Second Circuit Decision Provides States Latitude to Enact Renewable Energy Incentive Programs

By Henry E. Myers

On June 28, 2017, in Allco Finance Ltd. v. Klee, the U.S. Court of Appeals for the Second Circuit rejected two related challenges alleging that Connecticut programs pertaining to renewable energy generation violated federal law, bolstering states’ flexibility to craft renewable energy incentive programs. In doing so, the Second Circuit became the first federal court to apply the U.S. Supreme Court’s recent decision in Hughes v. Talen Energy, in which a unanimous court declared a similar Maryland program invalid under the Federal Power Act (FPA).

With some minor exceptions, the FPA grants the Federal Energy Regulatory Commission (FERC) exclusive jurisdiction to regulate interstate wholesale electricity sales. In states with deregulated energy markets, such as Connecticut, the FERC discharges its duty to ensure that wholesale electricity rates are “just and reasonable” through two mechanisms. First, proposed bilateral contracts for wholesale purchase between generators and utilities are subject to review by FERC. Second, FERC regulates the rules of competitive wholesale auctions. In these auctions, electricity generators offer to provide utilities, through an independent market administrator, with a certain amount of electricity for a specified price. The administrator accepts the least expensive subset of these bids capable of meeting estimated energy demand. The selected generators are paid the “clearing price,” which is set at the most expensive rate offered by one of the winning bidders. FERC regulations treat the clearing price as per se “just and reasonable.”

In its complaint, Allco alleged that Connecticut’s renewable energy procurement process invades an area of exclusive federal jurisdiction established under the FPA. In this process, Connecticut solicits proposals from renewable energy generators, selects winners from this solicitation, and “direct[s]” local utilities to “enter into” bilateral contracts, called “power purchase agreements” with the winning generators. Allco – itself a producer of renewable energy – had submitted proposals for five solar projects, but state officials selected two other projects and “ordered” Connecticut utilities to execute power purchase agreements at fixed wholesale prices with the winners. While these contracts were subject to final approval by FERC, Allco argued that this scheme effectively “compelled” a wholesale power transaction, and allowed the state to determine its own rates – something it argued to be preempted by the FPA.

In Talen Energy, the Supreme Court held that a Maryland scheme devised to subsidize the construction of a new gas-fired power plant was preempted by the FPA. The generator that built the plant was given, in exchange, a guaranteed contract price from a purchasing utility. In the contract, the utility promised to pay any difference between the guaranteed contract price and clearing price the generator obtained at a FERC-approved action in which it was otherwise required to participate as a prerequisite to sale. . By promising a price that was not subject to review by FERC, and potentially differed from the per se “just and reasonable” price that would be established at auction, the Supreme Court found that this scheme was preempted as an impermissible interference with FERC’s authority.

Allco contended that the same reasoning employed by the Supreme Court to invalidate Maryland’s program in Talen Energy applied to Connecticut’s renewable energy procurement program. The Second Circuit, however, adopted a narrow reading of Talen Energy and rejected Allco’s challenge to the procurement process. The Court found that even if Connecticut’s program had an “incidental effect on wholesale prices,” it did not trespass upon FERC’s jurisdiction and was distinguishable from Talen Energy. The Court contrasted Maryland’s program, which sought to circumvent FERC review, to Connecticut’s procurement process, which led to bilateral contracts that were still subject to FERC approval.

The Second Circuit also rejected Allco’s related Commerce Clause challenge to Connecticut’s Renewable Energy Credits program, which mandates that utilities either produce a certain proportion of electricity from renewable sources, or purchase an equivalent amount via renewable energy credits.

Connecticut’s program provides that credits can only be sourced from generators within Connecticut’s “control area” (most of New England) or generators in adjacent control areas for an additional price, thereby precluding purchase of credits from generators elsewhere in the country. Allco argued that this program violated the Commerce Clause by impermissibly discriminating against out-of-state interests. The Second Circuit upheld this program, finding that the geographical limitation serves Connecticut’s “legitimate interest in promoting increased production of renewable power generation in the region.”

By construing the Talen Energy decision to apply only to a narrow class of state schemes, rather than any scheme which might affect wholesale prices, and permitting geographical limitations on renewable energy credit programs, the Second Circuit affirmed the latitude of state authorities to incentivize generation of renewable energy.

For more information on state renewable energy procurement, please contact Dan Chorost, Alex Leff, or Devin McDougall.