The Federal Energy Regulatory Commission unanimously agreed last week to change the way it calculates return on equity (ROE) rates for electric utilities, moving to a two-step process it has long used for natural gas and oil pipelines that incorporates long-term growth rates.
But the panel split 3-1 over its first application of the new formula, tentatively setting the ROE for New England transmission owners at three-quarters of the top of the “zone of reasonableness,” a departure from the prior practice that used the midpoint in the range.
The case resulted from a complaint filed in 2011 by New England state officials and others that challenged the New England TOs’ 11.14% base ROE as unreasonable. The commission’s ruling (EL11-66-001) sets the ROE at 10.57% for the New England TOs, which include Northeast Utilities, Central Maine Power Co., National Grid and NextEra.
(Although the commission chose a higher position within the range, the New England TOs’ ROE was reduced because the new formula reduced the top end of the zone.)
The commission also ordered hearing and settlement judge procedures in five pending challenges to electric utility ROEs, saying they should be resolved within the new framework. These include a December 2012 complaint that sought to reduce the New England TOs’ ROE to 8.7% (EL13-33) and cases involving Florida Power Corp.(EL12-39), Duke Energy Florida (EL13-63 & EL12-39) and Southwestern Public Service Co. (EL12-59 and EL13-78 & EL12-59).
FERC Staff, Consumers Rebuffed
In setting the ROE at the 75th percentile of the zone of reasonableness, the commission majority sided with the TOs and rejected arguments by FERC trial staff and consumer representatives, who had argued for continuing the commission’s traditional use of the zone’s midpoint.
Acting Chair Cheryl LaFleur, a former executive vice president and acting CEO of National Grid, sided with the two Republican commissioners, Philip Moeller and Tony Clark, saying the change was justified because of the unusually low current interest rates.
Commissioner John Norris — a Democrat like LaFleur — issued a partial dissent, saying that while he agreed that the companies deserved an ROE increase, there was insufficient evidence to support setting the rate so high.
“This order tilts the balance too far,” Norris said in a statement during the commission’s public meeting. “They will clearly be celebrating in the corporate boardroom of Northeast Utilities today.”
New Formula
The order changes the methodology for electric utility ROEs from a one-step discounted cash flow (DCF) model to the same two-step DCF the commission has used for natural gas and oil pipeline ROEs. While the one-step methodology relies on only short-term growth rates, the two-step process includes short-term and long-term growth rate estimates.
The commission said the two-step process will produce a narrower zone of reasonableness because long-term growth rates are more stable than short-term growth rates and because the two-step methodology does not calculate a high-end and low-end cost of equity estimate for each company in the relevant proxy group.
The two-step methodology “is less likely to produce the anomalous results that can result from combining high and low dividend yields with high and low short-term projections of dividend growth to produce two estimates for each proxy company,” the commission said. “The end result is often a zone of reasonableness that is defined by two widely divergent growth rates that do not engender much confidence in the reliability of the estimates.”
The commission ordered a paper hearing to determine whether growth in gross domestic product should be the indicator for long-term growth rates, as it is in natural gas and oil pipeline proceedings. Using the GDP indicator, the commission tentatively set the zone of reasonableness as 7.03% to 11.74%.
The previous zone ranged from 7.3% to 13.1%. Thus, although the commission chose a higher position within the range, the reduced top end resulted in a decrease from the New England TOs’ previous ROE, which also included a post-hearing adder.
Clearing the Backlog
In announcing the ruling at last week’s commission meeting, LaFleur said that she had made acting on a backlog of ROE cases a high priority when she was appointed acting chair in November. “I established specific goals for addressing the ROE cases, including that any resolution would be fair to customers and investors, principled and sustainable, and represent a consensus of my colleagues. While we did not achieve unanimous agreement on all points, I believe that we have met these goals,” she said.
LaFleur said the grid’s shift from coal to natural gas and renewables “will require the construction of a significant amount of transmission in the coming years. I anticipate that this order, along with our recent compliance orders on Order No. 1000 will help provide some certainty to that process.”
Norris: `Troubling Precedent’
Norris praised LaFleur for pushing the commission to act on the ROE disputes, which he said “had been languishing too long.”
But he said the order sets a “troubling precedent” and may subject consumers to unjustly high rates in the future.
He said he would have ordered a paper hearing because there was insufficient evidence to support setting the rate at the 75th percentile.
“Regrettably, today’s order tilts the balance in favor of the New England transmission owners without further recourse and fails to adequately give a voice to consumer interests,” he wrote in his dissent.
“Looking beyond today’s order, my broader concern is that the precedent established through this adjustment could become the new norm that would potentially ratchet up and lock in substantially higher ROEs in future cases. I am further troubled by today’s order in light of recent commission decisions on Order No. 1000 compliance filings that have served to protect incumbent transmission owners from competition in the development of new transmission. Simply put, not only will incumbent transmission owners be more insulated from competition, they will also be the primary beneficiaries of the new precedent established in this proceeding that could provide for substantially higher ROEs.”
Treasury Bond Update Eliminated
The commission’s order also ends its practice of using U.S. Treasury bond yields to make a final ROE adjustment, which reflect changes in capital market conditions after the close of the record in a rate hearing. Instead, the commission’s decision will be based on the latest financial data available in the hearing record.
The D.C. Circuit Court of Appeals had ordered the commission to revisit the issue in a ruling on a 2008 ROE case involving Southern California Edison Co. The court said FERC should consider evidence that U.S. Treasury bond yields and corporate bond yields might be inversely related. The commission acknowledged that “there is not necessarily a one-to-one correlation between U.S. Treasury bond yields and public utility returns on equity.”
