On April 14, 2017, the United States Court of Appeals for the District of Columbia Circuit (“DC Circuit”) held that FERC erred in setting the base return on equity (“ROE”) for ISO New England Inc. (“ISO-NE”) at 10.57 percent. The DC Circuit granted a petition filed by a group of New England transmission owners (“NETOs”), and a separate petition filed by a group of wholesale transmission customers and other consumer-side stakeholders (collectively, “Customers”) located in the New England region. The DC Circuit vacated the underlying FERC order and remanded the case to FERC for further consideration.
This case stemmed from a 2011 complaint filed by the Customers under Section 206 of the Federal Power Act (“FPA”). The Customers alleged in the complaint that ISO-NE transmission owners’ base ROE of 11.14 percent, which had been initially established in 2006, had become unjust and unreasonable due to changes in the capital markets. The complaint was adjudicated before a FERC administrative law judge (“ALJ”), who concluded that the 11.14 percent base ROE was unjust and unreasonable. The ALJ further determined that an appropriate ROE zone of reasonableness was 6.1 percent to 13.2 percent, and established a new base ROE at the midpoint of the zone at 9.7 percent.
On review of the ALJ’s decision, FERC calculated a different zone of reasonableness of 7.03 percent to 11.74 percent. Though the midpoint of FERC’s zone of reasonableness was 9.39 percent, FERC opted to set the Base ROE at the midpoint of the upper half of the zone of reasonableness, or 10.57 percent. FERC reasoned that “anomalous capital market conditions” warranted setting the ROE above the midpoint. Additionally, FERC explained that because it had reduced the upper end of the zone of reasonableness from its 2006 level of 13.1 percent to 11.74 percent, the NETOs would have to cap incentive adders such that Base ROE plus incentives would not exceed the top end of the zone of reasonableness. Both the NETOs and the Customers petitioned the DC Circuit for review of FERC’s order setting the ROE at 10.57 percent.
The NETOs raised two distinct arguments on appeal. First, the NETOs argued that FERC failed to satisfy its burden under Section 206 of the FPA of demonstrating that the existing 11.14 percent base ROE, which was within FERC’s newly determined zone of reasonableness, was unjust and unreasonable. Second, the NETOs argued that the treatment of ROE incentive adders was beyond the scope of issues set for adjudication in the complaint proceeding, thus FERC violated the Due Process Clause and the Administrative Procedure Act in finding that such ROE incentive adders must be capped.
The DC Circuit agreed with the NETOs that FERC had failed to show that the existing base ROE of 11.14 percent was unjust and unreasonable. The DC Circuit rejected FERC’s argument that showing a base ROE of 10.57 percent was just and reasonable necessarily demonstrated that the existing higher base ROE was unjust and unreasonable. The DC Circuit noted that FERC “made no effort” to explain why the existing base ROE was unjust and unreasonable, and held that FERC had no authority under Section 206 of the FPA to change the base ROE without the requisite finding that the existing base ROE was unjust and unreasonable. In light of its finding on FERC’s base ROE, the DC Circuit did not reach the NETOs’ argument about incentive adders.
The Customers’ petition raised the single contention that FERC acted arbitrarily and capriciously in setting the base ROE at 10.57 percent – the midpoint of the upper half of the zone of reasonableness – rather than the 9.39 percent midpoint of the zone of reasonableness.
The DC Circuit agreed with the Customers. Specifically, the DC Circuit found that FERC failed to establish a “rational connection” between the record evidence and FERC’s decision to set the ROE at 10.57 percent. The DC Circuit noted that FERC’s mere finding that anomalous capital market conditions justify a base ROE above 9.39 percent does not alone constitute a reasoned basis for setting the base ROE at 10.57 percent. The DC Circuit noted further that none of the benchmarks or measures of central tendency on which FERC relied justified a specific base ROE of 10.57 percent.
The DC Circuit opinion is available here.