United States: Federal District Courts Standing Analysis And Dismissal Of Illinois ZEC Challenges Heads To Court Of Appeals

Last Updated: August 18 2017
Article by Adrienne Thompson and Jasmine C. Hites

On July 14, 2017, the United States District Court for the Northern District of Illinois, Eastern Division ("District Court"), issued a memorandum opinion and order dismissing various challenges to an Illinois "zero emission credit" ("ZEC") program passed into law at the end of 2016 ("ZEC Program"). After finding that the plaintiffs largely lacked standing to bring their claims, the District Court nonetheless reached the merits of, and rejected, the plaintiffs' preemption, equal protection, and dormant commerce clause challenges to the ZEC Program. Three days after its release, the ruling was appealed to the U.S. Court of Appeals for the Seventh Circuit ("Seventh Circuit").

As discussed previously (see May 2, 2017 edition of the WER), in December 2016, Illinois Governor Bruce Rauner signed the Future Energy Jobs Act ("the Act"). Among other provisions, the Act established the ZEC Program to provide financial support to certain in-state nuclear generators that have become uncompetitive in wholesale markets dominated by cheap natural gas and renewable energy. Through this program, eligible nuclear energy generators—currently, the Exelon-owned Clinton and Quad Cities nuclear facilities—create one ZEC per MWh of electricity that is produced and sold into the wholesale markets managed by PJM Interconnection, L.L.C. ("PJM") and the Midcontinent Independent System Operator, Inc. ("MISO"). The ZECs' price is determined through a formula based partly on the Social Cost of Carbon as well as factors derived from futures prices for wholesale energy and capacity in auctions administered by PJM and MISO. Illinois utilities, in turn, are required to buy ZECs in an amount equal to 16% of the electricity that they distribute each year. The cost for these ZEC purchases is passed down to retail customers in the form of distribution surcharges.

In February 2017, a group of wholesale generators and Illinois retail customers filed separate, but eventually consolidated, complaints in the District Court. The plaintiffs argued primarily that the ZEC Program is preempted by federal law for allegedly interfering with wholesale energy and capacity markets, which are under the Federal Energy Regulatory Commission's ("FERC") sole regulatory authority through the Federal Power Act ("FPA"). Plaintiffs also argued that the ZEC Program violates the dormant commerce clause doctrine for allegedly discriminating against out-of-state nuclear energy generators. The customer-plaintiffs argued separately that the ZEC Program violates the Constitution's equal protection clause by requiring Illinois electricity consumers to pay more than consumers in the other MISO and PJM states.

The Illinois Attorney General, representing the state as defendant, and Exelon as an intervening defendant, filed motions to dismiss the complaints. Both defendants asserted that the ZEC Program is not preempted by the FPA or otherwise unconstitutional. In particular, they defended the program as being within the jurisdiction of the states, which have regulatory authority over electricity generators under the FPA, and that it is similar to other FERC-approved state schemes that create marketable property interests in the environmental benefits of renewable energy generation—property interests that are often called Renewable Energy Credits ("RECs").

The District Court ultimately granted the motions to dismiss each of the challenges against the ZEC Program, but not before taking the unique position that the plaintiffs partially lacked standing to bring their claims—an issue that the Seventh Circuit will consider on appeal.

Standing

The District Court held that the customer-plaintiffs had standing to raise an equal protection claim, but that they, along with the generator-plaintiffs, could not sue under a dormant commerce clause theory because allowing non-Illinois nuclear generators to participate would not redress the injury allegedly stemming from the ZECs themselves. The District Court furthermore held that the customer-plaintiffs lacked standing to bring a preemption challenge because their alleged injury—the retail surcharge—was a matter expressly reserved to the states and therefore outside the "zone of interests" of the FPA.

The District Court determined that the generator-plaintiffs adequately alleged standing to sue the ZEC Program on the preemption theory that the Social Cost of Carbon calculation "injured" the generators by subsidizing the wholesale market participation of qualifying nuclear generators. In an unexpected twist, however, the District Court held that the generators nonetheless could not bring a preemption challenge because, in the court's estimation, the FPA's statutory scheme reveals no right of action for the plaintiffs, but rather, leaves enforcement solely up to FERC. Plaintiffs' back-up option for a right of action—declaratory relief under the Supremacy Clause, which was never directly challenged in the U.S. Supreme Court's 2016 decision in Hughes v. Talen Energy Mktg., LLC, 136 S.Ct. 1288 (2016)—would be judicially unadministrable. As the court reasoned, "[t]he declaration sought by plaintiffs would require a court to draw some lines, to give the state direction on how not to interfere with wholesale rates while acting within its undisputed authority to regulate, and once a court enters that arena, it treads on FERC's exclusive expertise."

Despite holding that the generator-plaintiffs alleged standing—but had no right of action—to challenge the ZEC Program, the District Court nonetheless reached the merits of each of the challenges, as summarized below.

Preemption Challenge

On the preemption challenge, the District Court held that the ZEC Program passed constitutional muster under the Supreme Court's previous preemption decisions, particularly Hughes. As the District Court reasoned, states may influence, through regulation, which generators participate in FERC's markets, even though the end result may affect those markets. The ZEC Program's focus on a certain type of electricity generation facility is no different, in the District Court's reasoning, than REC schemes and tax incentives meant to encourage renewable energy production. As the District Court reasoned, although the ZEC Program will affect wholesale rates, this is not its intended purpose, and thus, it is little different than the state antitrust law used to regulated wholesale gas prices, which the Supreme Court upheld in Oneok, Inc. v. Learjet, Inc., 135 S.Ct. 1591 (2015) despite the law's impact on wholesale markets.

The District Court also rejected plaintiffs' claims that the ZECs are "tethered" to the generators' wholesale market participation, in contravention of Hughes (see April 27, 2016 edition of the WER). The District Court reasoned that there was no such "tethering" because qualifying generators earn ZECs without clearing the capacity market or even participating in the energy auction, and because the ZEC pricing mechanism—consisting of the social cost of carbon and a composite of projected energy and capacity market prices—is outside of FERC's jurisdiction.

According to the District Court, "[t]he key inquiry is whether FERC or the state is regulating what takes place in their respective markets." If the state is regulating what takes place in the retail market, the District Court reasoned that, under FERC v. Elec. Power Supply Ass'n, 136 S.Ct. 760 (2016) (EPSA), "then the effect on wholesale rates is irrelevant." The District Court continued, "[r]ead together, EPSA and Hughes stand for the proposition that preemption applies whenever a tether to wholesale rates is indistinguishable from a direct effect on wholesale rates."

Dormant Commerce Clause and Equal Protection Clause Challenges

The District Court next rejected plaintiffs' dormant commerce clause and equal protection clause challenges. On the dormant commerce clause charges, the District Court held that the ZEC Program was not facially discriminatory because it does not preclude out-of-state generators from submitting bids for ZECs. Although the state created a new market through the ZEC Program, the District Court determined that the program has only an incidental burden on interstate commerce. Moreover, the stated purpose of the bill is to protect public health and the environment by offering credits to zero-emission generators. Upon applying the balancing test for non-facially discriminatory laws, the District Court determined that the alleged harm against out-of-state generators who will be competing against subsidized participants is not clearly excessive when balanced against the states' traditional authority over public health and welfare and the right to create a new market and determine its participants in a manner that does not unduly burden interstate commerce.

The District Court dismissed the customer-plaintiffs' allegation that the retail surcharge to fund the ZEC Program effectively made Illinois retail customers "second-class consumers" as compared to other consumers in the MISO and PJM states who would not have to pay the surcharge. In the District Court's opinion, Illinois did not violate the equal protection clause because the ZEC Program imposes the retail surcharge equally on everyone within the state of Illinois. Furthermore, not only did the state legislature have a rational basis for the ZEC Program, but it lacked the ability to impose any surcharge on people outside of Illinois in any event.

The District Court's decision, which can be viewed here, has been appealed to the Seventh Circuit. This is not the first challenge to the validity of ZECs. On the day that this blog post was published, a Judge in the U.S. District Court of the Southern District of New York issued a decision dismissing challenges to a similar ZEC program established in New York State.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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