On July 14, 2017, and several weeks after the Second Circuit rejected challenges to Connecticut’s renewable energy procurement process and renewable energy credit program (see Allco Fin. Ltd. v. Robert J. Klee (Docket Nos. 16-2946, 16-2949)), the U.S. District Court for the Northern District of Illinois dismissed challenges brought by independent power producers and customers against Illinois’ nuclear subsidy program (Village of Old Mill Creek v. Anthony M. Star, Docket Nos. 17 CV 1163, 17 CV 1164). This Illinois decision further support the authority of states to promote generation of their choosing and represents another narrow reading of the Supreme Court’s recent ruling in Hughes v. Talen Energy (136 S. Ct. 1288 (2016)).
In the state program at issue in Old Mill Creek, Illinois created a “zero emission credit” (ZEC), a tradeable credit (modeled after a renewable energy credit) which represents the environmental attributes of one megawatt hour of energy from specified zero emission facilities (in this case, selected nuclear power plants interconnected with the Midcontinent Independent System Operator (MISO) or PJM Interconnection (PJM)). The effective purpose of this program is to subsidize Exelon’s Clinton and Quad Cities nuclear facilities in Illinois, which Exelon had threatened to shut down if it did not receive government support.
Zero emissions facilities are selected pursuant to procurement process run by the Illinois Power Agency. Illinois utilities that sell electricity to customers are required to enter into 10-year contracts to purchase ZECs from the winning zero emissions facilities. The initial ZEC price is the Social Cost of Carbon (established at $16.50 per MWh in August 2016 by the U.S. Interagency Working Group on Social Cost of Carbon), but the ZEC price may be reduced if a specified market price index for the applicable delivery year exceeds an established baseline market price index. The costs of those ZECs are passed on to the utilities’ customers.
Customer and independent power producer groups challenged the Illinois ZEC program in Illinois federal district court, raising Federal Power Act preemption claims, dormant commerce clause claims, and equal protection claims. Plaintiffs argued that since the ZECs supplement the wholesale prices that the selected nuclear facilities receive, Illinois’ subsidy program would affect the Federal Energy Regulatory Commission (FERC)-regulated electricity market auction structure by effectively replacing the auction clearing price with the higher price preferred by Illinois. This allows the nuclear facilities to bid into the wholesale energy market auctions at artificially low prices (thereby depressing the auction clearing price for other auction participants) and imposes the ZEC costs on ratepayers.
The Illinois district court rejected these claims and granted the motions to dismiss. Although the court found that the claims were largely not justiciable due to a lack of standing and a limited private remedy being available under the Federal Power Act, the court also discussed the merits of the claims. The court found that states can use regulation to influence generator participation in FERC markets, noting that state renewable energy credit programs and tax incentives (which plaintiffs did not dispute) encourage renewable energy generators and, similarly, the ZEC program supports a certain type of electric generation facilities. According to the court, although Illinois’ regulations will affect wholesale electricity rates, those wholesale rates were not the target of the Illinois’ subsidy program. In evaluating the Illinois program, the key inquiry is whether FERC or the state is regulating what takes place in their respective markets, with the court finding that when the state regulates what takes place in the retail electricity market, then the effect on wholesale rates is irrelevant.
The court distinguished the Illinois program in Old Mill Creek from the Maryland program at issue in Hughes, emphasizing that Illinois does not mandate that the selected nuclear facilities participate in FERC-regulated wholesale auctions (even though the practical effect of Illinois’ program is that the nuclear facilities would have more financially flexibility to submit bids low enough to clear the auction). The selected nuclear facilities will receive ZECs whether or not they clear the FERC-regulated wholesale auctions, in contrast to the Maryland program in Hughes where payment was conditioned on the selected generator clearing the auction. So, according to the court, while Illinois is taking advantage of certain attributes of the FERC-regulated auctions to provide a benefit to nuclear facilities (by facilitating the facilities submitting bids low enough to clear the auction), Illinois is not imposing a condition directly on wholesale transactions. Furthermore, the initial price of ZECs (i.e., the Social Cost of Carbon) is unrelated to the wholesale price, and the ZEC price adjustments are not entirely based on the wholesale price a ZEC recipient receives (but rather are a composite of projected prices from the energy and capacity markets). The Maryland program in Hughes, by contrast, guaranteed the generator a specific price for participation in the wholesale auctions, and the payment the generator received under the Maryland program was completely dependent on the clearing price of the wholesale auction.
The court found that influencing the wholesale market by subsidizing a participant, without subsidizing the actual wholesale transaction, is indirect and not preempted. As the selected nuclear facilities can receive ZECs for producing electricity and the ZECs are not directly conditioned on clearing wholesale auctions, the court determined that Illinois’ nuclear subsidy program does not suffer from the “fatal defect” that the Supreme Court found in Hughes. The court declined to extend Hughes to invalidate state laws that do not include an express condition on wholesale auction participation, but that in practice (and when combined with other market forced) have the effect of conditioning payment on clearing the wholesale auction. According to the court, this type of action falls within the state’s authority to regulate generation.
The court compared ZECs to renewable energy credits, highlighting that FERC has concluded (in the renewable energy credit context) that environmental attributes can be unbundled from the sale of electricity without intruding on FERC’s jurisdiction and that such reasoning is persuasive when applied in the ZEC context. Thus, ZECs should not be considered part of a bundled electricity sale and that the ZEC contracts required by Illinois’s program are distinct from wholesale energy sales. The court also noted that FERC retains full authority to address any problems that the ZEC program creates with respect to just and reasonable wholesale rates (for example, FERC can modify the auction rules in the markets in which the selected nuclear facilities participate to take into account the subsidy payments).
In regards to the dormant commerce clause arguments, the court found that the Illinois statute is not facially discrimination and, although the evaluation may be tipped in favor of Exelon’s Clinton and Quad Cities nuclear facilities, the Illinois Power Agency has been given neutral, non-discriminatory standards to follow in administering the subsidy program. Furthermore, the court found that there was not a dormant commerce clause issue when a state creates a new market (in this case, the creation of ZECs) and exercises its right to favor its own citizens over others, and even though this new market may affect the wholesale energy market, such effect creates an incidental burden on the channels of interstate commerce. Illinois’ legitimate interests include environmental concerns, but also the right to participate in or create a market and the right to encourage power generation of its choosing. The court also rejected the plaintiffs’ equal protection arguments, finding that Illinois does not violate the equal protection clause by treating ratepayers in Illinois differently than citizens from other states that live in the MISO or PJM region (especially as Illinois likely does not have the authority to impose the costs of the ZEC program on people who live outside Illinois).
In summary, Old Mill Creek upheld the authority of states to promote generation of their choosing, even if the subsidy program had an effect on the wholesale energy markets. The court focused on the mandates contained in the legislation, and not on the practical effects that the legislation would cause. In this case, Illinois could not mandate that the selected nuclear facilities clear the wholesale auctions, but it can offer subsidies to the selected nuclear facilities with the full knowledge that those subsidies will allow the nuclear facilities to offer bids low enough to clear the wholesale auctions. Thus, based on this precedent, the less direct the ties the state program has to FERC-regulated wholesale markets, the more likely the state program is to withstand judicial scrutiny.
As appeals of the district court’s decision are likely being drafted right now, the Seventh Circuit will likely be weighing in on these issues as well. In addition, a New York court is also weighing similar challenges to New York’s nuclear subsidy program. So, there will be more to come on the balancing of federal and state jurisdiction over generation facilities and energy markets.