Public Service Enterprise Group, American Electric Power and FirstEnergy are among the utilities with the greatest risk of seeing their transmission rates decline as a result of the Federal Energy Regulatory Commission’s new formula for determining returns on equity, according to a new study.
Despite the new FERC methodology, however, transmission utilities still remain attractive investments with a “wide economic moat” similar to those for oil and gas pipelines, according to the study by Morningstar Institutional Equity Research.
Zone of Reasonableness
Last month, FERC changed the way it sets return on equity (ROE) rates for electric utilities, moving to a process it has long used for natural gas and oil pipelines. Ruling in a case involving New England transmission owners, it tentatively set the “zone of reasonableness” at 7.03% to 11.74%. The commission set the TOs’ base rate at 10.57%, a reduction from the previous 11.14%. (See FERC Splits over ROE.)
Utilities with FERC-approved returns on equity in the upper half of the zone could face reduced returns if Section 206 complaints are filed against them, Morningstar said. Such complaints are currently pending against Florida Power Corp., Duke Energy Florida and Southwestern Public Service Co.
Others vulnerable to rate cuts include ITC (currently earning rates of 12.38% to 13.88%) and PSEG (11.68% to 12.93%), according to the report.
Rate cuts could also be in the future for AEP and FirstEnergy, which have base ROEs above 10.57%, but the impact will be limited because their FERC-regulated transmission represents a small portion of their rate base.
By contrast, Edison International, Pacific Gas & Electric and Xcel Energy have FERC-allowed returns on equity near or below the base ROE for New England and might win increases, Morningstar said.
Wide Moat
Even after the reductions, FERC’s ROEs will exceed the average state-allowed ROEs, the report says.
The report cites several reasons why electric transmission is the “only regulated utility business with a wide economic moat”: Its impact on reliability and access to cheap generation; environmental rules encouraging remote renewable energy resources; and the certainty of cost recovery under FERC rules, which lowers utilities’ cost of capital.
“Transmission remains heavily regulated and faces some imminent competitive threats, but its efficient-scale competitive advantage is so strong that we expect returns on utilities’ transmission investments will continue to exceed costs of capital for many years,” the report says.
