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Transmission Incentive Overhaul

FERC’s ROE incentive adder policy sends the wrong signals.

Fortnightly Magazine - February 2009

at least not without a searching inquiry into whether the need for a large investment could have been avoided through steadier, incremental investments. Absent such an inquiry, a policy favoring enhanced, incentive ROEs for large projects encourages transmission owners to manufacture crises needing big solutions and perhaps to short-change what should be routine activities. Unfortunately, FERC has exacerbated this problem by rejecting assertions that current needs have resulted from past under-investment, for which a transmission owner ought not to be rewarded, and concluding instead that the timeliness of an investment response is irrelevant. 22 A timeliness requirement should be established.

Where the scope of the project for which an incentive ROE is sought appears to be a function of past under-investment, the commission should seek to eliminate the immediate disincentives to fixing the problems created by past under-investment, but without rewarding that behavior or encouraging similarly dilatory behavior going forward. Thus, in such situations, the commission may include 100 percent of CWIP in rate base (thereby bolstering cash flow during construction), and may provide abandoned-plant protection (thereby ensuring against a risk of loss in case the project is canceled for reasons beyond the applicant’s control), but should deny ROE adders for projects that merely make up for past under-investment leading to imminent reliability violations. Moreover, to ensure that internal capital goes where it’s needed, FERC should deny ROE adders for other projects by the same applicant until its transmission system is brought up to a reasonable baseline reliability level.

More generally, linking higher ROEs to the magnitude of proposed transmission projects may hit consumers with a quadruple punch. First, large investments result in large depreciation expenses. Second, linking higher ROEs to the magnitude of investment produces non-linear increases in the ROE component of transmission rates, as additional investment increases both rate base and the rate of return applied to rate base. Third, linking higher ROEs to the magnitude of project costs encourages inflated cost estimates (justifying higher ROEs) and the incurrence of actual cost over-runs (which inflate rate base, subject only to notoriously difficult-to-mount prudence challenges). Fourth, widespread reliance on incentive ROEs for large transmission projects creates a feedback loop that threatens to increase base ROEs. In Order No. 679-A (P 62), FERC “reject[ed] the contentions of certain customer groups that incentive ROEs [would] ‘destabilize’ the DCF methodology,” finding that “any incentive ROEs granted under 219 should have a minimal effect,” because “the ‘cash flows’ being measured in the DCF method are the cash flows of entire companies,” which “should not be significantly affected by an incentive return for any particular transmission project.” But projects like the Maine Power Reliability Project, which will increase CMP’s plant in service six-fold, contradict that assumption, and reliance on project size to justify higher ROEs simply magnifies that feedback problem.

Finally, in acting on incentive-rate applications, FERC nominally considers whether a proposed project would improve reliability or reduce congestion. What major transmission project would fail to accomplish one or the other, if not both? But thus far it’s refused to inquire into whether the project would