ALJ/DUG/hkr Date of Issuance 10/29/2010
Decision 10-10-035 October 28, 2010
BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA
In the Matter of the Application of San Jose Water Company (U168W) for Authority to Determine its Cost of Capital and to Apply that Cost of Capital in Rates for the Period From January 1, 2010 through December 31, 2012. |
Application 09-05-001 (Filed May 1, 2009) |
And Related Matters. |
Application 09-05-002 Application 09-05-003 Application 09-05-004 Application 09-05-005 |
DECISION ON BASE YEAR 2010 COST OF CAPITAL
AND SUBSEQUENT YEARS' ADJUSTMENT MECHANISM
FOR SAN JOSE WATER COMPANY, VALENCIA WATER COMPANY,
PARK WATER COMPANY AND APPLE VALLEY RANCHOS WATER COMPANY, SAN GABRIEL VALLEY WATER COMPANY,
AND SUBURBAN WATER SYSTEMS
DECISION ON BASE YEAR 2010 COST OF CAPITAL AND SUBSEQUENT YEARS' ADJUSTMENT MECHANISM FOR SAN JOSE WATER COMPANY, VALENCIA WATER COMPANY, PARK WATER COMPANY AND APPLE VALLEY RANCHOS WATER COMPANY, SAN GABRIEL VALLEY WATER COMPANY, AND SUBURBAN WATER SYSTEMS 22
2. Jurisdiction and Background 55
4. Summary of Applicants' Requests 66
5. Summary of DRA's Recommendations 77
6.1. 2008-2010 Financial Markets Environment 77
6.2. Government Action in the Financial Markets 99
6.3. Current Capital Conditions and the Volatility between
Stocks and Bonds 99
6.4. Water and Gas Distribution Stocks Compared
to Stocks in General 1111
7. Proxy Groups for Modeling 1212
8. Cost of Debt and Capital Structure 1919
10. Return on Equity and Market to Book Ratio 3131
11. DRA's Discounted Cash Flow Model 3333
11.1. DRA's Use of the Dividend Discount Model Version
of Discounted Cash Flow 3333
11.2. DRA Used a Discounted Cash Flow Model to Establish
Stockholders' Expected or Required Return 3434
11.3. Factors That Affect Discounted Cash Flow 3434
11.4. Use of Historical Earnings Growth, Dividends,
and Internal Growth 3434
11.5. DRA's Analysis for Its Two Proxy Groups 3535
11.6. DRA Used Wall Street Analysts' Earnings per
Share Growth 3636
11.7. Historical Growth for DRA's Proxy Groups 3636
11.8. Projected Growth Rates for DRA's Two Proxy Groups 3737
11.9. DRA's Use of Analysts' Forecasts of Expected 5-year
Earnings per Share Growth for Proxy Groups 3838
11.10. Summary of DRA's Analysis 3939
11.11. DRA's Return on Equity Using the Discounted
Cash Flow Model for the Two Proxy Groups 4040
12. Applicants' Discounted Cash Flow Analysis 4040
13. Capital Asset Pricing Model and Other Risk Premium Models 4343
13.1. The Risk-Free Interest Rate 4444
13.2. DRA's Capital Asset Pricing Model Risk-Free Interest Rate 4545
13.3. Capital Asset Pricing Model Betas 4545
14. DRA's Base Return on Equity Recommendation 4646
15. Adopted Return on Equity 4747
16. Relative Risks and Company Specific Risks 4848
16.2. DRA's Relative Risk Analysis 4949
16.2.1. DRA's Relative Risk Study 5050
16.2.2. DRA's Risk Premium Adjustments to Its
Proposed 9.75% Benchmark Return on Equity 5151
16.3. The Relevance of Size 5252
16.4. Park/Apple's Firm Specific Risk Adjustment 5454
17. Schedule for Subsequent Cost of Capital Proceedings 5959
18. Water Cost of Capital Adjustment Mechanism 6262
20. Comments on Proposed Decision 6666
21. Assignment of Proceeding 6868
DECISION ON BASE YEAR 2010 COST OF CAPITAL
AND SUBSEQUENT YEARS' ADJUSTMENT MECHANISM
FOR SAN JOSE WATER COMPANY, VALENCIA WATER COMPANY,
PARK WATER COMPANY AND APPLE VALLEY RANCHOS WATER COMPANY, SAN GABRIEL VALLEY WATER COMPANY,
AND SUBURBAN WATER SYSTEMS
1. Summary
This decision establishes the base year 2010 ratemaking return on common equity for San Jose Water Company (San Jose), Valencia Water Company (Valencia), Park Water Company and its affiliate Apple Valley Ranchos Water Company (Park/Apple), San Gabriel Valley Water Company (San Gabriel), and Suburban Water Systems (Suburban). This is the first proceeding for these six companies where the sole subject is cost of capital, separated from a general rate case, pursuant to Decision (D.) 07-05-062, the most recent rate case plan for the Class A water utilities. The rate case plan established that return on equity would be addressed for these companies in a consolidated proceeding, considering company-specific factors, rather than the past practice of treating cost of capital as one other cost item in the general rate cases.
In this decision, we adopt a base return on equity of 10.20% for all six applicants along with an individual capital structure and weighted cost of capital for each company. We take note of the financial markets' dislocation and therefore consider whether there are any extenuating circumstances of sufficient importance to warrant a departure from our normal procedures. The base return reflects the risk reductions inherent in all of the outstanding balancing accounts available to these companies including those with a Water Revenue Adjustment Mechanism and Modified Cost Balancing Account, although consideration of these risk reductions is not reflected in the results of any financial modeling to date. Based on our consideration of all circumstances, we will adopt a base return of 10.20% which is between the recommendations made by intervenors and the requests by the utilities and is after considering individual risk profiles, which include relative size of operations, capital ratios, and location. We adopt the following company-specific ratios and equity returns:
Second, this decision adopts a Cost of Capital Adjustment Mechanism which uses an interest rate index and a Moody's bond rating to adjust the return on equity and update the cost of capital for the two years 2011 and 2012 before the next cost of capital proceeding for a base year of 2013. This is the same mechanism recently adopted in D.09-07-051. For Valencia, we adopt a separate 2011 cost of capital to reflect a significant change in its capital ratio after this proceeding was submitted. We set aside submission for the purpose of modifying 2011 cost of capital for Valencia.1 We adjust the trigger mechanism otherwise used in D.09-07-051 to avoid an unintended reduction in return which may result from a high cost base year for the bond index which otherwise captures the unusual recent market instabilities.
Finally, this decision determines that San Jose shall file an application for a new 2012 base year cost of capital concurrent with the three large multi-district Class A water companies because it is much closer in size to those companies and much bigger than several of the other companies in this group. Additionally, Valencia shall file a separate cost of capital application concurrent with its next general rate case application so that its next base year for cost of capital coincides with its test year for the general rate case.
The specific cost impacts of this decision are not quantified and depend upon any other changes to revenue requirement scheduled for January 1, 2010. These proceedings are closed.
1 Valencia's June 16, 2010 motion was unopposed, DRA supports using the more recent data in its reply comments on the proposed decision. This results in a substantial change to 2011's cost of capital.
