Latham & Watkins Energy Regulatory & Markets Practice Group Cleantech Practice Group

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1 Number 844 March 30, 2009 Client Alert Latham & Watkins Energy Regulatory & Markets Practice Group Cleantech Practice Group FERC Takes An Initial Step Toward Establishing A Smart Grid Policy FERC invites comments on the proposed policy statement no later than May 11, The Federal Energy Regulatory Commission (FERC) took an initial step toward articulating a policy to foster the development of a national Smart Grid on March 19, 2009 with the release of its Smart Grid Proposed Policy Statement and Action Plan (Smart Grid Policy Statement). 1 The highlights of the Smart Grid Policy Statement are proposals to (i) establish an Interim Rate Policy that will give FERC-jurisdictional utilities an opportunity to recover the costs of qualifying grid investments through FERC-jurisdictional rates, 2 (ii) establish mechanisms for utilities to recover stranded costs associated with legacy systems that are replaced with new Smart Grid facilities, and (iii) potentially allow utilities to accelerate depreciation of Smart Grid deployments. FERC also identifies key priorities to guide the development of uniform interoperability standards, which are needed to ease the incorporation of new technologies into the electricity grid. FERC invites comments on the proposed policy statement no later than May 11, The Smart Grid Policy Statement is an important step that reflects FERC s commitment to facilitate the modernization of the United States electric grid to enhance efficiency and reliability. The Smart Grid Policy Statement provides an opportunity for utilities as well as developers of Smart Grid technologies to shape the initial regulatory discussions with respect to the transition to a Smart Grid, including the critical issue of recovery of and on investments in Smart Grid facilities through FERC-jurisdictional rates. Background Title XIII of the Energy Independence and Security Act of 2007 (EISA) established a general policy to transform the nation s electricity transmission and distribution systems into the Smart Grid. 3 The Smart Grid uses technology, including the increased use of digital information and controls technology, to provide for real-time coordination of information from generation supply resources, demand resources, and distributed energy resources and ultimately to empower consumers to better manage the use and cost of electric energy. 4 In so doing, Smart Grid technologies should provide for a more efficient balance between supply and demand and enhance reliability, security, energy efficiency and cost-effectiveness. EISA sets up a two-step process for implementation. First, the National Institute of Standards and Technology (NIST) coordinates the development of Latham & Watkins operates as a limited liability partnership worldwide with affiliated limited liability partnerships conducting the practice in the United Kingdom, France and Italy and an affiliated partnership conducting the practice in Hong Kong. Under New York s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY , Phone: Copyright 2009 Latham & Watkins. All Rights Reserved.

2 interoperability standards for Smart Grid devices that will apply broadly to ensure all technologies developed and installed in the grid can exchange information and work with each other. 5 Second, after sufficient consensus has been reached in the NIST process, 6 FERC will initiate a rulemaking proceeding to mandate appropriate standards to ensure Smart Grid functionality and interoperability pursuant to its jurisdiction over the transmission of electricity in interstate commerce under the Federal Powers Act (FPA). 7 In addition, Congress recently appropriated $4.5 billion to the Department of Energy (DOE) under the American Recovery and Reinvestment Act of 2009 (ARRA) to fund Smart Grid installations. 8 Under the DOE Smart Grid programs, utilities and other parties participating in approved demonstration projects are eligible for funding to cover up to 50 percent of the cost of qualifying advanced grid technology investments. 9 Similarly, DOE may provide up-front grants of up to 50 percent of the cost of investing in technologies compatible with the Smart Grid. The policies outlined in the Smart Grid Policy Statement will facilitate demonstration projects and other Smart Grid installations. ARRA also establishes a Smart Grid Clearinghouse at DOE to make realtime information about the Smart Grid available to the public and to facilitate the adoption of uniform standards and technologies. Under ARRA, utilities and other participants in the Smart Grid programs will be required to provide DOE with information about Smart Grid deployments for inclusion in the Clearinghouse as a condition of receiving federal funding, and will also be required to use open protocols and standards (e.g., Internet-based) when available and appropriate. Interim Rate Policy To Allow Cost Recovery Of Qualifying Investments Perhaps the most significant aspect of the Smart Grid Policy Statement is FERC s proposal to establish an Interim Rate Policy to allow public utilities that deploy Smart Grid systems prior to the adoption of interoperability standards to recover their costs through rate filings with FERC, including single issue rate filings. 10 FERC has jurisdiction under Section 205 of the FPA to establish rates and charges for or in connection with the transmission or sale of electric energy subject to FERC jurisdiction, 11 under which FERC may allow utilities to recover the costs of investing in new or upgraded facilities that are used and useful in providing actual electric service. 12 In the Smart Grid Policy Statement, FERC proposes to consider Smart Grid devices and equipment used and useful, which will allow cost recovery of such equipment as long as a utility can show that the deployment will not adversely affect the reliability and security of the bulk-power system and that it has minimized the possibility of stranded investment in the Smart Grid (i.e., the equipment can be upgraded in response to new technologies). FERC is likely to make compliance with interoperability standards a mandatory condition of rate recovery after such standards are established. FERC will require applicant utilities to make several showings as a condition of rate recovery. First, to demonstrate that a proposed Smart Grid deployment will not adversely affect grid reliability and security, FERC proposes to require that an applicant show that its installation will comply with FERC-approved reliability standards (e.g., Critical Infrastructure Protection Reliability Standards). 13 Second, an applicant will be required to inform FERC of the extent to which data communicated by Smart Grid devices is correct, whether data would be communicated only to authorized devices or persons, chosen methods to prevent and log unauthorized modifications of devices, chosen methods to protect devices physically, and the potential unauthorized use of devices. Third, an applicant must demonstrate that it has minimized the possibility of stranded investments by making good faith 2 Number 844 March 30, 2009

3 efforts to adhere to the vision of a Smart Grid. On this point, FERC emphasizes reliance by the utility on widely adopted and open interoperability standards and on systems that can be securely and quickly upgraded. Finally, FERC will require the utility seeking cost recovery to share information regarding its Smart Grid deployments with the DOE Smart Grid Clearinghouse, as established under ARRA. In addition to FPA Section 205 rate filings for new investments, FERC plans to accept requests from utilities for recovery of and on investments in legacy systems that are to be replaced by Smart Grid equipment, subject to a requirement that the utility submit a migration plan that reflects a concerted effort to upgrade, rather than replace, the existing system where feasible. FERC will also entertain rate treatment requests such as accelerated depreciation and abandonment authority tied to Smart Grid deployments. These measures will allow utilities to remove the costs of stranded legacy investments from their balance sheets. Priority Issues For The Development Of Interoperability Standards As discussed previously, NIST coordinates the development of interoperability standards for Smart Grid devices to ensure all technologies developed and installed in the grid can communicate and work with each other. On March 10, 2009, NIST released for comment the Smart Grid Issues Summary, which identified broadly accepted technology standards and sought to provide a roadmap for the development of new standards. 14 Similarly, FERC s Smart Grid Policy Statement identifies key challenges interoperability standards will need to address and articulates priorities to guide the industry to develop standards with a sense of urgency. Specifically, FERC targets for comment two crosscutting issues (i.e., system security and reliability and communication) and four key grid functionalities (i.e., widearea situational awareness, demand response, electric storage and electric transportation). With respect to system security and reliability, FERC proposes to require that a responsible entity subject to Commission-approved reliability standards ensure its compliance with these standards during and after installation of Smart Grid technologies. 15 To facilitate effective communication, FERC stresses the need for a common semantic framework such that the Smart Grid device will understand and respond to the data provided by counterpart devices in the grid. FERC similarly identifies four key functionalities that must be given priority in the process of developing interoperability standards. First, FERC identifies the need for greater widearea situational awareness, whereby a single device could display system conditions in real time. Second, FERC identifies Smart Grid enabled demand response as a priority because of the potential for load to be controlled in large part by consumers, whether voluntarily or through devices that automatically respond to grid conditions. Third, FERC seeks wider deployment of electricity storage technologies, which could be used to harmonize varying levels of supply and demand caused by normal fluctuations and the increasing use of variable generation supply as renewable and distributed energy resources are added to the grid. Finally, FERC wants a wider array of advanced electric transportation options that would charge in off-peak load periods and could provide additional input into the grid in times of peak demand. FERC invites comment on what factors it should consider to determine when sufficient consensus has been reached with respect to the development of interoperability standards that would warrant the initiation of a rulemaking proceeding. FERC also seeks comment on the best way to stage the adoption of subsequent waves of interoperability standards and whether it should 3 Number 844 March 30, 2009

4 establish formal procedures for parties to seek its guidance in the event negotiations on standards reach an impasse. Endnotes 1 Smart Grid Policy, 126 FERC 61,253 (2009) ( Smart Grid Policy Statement ); see also Statement of Acting Chairman John Wellinghoff on Smart Grid Development with Proposed Policy, Action Plan (Mar. 19, 2009), available at wellinghoff/2009/ wellinghoff.pdf. 2 Under Part II of the Federal Power Act (FPA), 16 U.S.C. 824 et seq., FERC has jurisdiction over a public utility, which is defined as an entity that owns or operates FERC-jurisdictional facilities, which, in turn, are facilities involved in the transmission of electric energy in interstate commerce and to the sale of electric energy at wholesale in interstate commerce. See 16 U.S.C Energy Independence and Security Act of 2007 (EISA), 15 U.S.C et seq. (2009). No agency has issued regulations governing the implementation of Smart Grid. 4 Title XIII of EISA broadly defines Smart Grid technologies and functions to include, among other things: increased use of digital information and controls technology; dynamic optimization of grid operations and resources; deployment and integration of distributed resources and generation facilities (including renewables); development and incorporation of demand response, demand-side resources and energy efficiency resources; deployment of technologies for metering that optimize the operation of consumer devices; deployment and integration of advanced electricity storage and peak-shaving technologies, such as electric vehicles; and the greater provision of information to consumers regarding grid conditions. EISA 1301, 15 U.S.C EISA 1305(a), 15 U.S.C (a). 6 EISA 1305(d), 15 U.S.C (d). 7 FPA 202, 16 U.S.C. 824a. 8 American Recovery and Reinvestment Act of 2009, Pub. L. No , div. A, tit. IV (2009) (expanding the scope of, and appropriating additional funding to support, the Smart Grid programs established in EISA). 9 Id FERC has previously signaled a willingness to incorporate certain advanced technologies into the grid and provide them possible means of cost recovery through FERC-jurisdictional rates. For example, in 2007, FERC mandated that certain independent regional grid operators treat demand response resources comparably with generation in procuring grid support services (referred to as ancillary services ) under their FERC-filed Open Access Transmission Tariffs. See Preventing Undue Discrimination and Preference in Transmission Service, Order No. 890, 72 Fed. Reg. 12,266, 12, (Mar. 15, 2007), FERC Stats. & Regs., 31,241 at P 888 (2007); see also, e.g., ISO New England, Inc. 123 FERC 61,133 at P 23 (2008) (ordering the New England grid operator to revise its market rules to allow non-generation resources, such as flywheel energy storage devices, to provide grid regulation and frequency response services); ISO New England Inc., Docket No. ER (Sept. 15, 2008) (unpublished letter order) (accepting compliance filing including proposed pilot program to allow certain non-generation resources to participate in market for grid regulation service). In the fall of 2008, FERC mandated the integration of demand response resources into bulk power markets administered by independent grid operators. See Wholesale Competition in Regions with Organized Electric Markets, Order 719, 73 Fed. Reg. 64,100, 64,103, 125 FERC 61,071 at P 15 (2008). 11 FPA 205, 16 U.S.C. 824d. FERC s jurisdiction under Section 205 of the FPA also applies to all rules and regulations affecting or pertaining to such rates and charges inasmuch as FERC must ensure that they are just and reasonable. Id. 12 See, e.g., NEPCO Municipal Rate Committee v. FERC, 668 F.2d 1327, (D.C. Cir. 1981) (applying Section 205 of the FPA). 13 The North American Electric Reliability Corporation (NERC) has developed uniform standards to guide the operation of the bulk power system and ensure its reliability. NERC, Reliability Standards for the Bulk Electric Systems of North America ( CIP Reliability Standards ), Feb. 25, 2009, available at Complete_Set_2009Feb25.pdf. These include Critical Infrastructure Protection standards on topics ranging from incident reporting of sabotage and other unusual occurrences (CIP ), security management controls (CIP 003-1), and physical security of cyber assets (CIP to -1a). Id. 14 National Institute of Standards and Technology, Smart Grid Issues Summary, Mar. 10, 2009, available at sabminutes/2009wint/8-1_draft%20nist%20 Smart%20Grid%20Issues%20Summary%20 10March2009.pdf. 4 Number 844 March 30, 2009

5 15 The CIP Reliability Standards are applicable to any Responsible Entity, consistently defined to include the following: a reliability coordinator, balancing authority, interchange authority, transmission service provider, transmission owner, transmission operator, generator owner, generator operator, load serving entity, NERC and regional reliability organizations. See CIP Reliability Standards, supra note 13, CIP to If you have any questions about this Client Alert, please contact one of the authors listed here or the Latham attorney with whom you normally consult: Michael J. Gergen michael.gergen@lw.com George (Chip) D. Cannon chip.cannon@lw.com Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorney whom you normally consult. A complete list of our Client Alerts can be found on our Web site at If you wish to update your contact details or customize the information you receive from Latham & Watkins, please visit to subscribe to our global client mailings program. Abu Dhabi Barcelona Brussels Chicago Doha Dubai Frankfurt Hamburg Hong Kong London Los Angeles Madrid Milan Moscow Munich New Jersey New York Northern Virginia Orange County Paris Rome San Diego San Francisco Shanghai Silicon Valley Singapore Tokyo 5 Number 844 March 30, 2009