Recent Orders Affirm FERC’s Changing Policy on Electric Utility Return-on-Equity Calculation
Tuesday, October 21, 2014

FERC issued two decisions on October 16 involving its policies for determining the return on equity (ROE) for transmission-owning members of ISO New England (ISO-NE) and the Midcontinent Independent System Operator, Inc. (MISO). Opinion No. 531-A confirms that gross domestic product (GDP) growth should be used to approximate long-term growth rates as part of FERC’s recently adopted two-step discounted cash flow (DCF) methodology.[1] The decision echoes FERC’s tentative finding in Opinion No. 531 regarding the use of GDP in the two-step DCF.[2] In a separate order, FERC set for hearing a complaint that alleged MISO transmission-owning members’ 12.38% base ROE is unjust and unreasonable.[3]

Opinion No. 531-A Confirms New FERC ROE Calculation Methodology

In Opinion No. 531-A, FERC addressed an issue it set for paper hearing in Opinion No. 531, namely, the long-term growth rate that should be used in the two-step DCF. In contrast to the single-step DCF methodology—which, prior to Opinion No. 531, applied to electric utilities—the two-step DCF methodology incorporates both short- and long-term growth rates. In Opinion No. 531, FERC tentatively found that long-term growth rates should be approximated by GDP growth, and Opinion No. 531-A affirms that approach. Based on these findings, FERC set the base ROE for ISO-NE transmission owners at 10.57%. It also stated that ISO-NE transmission owners’ maximum transmission ROE, including incentives, cannot exceed the upper range of the zone of reasonableness (11.74%) established in Opinion No. 531.

FERC’s New ROE Calculation May Affect MISO Transmission Owners

In a separate order, FERC set the MISO transmission owners’ 12.38% base ROE for hearing. Although the complaint giving rise to this order was filed before FERC adopted its two-step DCF methodology, it found that, even according to its one-step DCF methodology, complainants established a prima facie case that MISO transmission owners’ cost of equity may have declined significantly below their existing 12.38% base ROE.

FERC, however, rejected arguments that capital structures cannot include more than 50% common equity. FERC noted that it has never capped the capital structures used for ratemaking at a particular level, either for individual transmission owners or for groups of transmission owners. It also rejected arguments that a 50 basis point adder for participation in MISO and 100 basis point adders for independence should be discontinued. With regard to the former, FERC found that the regional transmission organization (RTO) participation incentive continues to be just and reasonable based on the economic and reliability benefits to consumers whose utilities are RTO members.


[1] Coakley v. Bangor Hydro-Elec. Co., Opinion No. 531-A, 149 FERC ¶ 61,032 (2014).

[2] Coakley v. Bangor Hydro-Elec. Co., Opinion No. 531, 149 FERC ¶ 61,234 (2014).

[3] Assoc. of Businesses Advocating Tariff Equity v. Midcontinent Indep. Sys. Operator, Inc., 148 FERC ¶ 61,049 (2014).

 

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