EEI: FERC should not lower base ROEs

Relying on a “single, mechanical” approach to determine base returns on equity (ROEs) for the transmission industry runs the risk that FERC will weigh evidence that does not reflect capital market realities, the Edison Electric Institute (EEI) said in a June 6 whitepaper.

EEI, the association of investor-owned utilities (IOUs), argued for maintaining current base ROEs, citing numerous rationales, including recent extreme weather events, the need to integrate renewable energy, challenges to reliability and FERC’s own policy to promote transmission development.

FERC is in the midst of a Federal Power Act Section 205 proceeding that was initiated in September 2011 by Massachusetts Attorney General Martha Coakley, who asked the commission to find the current base ROE of 11.16% in ISO-New England’s transmission tariff unjust and unreasonable

EEI listed several figures for projected investment in transmission, all of which, it argued, would be in danger of being reduced should the base ROE be lowered and investors decide to take their investments elsewhere.

These figures included $85bn of investment annually through 2015 in generation, transmission and distribution systems; $54.6bn in transmission projects through 2015; and $51.1bn in transmission for the 2013 to 2023 period. These capital needs are competing with global investments, including natural gas industry investments of $5T, as estimated by the American Petroleum Institute, and water utility investments of $1T, EEI said.

Since 2001, IOUs’ year-over-year transmission investment has increased from $5.8bn to $11.1bn in 2011.

“If returns on electric transmission infrastructure are not sufficient and stable, investors will avoid such investments and instead seek better and more stable returns elsewhere,” EEI said.

The association further posited that the efficacy of FERC’s discounted cash flow (DCF) approach to determining a just and reasonable base ROE has been undermined by the Federal Reserve’s policy in response to the 2008 recession, which has led to a cost of equity “far higher” than the traditional spread compared to the cost of debt. Low bond yields are anomalous, EEI argued, and “are expected to increase significantly, primarily driven by Treasury bonds being artificially and historically low, due to federal intervention to restore economic growth.”

EEI suggested FERC consider the risk premium method or the capital asset pricing model (CAPM), which would have the benefit of being simple and straightforward and “should not require a significant overhaul of the DCF methodology.”

EEI’s member IOUs are currently projected to invest $54.6bn through 2015, in 2011 dollars, based on current base ROE levels.

“While transmission investments by EEI’s members during 2014 and 2015 are anticipated to be significantly higher than in 2011, it is important to note that, given the length of time it takes to plan, permit, and build significant transmission projects (up to 10 years), the ramp up in investment reflects investment decisions made in response to policies enacted by Congress in [the Energy Policy Act of 2005] and appropriate ROEs,” EEI said. “These planned transmission investments are premised on ROEs that are consistent with currently authorized levels.”

EEI estimates the industry will invest another $51.1bn in 150 transmission projects for the 2013-2023 period. Of these, 52% are interstate projects and 76% support renewable integration. They do not include upgrades or existing infrastructure replacements.

The association also cited a Brattle Group estimate that $240bn to $320bn of investment is needed in transmission investment through 2030.

Reduced investment in transmission would lead to reliability risks, EEI argued.

“[T]he choices of how to meet particular reliability needs are numerous, and electric utilities must make those choices within the confines of capital limitations,” EEI said. “If ROEs for transmission are not sufficient, a utility may choose a short-term, more-local project or an alternative resource solution to maintain reliability rather than choose the riskier, more strategic option that could provide additional benefits to customers and be more cost-effective. Given the numerous risks and challenges associated with developing large‐scale transmission, it is critical that returns are sufficient to encourage EEI’s members to focus on evaluating and building the larger, more challenging projects needed for a more robust electric grid that will provide reliability and other benefits to customers in both the short and long term.”

The association also argued that without adequate returns to support transmission investment, projects evaluated in local and regional planning processes may not be undertaken because capital will be invested elsewhere, “likely resulting in delay or absence of projects required to address congestion, to implement public policy objectives, and to bring benefits to customers.”

EEI also pointed out that Congress recognized the risks surrounding transmission development and in Section 219 of the Federal Power Act, part of Congress’ Energy Policy Act of 2005 (EPAct), directed FERC to develop incentives to mitigate these risks.

“Congress has not amended or taken other action to diminish the importance of transmission investment since EPAct 2005, nor have project risks and challenges fundamentally changed,” EEI argued.

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.