Deep Dive Episode 241 – A Global Energy Crisis and the FERC [Keynote Address]

[Music and Narration]

 

Introduction:  Welcome to the Regulatory Transparency Project’s Fourth Branch podcast series. All expressions of opinion are those of the speaker.

 

On October 19, 2022, The Federalist Society’s Regulatory Transparency Project hosted an in-person event on A Global Energy Crisis and the Federal Energy Regulatory Commission. The event featured remarks from FERC Commissioner James Danly. The following are those remarks. Please enjoy.

 

Steven Schaefer: Good afternoon. Welcome to today’s event, “A Global Energy Crisis and the Federal Energy Regulatory Commission: A Discussion of Challenges and Opportunities.” My name is Steven Schaefer, and I’m the Director of The Federalist Society’s Regulatory Transparency Project. The Regulatory Transparency Project, also known as RTP, is an initiative dedicated to fostering discussion and debate surrounding the regulatory state.

Today’s event is brought to you by the Regulatory Transparency Project and co-sponsored by The Environmental Law and Property Rights Practice Group. Today, FERC Commissioner James P. Danly will address the present and future challenges facing the Commission. Afterward, a panel of stellar experts will discuss and debate issues surrounding the tension FERC faces between the rapid adoption of renewable generation sources and the reliability of the bulk power system.

 

Note: The Federalist Society takes no position on particular legal or public policy issues. All expressions of opinion are those of the speaker. 

 

Now, for a brief introduction of Commissioner Danly. James Danly was nominated and confirmed as a Commissioner on the Federal Energy Regulatory Commission on March 12, 2020. He served as the Chairman of the Federal Energy Regulatory Commission from November 5, 2020, to January 21, 2021. Danly previously served as general counsel to FERC. Prior to joining the Commission, he was a member of the Energy Regulation and Litigation Group at Skadden, Arps, Slate, and Meagher, and Flom, LLP. He is a former U.S. Army officer who served two tours in Iraq and received a Bronze Star and Purple Heart. He earned his juris doctor from Vanderbilt University Law School and his bachelor’s degree from Yale University. Commissioner Danly, over to you.

 

James Danly:  So hello, everyone. I should probably begin by saying what a treat it is for me to be speaking here. Thank you to FedSoc for putting this on. The location is beautiful. It’s always fun to be in the Mayflower, so I really appreciate that. Thank you. So the audience is, generally, sophisticated but probably not made up entirely inveterate FERC watchers, so two seconds about the structure of the Commission and the most important statutes that we administrate, and then I’ll move on to a couple of the biggest problems that FERC is facing and, in my opinion, creating. 

 

So, obviously, FERC — independent agency, five members, appointed by the president, confirmed by the senate, removal only for cause. Our jurisdiction — we have two major statutes, the Natural Gas Act and the Federal Power Act. And of the Natural Gas Act, the two most important provisions are Section 3 and Section 7. Section 3 is the process by which we review and approve or deny applications for the setting and construction of LNG export terminals. The actual movement of the commodity overseas, that’s a Department of Energy question, but we do the facility—the physical facility. And then Section 7 is the provision that permits for the review and approval or denial of an application to build interstate natural gas pipelines. And with the certificate of public convenience and necessity that results from an approval, the party holding that certificate can then initiate condemnation proceedings to get any land that they couldn’t negotiate an easement for. 

 

Under the Federal Power Act, the two major provisions are Section 205 — so for all sales of power and interstate commerce, you have to have a tariff on file that covers the rates, terms, and conditions of the service you provide. You cannot charge anybody for electric service without that tariff. Section 205 is how a utility files to amend its tariff and change the terms in which it provides service to its customers. Section 206 — and there’s a reason I’m getting into the details of the statute. It bears very importantly on what I think we’re doing wrong, and I’ll get into it in a minute. Section 206 is the companion statute—or the commanding provision—that allows a third party to complain against a utility and say that the rate that is on file, the prevailing rate, is not just and reasonable. After a hearing, if FERC determines that, in fact, step one of that Section 206 analysis, the rate is not just and reasonable, it can then go on to impose a replacement rate that is just and reasonable.

 

And it’s worth pausing for a minute to talk about what the regulatory paradigm is that—not just FERC, actually, all public utility commissions but—FERC employs. We have two parties that we have an interest in. We have the captive ratepayers who are interested in getting the benefits of the economies of scale that come with monopoly franchise utilities, but we also do not want monopoly franchise utility rents to be extracted from the ratepayers. At the same time, we have a property interest in the utilities that has to be looked out for. We have the irreducible constitutional minimum that if we are to avoid a taking, that utility must get a return of its investment. 

 

And then we have a statutory requirement—the just and reasonable rates requirement—that the amount of money that the utility gets is a return on investment—that is to say, a sufficient quantity of money back on the back end of its provision of service—that it is able to attract investment, and we can incentivize through those rates that they take in the proper expansion to serve further possible customers. 

 

In order to balance those two requirements, we have this long case law—that goes to not just FERC but every public utility commission in America—of what those rates are and what the proper titration of the return is in order to get that investment properly incentivized. 

 

And the way we used to do it in the old days—was this paradigmatic method by which the rates were determined—was cost of service rate making; that is, the utility would go out, they would provide electric service, they would come back in for a rate case—they still do this at the state level for retail service—and they say, “Here is what we spent. This is why it was justified. Please give us all of that plus a certain amount on top of it as the return for our shareholders.” That has changed over the years. And what we’ve done is replace it with a different system in which we use the market to determine what the proper rates are going to be in most cases. 

 

So the idea of this franchise monopoly, prohibition of rent extraction versus giving the correct return to the utilities, we have determined that those just and reasonable rates are pretty much approximated with what the rates would be in a competitive market, even though you can’t have competition because you have exclusive service territory. Competitive rates and just and reasonable rates are basically the same thing and can stand in for one another. That, at least, has been the longstanding case history, and the courts have upheld this repeatedly.

 

So the cost-of-service rate-making paradigm was replaced by a set of market-based rate regimes. That, in turn, was developed into a set of formula rates in which you have inputs as to who does what, where. You see this most obviously in the case of our markets—the regional transmission organizations and ISOs—in which you have elaborate market schemes which then result in clearing prices after auctions and the like. And those rates because they are—allegedly, at any rate— assumed to be competitive, are within the just and reasonable requirement of the statute. So that’s just a little bit of background about the basic theory of our regulatory scheme that’s been around for a hundred years and how it’s developed in, let’s say, the last 30 or 40. 

 

So, moving on to the two big problems I see—I could give a list of a hundred — oh, and I should mention one thing: we have, of course, a whole bunch of other authorities that are extremely important. Section 203 of the Federal Power Act — we oversee all mergers and dispositions of jurisdictional assets. Section 215 is our authority to ensure that — or to review and approve the reliability standards that NERC puts out—NERC is the North American Reliability Council, yeah. Is that Council or — yeah, Council. Sorry. Wow, I forgot the name of — those are all important, but fundamentally, those two provisions, the Natural Gas Act and the Federal Power Act—those provisions or those two statutes—are the heart of what we do. 

 

So, under the NGA, in the last couple of years, in the natural gas context, FERC has done, I believe, and I’ve been pretty vocal about it — has done just about everything it can to throw into uncertainty the regulatory scheme under which we review Section 3 and Section 7 applications, and in some cases, the process by which the review has been conducted has been absolutely shocking. It’s no exaggeration to say that in one case, in particular, it took more than a year to get to a yes or no answer on the merits about whether or not a parking lot could be expanded. This is because FERC, in the last couple years, has layered more and more and more environmental review, repeated questions, inquiries to the project proponents. 

 

So it used to be — we’ve heard from many people in the pipeline world — it used to be that you knew if you did your homework correctly and had a good application, you could — 18 to 24 months, you would have an answer on the merits, “yes” or “no” on your application, and now, nobody knows how long anything will take. On top of that, we’ve had a couple of issuances that have thrown into doubt the solidity of the certificates of public convenience and necessity, which are what is granted if a pipeline application is approved under Section 7, such that, in one case, it appeared that the Commission was relitigating a final and unappealable certificate, something that had never happened in a hundred years.  

 

In another case, we issued some policy statements that sought to encourage pipeline companies to mitigate the downstream — the effects of the downstream emissions of the combustion of the gas that they were providing transportation service to. And that encouragement—and I would call it not encouragement but something a little bit more than that—was backstopped in the very policy statement by saying, “If the proposed mitigation isn’t sufficient, we reserve the right to impose mitigation.” 

 

And the real problem there, of course, is that in the Natural Gas Act, we have been instructed by the courts that our objective under the NGA is to promote the orderly development of natural gas infrastructure to ensure plentiful supplies of natural gas to the American public. That’s the purpose of the NGA, as declared by the courts and Congress. It’s not an environmental statute and, certainly—as my colleague, Commissioner Christy, pointed out in his dissent and ended up being the reinvigoration of the major questions doctrine in West Virginia v. EPA—there’s nothing in the NGA about any of that. And so, using the bottleneck of the transportation services, the fulcrum around which to achieve separate and unarticulated goals, worthy though they may be, is not within the remit of the agency, in my opinion.

 

So we have a problem where we have a very capital-intensive industry, and we’re charged with promoting the development of infrastructure and ensuring plentiful supplies of natural gas. But what FERC has done has made it almost as difficult as possible to rationally allocate capital—if, indeed, you can even secure capital in the first place—to rationally allocate it to develop that infrastructure that’s necessary. And I will say that the infrastructure is necessary. 

 

We have terrible gas constraints in certain parts of the country such that we don’t actually know whether or not the Northeast—that is to say the area served by ISO New England, one of our markets in New England—whether they’re going to be able to maintain system stability and if they’re going to have resource adequacy. The prices for natural gas right now are converging between New England and Europe, and that’s because we don’t have sufficient natural gas infrastructure. That should shock everybody. And part of the reason we can’t develop it—there are many reasons, but one of the reasons—is that it’s very difficult to allocate capital rationally when the Commission makes regulatory uncertainty this profound.  

 

Moving on to the Federal Power Act—and you’ll understand now why it is I got into the details of Section 206—we have had a series of landmark orders in the past few decades that have opened up access to more markets for more participants in the utility system. And this began with Order 888, which basically declared that incumbent transmission owners were prejudicing merchant generators by not allowing them access to market through their transmission systems, and so, we demanded that all the transmission owners allow for open access for any comer who wants to use the transmission service.  

 

That was then followed by a series of orders that developed certain transmission planning requirements that created the system by which we have regional markets, and the most recent major undertaking we’ve had is a notice of proposed rulemaking that would seek to impose, on a nationwide basis, a mechanism by which all transmission planning has to occur. The purpose for this—at least to all appearances as far as I can tell—is to encourage the development of billions of dollars, as much as possible, of transmission to get as many of the remotely located renewables projects, which are only — which are being developed because of all the subsidies, both at the state and local level, to have their development — to get those to the revenue streams available in the markets.  

 

So having already been taxed to provide those tax incentives and subsidies, the way that that massive transmission billed out—which really will be billions of dollars—is going to come in the form of the socialization of the cost of that transmission billed out to the ratepayers who were just taxed to provide the subsidies, such that the speculators that own and are building all of the renewables projects in order to get hold of the production tax credits that they’re offered and the renewable energy credits, they get those once they get to market. And the way they’re going to build that is by then taxing the — or by having the costs foist on the ratepayer who just got taxed to provide the subsidies. I’ll leave it to you to determine if you think that’s good public policy or not. 

 

My main concern is the legality of it. Section 206 is not a general remit, in my view, to go out and do good regulatory things in the world. It is something much more akin to a cause of action, a common law, in which you have the right to bring a complaint to a tribunal and say, “This thing is wrong under these circumstances, and I wish to have this specific relief as a result of it.” That does not seem, to me, perfectly apposite to the generic proceedings that we have undertaken under Section 206 and claimed, despite the fact that the statute says, “upon complaint and after a hearing –” that, to me, means you have to make individualized assessments about whether or not the rates in specific cases are not just and reasonable. You can then foist a replacement rate on people, having made that determination. Here, what we’re saying is, “We don’t like the way things are done, generally, and because that’s not just and reasonable enough, we’re going to enforce a replacement rate, universally, throughout the entire country, regardless of what the actual rates charged are.” 

 

And I will tell you—in case you don’t know this—the rates are variant from one part of the country to the other. We have some areas of the country where the rates are so low that it almost doesn’t seem that they could be lower — that is, absent modular nuclear reactors being deployed or something like that. It seems impossible that we could have lower rates than we do in some regions of the country. And other regions of the country are so constrained that it is shocking how high the rates are. And to use Section 206, which is an individualized adjudicatory mechanism in which we sit as judges in the face of a complaint, to impose universal solutions across the entire country simply does not seem apposite to me. And I don’t think that the APA works what I see as being an effective substantive expansion of our power, simply because the APA says you can proceed by either mode, rulemaking or adjudication. 

 

So I think that any issuance we have is going to be vulnerable to challenge on that basis. And then we also have, again, West Virginia v. EPA. I’ve not seen any tax in the Federal Power Act that specifies that we have the responsibility or authority to direct people to conduct transmission planning according to our whim. I just don’t see it in there. And so, absent congressional action on this subject, I think it’s also vulnerable, potentially, to a challenge as being violative of the major questions doctrine. 

 

So those are the two main problems that I see. FERC is responsible for creating most of both of them. I’m going to be very interested to see what the discussion is afterward, and I know that FERC has historically been a sleepy little agency that has not drawn a whole lot of attention, but we found ourselves more and more in the public eye as the Commission has—in, again, my estimation at any rate—taken on more and more jurisdiction that I don’t think is necessarily properly within our ambit. So thank you very much.

 

[Music]

 

Conclusion:  On behalf of The Federalist Society’s Regulatory Transparency Project, thanks for tuning in to the Fourth Branch podcast. To catch every new episode when it’s released, you can subscribe on Apple Podcasts, Google Play, and Spreaker. For the latest from RTP, please visit our website at www.regproject.org.

 

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This has been a FedSoc audio production.

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