5. Resolution of Disputed Issues

The primary issues to be decided in determining ratepayer responsibilities for the cost recovery requested by Cal-Am are: (1) whether the San Clemente Dam is a used and useful utility asset; (2) whether Cal-Am pursued its Dam buttressing alternative in a prudent manner that meets our standards for cost recovery of the San Clemente Dam Memorandum Account; and (3) what level of funding and under what terms should ratepayers provide cost recovery for the Project. In addition to these cost recovery issues, there is a dispute regarding some of the land appurtenant to the Project. We also resolve this land issue in today's decision. We address the issues in the order listed above.

Cal-Am asserts that the existing San Clemente Dam is a used and useful utility asset because (1) it is available as a source of water supply to customers due to existing water permits, (2) it can be used for water supply to customers in emergencies, and (3) it holds in place approximately 2.5 million cubic yards of accumulated sediment, thereby minimizing downstream impact to fishery and frog habitat and to property owners.19 Cal-Am also argues that the Dam buttressing it has pursued is a viable option, and that under this alternative it would create a used and useful asset upon which it would be authorized an opportunity to earn a reasonable rate of return.20 The Conservancy confirms that buttressing is a viable option.21

DRA asserts that the Dam is not used and useful because (1) the Dam has not provided any water to Cal-Am's ratepayers since 2003 and (2) today it is a sediment-laden, environmentally harmful peril to endangered species and the community that lives downstream. In addition to providing no operational value to Cal-Am, DRA argues the Dam must be removed (at a huge expense) to prevent further harm to the environment and reduce the risk to the area downstream of the facility.22

The Planning and Conservation League Foundation (PCLF) asserts that the Dam should be considered used and useful because its retention of sediment reduces the threat of loss of life and property in downstream areas during flood events.

In assessing whether the Dam is used and useful today, we first look to Cal-Am's testimony. In response to a DRA data request, Cal-Am's engineering witness states that the utility "ceased using San Clemente Dam as a diversion point in the 2002-2003 water year" and "currently the San Clemente Dam does not provide any services related to water supply."23 However, the Dam is an authorized point of water rediversion under State Water Resources Control Board License 11866 for rediverting water at Los Padres Dam and is an authorized point of water rediversion under the joint Cal-Am - Monterey Peninsula Water Management District Aquifer Storage and Recovery Project under State Water Resources Board permit 20808A and draft permit 20808C.24 Although a 2001 Conservation Agreement between Cal-Am and National Oceanic and Atmospheric Association, and the NMFS requires Cal-Am to cease withdrawal of water from the San Clemente Dam the restriction is only applicable during non-emergency low-flow periods as defined in the Conservation Agreement.25

Further, the Dam has accumulated sediment, a natural process, since construction in 1921 and has continued to accumulate sediment since Cal-Am took ownership of the Dam in 1966 for public utility purposes at reasonable levels for a dam of its age.26 The Dam is currently maintaining in place approximately 2.5 million cubic yards of accumulated sediment that would negatively impact property and the environment if it were released uncontrolled into the downstream of the Carmel River. Cal-Am has also implemented and continues to implement dam safety actions in response to a DSOD directive as addressed in our prior History of Project discussion in Section 3.

The definition of a used and useful public utility asset is one that provides direct and ongoing benefits to customers. Cal-Am has maintained for public utility purposes valid permits to divert dam water and to use such water in emergency situations. Sediment also accumulated as an integral part of Cal-Am's public utility responsibility to provide water service to its customers, and was not necessarily within the control of Cal-Am. For example, landslides associated with construction of the Dormandy Airstrip in 1972 and the Marble Cone Fire in 1977 and high flows resulting from winter storms between 1978 and 1983 accounted for reservoir loss of approximately 470 acre-feet of storage. Heavy rainstorms experienced in the watershed in the spring of 1995 and 1999 resulted in extremely high flows and the loss of additional volume of storage.27

Cal-Am has monitored the sediment inflow at the Dam on a periodic basis. For example, it undertook a San Clemente Reservoir Dredging Feasibility Study in 1996 which included a field analysis of the sediment, review of dredging techniques, siltation stabilization alternatives, identification of sediment transport impacts and possible mitigation measures, and potential silt disposal alternatives.28 It also undertook a bathymetric survey of the dam's storage capacity in 2002 and again in 2009. As addressed in our subsequent Cal-Am's Pursuit of Dam Buttressing Prudency discussion, sediment mitigation measures are costly.

Therefore, we conclude that the San Clemente Dam provides ongoing benefits to ratepayers and is a used and useful asset for Cal-Am ratemaking purposes prior to decommissioning or retirement.

Here, we address the prudency of the Dam buttressing proposal that Cal-Am pursued as its preferred alternative in response to the DSOD's 1980 directive that Cal-Am evaluate the ability of San Clemente Dam to safely pass a probable maximum flood and withstand a maximum credible earthquake.29 Two EIRs undertaken by the California DSOD,30 designated EIR lead agency, were issued to resolve this DSOD directive.

However, DSOD withdrew its first EIR report in response to extensive public and agency comments. Its second EIR report, referred to as the Recirculated Draft EIR issued in 2000 received additional public and agency comments. An example of such comments is an April 3, 2000 letter to the U.S. Army Corps of Engineers, copied to Cal-Am, in which NMFS states that Cal-Am has chosen not to seriously consider a Dam removal option, even though several natural resource organizations have set this as a priority for funding and support, and that Cal-Am's proposed seismic retrofit project "does not provide flood storage, hydropower, or water storage."31

Cal-Am had requested DSOD consider the option of dam removal in its first EIR. DSOD was not in favor of that option because of the danger of impact on the project schedule and downstream damage and because the overall environmental impacts and project costs would be substantial and more significant than buttressing.32 Therefore, Cal-Am pursued buttressing and began incurring costs in that endeavor.

DSOD subsequently withdrew its Recirculated Draft EIR in 2002 due to further comments. DSOD then directed Cal-Am to take interim dam safety actions. A joint EIR/EIS process was initiated in 2004 designed to meet both federal and state environmental review requirements.

NMFS, in a June 30, 2006 letter to the U.S. Army Corps of Engineers addressing the Draft EIR/EIS, copied to Cal-Am, commented:

Our enclosed comments and detailed involvement since 2000 have provided the Corps the assistance necessary to develop and determine environmentally preferable alternatives. As stated in our April 5, 2006 letter, NMFS believes the use of sluice gates as proposed in the Proponent's Proposed Project and Alternative 1 is a fatal project flaw. The Draft EIR/EIS notes San Clemente Dam and Reservoir were never intended for flood control, and the San Clemente Dam Seismic Safety Project has neither flood storage nor flood operations criteria. The Draft EIR/EIS also notes San Clemente Reservoir does not provide water storage for the California American Water Company system and the Proponent's Proposed Project will not improve current or future water storage. A dam and reservoir that provides neither flood storage nor water storage, commensurate with the long-term adverse environmental impacts associated with operating and maintaining the dam, make it clear to NMFS that Alternative 2 (dam removal) or Alternative 3 (Carmel River reroute and dam removal) are the environmentally preferable alternatives. Implementation of the Proponent's Proposed Project or Alternative 1 will likely jeopardize S-CCC DPS steelhead and destroy designated critical habitat of S-CCC DPS.33

However, from a purely ecological standpoint, the Reroute and Removal project is not ideal. This alternative involves significant ecological impacts including the permanent loss of one-half mile of the Carmel River and an overall steeping of the historical channel gradient from the dam site through the area of the reservoir. The steeper grade of the rerouted river will present greater challenges for fish passage than the historical channel grade.34

Subsequently, a joint DSOD EIR/U.S. Army Corp of Engineers Environmental Impact Statement (joint EIR/EIS), certified on December 31, 2007, concluded that two of the projects evaluated, a dam buttressing project and dam removal and river reroute project, would have environmental impacts that are "not materially different."35

While several state and federal regulatory agencies sought to establish a dam removal alternative to buttressing, no clearly feasible dam removal project had been identified. The most significant challenge to removing the dam was finding a technically and economically feasible option for handling approximately 2.5 million cubic yards of sediment.36 Further, there is no inconsistency between the federal government's concern for the steelhead and other endangered or threatened species and the state's concern for seismic safety.

The current Dam through its years of operation has trapped an estimated sediment volume of 1,555 acre feet (2.5 million yards), leaving a remaining reservoir storage capacity of only 100 acre feet (a small pool near the Dam).37 At a normal rate of sediment inflow, this 100 acre feet will be gone between 2013 and 2017.38 To remove the accumulated sediment would be expensive, specifically dredging costs of $12 to $30 per cubic yard for the 2.5 million cubic yards of accumulated sediment,39 and removing it would require 125,000 truckloads at 20 cubic yards per truckload.40

Irrespective of this sedimentation problem, the Bureau of Reclamation acknowledged in its May 2011 review of Cal-Am's San Clemente Dam Reservoir management practices that dam safety problems (ability to withstand probable maximum flooding and maximum credible earthquake) are largely independent of the reservoir sedimentation problem.41

Regarding the NMFS concern for the environmental protection of steelhead, the Conservancy consulted with fisheries experts from both the NMFS and the DFG to develop a conceptual design for two fishways that would eliminate the need for sluicing sediment through the dam and thus address NMFS key concerns.42 Thus the Conservancy concluded that implementation of a modified buttressing project is feasible. While this modification would add approximately $17 million to the $49 million for a total estimated $66 million cost of buttressing the dam, buttressing costs would be significantly less than the $83 million estimated cost of the reroute and removal project.

Based on the discussion above, we find that Cal-Am's pursuit of dam buttressing was prudent, reasonable and appropriate to enable it to comply with the DSOD's seismic safety requirements while seeking to resolve this issue at least cost to its ratepayers. Our finding here is the same finding we made in our San Clemente Dam Usefulness discussion. The Dam is and has been a used and useful utility asset, and the Dam buttressing option Cal-Am pursued was undertaken to satisfy DSOD's directive to bring the dam up to current seismic safety standards. We next address cost issues.

As detailed in the application, Cal-Am has entered an agreement with the Conservancy for a public/private collaboration to meet the estimated cost of $83 million for the project. Under this agreement, the Conservancy will undertake efforts to secure approximately $34 million from state, federal, and private foundation resources, and Cal-Am will commit to funding the remaining $49 million in estimated costs. When the Project's construction is complete, the land will be donated to BLM to be maintained.

DRA supports the Project but does not support requiring current or future ratepayers to pay for the proposed costs because it asserts the costs have been exacerbated and in some cases caused by Cal-Am's mismanagement of the Dam. Its primary reasons for opposing ratepayer funding are: (1) Cal-Am, as the asset owner, did not account for its future obligation to remove the Dam at the end of its service life; (2) Cal-Am imprudently pursued an unviable project alternative, knowing it was unlikely to become the preferred alternative and which eventually resulted in an abandoned project; and (3) Cal-Am did not determine feasible alternatives for managing sedimentation during the Dam's useful life and did not effectively manage the sediment, resulting in a more technologically complicated and expensive Dam removal project.43

While DRA's primary recommendation is that as a result of the regulatory compact and past management decisions made by Cal-Am, no cost responsibility for the Project should be transferred to ratepayers, it presents an alternative recommendation should the Commission reject this position. As an alternative, DRA recommends: (1) there be an absolute cost cap of the $49 million on ratepayer responsibility for the Project's current and future liabilities, (2) the ratepayer cost responsibility be offset by the appropriate value of land sold or transferred as part of the Project, and (3) Cal-Am be precluded from earning an equity return on any Project cost responsibilities transferred to ratepayers.44

Representatives of the Conservancy and NMFS appeared as witnesses for Cal-Am and supported the Project. PCLF supports ratepayer cost recovery for the proposed Project, with the recommendations that the Commission include a cost cap informed by the updated cost estimate prepared by the Technical Review Team, that shareholders' return on the investment be limited and some adjustment of costs in the memorandum account considered, that there be appropriate reporting requirements, and that Cal-Am be directed to study the physical options for managing the continued sediment accumulation in its upstream Los Padres Dam. PCLF supports ratepayer funding in order for the project to go forward to address public safety issues in a timely manner.

While we share many of DRA's concerns with Cal-Am's actions regarding the Dam, particularly over the last 10-15 years, we believe that ratepayers should pay the reasonable costs associated with decommissioning, or retiring, the Dam. We are comfortable with the Project design as proposed, the recently updated cost estimates, and the oversight of the Technical Team assembled by the Conservancy. We are also comfortable with the public/private collaboration to meet the $83 million estimated cost of which Cal-Am Ratepayers are to be responsible for $49 million. Further, we find there is a strong public interest in having this Project completed in a timely manner. The concerns raised by DRA regarding Cal-Am's management of the Dam over the last 45 years should be carefully considered in our prudency review of the existing memorandum account, not in our commitment to enabling the Project to go forward.

Therefore, based on the record we find that a cost cap of $49 million for project costs incurred subsequent to December 31, 2012 is appropriate and that project actual costs should be recorded in a balancing account addressed in Section 5.5 Rate Recovery Mechanisms of this decision. Should the project exceed the $49 million cost cap, Cal-Am may file an application seeking authority to raise the cost cap. In addition, Cal-Am should be allowed to include interim safety and compliance costs and post-construction mitigation costs in the balancing account incurred and to be incurred to satisfy DSOD directive to address Dam seismic safety issues. We now address the historical cost being tracked in the San Clemente Dam Memorandum Account.

The San Clemente Dam Memorandum Account (Memorandum Account) has its beginnings in Cal-Am's 1993 general rate case(GRC) proceeding, when the Commission approved the inclusion into rate base of $790,000 and directed all other costs be tracked in a memorandum account. Memorandum account treatment has continued to the present except for the 2002 GRC proceeding, which allowed the costs to be treated as construction work in progress. The Commission transferred these costs back to the memorandum account in the next GRC proceeding based on its findings that the specific project to address seismic safety issues was unclear, as was the Dam's current use and usefulness.45

The Commission uses memorandum accounts rather than balancing accounts when the Commission has yet to review or authorize the costs being tracked and the ultimate recovery of costs being tracked is uncertain and will require a full reasonableness review. Cal-Am acknowledged the risks of recovery of this memorandum account in 2007 when it requested a higher carrying cost for the memorandum account based on the ultimate risk of recovery its investors faced:

The declaration explained that regulators may disallow some or all of the San Clemente Dam costs, which creates greater risk for recovery of the dam investment than on Cal-Am's previously-approved rate base.46

Cal-Am seeks rate recovery here for $26,802,658 for its initial surcharge. Part of this is tracked in the memorandum account, part is estimated, and part is for ongoing safety and compliance expenses. Specifically, $21,724,907 represents costs and interest in the memorandum account through October 31, 2010, $2,577,751 represents interest that is estimated to accrue between November 1, 2010 and December 31, 2012, and $2,500,000 represents estimated costs for interim dam safety and environmental measures from November 1, 2010 until the Dam is removed.

Cal-Am requests full recovery for all historical costs in the memorandum account through October 31, 2010, and full recovery for all estimated costs until the reroute and removal project is complete. Cal-Am selected the October 31, 2010 date because that was the date that cost shifted from San Clemente Dam related preconstruction costs to preliminary costs for the Reroute and Removal Project.47 Cal-Am asserts that the costs being tracked in the memorandum account were not discretionary costs, and "Cal-Am could not have chosen to not incur them."48

In its November 19, 2010, supplemental filing, Cal-Am provided invoices for all costs incurred after 2002, supported by supplemental direct testimony, and in its rebuttal testimony provided invoices for all pre-2002 costs.49 Of the $26,802,65850 that Cal-Am seeks full recovery for its historical costs tracked in the memorandum account as of October 31, 2010 and estimated costs to be incurred until the reroute and removal project is completed, DRA recommends the Commission approve only $100,654 for ratepayer recovery.

Testimony on the memorandum account's historical costs and costs estimated to be incurred until the reroute and removal project is completed was addressed in four primary cost categories. They were: (1) pre-2000 costs, (2) contractor costs, (3) compliance and maintenance costs, and (4) interest, labor, overhead, and corporate charges. We address each of these cost categories below.

Cal-Am distinguished the pre-2002 memorandum costs of $4,406,700 based on its position that DRA had reviewed and agreed to the reasonableness of these costs in Cal-Am's 2003 GRC proceeding, Application (A.) 02-04-022. In general, these costs consisted of engineering, legal, maintenance, communications and interest related to seismic safety issues addressed in our prior Dam Buttressing Prudency discussion in Section 5.2.

DRA recommended that the entire pre-2002 memorandum costs be disallowed because Cal-Am has been unable to provide adequate support for the reasonableness of these costs and, contrary to Cal-Am's position, the Commission has not previously determined the reasonableness of the pre-2002 costs.

DRA did actively request documentation and copies of invoices from Cal-Am. However, DRA was not able to verify the reasonableness of these costs because Cal-Am did not provide any documentation for the pre-2002 costs prior to the issuance of DRA's May 5, 2011 testimony and report. Cal-Am did not initially provide pre-2002 costs supporting documentation or copies of invoices because it was under the impression that pre-2002 costs had been previously reviewed and approved in its 2003 GRC. Cal-Am subsequently included in its May 25, 2011 supplemental testimony, a 34-page list, by category, of every invoice and individual charge to the memorandum account and steps that it took to ensure that such costs were reasonable and under control.51 Each entry provided the name of the vendor and a description of the nature of the charge, taken from the invoices. Based on our prior Dam Buttressing prudency discussion in Section 5.2, which concluded that the pre-2002 activities were incurred to address seismic and flood stability and review of the actual invoices, and based on our review of the invoices for these pre-2002 activities, we conclude that the $4,406,700 pre-2002 costs tracked in the memorandum account are reasonable and recoverable by Cal-Am.

Cal-Am tracked approximately $3,154,000 of contract costs in its memorandum account which were not put out for competitive bidding.

DRA recommended that these costs be disallowed because Cal-Am did not use a competitive bidding process to identify the most cost-effective contractor prior to awarding a contract for seven contracts awarded to engineering and consulting firms. Cal-Am acknowledged that it did not use a competitive bidding process for all of its contracts. However, it did follow company policies and procedures to provide services in a cost-effective manner.

Cal-Am explained that competitive bidding is only one method it uses to award contracts. Another method used by Cal-Am for awarding contracts to engineering and consulting firms is a Qualification Based Selection (QBS) procurement process. QBS is a procurement process established by federal law that was originally intended as a process for public agencies to use for the selection of architectural and engineering services for public projects which has been adopted by private owners. This process is endorsed by the American Institute of Architects, the National Society of Professional Engineers, American Public Works Association, and the American Water Works Association.52

Under the QBS process, consulting firms submit qualifications to a company, which evaluates and selects the most qualified firm, and then negotiates the project scope of work, schedule, budget, and consulting fee. Of the seven vendors DRA recommended disallowed for not taking steps in finding the most cost-effective contractors through a lack of competitive bidding process, four provided engineering, environmental, land surveying, or construction project management services, and two contractors provided legal services.53

DRA's audit confirmed that Cal-Am had received invoices and paid for the costs listed on the contracts.54 Hence, the contract amounts are not in dispute. Although Cal-Am did not use the competitive bidding process for all of its contracts it did use the recognized QBS procurement process for awarding contracts. Given that Cal-Am used a recognized acceptable process for awarding these contracts, the dollar amounts are not in dispute and that there is no evidence that the contractors are related to Cal-Am triggering the Commission's affiliated transaction rules, we find that the $3,154,000 of non-competitive bidding contractor costs included in the memorandum account is reasonable and should be recoverable by Cal-Am.

Cal-Am has tracked approximately $6,300,000 of post-2002 compliance and maintenance costs in its memorandum account. Of this amount, DRA recommended that only $100,000 should be allowed for cost recovery. DRA disallowed the remaining amount because those costs were incurred after September 30, 2003, the date DRA deemed the dam no longer used or useful.

We previously found in our San Clemente Dam Usefulness, Dam Buttressing, and Ratepayer Cost Responsibility discussions in Sections 5.1, 5.2, and 5.3 that the dam remains used and useful and that Cal-Am and its ratepayers are responsible for ongoing compliance and maintenance of the dam until the dam is retired or removed. Because the Dam remains used and useful, the post-2002 compliance and maintenance costs tracked in the memorandum account are reasonable and recoverable by Cal-Am.

Cal-Am tracks internal costs for company labor and overhead, employee expenses, utility plant overhead, and services. In addition to these costs, Cal-Am calculates and includes an interest component for the use of funds being tracked in the memorandum account. Cal-Am has tracked approximately $8,000,000 of post-2002 historical interest, labor, overhead, and corporate charges in its memorandum account as of October 31, 2010 and has estimated an additional $2,600,000 in interest to incur between November 1, 2010 and December 31, 2012.

DRA reviewed the calculations and rates used in tracking interest, labor, overhead and corporate charges in the memorandum account. DRA does not take exception to the calculations and rates. However, it does recommend a pro-rata disallowance of these tracked costs based on the amount of its recommended memorandum account disallowances of pre-2002 costs, contractor costs, and compliance and maintenance costs to Cal-Am's total memorandum account balance.

We have already found that the tracking of memorandum account costs for pre-2002 costs, contract costs, and compliance and maintenance costs are reasonable and should be recoverable. Further, DRA does not take exception to the calculations and rates used in this cost category. Therefore, we find that the interest, labor, overhead, and corporate charges tacked in the memorandum account are reasonably incurred.

The $21,724,907 costs tracked in the San Clemente Dam Memorandum Account as of October 31, 2010 and interest being accrued between November 1, 2010 and December 31, 2010 estimated at $2,577,751 is reasonable and should be recoverable in rates through the rate mechanism being adopted in this proceeding.

Cal-Am seeks to treat all Project costs as a regulatory asset and to begin recovering the estimated costs through a customer surcharge over a 20-year period. It requests a balancing account to track the timing of the Project expenditures and the amount recovered in rates and to have the balancing account accrue interest at the utility's authorized rate of return.

Cal-Am also requests the proposed balancing account include any financing costs it incurs because of delays or reductions in grant payments from the Conservancy and that it be allowed to file an advice letter to revise its estimated revenue if there is a significant change in the overall cost of the Project.

Cal-Am asserts that its balancing account proposal will ensure that its customers pay only for the actual costs of the Project, while also protecting the utility in case the Project costs exceed its current estimate of $49 million. Six months after completion of the Project, Cal-Am proposes to submit an application for review of the final project costs and true up of the balancing account. If actual construction costs are lower than estimated, the cost savings will be allocated between Cal-Am and the Conservancy based on the source of the savings.55 Cal-Am states it will also provide estimates of the remaining post-construction mitigation, compliance, monitoring and/or operation and maintenance costs in this final Project application.

Finally, Cal-Am requests that after the Commission's review of its final Project application, Cal-Am be authorized to discontinue the customer surcharge and instead include in customers' base rates the annual revenue requirement on the remaining balance of the regulatory asset and Cal-Am's share of the estimated post-construction costs.

DRA takes the position that current and future customers should be made completely immune to the financial impacts of the proposed Project based on past management decisions made by Cal-Am. Should the Commission disagree with its recommendation, DRA offers the following alternative recommendation:

1. Establish an absolute limit via a one-way balancing account of the Project's current and future liabilities that can be transferred to Cal-Am's ratepayers;

2. Offset the costs of any liabilities transferred to ratepayers in the one-way balancing account with the appropriate value of lands to be donated or sold;

3. Preclude Cal-Am from earning an equity return on the balance of Project liabilities that are transferred to ratepayers via the one-way balancing account; and

4. Keep Cal-Am's recovery of the deferred Project expenses in the balancing account outside of base rates in order to avoid the potential for inadvertently allowing an equity return to accumulate on an account balance that is unrelated to any used and useful project or ongoing customer service.

Following the criteria set forth above, and using a 2007 real-estate appraisal report provided by Cal-Am, DRA subtracts from $49 million (1) the $19,049,346 appraisal of Phase-One property in a 2007 McVay Appraisal Report56 pertaining to 1,000 acres of Cal-Am land and (2) the $100,654 in recommended recovery from the San Clemente Dam memorandum account to reach its recommended maximum allowable ratepayer funded Project recovery of $29,850,654.

Finally, while DRA believes that prior Commission decision precedent and standard practice support upholding a policy that deferred expense balances accumulate interest at the 90-day commercial paper rate, if the Commission were to consider other factors in determining a reasonable interest rate or carrying charge on the Project-related deferred expense balance, DRA testifies that the absolute maximum allowable interest rate should be Cal-Am's weighted average cost of debt, as determined in the periodic cost of capital proceedings and including a weighting for Cal-Am's short-term debt.57

As addressed in our Ratepayer Cost Responsibility discussion in Section 5.3, we find DRA's alternative proposal that the Commission establish a cost cap of $49 million for ratepayer cost responsibility appropriate. We also found that memorandum account cost recovery and carrying charges, offset by the tax benefit from the value of Cal-Am's land donation are a reasonable cost responsibility for ratepayer funding of the proposed Project. It is the amount requested by Cal-Am's public partners and will allow the Project to go forward on a timely basis and have construction meet the September 2012 start date requested by the DSOD. It will also provide an incentive for Cal-Am to manage the project costs effectively.

The Commission has addressed the issue of rate base recovery of costs from projects such as the project being addressed in this proceeding in numerous decisions.58 In most of those cases where a utility was either denied a rate of return or granted a rate of return, the amortization period was set at a reduced length of time, generally in the range of four to five years.

We do not agree with DRA and PCLF that Cal-Am's shareholders should not earn an equity return on this Project over the next 20 years. We reach this conclusion because (1) the Project will provide a benefit to Cal-Am's customers by resolving the Dam's seismic safety issues, improve the environmental conditions on the Carmel River, and preserve land as open space, and (2) as addressed in our prior ratepayer cost responsibility discussion, ratepayers should pay the reasonable costs associated with this Project. Cal-Am is funding its share of the Project with a mixture of long-term debt and equity. As such, Cal-Am should be provided an opportunity to earn a reasonable return on its investment. Moreover, we call attention to the fact that in A.88-03-047, Cal-Am requested a decommissioning plan for the Dam, which the Commission rejected in D.89-02-067. Subsequently, Cal-Am asked for pre-recovery costs in A.02-04-022. The Commission rejected the settlement, which included these costs and instead, in D.03-02-030, applied them to CWIP. Then, in D.06-11-050, the costs were returned to the memo account. These costs could have been recovered during the years from the 1990s, but they were not. It would not be reasonable to deny their recovery now.

This case presents a unique set of circumstances in that Cal-Am's recovery will be over a 20-year period, a substantially longer period of time than a typical four-to-five-year period. Our approval of the 20- recovery period is due to the fact that the dam removal is a long-term project, and therefore, a longer period of recovery is appropriate. We authorize here a regulatory asset/balancing account for Cal-Am's portion of the Project costs. We also find that Cal-Am should directly credit ratepayers through the regulatory asset/balancing account for the cash benefits of all tax savings resulting from this Project being able to be expensed in the period the actual construction costs are incurred. We adopt the following rate recovery mechanism:

a. The project will be a stand-alone ratemaking item until the first General Rate Case after the final review of all project costs.

b. Cal-Am will cease to track costs in the memorandum account on July 1, 2012.

c. All authorized incurred costs included in the memorandum account ($21,724,907 in pre-construction costs in the memorandum account as of October 31, 2010, $2,577,751 of interest as of December 31, 2011, authorized cost of capital from January 1, 2012 to June 30, 2012, interim dam safety and environmental costs for drawdowns and any of the $49 million in construction costs incurred along with its associated cost of capital) shall be transferred to the regulatory asset/balancing account.

d. Cal-Am will recover the regulatory asset/balancing account over a 20-year period starting July 1, 2012. During the interim recovery period, from July 1, 2012 up until the first day of the first test year when the revenue requirement will be included in base rates, the recovery will be based on a levelized revenue requirement which will be estimated based on total projected costs as set forth in Appendix 2 of this decision. The estimate shall be based on the utility's authorized cost of capital. The book amortization expense of the regulatory asset/balancing account will be based on the total estimated levelized surcharge billed less uncollectible account expense, taxes and authorized cost of capital on the actual regulatory asset/balancing account.

e. Actual expenditures for the project will be included in the regulatory asset/balancing account as they are incurred. The actual expenditures will include permitting, compliance review and preliminary engineering costs, construction costs, interim dam and environmental safety measures, and post-construction mitigation measures.

f. The revenue requirement will include applicable costs for uncollectible amounts, franchise fees, ad valorem taxes and income taxes.

g. The revenue requirement will be collected through a surcharge authorized in this proceeding based on the estimate developed per Appendix 2 of this decision.

h. The actual balance of the regulatory asset/balancing account, less accumulated amortization and associated deferred taxes, will be authorized to earn a return based on the currently authorized cost of capital.

i. For tax purposes the cost of the project will be deducted as authorized by the Internal Revenue Service.

j. The tax-effected difference between book amortization and the ability to take the tax deduction for the costs of the project will offset the regulatory asset/balancing account as a deferred tax for purposes of calculating the authorized cost of capital.

k. The deferred tax effect of tax depreciation of $13,405,109 already taken through December 31, 2009 will remain a reduction to rate base of the Monterey District and will not offset the regulatory asset/balancing account.

l. Any additional carrying costs related to interim financing will be tracked in the balancing account at the authorized cost of capital.

m. The regulatory asset/balancing account will draw interest at the authorized cost of capital. The balancing account will be closed at the time the regulatory asset moves into base rates. The balance at that point will remain in the regulatory asset/balancing account and will continue to be collected over the remainder of the 20- collection period using an updated levelized revenue requirement based on the ending net regulatory asset/balancing account, the current authorized cost of capital, the remaining years in the 20- recovery period, projected deferred taxes, uncollectible account expenses and taxes. The levelized revenue requirement set in base rates may still need to be adjusted periodically for changes in authorized cost of capital or for other items that may be delayed into the account such as the tax benefits of the land donation.

n. Post-construction mitigation costs will be included in the regulatory asset/balancing account balance and surcharge until the revenue requirement on the regulatory asset is included in base rates, at which time the post-construction mitigation costs will also be estimated in base rates as an expense.

o. The revenue requirement on the regulatory asset will move into base rates at the time of the first General Rate Case after the final review of all project costs.

p. The tax benefits derived from the transfer of the land including Parcels 417-051-004-000, 417-051-005-000, 417-051-010-000, and 417-051-011-000 will serve to reduce the collections required by the regulatory asset if the benefit was not already factored into base rates.

Cal-Am initially estimated that a surcharge of approximately $3.34 per month, or 8.79% would be required for the average residential customer using 70 billing units (at 10 cubic feet per billing unit) of water per month at a three-person household and a $50.10 surcharge, or 25.75%, for a large residential customer using 200 billing units of water a month in the Monterey Main System, based on a revenue requirement of $10,000,000, which is approximately the revenue requirement of the Reroute and Removal Project in 2015.59 It should be noted that the revenue requirement will vary each year thereby resulting in different required surcharges. A revised calculation of customer impact based on the billing surcharge percentage method proposed by Cal-Am in its initial application shows a surcharge of approximately 6.70 percent, or $2.55 per month for an average residential customer. Note that this method preserves the first tier of residential rates intact with no surcharge, as noted previously. Appendix 2 sets forth the initial balancing account amortization and customer surcharge.

Cal-Am proposes to donate 928 acres of land surrounding the Dam and reservoir to BLM and to credit ratepayers with the fair market value of the donated property.60 Cal-Am describes this land as, apart from the dam facilities, being "pristine open space adjacent to the Los Padres National Forest."61 A colored map, Exhibit 18, shows the four parcels proposed by Cal-Am, as well as an adjacent 77.6 acres, Parcel 417-051-003-000, recommended by DRA to be included in the Proposed Project.

DRA requests the $27,490,000 appraised value contained in a 2007 Cal-Am appraisal instead of the more recent 2010 appraisal of land that it owns in the vicinity of the Proposed Project be used as an offset to any regulatory asset authorized in this proceeding.62 The appraisal identifies this land as a Phase One, containing 1,000 acres and 21 potential building sites, with an appraised value of $19,950,000 and Phase Two, as covering 2,400 acres and 26 potential building sites, with an appraised value of $7,540,000. Phase One is the five adjacent parcels shown on Exhibit 18, and Phase Two is land located approximately six miles upstream, near Cal-Am's Los Padres Dam; the appraisal report is Attachment 8-2 to confidential Exhibit 24.

MPWMD requests that a 6.9-acre portion of one of Cal-Am's proposed parcels, Parcel 417-051-004-000, be subdivided prior to any land transfer to BLM and this portion, which houses the current Sleepy Hollow Steelhead Rearing Facility (Sleepy Hollow Facility) operated by MPWMD, be either retained by Cal-Am, transferred to MPWMD, or use given to MPWMD under an irrevocable long-term lease for as long as the facility is operated. The Sleepy Hollow Facility has been operational since 1997 and rescues and rears steelheads that are stranded in the Lower Carmel River; the facility is part of the mitigation measures required under MPWMD's 1990 Water Allocation Program EIR. Since Cal-Am is the largest diverter on the Carmel River, the construction and operation of the Sleepy Hollow Facility is funded by moneys derived from MPWMD's User Fee, which is collected by Cal-Am from its ratepayers.

We first address MPWMD's request. Cal-Am, the Conservancy, and NMFS, the project management team negotiating the land donation with the BLM, have all stated on this record their support for retaining the operation of the Sleepy Hollow Facility. However, as each party testified, the specific means by which this will be accomplished is still under discussion with the BLM. Based on the testimony, we are confident that the Sleepy Hollow Facility will remain a viable operation as long as it is necessary. Therefore, we will direct that the issue be discussed in each quarterly status report until resolved and we will not take any further action here.

Next, we turn to DRA's land proposal. While DRA testifies that the 2007 Phase-One appraisal of $27,490,000 applicable to 1,000 acres should be used as an offset to the regulatory asset, DRA does not recommend the specific amount of land to be negotiated for transfer to BLM. Cal-Am testifies that it did not include in its application the 77.6 acre Parcel 417-051-003-000 included in the 2007 appraisal because a 1.5 million gallon concrete water storage tank located on the property and maintained by Cal-Am is being used to provide public utility service to its customers and is not a necessary part of the project. Further, this parcel is not a part of the Reroute and Removal Project Agreement and the BLM has not agreed to accept the additional 77.6 acres of land.63

We concur with Cal-Am. No reasonable purpose has been presented to require Cal-Am to donate or transfer this parcel, being used for public utility purposes, into the Project. To the extent that this parcel is no longer used or useful for public utility purposes and Cal-Am subsequently decides to sell that parcel it will be required to comply with D.06-05-041 guidelines applicable to any gains on sale of the parcel. Thus, if Cal-Am decides to sell that parcel, then consistent with Sections 789 and 790 of the Public Utilities Code, Cal-Am shall invest the net proceeds in the water system plant, resulting in a reduction of future rate base and, hence, a benefit to customers in the form of lower rates than would otherwise be just and reasonable.

There is an assertion that Cal-Am may have violated Rule 1.1 of the Commission's Rules of Practice and Procedure and Sections 2107 and 2108 of the Public Utilities Code on the basis that Cal-Am misled the Commission in two earlier proceedings (its 2005 GRC proceeding A.05-02-012 and 2007 memorandum account proceeding A.07-02-023)  based on the appearance that Cal-Am represented that the Dam was currently providing a point of water diversion for customers in the winter months and that the planned buttressing would enable the Dam to be used and useful. However, a review of those proceedings does not support the assertion of a Rule 1.1 or Section 2107 or 2108 violation.

The Rule 1.1 violation assertion appears to be based on a misunderstanding that there is only one type of diversion applicable to the dam. That is, extracting water from the dam for customer use.

In the 2005 GRC proceeding, Cal-Am asserted that the dam was used and useful because it provides a point of diversion in the winter months and that water could be diverted in emergency circumstances. Its witness testified that the use of the Dam for this type of diversion had changed around 2003. The diversion feature of the Dam has been in use and was extensively used during winter season for extracting water from the Dam until the 2002-2003 water years, taking it to the plant below the Dam, treating the water, and sending it to customers. This is consistent with Cal-Am's testimony in this proceeding as addressed in our History of Project and San Clemente Dam Usefulness discussions.

In the 2007 memorandum account proceeding Cal-Am stated that the Dam impounds a reservoir and serves as a surface water diversion. Surface water diversion involves diverting water to the Dam, it does not involve extracting water from the Dam as discussed in the 2005 GRC proceeding. The dam is an authorized point of water rediversion under State Water Resources Control Board Licenses discussed in our prior San Clemente Dam Usefulness discussion in Section 5.1 and is available for emergency situations. This is also consistent with Cal-Am testimony addressed in our History of Project and San Clemente Dam Usefulness discussions in Sections 3 and 5.1.

A review of the prior proceedings with this proceeding finds no mention of Cal-Am testifying that dam buttressing would enable the Dam to be used and useful. As addressed in our History of the Project and San Clemente Dam Buttressing Prudency discussions, Cal-Am undertook buttressing activities upon a DSOD directive to satisfy current seismic safety standards so that the dam could safely pass a probable maximum flood and withstand a maximum credible earthquake. We find no basis for a Rule 1.1 violation based on Cal-Am's testimony. California American Water Company's dam diversion testimony is in compliance with Rule 1.1 of the Commission's Rules of Practice and Procedure and Sections 2107 and 2108 of the Public Utilities Code.

19 See July 7, 2011 Opening Brief at 50-51.

20 Id. at 54.

21 Exhibit 3, Chapman Rebuttal Testimony at 14.

22 See DRA's July 20, 2011 Reply Brief at 5.

23 Exhibit 23, Attachment 4-2.

24 Exhibit 4 at 34 and 35.

25 Id.

26 Exhibit 3, Svindland Rebuttal Testimony at 6.

27 Exhibit 4, Schubert Rebuttal Testimony at 37.

28 Exhibit 1, Schubert Direct Testimony at 7 and 8.

29 Exhibit 4, at Attachment 5.

30 The first EIR was issued on December 23, 1998 and the second EIR referred to as the Recirculated Draft EIR was issued in 2000.

31 Exhibit 23, Attachment 2-6 at 4-5.

32 Exhibit 31.

33 Id., Attachment 4-7 at 2 and 3.

34 Exhibit 4, Chapman Rebuttal Testimony at 4.

35 Exhibit 2 at 8.

36 Exhibit 3 at 2-3.

37 This is a high estimate of remaining storage capacity. Cal-Am's consultant estimates the Dam had approximately 70 acre-feet of remaining storage in 2008. See Exhibit 1, Schubert Direct Testimony, Tab 3 at 6.

38 Id. at 5.

39 Cal-Am's Opening Brief at 51.

40 DRA's July 7, 2011 Opening Brief at 40.

41 Exhibit 23, Attachment 7-2 at 15.

42 Exhibit 3, Chapman Rebuttal Testimony at 5.

43 Exhibit 23 at 7-2 and DRA's Opening Brief at 29.

44 Id. at 8-1 and 8-2.

45 Exhibit 1, Stephenson Testimony at 4 and Decision (D.) 06-11-050, issued December 1, 2006, mimeo at 40-46, Findings of Fact 24 and 25, Conclusion of Law 3, and Ordering Paragraph 19.

46 See D.08-05-036 issued on May 30, 2008, mimeo at 5. We note here that, without Commission authorization, Cal-Am's management took a different position and reflected the memorandum account in its balance sheet as a regulatory asset in its 2010 10-K Security and Exchange Commission filing, asserting that "it expected the costs to be fully recovered from customers in future rates." See 10-K filing at 83 and 98 and Exhibit 23, Attachment 8-1. The San Clemente Dam memorandum account is different than Cal-Am's Coastal Water Project memorandum account in that the Commission has reviewed and approved recovery of Coastal Water Project pre-construction costs incurred through December 31, 2008 and authorized a current surcharge.

47 Exhibit 8 at 9.

48 Cal-Am Opening Brief at 18. Cal-Am identifies historical costs as $6,662,700 for interim dam safety and annual environmental operating costs, plus interest, and the remaining $15,062, 207 as related to the EIRs.

49 Exhibit 4 at Attachment 4.

50 Due to the rounding of numbers the individual cost components being addressed will not add up to the total memorandum account balance.

51 Exhibit 4 at Attachment 4.

52 Exhibit 4 at 4-5.

53 Exhibit 4, Schubert Rebuttal Testimony at 6 and 7.

54 Exhibit 23 at Chapter 3.

55 Savings resulting from design changes or value engineering would be reflected in less funding being contributed by the Conservancy. Savings attributable to favorable market conditions in the construction industry would lower both the Conservancy and Cal-Am's contributions, proportional to their overall dollar contribution to the Project. Exhibit 1, Chapman Testimony at 10.

56 Although a more recent appraisal was performed in May of 2010, DRA relied on the 2007 McVay appraisal which covered approximately 3,400 acres and reflected real estate values prior to the real estate recession which began in 2008 (Exhibit 4, Schubert Rebuttal Testimony at 55).

57 DRA's alternative recommendation is included in testimony in Exhibit 23 at Chapter 8.

58 See for example D.11-05-018, D.97-11-074, D.96-01-011, D.95-12-063, D.92-08-036, D.88-12-108, and D.83-08-031.

59 Exhibit 1, Stephenson Testimony at 22 and 23.

60 Cal-Am's specific proposal states that the tax benefit of the land donation should be "generally equal" to the fair market value of the donated property, determined on the date of donation, and that this value should be deducted from the regulatory asset, thereby reducing the costs to ratepayers. See Exhibit 8 at 19.

61 Id. at 18.

62 Exhibit 4, Schubert Rebuttal Testimony at 55 and 56.

63 Exhibit 3 at 28.

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