July 10, 2017

Second Circuit Rejects Constitutional Attack Against Connecticut Renewables Bids

Holland & Knight Energy and Natural Resources Blog
Stephen J. Humes

A panel of the U.S. Second Circuit Court of Appeals recently rendered a decision upholding Connecticut’s renewable energy solicitations and the state’s renewable portfolio standard (RPS), rejecting a disgruntled bidder’s federalism claims at a time when an increasing number of states are seeking to pave their own way on clean energy options. 

The decision is good news for Connecticut and the other 28 states from Maine to California with similar RPS programs in that the Court embraces state actions to promote and procure renewable energy without finding federal preemption or other U.S. Constitutional infirmities.

Allco Finance Ltd. v. Klee is the first federal appeals court decision since the U.S. Supreme Court issued the landmark Hughes v. Talen Energy Marketing decision in April, 2016, but the Second Circuit interpreted the Hughes precedent narrowly and refused to extend its holding to other state procurements of long term contracts for renewable energy projects. The Allco decision is also significant because it comes at a time when state-sponsored incentives in New York and Illinois aimed at supporting at-risk nuclear power plants are facing similar attacks to the challenge launched in Allco.

Allco challenged Connecticut’s efforts to solicit proposals for renewable energy generation, select winning bids from such solicitations, and then directing Connecticut’s electric distribution utilities to enter into wholesale energy contracts with the winning bidders. Allco, an unsuccessful bidder in the process, also challenged separately Connecticut’s RPS, which requires load-serving entities (both electric utilities and competitive electric suppliers) either to produce renewable energy themselves or buy renewable energy credits (RECs) from other renewable energy producers located in the region. Allco alleged that its solar photovoltaic (PV) project in Georgia was discriminated against by Connecticut’s RPS program because Connecticut disqualifies RECs unless the underlying energy is deliverable into Connecticut (either directly as part of the ISO-NE area or indirectly through an adjacent control area). Allco also claimed injury in that renewable energy generators in adjacent control areas – though able to sell qualifying RECs – must pay a fee to transmit their energy into the ISO-NE grid in order to sell their RECs to Connecticut utilities pursuant to the market rules. Allco’s renewable project in New York would be burdened by the additional costs of delivery into Connecticut.

Hughes and a related case called Solomon v. Talen Energy Marketing involved federalism challenges to Maryland and New Jersey, respectively, seeking to enter into long-term contracts to incentivize construction of new natural gas fired power generation. The Supreme Court in Hughes held that the Federal Energy Regulatory Commission (FERC) preempts states from entering into long-term contracts that attempt to override the competitive wholesale power markets with different compensation mechanisms. States cannot “tether” their support for wholesale power generation on such projects clearing the FERC-approved wholesale capacity auctions. Such state action is preempted by FERC.

Citing Justice Sotomayor’s concurrence in Hughes, the Second Circuit in Allco noted that the Federal Power Act is a collaborative federalism statute that envisions federal-state cooperation and interdependence. “Where coordinate state and federal efforts exist within a complementary administrative framework, and in pursuit of common purposes, the case for federal preemption becomes a less persuasive one,” Sotomayor wrote in Hughes. Unlike the contracts in Hughes, however, the Connecticut renewables procurements involved purchases of RECs, not conventional wholesale capacity and energy.

Since Hughes, states have faced growing questions about whether renewable programs that included long-term contracts for RECs would survive a Hughes challenge.  New York and Illinois face litigation arising out of zero-emission credits, or ZECs, attributable to nuclear power generators and the question in those lawsuits is essentially whether ZEC procurement contracts are like the long-term contracts deemed invalid under Hughes, or if states can legally encourage separate compensation for ZECs outside the FERC wholesale market regime.

Massachusetts, New York, California, Oregon, Vermont, Washington and the California Air Resources Board were among those interested parties that filed briefs in support of Connecticut in the Allco case as the states seek clarity over the limits of allowable support for renewable energy and RPS programs.

In rejecting Allco’s federal preemption argument, the court reasoned that there are important distinctions between the Maryland program and Connecticut’s RFPs. “While Maryland sought essentially to override the terms set by the FERC-approved PJM auction, and required transfer of ownership through the FERC-approved auction, Connecticut’s program does not condition capacity transfers on any such auction. Connecticut, instead, transfers ownership of electricity from one party to another by contract, independent of the auction. . . and are, therefore, precisely what the Hughes court placed outside its limited holding.”

The Second Circuit also evaluated Allco’s claimed discrimination against its Georgia-sources RECs, noting that RECs are inventions of state property law and Connecticut was entitled to create a class RECs that differs from Allco’s Georgia facility’s RECs.  Further, Connecticut regulators can determine that their consumers’ need for a more diversified and renewable energy supply, accessible to them directly through their regional grid or indirectly through adjacent control areas, would not be served by RECs produced by Allco’s facility in Georgia – which is unable to transmit electricity into ISO-NE.

The Second Circuit endorsed Connecticut’s interest in protecting the market for RECs produced within the ISO-NE or in adjacent areas and found that Connecticut’s RPS program serves its legitimate state interest in promoting increased production of renewable power generation in the region, thereby protecting its citizens’ health, safety, and reliable access to power. “These means and ends are well within the scope of what Congress and FERC have traditionally allowed the States to do in the realm of energy regulation,” the Court said.  States have broad powers under state law to direct the planning and resource decisions of utilities under their jurisdiction. Quoting a FERC decision involving renewables in California, the Court said that “states may, for example, order utilities to build renewable generators themselves, or ... order utilities to purchase renewable generation.”

The Allco decision therefore offers a measure of comfort for state renewable energy procurement and RPS programs and helps the wholesale generation and renewable energy industries to understand with greater clarity the lines of cooperative federalism in electric power since Hughes.

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