Electricity Markets

No need for FERC to alter approach to setting ROEs, coalition says

Rebutting assertions made in a whitepaper published by the Edison Electric Institute, a coalition of entities representing consumer interests argues that there is no need to alter the Federal Energy Regulatory Commission’s approach to setting the return on equity component of electric transmission rates through the use of a two-step discounted cash flow, or DCF, method.

The EEI white paper offers no solid evidence to support its assertion that the Commission’s two-step DCF method is producing ROE results that are insufficient to attract capital investment in transmission infrastructure, the coalition says in its June 2018 response. Moreover, proposed changes outlined in the EEI paper would lower regulatory certainty and increase subjectivity in the ratemaking process, the coalition argues.

In late 2017, EEI published a whitepaper urging FERC to reassess whether its use of the two-step DCF method to set the ROE component of electric transmission rates is producing adequate equity returns. The whitepaper recommended a number of “solutions” aimed at “existing shortcomings in the current method of employing the two-step DCF approach.”

The coalition joining the June 2018 response to the EEI whitepaper included the American Public Power Association, the Coalition of MISO Transmission Customers; the National Association of State Utility Consumer Advocates; the National Rural Electric Cooperative Association; the Organization of MISO States, Inc.; the PJM Industrial Customer Coalition; and Transmission Access Policy Study Group.

EEI is a trade association that represents investor-owned utilities.

Capital investment in electric transmission assets is robust

The coalition disputed the EEI whitepaper’s premise that FERC’s standard two-step DCF model as applied to electric utilities may not be “leading to outcomes necessary to meet capital attraction standards and policy goals at a time when the transmission system requires expansion and enhancement.”

The EEI whitepaper, the coalition argues, cites no evidence that base ROEs established using the two-step DCF model are insufficient to attract capital investment in transmission infrastructure.  “This omission is unsurprising, as there is abundant evidence — including EEI’s own analyses — that public utilities are investing in transmission assets at a record pace.”

FERC refers to electric utilities it regulates as “public” utilities; however, these are not municipal utilities, but rather investor-owned utilities.

The coalition pointed out that as of September 2017, EEI projected that investor-owned utilities and stand-alone transmission companies would invest a record $23.9 billion in transmission assets in 2018. This figure is approximately 15% more than the 2016 transmission investment ($20.8 billion), and nearly double the level of investment just seven years ago ($12.0 billion).

While EEI expects transmission investment to moderate somewhat in 2019 and 2020, “concern about FERC-authorized ROEs is not among the factors cited for the moderation in projected investment,” the coalition went on to say.

Moreover, the industry’s credit rating has improved over the last eight years, which is noted by EEI in tracking credit ratings for the utility industry.

“The fact that credit ratings have improved in the face of large capital investments shows the market’s acceptance of utility-issued securities as low risk and stable, and does not suggest a need for changing the DCF method so that it would produce higher ROEs,” the coalition said.

DCF model is fundamentally sound

The group went on to argue that contrary to the whitepaper’s assertion, the DCF model is fundamentally sound.

Indeed, the EEI whitepaper acknowledged that the DCF model “is theoretically sound,” which the coalition said will not be news to the Commission, given that FERC has used some form of DCF model to set public utility and natural gas pipeline ROEs for decades. 

The Commission adopted the two-step DCF model for natural gas pipelines in 1994. In 2014, the Commission issued Opinion No. 531, in which it extended the method to electricity transmission rates for public utilities regulated under the Federal Power Act. 

When it adopted the two-step methodology for determining the rate of return on equity for Commission-jurisdictional electric utilities, FERC applied the methodology in a pending complaint case involving New England transmission owners.

While the coalition acknowledged that the DCF model relies on certain underlying assumptions, it pointed out that this is true of all methods for inferring the cost of equity.  The EEI whitepaper offers no basis for concluding that the assumptions underlying the Commission’s preferred DCF model “are any more problematic than those that underlie any alternative approach.”

Whitepaper proposals would decrease regulatory certainty

While the EEI whitepaper cites the need for “regulatory certainty” as a key consideration in establishing ROEs that will encourage investment, the coalition said that FERC’s two-step DCF model offers the stability and certainty that the market requires. But it “does not, and should not, guarantee any particular return.”

The EEI whitepaper “itself repeatedly contradicts its own appeal for ‘regulatory certainty,’ by proposing new and controversial changes to the Commission’s DCF model that would increase subjectivity in ratemaking. This subjectivity would be a recipe for lengthier, more complex and more fractious litigation in individual ROE cases, including appeals where outcomes based on subjective factors could be found arbitrary and capricious if applied inconsistently and without reasonable guidance or criteria.”

The impact on ratepayers

While the EEI whitepaper argues for higher returns for investors to promote new transmission investment, it suggests that the impact on customers would be insignificant because transmission currently represents only 11% of an electric customer’s bill, the coalition noted.

“In fact, the Energy Information Administration’s (EIA) 2018 Annual Energy Outlook puts that number at 12.5% for 2017 and projects that through 2050 the transmission component will increase by 24% and the distribution component by 25%, while the generation component will decrease by 10%.”

According to the coalition, information on transmission costs in regional transmission organizations and independent system operators shows that wholesale transmission costs are increasing, and that they account for a significant portion of the overall bill.  For some wholesale customers, transmission costs already approach 45% of their total electric costs, the coalition pointed out.

In addition, the percentage of transmission costs in customers’ bills as compared with other costs “says nothing about the rate impact on wholesale or retail rates of the significant changes to the DCF methodology sought by EEI.”

Flawed comparisons and an unjustified “wish list”

The EEI whitepaper, the coalition observed, argued that the ROE results produced by FERC’s two-step DCF methodology for electric transmission are too low when compared to the results produced by other methodologies and other market indicators.

But the group maintains that none of the alternative methods or other market indicators cited by the EEI whitepaper provides a reasonable or reliable basis to question the validity of the Commission’s two-step DCF model or to make significant changes to the model.

The EEI white paper simply offers an unjustified “wish list” of changes to the Commission’s DCF method geared toward increasing the ROE results, the coalition said.

Among other criticisms, the coalition said that the whitepaper’s comparison of DCF results to state-level ROEs authorized during July-December of 2016 is fundamentally flawed.

Although the EEI whitepaper implies that it is comparing FERC DCF results for transmission assets to state-allowed ROEs on distribution assets, the state ROEs depicted in related charts are all state electric ROEs, the coalition said. “These state-authorized ROEs may reflect any number of factors, which make the whitepaper’s simplistic comparison highly misleading.”

Because the EEI whitepaper fails to demonstrate any problem with FERC’s DCF model that requires a remedy, the coalition concludes, there is “no valid basis for FERC to entertain the result-driven and unreasonable ‘fixes’ that the whitepaper proposes.”