On May 21, 2020, FERC issued Opinion No. 569-A, which revised the Commission’s methodology for determining whether an established rate of return on equity (“ROE”) is just and reasonable under section 206 of the Federal Power Act (“FPA”). Among other things, Opinion No. 569-A accepts the use of a third financial model for establishing just and reasonable ROE for Transmission Owners (“TOs”)—the “Risk Premium Model” (which was rejected in an earlier opinion)—in addition to the previously accepted two-step discount cash flow (“DCF”) model and capital asset pricing model (“CAPM”). Commissioner Richard Glick dissented in part, arguing that FERC was “once again changing course and revamping [its] ROE methodology” to the detriment of regulatory certainty among TOs and investors. In a related action, FERC contemporaneously issued a Policy Statement clarifying that the newly revised ROE methodology in Opinion No. 569-A applies to natural gas and oil pipelines, with certain exceptions.
Opinion No. 569-A is the most recent action in a series of FERC proceedings related to Commission-allowed TO ROE analysis and methodology. Between 2011 and 2015, various customer groups filed complaints alleging that the base ROE available to TOs in ISO New England, Inc. (“ISO-NE”) and Midcontinent Independent System Operator (“MISO”) was unjust and unreasonable. In Opinion No. 531, FERC upheld an elevated ROE for ISO-NE TOs based on a variety of financial models—a methodology that was later applied to two complaint proceedings challenging the base ROEs of MISO TOs, and then ultimately vacated by the D.C. Circuit Court of Appeals in the ISO-NE proceeding.
In an October 16, 2018 order on remand from the D.C. Circuit, FERC outlined a new method to determine whether a utility’s ROE remains just and reasonable under FPA section 206 (“Coakley Briefing Order”). Among other things, FERC proposed in the Coakley Briefing Order to rely on four financial analyses for evaluating the just and reasonableness of ROE: the DCF, the CAPM, the earnings analysis (“Expected Earnings”), and the risk premium analysis (“Risk Premium”) (see October 25, 2018 edition of the WER). Shortly thereafter, FERC proposed to follow that same approach in the two MISO TO complaint proceedings, and directed briefing on how the proposed changes in the Coakley Briefing Order should apply (see November 20, 2018 edition of the WER).
On November 21, 2019, in Opinion No. 569, FERC adopted a revised version of the base ROE methodology proposed in the Coakley Briefing Order (see November 26, 2019 edition of the WER). Notably, in that revised methodology, FERC rejected the use of the Expected Earnings and Risk Premium models, finding that they were either not appropriate or largely redundant of other analyses. Rather, in calculating the zone of reasonableness for an ROE, FERC decided to equally weigh the DCF and CAPM financial models. If such ROE was found to be outside of the zone of reasonableness and was therefore unjust and unreasonable, FERC would then calculate a new base ROE by using the same models. Additionally, FERC adopted both high-end and low-end outlier tests that would eliminate outlier results from the DCF and CAPM proxy calculations. FERC then applied the newly-revised methodology to the facts of the two MISO TO complaints, finding in the first complaint proceeding that the existing 12.38 percent MISO TO ROE should be readjusted to 9.88 percent and ordering refunds accordingly. FERC dismissed the second complaint, concluding that the established ROE was not unjust and unreasonable. Various parties sought rehearing.
In FERC’s latest action, Opinion No. 569-A, FERC partially granted rehearing and clarification on aspects of its decision in Opinion No. 569. Among the Commission’s decisions, first, FERC again revised its ROE methodology, finding that the Risk Premium model should be used alongside the DCF and CAPM models and stating that any defects within the Risk Premium model were outweighed by the benefits of model diversity and reduced volatility. Second, FERC updated the DCF model’s methodology, finding that there should be short-term growth rate 80 percent weighting and the long-term growth rate 20 percent weighting. Third, in its review of the CAPM model, FERC clarified that it will consider the usage of Value Line short-term growth rates in future proceedings in addition to Institutional Brokers’ Estimate System growth rates. Fourth, FERC reviewed both the high-end and low-end outlier tests, and although it denied the requests for rehearing on the low-end outlier test, the Commission increased the high-end outlier test from 150% to 200% of the median result of the proxy group members in the applicable model. Fifth, FERC found that the zone of reasonableness calculated through the models of the methodology should be divided into three equal zones, as opposed to the quartile approach in Opinion No. 569, when determining whether an ROE is presumptively just and reasonable.
Finally, FERC applied its revised base ROE methodology to the facts of the complaint proceedings, revising the ROE in the first complaint proceeding from 9.88 percent to 10.02 percent and requiring refunds accordingly. FERC denied rehearing of its dismissal of the second complaint, finding, after the application of the new methodology, that the rate of 10.02 percent, as now established in the first complaint proceeding, was not shown to be unjust and unreasonable.
Commissioner Glick dissented in part to Opinion No. 569-A, disagreeing first with the majority’s “fiddling” with the ROE methodology. Commissioner Glick pointed to the fact that FERC, when crafting a new methodology, first considered using four financial models, then two models, and now has established three. He argued that the latest changes were not enacted due to a “dispassionate assessment of various technical questions” but rather were due to the majority’s subjective opinion that the results provided by the previous methodology would result in low ROEs. Second, Commissioner Glick reiterated his dissent in Opinion No. 569, stating that FERC should have ordered refunds of the unjust and unreasonable rates collected during the refund period related to the second complaint proceeding.
A copy of Opinion No. 569-A is available here.
On the same day that FERC provided the above Opinion No. 569-A, FERC also issued a Policy Statement clarifying that, subject to certain exceptions, the new ROE methodology adopted in Opinion Nos. 569 and 569-A will also be applied to natural gas and oil pipelines. Among the exceptions, the Policy Statement noted that the Risk Premium model will not be used, and that FERC will average the results of the DCF and CAPM analyses, giving equal weight to both models. The Policy Statement also clarified FERC’s policies governing the formation of proxy groups and the treatment of outliers in natural gas and oil pipeline proceedings.
A copy of the policy statement is available here.