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FERC applies new transmission ROE policy to MISO, slashes rate to 9.88%

The Federal Energy Regulatory Commission on Nov. 21 voted to adopt a draft order that lays out a new methodology for determining whether the return on equity for transmission owners is just and reasonable.

FERC then applied that new methodology to the Midcontinent ISO's existing 12.38% ROE, cutting it to 9.88%.

The order was issued in response to an April 2017 decision by the U.S. Court of Appeals for the District of Columbia Circuit to remand the commission's Opinion 531. That opinion modified FERC's ROE approach in response to a series of complaints involving a group of ISO New England transmission owners that date all the way back to 2011.

Opinion 531 adopted a two-step discounted cash flow, or DCF, analysis for calculating what is dubbed a "zone of reasonableness" for ROE based on a proxy group of similarly situated companies. The commission uses the same two-step DCF approach in determining ROEs for natural gas and oil pipelines. Based on the record in the New England proceedings, FERC ultimately found that the base ROE for electric transmission generally should be set halfway between the midpoint and the top of the zone of reasonableness.

However, the D.C. Circuit found that FERC erred by failing to explicitly find that the New England transmission owners' existing rate was unjust and unreasonable before setting a new rate. In remanding Opinion 531, the court instructed the commission to adequately explain why it was straying from its general practice of setting ROEs at the midpoint of the appropriate zone of reasonableness.

FERC offered an initial response to the remand in October 2018 by proposing to determine the appropriate ROE for electric transmission owners by giving equal weight to the results of four separate financial models: a DCF analysis; a capital-asset pricing model analysis; an expected earnings analyses; and a risk premium analysis.

The commission also initiated a paper hearing in February in two other complaint proceedings (FERC dockets EL14-12, EL15-45) that challenged the ROEs approved for MISO transmission owners, asking stakeholders to weigh in on whether the methodology proposed for New England also should be applied in the MISO region. And in March, the commission launched a related notice of inquiry (FERC docket PL19-4) soliciting feedback on whether its proposed approach should be applied consistently to companies across the electric, natural gas and oil industries.

'A negotiated compromise'

The draft order approved by the commission Nov. 21 adopted the use of the DCF model and capital-asset pricing model but rejected the use of the expected earnings and risk premium models included in the earlier proposal.

"I think there were questions regarding the legal risk associated with those approaches and I also thought it was very important that we achieve consensus, and this was a negotiated compromise," Commissioner Neil Chatterjee told reporters after FERC's regular open meeting.

According to the draft order, the DCF and capital-asset pricing models will be given equal weight in establishing a zone of reasonableness to evaluate whether an existing base ROE remains just and reasonable. The new methodology will specifically establish quartile ranges based on the risk profile of a utility. For average-risk utilities, the quartile is centered on the midpoint of the zone. The quartile for high-risk and low-risk utilities will be located between the upper and bottom halves of the zone, respectively.

Under the new approach, an ROE is presumed just and reasonable if it falls within the appropriate quartile and unjust and unreasonable if it falls outside that quartile.

MISO ROE subjected to new approach

In applying the revised methodology to the first of the two MISO complaints, FERC found the existing 12.38% ROE to be unjust and unreasonable, established a new 9.88% ROE, and ordered that refunds be provided accordingly for the period from Nov. 12, 2013, through Feb. 11, 2015. However, the commission dismissed the second complaint, which had a 15-month refund effective period that began Feb. 12, 2015, reasoning that it could only order refunds in that case if it found that the new ROE of 9.88% established in the first complaint is not just and reasonable.

That prompted a partial dissent from Commissioner Richard Glick, who argued during the meeting that the commission was engaging in "regulatory fiction" by denying consumers a refund that would have amounted to roughly $100 million.

"We're saying, 'Well, since we set the 9.88% ROE in the first proceeding, we're going to assume that that was the effective rate in the second complaint proceeding,' but it wasn't," Glick asserted. "In fact, it was actually still 12.38%, so in a sense ... consumers paid approximately $100 million more than they should have, but we're going to ignore that and just assume they were paying the effective rate of 9.88%, which again is just not true."

Based on the action in the MISO cases, lower ROEs can be expected for the undecided complaints involving New England transmission owners, ClearView Energy Partners LLC predicted in a Nov. 21 research note. Refunds in those cases will likely be limited to 15 months beginning from when the first complaint was filed in September 2011, ClearView said.

However, commission action on those proceedings could be delayed until FERC General Counsel James Danly, who in October was nominated to serve on the commission, is confirmed by the U.S. Senate due to potential recusal issues, the firm noted.

Following the Nov. 21 meeting, Chatterjee declined to offer his views on how the commission's new methodology will impact the broader notice of inquiry launched in March. "This proceeding relates to our policy for electric transmission and there are other parts of that NOI that I'm not going to speculate on right now," he said.