DC Circuit ruling gives FERC new chance to establish durable transmission ROEs

A federal appeals court ruling gives the Federal Energy Regulatory Commission a fresh opportunity to resolve long-running uncertainty over the returns it allows electric utilities to earn on transmission lines, according to industry experts.

At issue is an Aug. 9 ruling by the U.S. Court of Appeals for the District of Columbia Circuit that vacated and remanded a pair of FERC orders in which the agency reversed itself by using a three-model approach — instead of a two-model approach adopted just six months earlier — to set the base return on equity for transmission lines in the Midcontinent ISO region.

The D.C. Circuit's ruling leaves FERC without a fully litigated base ROE methodology to set returns on commission-jurisdictional power lines and energy sales as utilities and transmission developers ramp up efforts to expand the U.S. electric grid to accommodate more renewables.

However, the commission could respond to the court's decision in MISO Transmission Owners v. FERC (No. 16-1325) in a relatively straightforward way that gives the utility industry long-sought certainty on ROEs for transmission, experts said.

Background

The D.C. Circuit vacated orders (EL14-12, EL15-45) issued by FERC in May 2020, spelled out in Opinion 569-A, that set a base ROE for MISO transmission owners of 10.02%, up from 9.88%. That opinion departed from an earlier order — Opinion 569 — issued in November 2019 in response to two consumer complaints.

FERC issued Opinion 569-A after MISO transmission owners asked the commission to reconsider Opinion 569, which decreased the base ROE in the MISO region from 12.38% to 10.02%.

The commission had hoped to use Opinion 569 to resolve a series of complaints in the ISO New England region dating back to 2011.

Opinion 569 used a two-step discount cash flow, or DCF, model as well as a capital asset pricing model, or CAPM, to establish what it dubs the "zone of reasonableness" for ROEs. After using a single DCF model for years, FERC sought to use an average of the two models to better reflect how real investors would evaluate utilities.

In response to Opinion 569, however, MISO transmission owners and the trade association WIRES Group warned that the move could chill investment in new transmission at a time when it is needed more than ever.

FERC subsequently responded with Opinion 569-A, which added a third model — a risk premium model — that nudged the ROEs at issue up 14 basis points. Both the DCF and CAPM models use proxy groups of similarly situated companies to determine a range of reasonable returns, while the risk premium model incorporates forward-looking interest rate forecasts as a direct input.

In vacating and remanding Opinion 569-A, the D.C. Circuit faulted FERC for failing to adequately explain why it backtracked on using a model the agency explicitly rejected in Opinion 569.

Among other things, FERC concluded in Opinion 569 that the risk premium model, at least as applied to the MISO proceedings, "defies general financial logic" by keeping the return stable regardless of capital market conditions.

"Suffice it to say that in Opinion 569, FERC found the risk-premium model quite defective," the D.C. Circuit said. "FERC is, of course, entitled to change its mind. But to do so, it must provide a 'reasoned explanation' for its decision to disregard 'facts and circumstances that' justified its prior choice. Here, FERC failed to do that."

Stable, adequate ROEs needed for grid build-out

Christi Tezak, managing director at ClearView Energy Partners, noted that Opinion 569 was issued with near-unanimous support from the commission, including current Chairman Richard Glick.

Glick's sole objection as commissioner at the time dealt with "pancaked" complaints filed under Section 206 of the Federal Power Act. Pancaked complaints essentially seek to expand an initial refund period for contested rates if a complaint is not resolved within an initial 15-month period.

In Opinion 569, Glick objected to the majority's reasoning that because it cut the base ROE in MISO from 12.38% to 9.88% for an initial 15-month period, no refunds were warranted for a second refund period in one of the two complaints at issue.

"I dissent in part because today's order requires the MISO [transmission owners] to pay refunds only for the first complaint, and not the second complaint, even though it is undisputed that the unjust and unreasonable 12.38% ROE was in effect for the entire refund period established for the second complaint," Glick said.

Otherwise, Glick did not object to using DCF and CAPM models to establish base ROEs. The D.C. Circuit also found no fault with FERC using the two models, Tezak noted.

"When you look at transmission, the ROEs need to be stable and they need to be adequate, and I think that the two models combined get you there," Tezak said in an interview.

FERC has also become more cost-conscious since Opinion 569-A was issued.

In addition to Glick, fellow Democratic Commissioners Allison Clements and Willie Phillips, as well as Republican Commissioner Mark Christie, have all expressed misgivings about how the three-model methodology has been applied in subsequent proceedings. Republican Commissioner James Danly has also argued that FERC's revised methodology established under Opinion 569-A had become "too complicated," even though he initially supported it.

Blue Horseshoe Energy LLC President R. Scott Everngam, a senior analyst at FERC who worked closely on ROE policy before recently establishing his own consulting firm, said he does not expect the commission to allow future ROEs to dip too far.

"They can't let ROEs get so low that you can't get transmission built because I think there are too many people who want transmission built for different reasons, whether it's for renewables or grid security," Everngam said.

Everngam also said the D.C. Circuit's decision gives FERC more flexibility to further revise its ROE methodology if commissioners wish to do so.

"That's the one thing I'm happy with," Everngam said. "I wanted them to be able to use multiple models and at least the court affirmed you can do that."

Pending proceedings

The D.C. Circuit's ruling is expected to affect multiple proceedings in which FERC applied its now-vacated ROE methodology.

Those proceedings include a May 2021 order (ER13-1508) dealing with wholesale sales of energy and capacity for Entergy Corp.; a July 2021 order (ER18-1639) dealing with cost-of-service payments for Constellation Energy Corp.'s Mystic River 8 and 9 natural gas-fired generating units in Massachusetts; and a March 2022 order (ER16-2320) in a transmission rate case for Pacific Gas and Electric Co.

The Constellation Energy order was appealed to the D.C. Circuit in Constellation Mystic Power v. FERC (No. 20-1343). The Pacific Gas and Electric order was also appealed to the D.C. Circuit in Pacific Gas and Electric v. FERC (No. 22-1095).

The New England proceeding (EL11-66) that kicked off the entire saga more than a decade ago still remains pending before FERC.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.