On October 16, 2018, the Federal Energy Regulatory Commission (FERC) issued an order addressing four complaint proceedings involving the New England Transmission Owners' base rate of return on equity (ROE), including the proceeding in which the U.S. Court of Appeals for the D.C. Circuit in 2016 vacated and remanded FERC's Opinion No. 531. The order announces a significantly modified analytical framework for FERC’s determinations of ROE in rate cases under the Federal Power Act (FPA).
The October 16, 2018 order first describes FERC's “proposed framework” for deciding whether an existing ROE remains just and reasonable in a complaint proceeding. The most notable feature of FERC's new approach is the establishment of a “composite zone of reasonableness” based on equal weighting of the Discounted Cash Flow (DCF), a capital-asset pricing model analysis (CAPM), and an expected earnings analysis (Expected Earnings). This approach does not appear to be linked in any way to the “anomalous capital market conditions” on which FERC relied in Opinion No. 531, when it initially diverged from exclusive reliance on the DCF model. This order thus represents a more radical departure than Opinion No. 531 did from FERC’s long-standing reliance on the DCF model to the exclusion of other methods of estimating utilities’ cost of equity capital.
When FERC finds an existing ROE to be unjust and unreasonable, the October 16, 2018 order says it will then determine a new, just and reasonable ROE. FERC here again describes a new approach that underscores its abandonment of exclusive reliance on the DCF model. FERC describes dividing the zone of reasonableness into quartiles based on the midpoints/medians of the lower half of the zone, the entire range of returns, and the upper half of the zone. Those points will be the default ROE values for an entity of less than average risk (relative to the proxy group entities), of average risk, and of greater than average risk, respectively. Also noteworthy is that the cap on a utility’s total allowed ROE, the sum of its base ROE and any incentives authorized pursuant to FPA section 219, will be the top of "the composite zone of reasonableness produced by the DCF, CAPM, and Expected Earnings [models]." This approach presumably will mean a higher cap for the total allowed ROE in at least some (but not necessarily all) cases than would have applied when FERC looked solely to the top of the DCF range of returns.
This order leaves unclear whether FERC will immediately establish procedures for resolving numerous other pending complaints involving the base ROEs of other utilities, or instead will wait until the New England cases are fully resolved before further considering the remaining cases.
A copy of FERC's order is available here.
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