On January 8, 2018, the U.S. Court of Appeals for the Ninth Circuit (“Ninth Circuit”) ruled that FERC acted arbitrarily and capriciously in approving a 50 basis-point incentive adder to Pacific Gas & Electric Company’s (“PG&E”) return on equity (“ROE”) for its participation in the California Independent System Operator Corporation (“CAISO”).  In particular, the Ninth Circuit held that FERC did not follow its precedent by approving PG&E’s incentive adder while dismissing arguments that PG&E’s ongoing membership in CAISO was required by a California Public Utilities Commission (“CPUC”) order and thus was not voluntary.

In 2006, FERC issued Order No. 679, which approved an incentive adder of 50 basis-points to a transmission owner’s ROE for joining or continuing to participate in a regional transmission organization/independent system operator (“RTO/ISO”).  In creating this incentive adder, FERC reasoned that inducing transmission owners to become members in RTOs/ISOs would benefit consumers by ensuring reliability and reducing costs of delivered power and that “continuing membership is generally voluntary.”

Each year since FERC issued Order No. 679, PG&E requested, in its annual filings to update its transmission revenue requirement, approval of the incentive adder due to its ongoing membership in CAISO.  After PG&E requested the incentive adder in 2014 and 2015, CPUC protested the inclusion of the adder, arguing that PG&E’s ongoing membership in CAISO is not voluntary, but rather is mandated by state law.  Specifically, CPUC argued that, when it approved PG&E’s transfer of its transmission facilities to CAISO in 1997, it required PG&E to seek its approval prior to any further transfers of control.  As a result, CPUC argued that FERC should not reward PG&E with incentive adders for membership that is legally mandated and that approving PG&E’s request for the incentive adder would result in a “generic adder” in contravention of Order No. 679.  FERC rejected CPUC’s arguments, ruling that transmission owners with ongoing membership in an RTO/ISO are “presumed eligible” for the incentive adder.  After FERC denied CPUC’s rehearing request, CPUC petitioned the Ninth Circuit for review.

In its opinion, the Ninth Circuit held that Order No. 679 committed FERC to a case-by-case review of incentive adders and required FERC to approve an incentive adder “when justified,” and that a transmission owner’s membership in an RTO/ISO by itself is not dispositive.  Because FERC did not perform a case-by-case analysis but instead summarily approved PG&E’s incentive adder, the Ninth Circuit held that FERC had created a “generic adder” in violation of Order No. 679.  The Ninth Circuit also reasoned that when membership in an RTO/ISO is required, the incentive adder presumably is not justified because an incentive cannot induce behavior that is legally mandated.  Although FERC and PG&E argued that CPUC’s requirement that PG&E obtain its authorization prior to any decision to leave CAISO does not demonstrate that PG&E’s membership in CAISO is legally mandated, the Ninth Circuit noted that it could not uphold FERC’s decision on this ground because it was not used by FERC as grounds for approving PG&E’s incentive adder.  In conclusion, the Ninth Circuit held that FERC’s approval of PG&E’s incentive adder was arbitrary and capricious.

A copy of the opinion is available here.