By Doug Smith, David Yaffe, Rich Bonnifield, and Kevin Gallagher

On November 15, 2012, the Federal Energy Regulatory Commission (“FERC” or the “Commission”) issued a policy statement (“Policy Statement”) addressing applications for electric transmission investment incentives under Section 219 of the Federal Power Act.  The Policy Statement provides guidance and clarification on the Commission’s application of rate incentive policy, which is intended to encourage investment in transmission infrastructure while ensuring just and reasonable rates for electricity ratepayers.

BACKGROUND

The Energy Policy Act of 2005 added Section 219 to the Federal Power Act requiring FERC to adopt rules on incentive-based rates for transmission infrastructure investments.  On July 20, 2006, the Commission implemented Section 219 by issuing Order No. 679, which outlined policies and procedures for addressing incentive rate requests.  On May 19, 2011, the Commission issued a notice of inquiry seeking public comment on the Commission’s transmission incentives policies.  The Policy Statement results from the Commission’s review of comments received in response to the NOI.   

POLICY STATEMENT

In the Policy Statement, the Commission provides guidance and clarification on four transmission rate incentive issues.  Specifically, the Statement: (1) reframes the incentive rate “nexus test” and abandons the focus on the routine/non-routine distinction; (2) clarifies that applicants must take all reasonable steps to mitigate project risks, including application for risk-reducing incentives before requesting a ROE incentive adders ; (3) limits the applicability of an incentive ROE to the estimated cost of the project; and (4) clarifies that the Commission will no longer award a stand-alone ROE incentive for the use of advanced technology on the project.

Nexus Test.  The Policy Statement adopts a more rigorous application of the “nexus test” established in Order No. 679.  As refined in Order No. 679-A, the nexus test requires that requested incentives be “rationally tailored to the risks and challenges faced in constructing new transmission.”  In Baltimore Gas and Electric Company, the Commission modified the nexus test by concluding that the test is satisfied, and the project is deemed to face risks and challenges meriting the requested incentive(s), if the applicant demonstrates that the project is not routine.  In the Policy Statement, the Commission abandons the routine/non-routine analysis developed in BG&E and reframes the nexus test to focus on whether the total package of incentives requested is tailored to the project’s risks and challenges.

Risk-Reducing Incentives.  The Commission’s traditional ratemaking treatment allows for the recovery of a “just and reasonable” return on equity (“ROE”) to enable utilities to attract capital for transmission investment on reasonable terms.  Order No. 679 provided for an incentive ROE adder to attract new investment in transmission facilities and to account for risks and challenges not accounted for in the base ROE.  Order No. 679 also established certain other incentives to reduce a project’s financial and regulatory risks.  These include the inclusion of 100 percent of Construction Work in Progress (“CWIP”) in rate base, the recovery of 100 percent of pre-commercial costs as an expense or as a regulatory asset, and the recovery of 100 percent of prudently incurred abandoned plant costs.   Because those risk-reducing incentives may alleviate many, if not all, of the risks not accounted for in the base ROE, the Policy Statement clarifies that applicants seeking an incentive ROE must take all reasonable steps to mitigate project risks including the request for those other risk-reducing incentives.  

Incentive Return on Equity.  For those applicants requesting an incentive ROE together with the risk-reducing incentives, the Commission will apply its “total package analysis” to ensure that the effect of the risk-reducing incentives is appropriately accounted for.  The Policy Statement requires an applicant to make four showings to demonstrate that a project warrants an incentive ROE as a result of risks and challenges not addressed through either the base ROE or the risk-reducing incentives.  In particular, an applicant must:

• Identify the risks and challenges that are not accounted for in the base ROE or addressed through risk-reducing incentives;
• Demonstrate that the applicant is taking appropriate steps, and using appropriate mechanisms, to minimize project development risks.  The Commission specifically identified joint ownership arrangements as a means of diversifying financial risk across multiple owners and minimizing siting risks;
• Demonstrate that alternatives to the project have been, or will be, considered in either a relevant transmission planning process or another appropriate forum; and
• Commit to limiting the application of the incentive ROE to the estimated cost of the project.

The Commission highlighted that the type of transmission projects likely to warrant an incentive ROE are those that relieve chronic grid congestion and have a demonstrable cost-impact on consumers, address locational constrained generation resources, or facilitate grid efficiency and reliability through the application of new technologies.  This recitation was not intended to imply that other types of transmission projects could not obtain an incentive ROE.

Advanced Technologies.  The Commission’s existing policy considered the use of advanced technologies as part of the overall nexus analysis and as part of requests for a stand-alone incentive ROE.  Citing possible confusion from the different standards applicable in the two contexts, the Commission will no longer consider advanced technologies for purposes of a separate ROE incentive adder.  Instead, advanced technology deployment will contribute to the overall nexus analysis of project risks and challenges when an incentive ROE is sought.

IMPLICATIONS

The Policy Statement will apply on a prospective basis to incentive applications received after November 12, 2012.  The Statement signals that FERC intends to more critically review incentive rate applications, and particularly applications for incentive ROEs.  The Commission had already been moving in this direction in its case-specific orders over the past several years.  It remains to be seen whether the Commission’s implementation of the new Policy Statement will strike a workable balance that will effectively support development of critical infrastructure while protecting consumer interests. 

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