A Deep Dive
David E. Pomper, a partner at Spiegel & McDiarmid, LLP, has practiced energy law for almost three decades. He chiefly represents ratepayer constituencies — transmission-dependent utilities, state commissions, and official consumer advocates. He presented oral argument to the D.C. Circuit, and secured remands, in two of the leading FERC electric transmission ROE cases of recent years: Emera Maine v. FERC (concerning ROEs in New England) and Ky. PSC v. FERC (concerning ROEs in the Midwest, now Midcontinent, ISO.)
Through a series of orders that began with Martha Coakley, Att'y Gen. of Mass. v. Bangor Hydro-Elec. Co., 165 FERC ¶ 61,030, 2018 and cited here as Coakley, FERC has proposed a new approach to estimating the cost of equity capital invested in pipelines and electric utilities. As this article goes to press, the proposal remains under consideration.
If adopted, it would dilute FERC's prior sole reliance on the Discounted Cash Flow (DCF) method, as FERC would now also include, with equal weighting, three other methods: The Capital Asset Pricing Model (CAPM), Risk Premium (RP), and Expected Earnings (E/B).
Broadly speaking, DCF finds the discount rate that matches present stock prices to the present value of the expected stream of present and future dividends.
CAPM centers on the return from an economy-wide equity portfolio — the equity market return. The method takes the part of that equity market return that exceeds a risk-free, treasury-type yield, and multiplies it by an individual stock's beta, meaning its risk, i.e., volatility, relative to the portfolio.
RP infers the relationship between past allowed ROEs and the contemporaneous bond yields, and then extends that relationship to current bond yields.
E/B divides an entity's actual or forecast accounting earnings by that entity's contemporaneous equity book value.