FERC Stakes Out New Position on Return on Equity - Votes Out Major Orders Affecting Electric Utility Rate of Return Determinations

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The Federal Energy Regulatory Commission today issued a series of orders that collectively represent a significant change to its policy on utility rate of return on equity and will reshape the landscape for electric transmission development and operation and have ramifications in other cost-of-service contexts. ROE policy is always a high-profile rate case issue and subject to the scrutiny of asset owners, federal and state regulators, consumers and Wall Street alike. The adverse economic conditions of the past few years and resulting pressures that reduced allowable ROEs based on the existing formulae and principles historically applied by the Commission has further brought the need for policy reform to the forefront. Today’s orders appear to address (at least in part) those concerns.

New Two-Step DCF Analysis

The lead case, Martha Coakley, Massachusetts Attorney General, et. al, concerns a previously litigated determination of ROE affecting the transmission owners within the ISO New England footprint. The Commission announced a change in ROE determination policy, moving from a single step discounted cash flow analysis to a two-step discounted cash flow analysis that is comparable to the natural gas/oil pipeline analysis used by the Commission. The Commission will use both long-term and short-term growth estimates, as opposed to only short-term growth estimates, finding that relying only short-term growth estimates can create distortions under certain economic conditions. FERC also eliminated post-hearing adjustments to the base ROE through the use of U.S. treasury bond yields and also found that that the facts of the case justified setting the ISO New England base ROE at the half-way point between the midpoint and the upper end of the zone of reasonableness. The resulting base ROE for ISO New England transmission owners is 10.57 percent, markedly above the 9.7 percent found to be just and reasonable by the presiding judge in August 2013.

FERC also set several other pending ROE complaint cases for hearing, noting that evidentiary records should be established based on the guidance in the Coakley case, and acted on remand from the U.S. Court of Appeals with respect to a Southern California Edison return on equity proceeding that was initiated in 2008. The records developed in the complaint proceedings must also fully address whether a different point of central tendency should be used, as was done in the case described above. In effect, the Commission took the unique approach of implementing its new two-step DCF policy simultaneously with its creation of that policy.

New Policy Good or Bad? Commissioners Disagree.

Several of the Commissioners made astute observations concerning its actions today and they all recognized the significant change that their actions represent. There was agreement that the policy needed to be addressed, and ROE determinations must be set so as to attract needed investment for new transmission infrastructure development in the country. Commissioner Norris sharply called the order a win for those sitting in corporate boardrooms of the New England transmission owners. Others disagreed that was the case, indicating that the Commission could have gone further.

The orders have not been released, so the summary above is based on the statements of Commission staff and the Commissioners themselves at the open meeting.

Topics:  Electricity, FERC, ISOs, Transmission Grid, Utilities Sector

Published In: Energy & Utilities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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