On November 15, 2012, the Federal Energy Regulatory Commission issued a policy statement providing guidance on its evaluation of applications for electric transmission incentives under section 219 of the Federal Power Act and its Order No. 679 (the Incentive Rate Policy Statement). The Incentive Rate Policy Statement reflects a continuation of the trend of scaling back the incentives awarded to transmission developers, most notably, making it more difficult to obtain a substantial incentive return on equity (ROE), if any at all.

Since the issuance of Order No. 679, the Commission has evaluated more than 85 applications representing over $60 billion in potential transmission investment. In its more recent evaluation of incentive rate applications, however, FERC, under Chairman Jon Wellinghoff, had trended towards less “generous” packages of incentives awarded even when an applicant appeared to qualify under FERC precedent and regulations for a more “generous” incentive package, particularly with respect to the level of incentive ROEs. Whereas incentive ROE adders could be as high as 200 basis points in earlier years, more recent incentive ROE adders granted were 50 or 100 basis points, if any were granted at all.

The Incentive Rate Policy Statement continues the trend towards a prospective reduction of incentive packages granted by FERC. Among other things, the Commission stated that it expects that before an applicant seeks an incentive ROE based on the risks and challenges of a project, the applicant would take all reasonable steps to mitigate risks, including seeking incentives designed to reduce those risks, such as the CWIP recovery, pre-commercial cost recovery and abandoned plant cost recovery incentives. The Commission is signaling that incentive ROEs should be seen as a kind of “last line of defense” for mitigating the risks associated with transmission development. The Commission stated it will carefully apply its total package analysis to ensure that the effect of the risk-reducing incentives is appropriately accounted for in determining whether an incentive ROE based on risks and challenges is warranted, and if warranted, what level is appropriate.

As noted, this aspect of the Incentive Rate Policy Statement formally recognizes a shift that already has occurred. The Incentive Rate Policy Statement does, however, provide guidance on the additional showings that FERC expects from an applicant seeking an incentive ROE based on a project’s risks and challenges. Essentially, the Commission is looking for a demonstration that, in its effort to develop new transmission, the applicant faces risks and challenges that are not either already accounted for in the applicant’s base ROE or addressed through risk-reducing incentives. Notably, FERC expects an applicant to commit to cost containment in the application of the ROE incentive.

One issue to look at prospectively is the Commission’s application of the Incentive Rate Policy Statement to non-incumbent transmission developers. For many non-incumbent developers the benefits of the risk-reducing incentives, such as CWIP and abandonment, are illusory. That is because they often have no customers from which to recover the risk-reducing incentives prior to entering service. FERC’s incentive rate orders regularly question whether non-incumbents will have customers from which to recover these incentives. FERC might be more forgiving to non-incumbent developers with respect to its application of its incentive ROE policy in recognition of the limited value of risk-reducing incentives to non-incumbents.

The Incentive Rate Policy Statement, along with Commissioners’ Statements on the issuance, are available here.