Item E-1: Commissioner Allison Clements Dissent Regarding Entergy Return on Equity (ROE)

Commissioner Allison Clements Statement
May 20, 2021
Docket Nos. ER13-1508-001, et al.
Order: E-1

I agree that today’s order reasonably applies the Commission’s return on equity (ROE) policy established in Order 569-A to the facts in these proceedings.  I dissent because I do not believe our existing methodology for setting ROEs in jurisdictional cost-based rates fully carries out our consumer protection responsibility under the Federal Power Act.  As a result, I cannot conclude that the ROE established in these proceedings is just and reasonable.    

The common refrains on ROE policy are that setting ROEs is more art than science, and rigid adherence to any one or more financial models does not ensure satisfaction of the capital attraction standard the Supreme Court established in its Bluefield[1] and Hope[2] decisions.  I generally agree with these perspectives, but it is also true that after many years of debate, litigation, and careful consideration by this Commission, financial models remain the tool we have identified as appropriate to evaluate the justness and reasonableness of ROEs.  So, while I agree that we must scrutinize any ROE produced by the financial models we employ, our initial choices as to which models to employ and how to calibrate them remain of utmost importance.

The Commission in recent years undertook an exercise to evaluate anew its methodological approach to ROE across two series of proceedings involving transmission service ROEs for the New England and Midcontinent Independent System Operator, Inc. transmission owners.  In the latter proceeding,[3] the Commission initially established a new ROE policy in 2019 in Opinion No. 569.  While I may not agree with all of the methodological choices in that policy, I believe it moved the Commission in the right direction on ROE.  It identified two models, the longstanding Discounted Cash Flow model, or DCF, and the Capital Asset Pricing Model, or CAPM, as worthy of inclusion in our ROE analysis based on strong record evidence of their utility and widespread use by the financial community.  It also calibrated those models through myriad small, but important, decisions.  While no methodology is perfect, the Commission clearly wrestled with the tough questions and reached what it felt was a reasonable outcome.

Unfortunately, much of this was to be undone on rehearing in the same proceeding.  Opinion No. 569-A made a number of changes, all of which are difficult to understand based on consideration of the same record that led to Opinion No. 569.  The most notable change was the addition of the Risk Premium model, on which the Commission had levied substantial criticism in Opinion No. 569.  That criticism included (1) redundancy with the CAPM and over-emphasis on risk premium-based models (given that CAPM is also a risk premium model);[4] (2) potential distortionary effects of using settlement ROEs as inputs to the Risk Premium model;[5] (3) circularity because the Risk Premium model results are largely a function of past Commission ROE decisions;[6] (4) insufficient evidence that investors actually rely on the Risk Premium model to make investment decisions;[7] (5) less predictability and transparency than DCF and CAPM;[8] and (6) difficulty with contemporaneity of study periods and ROE application from prior ROE decisions.[9]

In addition to adding the Risk Premium model, Order No. 569-A also made a series of methodological changes to the DCF and CAPM, such as modifying the composite growth rate approach within the DCF and relaxing the high-end outlier test, without, in my view, justification for departure from the underlying order.  The effect of these modifications on the resulting ROE will naturally change over time as market conditions change, but in the aggregate they can be significant.  They also appear clearly aimed at raising ROEs.  Again, I appreciate that the Commission is obliged to consider not merely the methodology we apply but ultimately the resulting ROE number.  But to the extent the Commission finds the ROE produced by our models not just and reasonable, transparency and predictability dictate that we explain why we find the ROE lacking—including the criteria we have applied in reaching that conclusion—rather than altering methodological details to reach an alternate result.[10]

I highlight these details to explain my uneasiness with our current approach to ROE.  Today’s order relies on a strict application of the in my view erroneous methodology adopted in Opinion No. 569-A.  Given my skepticism that this methodology reflects a reasonable approach that balances utility and consumer interests, I cannot conclude that the resulting ROE in this proceeding is just and reasonable.[11]

The proceeding before us today addresses the ROE embedded in cost-based rates for energy and capacity sales among the Entergy affiliates.  But because the Commission’s ROE policy applies equally—and to greater overall effect—to transmission rates, I approach this issue with an eye toward that context as well. 

In the coming years, our nation’s electric grid will require tremendous investment in transmission.  The need is driven by the changing economics of power supply and flexible demand technologies; local, state, federal, utility and corporate decarbonization policies and commitments; and the need to upgrade aging electric infrastructure and design a more resilient grid in the face of increasing instances of extreme weather.  All credible studies suggest that this transmission investment is necessary and can ultimately be a net win for consumers.  Smart transmission investment enhances reliability and resilience, unlocks low-cost power sources, allows more efficient use of existing infrastructure, and minimizes the cost of meeting changing customer demand and public policies. The order of magnitude of transmission investment required to achieve these outcomes is unprecedented, which translates into a massive opportunity for utilities and transmission developers.[12]  But the value proposition for consumers is in no small part dependent on this Commission’s rigorous scrutiny of the rates charged for transmission service, of which ROE is a central component.

Given this context, I believe the Commission must revisit its existing ROE policy.  I appreciate that this policy has been unsettled for years, a state that increases investment uncertainty and extends litigation.  To be sure, I share the goal of a stable ROE policy that will speed rate proceedings and allow for timely ROE updates as market conditions change.  But we should not double down on the desire for near-term stability to strong detriment of consumer protection, and I worry our current ROE policy does just that.

For these reasons, I respectfully dissent.