Lowering the base return on equity (ROE) in ISO New England (ISO-NE) would be tantamount to returning the transmission industry to pre-2005 conditions, when rates of return were too low to encourage investment, the New England transmission owners (NETOs) argued in their pretrial brief filed April 30.
FERC has set for hearing a proceeding in which complainants have requested the ISO-NE base ROE be lowered from its current rate of 11.14% (FERC Docket No. EL11-66). FERC trial staff and complainants have requested a base ROE of 8.93% and 8.9%, respectively.
The NETOs’ pretrial brief focused on FERC’s agenda to encourage the development of electric transmission, the historical underinvestment in transmission, which Congress directed FERC to redress in the Federal Power Act of 2005, and the resultant transmission incentives, which the NETOs argued have been successful in encouraging transmission construction.
“The NETOs are in the middle of a $10bn transmission construction program, which is already saving consumers over $700m per year,” according to the pretrial brief. “Coming in the middle of the current transmission build-out, this change in policy would demonstrate the commission’s inconstancy in following through on previous policies and engender a lack of trust in this and other commission initiatives.”
The NETOs also argued that the requested lower base ROEs would be lower than “every other” state-approved ROE in the nation for the past two years, and 400 basis points below the average 2012 ROE for natural gas pipelines.
“The commission’s stated policy is to stimulate investment in the nation’s electric transmission system in order to make up for decades of under-investment in the transmission grid and because uses of the system are rapidly changing,” the NETOs said. “A key concern of both the commission and Congress has been making the necessary changes to the grid to enhance reliability to support a growing economy and protect national security.”
FERC trial staff prehearing brief
“There is substantial evidence in the record showing that the existing rate of return on equity, under current market conditions, is unjust and unreasonable,” according to the prehearing brief of FERC trial staff filed April 29.
The 11.14% base ROE was established using 2004 market data updated on the basis of bond yields in 2006.
“Since the existing 11.14% base ROE was established, the economic climate has been marked by falling interest rates,” according to the brief. “”[T]hese interest rate indications of a downward shift in equity returns required by investors are real. Therefore, the existing base ROE is unjust and unreasonable and must be replaced by a just and reasonable ROE.”
In their use of a national proxy group, the NETOs have failed to meet two of the three sources of standards for setting a return on equity, the Hope and Bluefield Supreme Court cases, according to the FERC trial staff brief. The third standard is the Federal Power Act.
Using a national proxy group yields a credit rating range of five notches, compared to the three notches that the ISO-NE transmission owner group spans.
“This leads to the incorrect inference that all members of the entire electric industry are all very ‘comparable’ to each other and that the proportion of risk in the entire electric industry mirrors the proportion of risk qualities in the ISO [NETOs], which it does not,” according to the pretrial brief. “This patently fails the Hope and Bluefield ‘comparable risk’ standard.”
According to FERC trial staff financial analyst Sabina Joe’s analysis of the credit rating risk factors, the NETOs have a low level of risk. Joe then developed a group of comparable-risk utilities by geography, namely in the Northeast “because these had in 2005 been found by the commission to be a ‘sufficiently representative universe of companies’ for calculating the existing ISO-NE base ROE,” Joe said.
Her updated proxy group contains 11 companies.
Furthermore, Joe said the NETOs’ testimony includes financial analyses that are inappropriate and skew ROE results and that the presiding judge should reject their use.
“The commission has consistently rejected the use of financial models other than the traditional DCF analysis,” she said.
The NETOs’ analyses include the risk premium approach, the application of the DCF model to a nonutility reference group, the capital asset pricing model (CAPM), the expected earnings approach, and consideration of flotation of assets.