D.C. Court of Appeals’ ruling reinforces FERC’s use of median in setting base ROE

The D.C. Circuit Court of Appeals on May 10 remanded to FERC Southern California Edison‘s (SCE) petition against the commission for its use of the median instead of the midpoint in determining the company’s base return on equity (ROE).

“SoCal Edison’s challenge to the commission’s use of the median, instead of the midpoint, to measure the base ROE of a single electric utility of average risk includes a statutory argument that effectively devolves into an argument that the commission’s use of the median was arbitrary and capricious,” according to the court opinion. “However viewed, SoCal Edison’s contentions face an uphill battle. As the Supreme Court has observed, ‘[t]he statutory requirement that rates be “just and reasonable” is obviously incapable of precise judicial definition, and we afford great deference to the commission in its rate decisions.'”

A proceeding is currently underway at FERC regarding the justness and reasonableness of ISO-New England’s base ROE. 

Under the Natural Gas Act, FERC has used the median to set ROEs. In 1998, FERC found that for a company of average risk, the ROE should be set at the median “because doing so ‘giv[es] consideration to more of the companies in the proxy group, rather than only those at the top and the bottom,’ and ‘will lessen the impact of any single proxy company whose ROE is atypically high or low,” according to the opinion.

FERC at the time said the median had important advantages over using the mean and midpoint, saying the median best represents central tendency in a skewed distribution, is less affected by extreme numbers than the midpoint, and aids in the commission’s efforts to treat all companies of average risk equally.

FERC had not followed the same approach with respect to electric utilities, however. Until 2008, the commission had used the midpoint to establish ROEs for electric utilities. SCE argued the commission’s decision in 2008 to use the median in a certain case (Golden Spread Electric Coop) was arbitrary and capricious.

“The record shows that the commission has not ‘glosse[d] over or swerve[d] from prior precedents without discussion [so as to] cross the line from tolerably terse to intolerably mute,'” according to the order. “[T]he commission did not hold SoCal Edison to a higher standard than the FPA [Federal Power Act] requires,” according to the order. “Rather, the commission concluded that the median methodology was preferable and it may, consistent with the FPA, reject a utility’s proposed methodology without assessing the justness or reasonableness of that methodology.”

FERC in November 2007 approved incentive rate treatment for SCE’s construction of three transmission projects, including rate adders of 0.75% for the Rancho Vista Project, 1.25% for the Devers-Palo Verde II (DPV2) and Tehachapi Projects; 0.50% across the board for joining the Cal-ISO; and 100% recovery for construction work in progress (CWIP).

In December 2007, SCE filed revisions to its transmission tariff, proposing a base ROE of 11.5% by reference to the midpoint (12.07%) of its proxy group.

“It calculated total ROEs, including incentives, that ranged from 12.75% to 13.25%: 12.75% for the Rancho Vista Project and 13.25% for both the DPV2 and Tehachapi projects,” according to the opinion.

After FERC accepted SCE’s proposed tariff revisions, the California Public Utilities Commission (CPUC) and others sought rehearing, arguing, among other things, that FERC should use the median, not the midpoint, of the zone of reasonableness in determining the ROE.

“SoCal Edison, offering expert testimony of Dr. Paul T. Hunt, argued that the midpoint emphasizes the range of the proxy group returns, the median causes distortions because it disregards that range, and the median produces lower ROEs thereby undermining the goal of congress and the commission of expanding the transmission grid,” according to the court opinion.

FERC, however, was not convinced. It found the zone of reasonableness to be between 7.80% and 16.19% and set SCE’s base ROE at the median of that zone, 10.55%.

“The commission rejected SoCal Edison’s midpoint-based ROE upon concluding that for a single electric utility of average risk ‘the best measure of central tendency is the median,’ … and stating that it was ‘not persuaded that our established procedures for determining a[n] ROE for a utility of average risk are not just and reasonable for setting SoCal Edison’s ROE,'” according to the opinion.

SCE’s challenge to FERC’s use of the median for an individual electric utility of average risk was the first to be brought before the court.

SCE is a subsidiary of Edison International (NYSE:EIX).

About Rosy Lum 525 Articles
Rosy Lum, Analyst for TransmissionHub, has been covering the U.S. energy industry since 2007. She began her career in energy journalism at SNL Financial, for which she established a New York news desk. She covered topics ranging from energy finance and renewable policies and incentives, to master limited partnerships and ETFs. Thereafter, she honed her energy and utility focus at the Financial Times' dealReporter, where she covered and broke oil and gas and utility mergers and acquisitions.