Discussion

Pursuant to Pub. Util. Code § 451, all rates charged by a public utility must be just and reasonable. The Commission has determined that such rates must be based on the reasonable cost of providing service to customers. Specifically, the Commission uses projections of future costs - a "future test year" - to evaluate whether the revenue to be collected from customers under proposed rates would cover the utility's costs.

For large water utilities, the Commission has set a three-year schedule for each utility to present a general rate case to the Commission. In this way, the Commission can monitor revenue and cost levels to ensure that the utility is neither over nor under earning. (See Re Schedule for Processing Rate Case Applications by Water Utilities, 37 CPUC2d 175 (D.90-08-045).)

For small water utilities, such as PAWW, the cost of presenting a formal rate case to the Commission is a significant expense.¹ The Commission, therefore, has established a simplified procedure for rate case review, which enables small water utilities to obtain rate review and any needed modifications more economically. The Commission has not imposed a specific time schedule on small water utilities to file general rate cases. Despite the flexibility the Commission has allowed small water utilities, the Commission has not wavered from its commitment to small water utilities charging cost-based rates.

Resolution W-4356 describes the staff's investigation and audit that led it to conclude that PAWW had allowed its rates to diverge substantially from its costs, and that it had been losing money since 1994. In 2000, our auditors found that the divergence resulted in operating expenses exceeding operating revenues, which justified an immediate 62% rate increase just to meet cash operating expenses, with no depreciation or return on rate base. Thus, PAWW's 2000 rates bore little relation to PAWW's 2000 costs. Failure to synchronize costs and rates is at odds with our fundamental commitment to cost-based rates.

PAWW sought to correct this imbalance in 2002 with its request to triple its rates. Although the Commission allowed only a bit more than doubling the rates, customers were understandably distressed by the size of this increase. Such an outcome, however, is directly attributable to PAWW's decisions not to seek rate review for over a decade.

Another likely outcome of postponing rate review for so long was that in the intervening decade PAWW would make management decisions that were inconsistent with Commission policy. PAWW's use of income tax refunds for operating and maintenance expenses was such a decision. When a public utility receives substantial and unexpected revenue, the Commission's strong preference is to evaluate prospectively options for allocating the revenue. Here, however, PAWW's long absence from Commission review has precluded prospective allocation.

The City has presented us with a sound argument for one possible allocation methodology, namely, treating the tax refund as a contribution in aid of construction. The California Constitution and the Public Utilities Code grant us sufficient ratemaking authority over PAWW to allow us to implement this option, and others, if we were to determine that such an outcome was appropriate in the circumstances. For the reasons set out below, however, we decline to do so.

PAWW's shareholders have incurred substantial out-of-pocket losses in the last several years. Our auditor documented a net operating loss of $56,687 in 2000, and the recently filed 2002 annual report showed a $28,636 loss, despite the rate increase authorized in October 2002. Losses of nearly $90,000 in just two years would suggest that over the last several years PAWW's losses have exceeded the net tax refund. More importantly, we are compelled to note the practical difficulties inherent in allocating funds that are no longer available. While the Commission can and does impute improperly used funds regardless of the actual availability of the funds, such ratemaking fictions are of little use to a small system, such as PAWW's, which requires actual cash to meet expenses. Accordingly, persuasive facts would be needed to justify setting aside these practical issues. In this case, the offers of proof included in the parties' briefs do not rise to that level.

PAWW management, with the assistance of counsel, sought and obtained the refund on its own initiative and did not seek reimbursement in rates for its legal costs. Moreover, our auditor found that PAWW used the tax refund for operating and maintenance expenses, which kept customer rates lower than a revenue requirement analysis would have supported. In Res. W-4356, we granted an interim increase that more than doubled rates, based on our determination that customer revenue had not been adequate to meet costs. Regardless of the outcome of the remaining, non-tax refund issues, it is clear that the lengthy rate case hiatus, which enabled this issue to remain dormant for so long, has benefited customers in the form of lower rates and has resulted in substantial losses for shareholders.

The City's proposed treatment of the tax refund as a contribution in aid of construction is but one of many allocation methodologies that we might use to address this issue. In its briefs, the City cites extensively to the Uniform System of Accounts for the proposition that the tax refund should be returned to the contributions in aid of construction account and used as a deduction to rate base. Simply crediting the amount to that account, however, does not resolve the ratemaking question. It is a well-settled proposition that accounting rules do not control ratemaking. (See, e.g., Decision No. 42068, (September 21, 1948) 48 CPUC 253, 257.)

The Commission has previously changed accounting and ratemaking treatment after the fact, rejecting assertions that to do so would violate the rule against retroactive ratemaking. In Re California Water Service Company, (1994) 56 CPUC2d 4 (D.94-09-032), the Commission ordered Cal Water to change its accounting and ratemaking for sale proceeds from 26 real estate parcels from giving all proceeds to shareholders to dividing the proceeds 50/50 between shareholders and ratepayers.² The Commission found that: "[Its] ratemaking authority is not constrained by the Uniform System of Accounts" and that such changes to a utility's accounting and ratemaking treatment do not constitute retroactive ratemaking. (Id. at 18.)

Here, as in the Cal Water decision, the Commission has the discretion to order changes in the accounting and ratemaking for this capital account. The Commission reached its decision in Cal Water by "weighing the equities and consideration of the ongoing needs of the utility." Consideration of similar factors in this case leads to today's decision declining to change PAWW's accounting and ratemaking treatment. Also as we did in Cal Water, we direct PAWW in the future to comply fully with the Uniform System of Accounts and to seek staff guidance when needed.

If the Commission had been presented with this issue in a timely manner, the Commission would have used its broad discretion in an orderly manner to allocate this extraordinary revenue pursuant to a wide range of potential allocation methodologies. However, retrospective allocation of the funds after the passage of many years adds substantial complexities including the potential for significant accounting adjustments to PAWW's books. While such adjustments are within the Commission's authority, such extraordinary actions must be taken in response to compelling circumstances, which we do not find here.

In sum, we are displeased with the circumstances surrounding the tax refunds and this long overdue rate case. After careful consideration of the argument and offers of proof presented by the City, we are not persuaded, however, that these circumstances have resulted in or will result in unjust or unreasonable rates, or that the public interest otherwise justifies further consideration of this nearly decade-old issue. Therefore, based on the unique circumstances of this case, we decline to change the ratemaking and accounting treatment of the income tax refunds.

To ensure that similar issues do not arise in the future, we will order PAWW to file an informal general rate case no less frequently than once every three calendar years.