FERC Adopts New Methodology to Determine Electric Utility ROE

by Davis Wright Tremaine LLP

In a long-awaited decision, the Federal Energy Regulatory Commission on June 19, 2014, revised its methodology for determining the rate of return on common equity (ROE) used to establish cost-based rates of public utilities subject to FERC jurisdiction. In Martha Coakley, et al. v. Bangor Hydro Electric Company, et al., 147 FERC ¶ 61,234 (2014) (FERC Docket No. EL11-66-000), the FERC adopts a two-step DCF methodology used in natural gas pipeline rate cases which utilizes both short-term and long-term growth projections. In the two-step DCF methodology adopted for electric utilities, the short-term forecast will receive a two-thirds weighting and the long-term forecast will receive a one-third weighting in calculation of the growth rate for the DCF model. The short-term growth estimate is to be based on the five year projections by IBES (or a comparable source), and the long-term growth estimate is to be based on the average of the GDP growth rates. FERC will apply the new methodology prospectively and to any pending ROE complaint proceeding in which a decision has not yet been made. 

Transmission customers and transmission owners across the country have been waiting to see how FERC would rule in this complaint proceeding, and how the ruling would impact other similar complaint proceedings challenging electric utilities’ ROE pending before the Commission. The proceeding in Martha Coakley, et al. was initiated by a complaint challenging the New England Transmission Owners’s region-wide ROE that was established in 2006. The complaint alleged that as a result of changes in changed economic conditions since that time, the existing 11.14% base ROE was excessive and unjust and unreasonable. Several similar complaints were filed subsequently against other transmission owners outside of New England. The FERC took no action on those complaints while Martha Coakley, et al. was pending.

In Martha Coakley, et al., the FERC affirmed in part and reversed in part the administrative law judge’s initial decision. After applying the revised methodology to the record in that case, the FERC tentatively determined that the base ROE to be used by New England Transmission Owners for calculating rates for transmission service should be reduced from 11.14% to 10.57%.

In the FERC’s view, the new DCF methodology will produce more stable results and minimize the possibility of anomalies. The FERC also adopted the following guidelines for establishing the appropriate ROE for electric utilities:

  • The dividend yield calculations should be based on financial data for a six-month period ending shortly before the start of an evidentiary hearing, and will not be updated after the close of the hearing.
  • The proxy group of utilities used to develop the ROE should be a national proxy group, not a regional proxy group. The use of Value Line data to select an appropriate proxy group is reasonable.
  • For the New England Transmission Owners,, the just and reasonable base ROE should be set halfway between the midpoint of the zone of reasonableness and the top of the zone of reasonableness. Participants in other proceedings in which ROE is an issue may present evidence to show that a different point within the range of reasonable rates should be used to establish the base ROE.
  • The ROE used by any transmission owner that has been granted ROE incentives to foster investment in transmission facilities may not exceed the high end of the zone of reasonableness. Therefore, if the total of the base ROE determined in the manner prescribed by the FERC and any ROE incentives would exceed the high end of the zone of reasonableness, the actual ROE used by a public utility would be limited by the high end of the zone of reasonableness.

While this decision may be a step toward providing regulatory certainty, there is more to come. Because the application of the long-term growth rate was not discussed during the evidentiary hearing in Martha Coakley, et al., the FERC reopened the record to allow the participants to brief the issue of which long-term growth rate should be used in the two-step DCF methodology. Also, Martha Coakley, et al. is subject requests for rehearing to the FERC, and thereafter to appellate review by an appropriate United States Court of Appeals.

During the FERC open meeting in which the draft decision was discussed, the Commissioners suggested that the decision was a compromise. FERC Commissioner Philip D. Moeller indicated that he would have preferred adoption of a somewhat higher ROE, while Commissioner John Norris did not believe that the 10.57% ROE tentatively adopted in Martha Coakley, et al. had been justified.

With the issuance of the decision in Martha Coakly, et al., the FERC has begun to address issues being raised in those other complaint proceedings. In orders issued on June 19, 2014, in some of those proceedings, the FERC provided for the conduct of an evidentiary hearings in which participants are to be guided by the revised DCF methodology prescribed in Opinion No. 531, but further provided for the conduct of settlement judge proceedings. Unless those cases are settled, the result in each of those cases will be based on the evidentiary records established in those cases.

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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