III. Position of the Parties

A. SDG&E

SDG&E seeks resolution of the following issues in this proceeding: (1) whether the intermediate term contracts entered into by SDG&E in late 1996 and early 1997 are shareholder assets; (2) authorization to impose a surcharge of 0.00349 cents/kWh for two years, and to continue the collection of the CTC; (3) to determine which customers of SDG&E should be responsible for the repayment of the AB 265 undercollection. Due to the size of the undercollection, SDG&E asserts that the Commission must act immediately to manage the undercollection and establish a plan to amortize the balance.

The issue of refunding the AB X1 43 balancing account overcollection of approximately $168 million was presented to the Commission in Advice Letter 1405-E, and is pending before the Commission in a draft resolution and a draft alternative resolution.

SDG&E contends that the fundamental factual issue is whether the three intermediate term contracts are shareholder assets or not. SDG&E asserts that they are, and that the Commission cannot confiscate the profits from these contracts without providing SDG&E's shareholders with just compensation.

SDG&E asserts that the status of the intermediate term contracts as shareholder assets became an issue only after AB 265 was enacted because it appeared the Commission was going to require SDG&E to use those contracts to reduce the AB 265 undercollection. SDG&E asserts that such use is inconsistent with the contracts' character as shareholder assets.

SDG&E contends that the restructuring of the electric industry, as implemented by AB 1890, created substantial risk to SDG&E's shareholders of stranded costs. According to SDG&E, the risk of stranded costs would come from unrecovered, uneconomic costs in the following manner:

"[D]uring the four-year AB 1890 transition period (1998 through 2001) the differential between SDG&E's revenues under the frozen rate and SDG&E's costs of electric service would be calculated on a monthly basis. If in any month during the transition period SDG&E's costs to provide electricity exceeded the revenue it collected from the frozen rates it charged its customers, SDG&E would have no excess revenues (called `headroom') to pay down its transition (or net uneconomic) costs. If SDG&E's revenues from frozen rates exceeded in any month SDG&E's costs of providing electricity to customers, that excess revenue would be headroom and allocated to paying down SDG&E's transition costs. If SDG&E was unable to pay off all its transition costs prior to March 31, 2002, then SDG&E shareholders, not ratepayers, would incur the entire loss resulting from those unrecovered, net uneconomic costs, denominated as `stranded costs.' Thus, SDG&E shareholders bore all risk in the event transition costs were not fully recovered." (SDG&E Opening Brief, p. 16, footnotes omitted.) ⁷

SDG&E asserts that it was concerned about its ability to recover all of its stranded, uneconomic costs in the time permitted by the Legislature. The primary factor in determining whether there would be headroom during the transition period was SDG&E's monthly variable cost of providing energy. This cost was based on the price of natural gas to fuel electric generation, and the market price of electricity. Under AB 1890, the market price of electricity would be the market-clearing price charged by the PX to SDG&E under the mandatory bid/buy. Thus, the full recovery of transition costs by SDG&E was highly dependent on the price that SDG&E would have to pay the PX for power each month.

During the summer of 1996, SDG&E forecast its shareholders' stranded cost exposure at approximately $1.7 billion. SDG&E's management sought to minimize this exposure to its shareholders. Management determined that it could hedge this risk by negotiating attractively priced power purchase contracts so that it could create additional headroom to accelerate the recovery of transition costs.⁸ SDG&E pursued the hedging strategy to protect its shareholders from potential losses.

SDG&E's Board of Directors, at Board meetings in October and November 1996, considered and approved the strategy of acquiring power purchase contracts to hedge the shareholder price risk. In October 1996, the Board was presented with a three-year contract with Illinova to purchase power for 1997, 1998 and 1999. It was made known to the Board that the power purchased for the first year of the Illinova contract was to supply a portion of SDG&E's short term power requirements for that year, and that the power for the second and third years was to implement SDG&E's shareholder price risk hedging strategy. SDG&E's management also requested that the Board authorize execution of "up to 650 MW per year of supplemental purchased power agreements for the years 1998 through 2001 to hedge against energy market price changes." At the October 1996 Board meeting, the Board authorized SDG&E to pursue the hedging strategy by authorizing that portion of the Illinova contract for 1998 and 1999, and further authorizing SDG&E to execute more contracts up to an additional 650 MW per year for 1998 through 2001 to "hedge against energy market price changes."⁹ (See Ex. 101, pp. 12-13, Attachments D-E.)

At the November 1996 Board meeting, SDG&E management presented the purchase power contracts with LG&E and Pacificorp. According to SDG&E witness Reed, the sole reason for these contracts was to hedge the shareholder price risk resulting from the frozen electric rates instituted by AB 1890, and had nothing to do with acquiring power to serve SDG&E's customers. The Board authorized the execution of those two contracts. (Ex. 101, p. 14, Att. F-G.)

SDG&E contends that although D.95-12-063, as modified by D.96-01-009, precluded SDG&E from entering into power purchase contracts for the purpose of supplying power for SDG&E's full service customers while the PX was in operation, that decision did not preclude SDG&E from acquiring power for other reasons, such as hedging the shareholders' AB 1890 price risk. SDG&E contends that other than the 1997 portion of the Illinova contract, none of the intermediate term contracts were entered into by SDG&E, or approved by its Board, for any purpose other than as shareholder hedges against the AB 1890 price risk. Since the contracts were acquired and used to hedge the shareholders' potential losses, SDG&E asserts that the contracts had nothing to do with the provisioning of utility service to its customers.

SDG&E contends that from the time the intermediate term contracts were acquired from the outset, until the issuance of D.01-05-035, SDG&E treated the intermediate term contracts consistently as shareholder assets. SDG&E contends that the ratepayers did not bear any of the risks related to the contracts, and that SDG&E shareholders bore the administration costs related to the contracts until the issuance of D.01-01-061.

SDG&E witness Lee Schavrien testified that for calendar year 1997, SDG&E's energy costs were entered into SDG&E's ECAC balancing account. The 1997 portion of the Illinova contract, which SDG&E asserts was to provide power to SDG&E's bundled service customers in 1997, had its costs booked to the ECAC. Schavrien states that this was the appropriate regulatory accounting treatment in 1997 because the Illinova energy was required by SDG&E to provide utility service to its customers.

Since the PX did not begin operations until April 1, 1998, SDG&E could not obtain energy from the PX as mandated by AB 1890 and Commission decisions. For the first three months of 1998, SDG&E continued to acquire energy from resources other than the PX to serve its customers. During the first three months of 1998, SDG&E used the power from the intermediate term contracts to supply SDG&E's short term requirements. The costs associated with those contracts for those three months were booked to the IPIDMA. SDG&E asserts that this use was consistent with SDG&E's intent to use these contracts as a hedging instrument because the use of the contracts created more headroom than would have been created if SDG&E went out and purchased new supplies for customers in that period. Contrary to the arguments of the other parties, SDG&E asserts that the use of the contracts during the first three months of 1998 to provide energy to retail customers, did not amount to a dedication of these assets for utility customers. Even if the Commission finds that a dedication occurred, SDG&E contends that the dedication should be limited to those three months.

SDG&E contends that because the intermediate term contracts are shareholder assets, SDG&E accounted for these contracts in a manner different from the other generation assets recorded to the TCBA.¹⁰ In any month when the revenues from the intermediate term contracts exceeded the costs, the net profits were booked in the cost portion of the TCBA as a negative cost, which reduced the positive current costs recorded in the TCBA for that month. If there was no net profit from the intermediate term contracts, nothing would be booked to the TCBA until there were sufficient profits generated in future months to offset all prior losses.¹¹ By crediting only net profits to the TCBA, SDG&E ensured that shareholders, and not ratepayers, would incur any losses from the transactions. The witness for the City of San Diego agreed that this would be the accounting result.

SDG&E's first Annual Transition Cost Proceeding (ATCP) application, A.98-09-009, was filed on September 1, 1998. The purpose of the ATCP was to allow the Commission to determine the reasonableness of all costs and revenues booked to the TCBA for the period January through June 1998. SDG&E's testimony in the ATCP identified the intermediate term contracts and described how the net profits were being applied to reduce the transition costs. (Ex. 107, Att. 1; See 15 R.T. 1406-1407.) According to SDG&E, the Energy Division conducted an audit or review of SDG&E's TCBA entries for the six-month record period. The Energy Division report stated that it had performed a "regulatory review" of SDG&E's TCBA expenses, and its compliance with Commission decisions and the Public Utilities Code. (Ex. 107, Att. 2; See D.00-02-048, fn. 2, p. 3.) Page 10 of the Energy Division report stated in part:

"SDG&E also included the profit from Purchased Power contracts that were not in rates prior to December 20, 1995. Energy Division could not find any Commission decisions that required SDG&E to record post-restructuring Purchased Power contract profits into its TCBA. SDG&E has since decided to remove the profit associated with these contracts from its TCBA." (Ex. 107, Att. 2, p. 10.)

SDG&E contends that at the urging of the Energy Division auditor assigned to SDG&E's first ATCP, SDG&E agreed to reverse all of the accounting entries related to the intermediate term contracts out of the TCBA. SDG&E witness Schavrien testified that in his conversations with the Energy Division auditor, the auditor agreed with him that the consequence of reversing the intermediate term contract net profits from the TCBA would be that the profits and losses from those contracts would go below the line directly to shareholders. SDG&E witness Thomas Whelan also spoke with the Energy Division auditor, and informed him that the removal of the profits from the TCBA would result in below the line treatment.

ORA's March 1999 report on SDG&E's first ATCP acknowledged that the Energy Division report had been completed, and that ORA had reviewed it. Nowhere in ORA's report did ORA criticize or disagree with the Energy Division report addressing SDG&E's accounting treatment of the intermediate term contracts.

SDG&E contends that the reversal of entries from the TCBA was reported in the Energy Division auditor's report, which was entered into evidence in the ATCP proceeding and considered by the Commission in SDG&E's first ATCP decision, D.00-02-048. (See D.00-02-048, p. 3.) SDG&E asserts that D.00-02-048 impliedly made a distinction between purchase power contracts that were eligible for transition cost recovery, and those that were not, i.e., the intermediate term contracts, by specifically referring to "eligible purchase power contracts." (D.00-02-048, p. 42.)

The TCBA accounting reversal took place in March 1999. SDG&E removed the intermediate term contract net profits, approximately $25.8 million, booked to the TCBA through January of 1999. Since there were no other regulatory accounts to show how SDG&E was using the intermediate term contracts to hedge the price risk created by AB 1890, SDG&E began to record the contracts below the line. This accounting treatment continued from February 1999 through January 2001. SDG&E contends that this accounting is consistent with the treatment of the intermediate term contracts as shareholder assets.

SDG&E's second ATCP for SDG&E was to allow the Commission to determine the reasonableness of all costs and revenues booked to SDG&E's TCBA for the record period of July 1998 through June 1999. SDG&E witness Schavrien testified that during the second ATCP, ORA's auditor was provided with workpapers demonstrating the removal of the intermediate term contracts from the TCBA in March 1999. SDG&E contends that ORA's report in the second ATCP found that "... the entries made to the TCBA during the record period July 1, 1998 through June 30, 1999 are reasonable." (Ex. 107, Att. 3) In the Commission's second ATCP decision, D.00-10-048, the Commission concluded that "SDG&E's entries to its TCBA for the record period July 1, 1998 through June 30, 1999 (record period) are reasonable." In ordering paragraph 1 of D.00-10-048, the Commission stated that SDG&E's entries to its TCBA "for the record period July 1, 1998 through June 30, 1999 (record period) are adopted as set forth herein." (D.00-10-48, pp. 8-9.)

SDG&E contends that neither ORA nor the Energy Division objected to SDG&E's accounting of the intermediate term contracts in either of the two ATCP proceedings. Both of the ATCP decisions were consistent with treatment of the intermediate term contracts as shareholder assets.¹² SDG&E asserts that it consistently treated the intermediate term contracts as shareholder assets until the Commission precluded that treatment in D.01-05-035.

SDG&E witness Schavrien testified that SDG&E began to treat the intermediate term contracts in a manner inconsistent with their use as shareholder assets only after the Commission issued D.01-01-061, and SDG&E's application for rehearing of that decision was denied in
D.01-05-035. D.01-01-061 ordered the three investor-owned utilities to use their URG to serve existing customers at cost based rates. SDG&E objected to the treatment of the intermediate term contracts in this manner because the contracts were shareholder assets. Selling the power from these contracts at cost to SDG&E's customers would deprive SDG&E's shareholders of any profits realized by selling the contracts at market prices.

D.01-05-035 ordered SDG&E to make the accounting adjustments so that the power from the intermediate term contracts were charged to customers at cost. SDG&E's Advice Letter 1328-E, filed on May 14, 2001, stated that SDG&E would make accounting adjustments to its balancing accounts to ensure that its customers would only pay cost for the power from February 1, 2000 forward. An accounting adjustment of $76.7 million was made to reverse the accounting that SDG&E had been making from February 1, 2001 through April 2001. From May 2001 through December 2001, as ordered by D.01-05-035, the intermediate term contracts were booked to the PECA at their actual cost.

In response to the City of San Diego's suggestion that SDG&E could have contributed the intermediate term contracts to ratepayers once the AB 1890 rate freeze was terminated, SDG&E asserts that this would have been contrary to management's fiduciary obligations to the corporation.

The other parties contend that the profits from the intermediate term contracts should be applied to offset the undercollection in AB 265 pursuant to §332.1(c). SDG&E asserts that the evidence demonstrates that the intermediate term contracts were not intended to be subject to AB 265, and that substantial legal precedents preclude the intermediate term contracts from being subject to AB 265.

SDG&E witness Schavrien testified that SDG&E never proposed to the Governor, the Legislature, or anyone else, that shareholder assets such as the intermediate term contracts be used to offset the undercollections caused by AB 265. When the Legislature was considering the adoption of AB 265, SDG&E had already reversed the net profits from the intermediate term contracts out of the TCBA, and was accounting for them below the line as shareholder assets. Since SDG&E considered the intermediate term contracts to be shareholder assets, SDG&E never discussed these contracts with the Governor and the Legislature. In addition, the first ATCP decision had already been issued, which SDG&E claims confirmed that the Commission was aware of the intermediate term contracts, and that SDG&E was going to remove the net profits from these contracts from the TCBA.

When SDG&E witness Schavrien made presentations regarding AB 265 to the Assembly's Utilities and Commerce Committee, he provided a package to the Committee that identified the URG assets that SDG&E believed should offset the AB 265 undercollection. SDG&E identified these assets as the Public Service of New Mexico contract, the Portland General Electric contract, the qualifying facility contracts, and San Onofre Nuclear Generating Station (SONGS). The list did not include the intermediate term contracts, as shown in Attachment 12 of Exhibit 108.

In sum, SDG&E asserts that since the intermediate term contracts are shareholder property, as opposed to assets dedicated to public use, any attempt by the Legislature or the Commission to apply the revenues from these contracts to the AB 265 undercollection without just compensation would amount to a taking and would violate the Fifth and Fourteenth Amendments to the United States Constitution. SDG&E asserts that the intermediate term contracts were never dedicated to public use, nor were they ever necessary or useful in the provisioning of utility service to the public. Thus, any attempt to use the revenues from the contracts to offset the AB 265 undercollection would amount to a taking.

SDG&E contends that the Commission should interpret the requirement in §332.1(c) of utilizing "revenues from utility-owned or managed generation assets to offset an undercollection," to apply only to those revenues historically recorded in the TCBA. That is, the §332.1(c) offset should only apply to assets dedicated to public use, and that it should not include the revenues from the intermediate term contracts which are shareholder assets.

According to SDG&E, the AB 265 undercollection on March 31, 2002 was $338 million, and on May 31, 2002 it was $324.7 million. SDG&E forecasts that the AB 265 undercollection, as of December 31, 2002, will be approximately $222 million. This reduction is accomplished, in part, through the end of year 2002 transfer to the TCBA of the proportionate share of the PECA overcollection, as described by SDG&E witness Schavrien in Exhibit 107. However, if the Commission lacks the authority to order SDG&E to sell the intermediate term contracts at cost to customers from February through December 2001, SDG&E contends that this forecast of the undercollection would be artificially low.

During the course of these proceedings, SDG&E has recommended that to recover the forecasted undercollection of $222 million, the Commission should authorize a .00349 cent per kWh surcharge for two years and continue the recovery of the CTC until December 31, 2004. At the end of the two-year period, the AB 265 undercollection would be eliminated, the surcharge would end, and the CTC rate would only be used to recover ongoing transition costs. Consistent with this recommendation, SDG&E proposed to adjust the surcharge, to be effective January 1, 2004, by an advice letter filed before the end of 2003, to reflect the forecasted December 31, 2003 balance in the AB 265 undercollection.

SDG&E has proposed that the surcharge be included as a separate line item on the bills of all customers subject to AB 265, including medical baseline and CARE customers, but excluding direct access customers. SDG&E believes that medical baseline and CARE customers should be responsible for the surcharge because they benefited from the AB 265 rate ceiling. All AB 265 customers, bundled and direct access customers would be responsible for the CTC charge.

SDG&E witness Schavrien provided testimony about what was being done to reduce the AB 265 undercollection. He stated that SDG&E has, and is continuing to apply 70% of all PECA overcollections to reduce the AB 265 undercollection. The PECA overcollection is being applied to the AB 265 undercollection because the PECA reflects the difference between SDG&E's electric commodity revenues charged under Schedule EECC (Electric Energy Commodity Cost) and SDG&E's recorded energy costs, after deducting revenues collected for and passed on to DWR for the energy it provides.¹³ The 70% reflects the approximate percentage of SDG&E's bundled service customer usage who are subject to AB 265.

SDG&E is also using the CTC rate to reduce the AB 265 undercollection. The CTC revenue requirement for 2002 is set at $115 million, the same amount that was used in 2001. SDG&E applies 60% of the CTC revenues to reduce the AB 265 undercollection, while the remaining 40% of the CTC revenues are allocated to customers not subject to the AB 265 legislation, i.e., the AB X1 43 customers. The 60% represents the approximate percentage of SDG&E's customer usage subject to AB 265 compared to all of SDG&E's electric customer usage, including direct access customers.

SDG&E and the other parties disagree about what monies could be used to reduce the undercollection after December 2001. ORA and UCAN believe that SDG&E will continue to incur overcollections in SDG&E's PECA account into 2003. SDG&E contends that this assumes that SDG&E's current system average rate will not change, which may not be the case. SDG&E believes that if the Commission decides to true-up SDG&E's DWR and URG related commodity rates with their respective actual revenue requirements in January 2003,¹⁴ it is likely that the current excess revenues in the PECA will diminish or be eliminated, thus reducing the amount that can be used to reduce the AB 265 undercollection. ORA's witness agreed that once the Commission establishes a new retail electric commodity rate for SDG&E in 2003, that the contributions from the PECA to the AB 265 undercollection will not be significant.

SDG&E notes that the $115 million CTC revenue requirement may no longer be available to reduce the AB 265 undercollection. SDG&E has proposed in Rulemaking (R.) 02-01-011, the direct access proceeding, that for 2003, the CTC revenue requirement be used solely for the recovery of eligible ongoing transition costs. If this proposal is adopted in that proceeding, the CTC rate would no longer be available to reduce the AB 265 undercollection.

SDG&E also asserts that the other sources of potential funds that ORA and UCAN rely on to reduce the undercollection are questionable as well. ORA expects that the AB 265 undercollection will be reduced by $130 million because the Commission will rule in its favor that the intermediate term contracts are not shareholder assets. SDG&E has already reflected the overcollections from the tree trimming accounts through December 31, 2002 in its forecasted undercollection of $222 million. SDG&E also contends that the revenues from SONGS' Incremental Cost Incentives Procedure (ICIP) will not be available to offset the AB 265 undercollection beginning in 2004, and that the Commission rejected the proposal to revisit the treatment of SONGS in D.02-01-063. SDG&E also contends that UCAN's request to modify the interest rate applicable to the AB 265 balancing account is contrary to years of Commission precedent.

UCAN's expectation that there may be a $120 million refund resulting from an adjustment of DWR revenues is extremely speculative because it is unknown whether it will be available to reduce the AB 265 undercollection. Although the Commission has the discretion over how this potential refund is to be used, SDG&E believes that the Commission will use the refund to offset SDG&E's allocation of DWR's revenue requirements for 2003 because it appears that SDG&E's allocation of DWR's revenue requirement for 2003 will be greater than SDG&E's 2002 allocation. If the potential refund from DWR is used to offset the AB 265 undercollection, SDG&E contends that only 70% of the $120 million should be used to pay down the AB 265 undercollection and that the remaining 30% should apply to SDG&E's large customers.

SDG&E contends that since SDG&E's AB 265 bundled customers received most of the benefits under AB 265, only those bundled customers, and not direct access customers, should incur the AB 265 surcharge. However, SDG&E proposes that direct access customers continue to be responsible for paying the CTC rate.

SDG&E believes that there are approximately 4200 current direct access customers who received AB 265 benefits amounting to approximately $21.4 million. However, given the computer and billing limitations of SDG&E, it would be extremely difficult to identify, for each current direct access customer, the amount of AB 265 benefits that they received. Although SDG&E is not proposing that current direct access customers be responsible for the proposed surcharge, SDG&E agrees that direct access customers should be responsible for some of the AB 265 undercollection by paying the CTC rate for 2003 and 2004. Due to the migration of customers from bundled service to direct access, and in and out of SDG&E's service territory, SDG&E contends that the collection of the full amount owed by each customer who benefited from AB 265 is practically impossible. Thus, according to SDG&E, its generalized approach for recovering the AB 265 undercollection is the only feasible option. SDG&E states that UCAN's witness Marcus agreed that although many of SDG&E's direct access customers should be responsible for at least some portion of the AB 265 undercollection, properly apportioning the undercollection among SDG&E's direct access customers would be extremely difficult given the limitations of SDG&E's computer and billing systems. (13 R.T. 1291-1292, 1320.)

SDG&E witness Schavrien testified that the Commission has effectively converted SDG&E's electric commodity rate into a frozen or fixed rate as a result of D.01-09-059. In that decision, a fixed retail commodity system average rate of 7.96 cents per kWh was established. Embedded in the system average rate is 6.5 cents per kWh for energy provided from SDG&E's URG. The remaining component of the charge reflects the rate assigned for energy purchased by DWR. Other Commission proceedings are looking at SDG&E's retail commodity system average rate, and SDG&E believes that the resulting new electric rates will be effective January 1, 2003. SDG&E recommends that the statutory ceiling under AB 265 should end, effective January 1, 2003, so that the new rate can be fully implemented.

Contrary to UCAN's assertion that the 98% figure that SDG&E uses in the proposed settlement of the federal court litigation is fictional, SDG&E maintains that the percentage figure must be viewed in the context of what occurred during the time period from June 1, 2000 through the end of 2001.

B. City of San Diego

The City of San Diego asserts that SDG&E has the burden of proving that the intermediate term contracts are not "utility-owned or managed generation assets" within the meaning of AB 265 and §332.1, and are not "utility retained generation" as defined by the Commission in D.01-01-061. SDG&E has not met that burden. The City of San Diego contends that the documents pertaining to the power purchase contracts demonstrate that the generation that was being purchased was to meet the needs of SDG&E's retail customers, and not to hedge shareholder price risk. The City of Diego contends that D.96-12-088 and D.97-12-021 prohibited SDG&E from entering into bilateral power purchase contracts outside of the PX for any purpose. Thus, the intermediate term contracts are utility-owned or managed generation assets within the meaning of AB 265, that the contracts are URG within the meaning of D.01-01-061, and the revenues from the intermediate term contracts must be used to offset the undercollection in SDG&E's AB 265 balancing account as required by the legislation.

The City of San Diego argues that at the time of drafting or voting on AB 265, the Legislature did not know of the three intermediate term contracts. These contracts were identified for the first time when
A.00-10-045 was filed, which took place after the enactment of AB 265. Subsequent testimony and hearings reveal that the intermediate term contracts were providing power to SDG&E at 1/10th of the then-prevailing wholesale market costs, and that SDG&E was realizing hundreds of millions of dollars in revenues and profits from selling this power into the power market.

The City of San Diego contends that the past accounting used by SDG&E for its generation assets is irrelevant to whether the asset is under SDG&E's ownership and control. Even if the intermediate term contracts are considered to be shareholder assets, the City of San Diego asserts that there would be no unconstitutional taking if the revenues from the intermediate term contracts were used to offset the AB 265 undercollection. The City of San Diego asserts that the Legislature has plenary authority to enact legislation governing the regulation of public utilities, including the disposition of generation under the control of SDG&E.

The City of San Diego contends that §332.1 prohibits an adjustment in the AB 265 rate ceiling until the accounting procedure mandated by AB 265 has been fully and properly implemented by the Commission, and such an adjustment is found to be in the public interest. This implementation includes using the revenues from the utility-owned or managed generation assets, which means using all the revenues from the intermediate term contracts to offset any undercollection of wholesale electric costs incurred by SDG&E on behalf of those customers. In addition, D.01-01-061 requires that all generation under the control of SDG&E be provided at cost to its customers.

The City of San Diego contends that after properly accounting for all the costs and revenues in the ERSA account, including accounting for the intermediate term contracts, SDG&E's request for a revenue shortfall surcharge should be rejected and no adjustment of the AB 265 rate ceiling is necessary. In addition, until it is determined in this proceeding that SDG&E has complied with AB 265, there is no basis for the Commission to settle the federal litigation with SDG&E.

C. California Farm Bureau Federation

The California Farm Bureau Federation (Farm Bureau) is interested in ensuring that the TCBA overcollection of $168 million is refunded to AB X1 43 customers. Resolution E-3781 has in fact assigned this amount as a credit to the AB X1 43 customers, as requested in SDG&E's Advice Letter 1405-E

The Farm Bureau states that SDG&E witness Schavrien provided additional direct testimony at the hearing regarding the $168 million TCBA overcollection. Schavrien testified that this overcollection did not include the AB 265 customers' share of the intermediate term contract revenues. Instead, the recommended refund of $168 million only includes the AB X1 43 customers' 30% share ($23 million) of the $77 million in intermediate term contract revenues. Aside from the $23 million, the $168 million overcollection is made up of $104 million in excess URG revenues booked to the TCBA, and $41 million in excess CTC revenues collected from AB X1 43 customers. (11 R.T. at pp. 1083, 1110-1113.)

The Farm Bureau requests that the Commission include in this decision a finding that SDG&E properly calculated the $168 million refund for AB X1 43 customers in Advice Letter 1405-E, and that the overcollection should be refunded these customers as recommended by SDG&E in that advice letter.

The Farm Bureau agrees with the other customer representatives that the revenues associated with the sales of energy from utility-owned or managed generation assets must be provided at cost to utility customers. However, the Farm Bureau disagrees with the assertions of the City of San Diego, ORA, and UCAN that "all" of the revenues associated with the intermediate term contracts must be used to offset the AB 265 undercollection. The Farm Bureau contends that §332.1 requires only that the Commission "utilize revenues associated with sales of energy from utility-owned or managed generation assets to offset an undercollection...." It is incorrect to presume that all of the revenues associated with the intermediate term contracts must be allocated only for the benefit of the AB 265 customers. Accordingly, the Commission must allocate a portion of the revenues from the intermediate term contracts to the AB X1 43 customers. Such an allocation would be consistent with the equitable process of allocating URG costs and revenues to all customers.

D. Federal Executive Agencies

The Federal Executive Agencies (FEA) point out that the City of San Diego and UCAN have stated that AB 265 requires that "all" profits from the intermediate term contracts must be applied to reduce the balance in the ERSA, and that ORA asserts that the net profits from the intermediate term contracts must be used to offset the AB 265 undercollection. FEA contends that nowhere in AB 265 does it specify that "all" revenues associated with the sales of energy from utility-owned or managed generation assets must be used to offset an undercollection. FEA asserts that the Legislature intended, by requiring an "accounting procedure," that the revenues allocable to the AB 265 customers be used to reduce the undercollection resulting from the AB 265 ceiling, and that the revenues allocable to non-AB 265 customers must be allocated to non-AB 265 customers.

FEA recommends that the Commission make clear in this decision that the accounting procedures required by AB 265 mandate that an appropriate amount of the profits from the intermediate term contracts be allocated to non-AB 265 customers. FEA points out that this is consistent with D.01-09-059 at page 28, where the Commission directed SDG&E to allocate its URG to all customer classes, not just to small customers.

E. Office of Ratepayer Advocates

In order to fully implement AB 265, ORA asserts that $130.64 million in intermediate term contract profits that were accrued from June 2000 through January 2001, plus interest, should be booked to the PECA. In addition, the $150.76 million in profits from February 2001 through December 2001 that were already credited to ratepayers pursuant to
D.01-01-061 should be affirmed. ORA contends that with the intermediate term contract profits properly booked to the PECA, the expected PECA overcollection, and anticipated 2003-2004 CTC revenues, the AB 265 undercollection can be recovered without SDG&E's proposed rate surcharge.

ORA takes the position that the net revenues and profits associated with the intermediate term contracts must be used to offset the AB 265 undercollection because those contracts are "utility-owned or managed generation assets" subject to §332.1. ORA asserts that nothing in §332.1 qualifies or defines "utility-owned or managed generation assets" so as to exclude the intermediate term contracts from offsetting an undercollection.

ORA asserts that SDG&E has failed to make a compelling argument as to why the intermediate term contracts should be excluded from the provisions of AB 265. SDG&E first raised the claim that the intermediate term contracts were shareholder assets when SDG&E applied for rehearing of D.01-05-035. It was only after the passage of AB 265 did SDG&E attempt to convince the Commission that the intermediate term contracts should be considered shareholder assets. The Commission has never found, explicitly or implicitly, that the intermediate term contracts are shareholder assets.

SDG&E's claim that the intermediate term contracts are shareholder assets is contrary to the actions which SDG&E took, and to Conclusion of Law 33 in the Preferred Policy Decision (D.95-12-063, as modified by
D.96-02-009 [64 CPUC2d 1, 91]). That Conclusion of Law states: "Utility property, such as a generation asset, that has received revenue recovery through rates is used and useful in the performance of the utility's duties to the public until such time as the Commission determines otherwise."

SDG&E admits in its opening brief at page 28 that it applied for and received dollar-for-dollar revenue recovery of the contract costs through the IPIDMA for the period between January and March 31, 1998, as well as through the ECAC for periods prior to 1998. Since SDG&E received recovery for these contracts, ORA contends that the contracts were used and useful until the Commission decides otherwise.

SDG&E's assertion that the contracts were shareholder assets is also contrary to the restrictions in the Preferred Policy Decision. The Preferred Policy Decision required the utilities to purchase all of their energy needs from the PX and to sell all of their generation into the PX, and prohibited contracts between the utility and affiliated generation companies and hedging transactions.

SDG&E's claim that the Commission, in approving SDG&E's TCBA entries in the first ATCP found that the intermediate term contracts to be shareholder assets, has no reasonable basis in law or fact and must be rejected. SDG&E relied on the Energy Division's report in that ATCP which stated:

"SDG&E also included the profit from Purchased Power contracts that were not in rates prior to December 20, 1995. Energy Division could not find any Commission decision that required SDG&E to record post restructuring Purchase Power contract profits into its TCBA. SDG&E has since decided to remove the profit associated with these contracts from its TCBA." (Ex. 107, p. 11.)

ORA asserts that despite the plain language of the above quote, SDG&E interpreted that language to mean that the Energy Division recommended that net contract revenues be removed from the TCBA. ORA contends that the Energy Division's finding plainly stated that SDG&E decided to reverse the accounting of the contract profits, and that SDG&E's own testimony indicates that this is exactly what SDG&E did. Although SDG&E states that it reversed the accounting of the net contract profits from the TCBA as a result of discussions with the Energy Division auditor during the regulatory review of SDG&E's TCBA entries, ORA contends that the auditor did not recommend reversal of the entries from the TCBA. Instead, the Energy Division merely concluded that it was unable to locate any Commission decisions that required SDG&E to book the net contract profits to the TCBA.

ORA asserts that the Commission's finding in its decision in the first ATCP that "SDG&E's entries to the TCBA are appropriate" cannot reasonably be interpreted to constitute an implicit finding that intermediate term contracts are shareholder assets. ORA contends that the Commission could not have made this finding in the first ATCP because the record, in particular SDG&E's own filings, was silent on this issue. SDG&E's testimony in the ATCP contained only one paragraph which described the intermediate term contracts, and a description of how the PX revenues were applied to transition costs. However, SDG&E's testimony did not state that the contracts were for hedging purposes.

ORA points out that in D.01-05-035, the Commission found that SDG&E "failed to establish a line of authority exempting the purchase contracts from our interim order in D.01-01-061...." (D.01-05-035, p. 16.) ORA asserts that SDG&E also failed in this proceeding to establish that the Commission exempted the intermediate term contracts from the Commission's ratemaking authority, and that the intermediate term contracts are to be excluded under AB 265.

SDG&E's argument that it entered into the intermediate term contracts for the exclusive purpose of hedging against shareholder price risk has no support in either Commission decisions or in SDG&E's own actions and statements. ORA states that SDG&E acknowledged in a letter from Sempra's Jim Cassie to State Senator Brulte that the Commission denied SDG&E's request to hedge commodity price risk in D.96-12-088. (See Ex. 127, Ex. WAM-6; Ex. 104, Att. 1.) ORA contends that SDG&E had no authority from the Commission to purchase forward contracts and to bid those into the PX to hedge commodity price risk. ORA asserts that the record is clear that SDG&E continued to execute its bilateral contracting plan even in the absence of authority from the Commission to enter into the bilateral contracts. ORA contends that accepting SDG&E's argument that it was only hedging against the AB 1890 risk would reward SDG&E for circumventing Commission authority.

ORA also asserts that SDG&E did not inform the Commission or the Legislature that the intermediate term contracts were being used solely as a hedge against the AB 1890 price risk until after AB 265 was enacted. In SDG&E's first ATCP, SDG&E did not discuss using these contracts solely as hedging instruments. Nor did SDG&E inform the Legislature during deliberations over AB 265 of its intention to use the contracts solely as a price risk hedge, even though it had ample opportunity to do so, or that it intended to keep the profits from the intermediate term contracts. ORA asserts that instead of announcing that it was using the intermediate term contracts for hedging, SDG&E publicly stated its intention to use the contracts to provide power to its customers by telling the FERC in August 1999 that it "wants to be able to sell outside the PX obligation to supply the electric commodity needs of its bundled customers with the same level of flexibility available to ... other competitors that are now operating in California." (Ex. 127, p. 8, Ex. WAM-1.)

ORA also states that until SDG&E reversed the booking of net contract profits from the TCBA, SDG&E's accounting of contract costs and revenues was consistent with its accounting treatment of other URG assets. ORA asserts that the decision to remove the contract profits from the TCBA was a unilateral move on the part of SDG&E.

ORA contends that the surcharge which SDG&E seeks is unnecessary. ORA asserts that the adoption of ORA's recommended adjustment for the intermediate term contracts, the application of the 2003-2004 CTC revenues, and the PECA overcollection will make the surcharge unnecessary. SDG&E has assumed for purposes of this proceeding that there will be no PECA overcollection in 2003 available to offset the AB 265 undercollection. But in R.02-01-011, SDG&E has proposed that its CTC and electric commodity rates be maintained at current levels. If that proposal is adopted, ORA contends that a PECA overcollection will be available to reduce the AB 265 undercollection.

ORA expects that there will be a PECA overcollection in 2003 and 2004, even if SDG&E's electric commodity rates are not frozen at their current levels. With SDG&E's proposal to keep current rates in place, ORA expects an even higher PECA overcollection amount than if rates were adjusted downward.¹⁵ On an annual basis, any overcollection recorded in the PECA will be transferred to the TCBA, and the amount attributable to AB 265 customers will be used to reduce the AB 265 undercollection.

Given the anticipated CTC revenues and the PECA overcollection, and assuming adoption of an adjustment of $130.64 million related to the intermediate term contracts, ORA contends that there is no need to impose the surcharge as proposed by SDG&E. In addition, ORA points out that this proceeding and R.02-01-011 need to be coordinated on the issue of the recovery of the AB 265 undercollection.

F. Utility Consumers' Action Network

UCAN contends that no rate increase is warranted. UCAN asserts that SDG&E's residential customers already pay the highest electric rates in California, if not in the country. Adding an additional surcharge upon the state's highest electric rates would be inequitable and unwarranted.

UCAN contends that the AB 265 undercollection can be eliminated within a year and a half without the need for any rate increase. This can be accomplished by taking the following action: (1) AB 265 requires that all of the profits from the intermediate term contracts must be applied to reduce the balance in the ERSA; (2) apply to the ERSA undercollection any additional monies coming from the DWR allocation adjustment, tree trimming surpluses, performance based ratemaking (PBR) electric distribution sharing adjustments, and setting the balancing account interest rate at 59.254% of the short-term paper rate to reflect the zero cost deferred taxes; (3) do not subject SDG&E's customers to a rate increase to accelerate the payment of the ERSA undercollection; (4) medical baseline and CARE customers should not be assessed any surcharge for accelerated payment of the ERSA; (5) SDG&E's small business and residential customers who were served by direct access providers during the November 2000 through January 2001 time frame should not be required to pay the portion of the CTC surcharges that are allocated to repayment of the ERSA; and (6) SDG&E's bills should be revised so that payment of the ERSA is reflected as a separate line-item, instead of being lumped into the CTC line-item charge.

UCAN asserts that there is no crisis relating to the recovery of the AB 265 amounts, particularly if the Commission's intermediate term contract decision is upheld. According to SDG&E's TCBA filings, the AB 265 undercollection at the end of 2001was $358 million. This amount is expected to decline to $222 million by the end of 2002. At this rate of recovery, UCAN asserts that the undercollection would be amortized in under two years.

UCAN also asserts that there are two trends which could increase the rate recovery. As noted by SDG&E, SDG&E's payments to DWR will decline significantly. UCAN states that this will create more headroom to pay off the AB 265 balance in 2003. Also, if there is still a balance in the AB 265 account at the beginning of 2004, the ICIP for SONGS will expire. If actual nuclear costs are 1 cent per kWh less than the ICIP, this will generate about $33 million per year of additional revenue that could be used to retire the AB 265 balance. In addition, if the $120 million refund from the adjustment of DWR's revenue occurs, and it is applied to the ERSA, this could pay off the AB 265 balancing account before the end of 2003.

UCAN asserts that AB 265 requires that the Commission apply all of the profits from the intermediate term contracts to offset the balancing account created by §332.1. UCAN contends that the legislative intent was for the Commission to utilize the revenues associated with the sales of energy from utility-owned or managed generation assets.

Although SDG&E contends that these intermediate term contracts are shareholder assets that are not subject to regulatory oversight, UCAN asserts that no such exemption or condition exists. UCAN contends that the Commission should reject SDG&E's claim that the intermediate term contracts are shareholder assets. UCAN asserts that AB 265 requires that all of the profits that SDG&E made from its intermediate term contracts must be applied to offset the balancing account created by §332.1. UCAN states that AB 265 did not condition or qualify the phrase in AB 265 that "The accounting procedure shall utilize revenues associated with sales of energy from utility-owned or managed generation assets to offset an undercollection, if undercollection occurs." Since the intermediate term contracts were owned by SDG&E, managed by SDG&E, and were sales of energy for generation, UCAN asserts that the revenues must be used to offset any undercollection. UCAN contends that the evidence shows that the intermediate term contracts were not shareholder assets, and that SDG&E failed to depose or subpoena the Energy Division auditor for this proceeding.

UCAN also asserts that since SDG&E representatives helped write the language contained in AB 265, to the extent there is any ambiguity; it should be construed against SDG&E. UCAN also contends that SDG&E misled the public and policymakers into thinking that there were no contracts in existence from which SDG&E was reaping profits. UCAN contends that the letter from Sempra's Cassie to Senator Brulte stated that in 1996 and in 1997, SDG&E sought to enter into energy contracts and was ordered by the Commission to buy only from the power exchange. UCAN asserts that the letter implies that SDG&E never had the authority to enter into any bilateral contracts, either for shareholders or ratepayers. UCAN contends that the central issue in this proceeding is if the Legislature knew about the intermediate term contracts, and would the Legislature have exempted the contracts from being applied to the undercollection if they knew.

As noted earlier, the AB 265 undercollection can be reduced by the refunds from the one-way tree trimming balancing account in 2001-2003. Based on past experience, UCAN estimates that this will amount to about $10 million per year. UCAN also proposes that any amounts that might be generated by sharing from the existing electric distribution PBR allocated to the electric department between 2001 and 2003 should be assigned to reduce the undercollection instead of being refunded to customers through a bill credit.

UCAN also recommends that on a going forward basis, that the balancing account interest rate for this account be set at 59.254% of the short-term paper rate. This would reflect that zero cost deferred taxes finance over 40% of the balancing account, that SDG&E will have use of this tax refund for a longer period of time, and that the tax refund will provide interest-free capital instead of having to borrow money.

UCAN objects to SDG&E's plan to include the surcharge on the rates of CARE and medical baseline customers. UCAN contends that these customers were not required to pay any increased rates for any portion of Southern California Edison Company's past power debts, and SDG&E's customers should be similarly exempted. UCAN also notes that the inclusion of the surcharge on these customers is a change from what SDG&E originally recommended when A.01-01-044 was filed.

UCAN contends that direct access customers, who did not contribute to the size of the AB 265 undercollection from June 2000 to February 7, 2001, should not be required to pay the portion of the CTC surcharges that are allocated to the repayment of the ERSA. UCAN asserts that it would be unfair to these customers if they were forced to repay the balance that they did not create, because they paid higher direct access rates without the benefit of the 6.5 cents/kWh cap. According to UCAN, the current CTC revenues are being applied almost totally to the repayment of the balancing account.

UCAN recommends that a practical and equitable method of dealing with these direct access customers is to exempt any residential customer or business customer under 100 kW who was a direct access customer during the period from November 2000 through January 2001 from paying the portion of the current CTC charge that goes toward the payment of the balancing account.¹⁶ Alternatively, UCAN recommends that the Commission order SDG&E to verify the period during which the largest number of residential and small business customers were served by direct access providers, and to propose a more feasible means of exempting this subset of customers from the surcharge.

UCAN points out that in SDG&E's opening brief at page 87, SDG&E states that the equity issue is bona fide, and that SDG&E's solution is to relieve the direct access customers from having to pay the proposed rate surcharge. UCAN points out, however, that SDG&E does not explain how it will distinguish between bundled and direct access customers. If SDG&E's proposal is to exempt current direct access customers from the unwarranted surcharge, with no consideration as to whether those customers were responsible for accruing the undercollection, such a proposal should not be accepted.

UCAN proposes that SDG&E be ordered to revise its bill to show the AB 265 ERSA payments as a separate line item, instead of using the CTC rate component to recover these costs. UCAN proposes that the CTC rate component should only be used for costs in excess of market from contracts and other elements of tail CTC rather than for repayment of the AB 265 undercollection.

Regarding the proposed settlement agreement for the federal litigation, UCAN points out that it is not an all-party agreement and that none of the other active parties in this proceeding support the settlement. Even if it is viewed as a settlement under the Commission's rules, UCAN contends that the settlement must be viewed as a contested settlement. UCAN also contends that SDG&E's claim that shareholders are receiving 98% of the profits from the intermediate term contracts is a deceptive proposal. UCAN contends that the proposed settlement agreement simply amounts to splitting the contract profits between customers and shareholders on an approximately 50/50 basis. UCAN contends that SDG&E has no colorable claim of entitlement to the 50% share.