FERC’s Opinion No. 531-B, issued March 3, 2015 (150 FERC ¶ 61,165) upheld FERC’s earlier rulings, Opinion Nos. 531 and 531-A, regarding the return on equity (ROE) the New England Transmission Owners (NETOs) should be allowed to charge through their transmission formula rates. Among other things, FERC affirmed its reliance on discounted cash flow (DCF) analysis to determine the ROE, its decision to calculate the dividend growth component of the DCF formula in part based on projections of growth in the gross national product, the use of the midpoint rather than the median of the zone of reasonableness when determining the ROE for a large group of utilities, and various other aspects of its DCF application. The most significant Opinion No. 531-B rulings related to its confirmation that an existing ROE is not necessarily just and reasonable even though it falls within the DCF-determined zone of reasonableness and that prevailing anomalous financial conditions coupled with the results of non-DCF ROE determination methods justified its placement of the ROE in the upper end of the zone of reasonableness.
FERC’s SECTION 206 AUTHORITY
The NETOs on rehearing contended that FERC’s authority differs under Federal Power Act (FPA) sections 205 and 206. They conceded FERC’s section 205 authority to disallow a utility’s proposed ROE even though the proposed ROE might fall within the zone of reasonableness. However, they contended that FERC lacked the section 206 authority to reduce an existing ROE that is within the zone of reasonableness. According to the NETOs, there is no single or pinpoint just and reasonable rate but all rates, and hence all ROEs, within the zone of reasonableness are just and reasonable. They argued that FERC has a two-fold rate revision burden in a section 206 proceeding. First, FERC must meet a burden of proof and establish that an existing ROE is unjust and unreasonable. Then, assuming the existing ROE is unjust and unreasonable, FERC may then proceed to the second step and determine a new just and reasonable ROE to replace the prior unjust and unreasonable ROE.
Since the NETOs’ pre-existing 11.14% was within the Commission-established zone of reasonableness, 7.03% on the low side and 11.74% on the high side, the NETOs maintained that their existing 11.14% ROE was just and reasonable and that FERC could not meet the initial requirement of determining that the 11.14% ROE is unjust and unreasonable. Accordingly, the NETOs argued, FERC could not reduce the 11.14% ROE to 10.57%, the ROE the FERC found to be just and reasonable, even though FERC might regard the 10.57% ROE as “more” just and reasonable than the 11.14% ROE (Opinion No. 531-B at PP 18-20, 22, 28).
In rejecting the NETO position, FERC reaffirmed its Opinion No. 531 ruling that the ROE zone of reasonableness was different than the zone of reasonableness applicable in other rate contexts. FERC acknowledged that rates computed based on different methods, e.g., an average cost rate and an incremental cost rate, could each be just and reasonable and each fall within the zone of reasonableness. FERC also acknowledged that in a section 206 proceeding it could not compel a utility to switch from one just and reasonable rate to another just and reasonable rate (P 23). However, FERC found that the ROE zone of reasonableness was different and only one step in the three-step process of determining a just and reasonable ROE. FERC explained that the three-step process required (1) identifying a proxy group of companies of comparable risk, (2) calculating a zone of reasonableness by applying DCF analysis to each comparable company, and (3) placing the ROE at the just and reasonable point within the zone of reasonableness (P 24).
According to FERC, since establishing the ROE zone of reasonableness was only one step in the ROE process, the ROE “zone of reasonableness has a particular, more technical meaning that differs from its meaning” in other rate contexts (P 24). On that basis, FERC found that the location of an existing ROE within the zone did not establish that the ROE was just and reasonable and did not prevent FERC from replacing that ROE with a new and lower ROE. FERC also rejected a corollary of the NETO position that an ROE at the bottom or the top of the ROE zone of reasonableness could be just and reasonable. Noting that the NETO zone of reasonableness was 7.3% to 11.74%, a 500 basis point difference, FERC found that not all ROEs within the zone satisfied the statutory justness and reasonableness requirement, citing its ruling in Bangor Hydro-Electric Co., 122 FERC ¶ 61,038, P 11 (2008) that “[c]certain rates though within the zone, may not be just and reasonable given the circumstances of the case.”
FERC also rejected a corollary of the NETO position that there could be one just and reasonable ROE under section 205 of the FPA and a different just and reasonable ROE under section 206. FERC stated the FPA consisted of a single statutory scheme and the justness and reasonableness benchmark was the same under both statutory provisions (PP 26-30). FERC emphasized that the FPA allowed it to utilize a single method to determine the ROE, allowed it to use the DCF method for that purpose, and that in using that method it determined that a single point within the zone of reasonableness was just and reasonable and that other points, whether above or below that point, were not just and reasonable even if they were within the zone of reasonableness (P 32). FERC also held that the same evidence that established the new ROE, 10.57% in the case of the NETOs, also establishes that the pre-existing ROE, 11.38% in the case of the NETOs, is no longer just and reasonable (P 34). Finally, FERC held that a base ROE as increased by an incentive adder was not necessarily just and reasonable. Instead, FERC explained that the base ROE is just and reasonable and the increment to the ROE merely recognizes special circumstances that justify allowing the utility an ROE in excess of the just and reasonable level (P 35).
PLACEMENT OF THE BASE ROE HALFWAY BETWEEN THE MIDPOINT AND UPPER END OF THE ZONE OF REASONABLENESS
FERC rejected rehearing objections by the complainants and certain transmission customers that it had erroneously found that the just and reasonable ROE was halfway between the midpoint, the so-called “central tendency” revealed by applying DCF analysis to comparable customers, and the upper end of the zone of reasonableness (P 29). FERC rejected arguments that financial conditions during the period relevant to its ROE determination represented a “new normal” (P 49). Instead, it reaffirmed its Opinion No. 531 findings that capital market conditions were anomalous as measured by historical experience. FERC also found that Treasury Bond yields, not economic growth as claimed by the rehearing, were an appropriate indicator of current capital market conditions.
FERC went on to find that those anomalous conditions could skew the DCF analyses and undermined its confidence that the DCF methodology was producing just and reasonable results (P 50). The Commission then verified its conclusion that these conditions could be adversely affecting the DCF analyses offered for the record by examining the results of alternative ROE calculation methods and analyzing the ROEs allowed by state commissions. FERC also relied on the results of these alternative methodologies and state commission allowed ROEs in determining that the just and reasonable ROE was halfway between the midpoint and the upper end of the zone of reasonableness (PP 49-50).
FERC’s rulings on the foregoing and other issues are now subject to judicial review in the U.S. Circuit Court of Appeals. If as is likely appeals are filed, a court decision clarifying the ROE rules might not be available for a year or longer.