On November 15, 2018, the Federal Energy Regulatory Commission (FERC) issued two orders addressing ongoing complaint proceedings involving the base rate of return on equity (ROE) of public utilities.  One order addresses two pending complaints challenging the MISO Transmission Owners’ base ROE (MISO Order), while the second addresses other pending ROE cases (Pending Cases Order).  Both orders adopt the proposed new ROE methodology described in FERC’s October order addressing the New England Transmission Owners’ base ROE (NETOs Order).

Consistent with the NETOs Order, the MISO Order proposes a methodology for calculating ROE based on a “composite zone of reasonableness” derived using three well-known models for estimating the cost of equity capital.  The “proposed” new paradigm gives equal weight to: FERC’s long-favored, two-step discounted cash flow (DCF) analysis; the capital-asset pricing model (CAPM); and Expected Earnings analysis.   FERC proposes to rely on the composite zone of reasonableness to:  (1) evaluate whether an existing base ROE is just and reasonable when the existing ROE is challenged under Federal Power Act section 206; and (2) set a new zone of reasonableness to determine a new base ROE and a new cap on ROE incentives when it finds an existing ROE to be unjust and unreasonable.

In evaluating the justness and reasonableness of an existing base ROE, FERC proposes dividing its composite zone into quartiles corresponding to presumptively reasonable base ROE ranges for low-risk, average-risk, and high-risk utilities.  It proposes to find unjust and unreasonable an existing ROE that falls outside of the applicable quartile range.

Should FERC find that an existing ROE is not just and reasonable under this approach, it proposes to set the new base ROE by taking the average of four cost of capital estimates, namely the midpoints (or medians when setting the ROE for an individual company) of the ranges produced by the DCF, CAPM, and Expected Earnings analyses, plus an estimate produced by a fourth method, the Risk Premium approach.

Like the NETOs Order, the MISO Order directs the parties to those proceedings to submit briefs on the merits of FERC’s new approach, and how to apply it to the pending complaints against the MISO Transmission Owners.

In its Pending Cases Order, FERC clarified that parties in other pending ROE proceedings should address the proposed new methodology in those proceedings, including submitting evidence concerning the merits of the proposed methodology and whether and how to apply it to the facts of each proceeding.   While FERC characterizes the proposed new ROE methodology as only a proposal, it declined to hold the pending proceedings in abeyance pending formal adoption of the new approach.

Finally, FERC’s November open meeting also included Chairman Chatterjee’s separate announcement that FERC will conduct a generic review of its base ROE and ROE incentives policies, with the timing and format of such review yet to be determined. Commissioners LaFleur and Glick both spoke in favor of this review.