COM/SK1/tjs DRAFT Agenda ID #3896

Alternate to Agenda ID #3523

Ratesetting

9/23/2004 Item 46b

Decision ALTERNATE PROPOSED DECISION OF COMMISSIONER KENNEDY (Mailed 9/9/2004) (Revised 9/22/04)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Joint Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Switching in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 01-02-024

(Filed February 21, 2001)

Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Loops in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 01-02-035

(Filed February 28, 2001)

Application of The Telephone Connection Local Services, LLC (U 5522 C) for the Commission to Reexamine the Recurring Costs and Prices of the DS-3 Entrance Facility Without Equipment in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 02-02-031

(Filed February 28, 2002)

Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Interoffice Transmission Facilities and Signaling Networks and Call-Related Databases in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 02-02-032

(Filed February 28, 2002)

Application of Pacific Bell Telephone Company (U 1001 C) for the Commission to Reexamine the Costs and Prices of the Expanded Interconnection Service Cross-Connect Network Element in the Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 02-02-034

(Filed February 28, 2002)

Application of XO California, Inc. (U 5553 C) for the Commission to Reexamine the Recurring Costs of DS1 and DS3 Unbundled Network Element Loops in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.

Application 02-03-002

(Filed March 1, 2002)

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK
ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY
DBA SBC CALIFORNIA

TABLE OF CONTENTS

Title Page

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY DBA SBC CALIFORNIA 3 3

I. Summary 3 3

II. Background 8 8

A. 2001 UNE Nominations 9 9

B. 2002 UNE Nominations 11 11

III. Applicable Standards 13 13

A. The Consensus Costing Principles 13 13

B. The TELRIC Standard 14 14

C. Supreme Court Review of TELRIC Standard 16 16

D. Recent Updates to TELRIC 16 16

E. Commission Cost Modeling Criteria 17 17

F. Burden of Proof 17 17

IV. Overview of Cost Models 18 18

A. HM 5.3 19 19

B. SBC-CA Models 21 21

V. Both HM 5.3 and the SBC-CA Models Are Flawed 23 23

A. Flaws in the SBC-CA Models 30 30

1. LoopCAT Flaws 33 33

a. Reliance on Embedded Network Data 33 33

b. LoopCAT's Network Configuration 43 43

c. Modeling of Multiple Dwelling Units 46 46

d. Integration of Loop Studies 47 47

2. SICAT Flaws 48 48

3. Transport and High Capacity Loop Study Flaws 49 49

4. Annual Cost Factors and Expenses 53 53

a. Auditing and Modifying ACFs 54 54

b. Shared and Common Costs 56 56

c. Elimination of Miscellaneous Expenses 58 58

i. Non-regulated Expenses 59 59

ii. Affiliate Transaction Expenses 60 60

iii. Project Pronto Expenses 62 62

iv. Transition Benefit Obligation (TBO) Expenses 63 63

v. Land and Building Factors 64 64

d. Inflation and Productivity 65 65

e. Summary of Annual Cost Factor and Expense Modeling Issues 68 68

5. Summary of SBC-CA Modeling Flaws 69 69

B. Flaws in the HM 5.3 Model 70 70

1. Engineering and Design Standards 72 72

2. Loop Modeling and Customer Location 79 79

a. Transparency of the Clustering Process 81 81

b. Accuracy of Customer Locations 83 83

c. Sensitivity to Clustering Changes 88 88

d. Cluster Size 90 90

e. Summary of Loop Modeling Criticism 92 92

3. Expert Judgments 93 93

4. Switching, Interoffice Demand, and Provisioning High Speed Services 96 96

5. Spare Capacity 100 100

6. Expenses 101 101

7. Validation of HM 5.3 Results 102 102

8. Summary of HM 5.3 Flaws 107 107

C. Adherence to Commission Modeling Criteria 108 108

D. Determination of UNE Rates Derived from SBC's LoopCAT and from HM 5.3 110 110

1. Rates 111 111

2. Description of HM 5.3 and SBC-CA Model Runs 121 121

VI. Modeling Inputs 129 129

A. Asset Lives and Depreciation 129 129

1. SBC-CA Proposal 129 129

2. DOD/FEA and Joint Applicant's Proposal 131 131

3. Discussion 134 134

B. Cost of Capital 137 137

1. SBC-CA Proposal 140 140

2. Joint Applicants' Proposal 142 142

3. Proposals of XO, Z-Tel and ORA/TURN 143 143

4. Discussion 143 143

a. Proxy Group 145 145

b. Cost of Equity 146 146

i. DCF Analysis 147 147

ii. Market Risk Premium in CAPM 150 150

iii. Risk Free Rate 154 154

iv. Beta 155 155

v. CAPM Summary and Resulting Cost of Equity 156 156

c. Qualitative Risk Issues 157 157

d. Cost of Debt 163 163

e. Capital Structure 165 165

f. Summary of Weighted Average Cost of Capital 168 168

C. IDLC/UDLC 169 169

1. Modeling Proposals 169 169

2. Discussion 171 171

D. DLC Costs 172 172

1. JA Approach 172 172

2. SBC-CA Approach 173 173

3. Discussion 174 174

E. Fill Factors in Loop Model 177 177

1. Copper Distribution Fill 180 180

a. JA Proposal 180 180

b. SBC-CA Proposal 182 182

c. Discussion 184 184

2. Copper Feeder 186 186

3. Fiber Feeder 187 187

4. DLC Common Equipment 190 190

5. DLC Plug-In Equipment 192 192

6. SAI Equipment Fill 193 193

7. Premise Termination Equipment 195 195

8. Correlation of Fill Factors and Maintenance Costs 198 198

F. Structure Sharing 201 201

G. Plant Mix Assumptions 204 204

H. Labor Cost Assumptions 205 205

1. HM 5.3 206 206

2. SBC-CA Models 207 207

3. Discussion. 208 208

I. Crossover Point 211 211

J. Switching Inputs 212 212

1. Switch Vendors 212 212

2. Percentage of New, Growth and Replacement Lines 215 215

3. Vertical Features Costs 217 217

a. JA Position 218 218

b. SBC-CA Position 219 219

c. Discussion. 220 220

4. Rate Structure 223 223

d. JA Position 224 224

e. SBC-CA Position 229 229

f. PacWest Position 231 231

g. Discussion 232 232

5. Switch Fill Factors 236 236

VII. DS-3 Loop Rates 238 238

VIII. Further UNE Reexamination Proceedings 239 239

IX. Assignment of Proceeding 240 240

X. Comments on Proposed Decision 240 240

A. Rates Based on the Midpoint of HM 5.3 and SBC-CA Models 241 241

B. Adopt Rates Based on the HM 5.3 Model 243 243

C. Adopt Rates Based on the SBC-CA Models 244 244

D. Corrections Were Ignored 244 244

E. The True-Up of Interim Rates 245 245

F. Price Squeeze Arguments 246 246

XI. Comments on the Revised Proposed Decision 247 247

XII. Comments on Alternate Proposed Decision 249 249

Findings of Fact 252 252

Conclusions of Law 266 266

ORDER 280 280

APPENDIX A Adopted UNE Rates

APPENDIX B Comparison of Proposed and Adopted UNE Rates

APPENDIX C Switching Rates Based on Minute of Use

APPENDIX D Glossary of Acronyms

APPENDIX E List of Appearances

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK
ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY
DBA SBC CALIFORNIA

I. Summary

This proceeding, known as the "UNE Reexamination," was initiated following formal requests by carriers interconnected with Pacific Bell Telephone Company d/b/a SBC California (hereinafter SBC-CA)¹ for the Commission to reexamine certain prices that SBC-CA charges competitors who purchase "unbundled network elements" (UNEs).² By purchasing UNEs, competitors are able to use portions of SBC-CA's network to offer competitive local exchange services.

In this decision, the Commission adopts updated and final rates for the following UNEs: loops (including deaveraged rates for 2-wire, DS-1 and DS-3 loops), switching, dedicated transport, signaling system 7 (SS7) links, and the DS-3 entrance facility without equipment.³ The newly adopted rates for the most frequently discussed UNEs are:

Table 1

Adopted UNE Rates

UNE	Adopted Rate⁴
Average 2-wire Loop	$15.07
Average DS-1 Loop	$73.78
Average DS-3 Loop⁵	$573.20
2-wire port	$3.27
UNE-Platform⁶	$19.59

The rates in today's order replace interim rates for loops and switching that were set in Decision (D.) 02-05-042.⁷ The rates in today's order for other UNEs, namely dedicated transport, SS7 links, and the DS-3 entrance facility without equipment, replace rates originally adopted in D.99-11-050.

In adopting today's rates, the Commission considered two divergent cost models offered by the parties to this proceeding. SBC-CA proposed updated UNE rates based on a series of cost models that it has developed for use in the 13 states in which its parent corporation, SBC, operates. AT&T Communications of California, Inc. (AT&T) and WorldCom, Inc. (WorldCom, now known as

"MCI")⁸ (hereinafter referred to as "Joint Applicants" or "JA") proposed updated UNE rates based on the latest version of the HAI Model, known as HM 5.3. The proposals of the parties differed greatly from each other and from the interim UNE rates currently in place as seen in the table below.⁹

Table 2

Comparison of Proposals

UNE	SBC-CA Proposal	JA Proposal	Interim Rate¹⁰
Average 2-wire Loop	$23.86	$5.24	$9.82
2-wire Port	$3.13	$1.28	$0.83
Switching Usage	$3.34	$1.57	$3.28
UNE-P	$30.33	$8.09	$13.93

After careful review of the competing cost models filed by SBC-CA and JA, the Commission finds that both models are flawed. The principal flaws with SBC-CA's models are that we are not able to modify easily many of the models' inputs to perform routine sensitivity analysis. When we attempt to modify certain inputs in the SBC-CA models, the lack of flow through from one model to the other necessitates extremely time-intensive manual manipulation that is prone to error.

The principal flaws with HM 5.3 are that we did not agree with certain of its input assumptions, particularly those related to clustering of customers into distribution areas, certain labor inputs, and the interoffice transport network. We were unable to modify these particular input assumptions at all.

It was not possible to fix all of the flaws identified in either model. Because both models were flawed, we initially found we could not rely on either model by itself to establish UNE rates. To the extent possible, the Commission modified both models to run with common inputs. As we modified these models and their inputs to resolve the many disputes and to bring the models in line with Commission precedent, federal requirements, and additional rationale we develop herein, we found that the resulting cost outputs of the models converged.

Following comments on the Proposed Decision, we made appropriate adjustments to both HM 5.3 and the SBC-CA models to correct what we agree were errors and to make necessary adjustments. During this process, we determined the SBC-CA models are unduly burdensome to operate because they require extremely time-intensive manual manipulation to make input modifications and the models are prone to input errors due to extraordinarily complex input modification requirements. Except for the local loop, where the SBC-CA model better tracks California costs, reliance on the SBC-CA models adds little to our analysis. Therefore, the rates we adopt in this order for UNE-L¹¹ are based on a blend of the SBC-CA and the HM 5.3 models. For all other costs we rely solely on HM 5.3.

Some of the key modeling inputs used for the Commission's model runs include a 10. 37% cost of capital, asset lives based on those previously adopted by this Commission, and a 41.7% copper distribution fill factor. The Commission's model runs include several inputs and assumptions proposed by SBC-CA, including plant mix, labor rates, Lucent and Nortel switch vendor assumptions, the forward-looking mix between Universal Digital Loop Carrier (UDLC) and Integrated Digital Loop Carrier (IDLC) technologies, and a 12,000-foot crossover point (beyond which fiber replaces copper). Furthermore, today's order adopts a flat-rate structure for the switching UNE wherein all switching costs are incorporated into one flat monthly port price, as proposed by JA.

As set forth in D.02-05-042 and D.02-09-052, SBC-CA must adjust, or "true-up" the interim rates it charged for its UNEs to the new rates adopted in this order. In other words, SBC-CA must calculate whether the previous interim rates were higher or lower than these newly adopted rates, and whether it has over or under-collected the appropriate revenues for any UNEs it sold at interim rates. This order stays the effective date of any true-up until its amount can be calculated and further proceedings held to determine payment options or consider other mitigations to minimize negative financial effects of the true-up on competitive carriers and customers. These further proceedings will also consider whether and how the Commission can expeditiously implement any shared and common cost markup changes, as recently ordered by the Ninth Circuit Court of Appeals, along with the true-up. (See AT&T Communications of California, Inc. v. Pacific Bell Telephone Company, 375 F.3d 894, Ninth Circuit 2002).

Finally, this order modifies the annual nomination process originally established in D.99-11-050 to suspend further review of SBC-CA's UNEs until February 2007, absent action by the FCC that alters the TELRIC methodology.

¹ To avoid confusion, we will generally refer to Pacific Bell Telephone Company (Pacific) as SBC-CA because much of the record in this case references "SBC Pacific" and "SBC California" rather than Pacific. We will refer to the parent company of SBC-CA as simply, "SBC." ² See Appendix D for a glossary of all acronyms used in this order. ³ See Appendix A for a complete list of the rates adopted in this order. ⁴ These rates include a 21% shared and common cost markup, as adopted in D.02-09-049. ⁵ In modeling DS-3 costs, the assumptions adopted in this decision produce costs substantially higher than that requested by SBC-CA. This result is so anomalous, that we believe that it is more reasonable to adopt that amounts requested by SBC-CA. This affects the following UNE's: DS-3 Loop, Unbundled Dedicated Transport using the DS-3 Loop, and the DS-3 Entrance Facility. ⁶ UNE-Platform (UNE-P) refers to the combination of a 2-wire loop, 2-wire port, and switching UNEs. ⁷ All of SBC-CA's UNE rates were further adjusted by D.03-07-023, which implemented an adjustment to SBC-CA's shared and common cost markup. ⁸ On April 20, 2004, WorldCom, Inc. completed its corporate reorganization and changed its name to MCI Inc. To avoid confusion, this order will refer to MCI/WorldCom because WorldCom was the name used on filings prior to submittal of the case. ⁹ For a complete comparison of the SBC-CA and JA UNE rate proposals, see Appendix B. ¹⁰ Interim rates initially adopted in D.02-05-042 and modified by D.03-07-023. ¹¹ We use the word UNE-L as a shorthand expression for all loop costs (such as 2-wire, 4-wire, Coin, PBX, and ISDN) with the exceptions of DS1 and DS3, which have large electronic components.