Understanding the Impact of ROE
Transmission is a key component of the power grid, and continued investment to expand and modernize transmission is necessary to maintain a reliable supply of energy to Americans across the country. At a time when demand for electricity is growing at unprecedented levels due to data centers, electric vehicles, a reviving manufacturing industry, and more, investment in the power grid is more necessary now than ever before.
One variable that significantly impacts whether there will be sufficient investment in transmission development and modernization is the Return on Equity (“ROE”) set by the Federal Energy Regulatory Commission (“FERC”).
What is ROE?
Private investment is the main driver of transmission expansion and modernization. Investment leads to growth and innovation that would not otherwise happen; bringing in investment capital allows a transmission company to take on new, groundbreaking projects with higher capacity and longer distances. Without the ability to take on these innovative projects, the power grid would not be able to keep up with the electricity demands of modern-day society.
An adequate and stable ROE is what attracts private investment to the utility sector. Without an adequate and stable ROE, investors will be far less interested in investing in our nation’s power grid, leaving the reliability of the grid exposed.
A transmission company’s ROE, which is regulated by FERC, is the return a company is allowed to earn on investments in the transmission grid. This return compensates private investors for placing their investment capital at risk. FERC regulates this return by computing various financial models as part of an overall methodology to identify a “just and reasonable” ROE that is ultimately included in the rates customers pay. It is FERC’s duty to strike a balance between ensuring utilities earn a return sufficient to attract investment capital while also ensuring the American people are not being unfairly overcharged for their electricity usage.
Throughout the 1970s-1990s, there was very low investment into the transmission sector while the ROE for transmission companies was at inadequate levels. The 2003 Northeast blackout was a wakeup call, as approximately 50 million Americans lost power due to an unreliable, underinvested grid. Following this reliability breach, Congress passed the Energy Policy Act of 2005, which directed FERC to establish incentives for transmission investment. FERC ultimately adopted several incentives to help increase transmission companies’ ROE to ensure that proper growth and stabilization of the power grid can take place.
Over the last decade, the methodology employed by FERC for establishing ROE has been uncertain due to numerous legal challenges and the need to establish an adequate ROE in the context of changing financial markets. This has led to uncertainty around the return on investment for electric transmission, and as a result, investment in transmission infrastructure has been viewed by investors as increasingly risky.
Think about it: would you want to invest money in an industry where at any moment, the return could be less than expected due to changing regulations? Or would you prefer to invest in an industry where you have more confidence that the return on your investment will be adequate? Investors have choices, which is why regulatory certainty is so valuable.
The Impact Today
In October 2024, FERC ruled on the methodology used to develop an electric transmission company’s ROE, ending the decade-long period of uncertainty around the return on investment in transmission. This ruling provides needed regulatory certainty to spur transmission investment at such a critical time for the power grid.
As new demands are placed on the grid, a predictable and transparent regulatory environment helps support our nation’s energy needs and provide the American people with reliable, safe, and affordable power.
FERC’s decision helps ensure continued investment in the transmission grid and allows transmission companies to do their job: maintaining and growing a reliable electric system. Our work is not over but this is a step in the right direction to ensure the regulatory landscape enables, rather than hinders, an efficient and economically sensible buildout of the grid.
