The Nickel Report

On November 19, 2020, the Federal Energy Regulatory Commission (“Commission”) issued Opinion No. 569-B, its latest order addressing evaluations of whether a public utility’s return on equity (“ROE”) is just and reasonable under Section 206 of the Federal Power Act (“FPA”). [1]  As described herein, the Commission largely reaffirmed the methodology established in its prior related opinions.  See here.

The Opinion No. 569 series of orders adopts a two-part framework for evaluating existing ROEs under FPA Section 206.  The first part of the framework is to evaluate whether the existing ROE is unjust and unreasonable.  If the existing ROE is found to be unjust and unreasonable, the second part of the framework is to establish what is a just and reasonable replacement ROE.

In Opinion No. 569-A, [2] the Commission settled on a comprehensive framework to evaluate ROE that relies on three analytical models – the discounted cash flow model (“DCF”), the capital asset pricing model (“CAPM”), and the risk premium model (“Risk Premium”).  The DCF model assumes that the value of a public utility’s stock is equal to the value of all future dividends to be paid by the public utility, discounted to present value using a rate of return commensurate with the investment’s risk.  The CAPM model is based on the premise that a stock’s rate of return is equal to the “risk free” rate of return (the interest rate on long-term U.S. Treasury bonds) plus a “risk premium,” which is a return percentage that reflects the additional risk of the stock over and above the risk-free rate.  The Risk Premium model is “based on the simple idea that since investors in stocks take greater risk than investors in bonds, the former expect to earn a return on a stock investment that reflects a ‘premium’ over and above the return they expect to earn on a bond investment.” [3]

The Commission also required that the composite zone of reasonableness be broken into thirds for purposes of evaluating the ROEs of high-risk, average-risk, and below-risk public utilities.  The Commission ordered the ROEs for Midcontinent Independent System Operator, Inc. (“MISO”) transmission owners to be 10.02% under the Opinion No. 569-A framework.

Opinion No. 569-B reaffirmed the methodology the Commission previously adopted in Opinion No. 569-A in response to various challenges.  First, Opinion No. 569-B rejected challenges to the weighting of short-term and long-term company growth rates in the DCF model. [4]  In Opinion No. 569-A, the Commission ruled that short-term growth rates should be given an 80% weighting in the DCF model, while the long-term growth rate should be given a 20% weighting.  Second, Opinion No. 569-B reaffirmed the ruling in Opinion No. 569-A that growth rates published in Value Line (an independent investment research firm) may be used in the CAPM model. [5]  Third, the Commission rejected challenges to the decision to use the Risk Premium model in calculating the zone of reasonableness, and to the manner in which the zone of reasonableness is used in the evaluations under FPA Section 206. [6]

The only significant change adopted by Opinion No. 569-B was a clarification that the Risk Premium model should employ certain historical utility bond yields and not, as the Commission had indicated in an order that predated the Opinion No. 569 series of orders, forward-looking bond yields. [7]  Opinion No. 569-B also acknowledged some typographical errors as well as an error in the Risk Premium model used in Opinion No. 569-A.  The Commission corrected these errors but found that they had only a de minimis impact on the results reached in Opinion No. 569-A, and therefore reaffirmed the use of a 10.02% ROE for MISO transmission owners.

As a final matter, it is notable that Commissioner Glick, who will potentially become the Commission Chairman when the presumptive Biden Administration takes office in January, concurred in part and dissented in part from Opinion No. 569-B.  Commissioner Glick agreed with the reaffirmation of the 10.02% ROE for MISO transmission owners but continued to disagree with the use of the Risk Premium model, and with the Commission’s refusal to grant refunds.

[1] Ass’n of Businesses Advocating Tariff Equity v. Midcontinent Indep. Sys. Operator, Inc., Opinion No. 569-B, 173 FERC ¶ 61,159 (2020) .

[2] Ass’n of Businesses Advocating Tariff Equity v. Midcontinent Indep. Sys. Operator, Inc., Opinion No. 569-A, 171 FERC ¶ 61,154 (2020)

[3] Opinion No. 569 at P 304.

[4] See Opinion No. 569-B at P 80.

[5] Id. at PP 90-91.

[6] Id. at PP 113-16.

[7] Id. at P 121.