31. Contingency/Risk Based Allowance
31.1. PG&E's Position
PG&E states that implementation of a dynamic pricing rate design for default PDP is a multifaceted, large-scale project that will impact numerous interrelated workstreams and products, adding that uncertainties and risks in complex projects such as this are normal. According to PG&E, a contingency is an essential element of a capital project estimate that provides an allowance for unforeseeable elements in a defined work scope, and is integral in creating a total estimate value that reflects the best representation of what the defined project scope will ultimately cost.
PG&E requested PwC's assessment of the factors creating uncertainty in PG&E's cost estimates and the resulting cost contingencies and risk-based allowance are included in PG&E's PDP cost forecast.
In order to do this, PwC states that it analyzed the risk profile for each of PG&E's program elements with incremental costs. Nearly 50 program elements were investigated, with separate contingencies ranging from 0% to 40% assigned to them by PwC.
In total, PG&E requests approximately $32.4 million for contingencies. The largest amount of $28.0 million relates to IT costs that are mostly capital expenditures. The next largest amount of $3.2 million relates to customer outreach expenses. The remaining $1.2 million in requested contingencies largely relate to other expense elements of PG&E's request.
31.2. FEA's Position
As a result of concerns about the magnitude of the IT contingency factor (33%) and the exposure of customers to paying higher costs than they should, FEA recommends that PG&E be required to undergo a reasonableness review, regardless of the level of project costs. As an alternative, FEA suggests that a maximum contingency allowance of 19% on the IT aspect of the project be permitted in order for PG&E to avoid a reasonableness review. FEA indicates that combining a 19% contingency allowance (the second highest of any requests for elements of the project) with the other proposed contingency allowances produces an overall contingency for the project of 16%, which is still larger than any contingency that the Commission previously has approved for PG&E PDP-related projects.
FEA recognizes that a contingency element is part of a reasonable cost estimation procedure. However, the presence of a large contingency on a project suggests to FEA that the project design is far from complete, and/or that there is a high potential for problems to be encountered in the implementation phase. Regardless, FEA asserts the high contingency factor, combined with PG&E's "free pass"37 cost recovery proposal, puts customers at significant risk. FEA believes this is inappropriate, and that PG&E should assume a greater responsibility for careful and diligent project execution.
31.3. TURN's Position
TURN states that common sense suggests that the IT cost risk in this case should be lower than the risk in, for example, the AMI case. According to TURN, in this case, PG&E is modifying billing and IT systems to accommodate new default dynamic tariffs, but very similar dynamic tariffs have been available, at least to the large C&I customers, on a voluntary basis for several years, while in the AMI case, PG&E had to modify its billing and IT systems to accommodate the collection and processing of hourly meter data for over five million residential customers and about one-half million small commercial and industrial customers, thus requiring the processing of 8,760 data points for millions of customers, as opposed to 12 data points for these customers. TURN understands that there is a significant amount of IT work required to improve the on-line analyses tools that customers can access to evaluate their rate options, but on a basic common-sense level, TURN does not understand the need to apply such a large IT contingency factor in this proceeding.
31.4. DRA's Position
PG&E included a 40% contingency for development costs for on-premise notification devices for small and medium C&I customers. If the Commission elects not to support DRA's proposal to eliminate these development costs, DRA recommends that the contingency be reduced to 20%, thereby reducing the contingency amount by $0.163 million. DRA understands that PG&E would be in the early stages of developing new notification equipment, however DRA asserts that the bulk of the features and components contained in these monitors are far from cutting edge. DRA indicates that signaling by light color is hardly new, and monitors have been equipped with liquid crystal display printouts and programmable features for quite some time.
DRA also states that the contingencies associated with its adjustments to customer outreach and IT cost recovery in this proceeding should likewise be excluded from rates authorized by this decision.
31.5. Discussion
We will not include contingencies in the cost recovery authorized by this decision. PG&E's contingency request totals over $32 million, or approximately 25.6% of the forecasted costs. This represents a substantial amount of unspecified work that has not, and by PG&E's cost recovery proposal will have not, specifically been reviewed for reasonableness before being included in rates. We realize contingencies have been authorized and included in rates in prior Commission proceedings. For instance, in PG&E's AMI decision, the adopted costs reflected an overall contingency of 7.9%,38 and in the SmartMeter Upgrade, adopted costs reflected an overall 12.9% contingency.39 However, 25.6% is a significant increase over these amounts. 40 We are concerned that our regulatory obligation to ensure just and reasonable rates is being eroded by including such large portions of project costs in rates, without having determined the reasonableness of the costs. At this point, we do not know what amount of contingencies will actually be expended, and for any amounts expended, what the related activities or materials are, whether the related activities or materials are necessary and optimal, and whether the associated costs are reasonable.
By PG&E's cost recovery proposal, through December 2010, recorded expenses and the revenue requirement associated with recorded capital assets would be recorded in the DPMA and transferred on a monthly basis to the Distribution Revenue Adjustment Mechanism (DRAM), to be recovered in rates through the AET advice letter filing. Beginning January 2011, cost recovery would be through test year 2011 and subsequent GRC authorizations. Also, if overall actual costs exceed the adopted cost estimate, PG&E can seek recovery of the difference through a traditional after-the-fact reasonableness review. As discussed further in this decision, these elements of PG&E's cost recovery proposal are adopted.
With our understanding of this cost recovery, we see no compelling reason for authorizing any contingencies in this proceeding, especially in light of our concern regarding the magnitude of the contingencies and our regulatory responsibilities. The exclusion of the contingency allowance does not preclude PG&E from recovering reasonable actual costs that are in excess of the forecasted amount. This opportunity to do so is balanced by the fact that although costs are forecasted in this proceeding, only the actual costs (up to the cost cap based on the forecasted costs) and not the forecasted costs are reflected in rates.
By this decision, PG&E can recover costs above the forecasted amounts whether the excess is related to contingency risks or any other reason, as long as PG&E can demonstrate the need for, and the reasonableness of, the additional expenditures in a reasonableness review. This is consistent with our responsibility to ensure just and reasonable rates, and is thus preferable to building in a contingency amount and allowing PG&E to spend that amount without having to justify the need for, or the reasonableness of, the expenditures.
Additionally, the effect of not including contingencies in this proceeding is likely to be small because of the following considerations.
After 2010, cost recovery for incremental PDP expenditures will be through GRCs. With respect to capital coasts, in GRCs, the recorded plant balances are generally incorporated to the extent possible. Therefore, the actual capital costs (including costs in excess of the forecasted amounts) for the projects considered in this proceeding will likely be reflected in rates from 2011 forward.41 Therefore, the vast majority of the capital related costs (depreciation, rate of return and taxes) could be recovered based on the actual capital costs of the project over its depreciable life, even without a reasonableness review filing by PG&E to recover costs in excess of forecasted.42 We note there is nothing to preclude other parties from challenging the reasonableness of recorded expenditures in GRCs. However, any rate adjustments to the capital related costs would be on a going forward basis only.
For expenses, we assume that PG&E has forecasted its costs for 2009 and 2010 based on the best information available at the time the forecasts are made. This is consistent with the way expenses are forecasted in GRCs where it is anticipated that actual costs could be either higher or lower than forecasted. Contingencies are not added to GRC forecasted expenses to fund perceived risks and uncertainties. We also note that PDP related expenses will likely be addressed in GRCs for the years 2011 and beyond. As such, explicit contingencies such as requested here will likely not be reflected for those years. In light of this, we see no overarching reason why contingencies related to annual PDP expenses are necessary, or even appropriate, in this proceeding.
Also, much of PG&E's reasoning for needing expense contingencies is not persuasive. For example, PG&E cites the possibility of delay, such as to CSOL implementation or SmartMeter deployment, and the need for additional costs to resolve the effects of such delay.43 We note that recovery of expenses in this proceeding relates mainly to costs estimated to occur in 2010, while PDP implementation will last well into 2012. If there are any delays as suggested by PG&E, we do not see 2010 expenses necessarily going up. In fact they may go down due to reduced activity. Certainly under those circumstances, expenses for 2011 or 2012 may increase over what is now forecasted. However, the appropriate level for those costs is not the subject of this proceeding. That will be determined in PG&E's 2011 GRC based on what is known at the time when those costs are considered. Effects of delays may specifically be known at that time.
PG&E also cites uncertainties related to the breadth and complexity of customer outreach as well as to future materials and media costs, without explaining why these uncertainties would likely only increase costs. It appears such uncertainties could either increase or decrease costs, depending on what was assumed and what actually happens, and do not justify a contingency that only reflects increased costs.
For these reasons, the elimination of contingencies should have little effect on PG&E's ability to recover its costs for 2009 and 2010 with the rates authorized by this decision.
37 By PG&E's cost recovery proposal, the Commission would find that all incremental costs authorized by this decision are reasonable so long as the actual costs are equal to or less than forecasted costs (including contingencies). Only actual costs in excess of the forecasted amounts would be subject to a traditional after-the-fact reasonableness review before being included in rates.
38 D.06-07-027 in A.05-06-028.
39 D.09-03-026 in A.07-12-009.
40 We also note that contingencies in the AMI and SmartMeter cases serve an additional purpose in that those proceedings were comparing incremental costs to incremental benefits to evaluate whether the programs should go forward. In these cases, it is important to reflect the contingencies up front so they can be included in the cost/benefit analysis. That is not the case in this proceeding.
41 In GRCs, capital project costs are forecasted and the authorized capital related costs are based on that amount until the next GRC, when the actual project costs would be reflected in the plant in service balances on which the annual capital related costs such as rate of return, income taxes and depreciation would be calculated.
42 It should be noted that, with respect to ongoing cost recovery for the CC&B upgrade from Version 1.5 to Version 2.3, PG&E must file an after-the-fact reasonableness application in order to recover capital costs related to any overruns to the $31,264,000 amount adopted in this decision. See Section 28.3.4.
43 See Exhibit 3 at 2-28 and 2-29.
