Overview
Overview
In its Notice of Proposed Rulemaking for Electric Transmission Incentives issued on March 20, 2020 (NOPR), the Federal Energy Regulatory Commission (FERC) proposes sweeping changes to its methodology for awarding return on equity (ROE) incentives for new transmission projects. In the NOPR, the Commission explains that since the issuance of Order No. 679 and its 2012 Policy Statement, significant changes have taken place in the electric power industry, such as changes in the resource mix, changes in load patterns, the issuance of Order No. 1000 relating to transmission planning and cost allocation, and challenges to maintaining the reliability of transmission infrastructure. These changes have caused FERC to reconsider its approach for evaluating transmission incentives. Principally, the NOPR proposes to:
- Shift away from awarding ROE economic incentives on the basis of the risks and challenges framework that has been used since Order No. 679 to a benefits-to-customers approach;
- Allow a 50 basis point ROE incentive for projects that provide reliability benefits above and beyond the requirements of the NERC reliability standards;
- Provide an incremental 100 basis point ROE incentive for certain advanced transmission technologies;
- Increase the ROE incentive for joining an RTO from 50 to 100 basis points;
- Cap transmission ROE incentives at 250 basis points rather than the top end of the zone of reasonableness;
- Eliminate the ROE incentive for independent transmission owners (transcos); and
- Retain the availability of non-ROE incentives, including abandoned plant cost recovery, CWIP, hypothetical capital structure, accelerated depreciation for rate recovery, and regulatory asset treatment.
These proposed increases in transmission incentive ROEs follows FERC's order last fall (Opinion No. 569) revising its base ROE methodology in a manner that would generally reduce base ROEs. That order remains subject to rehearing, while FERC's ROE Notice of Inquiry remains pending.
This alert focuses primarily on the first change proposed by the Commission – the shift in focus to project benefits rather than granting incentives on the basis of project risks and challenges. This and other changes that Steptoe’s Electric Practice Group view as representing the most significant shifts in policy and providing the most significant potential impacts on transmission development are detailed below.
Risks and Challenges versus Benefits Test
Congress mandated FERC to "establish, by rule, incentive-based…rate treatments for the transmission of electric energy in interstate commerce by public utilities for the purpose of benefitting consumers by ensuring reliability and reducing the cost of delivered power by reducing transmission congestion." 16 U.S.C. § 824s(a). Congress required that the rule promulgated by FERC "provide a return on equity that attracts new investment in transmission facilities." 16 U.S.C. § 824s(a).
In the NOPR, FERC explained that it has fulfilled its mandate in the past using a nexus test, which required a public utility to demonstrate that the total package of incentives it proposed was tailored to address the risks and challenges faced by the applicant in undertaking the project. Order No. 679, 116 FERC ¶ 61,057 at P 76 (2006). The nexus test was often viewed as onerous to meet, especially in non-RTO and ISO regions following the issuance of the 2012 Policy Statement in which FERC adopted a highly stringent approach for evaluating requests for transmission incentives. Under the 2012 Policy Statement, FERC required applicants for ROE incentives to demonstrate that the proposed project faced risks and challenges that were not already accounted for in the applicant's base ROE or through the availability of non-ROE incentives, such as construction work in progress (CWIP) or abandoned plant cost recovery. Following the issuance of the 2012 Policy Statement, FERC granted very few requests for ROE incentives and even in those cases, the level of the ROE incentives was limited. Thus, the NOPR represents a significant change in FERC policy designed to attract new transmission investments.
One of the principal policy changes proposed in the NOPR is moving away from the risks and challenges of analytical framework in favor of a benefits test, which FERC explained in the NOPR is intended to incentivize projects that more directly meet the statutory purpose of benefitting consumers through ensuring reliability or by reducing the cost of delivered power. An applicant can meet the benefits test for a project that costs in excess of $25 million in one of two ways: (1) by demonstrating the benefits exceed the costs by 3.98 times in the pre-development stage (eligible for one 50 basis point adder), or (2) by 5.17 times upon completion (eligible for another 50 basis point adder). In addition, a project can receive an additional 50 basis point adder if it is able to demonstrate significant and demonstrable reliability benefits above and beyond the requirements of the NERC reliability standards, and an incremental 100 basis point adder for advanced technologies that enhance reliability, efficiency, capacity, and improve the operation of new or existing transmission facilities.
Benefits Tests (Limited or Broad)
The proposed benefits test is intended to compare the economic benefits to the costs, and award incentives to those projects with the highest benefit to cost ratio. The particular method chosen, however, may prove controversial and too limited to achieve FERC's statutory mandates.
Benefits tests have been relied upon by the Commission to justify (and continue) ROE incentives for pre-Order No. 679 projects for some time, for example for the Path 15 Upgrade (W. Area Power Admin., 99 FERC ¶ 61,306, at 62,280 (2002)) and the San Francisco Trans Bay Cable (Trans Bay Cable LLC, 112 FERC ¶ 61,095, at P 24 (2005)). In addition, RTOs and ISOs employ various economic benefits tests to evaluate the selection of transmission projects within their regions. The Commission notes these various tests, for example, the California Independent System Operator Corporation (CAISO)'s case-by-case assessment of the benefits of a project under a wide range of potential economic benefits.
Instead of blessing the various net benefit models that different RTOs and ISOs employ, however, the Commission chose to place primary reliance on "adjusted production costs or similar measures of congestion reduction or certain other quantifiable benefits that are verifiable and not duplicative" that produce a defined benefit-to-cost ratio. The example FERC provided of an approved adjusted cost production model is one that reduces total transmission system cost (i.e., reduces system congestion) by an amount that justifies its cost. In other words, instead of blessing whatever benefits and models a region currently relies upon to approve transmission infrastructure, FERC is attempting to move to a uniform production cost model with a precisely defined benefit-to-cost ratio. The result is that if a region considers the dollar impacts of other economic benefits outside of transmission congestion, for example environmental benefits that reduce local capacity constraints (moving from solar and wind generation outside of a local load pocket and away from in-city fossil fuel generation), it is unclear whether these sorts of benefits may be considered in the future for possible economic incentive treatment. FERC notes it is open to comment on whether additional types of economic benefit measures should be considered and what range of benefits should be measured. RTOs, ISOs, and their stakeholders with valid concerns for their region would be encouraged to comment.
A major unanswered question is whether the incentives proposed for the limited projects contemplated is a proper balance to achieve FERC's statutory mandate to ensure a return on equity that attracts new investment in transmission facilities. FERC left unanswered why for projects that cost $25 million or more, providing a return on equity incentive to only projects that provide approximately four or five times the benefit to cost (and a much higher ratio for projects below $25 million) addresses this statutory mandate. Entities with valid and supported data that illuminate whether this will properly incentivize transmission infrastructure or instead increase the number of beneficial projects left in the engineering room dust bin would be encouraged to comment. The number of projects that can meet the reliability incentive and go above and beyond the NERC reliability requirements may inform whether the transmission project pie is increasing or decreasing with FERC's proposed balancing act.
If adopted, the benefits test may also drive developers to invest in only certain regions of the country. FERC has proposed a uniform benefits test, and states that it intends to impose a nationwide benefit to cost ratio for all transmission projects. Geography, however, may play an important part in a developer’s decision to build as the Commission’s own Appendix A, Table 1 shows, where the average approved project in certain regions far exceeded or failed (for instance in CAISO) the Commission's four to five times benefit-to-cost threshold. The Commission may not have adequately considered whether the benefits test and the particular benefits to costs ratio should be measured from the perspective of the nationwide grid, or rather region by region as transmission projects are currently selected and built.
Technology Incentive
The Federal Power Act requires FERC to incentivize transmission investment to "encourage deployment of transmission technologies and other measures to increase the capacity and efficiency of existing transmission facilities and improve the operation of the facilities." 16 U.S.C. § 824s(b)(3). FERC proposes to meet this statutory mandate by shifting from its current policy of considering the risks and challenges of incorporating advanced technologies to offering a separate incremental 100 basis point adder "for transmission technologies that, as deployed in certain circumstances, enhance reliability, efficiency, capacity, and improve the operation of new or existing transmission facilities." The rather broad definition of applicable technology is supported with examples (advanced line rating management, transmission topology optimization, and power flow control), and exclusions (transmission system assets traditionally associated with the transportation of electric power, such as power lines, power poles, capacitors, and other substation equipment).
Ultimately, FERC proposes to make a case-by-case determination of whether a technology meets its proposed definition. This case-by-case determination is likely to spawn litigation, but this may be unavoidable. Otherwise, FERC could potentially limit development of advanced technologies if it tries to define applicability too narrowly. In addition to meeting the required definition of advanced technology, the technology must meet the economic benefit-to-cost ratio outlined above. It is an open question, however, whether FERC's consideration of only production cost models and reduced transmission congestion in the calculation of the benefits-to-cost ratio adequately incentivizes technology that "increase capacity and efficiency…and improve operation" as required by Congress.
Incentivizing RTO and ISO Membership
The changes in policy proposed in the NOPR also appear intended to provide additional incentives to encourage RTO or ISO participation. The most obvious of those policy changes is the Commission's increase from a 50 basis points to a 100 basis points adder for membership in an RTO or ISO (whether voluntary or involuntary). In addition, in setting the benchmark for benefit studies as the adjusted production cost test employed by certain RTOs and ISOs, the Commission is leaving transmission owners that exist outside of RTO and ISO constructs with a major evidentiary hurdle in meeting the costs and benefits ratio standard that members of RTOs and ISOs will not face. While signaling that it is open to comment on the availability and accessibility of production cost tests in non-RTO or ISO regions, if adopted, the benefits test may drive transmission investment dollars away from non-RTO or ISO regions.
Cap on Incentives
FERC proposes to cap the total incentives to 250 basis points above the base return on equity, instead of limiting the total incentive ROE to the top end of the zone of reasonableness. This necessarily implicates the base level of returns on equity in FERC's statutory mandate to ensure new transmission investment through incentivized returns on equity. FERC's base return on equity policy has been recently amended in Opinion No. 569, and opposition from the investment community that this new policy unreasonably reduces base returns in recent capital market conditions have been loud and vociferous. Given that incentives are now tied to the base return on equity, the Commission’s statutory mandate to ensure new transmission infrastructure through a return on equity incentive is now inextricably bound up with the base return on equity policy and its perhaps depressed returns under recent capital market conditions. At the same time, FERC's Opinion No. 569 methodology generally appears to produce ROE incentive caps that are less than 250 basis points higher than the base ROE, so as long as that methodology remains in place, the NOPR proposal generally provides increased confidence that incentives, once granted, will not be taken away after the investment has been made. The NOPR also asks for comments as to whether applicants who previously received ROE incentives subject to the condition that the total incentive ROE must be capped at the top end of the zone of reasonableness should be allowed to request the removal of such condition and instead to replace it with a hard cap on the ROE incentives previously granted.
Comments on the NOPR are due 90 days after the date of publication in the Federal Register.
