Update – November 2, 2017 – Seventh Circuit ZEC Appeal Takes Shape

Last Friday, defendants Illinois and Exelon filed their briefs in the Seventh Circuit appeal of a lower court decision that dismissed complaints against the state’s Zero Emission Credit (ZEC) program. Now that both sides of the case have submitted briefs, we summarize the key substantive legal arguments before the court.

Illinois’ ZEC program requires a state agency to purchase ZECs from state-selected nuclear generators. Utilities are then required to purchase the ZECs from the agency, in proportion to their total retail sales. ZEC prices are set at the social cost of carbon, and can be adjusted downward if rates increase in FERC regulated energy and capacity markets. Plaintiff Electric Power Supply Association (EPSA) is appealing the district court’s dismissal of its Federal Power Act (FPA) preemption and dormant Commerce Clause claims.

Field Preemption
In its brief filed in late August, EPSA asserts that the ZEC program “invades FERC’s exclusive jurisdiction because it replaces the FERC-determined just and reasonable prices for wholesale electricity with a different rate determined by the state.” EPSA has two legal arguments to support this field preemption claim.

EPSA’s first legal argument is that ZECs are preempted based on a straightforward reading of section 205 of the FPA, which requires that all “charges . . . received by any public utility . . . in connection with” a wholesale sale be just and reasonable. EPSA argues that ZECs are preempted because they are payments received “in connection with” a wholesale sale and therefore fall under FERC’s exclusive jurisdiction over wholesale rates.

Illinois responds by pointing to 2012 FERC order holding that when renewable energy credits (RECs) are sold “independent[ly] of a wholesale electric energy transaction . . . the charge for the [] RECs is not a charge in connection with a wholesale sale of electricity.” The State argues that FERC’s order articulates an “independent transaction test” that provides FERC with jurisdiction over environmental attributes or emission allowances only when those instruments are sold together in a single transaction with wholesale energy. Because ZECs are sold independently from wholesale energy, ZEC revenue is not “received . . . in connection with” wholesale energy sales and ZECs are thus outside of FERC’s exclusive jurisdiction.

EPSA’s second argument is that the ZEC program is “functionally indistinguishable” from the program that the Supreme Court held was preempted in its 2016 Hughes decision. Because the value of ZEC payments can be adjusted based on outcomes in FERC-regulated auctions, EPSA asserts that ZECs are impermissibly “tethered to wholesale prices,” as Maryland’s program was. The result, according to EPSA, is that like Maryland’s program, ZEC payments “guarantee that over a wide-range of market-clearing prices” the state-selected plants “receive the rate that Illinois deems appropriate.”

Exelon counters that the impermissible “tether” in Hughes was to wholesale market participation, not wholesale prices. For Maryland, Exelon explains, it was critical that the state-selected plant clear the FERC-regulated market because Maryland “tied its subsidy to the generator’s actual wholesale auction revenues. Consequently, if the generator failed to clear the auction (and so had lower wholesale revenues), the State would have had to make up the lost revenue.” Not so for Illinois. ZECs provide no more than $16.50 per megawatt-hour, an amount based on the social cost of carbon. Moreover, ZEC payments are not linked to any generator’s actual wholesale revenues and can only be adjusted downward based on a composite of projected wholesale prices that no generator actually receives.

More fundamentally, Exelon argues that ZEC payments are in exchange for “producing electricity using a particular method, not as compensation for capacity and energy” sales. Maryland’s program was preempted because it “conditioned payment on wholesale auction sales, [thus] changing the amount received in exchange for wholesale power.”

Illinois adds that the independent transaction test highlights a legally relevant distinction between ZECs and Hughes. Maryland’s program “usurped FERC’s exclusive review authority under Section 205 because the payments they mandated were not independent of a wholesale sale, but instead were expressly conditioned on such a sale.” Illinois, by contrast, “regulates separate sales of ZECs, which represent the environmental benefits of nuclear power generation.”

Conflict Preemption
EPSA also claims that even if ZECs do not “intrude” on FERC’s exclusive jurisdiction over wholesale rates, Illinois’ program “directly interferes with the policy objectives reflected in FERC’s market-based ratesetting” and is therefore conflict preempted. It argues that ZECs have “distortive effects” on wholesale markets that will “discourage investment in more efficient generation and may lead to the retirement of plants that . . . would otherwise remain in the market.”

Illinois responds that EPSA has failed to point to any FERC order that “actually conflicts” with the ZEC program. Rather, as Exelon argues, EPSA has “invented the broader claim—essential to their argument—that FERC expects its auctions to be the exclusive driver of which plants operate and which retire, or of wholesale prices.” Illinois urges the court to “reject the position advanced by Plaintiffs and several amici supporting them that the FPA mandates a pure free-market, externality blind philosophy that elevates cost efficiency above all other considerations and is hostile to, or even prohibits, any accommodation of outside policies to protect public health.” Even if the court accepts EPSA’s view of energy markets, Illinois argues that FERC, not a federal court, is the proper forum for its claim that a state program distorts wholesale market outcomes.

Dormant Commerce Clause
Finally, EPSA claims that Illinois’ “market manipulation to prop up local businesses presents a textbook” dormant Commerce Clause violation. Although the statute does not explicitly select in-state plants, EPSA alleges that the procurement process is a “sham” intended to obscure the true intent of the program, which is to benefit two in-state plants. EPSA asserts that “on its face, and in effect,” the ZEC programs “interferes with interstate commerce.”

Both defendants highlight that the statute creating the ZEC program tasks regulators with selecting plants based on geographically neutral environmental criteria. According to Illinois, “a law that adopts neutral criteria to advance a valid health-and-safety objective does not facially discriminate just because application of those criteria may to some extent favor in-state activity.” Exelon adds that “if in-state plants best advance neutral environmental goals, their selection is not objectionable” under the dormant Commerce Clause.

With regard to ZECs’ allegedly discriminatory effects, Illinois notes that “the ZEC Program excludes fossil fuel plants in Illinois and other States alike. The ZEC Program, therefore, does not disadvantage Plaintiffs’ fossil fuel-based generating operations over similar plants in Illinois, much less do so because they are located out-of-state.”

The parties also argue about procedural issues, including whether EPSA has standing and whether private plaintiffs such as EPSA have the right to bring FPA preemption claims to federal court.

Appellants filed their brief on October 13 in the Second Circuit appeal of a district court decision upholding New York’s nearly identical ZEC program. New York and Exelon will file in a couple of weeks.

The Seventh Circuit briefs are available on the Illinois page