After five days of cross-examining witnesses, the hearing in ISO-New England’s (ISO-NE) base return on equity (ROE) proceeding held before FERC Administrative Law Judge Michael Cianci closed May 10 (FERC Docket No. EL11-66).
“I think it’s pretty clear that [the base ROE] is going to be somewhere in the center of one of the witnesses’ studies, or maybe a combination of the witnesses’ [studies],” one source told TransmissionHub.
FERC is scheduled to render a decision on Sept. 10, after briefs and reply briefs are submitted on June 6 and June 28, respectively.
According to the hearing transcripts, Cianci’s questions were largely trained on the testimonies of FERC staff analyst Sabina Joe and the New England transmission owners’ (NETOs) witness Dr. William Avera. Cianci directed shorter lines of questioning toward Dr. J. Randall Woolridge, who testified on behalf of the complainants; Dr. John Wilson, who testified on behalf of the Eastern Massachusetts Consumer-Owned Systems; and Ellen Lapson, who testified on behalf of the NETOs.
Avera and Lapson have defended the current base ROE of 11.14%; Joe and Woolridge have individually recommended a base ROE of 8.9%; and Wilson has recommended a base ROE in the range of 8.2% to 8.7%.
Massachusetts Attorney General Martha Coakley initiated the Federal Power Act Section 206 proceeding in September 2011, asking FERC to find the current base ROE of 11.14% in ISO-NE’s transmission tariff unjust and unreasonable, given certain economic conditions, including the decline in the cost of equity.
According to the NETOs, if FERC finds ISO-New England’s base ROE in its transmission tariff to be too high at 11.14% and lowers it to a level closer to the level recommended by complainants and FERC staff, regulatory bodies and consumer advocates may agitate for lower base ROEs in other regions; confidence in the stability of FERC’s policies may shatter; and the much-needed investment in the country’s electric infrastructure may plummet.
“The problem is, if FERC moves forward doing what it looks like it’s doing, it’s going to be removing incentives to construct transmission,” a second source said.
According to Lapson’s testimony on May 7, a base ROE lower than 10.5% would be detrimental to investment.
“Below 10.5 or 10.4% would be viewed as so shocking that it would materially reduce investment and the possibility of NETOs gaining capital to allocate to new transmission projects,” Lapson testified.
Upon questioning from Cianci, Lapson seemed to concede to a range of 10% to 10.5%.
Northeast Utilities (NYSE:NU) investors, however, would consider an ROE of 10% disappointing, according to Jeff Kotkin, vice president of investor relations.
“I talk to the people who buy our stock and I think a lot of them would be disappointed if that were the case,” Kotkin said. “Our investors are extremely, extremely focused on the outcome of this case.”
Northeast Utilities has invested $4.2bn in the New England transmission system since 2001. The company’s capital expenditure program for the five-year period beginning in 2013 is $3.9bn.
“There’s a lot of money that we have invested and expect to invest in the New England transmission system, so it’s a very important case for us,” Kotkin said.
Asked what the impact would be on the company’s investment program should the base ROE get lowered, Kotkin said, “We’re anticipating that the case will come out well and the strong incentives we’ve had for the last seven or eight years will continue to exist and that that we will get a competitive return on the next $4bn that we invest.”
The base ROE of 11.14% applies to local network service. Transmission companies can apply for FERC incentive adders on top of that. Northeast Utilities’ ROEs, including adders, range from 11.64% to 13.10%, according to an investor presentation.
The NETOs have argued that the ROEs proposed by the complainants and FERC staff would put their base ROE below the ROE approved “in every state jurisdiction for the last two years for investment in distribution assets,” according to their pre-trial brief. This could result in investors favoring “state-regulated utility functions,” which would be contrary to FERC’s policy objective to encourage transmission investment and development, they said.
“I think there is an expectation in the investment community that transmission will get somewhat or slightly somewhere north of average state returns,” Avera said during his testimony on May 9.
An industry lawyer said that in addition to the immediate impact lowering the ROE might have on investment, there is a longer-term and wider-reaching concern.
“You can see the ripple effect that [lowering the ROE] would have because then what happens is the next go-round where there’s a big infrastructure need, Wall Street is going to look at this and say, ‘We remember what happened in 2013 with transmission and FERC,” the lawyer said.
He also noted that there could be implications for the Midcontinent ISO (MISO), for example, which is pursuing the multi-value project (MVP) portfolio that was designed as a package of complementary transmission lines.
“If FERC issues an order finding that the existing ROE was unjust and unreasonable and lowering it to some number, that really will set off alarm bells because you have people, for instance, in the Midwest who have committed hundreds of millions of dollars of investment because the MISO ROE is sitting there at 12.38%,” the industry lawyer said. “It would make it harder for the MISO transmission owners to argue that they should still get a higher return.”
On the other hand, none of these things may happen.
“I’m not entirely sure this New England complaint is going to have the widespread precedential effect that everybody fears it might,” an industry expert told TransmissionHub. “Anything that’s done in a trial environment like this tends to be limited to the facts.”
He did concede, however, that if the base ROE is lowered, it was highly likely that other Section 206 filings would be made.
The complainants contend that transmission, as a cost-of-service business, should reflect the current interest rate environment, whereas the NETOs are essentially making an argument for a non-cost-of-service factor that FERC should take into account, the industry lawyer said.
“I think if you set the ROE at the cost of capital, people will still build,” the first source said. “The issue in these cases is what the base ROE is; they still get adders on top of that.”
Looking for signs
As evidenced in quarterly earnings calls, companies around the country are keeping an eye on this proceeding. The industry is also looking to recent judicial decisions as potentially offering guidance, such as the D.C. Court of Appeals’ May 10 decision to remand to FERC Southern California Edison’s petition to use the midpoint instead of the median of a range of base ROEs.
In setting the base ROE for an individual utility, FERC has used the median of a range of acceptable numbers, based on a national proxy group. For RTOs, specifically for MISO and ISO-NE, the commission has used the midpoint, which is calculated by averaging the highest number with the lowest number in a zone of reasonableness based on a regional proxy group. The median is the number that falls in the middle of a range of numbers.
The NETOs want to continue to use the midpoint, but have used a national proxy group of over 40 companies to determine that a base ROE of 11.14% is just and reasonable. The complainants argue that by using such a large proxy group, the NETOs have weighted the upper end of the zone, thereby skewing the results higher.
FERC analyst Joe has argued that if a national proxy group is used to determine the zone of reasonableness, then the median of that zone should be used.
“My testimony is, if a national proxy group is selected, because it is scattershot and you get way out extremes and lows, that a median should be used,” Joe said in reply to Cianci’s questioning May 10. “The precedent is a national proxy group has only been used for single electric utilities, and when it has been used, the median has been selected.”
Joe argued that a national proxy group of the entire electric industry doesn’t target the risk level of the transmission owners in ISO-NE, as the NETOs are “much less risky” than the entirety of the electric industry.
The first source and a person briefed on the hearings said the amount of time that Cianci spent questioning Joe may indicate that the judge has tipped his hand as to whose testimony he may be considering most strongly.
But all that remains conjecture at this point.
“We don’t know how this is going to come out yet,” the industry expert said. “I think the judge has a lot of sorting out to do here.”
*Eastern Massachusetts Consumer-Owned Systems (EMCOS) submitted Wilson’s testimony after FERC in October 2012 approved its motion to intervene in the proceeding. EMCOS comprises Braintree Electric Light Department, Hingham Municipal Lighting Plant, Reading Municipal Light Department and Taunton Municipal Lighting Plant
Sections 205 and 206 of the Federal Power Act deal with electric industry rate-setting. Section 205 allows a public utility to request a rate change, and Section 206 allows a third party, such as regulatory entities or consumer groups, to request a rate change. The burden of proof that the current rates are unjust and unreasonable lies with the party requesting the change.
NETOs: Bangor Hydro-Electric; Central Maine Power; New England Power d/b/a National Grid; New Hampshire Transmission d/b/a NextEra; NSTAR Electric and Gas; Northeast Utilities Service, on behalf of its operating company affiliates: Connecticut Light and Power; Western Massachusetts Electric Company and Public Service Company of New Hampshire; United Illuminating Company; Unitil Energy Systems and Fitchburg Gas and Electric Light Company; Vermont Transco; and ISO-NE.
Complainants: Martha Coakley, Massachusetts Attorney General; Connecticut Public Utilities Regulatory Authority; Massachusetts Department of Public Utilities; New Hampshire PUC; Connecticut Office of Consumer Counsel; Maine Office of the Public Advocate; George Jepsen, Connecticut Attorney General; New Hampshire Office of the Consumer Advocate; Rhode Island Division of Public Utilities and Carriers; Vermont Department of Public Service; Massachusetts Municipal Wholesale Electric Company; Associated Industries of Massachusetts; The Energy Consortium, Power Options; and the Industrial Energy Consumer Group