Edison Electric Institute requests rehearing on FERC’s return on equity opinion
Investment in multibillion-dollar, long-lived transmission assets requires regulatory certainty and a base return on equity (ROE) that reflects both the competition for investor capital and the risk associated with building and operating such assets, says the Edison Electric Institute (EEI) in a recent request for a rehearing of the Federal Energy Regulatory Commission’s (FERC) Opinion No. 569.
A utility’s ROE is defined as net income divided by the average shareholder’s equity. EEI, which represents all of the nation’s investor-owned electric companies, says its members need to increase profits so they can continue to attract capital needed for future infrastructure upgrades that meet customer demands.
But FERC’s Nov. 21, 2019 opinion, which established a new methodology for setting the ROE that electric utilities are entitled to earn on electric transmission investments, isn’t the best way to help EEI members do that, the association says in its 252-page filing.
Specifically, FERC’s new methodology determines whether an existing ROE has become unjust and unreasonable under existing law and establishes “a just and reasonable” ROE for public utilities by relying on two cost-of-equity models rather than FERC’s previously proposed four: the discounted cash flow (DCF) model and the Capital Assets Pricing Model (CAPM).
But EEI has “substantive issues” with this methodology and argues that it results “in rates that are unjust and unreasonable.”
“The Commission’s decision to significantly alter its proposed methodology for determining base ROE, without providing notice or opportunity for comment, creates regulatory uncertainty and has resulted in a base ROE and a base ROE methodology that will hamper electric utilities as they seek financing for these projects going forward,” according to EEI’s Dec. 23, 2019 filing.
EEI thinks that for ongoing transmission investments to occur, FERC should adopt a methodology that provides regulatory certainty regardless of market conditions for these assets, according to its filing.
In a nutshell, EEI wants FERC to not only use the DCF model and CAPM, but also the Expected Earnings and Risk Premium models.
“The use of a wider range of models is necessary to address the limitations of the particular models and their underlying assumptions,” according to EEI’s filing.
FERC, meanwhile, said it has found that the DCF model and CAPM method are most commonly used by investors to estimate the cost of equity, while the other two models are too complex and contain potential inaccuracies, according to its Opinion No. 569.
Therefore, FERC says that its DCF and CAPM analyses each will produce an ROE zone of reasonableness, which then will be weighted equally and averaged to create a composite zone of reasonableness. If FERC finds that an existing ROE has become unjust and unreasonable, the commission then will set a utility’s new ROE at one of several points within this zone of reasonableness.
But according to EEI, “reducing the number of the models used to create the composite zone of reasonableness substantially modifies and restricts the proposed ROE methodology.”
And changing the methodology for establishing base ROE “has industry-wide implications,” notes EEI.
For instance, continued investment in electric transmission — which EEI calls “the backbone of the Bulk Electric System” — is essential to meeting customer energy needs and to delivering an energy future that electricity customers want and expect.
This can only be achieved, EEI says in its filing, with:
– A sufficient transmission investment to address changing consumer needs;
– An evolving fuel mix for electric generation that is increasingly comprised of renewable and clean energy resources that need to be transported from remote locations to market centers;
– The potential for increased demand due to increased penetration of electric vehicles; and
– The need to integrate and accommodate new technologies.
“These goals are also consistent with stated Commission priorities, which include integration of storage as well as ensuring resilience and reliability of the electric system,” according to EEI’s filing.
But FERC’s actions thus far “are contrary to meeting these goals,” EEI says.
Additionally, EEI says that FERC’s opinion doesn’t provide regulatory certainty and “sends mixed signals to investors and transmission owners about the Commission’s commitment to ensuring that needed transmission is built.”
“Due to the important role of transmission in meeting future energy goals and promoting resilience and reliability, EEI seeks to intervene-out-of-time and seeks rehearing of Opinion No. 569,” which the association says also “fails to substantively address the comments and expert testimony on investor considerations” in an ongoing and related March 2019 notice of inquiry (NOI) that FERC issued to examine whether and how to revise its policies for determining ROE.
FERC’s issuance of Opinion No. 569 followed the submission of comments for that NOI and indicates that the commission continues its quest to revisit ROE policy for public utilities.
Likewise, EEI also plans to continue to “ensure that the industry as a whole has an opportunity to comment on the new methodology and address substantive issues with the new methodology that result in rates that are unjust and unreasonable.”
