On April, 14, 2017, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) vacated and remanded orders issued by the Federal Energy Regulatory Commission (FERC) which had established a new, and lower, return on equity (ROE) for certain New England transmission owners (Transmission Owners). The D.C. Circuit’s opinion clarifies that, prior to establishing a new ROE for transmission owners under Section 206 of the Federal Power Act, FERC must first make an independent and separate determination that the existing rate is unjust and unreasonable.

BACKGROUND

In 2011, the state of Massachusetts and other consumer-oriented stakeholders (Customers) filed a complaint pursuant to Section 206 of the Federal Power Act (FPA) alleging that the Transmission Owners’ base existing ROE of 11.14 percent had become unjust and unreasonable. According to the complaint, which was the first to challenge a base ROE after the economic recession of 2007, the Transmission Owners’ capital costs had declined significantly since the establishment of the existing ROE in 2006.

After an Administrative Law Judge decision established a base ROE of 9.7 percent for the Transmission Owners, FERC adopted a new, two-step, discounted cash flow (DCF) methodology for determining a utility’s ROE. Applying the new DCF methodology to the Transmission Owners, FERC established an ROE “zone of reasonableness” between 7.03 percent and 11.74 percent. Although the midpoint of this zone of reasonableness was 9.39 percent, and the midpoint typically establishes a utility’s base ROE, FERC determined that the midpoint was too low given the presence of “anomalous market conditions.” After consideration of alternative analyses, FERC determined that the Transmission Owners’ ROE should be 10.57 percent, which was the midpoint of the upper half of the newly determined zone of reasonableness.

Both the Transmission Owners and the Customers filed petitions for review. The Transmission Owners alleged that FERC had failed to satisfy the requirements of Section 206 because the agency did not first independently determine that the existing ROE was unjust and unreasonable prior to establishing a new ROE. The Customers argued that FERC failed to articulate a satisfactory explanation for placing the new ROE at the midpoint of the upper half of the zone of reasonableness.

DECISION

The D.C. Circuit granted the petitions for review for both the Transmission Owners and the Customers. With regard to the Transmission Owners’ challenge, the D.C. Circuit noted that Section 206 of the FPA requires FERC to make a separate and independent determination that an existing rate is unjust and unreasonable prior to establishing a new rate. In this proceeding, FERC had argued that the burden of proof under Section 206 could be satisfied using a single ROE analysis. Specifically, FERC argued that if a new ROE established by FERC is below the existing ROE then, by definition, the existing ROE is unjust and unreasonable. The Court disagreed and held that “finding that an existing rate is unjust and unreasonable is the ‘condition precedent’ to the FERC’s exercise of its section 206 authority to change that rate.”

Addressing the Customers’ challenge, the D.C. Circuit also ruled against FERC. Acknowledging that FERC has discretion to make pragmatic adjustments to a utility’s ROE based on specific circumstances, the Court found that, in this case, the agency had not adequately articulated its rationale for selecting the midpoint of the upper half of the zone of reasonableness. In particular, FERC had not sufficiently explained -- based on record evidence -- that 10.57 percent was a just and reasonable base ROE for the Transmission Owners. FERC cannot simply choose the midpoint of the upper half of the zone of reasonableness once it concludes that an upward adjustment from the midpoint of the zone of reasonableness is appropriate. Rather, FERC must take the additional step of establishing a rational connection between the record evidence and the new ROE.

IMPLICATIONS

The D.C. Circuit’s opinion is significant because it clarifies that, under Section 206, FERC has the burden of making an explicit determination that a utility’s existing ROE is unlawful before it is authorized to set a new ROE. This burden cannot be met using a single ROE analysis, whereby FERC establishes a new ROE and then uses that ROE to find that the existing ROE is unjust and unreasonable. The D.C. Circuit noted that the two-step process required by Section 206 is a form of statutory protection for utilities. Without a showing that an existing rate is unlawful, FERC has no authority to impose a new rate.

The Court also made clear that FERC does not have to accept as just and reasonable all existing ROEs that fall within the zone of reasonableness. The fact that a rate falls within a zone of reasonableness does not, by itself, establish that a particular rate is just and reasonable for a particular utility.

Finally, the Court’s opinion reinforces that the justification for any new ROE must be based on a sufficiently articulated relationship between the record evidence and the new ROE.

A copy of the D.C. Circuit’s decision can be found here.