• EEI Recommends Changes to FERC’s ROE Methodology
  • June 12, 2013 | Authors: Peter S. Glaser; Kevin C. Greene; Daniel L. Larcamp; Clifford S. Sikora; Lara L. Skidmore
  • Law Firms: Troutman Sanders LLP - Washington Office ; Troutman Sanders LLP - Atlanta Office ; Troutman Sanders LLP - Washington Office ; Troutman Sanders LLP - Portland Office
  • On June 6, 2013, the Edison Electric Institute (“EEI”) released a white paper recommending that FERC adjust its methodology for calculating utilities’ return on equity (“ROE”) for transmission investments. The white paper, “Transmission Investment: Adequate Returns and Regulatory Certainty Are Key,” highlighted that FERC’s discounted cash flow (“DCF”) model - a model used to estimate a utility’s cost of equity for setting regulated returns - is outdated and can result in substantially lower returns on equity, and therefore, recommended changes to the methodology.

    Noting that the “electric power industry is the most capital-intensive industry in the United States,” and that transmission investors require predictability before investment, EEI stated that FERC’s current model may not always provide a predictable ROE that transmission investors require. Specifically, EEI noted that the current DCF model does not take into account that: (1) current returns are still within the range of reasonableness; (2) there is no link between low interest rates and investors’ expected returns; and (3) adequate long-term returns are important to long-term transmission investment. Therefore, EEI recommends that FERC make four changes to its ROE methodology to account for changes in markets, ensure public policy goals are achieved, and that utilities continue to invest in transmission.

    • First, EEI recommended that FERC consider the use of alternative methods when determining ROE, such as the risk premium method, capital asset pricing model, or the application of the current DCF method to proxy companies from a similarly-situated industry. Using the results of these alternative methodologies, FERC could then use the results as benchmarks in determining an appropriate ROE. In addition to the alternative methodologies, EEI recommended that FERC allow flexibility in setting an ROE in the upper zone of reasonableness, depending on the benchmark results of other methodologies.
    • Second, EEI recommended that FERC increase its screens by 200-300 basis points above the prevailing long-term utility bond yield for low estimates in a proxy group; “and/or incorporate projected bond yields and then apply the currently applicable 100-basis-point threshold.”
    • Third, EEI recommended that FERC recognize that different values in the DCF model are independent of one another, and that just because a value greatly varies from another value, the entire estimate is not compromised. Additionally, EEI stated that FERC should discontinue its practice of removing the high and low value results from a proxy company if only a single DCF estimate is excluded.
    • Fourth, EEI recommended that FERC should reduce the time period for excluding companies from the proxy group that implemented a dividend reduction. EEI reasoned that FERC’s current practice of excluding companies from the proxy group for multiple years is unreasonable, because the DCF model only relies on data that is no more than six months old.

    EEI stated that making these changes will “reaffirm [FERC’s] commitment to transmission investment” and allow for a just and reasonable ROE for transmission investment.