The time-honored discounted cash flow method for determining appropriate utility returns falls short when interest rates are low. Inadequate ROEs ultimately increase cost of capital and wipe away...
Transmission Incentive Overhaul
FERC’s ROE incentive adder policy sends the wrong signals.
Since mid-2006, the Federal Energy Regulatory Commission (FERC) has responded to a Congressional directive by considering—and, generally, approving—scores of public utility requests for “incentive” rate treatment of new transmission investment. Recently, FERC has been ruling on incentive rate applications on an almost assembly-line basis. Between September 1 and December 4, 2008, FERC issued nearly a dozen separate incentive rate orders approving requests for hundreds of millions of dollars in incentives. But FERC must confront, directly and consistently, serious flaws in its emerging policy regarding one category of incentive: return on equity (ROE) incentive adders.
The need to delineate when and to what extent ROE adders are appropriate is more urgent than ever. Current transmission plans include billions of dollars in proposed new projects. The Obama Administration has promised to “moderniz[e] the grid,” 1 while interest groups have called for new facilities to interconnect renewable generation resources. 2 Unless FERC applies more focused guidelines, the ROE incentive regimen will function largely as a windfall for transmission owners and, worse, won’t encourage cost-efficient construction and maintenance of transmission systems.
Incentive Rate Regimen
In Section 219 of the Federal Power Act (FPA), 16 U.S.C. § 824s, enacted as part of the Energy Policy Act of 2005, 3 Congress addressed concerns about under-investment in transmission infrastructure. While assuming for purposes of this article that certain incentives may be needed to promote transmission construction, at the time Section 219 was enacted there was evidence suggesting the industry already had begun to remedy past under-investment. The Edison Electric Institute’s 2005 “EEI Survey of Transmission Investment” 4 found:
• “[T]he industry has reversed a long-standing downward trend in transmission investment,” id. at 3;
• “[T]ransmission investment, in constant dollars, declined from 1975 through 1998[, but]… has been increasing since 1999,” id.;
• “Over the 1999-2003 period, transmission investment increased at a 12 percent annual rate,” id. ; and
• Planned investment for 2004-08 was 62 percent of 2003 net book value, reaching “levels not seen in nearly 30 years,” id. at 5.
EPACT 2005 nonetheless directed FERC to establish, by rule, “incentive-based (including performance-based) rate treatments for the transmission of electric energy[,]” in order to “benefit consumers by ensuring reliability and reducing the cost of delivered power by reducing transmission congestion.” Among other things, Congress directed FERC to provide incentives that promote “reliable and economically efficient transmission” and to offer ROEs that will attract new transmission investment. Congress also instructed FERC to encourage deployment of transmission technologies and other measures to improve the capacity, efficiency, and operations of existing facilities. However, FERC’s discretion to adopt incentives was limited. FPA Section 219(d) provided that all incentive rates would remain “subject to the requirements of [FPA] sections 205 and 206” and must be “just and reasonable and not unduly discriminatory or preferential.”
In its rulemaking proceeding, 5 FERC announced its incentives regimen and a