5. Discussion

We will address the petition's request to recover the significant difference in interest cost for earlier debt issued in 2008 as a matter of fairness and do not need to address whether there are material impacts on earnings or rates.2 We take note of DRA's procedural objections, but do not believe they limit our discretion to consider a petition to modify, even if it may be an untimely one.

The temporary interest rate balancing account adopted in
D.09-05-019 allows the companies to record the difference in interest expense between the actual interest cost for long-term debt for debt issued after
January 1, 2009, and the interest cost included in the adopted cost of capital for debt issues in 2009 (or later, if there is no adjustment pursuant to the Water Cost of Capital Adjustment Mechanism discussed below). The account included interest costs for debt issued from the effective date of the decision forward and was to remain in effect until the next cost of capital proceeding for each company, which would end the balancing account and address its balance. (D.09-05-019 at 42.) For California American, the account did not include the debt issued late in 2008 at the unexpectedly high rate of 10%. That debt was, however, included in the 2009 embedded cost of debt based on the information and 6.95% forecast available when the filing was made in May of 2008. No party asked for, and no party was allowed, to update the forecast cost of debt or capital structure after the May 1, 2008 filing.

California American did not know that the base year 2009 cost of capital proposed decision would include a new temporary interest rate balancing account before it was mailed for public review and comment, on December 19, 2008. California American asserts now that such knowledge may have affected the management decision to issue debt before the cost of capital decision was adopted. (Petition at 4.) California American did refer to this debt issue in its opening comments on the proposed decision:

"Indeed, based upon its most recent financing, California American Water had to borrow long-term debt at a 10% coupon rate. In light of this and other factors, the Commission should revisit the 10.2% return on equity in Phase 2 of this proceeding." (Opening Comments at 13.)

Thus, at the time, California American cited its most recent high cost debt, not to change the weighted cost of debt included in base year 2009, but only as an argument to "revisit" the authorized return on equity in phase 2.

There is a significant cost difference, $1,067,500 per year, for California American when the actual cost at 10% is compared to the 2008 forecast cost of 6.95%, which is embedded in the adopted 2009 base year cost of capital.

The authorized return on equity was the primary focal point for all parties in the proceeding, although there were also issues surrounding capital structure and cost of debt. Thus, the proposed decision's discussion and the parties' comments were mainly directed at the most appropriate return on equity.

The final decision, besides adopting a return on equity of 10.2% for all three applicants, made a significant ratemaking adjustment when it adopted equity ratios lower than those proposed for two companies, California Water and Golden State. The final decision imputed a forecast of 8.5% cost for the debt to replace a portion of the equity proposed by applicants. This adjustment was made to address the relatively high equity ratios requested by those companies. (D.09-05-019 at 8 - 13.)

The temporary interest rate balancing account was a ratemaking adjustment adopted in the final decision to further protect ratepayers as well as shareholders from the impacts of potentially large changes in debt costs (up or down). The question now is whether, as a matter of fairness, we should recognize for California American the unexpected increase in new debt costs first incurred in the window of time between filing the application and the adoption of D.09-05-019.

The overarching purpose of D.09-05-019 was to adopt a reasonable cost of capital which would allow the utilities an opportunity to earn a fair return. The decision recognized, and addressed, the financial market's dislocation in late 2008 and early 2009.3 Therefore, we find that it is reasonable to adjust for the significant market impacts suffered by California American in late 2008 and allow the company to include the difference between the forecast 6.95% and 10% in the temporary interest rate balancing account. This provision will allow California American to prospectively recover the shortfall between the forecast interest rate and the actual interest rate. No further correction to the 2009 cost of capital is necessary.

5.1. Prospective Ratemaking

The Commission cannot authorize the recovery of costs already incurred by the applicants:

It is a well established tenet of the Commission that ratemaking is done on a prospective basis. The Commission's practice is not to authorize increased utility rates to account for previously incurred expenses, unless, before the utility incurs those expenses, the Commission has authorized the utility to book those expenses into a memorandum or balancing account for possible future recovery in rates. This practice is consistent with the rule against retroactive ratemaking. This impacts not only rate recovery for operational expenses, but also rate recovery for ownership costs, such as depreciation expense and return on investment.

(43 CPUC 2d 596 (1992) at 600.)

Therefore, we will only authorize the recovery of incremental interest costs incurred after the effective date of this decision for the $35,000,000 in long term debt issued in November, 2008. This will still allow California American to record in its temporary interest rate balancing account the $88,958 monthly difference until the Commission adopts a new cost of capital or the Water Cost of Capital Adjustment Mechanism is triggered so that the actual costs for the November 26, 2008 debt issue are included in the embedded cost of debt.

5.2. Water Cost of Capital Adjustment Mechanism

In D.09-07-051 the Commission adopted a Water Cost of Capital Adjustment Mechanism. In Section 2(b) of the settlement the parties agreed that, if the trigger mechanism is met, then the long-term debt costs are adjusted to actual as of August of the current year.4 Thus, if triggered, the 2010 cost of capital would be updated using recorded data as of August 2009. The mechanism is also applied for 2011. Any adjustment to the cost of capital for 2010 or 2011 would terminate any further recording of an under-or
over-collection of interest costs in the temporary interest rate balancing account pursuant to this decision.

2 We use "significant" in this section to mean "important enough to merit attention" (Oxford English Dictionary http://www.askoxford.com/concise_oed/significant?view=uk) and not to necessarily mean "material" in the technical language of financial reporting and disclosure. "Materiality is not a simple calculation. Rather it is a determination of what will vs. what will not affect the decision of a knowledgeable investor given a specific set of circumstances related to the fair presentation of a company's financial statements and disclosures concerning existing or future debt and equity instruments." (Journal of Accountancy May 2005. http://www.journalofaccountancy.com/Issues/2005/May/TheNewImportanceOfMateriality.htm.)

3 "We take note of the financial markets' dislocation and therefore consider whether there are any extenuating circumstances of sufficient importance to warrant a departure form our normal procedures." (D.09-05-019 at 2.)

4 Long-term debt and preferred stock costs are updated to reflect actual August
month-end embedded costs in that year ..." http://docs.cpuc.ca.gov/published/Graphics/105148.PDF (D.09-07-051,
Attachment A, Appendix A at 2.)

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