IV. Discussion

A. Introduction

The issues raised in this proceeding, and the evidence that was developed, impact the AB 265 surcharge that is being requested by SDG&E. In addition, the issues and the evidence developed in this proceeding have an impact on the AB X1 43 overcollection, and directly relate to the substance of the Writ Petition before the Court of Appeal and the proposed settlement of the federal litigation involving D.01-01-061 and D.01-05-035.

In this decision, we are addressing only two issues: (1) SDG&E's request for the AB 265 surcharge; and (2) SDG&E's proposed settlement of June 14, 2002. However, in order decide these issues, it is necessary for us to review the arguments and the evidence that the parties have raised.

B. AB X1 43 Overcollection

AB X1 43 imposed a frozen electricity rate of 6.5 cents per kWh on large customers, i.e., on non-AB 265 customers, and allowed any revenue shortfall to be recovered from these customers. However, instead of a shortfall, SDG&E asserts that there is a balancing account overcollection of approximately $168 million for these AB X1 43 customers. SDG&E proposed in Advice Letter 1405-E to return this overcollection as a credit to the rates of these large customers. SDG&E proposed in Advice Letter 1405-E to return this overcollection as a credit to the rates of these large customers. SDG&E's proposal was approved by the Commission on November 7, 2002 when it issued Resolution E-3781.

SDG&E has requested that a two-year surcharge of 0.00349 cents/kWh be imposed on all AB 265 customers. In addition, SDG&E has requested that the CTC rate recovery continue for that two-year period, and that all customer groups pay this charge. SDG&E recommends that this proposal be authorized by the Commission so that the forecasted AB 265 undercollection of $222 million can be recovered from its customers in a timely manner in order to preserve SDG&E's financial well-being. The City of San Diego, ORA and UCAN argue that the surcharge is unnecessary, and that the AB 265 undercollection will be eliminated over time if certain offsets are allowed or continued.

A key issue regarding SDG&E's surcharge request has to do with the net profits that were derived from the intermediate term contracts that SDG&E entered into in late 1996 and early 1997. The power from those contracts was sold into the market by SDG&E during the period from April 1998 until the Commission ordered SDG&E in May 2001 to make the necessary accounting adjustments to comply with the requirement in D.01-01-061 that URG be first used to serve existing customers at cost-based rates.

SDG&E contends that the net profits from the intermediate term contracts belong to its shareholders. SDG&E argues that since the intermediate term contracts are shareholder assets, the net revenues from those contracts cannot be used to offset the AB 265 undercollection. The City of San Diego, ORA and UCAN argue that the intermediate term contracts are "utility-owned or managed generation assets." As such, the net revenues from the intermediate term contracts must be used to offset the undercollection in the ERSA as required by AB 265. The Farm Bureau and FEA contend that only the AB 265 customers' portion of the net revenues from the intermediate term contracts should be used to offset the undercollection, and that the revenues allocable to non-AB 265 customers must be allocated to the non-AB 265 customers.

The offset provision appears in §332.1(c), which was added to the code by AB 265. Section 332.1(c) provides:

"The commission shall establish an accounting procedure to track and recover reasonable and prudent costs of providing electric energy to retail customers unrecovered through retail bills due to the application of the ceiling provided for in subdivision (b). 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. The accounting procedure shall be reviewed periodically by the commission, but not less frequently than semiannually. The commission may utilize an existing proceeding to perform the review. The accounting procedure and review shall provide a reasonable opportunity for San Diego Gas and Electric Company to recover its reasonable and prudent costs of service over a reasonable period of time."

The parties to this proceeding have focused in on the issue of whether the intermediate term contracts are shareholder assets or assets dedicated to the use of utility customers. All of the parties seem to believe that the characterization of the intermediate term contracts should control whether the net revenues from those contracts should be used to offset the AB 265 undercollection.

We note that the arguments and the evidence over whether the intermediate term contracts are shareholder assets, or assets dedicated to the use of utility customers, are conflicting. On the one hand, SDG&E acknowledges that the 1997 portion of the Illinova contract was used to serve SDG&E customers in 1997, and during the first three months of 1998, the power from all three contracts was used to supply electricity to its customers. The Preferred Policy Decision specifically states that: "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." (64 CPUC2d 1, 49-50, COL 33, p. 91.) Presumably, a determination that a generation asset is no longer used and useful would only come after a §851 request is made to the Commission by the utility, which never occurred with respect to the intermediate term contracts. In addition, Sempra's letter to Senator Brulte implies that SDG&E was prohibited from engaging in hedging transactions by the Commission. The events surrounding the Energy Division regulatory review of the TCBA in the first ATCP, as evidenced by SDG&E's written testimony in Exhibit 107, could also support a finding that SDG&E's hedging strategy was not disclosed to the Commission. All of the evidence cited above could lead us to conclude that the intermediate term contracts were used by SDG&E for the benefit of utility customers.

On the other hand, an argument could also be made that with the exception of 1997, and possibly the first three months of 1998, the intermediate term contracts were treated by SDG&E as shareholder assets, and such treatment was approved by the Commission. Such an argument finds support in the documents discussing hedging at SDG&E's Board of Director meetings in October and November 1996, SDG&E's written testimony in Exhibit 107 for the first ATCP which described the intermediate term contracts and how they were treated in the TCBA, the Energy Division auditor's review of the TCBA entries and adjustment and his discussions with SDG&E witnesses, and the Commission's first and second ATCP decisions which incorporated the reviews by the Energy Division and ORA of the TCBA entries and adjustments. All of the evidence cited above could lead us to a contrary conclusion that the intermediate term contracts were treated as shareholder assets.

When all of this evidence is looked at in the aggregate, SDG&E's testimony supporting its position that the intermediate term contracts are shareholder assets not dedicated to public utility use was particularly strong, because evidence was provided by percipient witnesses to the negotiation, approval, use, and regulatory accounting of those contracts and buttressed by documentary evidence. By contrast, the evidence provided by witnesses for the City of San Diego and ORA that the intermediate term contracts are ratepayer assets had obvious weaknesses including lack of relevant supporting documentary evidence and lack of percipient witnesses. This balancing of the evidence in the aggregate provides abundant support for us to find that the adoption of the June 14, 2002 proposed settlement agreement is both supported by the record evidence in this proceeding and provides a just and reasonable basis to resolve the outstanding issues surrounding the intermediate term contracts.

Moreover, whether the intermediate term contracts are the private property of SDG&E's shareholders (and therefore cannot be taken for the benefit of SDG&E's ratepayers without the payment of just compensation) or have been permanently dedicated by SDG&E to public utility use is a question of fact for the Commission:

"Whether or not dedication has occurred is a factual issue, to be determined on a case-by-case basis. Courts caution that `to hold that property has been dedicated to a public use is not a trivial thing, and such dedication is never presumed without evidence of unequivocal intention.' (Allen, 179 Cal. at 85, citations omitted)."

See, D.01-08-061; 2001 Cal. PUC LEXIS 512, *14, *15.

The California Supreme Court has made it abundantly clear that, while a utility cannot voluntarily withdraw property dedicated to public utility use from that use, a utility is free to use property not dedicated to public use (i.e. private property) as it sees fit unimpeded by Commission regulation. For example, the Court stated in a case involving Richfield Oil Corporation:

See, Richfield Oil Corporation v. Cal. Pub. Util. Comm'n, (1960) 54 Cal.2d 419, 435-436. The Commission acknowledges this legal principle:

See, Houchen v. Pacific Bell, D.97-01-005; 70 CPUC 2d 567, 568; 1997 Cal. PUC LEXIS 5, *2

By dedicating its assets to a public use a utility submits those assets to the reasonable rate regulation of the Commission. By contrast, property not dedicated to public use that is taken for a governmental use (what we would have here) is analyzed as an "actual taking" (Loretto v. Manhattan Teleprompter CATV Corp. (1982) 458 U.S. 419, 427) requiring the State to pay for the property taken (Yee v. Escondido (1992) 118 L.Ed.2d 153, 162).

It has long been the law in California that the Commission will run afoul of the aforementioned constitutional limitation should the Commission compel a public utility to dedicate to public use its private property not theretofore dedicated to public use:

"The provisions of this act [Public Utilities Act] could not authorize the commission to compel such corporation [the utility] to dedicate additional property to public use without additional compensation. When a corporation voluntarily devotes a part of its property to public use, it is to be presumed that it makes the dedication because it is satisfied with the return which it expects to receive, and in that way it is deemed to have been compensated for such dedication. But when it is forced to devote to public use additional property which it has not dedicated to public use, or is compelled to extend its service to supply uses or territory not embraced in the original dedication, it must, under our constitutional provisions, as a condition precedent, be compensated for the value of the new property taken or new use exacted.

See, Atchison, Topeka and Santa Fe Railway Company v. Cal. R.R. Comm'n, (1916) 173 Cal. 577, 584-585.

As the foregoing discussion demonstrates, there are arguments on both sides of the question of whether the intermediate term contracts should properly be treated as ratepayer or shareholder assets. However, the adoption by the Commission of the proposed settlement of the federal litigation that SDG&E offered on June 14, 2002 would make it unnecessary for us to resolve this question. There are a number of reasons that lead us to conclude that SDG&E's proposed settlement is reasonable in light of the whole record of this proceeding, consistent with law and in the public interest and that the Commission should accordingly approve it.

We first address the question of whether the intermediate term contracts are shareholder assets or are assets dedicated to the use of SDG&E's customers. The record evidence on this question is conflicting, and based on the close balance of the relative equities involved, an "all or nothing" decision on this point would be unfair either to ratepayers or to SDG&E's shareholders.

The Commission's decisions that required SDG&E to book the profits from the intermediate term contracts for the benefit of ratepayers (D. 01-01-061 and D. 01-05-035) did not take effect until February 1, 2001. SDG&E has accordingly, to date, nominally retained the profits from these contracts for the period from April 1998 through January of 2001. The amount of these profits that SDG&E has, to date, nominally retained include the following: $67 million for the period from April 1998, when SDG&E began taking power under the intermediate term contracts, until June 2000, when AB 265 took effect, and $130 million for the period from June 2000 through January 2001.

Although SDG&E has nominally retained, to date, $197 million in profits from the contracts, SDG&E has effectively foregone $100 million of these profits in connection with another settlement approved by the Commission. In D.01-11-029, the Commission approved a settlement, offered by SDG&E and ORA, in the Third Annual Transition Cost Proceeding (A.00-10-008), under which SDG&E agreed to write down the AB 265 undercollection by $100 million. The specific issue resolved in that settlement was the reasonableness of SDG&E's energy procurement activities from July 1, 1999 through February 7, 2001. Although the issue of the treatment of the intermediate term contracts as ratepayer or as shareholder assets was before the same parties in other proceedings at the time of that earlier settlement, this issue was not an explicit part of the settlement of A.00-10-008.

The Commission's approval of the $100 million settlement in A.00-10-008 was just one of the implementing decisions required of the Commission as a result of the MOU between SDG&E and the State (through DWR). SDG&E's agreement to the settlement of A.00-10-008 for a $100 million write-off was part of the totality of agreements made in the MOU, which included, among other things, Commission approval of all "CPUC Implementing Decisions" specified in the MOU. Thus, in the view of SDG&E, its agreement to the settlement of A.00-10-008 had the effect of reducing its profits from the intermediate term contracts by $100 million even though the terms of the settlement in A.00-10-008 did not state that the profits from those contracts would be the source of these funds.

Because SDG&E, acting in compliance with the Commission's decisions, has already booked a substantial portion of the profits from the intermediate term contracts to offset the AB 265 undercollection and has booked another significant portion of said profits to credit the TCBA for large commercial and industrial customers, it would work a substantial hardship on all SDG&E customers if SDG&E were to prevail on the merits in either the federal or state litigation. SDG&E believes that if it had not been restricted by the Commission's decisions in D.01-01-061 and
D.01-05-035, and had it been able to sell the power from the contracts on the open market without any regulatory restriction, it would potentially have been able to recoup more than $350 million in profits from the contracts for the period from February through December 2001. In light of the potential exposure to ratepayers, the Commission agrees with SDG&E that the costs and risk of further litigation in the federal lawsuit is not in the public interest and that a settlement of this dispute is in the mutual interests of the Commission and SDG&E, in the interest of SDG&E's ratepayers, and in the public interest.

The Commission further agrees with SDG&E that the allocation to ratepayers of the $175 million that SDG&E has already booked to the benefit of ratepayers pursuant to Commission Decisions D.01-01-061 and D.01-05-035, plus the additional $24 million that SDG&E will book to the benefit of ratepayers pursuant to the proposed settlement, and the allocation to SDG&E's shareholders of the $173 million in profits from the contracts that SDG&E has nominally retained, represent a fair and reasonable apportionment of the litigation risk that the Commission and SDG&E respectively bear in the federal and state litigation. Although this decision has reviewed the intermediate term contracts in this proceeding, as D.01-05-035 at page 10 noted we would, today's decision does not revisit the decisions that the Commission made in D.01-01-061 and
D.01-05-035 with respect to the intermediate term contracts.

Since the intermediate term contracts were made subject to the URG requirement in D.01-01-061, the net revenues generated for the period from February 1, 2001 through December 31, 2001 have already been accounted for as directed by the Commission in the PECA. As a result of the Commission's adoption of SDG&E's June 14, 2001 proposed settlement, the AB 265 undercollection will be reduced by an additional $24 million.

As ORA points out, the profits from the intermediate term contracts for the period from June 2000 through January 31, 2001 have not been credited to the PECA. The net revenues for this eight-month period amount to $130 million plus interest. Although AB 265 was signed into law on September 6, 2000, the rate ceiling was made retroactive to June 1, 2000. Since the offset provision in §332.1(c) relates to the undercollection created by the rate ceiling, ORA believes that the offset of utility-owned or managed generation assets should begin on June 1, 2000 and end on January 31, 2001.

We decline to adopt the recommendation of ORA regarding the offset period and the offset revenue amount that should be adopted. As already noted above, the June 14, 2002 settlement offered by SDG&E represents a fair and reasonable apportionment of the litigation risk that the Commission and SDG&E respectively bear on this issue in the federal litigation and should accordingly be adopted by the Commission.

The Farm Bureau and FEA contend that the Commission should only allocate a portion of the revenues from the intermediate term contracts to offset the AB 265 undercollection. They contend that the allocation should reflect the allocation of URG to all customer classes.

We decline to adopt the recommendation of the Farm Bureau and FEA. Since SDG&E's advice letter to credit the $168 million overcollection to AB X1 43 customers has been approved, large customers will receive a credit on their future bills. AB 265 customers, on the other hand, face a forecasted undercollection of $222 million. AB 265 customers should be protected from further rate increases, and the adoption of SDG&E's proposed settlement will move us affirmatively toward the achievement of that objective. This will reduce the expected AB 265 undercollection to approximately $198 million.

The parties opposed to SDG&E's request for a surcharge have also made other recommendations regarding how the AB 265 undercollection can be eliminated.

One key recommendation that UCAN suggested is to use the $120 million true-up adjustment that DWR has indicated that it will make to SDG&E's rates. This adjustment would true-up DWR's forecasted and actual revenue requirements in 2001 and 2002. (See D.02-02-052, pp. 77-82; D.02-03-062, pp. 29-30.) SDG&E witness Schavrien estimates this adjustment at $120 million, and that the AB 265 customers' share would be 70% of the $120 million. (12 R.T. 1179-1182.) Schavrien testified that the "Commission can choose to apply it to the ERSA account, which San Diego would not oppose, or it could choose to true it up against the ... rate that has to be paid to CDWR for 2003." (12 R.T. 1181-1182.)

If $84 million (70% of the $120 million) of the expected adjustment from DWR is used to reduce the AB 265 undercollection, this would reduce our estimated undercollection of $198 million, after the adoption of SDG&E's proposed settlement, to $114 million in 2003. Other kinds of potential offsets have been mentioned by the parties as well, some of which are dependent on the outcomes of other proceedings. SDG&E also points out that it estimates the AB 265 undercollection will be eliminated in the fourth quarter of 2005 if no surcharge is imposed and the current CTC rate continues. (See Ex. 108, p. 3, Att. 10.)

It is apparent from the evidence that there are viable options for reducing the AB 265 undercollection other than imposing a surcharge on customers' rates. These options should be pursued instead of burdening AB 265 customers with an additional increase in rates. Accordingly, the assigned Commissioner should coordinate with the Energy Division staff in the other proceedings in which the $120 million true-up adjustment is being discussed, to determine whether $84 million of it can be used to reduce the AB 265 undercollection.

Based on the evidence presented, the additional $24 million offset, the potential $120 million refund, other possible overcollections that could be used to offset the AB 265 undercollection, and the detrimental impact that the surcharge would have on the rates of SDG&E's AB 265 customers, the request for a surcharge of 0.00349 cents/kWh for a period of two years on SDG&E's AB 265 customers is denied.

In order to keep the Commission abreast of the AB 265 undercollection, SDG&E shall file a quarterly report in this docket, beginning on the first business day in January 2003, and continuing on the first business day of each succeeding quarter until the AB 265 undercollection is eliminated, detailing the AB 265 undercollection and all offsetting adjustments to the undercollection.

Section 332.1(b) provides in pertinent part that if the Commission finds it to be in the public interest, the rate "ceiling may be extended through December 2003 and may be adjusted as provided in subdivision (d)."

SDG&E and ORA recommend that the Commission allow the 6.5 cents/kWh rate ceiling to terminate on December 31, 2002. By ending the rate ceiling, this will allow the Commission to implement the new DWR and URG revenue requirements for 2003. No other party has expressed an interest in extending the rate ceiling. We find that the rate ceiling should be allowed to terminate on December 31, 2002.

As mentioned in the positions of the parties, other issues have been raised in connection with the surcharge that SDG&E requests. However, since this decision denies SDG&E's request for a surcharge, those surcharge-related issues are moot and do not require further discussion.

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