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ORA recommends that the Commission disallow $7,269,315 of the gas costs incurred during the review period for Southwest's rates. ORA states:


"The disallowance is based on savings that would have been generated had Southwest injected gas during its contracted injection months to fill its storage resources for withdrawal in the winter, thus reducing the amount of purchased flowing gas supplies. The disallowance has been adjusted to account for variable storage injection and withdrawal costs, the carrying cost of storage, in-kind fuel, and revenues derived from Southwest's sale of storage capacity during the latter part of the winter of 2000-2001."51

The ORA methodology assumes average monthly withdrawals over the traditional heating months of November through March, and equal injections during the preceding injection months. ORA also assumes that Southwest's average monthly cost of gas during the winter months would have been "avoided" had Southwest injected adequate gas. ORA uses market index prices to calculate the cost of injecting additional gas. Finally, ORA reduces its disallowance calculation by "the revenues derived from Southwest Gas' sale of storage capacity during the latter part of the winter."52

County

The County recommends a disallowance of $11.7 million. The County develops its estimate by modeling the reduction in Southwest's core portfolio costs that would occur if it had followed the "strategy of using storage injections and withdrawals to levelize its monthly purchases of core supplies."53 The County further assumes that Southwest should have filled its storage capacity by November 1, 2000 and have drawn it down to 0.17 Bcf by April 1, 2001. The County estimates, using cost indices for both gas injections and withdrawals, that Southwest would have saved $14.4 million is gas procurement costs. The County, noting that Southwest saved customers $2.7 through the brokering of unused storage capacity and through interstate capacity swaps, reduces the proposed disallowance to $11.7 million.

Southwest

Southwest contends that the disallowance calculations presented by ORA and the County are fundamentally flawed.54 Southwest states that ORA's simple policy of filling storage through equal monthly injections and draining storage through equal monthly withdrawals "completely fails to acknowledge the prevailing economic considerations."55 Southwest hypothesizes that a different pattern of storage injection and withdrawal, i.e., maximal injections July-September with withdrawals in November and December would reduce the proposed disallowance to $2,024,355. Further, Southwest notes that it has never been its practice or Commission policy to require the filling of storage, and that its average injection level of the four winters prior to winter 2000-01 approximated 77%. Southwest states "If one recalculates ORA's disallowance, taking into account the economic decisions Southwest would have had to make to comply with the Storage Decision, and if Southwest had a `fill storage at any cost' target of 83% (or any inventory level less than 83%, i.e., 77%) there would be no disallowance."56

Southwest reaches a similar result in its analysis of the County's proposed disallowance. Southwest argues that the County also adopts a "fill storage at any cost" premise that is devoid of economic analysis. Southwest further argues that the County's use of market indices to calculate the cost savings is "incomprehensible . . . in the face of a record replete with evidence that Southwest's procurement efforts have significantly `beat the market.'"57 Southwest concludes that if it had conducted a similar analysis for the County's proposed disallowance as it had for ORA, then the County's flawed costs assumptions would have led to "a mathematically similar but deficient result."58

Discussion: Disallowance Should Be $5.799Million; Rebates Due to Customers Based on Consumption in winter 2000-01.

We find the methodology used by ORA to be both a simple and reasonable way for determining the appropriate disallowance. In particular, we conclude that ORA's methodology, which assumes equal injections over the summer of 2000 followed by equal monthly withdrawals over the winter of 2000-2001 is a reasonable model for procurement activities.

Assuming that the prudent course of action for Southwest was to fill its contracted storage completely before the winter of 2000-2001, ORA's methodology leads to a disallowance of $7,269,315. Since Southwest filled 11% of its storage, this disallowance works out to $81,677 for each percentage point of available storage that Southwest failed to use. Because we have assumed that Southwest would have reached a five-year average storage fill level of 82% (or secured futures contracts for gas amounting to an equivalent amount), we therefore determine that a disallowance of $5,799,067 is warranted.59

We find ORA's methodology more reasonable than that proposed by the County. ORA's methodology seeks to levelize the monthly injections and withdrawals of gas, while the County's methodology seeks to levelize the purchase of monthly core supplies. Since it is not possible on a going-forward-basis to know the pattern of demand for future months, we conclude that it is not possible for a manager to implement the County's procurement and storage strategy, except in a rough or approximate way. Concerning the price of the gas that Southwest could have avoided purchasing in the winter if it had filled storage, the County's methodology prices the gas at the level of market indices, while ORA's methodology assumes that Southwest's avoided purchases would reflect the average that Southwest actually paid during this period (which was less than the indexed prices). Again, we find ORA's assumption more reasonable, for there is no evidence indicating that Southwest paid market prices for the gas it purchased.

Finally, we find Southwest's assumptions about the operation of storage and withdrawal - maximal injections July-September with withdrawals in November and December - to be an unreasonable pattern of operation. In particular, when faced with the skyrocketing price of gas in the winter of 2000-2001, why would Southwest drain its entire storage in the first two months of the winter? This pattern of storage operation is unreasonable.

In summary, the methodology for calculating a disallowance proposed by ORA is reasonable. However, we base our disallowance on our assumption that Southwest would have used 82% of the contracted storage or would have arranged for the delivery of an equivalent amount of gas during the winter via futures contracts purchased in the summer. Using ORA's methodology to estimate the cost savings of filling the storage from the 11% level that Southwest procured to the 82% level of storage utilization, we estimate that Southwest should have saved $5,799,067.60 We adopt this figure as our disallowance.61

51 ORA, Opening Brief, p. 8, citing Exh. 100, pp. 3-9, app. A. 52 Exh. 100, p. 3-9 and Exh. 100, Appendix A. 53 County, Opening Brief, p. 25. 54 Southwest notes that its fundamental position is that no disallowance is warranted, but that the "underlying rationale and their calculations would violate the Commission's Storage Decision." Southwest, Opening Brief, p. 33. 55 Southwest, Opening Brief, p. 34. 56 Ibid., p. 35 57 Ibid., p. 36 58 Ibid., p. 36 59 $5,799,067= $81,677 x (82-11). 60 Exhibit 2A indicates that Southwest spent $67.2 million on gas from November 2000 to March 2001. Thus, a disallowance of $5,800,000 million will reduce winter gas costs by 8.6%. 61 Exhibit 5 indicates that Southwest's net California income for the 12 months ending September 2001 was $1,433,287. Thus, the adopted disallowance equals approximately 2.2 years of California profits.

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