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Transmission Incentive Overhaul

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

Fortnightly Magazine - February 2009

to specify what steps they would take for an enhanced ROE that they would not pursue for a “normal” one.

Similar concerns arise when awarding ROE adders to address financing risks. Higher returns always will be more attractive to external investors and more successful in competition for internal capital. But that proves too much and doesn’t justify routinely awarding transmission owners enhanced ROEs near the top of the range of reasonableness. While the purpose of both Section 219 and FERC’s rulemaking was to encourage cost-effective transmission expansion bolstering reliability and reducing delivered power costs, higher returns will not achieve these objectives unless they are targeted at real impediments to transmission construction. There is no evidence that transmission construction has been impeded because the baseline ROEs applied to completed projects in rate base are too low, or that baseline ROEs will be insufficient to encourage new transmission investment once other risks are addressed by other incentives. Legitimate cash-flow concerns during construction can be addressed through permitting recovery of CWIP. Concerns that a project may not gain siting approval, leaving investors responsible for unrecoverable project development costs, can be addressed through abandoned plant protections. Concerns about the timeliness of rate recovery should be assuaged where formula rates are present. None of these factors justifies ladling an enhanced ROE on top of project costs.

Incentive Rates: The Road Ahead

FERC should address several questions concerning ROE incentives adders. Most fundamentally, it should delineate, through the adoption of objective incentive-ROE eligibility criteria, the risks associated with, and the performance expected from, transmission owners under commission-approved base ROEs.

ROE adders aside, customers and FERC should expect transmission companies to plan, construct, operate, and maintain their systems in accordance with applicable reliability criteria, including periodic assessments of system reliability and timely pursuit of basic system upgrades. The commission said as much in a pre-incentives regimen decision rejecting a proposed transmission incentive program that would have “unjustly reward[ed a transmission owner] for doing what it’s supposed to do, i.e., to adequately maintain its facilities in a prudent, cost-effective manner.” 17 Likewise, customers and FERC should expect transmission owners to follow through, without additional incentives, on prior commitments to build new transmission facilities. Such commitments may include obligations to build facilities identified as needed through regional planning processes under an RTO tariff, conditions on FERC approval of dispositions of jurisdictional assets, or obligations undertaken in satisfaction of state regulatory requirements.

Where investment is truly optional, FERC should consider carefully whether enhanced ROEs are necessary to induce it. ROE adders should be available only where optional investment involves a risk of loss that: A) goes beyond the risks reflected in the base ROE; and B) is not eliminated by other granted incentives, such as inclusion of CWIP in rate base or recovery of abandoned-plant costs. Where FERC approves an ROE adder, it should support that determination with factual findings about how the enhanced ROE will help overcome project risks and why the ROE adder was set at the specific level chosen.

FERC also should explain fully why ROE adders are