Electric Power Supply Ass'n v. Federal Energy Regulatory Commission

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued September 23, 2013 Decided May 23, 2014

No. 11-1486

ELECTRIC POWER SUPPLY ASSOCIATION,
PETITIONER

v.

FEDERAL ENERGY REGULATORY COMMISSION,
RESPONDENT

MADISON GAS AND ELECTRIC COMPANY, ET AL.,
INTERVENORS

Consolidated with 11-1489, 12-1088, 12-1091, 12-1093

On Petitions for Review of Orders of the
Federal Energy Regulatory Commission

Ashley C. Parrish argued the cause for petitioners
Electric Power Supply Association, et al. With him on the
briefs were David G. Tewksbury, Stephanie S. Lim, David B.
Raskin, Harvey L. Reiter, and Adrienne E. Clair.

Daniel J. Shonkwiler argued the cause for petitioners
California Independent System Operator Corporation, et al.
With him on the briefs were Nancy J. Saracino, Roger E.
 2
Collanton, Frank R. Lindh, Mary F. McKenzie, and Charlyn
A. Hook.

Sandra E. Rizzo was on the brief for intervenors PJP
Power Providers Group, et al. in support of petitioners.

Jeffrey A. Lamken, Martin V. Totaro, and John L.
Shepherd Jr. were on the brief for amici curiae Robert L.
Borlick, et al. in support of petitioners.

Robert H. Solomon, Solicitor, Federal Energy Regulatory
Commission, argued the cause for respondent. With him on
the brief were David L. Morenoff, Acting General Counsel,
and Holly E. Cafer, Attorney.

Donald J. Sipe, Jonathan G. Mermin, Robert A. Weishaar
Jr., Joseph D. Shelby, Barry S. Spector, Paul M. Flynn, Kriss
E. Brown, Marvin T. Griff, Miles H. Mitchell, Ransom E.
Davis, and Owen J. Kopon were on the brief for intervenors
Counsel of Coalition of Midwest Transmission Customers, et
al. in support of respondent.

Vickie L. Patton and John N. Moore were on the brief for
amici curiae Environmental Defense Fund, et al. in support of
respondent.

Before: BROWN, Circuit Judge, and EDWARDS and
SILBERMAN, Senior Circuit Judges.

Opinion for the Court by Circuit Judge BROWN.

Dissenting opinion filed by Senior Circuit Judge EDWARDS.

BROWN, Circuit Judge: Electric Power Supply
Association and four other energy industry associations
 3
(“Petitioners”) petition this court for review of a final rule by
the Federal Energy Regulatory Commission (“FERC” or “the
Commission”) governing what FERC calls “demand response
resources in the wholesale energy market.” The rule seeks to
incentivize retail customers to reduce electricity consumption
when economically efficient. Petitioners complain FERC’s
new rule goes too far, encroaching on the states’ exclusive
jurisdiction to regulate the retail market. We agree and vacate
the rule in its entirety.

I

Under the Federal Power Act (“FPA” or “the Act”) the
Commission is generally charged with regulating the
transmission and sale of electric power in interstate
commerce. The FPA “split[s] [jurisdiction over the sale and
delivery of electricity] between the federal government and
the states on the basis of the type of service being provided
and the nature of the energy sale.” Niagara Mohawk Power
Corp. v. FERC, 452 F.3d 822, 824 (D.C. Cir. 2006). Section
201 of the Act empowers FERC to regulate “the sale of
electric energy at wholesale in interstate commerce.”
16 U.S.C. § 824(b)(1) (emphasis added). Thus, “FERC’s
jurisdiction over the sale of electricity has been specifically
confined to the wholesale market.” New York v. FERC, 535
U.S. 1, 19 (2002).

The Commission concedes that “demand response is a
complex matter that lies at the confluence of state and federal
jurisdiction.” See Demand Response Compensation in
Organized Wholesale Energy Markets, 134 FERC ¶ 61,187,
2011 WL 890975, at *30 (Mar. 15, 2011) [hereinafter Order
745]. For more than a decade, FERC has permitted demand-
side resources to participate in organized wholesale markets,
allowing Independent System Operators (ISOs) and Regional
 4
Transmission Organizations (RTOs) to use demand-side
resources to meet their systems’ needs for wholesale energy,
capacity, and ancillary services. As this court has noted,
Congress in 2005 declared “the policy of the United States
that time-based pricing and other forms of demand response .
. . shall be encouraged . . . and unnecessary barriers to
demand response participation in energy, capacity and
ancillary service markets shall be eliminated.” Ind. Util. Reg.
Comm’n v. FERC, 668 F.3d 735, 736 (D.C. Cir. 2012) (citing
16 U.S.C. § 2642). The Commission has issued dozens of
orders on demand-side resource participation, and ISOs and
RTOs maintaining economic demand response programs
could file tariffs with the Commission and accept bids for
ancillary services and from aggregators of retail customers
directly into the wholesale energy markets. See Wholesale
Competition in Regions with Organized Electric Markets,
73 Fed. Reg. ¶ 64,100, 64,101 (Oct. 28, 2008) (to be codified
at 18 C.F.R. pt. 35) [Order 719].

Order 745 establishes uniform compensation levels for
suppliers of demand response resources who participate in the
“day-ahead and real-time energy markets.” Order 745, 2011
WL 890975, at *1. The order directs ISOs and RTOs to pay
those suppliers, including aggregators of retail customers, the
full locational marginal price (LMP), or the marginal value of
resources in each market typically used to compensate
generators. The Commission conditioned the payment of full
LMP on the ability of a demand response resource to replace
a generation resource and required demand response to be
cost effective. Cost effectiveness would be determined by a
newly devised “net benefits test,” which FERC directed ISOs
and RTOs to implement. FERC acknowledged that the cost
of payments to retail customers to encourage reduced energy
consumption would have to be subsidized by load-serving
entities participating in the wholesale market. Id. ¶ 99, 2011
 5
WL 890975, at *27; see also id. ¶ 102. Finally, the rule
allocated the costs of demand response payments
proportionally to all entities that purchase from the relevant
energy markets during times when demand response
resources enter the market. Commissioner Moeller dissented,
arguing the Commission’s retail customer compensation
scheme conflicted both with FERC’s efforts to promote
competitive markets and with its statutory mandate to ensure
supplies of electric energy at just, reasonable, and not unduly
preferential or discriminatory rates. See id., 2011 WL 890975,
at *34–39.

Requests for rehearing and clarification were filed by
ISOs, RTOs, state regulatory commissions, trade associations,
publicly owned utilities, transmission owners, suppliers, and
others. The Commission, in another 2–1 decision, confirmed
its approach and Petitioners filed timely petitions for review.

II

The Administrative Procedure Act (APA) directs us to
“hold unlawful and set aside agency action . . . in excess of
statutory jurisdiction, authority, or limitations.” 5 U.S.C.
§ 706(2)(C). “FERC is a creature of statute” and thus “has no
power to act unless and until Congress confers power upon
it.” Cal. Indep. Sys. Operator Corp. (CAISO) v. FERC, 372
F.3d 395, 398 (D.C. Cir. 2004) (citing La. Pub. Serv. Comm’n
v. FCC, 476 U.S. 355, 374 (1986)). If FERC lacks authority
under the Federal Power Act to promulgate a rule, its action is
“plainly contrary to law and cannot stand.” See Michigan v.
EPA, 268 F.3d 1075, 1081 (D.C. Cir. 2001).

We address FERC’s assertion of its statutory authority
under the familiar Chevron doctrine. See City of Arlington,
Tex. v. FCC, 133 S. Ct. 1863, 1870–71 (2013). The question
 6
is “whether the statutory text forecloses the agency’s assertion
of authority.” Id. at 1871. If, however, the statute is silent or
ambiguous on the specific issue, we must defer to the
agency’s reasonable construction of the statute. Id. at 1868.

FERC claims when retail consumers voluntarily
participate in the wholesale market, they fall within the
Commission’s exclusive jurisdiction to make rules for that
market. Petitioners protest that retail sales of electricity are
within the traditional and “exclusive jurisdiction of the States”
and regulating consumption by retail electricity customers is a
regulation of retail, not wholesale, activity. Reply Br. 11–12.
The problem, Petitioners say, is the Commission has no
authority to draw retail customers into the wholesale markets
by paying them not to make retail purchases.

Initially, we note the regulations have a single definition
of “demand response”—a “reduction in the consumption of
electric energy by customers from their expected consumption
in response to an increase in the price of electric energy or to
incentive payments designed to induce lower consumption of
electric energy.” 18 C.F.R. § 35.28(b)(4) (emphasis added);
see also Order 745, 2011 WL 890975, at *1 n.2. High retail
rates will reduce demand. Conversely, if consumers are paid
to reduce demand, prices fall. FERC acknowledges the first
case, “price-responsive demand” is a “retail-level” demand
response.” See Order 745, 2011 WL 890975, at *1–3 & n.2
(citing 18 C.F.R. § 35.28(b)(4)). In contrast, FERC dubs a
reduction in the consumption of energy in response to
incentive payments a “wholesale demand response.” See
FERC Br. 5, 34; see also Order 745, 2011 WL 890975, at *1–
3 & n.2 (citing 18 C.F.R. § 35.28(b)(4)). The Commission
draws this distinction between “wholesale demand response”
and “retail demand response” in an attempt to narrow the
logical reach of its rule. See, e.g., FERC Br. 5 (“[T]he
 7
Commission has made plain that its focus is narrow and that it
addresses only wholesale demand response.”); id. (“States
remain free to authorize and oversee retail demand response
programs.”); id. at 14–15. Yet FERC acknowledges
“wholesale demand response” is a fiction of its own
construction. See Oral Arg. Tape, No. 11-1486, at 27:31
(Sept. 23, 2013) (conceding “selling” demand response
resources in the wholesale market “is a bit of a fiction”).
Demand response resources do not actually sell into the
market. Demand response does not involve a sale, and the
resources “participate” only by declining to act.

As noted, and as the Commission concedes, demand
response is not a wholesale sale of electricity; in fact, it is not
a sale at all. See Order 745, 2011 WL 890975, at *18 (“[T]he
Commission does not view demand response as a resale of
energy back into the energy market.”). Thus, FERC astutely
does not rely exclusively on its wholesale jurisdiction under
§ 201(b)(1) for authority. See Niagara Mohawk Power Corp.,
452 F.3d at 828 & n.7.

Instead, FERC argues §§ 205 and 206 grant the agency
authority over demand response resources in the wholesale
market. These provisions task FERC with ensuring “all rules
and regulations affecting . . . rates” in connection with the
wholesale sale of electric energy are “just and reasonable.”
16 U.S.C. § 824d(a) (emphasis added); see also id. § 824e(a).
Thus, the Commission argues it has jurisdiction over demand
response because it “directly affects wholesale rates.” FERC
Br. 32–34; see also Order 745, 2011 WL 890975, at *30.

We agree with the Commission that demand response
compensation affects the wholesale market. Because of the
direct link between wholesale and retail markets, compare
FERC Br. 32, with Pet’rs Br. 11–14 (describing the “direct”
 8
relationship between wholesale and retail rates), and Reply
Br. 12 (“[T]here is undeniably a link between wholesale rates
and retail sales”), a change in one market will inevitably beget
a change in the other. Reducing retail consumption—through
demand response payments—will lower the wholesale price.
See Oral Arg. Tape, at 33:13. Demand response will also
increase system reliability. FERC Br. 33. Because incentive-
driven demand response affects the wholesale market in these
ways, the Commission argues §§ 205 and 206 are clear grants
of agency power to promulgate Order 745.

The Commission’s rationale, however, has no limiting
principle. Without boundaries, §§ 205 and 206 could
ostensibly authorize FERC to regulate any number of areas,
including the steel, fuel, and labor markets. FERC proposes
the “affecting” jurisdiction can be appropriately limited to
“direct participants” in jurisdictional wholesale energy
markets. See FERC Br. 37. But, as this case demonstrates, the
directness of participation may be a function of the richness of
the incentives FERC commands. The commission’s authority
must be cabined by something sturdier than creative
characterizations. See Altamonte Gas Transmission Co. v.
FERC, 92 F.3d 1239, 1248 (D.C. Cir. 1996) (noting FERC
cannot “do indirectly what it could not do directly”). The
“direct participant” theory also assumes FERC can “lure”
non-jurisdictional resources into the wholesale market in the
first place to create jurisdiction, see Oral Arg. Tape, at 29:52,
which is the heart of the Petitioners’ challenge.

The limits of §§ 205 and 206 are best determined in the
context of the overall statutory scheme. See FDA v. Brown &
Williamson Tobacco Corp., 529 U.S. 120, 132–33 (2000).
Congressional intent is clearly articulated in § 201’s text:
FERC’s reach “extend[s] only to those matters which are not
subject to regulation by the States.” 16 U.S.C. § 824(a).
 9
States retain exclusive authority to regulate the retail market.
See Niagara Mohawk Power Corp., 452 F.3d at 824. Absent
a “clear and specific grant of jurisdiction” elsewhere, see New
York, 535 U.S. at 22, the agency cannot regulate areas left to
the states. The broad “affecting” language of §§ 205 and 206
does not erase the specific limits of § 201.1 See generally
RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.
Ct. 2065, 2071 (2012); sections 205 and 206 do not constitute
a “clear and specific grant of jurisdiction.” Indeed, the
Commission agrees its jurisdiction to regulate practices
“affecting” rates does not “trump[] the express limitation on
its authority to regulate non-wholesale sales.” FERC Br. 34–
35. Otherwise, FERC could engage in direct regulation of the
retail market whenever the retail market affects the wholesale
market, which would render the retail market prohibition
useless. Cf. Morpho Detection, Inc. v. TSA, 717 F.3d 975,

1
The Dissent focuses extensively on § 201(b)(1), positing that the
“jurisdictional issue turns on a rather straightforward question of
statutory interpretation: whether a promise to forgo consumption of
electricity that would have been purchased in the retail electricity
market unambiguously constitutes a “sale of electric energy” under
section 201(b)(1).” Dissenting Op. at 3. The jurisdictional issue is
not quite so narrow. In fact, even the Commission does not
characterize the challenge this way and never offers an
interpretation of § 201(b)(1), arguing instead that demand response
resources are direct participants in wholesale markets. See FERC
Br. 34–40. Though our review is deferential, even if we reached
Chevron step two, we could not defer to an interpretation the
agency has not offered.
In any event, we do not base our conclusion on the “any other
sales” language of § 201(b)(1). Rather, we look to the statutory
scheme as a whole and find that demand response, while not
necessarily a retail sale, is indeed part of the retail market, which,
as the statute and case law confirm, is exclusively within the state’s
jurisdiction.
 10
981 (D.C. Cir. 2013) (declining to “adopt a reading that
would render the . . . general rule a nullity”).

In addition, if FERC’s arguments are followed to their
logical conclusions, price-responsive demand response—
retail demand response in “FERC speak”—would also affect
jurisdictional rates in the same way as the type of demand
response at issue in FERC’s rule here, and FERC’s authority
regarding demand response would be almost limitless.
Although the current rule leaves price-responsive demand
untouched, nothing would stop FERC from expanding this
regulation and encroaching further on state authority in the
future.

Thus, FERC can regulate practices affecting the wholesale
market under §§ 205 and 206, provided the Commission is
not directly regulating a matter subject to state control, such
as the retail market. Cf. Conn. Dep’t of Pub. Util. Control v.
FERC, 569 F.3d 477, 479 (D.C. Cir. 2009) (finding FERC
could regulate the installed capacity market under its affecting
jurisdiction because FERC did not engage in direct regulation
of an area subject to exclusive state control). 2

2
Connecticut Department of Public Utility Control v. FERC, 569
F.3d 477 (D.C. Cir. 2009), does not sanction FERC’s rule. In
Connecticut, FERC raised the capacity requirement and incidentally
incentivized construction of more generation facilities, which are
subject to state control; here, the Commission’s rule reaches
directly into the retail market to draw retail consumers into its
scheme. Here, FERC’s incentive is not merely a logical byproduct
of the rule; it is the rule. According to the Dissent, “FERC can
indirectly incentivize action that it cannot directly require so long as
it is otherwise acting within its jurisdiction.” Dissenting Op. at 18.
We agree Connecticut cannot control where FERC has directly
incentivized action it cannot directly require.
 11
The fact that the Commission is only “luring” the resource
to enter the market instead of requiring entry does not
undercut the force of Petitioners’ challenge. The lure is
change of the retail rate. Demand response—simply put—is
part of the retail market. It involves retail customers, their
decision whether to purchase at retail, and the levels of retail
electricity consumption. If FERC had directed ISOs to give a
credit to any consumer who reduced its expected use of retail
electricity, FERC would be directly regulating the retail rate.
At oral argument, the Commission conceded crediting would
be an impermissible intrusion into the retail market. See Oral
Arg. Tape, at 27:15. Ordering an ISO to compensate a
consumer for reducing its demand is the same in substance
and effect as issuing a credit. 3 Thus, while it is true demand
response can occur in two ways—through a response to either
price change or incentive payments—nothing about the latter
makes it “wholesale.” A buyer is a buyer, but a reduction in
consumption cannot be a “wholesale sale.” FERC’s
metaphysical distinction between price-responsive demand
and incentive-based demand cannot solve its jurisdictional
quandary.

Nor does FERC’s reliance on a statement of
congressional policy from the Energy Policy Act of 2005 save
its rule. FERC insists its actions “are consistent with
Congressional policy requiring federal level facilitation of
demand response, because this final rule is designed to
remove barriers to demand response participation in the
organized wholesale energy markets.” Order 745, 2011 WL
890975, at *30. FERC’s reliance on this language is

3
The agency’s concession contradicts the Dissent’s contention that
FERC can regulate demand response here because “non-
consumption [does not] constitute an ‘other sale,’” Dissenting Op.
at 16.
 12
perplexing; if anything, the policy statement supports the
opposite conclusion, that Congress intended demand response
resources to be regulated by states, as part of the retail market.

The Energy Policy Act of 2005 confirms the national
policy of encouraging and facilitating “the deployment of
[time-based pricing and other demand response] technology
and devices that enable electricity customers to participate in
such pricing and demand response systems . . . and
[eliminating] unnecessary barriers to demand response
participation in energy, capacity and ancillary service
markets.” Pub. L. No. 109-58, § 1252(f), 119 Stat. 594, 966
(2005). As an initial matter, even if § 1252(f) supports
FERC’s authority, the Commission cannot rely on the section
for an independent source of power. Policy statements like
§ 1252(f) “are just that—statements of policy. They are not
delegations of regulatory authority.” See Comcast Corp. v.
FCC, 600 F.3d 642, 654 (D.C. Cir. 2010); cf. New York, 535
U.S. at 22 (finding that a “mere policy declaration . . . cannot
nullify a clear and specific grant of jurisdiction”). Thus, the
relevant sections of the Energy Policy Act of 2005 can only
be used to “help delineate the contours of statutory authority.”
Comcast Corp., 600 F.3d at 654. And here, those contours do
not encompass federal regulation of demand response.

FERC latches onto the language in § 1252(f) requiring
elimination of “unnecessary barriers to demand response
participation in energy . . . service markets” to support its
claim that Order 745 advances congressional policy. See
FERC Br. 40. In Order 745, however, FERC went far beyond
removing barriers to demand response resources. Instead of
simply “removing barriers,” the rule draws demand response
resources into the market and then dictates the compensation
providers of such resources must receive.
 13
We think the title of the section is noteworthy: “Federal
Encouragement of Demand Response Devices.” (emphasis
added). Pub. L. No. 109-58, § 1252(f), 119 Stat. 594, 966.
“To encourage” is not “to regulate.” Although the title is “not
dispositive of the provision’s meaning,” “it is not too much to
expect that it has something to do with the subject matter” of
the section. See CAISO, 372 F.3d at 399. And here, “review
of the statutory text reveals that [the title] has everything to do
with the subject matter.” See id. The section dictates demand
response is to be “encouraged” and “facilitated,” not directly
regulated as Order 745 proposes.

This is obvious when § 1252(f) is read in tandem with
§ 1252(e), “Demand Response and Regional Coordination,”
which declares it the “policy of the United States to encourage
States to coordinate, on a regional basis, State energy policies
to provide reliable and affordable demand response services
to the public.” Pub. L. No. 109-58, § 1252(e), 119 Stat. 594,
966. This language underscores that states, not the
Commission, regulate demand response. Indeed, § 1252(e)
goes on to note FERC should “provide technical assistance to
States and regional organizations . . . in . . . developing plans
and programs to use demand response to respond to peak
demand or emergency needs.” Id. The Commission is also to
prepare an annual report, assessing demand response
resources. Id. Thus, the Energy Policy Act clarifies FERC’s
authority over demand response resources is limited: its role
is to assist and advise state and regional programs.

Even more importantly, the Energy Policy Act statements
show Congress understood the importance of demand
response resources to the wholesale market—an importance
Petitioners do not dispute. Yet, despite this significant impact
on the wholesale market, Congress left regulation of this
 14
aspect of retail demand up to the states, rather than to the
federal government.

Because the Federal Power Act unambiguously restricts
FERC from regulating the retail market, we need not reach
Chevron step two. But even if we assumed the statute was
ambiguous—as Judge Edwards argues, we would find
FERC’s construction of it to be unreasonable for the same
reasons we find the statute unambiguous. Because FERC’s
rule entails direct regulation of the retail market—a matter
exclusively within state control—it exceeds the Commission’s
authority.

IV

Alternatively, even if we assume FERC had statutory
authority to execute the Rule in the first place, Order 745
would still fail because it was arbitrary and capricious.

Under the APA, we must set aside orders that are
“arbitrary, capricious, an abuse of discretion, or otherwise not
in accordance with law.” 5 U.S.C. § 706(2)(A). In particular,
“it most emphatically remains the duty of this court to ensure
that an agency engage the arguments raised before it,” NorAM
Gas Transmission Co. v. FERC, 148 F.3d 1158, 1165 (D.C.
Cir. 1998), including the arguments of the agency’s dissenting
commissioners, Am. Gas Ass’n v FERC, 593 F.3d 14, 19
(D.C. Cir. 2010); see also Kamargo Corp. v. FERC, 852 F.2d
1392, 1398 (D.C. Cir. 1988) (“We recognize that this case
presents a difficult problem for the Commission, but we think
it has no alternative but to confront the questions raised by the
[commissioner’s] dissent.”).

A review of the record reveals FERC failed to properly
consider—and engage—Commissioner Moeller’s reasonable
 15
(and persuasive) arguments, reiterating the concerns of
Petitioners and other parties, that Order 745 will result in
unjust and discriminatory rates. Moeller argued Order 745
“overcompensat[es]” demand response resources because it
“requires that demand resource[s] be paid the full LMP plus
be allowed to retain the savings associated with [the
provider’s] avoided retail generation cost.” Demand
Response Compensation in Organized Wholesale Energy
Markets: Order on Rehearing and Clarification, 137 FERC
¶ 61,215, 2011 WL 6523756, at *38 (Dec. 15, 2011)
[hereinafter Order 745-A] (Moeller, dissenting); see also
Pet’rs Br. 45–50. The Commission then responded that
demand response resources are comparable to generation
resources and should therefore receive the same level of
compensation. Order 745-A, 2011 WL 6523756, at *14–15.
Yet comparable contributions cannot be the reason for equal
compensation, when generation resources are incomparably
saddled with generation costs. Nor can FERC justify its
current overcompensation by pointing to past under-
compensation. 4 Although we need not delve now into the
dispute among experts, see, e.g., Br. of Leading Economists
as Amicus Curiae in Support of Pet’rs, the potential windfall
to demand response resources seems troubling, and the
Commissioner’s concerns are certainly valid. Indeed,
“overcompensation cannot be just and reasonable,” Order
745-A, 2011 WL 6523756, at *38 (Moeller, dissenting), and
the Commission has not adequately explained how their
system results in just compensation.

4
Similarly, the hope that demand response resources will use the
expected windfall for “capital improvements,” see Dissenting Op.
at 24, does not respond to Petitioner’s concerns that the
overcompensation is unfair and discriminatory.
 16
The Commission cannot simply talk around the arguments
raised before it; reasoned decisionmaking requires more: a
“direct response,” which FERC failed to provide here. See
Am. Gas Ass’n, 539 F.3d at 20. Thus, if FERC thinks its
jurisdictional struggles are its only concern with Order 745, it
is mistaken. We would still vacate the Rule if we engaged the
Petitioners’ substantive arguments.

V

Ultimately, given Order 745’s direct regulation of the
retail market, we vacate the rule in its entirety as ultra vires
agency action.

For the reasons set forth above, we vacate and remand the
rulings under review.

So ordered.
 EDWARDS, Senior Circuit Judge, dissenting: Under the
Federal Power Act, regulatory authority over the nation’s
electricity markets is bifurcated between the States and the
federal government. In simplified terms, the Federal Energy
Regulatory Commission (“FERC” or “Commission”) has
authority over wholesale electricity sales but not retail
electricity sales, with the latter solely subject to State
regulation. See 16 U.S.C. § 824(a), (b)(1). The consolidated
petitions before the court call on us to parse this jurisdictional
line between FERC’s wholesale jurisdiction and the States’
retail jurisdiction – a line which this court and the Supreme
Court have recognized is neither neat nor tidy. See New York
v. FERC, 535 U.S. 1, 16 (2002) (“[T]he landscape of the
electric industry has changed since the enactment of the
[Federal Power Act], when the electricity universe was
‘neatly divided into spheres of retail versus wholesale sales.’”
(quoting Transmission Access Policy Study Grp. v. FERC,
225 F.3d 667, 691 (D.C. Cir. 2000))).

Petitioners challenge Order 745, a rule imposing certain
compensation requirements on the administrators of the
nation’s wholesale electricity markets. See Order 745,
Demand Response Compensation in Organized Wholesale
Energy Markets, 134 FERC ¶ 61,187, 2011 WL 890975, at *1
(Mar. 15, 2011). The rule requires these wholesale-market
administrators – called Regional Transmission Organizations
(“RTOs”) and Independent System Operators (“ISOs”) – to
compensate so-called “demand response resources” at a
specified price when certain conditions are met. As relevant
here, “demand response resources” are essentially electricity
consumers, often bundled together by a third-party
aggregator, who agree to reduce their electricity consumption
in exchange for incentive payments. See 18 C.F.R.
§ 35.28(b)(4)-(5). The pun scattered throughout the record is
that while generators produce megawatts, consumers produce
“negawatts.” In effect, Order 745 requires that, at certain
times, megawatts and negawatts receive the same amount of
 2
payment in wholesale markets, an amount called the
“locational marginal price” or “LMP.”

Although the challenged rule requires ISOs and RTOs to
pay demand response resources a specified compensation
(LMP), this requirement is applicable only when two
conditions are met: (1) when the demand response resource is
capable of balancing supply and demand in the wholesale
market, and (2) when compensating the demand response
resource is cost-effective under a “net benefits test”
prescribed by the rule. The specific mechanics of these
conditions and of the “net benefits test” are less important
than what they accomplish. The critical point here is that,
because of the specified conditions, Order 745 requires
compensation of demand response resources only when their
participation in a wholesale electricity market actually lowers
the market-clearing price for wholesale electricity.

With these basics in hand, it is easy to see why FERC
stated in its rulemaking that “jurisdiction over demand
response is a complex matter that lies at the confluence of
state and federal jurisdiction.” Order 745, 2011 WL 890975,
at *30. On one view, the demand response resources subject
to the rule directly affect the wholesale price of electricity.
That is, the final rule’s conditions operate to ensure that every
negawatt of forgone consumption receiving compensation
reduces both the quantity of electricity produced and its
wholesale price. Focusing on this direct effect – direct, it
bears repeating, because under the rule’s conditions all
demand response resources receiving compensation reduce
the market-clearing price – it is easy to conceive of Order 745
as permissibly falling on the wholesale side of the wholesale-
retail jurisdictional line. On another view, however, the
electricity not consumed thanks to the rule’s compensation
payments would have been consumed first in a retail market.
 3
Focusing on the market in which the consumption would have
occurred in the first instance, one can conceive of Order 745
as impermissibly falling on the retail side of the jurisdictional
line.

The task for this court, of course, is not to divine from
first principles whether a demand response resource subject to
Order 745 is best considered a matter of wholesale or retail
electricity regulation. Rather, our task is one of statutory
interpretation within the familiar Chevron framework. See
Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467
U.S. 837, 842-44 (1984); see also Cal. Indep. Sys. Operator
Corp. (CAISO) v. FERC, 372 F.3d 395, 399-400 (D.C. Cir.
2004). The Commission has interpreted the Federal Power
Act to permit it to issue Order 745. And it falls to this court to
determine whether the Act unambiguously “sp[eaks] to the
precise question,” 467 U.S. at 842 (Chevron step one), and, if
not, whether the Commission’s interpretation is a permissible
construction of the statute, id. at 843 (Chevron step two).

Though the rule and its operation are highly technical, the
primary jurisdictional issue raised in these consolidated
petitions turns on a rather straightforward question of
statutory interpretation: whether a promise to forgo
consumption of electricity that would have been purchased in
a retail electricity market unambiguously constitutes a “sale of
electric energy” under section 201(b)(1) of the Federal Power
Act. 16 U.S.C. § 824(b)(1). If so, the Commission lacked
jurisdiction to issue Order 745 because section 201(b)(1) of
the Act states, in relevant part, that the “provisions of this
subchapter shall apply . . . to the sale of electric energy at
wholesale in interstate commerce, but . . . shall not apply to
any other sale of electric energy.” Id. (emphasis added).
 4
The statute, to my mind, is ambiguous regarding whether
forgone consumption constitutes a “sale” under section
201(b)(1). Because of this ambiguity, the Act is also
ambiguous as to whether a rule requiring administrators of
wholesale markets to pay a specified level of compensation
for such forgone consumption constitutes “direct regulation”
of retail sales that would contravene the limitations of section
201. Conn. Dep’t of Pub. Util. Control v. FERC, 569 F.3d
477, 481-82 (D.C. Cir. 2009) (holding that FERC’s approval
of an Installed Capacity Requirement was not “direct
regulation” of electrical generation facilities and, thus, did not
violate section 201 (emphasis added)). Because the Act is
ambiguous regarding FERC’s authority to require ISOs and
RTOs to pay demand response resources, we are obliged to
defer under Chevron to the Commission’s permissible
construction of “a statutory ambiguity that concerns the scope
of the agency’s statutory authority (that is, its jurisdiction).”
City of Arlington v. FCC, 133 S. Ct. 1863, 1868, 1874-75
(2013).

Absent an affirmative limitation under section 201, there
is no doubt that demand response participation in wholesale
markets and the ISOs’ and RTOs’ market rules concerning
such participation constitute “practice[s] . . . affecting”
wholesale rates under section 206 of the Act. 16 U.S.C.
§ 824e(a); see also id. § 824d(a) (providing that “all rules and
regulations affecting or pertaining to [wholesale] rates or
charges shall be just and reasonable”). Petitioners’ arguments
to the contrary ignore the direct effect that the ISOs’ and
RTOs’ market rules have on wholesale electricity rates
squarely within FERC’s jurisdiction. The Commission has
authority to “determine the just and reasonable . . . practice”
by setting a level of compensation for demand response
resources that, in its expert judgment, will ensure that the
rates charged in wholesale electricity markets are “just and
 5
reasonable.” Id. § 824e(a). It was therefore reasonable for the
Commission to conclude that it could issue Order 745 under
the Act’s “affecting” jurisdiction. See id. §§ 824e(a), 824d(a).

In addition to challenging FERC’s jurisdiction,
Petitioners argue that its decision to mandate compensation
equal to the LMP was arbitrary and capricious. Petitioners
believe that the LMP overcompensates demand response
resources since they also realize savings from not having to
purchase retail electricity. The Commission, Petitioners insist,
should have set the compensation level at the LMP minus the
retail cost of the forgone electricity. But the Commission’s
decision in this regard was reasonable and adequately
explained.

For these reasons, explained below in greater detail, I
respectfully dissent.

I. BACKGROUND

A. The Problem

To understand this case, one must appreciate the scope
and significance of the problem FERC sought to address in
Order 745. Three characteristics of the nation’s electricity
market go a long way toward framing the problem. First,
electricity, unlike most commodities, cannot be stored for
later use. There must instead be a continual, contemporaneous
matching of supply to meet current electricity demand.
Second, not all power plants are created equal: some are
efficient and cheap; others, inefficient and expensive. Third,
most retail consumers are charged a fixed price for electricity
that does not adjust in the moment to temporary spikes in the
cost of producing electricity.
 6
The first two characteristics, in tandem, cause significant
fluctuations in the cost of supplying electricity at different
times of day. During periods of regular electricity
consumption, only the efficient and cheap power plants need
be deployed. But at hours of peak usage (e.g., a summer
afternoon in Washington, D.C. when countless air
conditioners toil against the humidity and heat), the suppliers
of electricity must marshal the least efficient and most costly
power plants to match the soaring demand for electricity. It is
because electricity cannot be efficiently stored that these
periods of peak demand must be met with new generation and
not stockpiled supply.

In a perfect market, or even in a well-functioning market,
the skyrocketing cost of producing additional electricity at
hours of peak usage would be reflected in temporarily higher
prices charged to consumers. In turn, this increased price
would reduce the megawatts of electricity demanded, as some
individuals and businesses would, for example, turn off their
air conditioners to save money. The market would thereby
reach an efficient equilibrium.

But here is where the third characteristic of electricity
markets comes in. Retail electricity prices are generally
regulated to remain constant over longer periods of time. That
is, consumers do not pay different amounts during different
hours of the day, notwithstanding the sharply vacillating cost
of producing electricity. Electricity demand thus does not
respond to time-sensitive price signals. As a result, there are
times when people and businesses consume electricity that
costs more to produce than it is worth to them to consume.
This is inefficient.

Wholesale electricity markets, which are under FERC’s
jurisdiction, suffer the same inefficiency. Since retail demand
 7
is not price-responsive, the aggregate amount of electricity
demanded in the wholesale market by the entities that serve
retail customers is also uncoupled from the time-specific price
of supplying electricity. In economic terms, the demand for
electricity in the wholesale market is inelastic. See Order
745-A, Demand Response Compensation in Organized
Wholesale Energy Markets, 137 FERC ¶ 61,215, 2011 WL
6523756, at *9 (Dec. 15, 2011).

The Commission recognizes the problem. As it observed
in its order denying requests for rehearing of Order 745,

[a] properly functioning market should reflect both the
willingness of sellers to sell at a price and the willingness
of buyers to purchase at a price. In an RTO- or ISO-run
market, however, buyers are generally unable to directly
express their willingness to pay for a product at the price
offered. As discussed later, RTOs and ISOs cannot
isolate individual buyers’ willingness to pay which
results in extremely inelastic demand.

Id.; see also Order 745, 2011 WL 890975, at *1 (“[A] market
functions effectively only when both supply and demand can
meaningfully participate.” (emphasis added)).

B. FERC’s Solution

Having identified a problem in the wholesale electricity
market, the Commission has a statutory obligation to do what
it can to fix it. That is because FERC is charged under the
Federal Power Act with ensuring that wholesale electricity
rates are “just and reasonable.” 16 U.S.C. §§ 824d(a),
824e(a). It must ensure that all “rates and charges made,
demanded, or received by any public utility for or in
connection with the . . . sale of electric energy subject to the
 8
jurisdiction of the Commission” are “just and reasonable.” Id.
§ 824d(a) (emphasis added); see also id. § 824(a). And when
FERC determines that a “practice . . . affecting” such a rate is
unjust or unreasonable, it must itself determine and fix “the
just and reasonable . . . practice . . . to be thereafter observed.”
Id. § 824e(a).

Consistent with its statutory duty and in view of the
market distortions caused by inelastic wholesale demand, the
Commission has initiated a series of reforms to open
wholesale markets to “demand response resources.” For our
purposes, “demand response resources” are resources that are
capable of reducing “the consumption of electric energy by
customers from their expected consumption in response . . . to
incentive payments designed to induce lower consumption of
electric energy.” 18 C.F.R. § 35.28(b)(4)-(5). Put simply,
demand response resources agree not to purchase electricity in
exchange for payment.

The basic premise of FERC’s demand-response reforms
is that there are two ways that wholesale-market
administrators (i.e., ISOs and RTOs) can balance wholesale
supply and demand: by increasing the supply of electricity or
by decreasing the demand for it. See Order 745-A, 2011 WL
6523756, at *14. An ISO or RTO reduces wholesale demand
when it pays a demand response resource because that
resource will forgo electricity consumption in the retail
market, which, in turn, will lead to fewer megawatts of
electricity being demanded in the aggregate in that ISO’s or
RTO’s wholesale market. At certain times (e.g., summer
afternoons in Washington, D.C.), paying incentive payments
to induce consumers not to consume electricity may be
cheaper than paying generators to produce more power;
negawatts, in such circumstances, are the cheaper alternative.
And because, functionally, there is little difference to
 9
wholesale-market administrators between a megawatt and a
negawatt (both assist equally in the administrator’s task of
bringing wholesale demand and supply into equipoise),
demand response resources are capable of competing directly
with traditional generation resources so long as the
appropriate market rules are in place.

For some years now, FERC has recognized that the direct
participation of demand response resources in wholesale
markets improves the functioning of these markets in several
respects. First, it lowers wholesale prices because “lower
demand means a lower wholesale price.” Order 719-A,
Wholesale Competition in Regions with Organized Electric
Markets, 128 FERC ¶ 61,059, 2009 WL 2115220, at **12
(July 16, 2009). Second, it mitigates the market power of
suppliers of electricity because they have to compete with
demand response resources and adjust their bidding strategy
accordingly. See id. (“[T]he more demand response is able to
reduce peak prices, the more downward pressure it places on
generator bidding strategies by increasing the risk to a
supplier that it will not be dispatched if it bids a price that is
too high.”). Third, demand response “enhances system
reliability,” for example, by “reducing electricity demand at
critical times (e.g., when a generator or a transmission line
unexpectedly fails).” Id. at **12 & n.76; see also Order
745-A, 2011 WL 6523756, at *6 (“[D]emand response
generally can be dispatched by the [ISO or RTO] with a
minimal notice period, helping to balance the electric system
in the event that an unexpected contingency occurs.”).

The benefits of demand response participating in
wholesale markets are beyond reproach. Commissioner
Moeller, who dissented in Order 745, put it best:
 10
While the merits of various methods for
compensating demand response were discussed at length
in the course of this rulemaking, nowhere did I review
any comment or hear any testimony that questioned the
benefit of having demand response resources participate
in the organized wholesale energy markets. On this point,
there is no debate. The fact is that demand response plays
a very important role in these markets by providing
significant economic, reliability, and other market-related
benefits.

Order 745, 2011 WL 890975, at *34 (emphasis added)
(Moeller, dissenting).

It is no surprise, then, that FERC has initiated a series of
reforms to open up its markets to demand response, on the
theory that doing so helps to ensure “just and reasonable”
wholesale rates by improving how these markets function in
the three ways just mentioned. See Order 890, Preventing
Undue Discrimination and Preference in Transmission
Service, 72 Fed. Reg. 12,226, 12,378 (Mar. 15, 2007); Order
719, Wholesale Competition in Regions with Organized
Electric Markets, 73 Fed. Reg. 64,100 (Oct. 28, 2008); see
also Br. for Resp’t at 11-13 (providing overview of these
rulemakings); id. at 12 (noting that, before Order 719, FERC
had approved proposals by various ISOs and RTOs “to allow
demand response participation in their ancillary services
markets” (citations omitted)).

In particular, in Order 719 FERC required ISOs and
RTOs to “accept bids from demand response resources in
RTOs’ and ISOs’ markets for certain ancillary services on a
basis comparable to other resources” and, in certain
circumstances, to “permit an aggregator of retail customers
. . . to bid demand response on behalf of retail customers
 11
directly into the organized energy market.” Order 719-A,
2009 WL 2115220, at **1. But FERC placed an important
condition on this requirement; ISOs and RTOs were required
to accept bids from demand response “unless not permitted by
the laws or regulations of the relevant electric retail regulatory
authority.” 18 C.F.R. § 35.28(g)(1)(i)(A), (iii); Order 719-A,
2009 WL 2115220, at **13. Finally, recognizing that “further
reforms may be necessary to eliminate barriers to demand
response in the future,” FERC further ordered ISOs and RTOs
to “assess and report on any remaining barriers to comparable
treatment of demand response resources that are within the
Commission’s jurisdiction.” Order 719-A, 2009 WL 2115220,
at **1.

And further reforms were indeed necessary. Prior to
issuing Order 745, ISOs and RTOs had differing practices
concerning the level of compensation to be paid to demand
response resources in their markets. Order 745, 2011 WL
890975, at *4. The Commission found that many ISOs and
RTOs undercompensated demand response resources in
certain circumstances. See id. at *16. It reached this finding in
light of existing barriers to demand response participation in
wholesale markets, including “the lack of market incentives to
invest in enabling technologies that would allow electric
customers and aggregators of retail customers to see and
respond to changes in marginal costs of providing electric
service as those costs change.” Id.; see also id. (“[T]he
inadequate compensation mechanisms in place today in
wholesale energy markets fail to induce sufficient investment
in demand response resource infrastructure and expertise that
could lead to adequate levels of demand response
procurement. Without sufficient investment in the development
of demand response, demand response resources simply
cannot be procured because they do not yet exist as
resources. Such investment will not occur so long as
 12
compensation undervalues demand response resources.”
(emphasis added) (quoting a commenter)).

Order 745 sought to correct the undercompensation
problem by mandating that ISOs and RTOs pay demand
response resources the same market price that they pay to
generators, i.e., LMP. But it limited this compensation
requirement to circumstances where two specific conditions
are met. LMP-compensation would be required only when (1)
“the demand response resource [is] able to displace a
generation resource in a manner that serves the RTO or ISO
in balancing supply and demand,” and (2) “the payment of
LMP . . . [is] cost-effective, as determined by [a] net benefits
test.” Id. at *13; see also 18 C.F.R. § 35.28(g)(1)(v)(A).

FERC understood that it had authority to correct the
undercompensation problem because, in the absence of
adequate compensation, too few demand response resources
affirmatively bid into the wholesale markets. And such
participation is necessary for the market to function rationally
and reach “just and reasonable” rates. As FERC stated:

We find, based on the record here that, when a demand
response resource has the capability to balance supply
and demand as an alternative to a generation resource,
and when . . . paying LMP to that demand response
resource is shown to be cost-effective as determined by
the net benefits test described herein, payment by an
RTO or ISO of compensation other than the LMP is
unjust and unreasonable. When these conditions are met,
we find that payment of LMP to these resources will
result in just and reasonable rates for ratepayers.

Order 745, 2011 WL 890975, at *13 (emphasis added).
 13
II. ANALYSIS

A. Jurisdiction

Petitioners argue that Order 745 is “in excess” of FERC’s
“statutory jurisdiction.” Br. of Pet’rs Elec. Power Supply
Ass’n, et al. (“Br. of Pet’rs”) at 27 (citing 5 U.S.C.
§ 706(2)(C)). We evaluate this contention under Chevron and
defer to FERC’s permissible construction of its authorizing
statute, regardless of “whether the interpretive question
presented is ‘jurisdictional.’” City of Arlington, 133 S. Ct. at
1874-75; see also Connecticut, 569 F.3d at 481. The proper
question is thus whether the Act unambiguously forecloses
FERC from issuing Order 745 under its “affecting”
jurisdiction. See 16 U.S.C. § 824e; Chevron, 467 U.S. at 842.

FERC’s explanation of its jurisdiction under the Federal
Power Act is straightforward and sensible. FERC has the
authority and responsibility to correct any “practice . . .
affecting” wholesale electricity rates that the Commission
determines to be “unjust” or “unreasonable.” 16 U.S.C.
§ 824e(a); see also id. § 824d(a). In its view, the ISOs’ and
RTOs’ rules governing the participation of demand response
resources in the nation’s wholesale electricity markets are
“practices affecting [wholesale electricity] rates.” Order
745-A, 2011 WL 6523756, at *10 (quoting 16 U.S.C.
§§ 824d, 824e). That is, an ISO’s or RTO’s market rules
governing how a demand response resource may compete in
its wholesale market, including the terms by which a demand
response resource is to be compensated in the market, are
“practices affecting” that wholesale market’s rates for
electricity. And FERC has determined that an ISO’s or RTO’s
“practice” is unjust and unreasonable to the degree that it
inadequately compensates demand response resources capable
of supplanting more expensive generation resources. See id. at
 14
*36. As explained above, FERC has found that demand
response improves the functioning of wholesale markets by
(1) lowering the wholesale price of electricity, (2) exerting
downward pressure on generators’ market power, and (3)
enhancing system reliability.

FERC’s explanation is consistent with our case law. In
Connecticut, we considered whether FERC has jurisdiction to
review an ISO’s capacity charges. 569 F.3d at 478-79.
Capacity is not electricity but the ability to produce it when
needed, and in Connecticut the ISO had established a market
where capacity providers – generators, prospective generators,
and demand response resources – competitively bid to meet
the ISO’s capacity needs three years in the future. Id. at 479-
81. Generation, like retail sales, is expressly the domain of
State regulation under section 201, 16 U.S.C. § 824(b)(1), and
the petitioners argued that by increasing the overall capacity
requirement the ISO was improperly requiring the installation
of new generation resources. 569 F.3d at 481. We disagreed
and held that FERC had “affecting” jurisdiction under section
206 because “capacity decisions . . . affect FERC-
jurisdictional transmission rates for that system without
directly implicating generation facilities.” Id. at 484. That the
capacity requirement helped to “find the right price” was
enough of an effect to satisfy section 206. Id. at 485.

Petitioners’ specific arguments against FERC’s
exercising jurisdiction are unpersuasive. First, Petitioners
note that section 201 of the Act establishes a clear
jurisdictional line between “the sale of electric energy at
wholesale in interstate commerce,” which is properly the
subject of FERC’s jurisdiction, and “any other sale of electric
energy.” Br. of Pet’rs at 27-28 (citing 16 U.S.C. § 824(a),
(b)(1)). According to Petitioners, the Commission has
transgressed this line because it “has ordered ISOs and RTOs
 15
to pay retail customers for reducing their retail purchases of
electricity.” Id. at 28.

But this argument mischaracterizes the rule and papers
over a key ambiguity. First, the mischaracterization:
Petitioners are wrong inasmuch as they imply that FERC
requires all ISOs and RTOs to pay demand response
resources a minimum level of compensation (LMP). The
compensation requirement promulgated in Order 745 does not
apply unless an ISO or RTO “has a tariff provision permitting
demand response resources to participate as a resource in the
energy market.” 18 C.F.R. § 35.28(g)(1)(v). And the
regulation’s requirement that ISOs and RTOs accept bids
from demand response resources comes with a key caveat: the
requirement applies “unless not permitted by the laws or
regulations of the relevant electric retail regulatory authority.”
Id. § 35.28(g)(1)(i)(A); see also id. § 35.28(g)(1)(iii). In other
words, there is a carve-out from the compensation
requirement for ISOs and RTOs in States where local
regulatory law stands in the way. Thus, the Order preserves
State regulation of retail markets. This is hardly the stuff of
grand agency overreach.

More fundamentally, Petitioners’ argument founders on a
statutory ambiguity they ignore. Section 201 makes clear that
FERC may regulate “the sale of electric energy at wholesale
in interstate commerce” but not “any other sale of electric
energy.” 16 U.S.C. § 824(b)(1) (emphasis added). The
demand response at issue here is forgone consumption, which
is no “sale” at all. Perhaps the phrase “any other sale of
electric energy” could be interpreted to include non-sales that
would have been sales in the retail market, but it certainly
does not require such a reading. It is reasonable to categorize
demand response as neither a retail sale nor wholesale sale
under the Federal Power Act. And on this understanding,
 16
section 201 “says nothing about” FERC’s power to review
compensation rates for demand response in wholesale
electricity markets. Connecticut, 569 F.3d at 483.

Nor is Petitioners’ argument under section 201 made any
stronger by reference to subsection (a). This prefatory
subsection states that while “Federal regulation . . . of electric
energy in interstate commerce and the sale of such energy at
wholesale in interstate commerce is necessary in the public
interest,” federal regulation should “extend only to those
matters which are not subject to regulation by the States.” 16
U.S.C. § 824(a). But the Supreme Court has made clear that
“the precise reserved state powers language in § 201(a)” is a
“mere policy declaration that cannot nullify a clear and
specific grant of jurisdiction, even if the particular grant
seems inconsistent with the broadly expressed purpose.” New
York, 535 U.S. at 22 (emphasis added) (internal quotation
marks omitted). And, as I discuss below, section 206’s
specific grant of “affecting” jurisdiction quite clearly
authorized FERC to issue Order 745.

The most that can be said of section 201 is that it
commits regulation of retail sales to the States and regulation
of wholesale sales to the Commission. And while it is true
that the forgone consumption would have been purchased in
the first instance in the retail market, it does not follow from
this fact that non-consumption constitutes an “other sale”
under section 201(b). There was no sale, period. And the
statute does not give a clear indication that Congress intended
to foreclose FERC from regulating non-sales that have a
direct effect on the wholesale markets under FERC’s
jurisdiction.

Even assuming that the Federal Power Act requires
demand response resources to be considered inextricably part
 17
of retail “sales” subject solely to State regulation, Order 745
does not engage in the type of “direct regulation” that would
violate section 201. See Connecticut, 569 F.3d at 481. Order
745 does not require anything of retail electricity consumers
and leaves it to the States to decide whether to permit demand
response. All Order 745 says is that if a State’s laws permit
demand response to be bid into electricity markets, and if a
demand response resource affirmatively decides to participate
in an ISO’s or RTO’s wholesale electricity market, and if that
demand response resource would in a particular circumstance
allow the ISO or RTO to balance wholesale supply and
demand, and if paying that demand resource would be a net
benefit to the system, then the ISO or RTO must pay that
resource the LMP. That is it. This requirement will no doubt
affect how much electricity is consumed by a small subset of
retail consumers who elect to participate as demand response
resources in wholesale markets. But that fact does not render
Order 745 “direct regulation” of the retail market. Authority
over retail rates and over whether to permit demand response
remains vested solely in the States.

In this respect, Order 745 is similar to the capacity rule in
Connecticut that we found did not directly regulate generation
facilities. 569 F.3d at 482. Even though increasing the
capacity requirement incentivized the procurement of
additional resources, including new generation facilities, to
meet the higher requirement, we recognized that States
retained their ultimate authority over the construction of new
generation facilities. Id.at 481-82. And because the capacity
requirements could be met in other ways aside from building
new generators (e.g., through demand response or capacity
contracts), it was irrelevant that “public utilities . . .
overwhelmingly responded to [increased capacity
requirements] by choosing to allow construction of new
facilities over other alternatives.” Id. at 482. The lesson of
 18
Connecticut is that FERC can indirectly incentivize action
that it cannot directly require so long as it is otherwise acting
within its jurisdiction – and that doing so does not constitute
impermissible direct regulation of an area reserved to the
States. So too here: Order 745 may encourage more demand
response, but States retain the ultimate authority to approve
the practice.

Second, Petitioners argue that the FERC’s “affecting”
jurisdiction under sections 205 and 206 of the Act “does not
extend so far as to allow the Commission to regulate directly
the retail services that are expressly carved out from the scope
of its jurisdiction.” Br. of Pet’rs at 30-31 (citing 16 U.S.C.
§ 824(a), (b)(1)). To a large degree, this argument simply
rehashes Petitioners’ erroneous reading of section 201 and
fails for the reasons just described. Demand response
resources are promises to forgo consumption of electricity and
therefore are not retail “sales.” This is not changed by the fact
that forgone consumption would have taken place in the first
instance in a retail market. Because of this, the Commission’s
asserting “affecting” jurisdiction over demand response does
not, as Petitioners suggest, “nullify[]” a limitation set forth in
section 201. Id. at 32.

To be sure, section 206 cannot be read to displace
unambiguous jurisdictional limits imposed by section 201(b).
Suppose, for example, that FERC issued a rule requiring ISOs
and RTOs to condition all wholesale sales of electricity on
load-serving entities’ agreeing to charge retail customers with
real-time pricing that adjusted hourly for variations in the cost
of producing electricity. Such a rule would unambiguously
regulate each retail “sale” because it would mandate a
particular form of compensation for actual – not
counterfactual – retail sales. Thus, while price-responsive
retail pricing would no doubt “affect” the wholesale rate,
 19
FERC could not claim jurisdiction under sections 205 and 206
because the subchapter which includes these sections “shall
not apply to any other sale of electric energy.” 16 U.S.C.
§ 824(b)(1) (emphasis added). This example plainly differs
from the present case because demand response resources are
forgone sales or non-sales, and therefore it is at best
ambiguous whether the limitation in section 201(b) applies.
See Connecticut, 569 F.3d at 483 (“Section 201 prohibits the
Commission from regulating generation facilities but says
nothing about its power to review the capacity requirements
that an [ISO] imposes on member [utilities].”).

To bolster their case, Petitioners invoke the specter of
limitless federal authority if FERC is permitted to exercise
“affecting” jurisdiction to issue Order 745. They caution that
“the Commission’s expansive interpretation of its ‘affecting’
jurisdiction would allow it to regulate any number of
activities – such as the purchase or sale of steel, fuel, labor,
and other inputs influencing the cost to generate or transmit
electricity – merely by redefining the activities as ‘practices’
that affect wholesale rates.” Br. of Pet’rs at 33.

This argument cannot carry the day because it ignores at
least two important limits. It first ignores section 201’s limit
proscribing any “direct regulation” of retail sales (which
would bar the hypothetical rule, discussed above, in which
FERC tries to mandate that retail sales have dynamic, time-
responsive pricing). See Connecticut, 569 F.3d at 481. It also
ignores the limitations we announced in CAISO, 372 F.3d
395. There, we held that FERC exceeded its jurisdiction when
it replaced the board members of an ISO on the theory that the
composition of the ISO’s board was a “practice . . . affecting
[a] rate” under section 206(a). Id. at 399. We held that
“section 206’s empowering of the Commission to assess the
justness and reasonableness of practices affecting rates of
 20
electric utilities is limited to those methods or ways of doing
things on the part of the utility that directly affect the rate or
are closely related to the rate, not all those remote things
beyond the rate structure that might in some sense indirectly
or ultimately do so.” Id. at 403 (emphasis added).

These limits foreclose the parade of horribles marshaled
by Petitioners. Like replacing the ISO’s board of directors in
CAISO, FERC could not, consistent with Circuit precedent,
regulate markets in steel, fuel, labor, and other inputs for
generating electricity, which constitute “remote things beyond
the rate structure that might in some sense indirectly or
ultimately” affect the wholesale rate of electricity. Id.; see
also Calpine Corp. v. FERC, 702 F.3d 41, 47 (D.C. Cir. 2012)
(affirming FERC’s determination that it lacked “affecting”
jurisdiction over station power, which is a necessary input to
energy production, because there was not a “sufficient nexus
with wholesale transactions” (internal quotation marks
omitted) (citing City of Cleveland v. FERC, 773 F.2d 1368,
1376 (D.C. Cir. 1985))); City of Cleveland, 773 F.2d at 1376
(“[T]here is an infinitude of practices affecting rates and
service. The statutory directive must reasonably be read to
require the recitation of only those practices that affect rates
and service significantly . . . .” (emphasis added)).

Order 745 passes the CAISO test quite comfortably
because the demand response resources subject to the rule
have a quintessentially “direct” effect on wholesale rates. The
rule’s compensation requirement applies only when an ISO or
RTO can use the demand response resource in lieu of a
generation resource to balance supply and demand, and only
when paying a demand response resource is cost-effective
under the rule’s net benefits test. 18 C.F.R.
§ 35.28(g)(1)(v)(A). Order 745 thus does not purport to
regulate demand response writ large; its compensation
 21
requirement applies only when the demand response by
definition alters the wholesale electricity price. That is about
as “direct” an effect and as clear a “nexus” with the wholesale
transaction as can be imagined. See Calpine Corp., 702 F.3d
at 47; CAISO, 372 F.3d at 403; City of Cleveland, 773 F.2d at
1376. There can be little doubt that FERC has the authority to
review the justness and reasonableness of rates that are so
closely connected with the healthy functioning of its
jurisdictional markets; this, as we said in Connecticut, is the
“heartland of the Commission’s section 206 jurisdiction.” 569
F.3d at 483.

Third, Petitioners argue that the Commission’s orders
exceed its jurisdiction because “they unreasonably interfere
with existing state and local programs addressing retail
customer ‘demand response.’” Br. of Pet’rs at 41. Any such
effect, however, is merely incidental. As the Commission
correctly observed, Order 745 “does not directly affect retail-
level demand response programs, nor does it require that
demand response resources offer into the wholesale market
only. Indeed, the organized wholesale energy markets can and
do operate simultaneously with retail-level programs . . . .”
Order 745-A, 2011 WL 6523756, at *19. FERC’s reforms in
Order 745 run on a parallel track with State-level reforms.
And to the degree that FERC’s reforms incidentally affect
parallel State-level initiatives, that does not render FERC’s
actions improper. See Nat’l Ass’n of Regulatory Util.
Comm’rs v. FERC, 475 F.3d 1277, 1280 (D.C. Cir. 2007)
(observing that FERC’s authority to act within its statutory
scope of jurisdiction “may, of course, impinge as a practical
matter on the behavior of non-jurisdictional” entities).

* * *
 22
To summarize: FERC’s jurisdiction turns on two issues:
(1) whether demand response is a retail “sale” or is otherwise
unambiguously committed to State regulation under the
Federal Power Act, and (2) whether sections 205 and 206
clearly grant jurisdiction to FERC to regulate how wholesale-
market administrators compensate demand response resources
that “directly affect” wholesale prices. Unless we inject
quasi-philosophy into our Chevron analysis (what is the sound
of one hand clapping? what is the true nature of a sale that
was never made? of megawatts never consumed?), I think it
clear that the Federal Power Act does not precisely address
the first question; forgone consumption is not unambiguously
a “sale,” nor does the statute dictate that demand response be
treated solely as a matter of retail regulation. And the second
question is resolved, in my view, by the terms of Order 745
which narrowly apply only to demand response resources that
by definition directly affect the wholesale rates of electricity.
This falls squarely within the Commission’s “affecting”
jurisdiction. See 16 U.S.C. §§ 824d, 824e. The proper course
for this court is to defer to the Commission’s well-reasoned
and permissible interpretation of its authority under the
statute.

B. Level of Compensation

Petitioners also argue that Order 745 is arbitrary and
capricious under 5 U.S.C. § 706(2)(A). In reviewing such
claims, we consider whether FERC “examine[d] the relevant
data and articulate[d] a satisfactory explanation for its action
including a rational connection between the facts found and
the choice made.” Motor Vehicle Mfrs. Ass’n of the U.S. v.
State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)
(internal quotation marks omitted). We also afford significant
deference to FERC in light of the highly technical regulatory
landscape that is its purview. Indeed, “the Commission enjoys
 23
broad discretion to invoke its expertise in balancing
competing interests and drawing administrative lines.” Am.
Gas Ass’n v. FERC, 593 F.3d 14, 19 (D.C. Cir. 2010). And
we “afford great deference to the Commission” in cases
involving ratemaking decisions as the “statutory requirement
that rates be ‘just and reasonable’ is obviously incapable of
precise judicial definition.” Morgan Stanley Capital Grp. Inc.
v. Pub. Util. Dist. No. 1, 554 U.S. 527, 532 (2008). Finally, to
the extent that the Commission bases its actions on factual
findings, such findings are conclusive if supported by
substantial evidence. 16 U.S.C. § 825l(b).

Petitioners’ chief complaint is that Order 745 sets the
required compensation level for demand response at the LMP
(recall: locational marginal price). LMP equals “the marginal
value of an increase in supply or a reduction in consumption
at each node within” an ISO’s or RTO’s wholesale market,
and is the compensation generation resources generally
receive. Order 745-A, 2011 WL 6523756, at *20. Petitioners
complain that demand response resources already get the
benefit of the forgone expense of retail electricity
(abbreviated in the record as “G”). Therefore, Petitioners
contend that, under FERC’s rule, demand response resources
effectively receive a “double payment”: LMP plus G. Br. of
Pet’rs at 47. According to Petitioners, requiring LMP
compensation thus results in unjust and discriminatory
overcompensation of demand response resources. Id. at 45-
50; see also Order 745-A, 2011 WL 6523756, *38 (Moeller,
dissenting).

It is of course true, as the majority observes, that FERC is
“bounded by the requirements of reasoned decisionmaking.”
Am. Gas Ass’n, 593 F.3d at 19. Therefore, FERC was
required to provide a “direct response” to the Petitioners’ and
the dissenting Commissioner’s concerns about
 24
overcompensation. Id. at 20. This is precisely what the
Commission did in carefully explaining how Order 745’s
setting compensation at the LMP was neither discriminatory
nor unjust.

To begin with, FERC provided a thorough explanation
for why compensating demand response at the LMP (and not
LMP - G) was neither unjust nor over-compensatory. It
explained that such compensation was necessary to encourage
an adequate level of demand response participation in
wholesale markets in light of existing market barriers. See
Order 745-A, 2011 WL 6523756, at *15 (noting that
Petitioners “fail to acknowledge the market imperfections
caused by the existing barriers to demand response”). That
last part – the market barriers – is the key. The Commission
has identified numerous barriers preventing adequate
participation of demand response in wholesale markets. Order
745, 2011 WL 890975, at *16 & n.122 (citing study). Indeed,
citing record evidence, the Commission explained that “the
inadequate compensation mechanisms in place today in
wholesale energy markets fail to induce sufficient investment
in demand response resource infrastructure and expertise that
could lead to adequate levels of demand response
procurement.” Id. at *16 (quoting a commenter). FERC
further explained that “a lack of incentives to invest in
enabling technologies can be addressed by making additional
investment resources available to market participants” and
that paying LMP “to demand response will provide the proper
level of investment resources available for capital
improvements.” Order 745-A, 2011 WL 6523756, at *16. In
view of these barriers, and the value of demand response
participation to ensuring “just and reasonable” wholesale
rates, the Commission concluded that LMP was the
appropriate level of compensation.
 25
FERC sums it up well:

The Commission acknowledged that noted experts
differed on whether paying LMP in the current
circumstances facing the wholesale electric market is a
reasonable price. In determining that LMP is the just and
reasonable price to pay for demand response, the
Commission examined some of the previously
recognized barriers to demand response that exist in
current wholesale markets. These barriers create an
inelastic demand curve in the wholesale energy market
that results in higher wholesale prices than would be
observed if the demand side of the market were fully
developed. The Commission found that paying LMP
when cost-effective may help remove these barriers to
entry of potential demand response resources, and,
thereby, help move prices closer to the levels that would
result if all demand could respond to the marginal price
of energy.

Id. at *17. This is a “direct response” to the points raised by
the Petitioners. Am. Gas Ass’n, 593 F.3d at 20.

With respect to the argument that utilizing the LMP is
somehow discriminatory because incomparable resources are
paid comparable amounts, the Commission offered reasonable
grounds for treating demand response as comparable to
generation resources. The Commission observed that, from
the perspective of an ISO or RTO, a demand response
resource was comparable to a generation resource inasmuch
as demand response is equally capable of balancing wholesale
supply and demand. Order 745-A, 2011 WL 6523756, at *14.
This is not the sum total of the explanation, however. In the
same section of its order, the Commission explained that
“examining cost avoidance by demand response resources is
 26
not consistent with the treatment of generation. In the absence
of market power concerns, the Commission generally does
not examine each of the costs of production for individual
resources participating as supply resources in the organized
wholesale electricity markets.” Id. at *17; see also id. at *21.
FERC continued: “we note that certain generators may
receive benefits or savings in the form of credits or in other
forms. In these cases, the generators realize a value of LMP
plus the credit or savings, but ISOs or RTOs do not take such
benefits or savings into account in determining how much to
pay those resources.” Id. at *17 n.122. The point is that the
comparability of compensation is assessed without regard to
outside costs and credits; just as two generators are both
compensated at the LMP even though only one might be
receiving a tax credit for producing energy, so too with
comparing demand response resources to generation
resources. This was clearly explained, and it is reasonable.

This court has no business second-guessing the
Commission’s judgment on the level of compensation. See
La. Pub. Serv. Comm’n v. FERC, 551 F.3d 1042, 1045 (D.C.
Cir. 2008) (noting that “[w]here the subject of our review is . .
. a predictive judgment by FERC about the effects of a
proposed remedy . . . , our deference is at its zenith”); Pub.
Serv. Comm’n of Ky. v. FERC, 397 F.3d 1004, 1009 (D.C.
Cir. 2005) (holding that “more than second-guessing close
judgment calls is required to show that a rate order is arbitrary
and capricious” (citation omitted)); Envtl. Action, Inc. v.
FERC, 939 F.2d 1057, 1064 (D.C. Cir. 1991) (“[I]t is within
the scope of the agency’s expertise to make . . . a prediction
about the market it regulates, and a reasonable prediction
deserves our deference notwithstanding that there might also
be another reasonable view.”).
 27
Whatever policy disagreements one might have with
Order 745’s decision to compensate demand response
resources at the LMP (and there are legitimate disagreements
to be had), the rule does not fail for want of reasoned
decisionmaking. FERC’s judgment is owed deference because
it has put forth a reasonable multi-step explanation of its
decision to mandate LMP compensation. First, responsive
demand is a necessary component of a well-functioning
wholesale market, and FERC understood that its obligation to
ensure just and reasonable rates required it to facilitate an
adequate level of demand response participation in its
jurisdictional markets. See Order 745, 2011 WL 890975, at
*16. Second, FERC concluded that market barriers were
inhibiting an adequate level of demand response participation.
See id. Third, FERC concluded that mandating LMP would
provide the proper incentives for demand response resources
to overcome these barriers to participation in the wholesale
market. See id.; see also Notice of Proposed Rulemaking,
Demand Response Compensation in Organized Wholesale
Energy Markets, reprinted in J.A. 208, 220-21 (stating that
“demand response resources react correspondingly to
increases or decreases in payment” and citing study showing
that switching from LMP to LMP - G compensation resulted
in a 36.8% decrease in demand response participation in the
ISO being studied).

III. CONCLUSION

FERC had jurisdiction to issue Order 745 because
demand response is not unambiguously a matter of retail
regulation under the Federal Power Act, and because the
demand response resources subject to the rule directly affect
wholesale electricity prices. See 16 U.S.C. §§ 824d, 824e.
And the Commission’s decision to require compensation
equal to the LMP, rather than LMP - G, was not arbitrary or
 28
capricious. The majority disagrees on both points. The
unfortunate consequence is that a promising rule of national
significance – promulgated by the agency that has been
authorized by Congress to address the matters in issue – is
laid aside on grounds that I think are inconsistent with the
statute, at odds with applicable precedent, and impossible to
square with our limited scope of review. I therefore
respectfully dissent.