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FERC lays out potential new policy for setting transmission ROEs

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FERC lays out potential new policy for setting transmission ROEs

Federal regulators have proposed a new methodology for determining the appropriate return on equity for transmission owners in New England and possibly elsewhere.

The Federal Energy Regulatory Commission 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 discounted cash flow, or DCF, analysis. That change will help "ensure that our chosen ROE is based on substantial evidence and bring our methodology into closer alignment with how investors inform their investment decisions," the agency explained.

FERC's proposed new policy came in an order addressing four separate challenges to the ROE approved for transmission-owning members of the ISO New England. The agency said it intends to apply the new policy to those complaint proceedings, one of which found its way back to FERC following a court remand.

In ruling on the first of those complaints (FERC docket EL11-66) in June 2014, the commission issued Opinion 531 through which it adopted a two-step DCF approach to establishing a zone of reasonableness based on a proxy group of similarly situated companies. Opinion 531 also determined that the base ROE for New England transmission owners should be set halfway between the midpoint and the top of the resulting new zone of reasonableness, which effectively reduced it from 11.14% to 10.57%.

The commission has not yet issued final rulings in the three subsequent complaint proceedings (EL13-33, EL14-86, EL16-64), but the U.S. Court of Appeals for the District of Columbia Circuit in April 2017 remanded Opinion 531. The court said FERC erred by failing to explicitly find that the transmission owners' existing rate was unjust and unreasonable before setting a new rate and to adequately explain why it was straying from its general practice of setting ROEs at the midpoint of the appropriate zone of reasonableness.

In its Oct. 16 order, FERC responded to the remand by proposing to make major changes to the way it determines whether an existing ROE remains just and reasonable and, if not, the way it sets a new ROE.

As a first step, the commission said it would establish a composite zone of reasonableness using a DCF analysis, a capital-asset pricing model analysis and an expected earnings analysis. It would then use that composite zone to identify "a range of presumptively just and reasonable ROEs."

"Under this approach, we intend to dismiss an ROE complaint if the targeted utility's existing ROE falls within the range of presumptively just and reasonable ROEs for a utility of its risk profile — unless that presumption is sufficiently rebutted," FERC said.

The complaint proceedings not dismissed at that point would move on to the second step, which would involve FERC determining a just and reasonable ROE by averaging four separate cost-of-equity estimates. Three of those estimates would be produced using the "central tendency" of the zones of reasonableness established by the DCF, capital-asset pricing and expected earnings analyses, and the fourth would reflect the "sole numerical figure" produced by a risk premium analysis.

In keeping with its previously established practice, FERC would consider the central tendency to be the median for an electric utility of average risk filing individually and the midpoint for those applying as a regional group.

FERC applied its proposed methodology to the complaint addressed by Opinion 531 and preliminarily found that the New England transmission owners' previously approved base ROE of 11.14% is unjust and unreasonable and that the appropriate replacement base ROE is 10.41% with a cap of 13.08% for the overall ROE, including incentives.

The commission directed the parties to all four complaint proceedings to submit briefs weighing in on its proposal. But if the new methodology ultimately is adopted, the order explained, FERC intends to exercise its "broad remedial authority" to correct its legal error by setting the New England transmission owners' base ROE at 10.41%, effective retroactively to Oct. 16, 2014, and mandating refunds.

The order did not specifically say whether the proposed new policy would be used in New England alone or applied more generally to transmission owner ROEs outside that region. Opinion 531 was a ruling on a single complaint proceeding, yet the precedent it set then was applied broadly.