Week Ending May 22, 2020

ROE Policy Modified for Pipelines, Utilities; Proxy Group Change for Pipelines

This Article Appears as Published in Foster Report No 3300

FERC modified its policy for setting the rate return on equity (ROE) for public utilities and oil and natural gas pipelines in separate but related actions May 21, marking the latest tweak in a policy that was adopted just six months earlier in Opinion 569.

The changes from the November order applying to transmission owners include: use of the risk premium model that was rejected six months ago; changes to the weighting of short-term and long-term economic growth rates; use of Value Line Inc. data in the Capital Asset Pricing Model (CAPM); an increase to the high-end outlier test from 150% to 200% of the median result for all proxy group members in the CAPM; and a few others.

The changes adopted in Opinion 569-A were applied to transmission owners in the Midcontinent Independent System Operator (MISO) following complaints, with the end result changing the base ROE to 10.02% from the 9.88% set in November (EL14-12, EL15-43). When it acted on the complaints in November, FERC said the risk premium model had flaws and was duplicative of CAPM, which would be used in conjunction with the traditional discounted cash flow (DCF) model.

The new policy will use the DCF model, CAPM and the risk premium model. The risk premium model is based on the idea that investors in stocks take greater risks than bond investors, and the model incorporates a risk premium for ROE calculations for public utilities, without including long-term bond yields.

During a press conference after the May 21 open meeting, which was conducted by telephone, Chairman Neil Chatterjee said upon reconsidering the issues and points raised by parties, FERC found that the benefits of economic model diversity and the averaging of more models outweighs the imperfections of the risk premium model. The risk premium model and CAPM use different inputs, he added.

FERC used the determinations in Opinion 569-A as the basis for changing the way it calculates ROE for oil and natural gas pipelines, with a few changes to account for the differences in the energy sectors and input from parties that filed comments on a notice of inquiry (NOI) issued in 2019. The policy statement (PL19-4) adopts the use of DCF and CAPM, giving equal weight to each model, but does not use the risk premium model.

In comments on the NOI, pipeline shippers suggested retention of the DCF model only, which provides a standard approach and predictability for all parties, while pipelines said consideration of other economic models should be incorporated.

The pipeline policy statement retains the two-thirds and one-third weighting of short-term and long-term growth projections, respectively, in the DCF model and will allow inclusion of Canadian pipeline companies in proxy groups for U.S. pipelines in rate cases. FERC had not allowed Canadian companies in proxy groups previously because of different regulatory treatment, but consolidation in the pipeline sector and added private equity investors taking companies private created difficulties reaching proxy groups with four or five similar entities.

Unlike on the power side, the Commission declined to adopt a specific outlier test within proxy groups, stating that it will address any outliers on a case-by-case basis.

FERC encouraged oil pipelines to file updated information for page 700 of their Form 6 to reflect the policy revisions.

The modifications of a policy adopted six months ago for transmission owners prompted Commissioner Richard Glick to concur and dissent in part, with comments at the meeting and a statement on his views. The end result of the MISO proceeding may be an appropriate ROE, but the way it was reached did not sit well with him, and the constant tinkering creates uncertainty among investors, Glick said. The inclusion of the risk premium model after so thoroughly explaining why it is not needed is particularly odd, he said.

Determining ROE is not an exact science, and the process involves a bit of art within the economic modeling methodologies used, which is why Glick dissented in part and not a full dissent, he said. Given the frequent tweaking of the inputs, however, it will be interesting to see how the Commission justifies the policies before an appeals court, he said.

Chatterjee practically begged companies to seek rehearing of Opinion 569 at a previous open meeting, and the revisions should not be portrayed “as a dispassionate assessment of various technical questions,” Glick said. “It appears that the Commission again has chosen a path directed by the results, in this case the perceived need to award a higher ROE, rather than the law and the facts,” he said.

Commissioner Bernard McNamee said setting ROE is one of the most important jobs FERC has, and he agreed with Glick that that it is as much art as science. Investor needs are not easy to understand, and in looking at a lot of information “we don’t always get it right,” which is why the rehearing order makes changes to Opinion 569, McNamee said. The aim is always to ensure just and reasonable rates for consumers and allowing reasonable returns for investors, he said.

The changes being made in the methodologies reflect changes taking place in the markets FERC regulates, McNamee continued. True competitive markets have supply and demand and basic economic principles to follow and reward or punish investors. FERC is trying to approximate what a market would produce, because regulated power markets and pipelines are not pure markets, he said, adding that he hopes the rulings provide certainty to the regulated entities and investors.

During the meeting, Commissioner James Danly did not comment on the ROE policy changes, or most of the other items addressed on the agenda. His lone remark was about a proposed policy statement (PL 20-7) on FERC allowing waivers of tariff provisions while avoiding running afoul of the courts’ prohibition of retroactive ratemaking. There may be some uncertainty regarding tariff waivers and the filed rate doctrine, and the proposed policy statement is designed to address any uncertainty, Danly said.

By Tom Tiernan ttiernan@fosterreport.com

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