5. Forward-looking Just and Reasonable Rates
Chevron argues that a just and reasonable rate for 2010 is $1.34 per barrel with a PLA of 0.10%. Applicant argues that a just and reasonable rate for 2010 is $2.04 per barrel with a PLA of 0.25%. Because Applicant's proposed rate is based on its erroneous contention that it lacks market power, we reject it and limit our discussion to consideration of Chevron's proposed rate and its underlying justification.
Chevron's proposed rate was developed by its witness O'Loughlin. As is common in rate-setting proceedings such as this, O'Loughlin derived his proposed rate from a consideration of four elements: rate base, capital structure, cost of capital, and operating expenses. Each of these elements needs to be separately justified and we consider them in turn.
5.1. Rate Base
O'Loughlin used the depreciated original cost method to value the assets in the rate base, which is our preferred ratemaking methodology. On that basis, with the contested assets included in the rate base, he determined that the appropriate 2010 test year rate base is $110,487,187.36 Original cost methodology requires valuing assets from the time they are placed in public service. O'Louglin's rate base calculation includes the original cost less depreciation of assets placed in service by the Pipeline beginning in 1996. He chose the 1996 starting date because in D.07-12-021, in which we rejected the Shell Parties' challenge to D.07-07-040, we noted that the Pipeline had been providing oil transportation services to third parties since 1996:
"Shell has substantially more capacity on the Pipeline than it needs, and has continually provided this capacity to third parties since 1996."37
SPBPC argues that the quoted language from D.07-12-021 is not based on specific findings of fact or conclusions of law in that proceeding regarding the status of the Pipeline in 1996 and therefore cannot be used to support the 1996 asset valuation date.38 But D.07-12-021 was a decision on SPBPC's application for rehearing of D.07-07-040 that did not involve the taking of additional evidence. And though we did not identify a specific dedication date in D.07-07-040, we noted in D.07-12-021 that there is ample evidence in the record of D.07-07-040 to support the conclusions we reached, including the conclusion that the Pipeline had been dedicated to public service as early as 1996. Therefore it was appropriate for O'Loughlin to depreciate the original cost of assets added to the rate base in 1996 and afterwards.39 O'Loughlin used cost data supplied by Applicant and applied conventional depreciation schedules to the equipment and we adopt his computed value of $110,487,187 as the 2010 Test Year rate base.
5.2. Capital Structure
Applicant is a wholly-owned subsidiary of SOPUS40 and has an actual capital structure that is 100% equity. For rate-making purposes, Applicant's expert Teece proposed that its capital structure be deemed to consist of 90.49% equity and 9.51% debt, the weighted average capital structure of 4 major integrated oil companies (Shell, BP plc, Chevron and ExxonMobil Corporation).41 Chevron's expert Vilbert proposed that Applicant should be deemed to have a balanced capital structure consisting of 50% equity and 50% debt,42 approximating the average capital structure of a comparison group of seven independent pipeline corporations (Buckeye Energy Partners LP, Enbridge Energy Partners LP, Kinder Morgan Energy Partners LP, Magellan Midstream Partners LP, NuStar Energy LP, Plains All American Pipeline LP and Sunoco Logistic Partners LP).43 As we noted above, our jurisdiction does not extend beyond the operation of the Pipeline to include the other operations of large integrated oil companies such as those included in Teece's sample. Accordingly, a comparison group of pipeline companies, such as those proposed by Vilbert, provides a truer comparison for ratemaking purposes. Further, as Chevron witness O'Loughlin points out, we have used reference groups of pipeline companies, rather than integrated oil companies, in other similar proceedings44 and we do so again here. We accept Vilbert's proposed capital structure of 50% equity and 50% debt as Applicant's capital structure for ratemaking purposes.
5.3. Cost of Capital
On behalf of Applicant, Teece proposed a 2010 cost of equity of 10.91% and a weighted average cost of capital (WACC) of 10.37%.45 Vilbert and O'Loughlin, on behalf of Chevron, proposed a 2010 cost of equity of 13 % and a WACC of 9.75%.46 The difference in the estimated cost of equity largely reflects the respective capital structures. Highly leveraged equity (i.e., equity that is matched or exceeded in amount by debt) is riskier than unleveraged or slightly leveraged equity and hence commands a higher price. In this case, Teece's proposed capital structure contains less than 10% debt and the cost of equity is correspondingly low. Vilbert's capital structure, with 50% debt, puts equity holders at greater risk and his proposed cost of equity (13%) reflects that higher risk. Notwithstanding that Vilbert's proposed cost of equity is higher than Teece's, his proposed WACC is substantially lower, since half of Applicant's capital is assumed to be low-cost debt. We agree with Vilbert that 13% is a reasonable estimate for the cost of equity in a balanced capital structure and we adopt his proposed WACC of 9.75%.
5.4. Test Year Operating Expenses
Applicant's witness Rathermel estimated the Pipeline's Test Year 2010 operating expenses as $49,658,000. Chevron's witness O'Loughlin estimated the Pipeline's Test Year 2010 Operating Expenses as $46,209,173. The difference represents O'Loughlin's adjustments to Rathermels' estimate. Expense categories adjusted by O'Loughlin include: Pipeline Loss Allowance, Litigation Expense, Right of Way Conversion Costs, Overhead Expense, and Fuel and Power Expense.
1. With regard to Pipeline Loss Allowance, O'Loughlin proposes that the Pipeline charge its shippers a PLA of 0.10% which is slightly higher than the actual loss incurred during transit in recent years.
2. He recommends disallowing that portion of litigation expense that reflects the Pipeline's unsuccessful effort to obtain Commission approval of market-based rates.
3. He also recommends disallowance of the costs incurred by the Pipeline's parent SOPUS in transferring ownership of the Pipeline to SPBPC.
4. He proposes to adjust Overhead Expense by applying the so-called Massachusetts Formula, a standard formula used by FERC, to allocate corporate overhead costs that cannot be directly charged or assigned to subsidiary companies.
5. Finally, he proposes to adjust Fuel and Power Expense to correct for an unreasonably low estimate of future throughput.
We concur with all of the above recommendations. There is no good policy reason for the estimated PLA to differ significantly from the actual PLA. Commission litigation expenses related to the effort to obtain approval for market rates are a one-time past expense inappropriately included in a forecast of future expenses. SOPUS voluntarily undertook to transfer ownership of the Pipeline to SPBPC and the costs of doing so are properly those of the ultimate owners rather than the shippers. We endorse the use of the FERC methodology for overhead allocation and we note that the record bears out O'Loughlin's contention that the Applicant underestimated future throughput.
For the reasons given, we find that Test Year 2010 Operating Expenses are $46,209,173.
5.5. Test Year Cost of Service
We now turn to the parties' estimates of Test Year 2010 Cost of Service. In keeping with our decision to set rates on traditional cost of service principles, we consider only estimates based on applying such principles. Applicant's witness Van Hoecke's estimate of the Test Year 2010 Cost of Service on those principles is $72.1 million47 while Chevron's witness O'Loughlin's estimate on the same principles is $67.5 million.48 The difference between these two estimates primarily reflects the sensitivity of the ratesetting process to the capital structure assumption. Van Hoecke's estimate is based on a 91-9 capital structure while O'Loughlin's is based on a 50-50 capital structure. If Van Hoecke's estimate is further modified by replacing his capital structure with a 50-50 capital structure, his 2010 Test Year Cost of Service estimate drops to $66.7 million, minimally different from that of O'Loughlin. While we could adopt either value without significantly affecting the final calculation of a just and reasonable rate, we accept O'Loughlin's $67.5 million value consistent with other decisions made in the course of this opinion.
36 Exhibit Chevron 49, Attachment MPO _81, Table 3.
37 D.07-21-021 Section E-3.
38 SPBPC Opening Brief at 76.
39 Tesoro's witness Ashton also uses the 1996 date for valuation but relies on the CRNLD method of valuation, rather than original cost less depreciation, to derive a proposed rate. Since we prefer the original cost methodology, we do not further discuss Ashton's calculations.
40 Exhibit Chevron 49, attachment MPO_36.
41 Exhibit SP-33, Teece Direct Testimony at 9.
42 Exhibit Chevron 22, Vilbert Direct Testimony at 4.
43 Ibid., at 18-22.
44 Exhibit Chevron 49, at 10.
45 Exhibit SP-33 at 9.
46 Exhibit Chevron 49, Attachment MPO_81.
47 Van Hoecke's recommended Test Year 2010 Cost of Service is $97.9 million, based on the CRNLD method of valuation and a 2007 starting year. The $72.1 million estimate is the result of changing the starting year to 1996 and applying the depreciated original cost method of valuation to the components of the rate base.
48 Exhibit Chevron 49 attachment MPO_60, at 73; Exhibit Chevron 50, attachment MPO_84.
