On Tuesday evening, October 16th, the Federal Energy Regulatory Commission (FERC) issued an order regarding the New England Transmission Owners' (NETOs) rate of return on equity (ROE). The order had been scheduled for consideration at FERC's October 18th meeting, and was issued early.
The order addresses the four Federal Power Act Section 206 complaints that various parties have filed against the NETOs' ROEs since 2011. FERC’s resolution of the first such complaint in FERC Opinion No. 531 was reversed by the DC Circuit in 2017 in Emera Maine v. FERC. The order responds to the two defects in Opinion No. 531 that the DC Circuit identified in its opinion, and proposes a new method for resolving these and other Section 206 complaints. The order does not state whether FERC would apply the new method it outlines for determining a just and reasonable ROE in a Section 206 proceeding to Section 205 proceedings as well, but we infer that that is FERC's intent. FERC characterizes its rulings as a "proposal," and orders the parties to the case to submit briefs addressing the proposal.
The order first addresses how FERC proposes to determine whether an existing ROE is unjust and unreasonable – the first prong in a Section 206 complaint. The DC Circuit had reversed FERC on this issue. FERC states that it will determine a "composite" zone of reasonableness based on the results of three models: the Discounted Cash Flow (DCF), Capital Asset Pricing Model (CAPM), and Expected Earnings models. The low end of the composite zone will be based on the average low-end result for the three models, and the high end of the composite zone will be based on the average high-end result for the three models. Within that composite zone, a smaller, "presumptively reasonable" zone will be established. For "a diverse group of average risk utilities" (such as the NETOs), the smaller zone will be centered on the midpoint, and be comprised of the second and third quartiles of the composite zone (e.g., if the composite zone is 8 to 12 percent, the presumptively reasonable zone is 9 to 11 percent). In cases where the ROE of a single utility of average risk is at issue, the top and bottom halves will be split based on the median (rather than the midpoint), and then further split based on the median of the bottom half and the median of the top half. Absent additional evidence to the contrary, if the utility's existing ROE falls within the presumptively reasonable zone, it is not unjust and unreasonable. FERC stressed that in addition to applying this mathematical exercise, it may consider changes in capital market conditions since the existing ROE was established, in assessing whether the ROE is unjust and unreasonable.
The order next addresses how, if FERC found the existing ROE unjust and unreasonable, it would determine the new just and reasonable ROE – the second prong of a Section 206 case. The DC Circuit had reversed FERC on this issue as well. For a diverse group of average risk utilities, FERC will average four values: the midpoints of the DCF, CAPM and Expected Earnings models, and the results of the Risk Premium model. For a single utility of average risk, FERC will average the medians rather than the midpoints. FERC states that it will not include state ROEs in this averaging process but that it somehow will consider state ROEs if the record demonstrates investors are using it to inform their investment decisions. FERC had relied on state ROEs in Opinion No. 531.
FERC states that it would continue to use the same proxy group criteria it established in Opinion No. 531 to run the ROE models, but it made a significant change to the manner in which it applied one of those criteria: the high-end outlier test. FERC states it would exclude ROE results that were more than 150% of the median result of all proxy group members, subject to a "natural break" analysis similar to what FERC employs for low-end outliers. The "natural break" caveat appears designed to give FERC the flexibility to draw the line slightly above or below 150%, based on the "natural break" of the data. FERC also stated that its high-end outlier and low-end outlier tests for inclusion in the proxy group must be applied separately to each model – the DCF, CAPM, Expected Earnings analyses.
FERC states that in view of its new methods, consideration of whether anomalous capital market conditions exist is "of less importance" and "largely irrelevant."
FERC directed the parties to the four NETO complaint proceedings to submit briefs (with accompanying evidence, if desired) by December 15, 2018, addressing FERC’s proposal approaches and how to apply them to the four cases. Any additional evidence must relate to the periods before the conclusion of the respective hearings. FERC also stated that in view of its greater reliance on alternative ROE models under its new proposal, the parties may address whether there should be any adjustments to the manner in which FERC implemented these models in Opinion No. 531. In the later NETO complaint proceedings, the complainants and FERC Trial Staff proposed significant adjustments to FERC's implementation of these models, producing lower results.
Reply briefs are due January 14, 2019.