On August 26, 2013, Southern California Edison Company (SCE) submitted an Offer of Settlement in its long pending Federal Energy Regulatory Commission (FERC or “Commission”) rate case.1 The settlement provides for a base return on equity (ROE) of 9.3 percent, plus an adder for independent system operator participation of 0.5 percent, plus project rate incentive adders as approved by the Commission. Interestingly, the settlement precludes, with certain exceptions, new SCE petitions requesting transmission rate incentives or Commission grants of policy-based incentive rate treatment pursuant to its general discretionary authority prior to January 1, 2018. The limitation on filing new incentive requests for ROE project adders applies only until July 1, 2015.2
Presiding Administrative Law Judge Michael J. Cianci Jr. recently found in his initial decision in Coakley v. Bangor Hydro-Electric Co.,3 the New England Transmission Owners’ (NETOs) current base ROE of 11.14 percent unjust and unreasonable. Relying on the FERC’s traditional discounted cash flow (DCF) analysis prepared on behalf of the NETOs, Judge Cianci found that the just and reasonable prospective base ROE is 9.7 percent. Judge Cianci left modifications to the DCF analysis, adoption of alternative financial models and adjustments to the ROE for policy reasons to the Commission.
The NETOs contended “that the traditional DCF methodology has understated the NETOs [sic] true cost of equity in these unusual financial and economic times, arguing that alternate methods should be considered by the Commission.”4 They asserted that the Commission’s traditional DCF analysis will understate the NETOs’ cost of equity due to the prevailing unusual economic conditions caused, in particular, by the actions taken by the Federal Reserve Board of Governors to set and maintain historically low interest rates.5 They argued for adjustments to the ROE as determined in accordance with the Commission’s DCF precedent and ratemaking principles.
Judge Cianci found the testimony of the NETOs’ experts to the effect that “if ROE is set substantially below 10 percent for long periods . . . , it could negatively impact future investment in the NETOs . . . to have moderate probative value.”6 He concluded that, “[i]f transmission investment is substantially limited in the future, it will have a negative impact upon operational needs, reliability, and ultimately ratepayers’ future costs.”7
When the Commission set the NETOs’ current base ROE of 11.14 percent, it included an upward adjustment in the base ROE to account for changes in capital market conditions—specifically, the monthly yields on ten-year constant maturity U.S. Treasury Bonds—between the date of the issuance of the initial decision in that case and the date of the Commission’s order.8 The current rate for those U.S. Treasury Bonds is up from that used in the NETOs’ DCF analysis in support of the prospective ROE. By the time the Commission issues its order in that proceeding, the base ROE may be in the mid-10 percent range or even higher.
ROE is set differently for individual transmission owners such as SCE (e.g., at the median of the range of reasonableness) than for groups of transmission owners such as the NETOs (e.g., at the mid-point). Nevertheless, SCE apparently felt that a base ROE of 9.3 percent reflected its current cost of equity and was sufficient to assure future investment in SCE. It is in these circumstances that the Commission will have to decide whether ROEs set using its traditional DCF analysis, as adjusted, are at levels sufficient to attract the capital necessary to assure future electric utility company investment.
1 Southern Cal. Edison Co., Southern California Edison Company’s Explanatory Statement and Offer of Settlement, filed Aug. 26, 2013, Docket No. ER11-3697-005 (“Offer of Settlement”).
2 Offer of Settlement § 3.6.
3 144 FERC ¶ 63,012 (2013) (“Initial Decision”).
4 Id. at P 549.
5 Id. at P 550.
6 Initial Decision at P 576.
8 Bangor Hydro-Elec. Co., Opinion No. 489, 117 FERC ¶ 61,129 at P 81 (2006), order on reh’g, 122 FERC ¶ 61,265, order granting clarification, 124 FERC ¶ 61,136 (2008).