[BETA] Fortnightly

Regulators are in the unenviable position of determining an allowance for ROE that’s fair to consumers and investors in a volatile economy. The cases that stand out this year are those in which regulators explored the limits of their discretion.

A review of the rate cases decided over the past year indicates that the economy remains at the forefront in the news, and on the minds of regulators in rate-case proceedings. The issue has taken a new twist, however, as regulators are now placed in the unenviable position of determining an allowance for return on equity (ROE) that’s fair to consumers and investors in a volatile economy. When Fortnightly presented this feature last year, we reported that regulators were seeking to determine the effect the dip in the stock market, falling interest rates and tightening credit might have on financial modeling, as well as subjective views of the return necessary to attract investors. This time, the cases that stand out are those in which regulators are exploring the limits of their discretion under the regulatory compact to balance the interests of consumers and shareholders in the face of a severe economic downturn.

The task of setting the return or profit component of regulated rates for utility service is one that begins with a review of mathematically derived estimates of the return expected by investors in the future. Regulators also are called on to use their informed judgement to produce a result that’s fair to consumers and investors alike. The final answer often is expressed as a range of “reasonable” results that would at either end provide a fair return to investors and reasonable rates for consumers. This gives regulators some wiggle room when determining a final ROE figure or when seeking other ways to hold down rates for consumers—or to keep rates high enough to make sure a utility has access to capital.

A recent case decided in Michigan shows how the financial crisis might redound to the benefit of shareholders in a rate-case setting. In that case, the state public service commission (PSC) ruled that Detroit Edison’s ROE should remain at 11 percent, even though its staff recommended a rate of 10.5 percent and other parties presented evidence supporting lower figures. The utility had asked for an allowance of 11.25 percent, a rate only slightly above the approved rate set in 2006. The PSC concluded that maintaining the status quo on the company’s ROE in light of Michigan’s economic circumstances and the U.S. credit crisis was the most prudent course of action. The commission said the worldwide crisis and ensuing breakdown in confidence among financial institutions led to rising long-term borrowing rates. It also noted that the credit-system freeze causes concern for the utility’s continued ability to provide financing for infrastructure investment needs, and then to continue to provide safe, reliable and abundant power at reasonable rates. The PSC concluded that “a cautious approach in changing the company’s