On May 21, 2020, in Opinion No. 569-A, the Federal Energy Regulatory Commission (FERC or the Commission) substantially revised its methodology for establishing the base return on equity (ROE) for public utility rates under section 206 of the Federal Power Act (FPA). The immediate result of this decision was a 14-basis point increase in the ROE for Midcontinent Independent System Operator, Inc. (MISO) transmission owners. Opinion No. 569-A also adopts a new framework that FERC will utilize to assess and establish the base ROE for other FERC-jurisdictional transmission owners.
In Opinion No. 569, the order which Opinion No. 569-A revises on rehearing, FERC established a base ROE of 9.88% for the transmission-owning members of MISO. Opinion No. 569 was noteworthy for several reasons, including: (1) FERC’s adoption of a new methodology to determine whether a base ROE is unjust and unreasonable; (2) the adoption of that same methodology to establish the new base ROE; and (3) the resultant reduction in the base ROE of 250 basis points for the transmission-owning members of MISO.
Prior to Opinion No. 569, FERC had proposed to rely on three financial models—a discounted cash flow model (DCF), a capital asset pricing model (CAPM), and expected earnings model—to establish a composite zone of reasonableness to evaluate whether an existing ROE remained just and reasonable. If a rate was determined to be unjust and unreasonable, FERC proposed to employ four financial models, the three listed above plus a Risk Premium Model (RPM), to determine a new just and reasonable rate. In Opinion No. 569, however, FERC changed course and determined that it would rely only on the DCF and CAPM models to both assess whether an existing rate is unjust and unreasonable and to determine a new just and reasonable rate.
Applying this new framework, FERC determined that the base ROE of transmission-owning members of MISO was unjust and unreasonable. As required by section 206 of the FPA, FERC then established a new base ROE of 9.88% for the transmission-owning members of MISO using the central tendency of the overall zone of reasonableness established by the DCF and CAPM methodologies.
FERC’s Revised Methodology
Opinion No. 569-A revises the methodology established in Opinion No. 569. Applying the new methodology, FERC found that the MISO transmission owners’ base ROE should be set at 10.02%, a 14-basis point increase over the Opinion No. 569 base ROE. Most notably, under the new framework established by Opinion No. 569-A, FERC will use the RPM, DCF, and CAPM methodologies under both prongs of the FPA section 206 analysis to assess and establish base ROE.
In addition, FERC’s order addressed and modified a number of inputs into its ROE analysis, namely by:
- Giving the short-term growth rate 80% weighting and the long-term growth rate 20% weighting in FERC’s two-step DCF model, an increase from the prior roughly 66.67%/33.33% allocation;
- Clarifying that FERC will consider the use of Value Line growth rates in future proceedings’ CAPM analyses, rather than only relying upon Institutional Brokers’ Estimate System growth rates;
- Increasing the high-end outlier test from 150% to 200% of the median result of all of the potential proxy group members in that model, subject to a natural break analysis; and
- Calculating the ranges of presumptively just and reasonable base ROEs by dividing the overall composite zone of reasonableness into equal thirds, instead of using the quartile approach applied in Opinion No. 569.
During FERC’s open meeting on May 21, 2020, Chairman Neil Chatterjee explained that the new order “improves upon Opinion 569 by promoting model diversity and making practical adjustments to the models to ensure they better reflect investor expectations while remaining legally durable.”
Commissioner Richard Glick issued a separate statement dissenting in part and concurring in part. Commissioner Glick explained that “even if the end result is an appropriate number” for the MISO transmission owners’ ROE, he did not believe that the “order adequately justifie[d] several of the changes it adopt[ed].” Commissioner Glick also took issue with the Commission’s refusal to order refunds for the fifteen-month refund period established by the complainants’ second complaint against the MISO transmission owners.
Parties to the initial and subsequent complaints against the MISO transmission owners are expected to challenge Opinion No. 569-A. Among other things, the complainants are likely to echo Commissioner Glick’s claims that the Commission failed to adequately justify its decision to embrace the use of the RPM to determine base ROE when it rejected that methodology six months ago in Opinion No. 569. Additionally, the complainants are likely to challenge the Commission’s determination that refunds should not be awarded for the refund period established by the complainants’ second complaint against the MISO transmission owners.
Baker Botts will continue to provide updates on the Commission’s ROE polices as developments warrant.
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