America relies on a strong and secure electric transmission grid. From integrating and supporting more renewable energy sources, to balancing out power plant retirements, to meeting a growing list of mandatory reliability standards and protecting against cyber attacks, the numerous benefits of a robust transmission network are undisputed, and the nation’s investor-owned electric companies continue to invest to realize them for the benefit of their customers.
Since 2001, Edison Electric Institute (EEI) members’ year-over-year transmission investment has more than doubled from US$5.8 billion in 2001 to $14.1 billion in 2012. Looking ahead, the industry is moving forward to devote even more.
Reducing Transmission Returns
EEI’s 2013 “Transmission Projects: At A Glance” report highlights more than 150 planned transmission projects, totaling about $51.1 billion (nominal dollars) planned through 2023. These projects do not include investments in transmission upgrades or replacements to existing facilities, which run several billion dollars annually. Although the proposed investment numbers are significant, the Brattle Group estimates that $240 billion to $320 billion will be needed through 2030.
Yet, even with this clear need for greater transmission investment, many electric companies are concerned about a movement to have federal regulators significantly reduce their returns on equity (ROE) for transmission investment. With interest rates at historic lows, some state officials, environmental groups and other stakeholders have advocated for a narrow, mechanistic application of the Federal Energy Regulatory Commission’s (FERC’s) preferred discounted cash flow (DCF) financial model for determining authorized returns. This can significantly reduce existing base transmission ROE by 100 to 200 basis points, to around 9% — an amount insufficient to attract the substantial capital investment for transmission.
Balancing Short- and Long-Term Needs
In its white paper, “Transmission Investment — Adequate Returns and Regulatory Certainty Are Key,” EEI argues that to continue to attract capital for transmission investment, FERC should balance the need to promote investment in long-term infrastructure assets such as transmission with the short-term, cyclical movements in the capital markets.
In the past, FERC has adjusted its regulatory methodologies to reflect market realities to ensure that ROE remain within the range of reasonableness. It is critical now that FERC reaffirm its commitment to needed transmission investment.
Facing the Risks of Transmission Investment
The challenges being raised, however, fail to demonstrate that the risks of developing transmission have somehow lessened. Opposition to building new transmission facilities never seems to abate. Indeed, with more stakeholder involvement in regional decision making and more competition, the risks of building transmission now seem greater than ever.
Compared to other assets, transmission investments are risky and require long lead times for the planning process and stakeholder involvement. They also often face extensive litigation on siting and related issues; in addition, cost recovery can be challenging.
Capital markets are highly sophisticated, so if returns on electric transmission infrastructure are not sufficient and stable, investors will avoid such investments and will seek better and more stable returns elsewhere. For example, a review of FERC’s historical decisions indicates that, in 2011, FERC’s approved ROE for natural gas pipelines were 264 basis points higher, on average, than those of electric companies and present alternative investment opportunities.
Recognizing the Need for Change
Given the risks and challenges associated with developing large-scale transmission, it is critical that FERC take the opportunity to consider the practical and necessary adjustments to its DCF methodology. FERC should make these practical adjustments to its ROE methodology immediately to better align it with current market conditions and assure reasonable returns. Furthermore, these changes have the benefit of being relatively simple and straightforward and, therefore, should not require a significant overhaul of the DCF methodology.
Finally, FERC needs to consider the long-term implications of compromising its policy of promoting transmission investment. The record shows that electric companies responded to FERC’s policy of promoting transmission by increasing their investments in this area significantly to the benefit of wholesale markets, reliability, renewable integration and customers nationwide. In addition, numerous utilities pursued the development of wholesale energy markets by joining ISOs and RTOs per FERC policy. For FERC to backtrack now would signal to the companies and investors that its policies lack stability and durability.