ReviewOfPhase2

• Set ALLOWTOPICVIEW = Main.ProgressiveStrategyGroup

• SCE40 -- SCE-40 SONGS OII Phase II Testimony Providing Ratemaking Proposal.

**Investment And Cost-of-Service Principles** In California, as in most jurisdictions, rates are determined by state regulatory commissions under cost-of-service principles that evolved from court decisions. The United States Supreme Court's opinions in *Bluefield* and *Hope* are seminal cases in this area. Prior to those decisions, a debate had taken place in the courts and before regulatory commissions over how to value utility assets when setting rates. In *Bluefield*, the Court held that denying utilities a "reasonable return" on the value of useful assets is unconstitutional. Clarifying this standard, the Court in *Hope* concluded in broad terms that utility revenues must be sufficient to cover both operating expenses and capital costs such as "service on the debt and dividends on the stock." *Hope* further held that utility assets should be valued at their original cost, rather than reproduction cost or fair market value, for the purpose of determining a utility's capital costs. In other words, the fundamental principle of rate regulation is that rates should be designed so as to produce sufficient revenue to enable the utility to recover its prudently incurred costs, including its investments, along with a fair rate of return on its investments. When an asset is retired before it is fully depreciated, it has been this Commission's practice to adjust the rate of return during the amortization of the value of the unrecovered investments. Consistent with these principles, the Commission should allow SCE to recover all prudently incurred capital investments in SONGS. To the extent the capital investment is associated with assets that remain used and useful to customers, this recovery should come in the form of depreciation expenses, taxes and authorized rate of returnfollowing the Commission's practice during normal operating conditions. For assets that are no longer used and useful to customers, the remaining net investment may earn a lesser return while being amortized on an accelerated basis. In regard to SONGS, Commission precedent and traditional cost-of-service ratemaking weighs in favor of allowing SCE to amortize the capital investments that are no longer used and useful over a 5-year period with a 5.54% rate of return to recover its contractual obligations from debt and preferred financings, as authorized in its capital structure. p6-28
Several key decisions demonstrate the Commission's historical ratemaking treatment of such assets. For example, in 1985, the Commission allowed Pacific Gas and Electric Company (PG&E) to recover its remaining capital investment after the utility retired its nuclear power plant at Humboldt Bay based on seismic concerns. \[D85-08-046 - not available on line\] Although PG&E was not permitted to continue earning a. return on this investment, the Commission explained that “[i]n the case of a premature retirement, the ratepayer typically still pays for all of the plant's direct cost even though the plant did not operate as long as was expected." More recently, the Commission allowed Golden State Water Company to recover its undepreciated capital investment in the Hill Street water facility, which the utility prematurely retired after receiving water quality violations from the California Department of Public Health \[D11-09-017\] From [A.09-08-004](http://docs.cpuc.ca.gov/PublishedDocs/WORD_PDF/FINAL_DECISION/119896.PDF)

On August 6, 2009, Golden State Watter Company (Golden State) filed this application requesting authorization to implement corrective measures to address water quality problems in its Bay Point Customer Service Area (Bay Point district). Golden State states that this application is in response to (1) a California Public Utilities Commission (Commission or CPUC) directive in its last general rate case (GRC) decision, Decision (D.) 08-01-043, to propose a means to fluoridate its water, and (2) an order from the California Department of Public Health in early 2008 to cease violating the total trihalomethanes (TTHM) Maximum Contaminant Level (MCL) in its drinking water. Recognizing that the method selected to address the TTHM issue in Bay Point district would impact the decision on how to address fluoridation, Golden State combined its analysis of the best options and on June 6, 2009 submitted Advice Letter (AL) 1295-W to the Commission's Division of Water and Audits (DWA). In its disposition of AL 1295-W, DWA stated that the relief requested went substantially beyond the directives of D.08-01-043 and Golden State must submit its request by formal application. \... Pg 7
\[Dr. Brunner\] states that in Golden State's last GRC in 2007, the customers already paid more for their drinking water than did customers in neighboring communities, and Golden State's drinking water was of poorer quality and contained higher levels of potentially cancer-causing disinfection byproducts. Now that Golden State is connected to the CCWD, it does not have to operate its existing water treatment plant and, because Golden State is instead purchasing treated water from CCWD, there should be economies of scale for both Golden State and CCWD. Due to the high poverty rate in the Bay Point area, Dr. Brunner considers it unjust that Bay Point families should be asked to pay disproportionately more for just bringing their drinking water quality up to the same level that neighboring communities already receive, with no added benefit. \... Pg 5
DRA recommends the following ratemaking treatment for Hill Street and the Contra Costa agreement. First, the Commission should take the remaining undepreciated balance for Hill Street out of rate base, and amortize this amount in rates over 10 years, because Hill Street is no longer used or useful, provides no benefit to ratepayers, and therefore does not qualify for rate base treatment (including earning a full rate of return). DRA also argues the Contra Costa agreement is neither a true capitalized lease nor an intangible asset as the Commission has analyzed those concepts in prior decisions. (DRA Opening Brief at 8--9.) Thus, DRA argues the agreement should not be included in rate base but instead should be treated as a rental agreement, and as with any other rental agreement, Golden State should recover the cost as an operating expense. (Id . at 9-10.) **Discussion** We will allow Golden State to recover its undepreciated investment in Hill Street and allow as a reasonable carrying cost the company's incremental cost of debt. We will also allow Golden State to amortize the prepayment of the capacity charge in the water purchase agreement and allow the same carrying cost. Golden State is not entitled to earn an equity return on either transaction.

RCL comment:

The Hill Street Water Facility could have been improved to eliminate the existing contaminants and add fluoridation. However, the cost/benefit analysis weighed toward getting water from the larger district, which it was recently combined with. Thus, there was no decision by Golden State that instigated the closure, no bad decision to install new pumps, for example, that were faulty and thus the closure. This fact should be brought out in cross examination. We reject Golden State's rate base proposal for both Hill Street and the Contra Costa agreement because it is unreasonable to burden ratepayers with a rate base treatment for two facilities performing or intended to perform the same function. Hill Street must be abandoned, and while it is reasonable to return the undepreciated balance, it is not reasonable for ratepayers to pay a return on equity as if Hill Street were still used and useful or capable of providing adequate service. Hill Street is neither.

From Wikipedia:
Trihalomethanes are formed as a by-product predominantly when chlorine is used to disinfect water for drinking. They represent one group of chemicals generally referred to as disinfection by-products. They result from the reaction of chlorine and/or bromine with organic matter present in the water being treated. The THMs produced have been associated through epidemiological studies with some adverse health effects. Many governments set limits on the amount permissible in drinking water. However, trihalomethanes are only one group of many hundreds of possible disinfection by-products---the vast majority of which are not monitored---and it has not yet been clearly demonstrated which of these are the most plausible candidate for causation of these health effects. In the United States, the EPA limits the total concentration of the four chief constituents (chloroform, bromoform, bromodichloromethane, and dibromochloromethane), referred to as total trihalomethanes (TTHM), to 80 parts per billion in treated water.

The Commission also applied these ratemaking principles in SCE's most recent General Rate Case (GRC) decision. In that decision, the Commission allowed SCE to recover its capital investments in two different assets that were retired before they were fully depreciated. First, the Commission allowed SCE to recover its entire remaining capital investment in the Mohave Generating Station, a coal plant that SCE had retired before the end of its depreciable life in light of costs and regulatory hurdles related to environmental issues. Likewise, the Commission allowed SCE to recover its entire remaining capital investments in electromechanical meter equipment that SCE retired early in order to make way for new meter technology.

- Supreme Court Case "Bluefield Water Works v. Public Service Comm'n - 262 U.S. 679 (1923)" \--

4. Rates which are not sufficient to yield a reasonable return on the value of the property used at the time it is being used to render the service of the utility to the public are unjust, unreasonable, and confiscatory, and their enforcement deprives the public utility company of its property, in violation of the Fourteenth Amendment. P. 262 U. S. 690. 5. A public utility is entitled to such rates as will permit it to earn a return on the value of the property it employs for the convenience of the public equal to that generally being made at the same time and in the same region of the country on investments Page 262 U. S. 680 in other business undertakings which are attended by corresponding risks and uncertainties, but it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or speculative ventures. P. 262 U. S. 692.

- Supreme Court Case "PC v. Hope Nat. Gas Co. - 320 U.S. 591 (1944)"

We held in the Natural Gas Pipeline Co. case that there was no constitutional requirement "that the owner who embarks in a wasting-asset business of limited life shall receive at the end more than he has put into it." 315 U.S. p. 315 U. S. 593.

- Supreme Court Case "FPC v. Natural Gas Pipeline Co. - 315 U.S. 575 (1942)"

But here, the 6 1/2% rate of return allowed on the amortized portion of the rate base includes compensation for the business risk, and the risk is an incident of the business in which the companies have hazarded their capital, and in which they propose to invest additional capital. The Commission declared it adopted this method to avoid the inequitable result which would follow if the companies were permitted to include in their charges to the public 6 1/2% on the amortized portion of the base, while treating it as earning only 2%. The Commission's conclusion that this is an appropriate method is supported by the evidence, and, in any case, it does not appear that it has deprived, or will deprive, the companies of property. Fair Rate of Return. The Commission found that "6 1/2 percent is a fair annual rate of return upon the rate base allowed," which it had characterized as "a generous allowance." The courts are required to accept the Commission's findings if they are supported by substantial evidence. § 19(b). We cannot say, on this record, that the Commission was bound to allow a higher rate. The evidence shows that profits earned by individual industrial corporations declined from 11.3% on invested capital in 1929 to 5.1% in 1938. The profits of utility corporations declined during the same period from 7.2% to 5.1%. For railroad corporations, the decline was from 6.4% to 2.3%. Interest rates were at a low level on all forms of investment, and among the lowest that have Page 315 U. S. 597 ever existed. The securities of natural gas companies were sold at rates of return of from 3% to 6%, with yields on most of their bond issues between 3% and 4%. The interest on large loans ranged from 2% to 3.25%. The regulated business here seems exceptionally free from hazards which might otherwise call for special consideration in determining the fair rate of return. Substantially all its product is distributed in the metropolitan area of Chicago, a stable and growing market, through distributing companies which own 26% of the investment of the Natural Gas Pipeline Company. Ninety percent of its gas is taken under contract by the Chicago District Pipeline Company. The contract runs until 1946 or until 1951, at the option of the companies. Under it, the District Company is bound to take, or at least pay for, 66 2/3% of the companies' gas, and performance is guaranteed by the three companies distributing the gas in Chicago. The danger of early exhaustion of the gas field was fully taken into account in the estimate of its life, and the companies' estimate was accepted. Provision for the complete amortization of the investment within that period affords a security to the investment which is lacking to those industries whose capital investments must be continued for an indefinite period. The companies' affiliation with the six large corporations which directly or indirectly own all the stock places them in a strong position for their future financing. The business is in the same position as other similar businesses with respect to increased taxation, inflation, and costs of operation. Other factors such as credit risks, risks of technological changes, varying demands for product, relatively small labor requirements, and conversion of inventory into cash compare more favorably. After a full consideration of all of these factors and of expert testimony, the Commission concluded that the prescribed reduction in Page 315 U. S. 598 revenues was just and reasonable, and that the 6 1/2% was a fair rate of return.