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FERC launches inquiries into ROE setting, transmission incentive policies

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FERC launches inquiries into ROE setting, transmission incentive policies

Following through on a pledge made months earlier, the Federal Energy Regulatory Commission on March 21 initiated a broad inquiry aimed at examining the way it sets the base rate of return on equity for electric utilities.

Among other things, the agency will consider whether it should establish a uniform set of ROE-setting policies to be applied consistently to companies across the electric, natural gas and oil industries.

FERC also established a separate inquiry reconsidering the incentive policies it established in 2006 to encourage transmission investment in accordance with the Energy Policy Act of 2005, or EPAct 2005.

"What all this boils down to is the fact that getting these policies right will be critical to ensuring that the energy revolution we're currently undergoing results in more reliable service and lower prices for customers," FERC Chairman Neil Chatterjee said during the agency's March 21 regular open meeting at which the two notices of inquiry were presented.

ROE setting

Although FERC traditionally has used a different policy for setting the base ROE for electric utilities than it has for interstate natural gas and oil pipelines, it sought in June 2014 (FERC docket EL11-66) to bring those policies more closely into alignment by adopting a new methodology for determining an appropriate zone of reasonableness for New England transmission owners' ROEs.

Of particular significance here, FERC through Opinion 531 abandoned its historic policy of using a one-step discounted cash flow, or DCF, methodology to determine base ROEs for electric utilities and instead began using the same two-step DCF approach it applies when determining ROEs for natural gas and oil pipelines.

FERC also deviated from its usual practice of setting the approved ROE at the midpoint or median of the applicable zone of reasonableness and instead set it halfway between the midpoint and the top of that zone, but a federal appeals court subsequently remanded that decision. The court found that FERC failed to adequately explain its reason for doing so and that the agency needed to determine whether the existing ROE was unjust and unreasonable before setting a new one.

Returning to the drawing board, FERC in October 2018 proposed a new methodology for determining the appropriate ROE for transmission-owning member of the ISO New England and possibly elsewhere. FERC said it intends to "give equal weight" to the results of four separate financial models instead of continuing its historical practice of relying primarily on the results of a DCF analysis and established a mechanism for addressing complaints challenging an existing ROE.

FERC later initiated a paper hearing in two other complaint proceedings (FERC dockets EL14-12, EL15-45) that challenged the ROEs approved for Midcontinent ISO transmission owners, asking stakeholders to weigh in on whether the methodology proposed for New England should also be applied in that region.

In its March 21 notice of inquiry (FERC docket PL19-4) launching an examination of its ROE-setting policies, the agency explained that the broad inquiry does not affect the process that FERC established in the ISO-NE and MISO complaint proceedings.

It does, however, seek to "gauge whether there is a need to add to, modify, or eliminate" any existing policies by asking stakeholders to weigh in on issues such as the role base ROEs play in investment decisions and whether FERC should have a single ROE policy applicable across the electric, interstate natural gas and oil pipeline industries.

"What, if any, differences between public utilities on the one hand and natural gas and oil pipelines on the other would justify using different methodologies to determine their ROEs," FERC asked.

FERC also sought comment on how well the DCF model performs over time and under different investment conditions, the appropriate composition of proxy groups, and the proper placement of a base ROE within the zone of reasonableness.

Other questions posed by the commission seek to flesh out the pros and cons of using financial models other than the DCF and to examine the mismatch between market-based ROE determinations and book-value rate base. FERC also raised an issue at the heart of the court remand — how the agency should determine whether an existing ROE is unjust and unreasonable.

Transmission incentives

The second initiative unveiled during the commission's March 21 meeting seeks to determine whether any changes should be made to FERC's 13-year-old transmission incentive policies.

EPAct 2005 directed FERC to provide incentives for transmission investment that will help ensure the reliability of the grid and lower the cost of delivered power to customers by reducing transmission congestion.

Issued in 2006, FERC's rule implementing that mandate, Order 679, offered incentive ROE rates for new transmission investments as well as a higher ROE for utilities that join a regional transmission organization or independent system operator and for independent transmission companies, or transcos. The final rule also offered certain non-ROE incentives, including the recovery of 100% of prudently incurred construction-work-in-progress costs, precommercial operation costs and development costs when a project is abandoned for reasons beyond the developer's control. FERC also agreed to consider hypothetical capital structures and requests for accelerated depreciation.

Since then, the commission has taken steps to fine-tune and/or clarify its incentive policies, most recently in late 2012 when it issued a policy statement making certain tweaks, such as backing away from its previous reliance on the distinction between routine and nonroutine projects for determining eligibility for incentives.

But some of those incentives have become controversial over time, particularly the transco and RTO-participation ROE adders. In July 2018, Commissioner Richard Glick called on FERC to take a fresh look at the transco incentive, and the agency during its regular open meeting the following November announced that it would launch a generic proceeding to look at all its incentive policies.

FERC's March 21 notice of inquiry (FERC docket PL19-3) did just that.

Noting that transmission incentives traditionally have been granted based on the risks and challenges of the project, FERC asked whether the focus should now shift more toward looking at the benefits a project provides in light of changes that have occurred since 2006 with respect to how transmission is planned, developed, operated and maintained.

Moreover, as FERC essentially has been using risks and challenges as a proxy for expected reliability and congestion reduction benefits, the notice asked whether such an approach remains effective. If not, the commission sought stakeholder input on more appropriate ways of measuring the economic efficiency and reliability benefits of a project.

The notice also raised questions such as should certain incentives, such as abandoned plant recovery and accelerated depreciation, be granted automatically rather than on a case-by-case basis and should the transco and RTO incentives be modified, eliminated or perhaps limited to a set number of years?

Other topics addressed in the notice include how incentives interact with base ROE as well as the possibility of establishing metrics for evaluating the effectiveness of incentives.

Initial comments on each notice of inquiry will be due 90 days after its publication in the Federal Register.