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 may have a bearing on, or may influence, the outcome 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 only concerned about the request for the AB 265 surcharge and its relationship to the mandates set forth in that legislation. However, in order to reach such a decision, it is necessary for us to review the arguments and the evidence that the parties have raised. This review, and the discussion which follows, may therefore impact the issues being addressed elsewhere.

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 is proposing in Advice Letter 1405-E to return this overcollection as a credit to the rates of these large customers. Action on that advice letter is currently pending before the Commission in the form of a draft resolution and a draft alternate resolution.

Today's decision does not take any action regarding SDG&E's proposal in Advice Letter 1405-E. However, SDG&E witness Schavrien provided testimony during the hearings which has a bearing on Advice Letter 1405-E. Schavrien testified that the $168 million is made up of primarily three components, and that the AB 265 customers' share of the intermediate term contract revenues is not included in the $168 million overcollection. Instead, the $168 million overcollection only includes the AB X1 43 customers' 30% share ($23 million) of the $77 million resulting from the adjustment of the intermediate term contract revenues in the TCBA, as required by D.01-05-035, that accrued from February 2001 through April 2001.¹⁸ The rest of the $168 million overcollection is made up of $104 million in excess URG revenues recorded to the TCBA, and $41 million in excess CTC revenues that has been collected from AB X1 43 customers. (See 11 R.T. at pp. 1082-1083, 1110-1113.)

Since SDG&E has requested that the $168 million overcollection be addressed through the advice letter process, today's decision does not resolve that request.¹⁹

C. AB 265 Surcharge Request

1. Introduction

SDG&E is requesting that a two-year surcharge of 0.00349 cents/kWh be imposed on all AB 265 customers. In addition, SDG&E requests 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.

The central 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."

2. The Relevancy Of The Character Of The Intermediate Term Contracts

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.

The City of San Diego notes that the past accounting treatment by SDG&E is irrelevant to whether the asset was under SDG&E's ownership and control. We agree with the City of San Diego on this point. The characterization of the intermediate term contracts should not control whether the net revenues should be used to offset the undercollection. This is made clear by a review of § 332.1(c). The offset provision in § 332.1(c) states 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." If the energy being sold from the assets are "utility-owned or managed generation assets," then the revenues associated with such sales must be used to offset the AB 265 undercollection.

The phrase "utility-owned or managed generation assets" does not make a distinction between a generation asset that serves shareholder interests, i.e., for use as a hedging instrument, and a generation asset that is used by the utility for the benefit of its utility customers. Instead, the operative words to examine are whether the utility "owns" or "manages" the generation asset. The intermediate term contracts were owned and managed by SDG&E because SDG&E signed the contracts with Illinova, LG&E, and PacifiCorp. SDG&E managed and controlled these assets by using the power to serve customers needs and selling the power to the PX and into the market. The sale of energy from these contracts, which were owned and managed by SDG&E, triggered the application of the offset provision in § 332.1(c).

Additionally, the Commission has the authority to "supervise and regulate every public utility in the State, and may do all things, whether specifically designated in this part or in addition thereto, which are necessary and convenient in the exercise of such power and jurisdiction." (§ 701.) As part of the Commission's ratemaking authority, it is authorized to determine just and reasonable rates. (§§ 451, 454, 728, 729.) The Commission, and not the utility, is authorized to determine the appropriate accounting of assets, costs, and revenues for ratemaking purposes. (§ 792, 792.5, 794; See D.01-05-035, pp. 17-18.) This broad ratemaking authority extends to all of SDG&E's electricity assets.

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.²⁰ 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.

SDG&E's argument that the intermediate term contracts were shareholder assets is particularly interesting in that SDG&E did not make this known to Commission staff until, at the earliest, late 1998 or early 1999 during the first ATCP. Assuming that the intermediate term contracts were treated by SDG&E as shareholder assets,²¹ SDG&E failed to report this affiliate transaction as required by the affiliate transaction reporting requirements in D.93-02-019 (48 CPUC2d 163) and its holding company decision in D.95-12-018 (62 CPUC2d 626).²² Both of these decisions required SDG&E to report any goods or services that SDG&E provided to any of its affiliated entities, and the sale or transfer of any tangible asset from SDG&E to an affiliated entity.

A review of SDG&E's annual "Affiliate Transaction Report" for 1996 through 2000, which SDG&E was required to file pursuant to D.93-02-019 and § 587, failed to list or disclose the use by Enova Corporation or Sempra, SDG&E's parent companies, of the intermediate term contracts for hedging purposes. The hedging strategy may also be contrary to the requirement in D.95-12-018 that the "capital requirements of SDG&E, as determined to be necessary to meet its obligations to serve, shall be given first priority by the Board of Directors of Parent and SDG&E." (62 CPUC2d at pp. 638, 651.)

Thus, SDG&E did not affirmatively advise the Commission, as was its regulatory duty, that the intermediate term contracts were being used by its parent holding company as a shareholder asset to hedge its financial exposure. SDG&E should not be allowed to argue that the intermediate term contracts were shareholder assets while ignoring Commission decisions to report these kinds of affiliate transactions to the Commission.

However, as discussed at the outset of this section, it makes no difference for the purpose of the offset provision in §332.1(c) whether the intermediate term contracts are shareholder assets, or assets used by the utility for the benefit of utility customers.

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.01-05-061 with respect to the intermediate term contracts. However, we point out that the characterization of the intermediate term contracts should make no difference to the application of the URG requirement in D.01-01-061 to those contracts. Both D.01-01-061 and D.01-05-035 recognized that the requirement to use URG assets, including the intermediate term contracts, to serve existing customers at cost based rates was based on the emergency situation that existed at the time.

We turn next to the argument of SDG&E that the Assembly committee considering the AB 265 legislation was aware of which utility owned or managed generation assets should be subject to offset. According to witness Schavrien, SDG&E provided a presentation package to the committee which listed the names of generation assets that should be subject to offset, and that the list did not include the intermediate term contracts. However, we have carefully reviewed AB 265 and § 332.1(c). There is nothing in AB 265 which lists which utility-owned or managed generation assets should be subject to, or excluded from, the offset provision in § 332.1(c). Section 332.1(c) did not identify any generation asset that was to be excluded from the offset mechanism. Since § 332.1(c) only refers to "revenues associated with sales of energy from utility-owned or managed generation assets to offset an undercollection," all utility-owned or managed generation assets, including the intermediate term contracts, are subject to the offset provision.

SDG&E argues that if the Commission requires the revenues from the intermediate term contracts to be offset against the AB 265 undercollection that this will amount to a taking of SDG&E's property without just compensation. We are not persuaded by SDG&E's argument that a taking exists. First, as we noted earlier, the Commission retains the authority to decide how the assets of a utility should be treated. Second, the discussion of SDG&E's taking argument in D.01-05-035 at pages 18 to 19 is relevant to SDG&E's arguments, and need not be repeated here.

Accordingly, we conclude that the offset provision in §332.1(c) applies to the net revenues associated with the sales of energy from the intermediate term contracts because SDG&E owned, managed and controlled those generation assets and sold the energy from those contracts.

3. The Offset Period And Offset Revenue Amount

We next turn to the period in which the offset should apply, and the amount of the offset. 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.

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.

The eight-month period that ORA suggests, should be used to determine the amount of revenues to offset against the undercollection. The AB 265 undercollection began when the rate ceiling was made retroactive to June 1, 2000. Since the accounting procedure in §332.1(c) was intended to track and recover the difference between the rate ceiling and the price paid for electricity, the offset provision should also relate back to June 1, 2000.

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 regarding how much of the $130 million should be offset against the AB 265 undercollection. If SDG&E's advice letter to credit the $168 million overcollection to AB X1 43 customers is 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 the additional surcharge, and the full use of the $130 million will achieve that objective. This will reduce the expected AB 265 undercollection to approximately $92 million.

As required by §332.1(c), and pursuant to the Commission's ratemaking authority, the entire $130 million, plus interest, in net revenues from the sales of energy from the intermediate term contracts during the period from June 1, 2000 through January 31, 2001, shall be used to offset the AB 265 undercollection in the ERSA. SDG&E shall be directed to make the necessary accounting adjustments in an advice letter filing to be made within 20 days of the effective date of this decision.

4. Other Sources Of Reducing The Undercollection

SDG&E's forecasted undercollection of $222 million by the end of 2002 is premised on applying a projected year-end PECA overcollection to the AB 265 undercollection. SDG&E requests that the balance in the PECA as of December 31, 2002, be transferred to the TCBA and applied 70% to AB 265 customers and 30% to non-AB 265 customers. SDG&E states that such treatment is consistent with SDG&E's adopted PECA tariff. (See SDG&E Preliminary Statement, II. Balancing Accounts, § K.5.a.) In its comments to the proposed decision, SDG&E states that the Commission should approve the transfer of the AB 265 portion of the PECA overcollection, and that the PECA portion applicable to AB X1 43 customers need not be addressed because of other proceedings. SDG&E's request to transfer the AB 265 portion of the overcollection balance in the PECA, as of December 31, 2002, to the TCBA, is granted.

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 $92 million, after the offset adjustment, to $8 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 the potential to reduce the AB 265 undercollection through means other than imposing a surcharge on customers' rates, are viable options. These options should be pursued instead of burdening AB 265 customers with the surcharge that SDG&E requests. 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 offset as required by § 332.1(c), 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.

5. Rate Ceiling

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.

6. Miscellaneous

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.