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FERC Modifies Approach to Return on Equity for Utilities and Pipelines

On May 21, 2020, the Federal Energy Regulatory Commission (FERC), issued two orders that modify its approach to analyzing the rate of return on equity (ROE) authorized for recovery under FERC-jurisdictional rates charged by public utilities and gas and oil pipelines. The first order, Opinion No. 569‑A, refines the ROE methodology for public utilities. The second is a policy statement that applies, with certain exceptions, FERC’s refined ROE methodology to natural gas and oil pipelines (Pipeline Policy Statement).

Opinion No. 569-A revises the new ROE methodology established in a complaint proceeding in 2019 by Opinion No. 569, finds that the Midcontinent Independent System Operator, Inc. (MISO) Transmission Owners’ base ROE should be set at 10.02% (instead of 9.88% under Opinion No. 569), and affirms FERC’s decision to dismiss a second complaint against the MISO Transmission Owners. Opinion No. 569-A chiefly grants rehearing of Opinion No. 569 to make the following adjustments to FERC’s ROE methodology:

  • Adopting a three-method (instead of two-method) hybrid ROE methodology by adding consideration of the risk premium model under both prongs of the Federal Power Act section 206 analysis, instead of relying on only the discounted cash flow (DCF) method and capital asset pricing model (CAPM);
  • In the two-step DCF portion of the hybrid methodology, giving 80% weight to the short-term growth rate and 20% weight to the long-term growth rate;
  • Clarifying that FERC will consider the use of Value Line growth rates in future proceedings’ CAPM analyses;
  • Increasing the parameter for FERC’s high-end outlier test from 150% to 200% of the median result of all of the potential proxy group members in that model, still subject to a “natural break” analysis; and
  • Retaining the concept of risk-conscious ranges of presumptively just and reasonable base ROEs, but abandoning Opinion No. 569’s quartile approach and instead adopting an approach that divides the overall composite zone of reasonableness into equal thirds.

The Pipeline Policy Statement announced that, with a few exceptions to account for statutory, operational, organizational, and competitive differences among the industries, FERC will apply to jurisdictional natural gas and oil pipelines the same methodology it will now use for analyzing public utility ROEs. Among the exceptions, FERC says that, for pipelines, it will average the results of the DCF and CAPM models, giving equal weight to each, but will not use the risk premium model because there is insufficient data to estimate cost of equity using the risk premium for gas and oil pipelines.

Additionally, unlike Opinion No. 569-A, the Pipeline Policy Statement announces that FERC will retain the existing two-thirds/one-third weighting between the short- and long-term growth rates in the two-step DCF model, and declines to adopt any specific high-end or low-end outlier tests. The Pipeline Policy Statement also clarifies FERC’s policies for composing proxy groups in pipeline proceedings, saying that FERC will consider proposals to include Canadian companies in pipeline proxy groups while continuing to apply proxy group criteria flexibly until sufficient proxy group members are obtained. The Pipeline Policy Statement additionally encourages oil pipelines to file revised FERC Form No. 6, page 700s to reflect the new ROE policy.

As applied to the 2015 study period for the first complaint against the MISO Transmission Owners, FERC’s refined ROE methodology produced a composite zone of reasonableness of 7.42% to 12.62%, with the midpoint of that zone of reasonableness at 10.02% and a presumptively just and reasonable range of returns for utilities of average risk (i.e., the middle third of the composite range) of 9.15% to 10.89%. Opinion No. 569-A thus concluded that although the MISO Transmission Owners’ prior 12.38% base ROE resided within the larger composite zone of reasonableness, it fell outside the range of presumptively just and reasonable range of returns, and was no longer just and reasonable. FERC therefore established a new base ROE of 10.02% (again, instead of the 9.88% set by Opinion No. 569). Opinion No. 569-A also capped collection of ROE incentives for the MISO Transmission Owners at an all-in ROE amount equal to the top of the composite zone, 12.62%.