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Transmission Incentive Overhaul

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

Fortnightly Magazine - February 2009

new set of procedures, codified at 18 C.F.R. § 35.35. FERC did not “grant outright any incentives to any public utility,” but instead “identif[ied] specific incentives that the Commission will allow when justified in …individual declaratory orders or section 205 filings.” Order No. 679 lists potential incentives—including recovery of 100 percent of construction work in progress (CWIP) payments, hypothetical capital structures, accelerated depreciation, recovery of abandoned plant costs, and incentive ROE adders—and allows applicants to propose combinations that best match their circumstances.

In adopting an incentive rate program, FERC acknowledged the need to balance consumer and investor interests and to ensure that incentives would be based on project-specific evidentiary showings. Thus, FERC determined that applicants must demonstrate a “nexus,” or linkage, between a proposed incentive and demonstrable risks and challenges faced by the applicant. FERC also concluded that multiple incentives would be approved only if the “incentive package as a whole results in a just and reasonable rate,” subsequently noting that “[i]f some of the incentives in the package reduce the risks of the project, that fact will be taken into account in any request for an enhanced ROE.”

While declining to enumerate specific incentive-worthy project types, FERC explained that the “most compelling case for incentives are new projects that present special risks or challenges, not routine investments made in the ordinary course of expanding the system to provide safe and reliable transmission service.” For example, FERC stated that large interstate transmission projects can face substantial and unique risks. Moreover, FERC asserted, such projects are built only at the election of investors, as no single entity is required to undertake them, thus rendering an incentive-based ROE appropriate to encourage proactive behavior. In contrast, FERC noted that routine investments “have [generally] been adequately addressed through traditional ratemaking because there is an obligation to construct them and high assurance of recovery of the related costs.” FERC also observed that “formula rates can provide the certainty of recovery that is conducive to large transmission expansion programs.” But even for investments that do not require enhanced ROEs, FERC observed that other incentives (such as 100 percent CWIP recovery) may remain appropriate.

Incentive Rate Regimen in Practice

FERC’s rate incentives program has not functioned as laid out in its rulemaking orders. Although FERC denied establishing a lenient test for incentives and vowed not to “provide incentives that only serve to increase rates without providing any real incentives to construct new transmission infrastructure[,]” in practice it has granted requested incentives, including enhanced ROEs, almost routinely. Moreover, FERC has done so (often on a 3-2 vote) based on highly general “nexus” findings that appear at times to lack substantive content. The approved ROE adders have been substantial, including some as high as a 2 percent or 200 basis points. 6 While FERC caps any approved ROE incentive adder at the top of the zone of reasonableness, this doesn’t per se establish that the ROE in any individual proceeding is reasonable. 7 More generally, regulation seeks to ensure that reliable service is provided at the lowest, and not the highest,