Court Tells FERC to Reconsider Incentive Adder for RTO Membership

A federal appellate court has determined that the Federal Energy Regulatory Commission (FERC) had been issuing certain California electric utility transmission rate decisions in a rote or routine manner without adequate reasoning to back them up.

The court thus moved to return the proceedings to the FERC for further deliberations. The two FERC orders at issue pertained to Pacific Gas & Electric Company (PG&E) and the utility’s transmission tariffs for 2016 and 2017. For each year, the FERC, stating that it was a matter of long-standing practice under Order 679, had permitted the company to include a 50-basis-point adder to the return-on-equity (ROE) component of its transmission rates to account for the utility’s membership in the regional transmission organization (RTO) that oversees California’s grid, the California Independent System Operator (CAISO).

However, the California Public Utilities Commission (PUC) for a number of years has objected to FERC’s authorization of such adders for PG&E and other similarly situated investor-owned utilities (IOUs) in the state, saying that the construct created in Order 679 for the adders was inapropos in California. The state commission expounded that the adder measure was designed as an incentive mechanism for IOUs to join and remain in RTOs and/or ISOs. But in California, the PUC argued, participation in CAISO is mandatory under state law, such that no incentive adjustment to ROE is necessary. In comportment with the terms of the Energy Policy Act of 2005 (EPAct), the FERC in 2006 had promulgated Order 679, which crafted the ROE incentive device for transmission-owning utilities.

Notably, however, the adder was not identified as a “generic” adder that would be automatically applicable on a uniform basis nationwide. Rather, the adder was designed to be awarded on a case-by-case basis after review by the FERC. According to the California PUC, though, the FERC over the years had developed a pattern of considering utility proposals for the ROE adders on a routine basis, authorizing such upward adjustments to ROE for utilities year-after-year, regardless of whether the applicant utility had shown any true justification for the adder. The state commission estimated that incentive adjustments were costing consumers in California millions of dollars in transmission costs that they should not have had to shoulder.

In siding with the California commission, the U.S. Court of Appeals for the Ninth Circuit ruled that the FERC was misinterpreting its own order. The court held that Order 679 could not be construed as “justifying summary grants” of incentive adjustments. The court stated that FERC’s recent pronouncements on the ROE adders appeared to be an attempt to transform the provisions in Order 679 into carte blanche for a generic adder mechanism. From the court’s perspective, Order 679, at least as currently applied by the FERC, is clearly at odds with EPAct. In arriving at that conclusion, the court rejected the FERC’s argument that EPAct envisioned the adder as being appropriate for ongoing membership in an RTO or ISO, not just initial joinder with such an organization.

The court said that the FERC’s emphasis on continued membership in an RTO/ISO for purposes of warranting an adder was misplaced, especially in a jurisdiction like California, where participation in CAISO is not discretionary on the part of regulated utilities. The court seemed to accept the California PUC’s position that no ROE adder is required in that state in order to motivate a utility to join CAISO since state law prescribes such membership as mandatory. The court asserted that even if Order 679 had been crafted with the idea that membership in all RTOs/ISOs would be voluntary, the FERC should not have disregarded the ISO legal standards peculiar to California.

Nevertheless, the court decided to remand the PG&E cases back to the FERC. The court explained that while there did not appear to be a rational basis for the 50-basis-point incentive adjustment for PG&E in light of California’s ISO structure, there could be other factors that would weigh in favor of an adder. Addressing that point, however, the court indicated that the FERC’s approval of an adder for PG&E was deficient in that it failed to detail the basis for the ROE adjustment. The court said that it is not enough for the FERC to simply grant an ROE incentive adjustment without tracing the way in which it calculated the adder.

Consequently, the court charged the FERC on remand with revisiting the PG&E adders and providing a firm basis for the calculation thereof. While the court’s decision focused primarily on substantive grounds, it also addressed a procedural issue raised by the FERC, under which the agency contended that the California PUC’s claims should be deemed moot because it had failed to seek rehearing of numerous other PG&E adder rulings that had been rendered prior to 2016 and 2017.

In dismissing the FERC’s arguments, the court pointed out that those earlier PG&E decisions were distinguishable from the more recent ones in that they were the product of settlement negotiations to which the PUC had assented. Given the settlement terms and the PUC’s consent thereto, the court found that the state commission had properly refrained from appealing the earlier ROE adders. By contrast, the court said, the latest PG&E adders had been awarded despite protests from the PUC, which prompted the state commission to seek rehearing before the FERC prior to filing suit in court.

Determining that the state commission had followed all proper procedure, appealing to the federal court only after its request for rehearing had been denied by the FERC, the court held that the lack of rehearing petitions in prior years did not preclude the PUC’s present filing. California Public Utilities Commission et al. v. Federal Energy Regulatory Commission and Pacific Gas & Electric Co., No. 16-70481, Jan. 8, 2018 (9th Cir.).