1988), vacated as moot 70 FERC ¶ 61,014 (1995). See also Midwest Power Syst., Inc., 78 FERC ¶ 61,067 (1997); So. Cal. Edison Co., 70 FERC ¶ 61,215, reconsideration denied, 71 FERC ¶ 61,269 (1995); Conn. Light and Power Co., 70 FERC ¶ 61,012, reconsideration denied, 71 FERC ¶ 61,035 (1995), appeal dismissed, Niagara Mohawk Power Corp. v. FERC, 117 F.3d 1485 (D.C. Cir. 1997).

On the other hand, there have been important developments since FERC last addressed a similar preemption question. First, in many areas of the United States, avoided-cost rates have fallen. Second, the states are taking ever-greater interest in encouraging alternative forms of electrical supply as a means of addressing local environmental problems. Some state policy-makers believe that avoided-cost rates – as determined using FERC-approved methodologies – do not adequately reflect the environmental cost of using traditional forms of supply. Against this backdrop, FERC's finding of preemption puts pressure on the states to develop new means to encourage the development of alternative sources of energy.

FERC's July 15 decision leaves open important questions for other regions. In 2005, Congress amended PURPA to eliminate utilities' purchase obligation when a qualifying facility has access to a competitive market. See 16 U.S.C. § 824a-3(m). Utilities in California remain subject to the purchase obligation, but utilities in several other regions are no longer subject to that obligation. See 18 C.F.R. § 292.309. It remains to be seen whether PURPA preempts states in those regions from imposing a purchase obligation and from setting associated prices.