Arguments that Entergy’s (NYSE:ETR) disposition of its transmission business to ITC Holdings (NYSE:ITC) will result in higher rates to consumers were dismissed in FERC’s June 20 order approving the transaction.
“Although rates will increase for some customers as a result of this transaction, applicants [ITC and Entergy] have shown that the proposed transaction will result in offsetting benefits,” FERC said in the order (FERC Docket No. EC12-145).
Among protestors’ concerns to the spinoff of Entergy’s transmission business to ITC were return on equity (ROE) and capital structure.
Protestors included the Texas and Louisiana regulatory commissions and the Joint Customers, a group comprising the South Mississippi Electric Power Association, Arkansas Electric Cooperative Corporation, Mississippi Delta Energy Agency, Clarksdale Public Utilities Commission, The Public Service Commission of Yazoo City, Arkansas Cities, and Municipal Energy Agency of Mississippi.
Joint Customers argued that the 60/40 equity/debt split proposed for the new ITC subsidiaries that will operate Entergy’s transmission business once the transaction is complete will lead to an unjustified increase in rates, as ITC will be able to issue debt at the holding company at low interest rates, perhaps around 3.5%, and push that debt to the operating company level, essentially converting it to common equity capital.
Doing so would allow ITC to earn equity returns on debt.
“There, the borrowed funds will earn a guaranteed formula-based equity return, the 12.38% MISO ROE,” FERC summarized the Joint Customers argument in the June 20 order. “ITC Holdings will pay the bondholders the 3.5% for the borrowed funds, and provide the remaining 8.88% that was collected from ratepayers directly to ITC Holdings’ stockholders.”
This leads to a equity/debt split of 30/70, Joint Customers said, adding that FERC should require the “real source” of the funds used to finance the rate bases of the operating companies and their actual costs be used in the transmission formula rates of the new ITC subsidiaries.
Furthermore, the 60/40 split could result in ITC collecting income tax from transmission ratepayers that the company will not ultimately pay, because ITC’s holding company tax obligation will be based on a lower equity ratio and higher tax deductible interest.
In terms of ROE, the Louisiana commission argued that the Midcontinent ISO’s (MISO) base ROE of 12.38% in its transmission tariff would lead to a rate increase for Louisiana customers.
Joint Customers submitted a discounted cash flow (DCF) analysis calculating base ROE of 8.91%.
“Contrary to protestors’ arguments, we find that the increase in ROE is a consequence of Entergy’s integration into MISO rather than the proposed transaction: Entergy would adopt the MISO ROE irrespective of the proposed transaction,” FERC said. “Likewise, since ITC Holdings will also become a MISO transmission owner with respect to the Entergy transmission facilities if the proposed transaction closes, the new ITC operating companies would also be entitled to the 12.38% MISO ROE as part of their formula rates.”
The commission also noted that under hold harmless commitments the companies have made, ratepayers will not feel the effect of transaction-related costs for five years.