FERC Toughens Policy on Transmission Rate Incentives

On December 30, 2010, the Federal Energy Regulatory Commission (FERC) announced in two orders that it was changing its policy on granting incentive-based rate treatment when presented with an application requesting incentives for multiple transmission projects.  One order applied to the application of Public Service Electric & Gas Company (PSE&G); the other applied to Oklahoma Gas & Electric Company (OG&E).  In each situation, the utility presented an application covering multiple transmission projects that had all been approved by the planning process of a regional transmission organization as being needed for either reliability or economic purposes, or both.  Perhaps coincidentally, the aggregate investment by each utility in its group of projects was projected to be just under $1 billion.  Both applications sought approval of: (a) the right to include 100% of construction work in progress (CWIP) in rate base as construction continued; and (b) the right to recover abandoned plant costs if the utility found it necessary to terminate any or all of the transmission projects before completion, as well as related regulatory requests.  Neither application sought increases in the allowed return on equity.  While FERC found in both cases that the applications met the threshold requirement of Order No. 679, i.e. that the projects increased reliability or decreased congestion or both, both utilities failed with respect to certain of the projects to meet the “nexus” requirement of Order No. 679.  Specifically, the utilities failed to provide sufficient information about each individual project that tied the need for the incentives to the particular risks faced by each project.

OVERVIEW OF ORDERS AND FERC POLICY

FERC considered proposed tariff revisions submitted by PSE&G to implement requested transmission rate incentives for four projects.  The combined projects involved construction of approximately 124 miles of transmission lines, with an estimated total cost of $979 million.  OG&E submitted proposed tariff revisions to implement requested transmission rate incentives for eight projects.  The combined projects involved construction of 555 miles of new transmission lines at a cost of $936 million.  PSE&G and OG&E presented information on the regulatory challenges of gaining approvals for the projects, the construction and environmental challenges due to the length of the lines and their passage through sensitive areas, and the financial risks involved in the up-front cash expenditures required for all projects.  PSE&G and OG&E argued that the requested incentives would allow the utilities to recover financing costs before the projects entered into service, ensure adequate cash flow during the construction phase, and provide benefits to consumers.  PSE&G contended that including 100% CWIP in rate base would reduce the costs of its projects by $182 million.

After considering the proposals, FERC noted that there may be significant common risks and challenges faced by a utility in constructing multiple projects that would justify consideration of the group in a single application.  Thus, the group of projects could be deemed to merit incentive rate treatment in the aggregate, when they may not qualify for incentive treatment individually.  Under this new test, an applicant may demonstrate that a number of individual projects are properly considered to comprise a single project, in which case FERC will consider whether incentives are warranted for the single project under the nexus test.  In the absence of the justification of consideration of multiple transmission projects as a package, FERC announced that it will require each applicant to demonstrate a nexus between the incentive sought and the investment being made on a project-by-project basis.  Alternatively, a company may request incentives for numerous unconnected projects at the same time, but the company still must provide sufficient justification for why each project individually qualifies for incentives under the nexus test.  FERC found that neither PSE&G nor OG&E had met the test to justify incentives for their respective groups of projects in the aggregate.  The evidence that PSE&G and OG&E presented on the aggregate scope, effects, and risks associated with the combined projects was not sufficient to meet the nexus test for the individual projects, with the exception of several of the projects proposed by OG&E.

Commissioner Norris dissented in part from both orders.  He supported the majority’s decision to require that applicants provide more project-specific information to show that the incentives they propose are warranted, but disagreed with FERC’s refusal to include 100% of CWIP in rate base.  He noted that consumers will almost always benefit by granting 100% CWIP in rate base, which reduces the utilities’ revenue requirements and mitigates rate shock when the projects go into service.  The Commissioner argued that applicants should be allowed to demonstrate that a group of unconnected projects may, when considered together, merit incentive rate treatment that will benefit customers, as 100% CWIP would in these cases. 

IMPLICATIONS FOR APPLICANTS

These orders demonstrate that FERC will not grant transmission rate incentives based on a utility’s assertion that the group of projects will increase invested transmission capital by a substantial percentage.  Under its new policy, FERC will more closely scrutinize the evidence presented when applicants request incentives for multiple projects in a single application.  Applications must present evidence on the scope, effect, and the challenges or risks faced by the applicant for each individual project, unless the group of projects together comprise a “single project.”  The orders, however, provide little guidance on the process by which an applicant can demonstrate that separate projects should be considered as a “single project.”  It is not clear what type of evidence should be presented, nor if there is a threshold that must be met.