Currently there are four pending complaints against the New England Transmission Owner’s (NETOs) rate of return on equity (ROE) that date back to 2011. Each complaint has been fully litigated before an Administrative Law Judge (ALJ) with only the first complaint resulting in a FERC Commission decision (Opinion No. 531). The D.C. Circuit Court of Appeals vacated the Commission’s determinations in its order on the First Complaint (Opinion No. 531). In the meantime, the NETOs are continuing to collect their 10.57% base ROE, although the Commission has indicated that it will exercise its “broad remedial authority” to correct its legal error to make whatever ROE it sets on remand effective as of the date of Opinion No. 531.
On October 16, 2018, FERC issued an order in these complaint cases. In its Order, FERC set forth its methodology for addressing ROE complaints while considering the remand from the DC Court. In its new methodology, FERC intends to give equal weight to the results of the four financial models in the record in the NETO cases, instead of primarily relying on the two-step discount cash flow (DCF) model. In relying on a broader range of record evidence to estimate the NETOs’ cost of equity, FERC will ensure that the selected ROE is based on substantial evidence and bring its methodology into closer alignment with how investors make investment decisions.
To determine whether an existing ROE remains just and reasonable (i.e., the first prong of the Federal Power Act (FPA) section 206 analysis), FERC proposes to (1) rely on the three financial models that produce zones of reasonableness—the DCF, capital asset pricing model (CAPM), and Expected Earnings Analysis models—to establish a composite zone of reasonableness; and (2) relying on that composite zone of reasonableness as an evidentiary tool to identify a range of presumptively just and reasonable ROEs for utilities with a similar risk profile to the targeted utility. Under this approach, FERC intends to dismiss an ROE complaint if the targeted utility’s existing ROE falls within the range of presumptively just and reasonable ROEs for a utility of its risk profile—unless that presumption is sufficiently rebutted.
Each of these three methodologies relies on a proxy group to determine a zone of reasonableness, and thus the top and bottom of the zone of reasonableness produced by each methodology can be averaged to determine a single composite zone of reasonableness. After determining the composite zone of reasonableness, FERC will then calculate the lower midpoint/median, midpoint/median, and upper midpoint/median of that zone. The presumptively just and reasonable ROEs for below-average-, average-, and above-average-risk utilities will then be the quartile of the zone corresponding to the lower midpoint/median, midpoint/median, and upper midpoint/median, respectively.
Where the existing ROE has been shown to be unjust and unreasonable and therefore moving to the second prong of the FPA section 206 analysis, FERC proposes to rely on all four financial models in the record—i.e., the three listed above, plus the Risk Premium Model—to produce four separate cost of equity estimates. FERC proposes to give them equal weight by averaging the four estimates to produce the just and reasonable ROE. For each of the DCF, CAPM, and Expected Earnings Analysis models, FERC proposes to use the central tendency of the respective zones of reasonableness as the cost of equity estimate for average risk utilities. FERC would then average those three midpoint/median figures with the sole numerical figure produced by the Risk Premium Model to determine the ROE of average risk utilities. FERC would use the midpoint/medians of the resulting lower and upper halves of the zone of reasonableness to determine ROEs for below or above average risk utilities, respectively. Because its current policy is to cap a utility’s total ROE, i.e., its base ROE plus rate incentive ROE adders, at the top of the zone of reasonableness, FERC proposes to use the composite zone of reasonableness produced by the DCF, CAPM, and Expected Earnings Analysis to establish the cap on a utility’s total ROE.
In its Order, FERC performs an illustrative calculation using record evidence from the First Complaint proceeding. That calculation indicates that, for the time period at issue in the First Complaint, (1) the range of presumptively just and reasonable ROEs for NETOs is 9.60% to 10.99%; (2) NETOs’ preexisting ROE of 11.14% is therefore unjust and unreasonable; (3) the just and reasonable ROE is 10.41% (compared to 10.57% in Opinion No. 531); and (4) the cap on NETOs’ total ROE is 13.08% (compared to 11.74% in Opinion 531). However, these findings are merely preliminary. FERC concludes its order by establishing a paper hearing and directing parties to submit briefs regarding the proposal to the section 206 complaints and how to apply the proposal to the First, Second, Third, and Fourth Complaints. The participants should submit separate briefs regarding each of the complaints. Initial briefs are due December 17th. Responses to those initial briefs shall be due 30 days later. No answers or additional briefs will be permitted.