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Transmission Incentive Overhaul

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

Fortnightly Magazine - February 2009

appropriate where they are part of a package of incentive rate treatments or where other risk-mitigating factors (such as formula rates) are present. While FERC’s rulemaking orders opined that transmission owners might not be eligible for any ROE adder when CWIP and abandoned-plant protections are granted, in practice FERC has reduced ROE adders only slightly (and inconsistently) in light of the grant of such incentives. Indeed, FERC since has rejected the notion of generic ROE-adder reductions in such cases, 18 and the question whether any ROE adder is justified (and not one that is simply reduced from 150 to 125 basis points) has been raised only in dissenting opinions. Similarly, FERC has deemed irrelevant whether costs are recovered pursuant to a formula rate.

While Congress directed FERC to “establish … incentive-based (including performance-based) rate treatments” and to “provide a return on equity that attracts new investment in transmission facilities,” [see FPA §§ 219(a), (b)(2)] that doesn’t mean an ROE near the top of the zone of reasonableness is appropriate in every case—or even most cases. Indeed, FERC’s emerging policy toward incentive ROE adders for new transmission facilities may have serious unintended, adverse consequences. First, transmission owner investment is not an end in itself. The Congressional and regulatory goal is construction of “economically efficient transmission” for the purpose of “ensuring reliability and reducing the cost of delivered power,” (id., §§ 219(a), (b)(1)) , but overly generous ROEs may impede those goals—particularly where state regulatory authorities (including siting authorities) oppose new transmission that would allow low-cost resources to be exported out-of-state. Increasing the cost of such transmission facilities by awarding incentive ROEs will make it even harder to obtain the necessary state approvals. In other words, increasing the cost of new transmission (by what can amount to hundreds of millions of dollars over the life of a facility) can be expected to incentivize both transmission owner investment and opposition to the project. 19

There also is a concern that FERC’s current approach to determining when an ROE adder will be granted creates perverse incentives. A major factor in the commission’s decisions about whether to approve an incentive ROE has been the scope of the project(s) at issue. FERC has explained that assessment of project scope involves “factors such as size, dollar investment, increase in transfer capability, involvement of multiple entities or jurisdictions, and effect on the region” and that applicants must present “data distinguishing the project from other transmission projects or upgrades that are constructed in the ordinary course of maintaining a utility’s transmission system.” 20 FERC has encouraged submission of data comparing “total investment in a range of projects to some other aggregate measure of investment, such as total rate base or recent annual investment levels,” and it has held that groups of projects that are routine when considered individually may be treated as non-routine in the aggregate. (Id.) Thus, applicants frequently tout the magnitude of investment(s) at issue, particularly in contrast to historical levels. 21

The magnitude of investment should not be a basis for determining whether an incentive ROE is justified,