Implications of FERC Staff Recommendation to Lower the Base ROE for Transmission in New England

Implications of FERC Staff Recommendation to Lower the Base ROE for Transmission in New England


Michael Kline, Principal

Berkeley Research Group, LLC (Washington, DC)


Barclay Gibbs, Principal

Berkeley Research Group, LLC (Washington, DC)


Duncan Anderson, Senior Associate

Berkeley Research Group, LLC (Washington, DC)


On September 30, 2011, a group of New England stakeholders filed a complaint with the Federal Energy Regulatory Commission (“FERC”) requesting that the Base Return on Equity (“ROE”) for New England transmission owners be reduced from 11.14 percent to 9.2 percent.[1] The stakeholders include several industrial groups, the Massachusetts’ attorney general, and other state regulators. In their complaint, stakeholders allege that “[d]ue to changes in the capital markets since the Bangor Hydro proceeding, the 11.14 percent Base ROE is no longer just and reasonable.”[2] The current rate of 11.14 percent was set in in the Bangor Hydro proceedings and based on market information from 2004 and bond yields from 2006.[3]

FERC staffer Sabina Joe responded by submitting testimony before the Commission on January 18, 2013, recommending that the Base ROE be reduced from 11.14 percent to 9.66 percent, which was the midpoint of the results of her discounted cash flow (DCF) analysis, which indicated an ROE of between “6.82 percent to 12.51 percent.”[4] If the Commission adopts her recommendation, then Ms. Joe estimates it will mean $202.6 million in savings from Regional Network Service for ratepayers in New England, plus additional savings from reduced payments for Local Network Service.[5]

One reason the impending decision has ramifications for transmission owners and ratepayers beyond New England is that the transmission owners argued that current U.S. Treasury yields, and by implication current market returns, are anomalously low. Because this argument for higher ROEs hinges on the view that Treasury yields will be higher in the near to mid-term, if true it implies that an upwards adjustment to current Treasury yields should be made when setting transmission ROEs throughout the country.

However, in addition to noting that ten-year U.S. Treasury yields have declined significantly since the Base ROE was set (from 4.88 percent in August 2006 to 1.72 percent in December 2012),[6] Ms. Joe explicitly rejected the argument that the Base ROE should be adjusted upwards to account for the recent low yield on U.S. Treasuries, noting that the Federal Reserve’s QE4 policy “vows to keep interest rates low until unemployment drops to at least 6.5% and inflation exceeds 2.5%.”[7] This led her to conclude that “[l]ower future returns are widely expected as the ‘new normal’ in contrast to double digit returns in past economic climates.”[8] In other words, transmission owners should not expect the relatively high returns they enjoyed in the past, because returns on all investments are likely to be lower going forward.

Implications for Ratepayers and Investors

As stated above, if the Commission accepts staff’s recommendations, it could have ramifications for ratepayers and transmission owners in other parts of the country as well, because Ms. Joe’s conclusions were based on macroeconomic factors (lower bond yields and market equity returns) that would arguably impact transmission projects throughout the country.

In the Midwest Independent System Operator (“MISO”) market for example, FERC set the ROE for transmission projects at 12.38 percent on April 25, 2002, and finalized it on June 3, 2005.[9] Clearly, market conditions have changed in the past 11 years; for example, the yield on ten-year Treasuries has fallen from 5.10 percent to 1.88 percent during the same time period.[10] Thus, if the Commission were to revisit rates, it seems likely it would recommend a lower ROE.

In fact, there are already other challenges to current ROE levels beyond what is happening in New England. For example, when Duke Energy Ohio and Kentucky joined PJM, they sought to maintain their MISO ROE of 12.38 percent. American Municipal Power and Indiana Municipal Power Agency filed a complaint with the FERC, protesting, in part, because the 12.38 percent ROE did not reflect current market conditions.[11] Ultimately, the parties agreed to reduce the ROE for Duke Ohio and Kentucky to 10.88 percent, plus a 50-basis-point adder for belonging to the RTO (11.38 percent ROE in total). On February 25, 2013, FERC staff submitted testimony stating that they do not object to the proposed ROE.[12]

In a similar challenge, Seminole Electric Cooperative, Inc. and Florida Municipal Power Agency submitted a complaint to the FERC requesting that the Florida Power Corporation’s transmission ROE be reduced from 10.8 percent (where it had been set in October 2007) to 9.02 percent. As of the writing of this article, FERC staff has not yet offered an opinion on this matter.[13]


To some extent, market indicators support Ms. Joe’s conclusions. For example, as shown in Table 1, in the four years since the recession ended, Morningstar’s estimates for the median ROE required of electric utilities by the market have generally been lower than they were during the previous eight years. Moreover, for all of their estimate methodologies, the average market ROE over the last four years has been lower than in the previous eight. Notably, the results of Morningstar’s DCF analyses, which are based on methodologies similar to that used by FERC, show an especially sharp drop after the recession, which began in 2007 and ended in 2009.

Table 1: Morningstar Estimates for Median Electric Utilities ROE Over Time[14]



Interestingly, while market returns have fallen in recent years, ratemaking bodies have reduced ROEs more gradually. As shown in Figure 1, the average approved ROE for electric utilities has only fallen by about 50 basis points since 2006 and by slightly over 100 basis points since 2002. This suggests that ratemakers are taking a conservative approach that balances economic concerns (overpayment by ratepayers) with reliability.

Figure 1: SNL Database of ROEs from Approved Rate Cases Since 2002[15]



If the current economic environment of low returns is indeed the new normal, then it makes sense to lower ROE. However, this approach could lead to reliability issues. Since Section 219 of the Federal Power Act states that the ROEs should be set to promote reliability as well as economic efficiency, the Commission will consider the reliability consequences of setting the ROEs too low.[16] It is certainly possible that systemic deficits combined with the Federal Reserve’s policy of quantitative easing could lead to higher inflation in the medium term and, correspondingly, to an increase in the nominal required return for transmission investments. Given that ROEs set by regulatory bodies tend to be somewhat sticky and unresponsive to changes in the market, lowering ROEs now creates the possibility of underinvestment in new capital in the electric sector over the next decade.

If, as Ms. Joe concludes, these changes are not temporary anomalies but rather fundamental changes in investor expectations, then that suggests lowering the ROE on transmission projects would be appropriate. However, as Ms. Joe herself notes, if the ROE is set too low (below the risk-adjusted rate that the market requires), it could lead “to under allocation of capital resources to the electric system.”[17]

Academic literature supports the conclusion that reliability suffers when regulatory regimes underincentivize new transmission. In Price-cap regulation and investment behavior: how real options can explain underinvestment, Thomas Nagel and Margarethe Rammerstorfer explored how regulation could lead to underinvestment in transmission under a hypothetical price cap regulatory scheme.[18] As part of the paper, they examined loss of load in six European countries and found that “countries with incentive-based regulatory schemes have a lower amount of unavailable electricity, whereas cap regulated countries such as Hungary, Ireland and Italy have a relatively high amount of unavailability.”[19] In their conclusion the authors note that “enhancing price-cap regulation with incentive-based components. . . results in an increase in investment” and that “it appears that there is less investment in countries with price-cap regulation.”[20] While the work by Nagel and Rammerstorfer does not directly address the impact on reliability of setting a low ROE for transmission investment, it demonstrates that if regulatory programs are not correctly structured, it can lead to lower levels of transmission investment and higher loss of load. In the context of the North American transmission system, it suggests that lowering ROEs has the potential to impact reliability.

The Commission may prefer to err on the side of setting ROEs high to achieve the reliability goals of the Federal Power Act, rather than attempting to perfectly match market conditions and risk underinvestment in the event that changing market conditions lead to a demand for higher equity returns. Simply put, setting the ROE too low could deter investors from making transmission upgrades, which could, in turn, create long-run economic and reliability concerns for ratepayers. For that reason, setting the appropriate ROE for new transmission now is an important issue that could have significant ramifications for the entire electricity sector in the decade to come.



The Authors:

The authors are with Berkeley Research Group (BRG), a leading global expert services and consulting firm that provides independent expert testimony, litigation and regulatory support, authoritative studies, strategic advice, and document and data analytics to major law firms, Fortune 500 corporations, government agencies, and regulatory bodies around the world. 


Michael Kline:

Barclay Gibbs:

Duncan Anderson:


Nagel, Thomas and Margarethe Rammerstorfer (2008/2009). “Price-cap regulation and investment behavior: how real options can explain underinvestment “, The Journal of Energy Markets 1(4): 23-45.

[1] Complaint of Martha Coakley, Attorney General of the Commonwealth of Massachusetts, et al. Challenging Base Return on Equity, Docket No. EL11-66-000 (filed Sept. 30, 2011), page 3.

[2] Ibid., page 17.

[3] Ibid., page 17.

[4] Prepared Direct and Answering Testimony of Commission Trial Staff Witness, Sabina U. Joe under EL11-66, page 5.

[5] Ibid., page 8.

[6] Ibid., page 11.

[7] Ibid., page 71.

[8] Summary of Testimony of Sabina Joe for the Commission Trial Staff, page 3.

[9] From MISO e-mail to E-RSC Working Group (August 5, 2011).

[10] SNL Financial LC (2013). The yield on ten-year Treasuries was 5.10 percent on April 25, 2002 and 1.88 percent on February 25, 2013. Accessed at:

[11] FERC, “Order on Proposed Tariff Revisions and Establishing Hearing and Settlement Judge Procedures,” Dockets ER12-91-000, ER12-91-002, ER12-92-002, page 24 (April 24, 2012).

[12] Initial Comments of the Commission Trial Staff Concerning Settlement, Dockets ER12-91-000, ER12-91-002, ER12-92-002, ER12-92-005, page 1.

[13] Motion Requesting Action on Complaint, Docket EL12-39-000, page 1.

[14] Morningstar. Estimates for SIC Code 4911.

[15] SNL. SNL Database of ROEs from Approved Rate Cases Since 2002. Accessed at:

[16] Federal Power Act, Section 219. Transmission Infrastructure Investment, 16 USC § 824s.

[17] Prepared Direct and Answering Testimony of Commission Trial Staff Witness, Sabina U. Joe under EL11-66, page 10.

[18] Price cap regulation differs from rate of return regulation. Under rate of return regulation, price is set with the intent of providing transmission owners with a given rate of return on invested capital. Under price cap regulation the regulatory goal is also to achieve a given rate of return on invested capital, but regulators only set a maximum price – allowing owners discretion to charge less under appropriate market conditions.

[19] Ibid., page 42.

[20] Nagel, Thomas and Margarethe Rammerstorfer (2008/2009). “Price-cap regulation and investment behavior: how real options can explain underinvestment “, The Journal of Energy Markets 1(4): 23-45, Page 42


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