On August 6, 2013, FERC Administrative Law Judge Michael J. Cianci issued an initial decision on the complaint filed against the New England Transmission Owners (NETOs) seeking to reduce their currently effective 11.14% base return on equity (ROE) (FERC Docket Nos. EL11-66-000, et al.). Applying FERC’s traditional discounted cash flow (DCF) analysis to financial data largely for the period May 2012 – October 2012, Judge Cianci would require the NETOs to use a 10.6% base ROE to make refunds for transmission service provided between October 1, 2011 and December 31, 2012. Applying the same DCF analysis to financial data largely for the period October 2012 – March 2013, Judge Cianci would allow the NETOs a 9.7% ROE that would apply prospectively once FERC ultimately issues its order in the case (assuming FERC sustains Judge Cianci’s rulings; see PP* 544, 559-560). These rulings undoubtedly are disappointing both to the NETOs, who opposed any reduction in the 11.14% base ROE, and the complainants, who advocated substantially lower ROEs (8.3% to 8.9%) than Judge Cianci would allow.

On the positive side for the NETOs, Judge Cianci found that reducing utility ROEs below 10% for a prolonged period could be harmful to the industry (P 576). He also resolved virtually all conventional DCF methodological issues in the NETOs’ favor and his 10.6% and 9.7% ROEs were the ROEs developed in the NETOs’ conventional DCF analysis (PP 551, 552, 557). This would suggest that the 10.6% and 9.7% ROEs represent the maximum possible ROEs given the financial market data and the constraints of FERC precedent.

Judge Cianci expressly declined to rule on an issue that was hotly contested by both the NETOs and the complainants. The issue is whether post-2007 financial market conditions cause the DCF method to understate ROE costs and require modification of FERC’s conventional DCF analysis by use of alternative ROE methodologies (e.g., CAPM) to determine the NETOs’ actual common equity costs. A related issue, also hotly disputed by the parties, is whether the billions of dollars of required new transmission investment should also impact the ROE calculus.

The NETOs and the complainants are free to dispute all aspects of Judge Cianci’s decision through the FERC appeal process. The initial appellate briefs (known as briefs on exceptions) are due September 20, 2013, and briefs opposing exceptions are due October 24, 2013. The ultimate FERC ruling in this case will clarify and/or modify FERC’s ROE policy and is likely to be of extreme importance not only to the NETOs and their customers but to all utilities who charge or pay FERC jurisdictional transmission rates.

Two elements of Judge Cianci’s decision merit additional comment.

First, his decision concerned the NETOs collectively with the result that the ROE benchmark was the so-called “mid-point” of the zone of reasonableness (the mid-point is the average of the highest and lowest returns within the zone). The benchmark for an individual utility would be the “median” (the median is the point within the zone of reasonableness where half the returns are higher and half the returns are lower). Under current conditions, the median would be somewhat lower than the midpoint. Thus, other things being equal (they never are), a hypothetical Judge Cianci decision in an individual utility rate case would result in somewhat lower ROEs.

Second, due to the statutory fifteen-month limitation on retroactive refunds, the NETOs will not be required to make Docket No. EL11-66-000 refunds for the period between January 1, 2013 and the issuance date of the final FERC order. However, FERC has not yet acted on a second ROE complaint currently pending against the NETOs (Docket No. EL13-33-000). Although FERC would need to make new ROE findings in the new docket, this second complaint could close the Docket No. EL11-66-000 gap, and expose the NETOs to “back-to-back” ROE refunds for a 15-month period beginning January 1, 2013.

The initial decision is available here.

* “P” refers to the relevant numbered paragraph in the initial decision.