On April 11, 2019, in FERC ER19-1553, Southern California Edison (SCE) filed changes to its transmission formula rate due to dramatic material changes to SCE’s regulatory and financial conditions that have occurred since SCE filed its currently effective Formula Rate (the “Second Formula Rate”) in October 2017. Beginning in December 2017, several wind-driven wildfires impacted portions of SCE’s service territory and caused substantial damage to both residential and business properties and service outages for some of SCE’s customers. California has unique inverse condemnation laws. These laws provide that an electric utility will be held strictly liable for property damages and legal fees if its facilities are the substantial cause of a fire regardless of fault and even if the utility was fully compliant with all applicable rules and regulations and acted reasonably. As a result of these laws and recent fires, SCE is exposed to significant potential wildfire damage claims. In 2017, the California Public Utilities Commission (“CPUC”) issued a decision holding that it could preclude a utility from recovering these court-assigned costs if it finds the utility was not prudent, even if the source of the alleged imprudent conduct was not directly the cause of the fire. The decision creates significant CPUC-related cost-recovery uncertainty and, as a result, SCE recently announced an accrual of a 2018 fourth quarter non-cash charge against earnings of $1.8 billion due to potential wildfire damages that would be dependent upon CPUC-approval.
SCE filed proposed revisions to its Formula Rate to account for the above risk in a manner sufficient to attract the capital necessary to provide safe and reliable electric service. SCE requested a base ROE that is founded on, and fully supported by, FERC’s established ROE policies. SCE applied the four financial models utilized in the Commission’s October 2018 Order Directing Briefs in the New England Transmission Owner (NETO) ROE cases - which includes the Discounted Cash Flow (“DCF”) model, the Capital Asset Pricing Model (“CAPM”), the historical Risk Premium model, and Expected Earnings—and determined the ROE that is required to reflect the significant non-wildfire regulatory and legislative risks that SCE faces as a public electric utility operating in California. That base ROE is 11.12%. SCE also analyzed how the additional risks it faces as a result of wildfires affect SCE’s ability to attract capital. While these wildfire risks required additional analysis to complement the conventional application of the four financial models, this additional analysis is fully consistent with FERC’s rationale in the NETO Order Directing Briefs because this analysis connects SCE’s circumstance and its unique risks with the capital attraction standard that underlies the Commission’s ROE policies. SCE accordingly requests an increase to its base ROE 0f 6.0% to account for the asymmetric wildfire risk (total base ROE of 17.12%). SCE also asks that, in determining its capitalization and costs of capital, the charge to earnings described above ($1.8 B) be removed from its common equity balance along with any debt incurred related to the wildfire liabilities. SCE’s proposed retail transmission revenue requirement for calendar year 2019 (effective June 12, 2019) is $1,328,294,741, which compares to the current amount for calendar year 2018 of $1,038,486,906.
Recently FERC has issued orders directing TOs to eliminate the two-step approach for addressing ADIT in formula rates with projections. Previously, many TOs believed that the IRS required, for projecting ADIT balances, use of its proration methodology and then, in addition, use of the conventional 13-month averaging to that proration result. TOs thought the averaging was necessary in order to meet the IRS’ consistency requirements. In April 2017, the IRS issued a Private Letter Ruling (PLR) in which it clarified that the averaging, in addition to the proration methodology, was unnecessary. Thus TOs have been making filings to eliminate the averaging from the ADIT projection.
For the True-up calculation, all TOs have held that the IRS proration requirement does not apply to the calculation of the revenue to which the utility would have been entitled had it based its projected rate computation on what turned out to be the actual results for that period. The result is to ignore proration in the True-up calculation and reverse the impact of the application of the proration requirement embedded in the projected rate calculation (i.e., the true-up would be to a revenue number that did not reflect any proration). However, in the PLR, the IRS said that to make proration matter, the freedom from proration can only apply to the variations in the changes in the ADIT balance used in the True-Up component, not to the entire change in the ADIT balances used in that computation. The IRS stated that the True-Up component is determined by reference to a purely historical period and, accordingly, there is no need to use the proration formula to calculate the differences between projected ADIT balance and the actual ADIT balance during the period. In calculating the True-Up, proration applies to the original projection amount, but the actual amount added to the ADIT over the test year is not modified by application of the proration formula.
ATC proposed to FERC in EL18-157 not to apply the proration formula to the variances in the monthly ADIT balances but, instead, to apply its “normal” regulatory convention (a 13-month average) to those variances. ATC proposed to add the result of this calculation to the ADIT balance originally used in the calculation of the projected rate – that is, the prorated balance. In this way, ATC would preserve the effect of the proration requirement embedded in the projected rate, avoid applying proration to the differences between projected and actual ADIT balances and comply with the consistency rule with respect to those variances.
GridLiance and Certain MISO TOs take a different and more complicated approach in the True-up calculation. The differences attributable to over-projection of ADIT in the annual projection will result in a proportionate reversal of the projected prorated ADIT activity to the extent of the over-projection. The differences attributable to under-projection of ADIT in the annual projection will result in an adjustment to the projected prorated ADIT activity by the difference between the projected monthly activity and the actual monthly activity. However, when projected monthly ADIT activity is an increase and actual monthly ADIT activity is a decrease, actual monthly ADIT activity will be used. Likewise, when projected monthly ADIT activity is a decrease and actual monthly ADIT activity is an increase, actual monthly ADIT activity will be used.
Please contact Dumais Consulting if you want to see examples of both approaches.
In an Order issued by FERC on January 29, 2019 in ER18-2342, FERC accepted GridLiance Heartland’s proposed formula rate and protocols, including the MISO 10.32% base ROE, a 50 basis point RTO Participation Adder, and the Regulatory Asset and Hypothetical Capital Structure incentives, and granted GridLiance Heartland’s request for authorization to replicate its Formula Rate and incentives granted in this docket for future affiliates formed to operate in MISO. Prior to GridLiance using the formula rate (currently it does not own any transmission assets in MISO), it must submit a filing pursuant to section 205 to include the Formula Rate in the MISO OATT. FERC allowed GridLiance to include an income tax allowance in the proposed Formula Rate, but suspended the issue, subject to refund, and set the matter for hearing and settlement judge procedures. In fact, FERC initiated a Section 206 investigation (EL19-29) on the appropriateness of GridLiance’ s inclusion of an income tax allowance in two other formula rates - GridLiance High Plains and GridLiance West. FERC is concerned that including an income tax allowance in these Formula Rates may cause the same double recovery of income taxes described in United Airlines (DC Court of Appeals) and in FERC’s Revised Policy Statement on income taxes.
Below are items discussed by FERC in the Order that are worthy of individual summary:
1. FERC stated concern over the cost of debt included in the Formula Rate during the period when GridLiance Heartland may acquire construction financing but prior to acquiring any long-term debt. FERC found GridLiance Heartland’s proposal to use a proxy debt rate for the period in which GridLiance Heartland does not hold any debt just and reasonable, but also found that GridLiance Heartland’s Formula Rate should track actual costs to the extent possible. Accordingly, FERC required that GridLiance Heartland revise its Formula Rate to provide for recovery of actual short-term debt from construction financing, as necessary, during the period that GridLiance Heartland acquires construction financing but prior to issuing long-term debt.
2. FERC found GridLiance Heartland’s affiliate cost allocation description acceptable for informational purposes with the understanding that GridLiance Heartland must provide in its annual update and informational filings details describing the affiliate cost allocation used for the applicable rate year and any changes from the previous year, as well as the magnitude of such costs, and that any interested party will have the chance to review the affiliate cost allocation methodology and associated costs during the information exchange and challenge periods. GridLiance Heartland will bear the burden of proof to demonstrate that its affiliate cost allocation methodology and associated costs are just and reasonable.
3. FERC granted GridLiance Heartland’s request for authorization to use a hypothetical capital structure of 60% equity and 40% debt, as well as GridLiance Heartland’s proposal to adopt its actual capital structure, capped at 60% equity, once it has any assets in service. FERC understands that nonincumbent transmission developers have a particular need for the Hypothetical Capital Structure Incentive because it establishes certain financial principles that incumbent transmission owners currently have in place but that remain undetermined for nonincumbent transmission developers and that granting this request furthers the policy goal of facilitating the participation of nonincumbent transmission developers in the Order No. 1000 transmission planning processes, thereby encouraging competition.
4. FERC granted GridLiance Heartland the Regulatory Asset Incentive as nonincumbent transmission developers bidding on regional transmission projects in MISO’s competitive solicitation process must incur early pre-commercial and formation costs, but do not have a mechanism to recover these costs as they are incurred, as do incumbent transmission owners. FERC granted carrying costs, provided they would not result in a higher amount of interest than is allowed for construction expenditures that accrue in Allowance for Funds Used During Construction. FERC stated that GridLiance Heartland must make a section 205 filing to demonstrate that the pre-commercial and formation costs are just and reasonable before it includes them in rates and that GridLiance Heartland must establish that the costs included in the regulatory asset are costs that otherwise would have been chargeable to expense in the period incurred but were deferred consistent with the authorization granted herein.
 In the Policy Statement, FERC found that an impermissible double recovery results from granting a Master Limited Partnership (MLP) natural gas pipeline both an income tax allowance and a return on equity pursuant to the discounted cash flow methodology. FERC stated in the Policy Statement that it would address this issue for non-MLP partnership forms as those issues arise in subsequent proceedings. That is what they are doing here with GridLiance.
Republic Transmission, which is owned by LSP Power and Hoosier Energy Rural Electric Cooperative, filed a formula rate at FERC in ER 19-605. Republic Transmission was selected in a MISO competitive process to build a new 345 kV transmission line providing market efficiency benefits, to be constructed between the existing Duff substation in Indiana and the existing Coleman substation in Kentucky (the “Project”). The Project has an expected in-service date of June 2020.
The formula rate has some innovative approaches in order to incorporate the results of the competitive process. The formula rate includes:
FERC Addresses IRS Required treatment of accumulated deferred income taxes in electric transmission rates
In an order issued June 21, 2018, FERC instituted a section 206 proceedings to examine the methodology utilized by Ameren Illinois, Ameren Transmission of Illinois, and Northern States Power Company, for calculating Accumulated Deferred Income Tax (ADIT) balances in their projected test year or annual true-up calculations for their electric transmission formula rates. In a June 2018 Order, FERC explained that in light of the IRS April 2017 Private Letter Ruling, FERC undertook a review of Commission-jurisdictional transmission formula rates and identified Ameren, NSP Companies, and other transmission owners who currently use the two-step averaging methodology to calculate the ADIT component of rate base in their projected test year calculations or annual true-up calculations for their transmission formula rates. The two-step approach involves projecting ADIT balances using the prescribed IRS proration approach (Step 1) and then averaging the beginning and ending projected ADIT amounts from Step 1 (Step 2). FERC concluded that if the IRS’s proration methodology is applied to calculate ADIT balances in forward-looking formula rates, then the additional averaging step (Step 2) is not needed need to comply with the Consistency Rule (using same methodology to project tax expenses, depreciation expenses, ADIT and rate base). Thus, the two-step averaging methodology is not necessary to comply with the IRS Normalization Rules and results in understating ADIT balances and overstating rate base and revenue requirements. Several transmission owners, in addition to Ameren and Northern States (Public Service Company of Colorado, Southwestern Public Service Company, ALLETE, Montana-Dakota Utilities Co., Northern Indiana Public Service Company, Otter Tail Power Company, Southern Indiana Gas & Electric Company, International Transmission Company, ITC Midwest, Michigan Electric Transmission Company, American Transmission Company, TransCanyon DCR, Virginia Electric and Power Company, GridLiance and Southern California Edison) filed changes which FERC approved), or were ordered to file changes, to their transmission formula rates to eliminate the second step (averaging of the prorated balances).
For the orders, please click on the link below:
On November 15, 2018, FERC issued a Notice of Proposed Rulemaking (NOPR), a policy statement, and several orders implementing individual rate revisions and reductions to reflect the impact of Tax Reform in transmission formula rates. The NOPR (RM19-5-000) proposes to require each transmission provider with transmission rates under an Open Access Transmission Tariff , a transmission owner tariff or a rate schedule to revise those rates to account for changes caused by the Tax Cuts and Jobs Act. These proposed reforms are designed to address the tax law’s effects on the Accumulated Deferred Income Taxes (ADIT) reflected in their transmission rates. Under these reforms, all public utilities with transmission formula rates would:
· include mechanisms to deduct any excess ADIT from or add any deficient ADIT to their rate bases;
· include mechanisms in those rates that would raise or lower their income tax allowances by any amortized excess or deficient ADIT; and
· incorporate a new permanent worksheet into their rates that will annually track information related to excess or deficient ADIT.
All public utilities with transmission stated rates would determine the amount of excess and deferred income tax caused by the reduced federal corporate income tax rate and return or recover this amount to or from customers. Comments are due 30 days from when the NOPR is published in the Federal Register. Here is the link to the NOPR: https://www.ferc.gov/whats-new/comm-meet/2018/111518/E-1.pdf?csrt=13550044115908092740.
FERC also issued a policy statement (PL19-2-000) which provides accounting and ratemaking guidance for treatment of ADIT for all FERC-jurisdictional public utilities, natural gas pipelines and oil pipelines. The policy statement also addresses the accounting and ratemaking treatment of ADIT following the sale or retirement of an asset after December 31, 2017. Here is the link to the Policy Statement: https://www.ferc.gov/whats-new/comm-meet/2018/111518/E-1.pdf?csrt=13550044115908092740.
FERC also approved an accounting request from the Edison Electric Institute (AC18-59-000) related to recording a reclassification of any stranded tax effects from Tax Reform. Lastly, FERC acted on 46 of the Federal Power Act section 206 show-cause investigations initiated in March, in which the Commission directed certain public utilities whose transmission tariffs specifically reference tax rates of 35 percent to reduce their tax rates to 21 percent or show why they did not need to do so.
Dumais Consulting welcomes the opportunity to help entities with comments to FERC on the NOPR and in complying with the eventual requirements both for accounting and electric transmission in formula rates. Please contact Dumais Consulting at www.DumaisConsulting.com.
Dr. Paul Dumais
CEO of Dumais Consulting with expertise in FERC regulatory matters, including transmission formula rates.