IV. Discussion

A. Stipulations

During the course of hearings, the parties modified their positions so as to result in substantial agreement between the parties concerning nearly all of the issues in this application. For example, ORA agrees with Cal Water's estimates for customers, consumption, and purchased power, as well as most if its estimates for plant. These stipulated numbers are reasonable estimates and are reflected in the results of operations tables attached hereto.

Because the ROR and ROE are being fully litigated in Application (A.) 03-01-034, et al., Cal Water and ORA agreed it would be reasonable, as well as more efficient and less burdensome, to stipulate to interim cost of capital calculations for this proceeding pending resolution of A.03-01-034. These stipulations are 8.11% for an interim ROR and 9.32% for an interim ROE. The parties further agreed that, upon resolution of A.03-01-034, Cal Water's authorized ROR and ROE for that proceeding will be applied prospectively to the Redwood Valley District. The interim cost of capital would apply only to the Redwood Valley District and only to this application.

We agree that the interim ROE and ROR are reasonable to apply to this application. However, we will adopt these figures for use throughout this rate case cycle for this district only. Cal Water and ORA agreed to use the ROE and ROR adopted in A.03-01-034 for prospective use for this district, based on the assumption that the parties would fully litigate these issues in A.03-01-034. However, there is currently a settlement pending in that application. In settlements, the parties do not fully litigate the issues, but rather, make case-specific tradeoffs. We cannot determine on this record whether or not the tradeoffs made in A.03-01-034 are reasonable for this district. We therefore adopt an 8.11% ROR and a 9.32% ROE purposes of the test year and attrition year rate adjustments approved in this application.

B. Cost of Lucerne Treatment Plant and Upgrades to Coast Springs

Cal Water and ORA agree that the estimated costs of the new Lucerne treatment plant should not be included in rates in this decision. They anticipate that a low interest loan from the SDWSRF will fund the Lucerne project. DHS has the authority to approve eligibility for the loan while the Department of Water Resources (DWR), as the lending agency, actually approves terms and issues the loan.¹

Cal Water argues that the Commission should authorize it to establish a memorandum account to track the expenditures and capitalized interest for the Lucerne treatment plant as well as the costs of a backup generator, should one be necessary. According to Cal Water, a memorandum account is appropriate here because, ordinarily, this treatment plant would be included in rate base. To the extent Cal Water does not receive SDWSRF funds to cover the expenses, Cal Water believes it should be guaranteed recovery, and argues that a memorandum account is reasonable to protect Cal Water against the possibility that funding will not be available for all or part of the treatment plant.

ORA believes that the Commission should not establish a memorandum account at this time. ORA notes that the amount at issue for the Lucerne treatment plant is an estimated $1.3 million, or 51% of Cal Water's total proposed 2003 rate base for Redwood. ORA argues that DHS has issued the Lucerne project a priority "D" rating, which usually results in the issuance of funding. Thus, ORA believes the Lucerne project will be funded through the SDWSRF monies.² If not, ORA believes that Cal Water can file an application requesting an appropriate change to rates. ORA believes this is the more prudent course, given the large amount of the project.

We find that the costs of the Lucerne treatment plant can have a large impact on rates. It is probable that Cal Water will receive substantial, possibly full, funding from DWR. Cal Water can then file by advice letter to seek Commission approval for a rate adjustment to repay the DWR loan. If DWR does not approve the loan, Cal Water should file an application requesting increased rates to offset the increased rate base. In that way, the Commission would have current cost information, as well as information as to why DWR did not approve the loan, before making a decision that could severely impact rates.

For similar reasons, we reach the same result for upgrading the Coast Springs water treatment plant and drilling a new well. This project has also received a priority "D" rating from DHS.

Young argues that should SDWSRF funding for the Coast Springs and Lucerne treatment plants prove unavailable, Cal Water should bear the burden of proving that the cause of the denial was solely due to DHS or others. The argument is premature. Issues regarding ratemaking for these projects, if SDWSRF funding is denied, can be explored in an any application Cal Water may file to request such ratemaking.

C. Rate Design

The issue of the appropriate rate design for the Redwood Valley District was the most contested in this proceeding, because this is the first time these individual divisions have been combined into a single district, and thus, there is no precedent for the district's rate design.

1. Cal Water's Three-Rate Structure Rate Design Proposal

Cal Water advocates a three-rate structure rate design proposal. Under this proposal, four of the divisions would have the same rates, and two divisions (Lucerne and Coast Springs) would each have their own rate. Cal Water believes that a uniform rate design for Armstrong, Noel Heights, Rancho del Paradiso, and Hawkins is appropriate because these are geographically proximate divisions with relatively similar current rates.

Cal Water advocates that Coast Springs should have a separate rate design because a uniform rate design for all divisions would substantially lower the water rates of customers in Coast Springs. This could be a problem, according to Cal Water, because there is currently a water supply problem and a service moratorium in Coast Springs, and Cal Water is concerned that a substantial decrease in water rates would serve as an incentive for increased water use in that division. Cal Water disagrees with ORA that this potential issue can be adequately addressed, if necessary, by levying fines or by water rationing.

Cal Water also proposes that Lucerne have separate rate design because this would result in less of a rate increase for that division than would a uniform rate design. Cal Water objects to ORA's proposal that Cal Water have a uniform rate design but phase the Lucerne rates in over time. Cal Water estimates that the proposal would cause it to lose about $170,000 in revenues that it believes it should recover. Cal Water states that it has filed a general rate case for the Redwood Valley District at the earliest opportunity, given the acquisition history of these divisions,³ and therefore it should not suffer financially because a large increase in rates is currently necessary.

2. ORA and Intervenor Pareas' Uniform Rate Design Proposal

ORA and Pareas propose a uniform rate design throughout the Redwood Valley District because it has a relatively small number of customers (about 1,896) and the cost of service is similar. ORA states that in order to effectively spread costs across such a small customer base, the Commission should not exclude any specific area from the rate base calculation. To do so, according to ORA, would cause the remaining customers to experience larger fluctuations in rates.

ORA and Pareas also argue that the cost of service is similar for four of the six divisions, constituting 94% of the customers. The cost of service for the remaining 6% located in Noel Heights and Rancho del Paradiso is higher because of recent upgrades to their systems. ORA and Pareas state that the remaining 94% of the customers will experience similar upgrades to their systems in the near future, which should result in similar costs of service for all customers, further justifying a uniform rate design.

ORA concede that the Commission has criticized a uniform rate design when a district contains geographically diverse areas, citing Suburban Water Systems, D.03-05-078, 2002 Cal. PUC LEXIS 938 **43-44. However, ORA believes the factors listed above weigh in favor of a uniform rate design, notwithstanding the geographic diversity of the Redwood Valley District. ORA also recommends that the rates for Lucerne be phased in over four years because Cal Water has never sought a rate increase for Lucerne until now, and therefore did not keep up with its increasing revenue requirement in Lucerne by filing more frequent rate cases or a rate case sooner.

ORA and Pareas agree that Coast Spring's rates will decrease under a uniform rate design, but argue that there is no evidence on the record to prove a current or future water shortage. ORA submits that the existing moratorium on additional connections serves to protect Coast Springs from increased consumption. Also, ORA argues that should Cal Water encounter increased usage as a result of decreased rates for Coast Springs, it could curtail usage to current amounts, institute a water conservation campaign, or implement penalties for overconsumption as a last resort. ORA and Pareas believe a uniform rate design is thus reasonable for Coast Springs, which is currently bearing a disproportionately high percentage of the costs.

3. Intervenor Young's Separate Rate Design Proposal

Young believes that Cal Water should employ a separate rate design for each division, and that Cal Water similarly should maintain separate accounting. His recommendation is based on equity, the unique characteristics of each division, and the various financial and physical challenges each division

faces. Young believes that a uniform rate design has merit and should be evaluated again in Redwood Valley's next general rate case.

Young notes that he is an intervenor with interests in the Coast Springs service territory, yet is recommending a separate rate design for each division, even though he would receive a financial benefit with a uniform rate design. Young believes that it is more equitable to pay the rates that result from the conditions in the area, rather than to pay based upon the arbitrary formation of this diverse district.

4. Discussion

We begin with the following table comparing the effect on the average monthly bill of implementing each of the rate design proposals.⁴

Uniform Rate Design⁵

Existing Rates At 2004 Rates

	Service Charge	Quantity Charge	Av. Monthly Bill		Service Charge	Quantity Charge	Av. Monthly Bill
Armstrong	19.95	1.82	$42.87		16.30	2.6231	$47.09
Coast Springs	30.48	6.18	$53.34		16.30	2.6231	$32.37
Hawkins	23.00	2.01	$43.70		16.30	2.6231	$43.32
Lucerne	12.90	1.17	$27.33		16.30	2.6231	$48.78
Noel Heights	19.95	1.82	$32.76		16.30	2.6231	$33.37
Rancho Del Paradiso	29.65	1.85	$42.59		16.30	2.6231	$32.48

Separate Rate Design

Existing Rates At 2004 Rates

	Service Charge	Quantity Charge	Av. Monthly Bill		Service Charge	Quantity Charge	Av. Monthly Bill
Armstrong	19.95	1.82	$42.87		19.70	2.55185	$49.79
Coast Springs	30.48	6.18	$53.34		12.80	4.58405	$36.12
Hawkins	23.00	2.01	$43.70		21.80	2.9458	$52.14
Lucerne	12.90	1.17	$27.33		14.30	2.1942	$43.18
Noel Heights	19.95	1.82	$32.76		32.60	8.6712	$81.72
Rancho Del Paradiso	29.65	1.85	$42.59		35.00	11.1667	$87.07

Three-Rate Structure Rate Design

Existing Rates At 2004 Rates

	Service Charge	Quantity Charge	Av. Monthly Bill		Service Charge	Quantity Charge	Av. Monthly Bill
Armstrong	19.95	1.82	$42.87		23.40	3.5948	$63.71
Coast Springs	30.48	6.18	$53.34		12.80	4.5841	$36.12
Hawkins	23.00	2.01	$43.70		23.40	3.5948	$60.43
Lucerne	12.90	1.17	$27.33		14.30	2.1942	$43.18
Noel Heights	19.95	1.82	$32.76		23.40	3.5948	$45.62
Rancho Del Paradiso	29.65	1.85	$42.59		23.40	3.5948	$43.66

We adopt the three-rate structure rate design for this proceeding. Under this structure, Armstrong, Hawkins, Noel Heights and Rancho del Paradiso will have a uniform rate design structure and Lucerne and Coast Springs will each have a separate rate design. This makes sense geographically, because the four areas we combine for rates are all geographically proximate. Also, Armstrong and Noel Heights' rate design has been uniform in the past, prior to Dominguez acquiring these divisions. (See D.98-11-018, 82 CPUC2d 658.) Therefore, a separate rate design for each of the Sonoma County divisions would change current practice with respect to Armstrong and Noel Heights.

Located in Marin and Lake Counties respectively, Coast Springs and Lucerne are more geographically isolated from the rest of the divisions and have unique issues. If we directed a uniform rate design, the average monthly bill in Lucerne would increase by about 78% as opposed to 59% at the current increase. ORA would address this problem by phasing in rates over the rate case cycle. However, at the end of the four-year phase-in, Lucerne customers would still pay the higher amount, which we do not believe is necessary at this time.

However, we see merit in a uniform rate design proposal in the future, and direct Cal Water to explore this option in its next rate case application.

D. Attrition Adjustment

Cal Water believes that it should receive an attrition adjustment for 2005 and 2006, arguing that the Commission's current Rate Case Plan, set forth in D.90-08-045, 37 CPUC2d 175, 187-188, expressly authorizes utilities such as Cal Water to seek increases in rates for non-test years through attrition filings. Moreover, according to Cal Water, the rates in the Redwood Valley District are currently too low to provide for a reliable and safe water supply, and its estimated attrition increases for 2005 and 2006 are lower than the increases for test years 2003 and 2004. Cal Water concedes that significant, non-recurring expenses, such as the Lucerne and Coast Springs water treatment plants, should not be factors included in any attrition request.

ORA believes that the rate case plan does not guarantee an attrition adjustment, but rather, merely permits a utility to apply for one. ORA further states that the underlying attrition policy for all types of utilities is similar, and this particular case does not merit an attrition adjustment. ORA argues that the Commission began to rely on the attrition adjustment in the late 1970s and early 1980s to protect utilities from extraordinarily high inflation and the general economic volatility where the normal productivity gains of the utility could not keep up with the cost of inflation. Because this is not the current situation, ORA believes attrition is not warranted here. Finally, ORA agrees with Cal Water that significant non-recurring expenses should not be included as factors in any attrition request, should the Commission authorize it.

Intervenors Pareas and Young agree with ORA that an attrition increase is not warranted in this case. Young argues that there are opportunities for Cal Water to either increase revenues or decrease costs in attrition years, including efficiency savings and increased usage or customers if the Coast Springs moratorium is lifted.

We will permit Cal Water to file for attrition adjustments for years 2005 and 2006. The prior owners of the divisions that now make up the Redwood Valley District did not routinely file general rate cases with the Commission. This is one of the reasons that there is a substantial rate increase for certain divisions at this time. In a choice between two options, we would prefer that necessary rate increases be small and more frequent, rather than very large and infrequent, so that customers and the local economy have the opportunity to adjust to the necessary increased rates.