Return On Equity: Regulators Trust, but Verify

Deck: 

Some recent utility rate proceedings cast doubt on new ROE models and “risk adders.”

Fortnightly Magazine - November 2006
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The results of Public Utilities Fortnightly’s annual survey of rates of return on equity (ROE) authorized for major electric and natural-gas utilities broadly show a continuing decline in the level of debate over issues specific to restructuring of the electric market. The survey also reveals a subtle shift back to investor requirements and overall business risks faced by regulated energy companies.

For example, in a gas rate case decided in Nevada, regulators rejected an ROE “risk adder” proposed by a natural-gas local distribution company and reminded the utility that hard evidence such as credit ratings and regulatory rulings are what makes the difference in a rate-case setting.

The Illinois Commerce Commission reviewed the underpinnings of the traditional ROE process when it rejected a proposal by a party to a major electric rate case to switch to a completely new approach, purportedly based on direct evidence from the investment-banking community. As it turned out, the so-called “investment-bank analysis” produced an ROE estimate much lower than any produced by the standard financial models normally relied upon in rate cases. The commission concluded it had no way to know what assumptions investment bankers use when putting a value on utility stocks, or whether such an estimate might satisfy the legal requirement for just-and-reasonable rates in a regulated market.

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