Update – September 14, 2018 – 7th Circuit Affirms Dismissal of Complaints about Illinois Zero Emission Credit Program

Yesterday, the Seventh Circuit affirmed a lower court decision that dismissed Federal Power Act preemption and dormant Commerce Clause claims against Illinois’ zero-emission credit (ZEC) program. The eight-page opinion authored by Judge Easterbrook adds to the body of case law that supports broad state authority to enact clean energy programs, even when those programs “affect” FERC-regulated power markets. A suit challenging New York’s nearly identical program is pending before the Second Circuit.

In December 2016, the Illinois legislature enacted an energy reform bill that included the ZEC program. The law tasks state regulators with selecting nuclear plants to generate ZECs based on various criteria and requires utilities to purchase those ZECs. The law initially prices ZECs based on the social cost of carbon and adjusts the price downward if an index of wholesale power prices exceeds a certain amount.

After its claims against the ZEC program were dismissed by a district court, the Electric Power Supply Association (EPSA) argued on appeal that ZECs are preempted by the Federal Power Act because they are payments in connection with FERC-regulated wholesale sales. This encompassing view of FERC jurisdiction threatened to invalidate numerous state programs, including renewable energy credit (REC) programs. As the case progressed, EPSA appeared to back away from this argument and focused on the narrower claim that the program is invalid under the 2016 Supreme Court decision Hughes v. Talen. Per the court’s summary, EPSA argued that ZECs are preempted because the state is “indirectly regulat[ing] the [FERC-regulated] auction by using average auction prices as a component in a formula that affects the cost of a [ZEC].”

The panel rejected EPSA’s preemption theory, concluding that while federally regulated rates might affect the state-set ZEC price, ZECs permissibly influence the outcome of federally regulated auctions. By keeping nuclear plants in business through the award of ZECs, the state changes the total supply in the market and thus lowers the price paid to all generators in the auction. According to the court, “a state policy that affects price only by increasing the quantity of power available for sale is not preempted by federal law.” The Second Circuit in Klee and the Third Circuit in Solomon reached the same conclusion. Thus, three federal appeals courts have recently held that a state policy is not preempted merely because it incentivizes the construction of new capacity or the continued operation of existing capacity.

Yesterday’s decision also agreed with the Klee court’s narrow reading of the Supreme Court’s Hughes decision. In Hughes, the Court held that Maryland’s program to induce the construction of a new natural gas fired generator was preempted because it conditioned payment of funds on the state’s favored generator participating in the federally regulated auction. Yesterday’s decision rejected EPSA’s efforts to expand the Court’s holding and upheld the ZEC program because it rewards power generation, regardless of where the power is sold.

The panel also held that the ZEC program does not “overtly” discriminate under the dormant Commerce Clause. It rejected EPSA’s claim that the program unduly burdens interstate commerce, as well, finding that the Federal Power Act’s reservation of state authority over generation facilities would be meaningless if states could not choose among in-state generation facilities.

The decision is available on the Illinois page.