7. Reasonableness of Costs

This section addresses SDG&E's prudence in controlling and reasonably managing the costs incurred to restore service following the 2003 Wildfires. Before we can consider the reasonableness of the proposed allocation of costs to retail customers we must first examine the total costs incurred, consider any available revenues to offset to these costs to determine the incremental costs, and then determine the appropriate allocation of incremental costs.

SDG&E stated that it had no insurance coverage that would reimburse the costs of the Wildfires. The justification is the cost of insurance estimated at $10 million annually with limits of $20 million in coverage.22 Thus in about six-years the premiums would have equaled the cost of the Wildfires and coverage would have only reimbursed a third of the costs. Based on this explanation it is reasonable not to expect insurance coverage for these costs.

SDG&E used an "incremental cost criteria" to calculate costs includable in the Wildfire Account. That is, the company assumed direct labor at straight - time (excluding overtime) and other costs that were incurred solely to restore service are incremental to existing costs already included in rates. SDG&E stated its belief that this approach is in conformance with Resolution E-3238. ORA concludes that SDG&E's calculations of incremental costs are a reasonable basis for recovering the Wildfire Account. ORA further supports the recovery of the incremental costs either through the amortization of the expenses included in the Wildfire Account and the capital expenditures added to SDG&E's rate base, as calculated by SDG&E.23 UCAN notes various adjustments and proposes several specific disallowances, and in addition to those issues which are discussed below, UCAN otherwise opposes the rate recovery of the Wildfire Account costs based on its burden of proof arguments.

We find that, except for the changes adopted in this decision, SDG&E has otherwise accounted for its costs in a reasonable manner and it is reasonable to allow rate recovery of the Wildfire Account costs (after adjustment).

ORA's prepared testimony in Ex. ORA-1 indicates that its staff conducted a review of the costs incurred to restore service and found only the one exception noted in its testimony. Otherwise, ORA believes the incremental costs to be reasonable.24 Under cross examination by UCAN, ORA was asked about its finding that SDG&E has only included costs in the Wildfire Account that are incremental to existing allowances in rates, are related solely to the restoration of service after the Wildfires, and are recoverable within the definition of the catastrophic event memorandum account.25 UCAN questioned ORA's witness on the criterion used in its testimony to determine, for example, that "ORA finds the remaining Services/Other costs to be reasonable and SDG&E should be allowed to recover these costs in rates."26

ORA did not evaluate the costs included in the account against an objective standard in order to form an opinion on whether or not SDG&E had paid an excessive price. ORA's analysis was limited to determining whether, in its opinion, the costs were incremental to allowances existing in rates and the costs were only incurred to restore service after the Wildfires.27

The one cost recovery exception noted by ORA is to exclude from recovery $9,146 for advertisements used to publicly thank the other utilities that provided mutual assistance to SDG&E.28 We will adopt this minor adjustment, with which SDG&E has agreed, not because the utilities were reimbursed for their costs, as suggested by ORA, but because it is an unnecessary cost to restore service.

ORA again limited its review in this proceeding to the same level where it was criticized in D.01-02-075 because it "did not review the reasonableness of the expenditures from a cost causation perspective or from a cost reduction or avoidance perspective."29 In future reviews of catastrophic event memo accounts we believe that ORA should not limit its analysis to whether or not the costs were incremental. We believe that ORA should also "review the reasonableness of expenditures for a cost causation perspective or from a cost reduction or avoidance perspective" as we have previously stated in D.01-02-075.

UCAN submitted prepared testimony in Ex. UCAN-151, which makes several recommendations:

1. Disallow $738,400 for food-related costs that cannot be justified. (p. 6.)

2. An estimated $42,348 in pole test and treat expenses avoided over the next 4 years should be offset against the Wildfire Account O&M expense. (p. 7.)

3. Prior to evidentiary hearings, UCAN was concerned that SDG&E used an incorrect franchise fee and uncollectible allowance for an error of $67,000. (p. 10.)

4. UCAN expresses a non-monetary concern that SDG&E's tree-trimming inventory has increased, rather than decreased in the fire-damaged area. (p. 8.)

5. SDG&E incorrectly accounts for $7.2 million in various Support Services as an expense, which should be allocated between expense and capital (rate base) based on the relative split of direct labor - 15.8% to expense and 84.2% to capital. (p. 9.)

6. Because of the rate impact of SDG&E's Cost of Service A.02-12-028 (2004 increase under collection plus 2005 attrition increase.) the Commission should amortize the Wildfire Account over 2 years instead of 1. (pp. 10-11.)

UCAN applies an additional reasonableness test to SDG&E's request that was not employed by ORA. UCAN argues that some of SDG&E's costs are excessive when compared to a fair market price for the commodity.30 UCAN does not dispute that SDG&E incurred the costs nor does it disagree with SDG&E's process for allocating costs to the Wildfire Account. It does take exception to the ratemaking treatment of certain costs. UCAN in total considered cost causation, cost reduction and cost avoidance as a part of its examination of SDG&E's proposals.

The company spent $5.4 million to provide meals, snacks, water and other items, and over 92,000 meals. UCAN could not determine the accuracy of the 92,000 meal count. UCAN disputes the total based upon the duration of the project and the number of personnel involved. UCAN first equates the total to 30,677 person-days of meals, assuming 3 meals per day. Next, UCAN argues that the personnel counts provided by SDG&E in testimony and data responses total only 1,339 and not 1,800 as stated by the company in Ex. SDG&E-2 and this suggests 5,400 meals a day not the 6000 included in Ex. SDG&E-2.31 UCAN expresses a concern with SDG&E's contract management practices and concludes that SDG&E did not exercise sufficient reasonable control over costs or the performance of some vendors.

UCAN's Food Service Analysis32

    Meals

27%

$1,458,000

    Snacks

9%

486,000

    Drinks (water, Gatorade, etc.)

28%

1,512,000

    Staff & Set Up

15%

810,000

    Other Ancillary (tents, porta-potties)

15%

810,000

    Tax

7%

378,000

    Total (rounded)

100%

$5,454,000

UCAN closely examined the snack and drink (snacks) cost of approximately $2 million and took exception to the costs incurred for Gatorade, bottled water and Red Bull energy drink. UCAN opined that SDG&E paid its vendors a significant premium compared to the nearby COSTCO in La Mesa, California, and based on a daily consumption calculation, determined that SDG&E was over-charged by $582,300.33 UCAN pointed out that not only did employees appear to consume extraordinary quantities (even after allowing for the prevailing conditions) but that SDG&E exercised no reasonable control over unit costs. UCAN justifies the disallowance by showing that the other costs included in a typical retail price are already separately charged to the Wildfire Account as ancillary costs and labor.

SDG&E's rebuttal testimony objects to UCAN's price comparison and argues that it "did not have the luxury of time or resources to evaluate all options ahead of time, plan out exactly what was needed and then competitively bid for these emergency services and supplies." SDG&E argues too that it was against company practices for employees to make purchases on behalf of SDG&E34 without going through established processes"35 SDG&E also argues that UCAN made a simplistic count of meals without considering such things as some tired and hungry employees (Ex. SDG&E-4) ate more than a single portion, there was no "rationing," the incidental feeding of police, fireman and even fire victims, and overall, UCAN did not consider the complexity of the project to quickly restore service after the wildfires. The company concludes that it "followed its procedures and generally accepted practices and utilized established catering firms that it believed could meet the challenge during this extraordinary time. The unit prices for meals, snacks and drinks were in line with typical rates utilized by the catering industry."36

UCAN proposes to apply a further appropriate test to the costs that is more rigorous than the ORA tests discussed above. UCAN argues that SDG&E unreasonably paid excessive prices that were charged by the food service vendors for the basic commodities of bottled water and various energy drinks by failing to exercise reasonable control over the contractors or its own employees.

The essential question is whether SDG&E exercised sufficient control over its vendors to ensure that despite the desperate situation of the Wildfires it paid reasonable prices for essentially basic commodities: bottled water, energy drinks, and snacks. UCAN argues convincingly that all overhead for the vendors, labor, tents, etc., were fully recovered separately and therefore the implicit conclusion is that the mark-ups on the commodities paid by SDG&E are unreasonable. To disallow the snack costs identified by UCAN it is necessary to find whether SDG&E would have failed the prudent manager standard discussed above.

SDG&E cannot avoid its responsibility to prudently control all costs by merely pointing to a contract with its vendors. Taking the time to properly manage contracts and control costs is not a luxury; it is SDG&E's obligation in exchange for recovering its reasonable costs. SDG&E offers no evidence that it actively controlled costs, except for a blanket 10% reduction negotiated after the fact with one vendor.37 We agree with UCAN that regardless of the circumstances, the company has an obligation to ensure that the price it pays for standard food service products is reasonable. The COSTCO prices are an adequate proxy for a fair market price; these may not be the lowest possible price considering the huge volumes involved, but they are a clearly available local option. SDG&E tries to suggest that the COSTCO comparison is trivial, but the issue is important. We do not suggest that workers did not need these foodstuffs in reasonable quantities, but that SDG&E failed to exercise adequate control and wasted over half a million dollars by not managing the costs of support service contracts. The other costs incurred by the vendors were fully compensated by SDG&E, and we have no reason to find that these drinks were the sole source of profit margin to the vendor. Therefore we will disallow $582,300 for SDG&E's failure to ensure that the snack food prices for standard food service products were charged at a reasonable market price.

UCAN argues in its opening brief that food services costs should be further reduced by $113,11138 based on its calculation of extra (i.e., unnecessary) meals. UCAN argues that the contract should have been on a per person basis, not a meals-equivalent. The contracts with Ranch Catering, for example, did not impose a head count condition on payment; nor can we determine whether the unit cost would have changed if the obligation was to feed everyone on a per-person charge. SDG&E argued it wanted no worker to go back to work hungry and so it did not ration food. We accept that the workers quite likely ate more than a single standard serving of food as measured by the caterers, and we accept as reasonable that SDG&E did not want the workers to lack sufficient volume of appropriate food and beverages.

The Wildfires were a unique event (otherwise CEMA would not apply) and thus the prudent manager standard has to be applied with consideration of the unique circumstances of the Wildfires. SDG&E does not regularly feed its field construction and repair personnel and so we expect reasonable care over catering contracts but we cannot expect perfection. We will not make the additional disallowance to meals.

UCAN determined that SDG&E replaced 2,872 poles used for distribution service, and that 73% of the destroyed poles (2,096) were over 15 years old which put them on a 10-year inspection and treatment cycle. UCAN believes that no inspection will be needed on the new poles during the next 10 years and this will avoid inspections at $34.29 per pole.39 UCAN allows for the 30% of 2,096 older poles (861) that were already inspected before they were destroyed by the fire so SDG&E only avoids inspecting the remaining 70% or 1,235 poles that were destroyed before inspection. Savings calculated by UCAN total $42,348.40 UCAN proposes to offset this amount from the Wildfire Account and avoid the complication of adjusting base rates to reduce the number of pole inspections forecast in base margin rates.

SDG&E responds that an offset is unreasonable because under conventional cost of service ratemaking "practices do not require the utility to expend every dollar of its authorized revenue requirement as the utility may have predicted would be necessary in its cost of service application. To the contrary, traditional test year ratemaking principles permit the utility to redeploy its authorized revenue requirement in order to accommodate the real world circumstances it encounters during the test period."41 SDG&E argues further that money "saved from avoiding inspections of the recently replaced poles, if not needed for inspection and treatment of other poles, will most likely be spent on other reliability-related activities."42

We are not persuaded by SDG&E's ratemaking argument, because the CEMA process itself is an exemption to accommodate the real world during the test period so that SDG&E does not have to bear the entire cost of a disaster like the Wildfires. It appears that SDG&E wants to pass along the

unanticipated costs of the Wildfires without surrendering the savings if other costs are avoided. The company accuses UCAN of "cherry-picking" an issue where costs are likely to be avoided while ignoring "those that could cause future costs to increase," without citing any probable cost increases. UCAN's suggestion is not extreme or improbable; it is a reasonable recognition that a large number of unexpected new poles displaced older poles that would otherwise have to be inspected in the near-term. Additionally, this savings is from revenues otherwise already in rates that will not need to be spent and is available to offset a very small part of the Wildfire Account. Our guidelines in Resolution E- 3238 anticipate this type of offset by looking for available revenues already in rates. We will require SDG&E to offset the $42,348 savings for pole inspection and testing against the Wildfire Account balance.

SDG&E requests $627,000 for both franchise fees and otherwise uncollectible revenue (billed to customers but never collected).43 Initially UCAN identified what it believed to be a computational error of $7,000 for Franchise Fees and Uncollectibles. SDG&E testified that the correct calculation is to increase the recoverable costs ($15,300,000) by a factor that recovers both the uncollectible allowance and the appropriate franchise fees. This is a typical ratemaking convention to ensure the utility an opportunity to recover the full amount of authorized revenues. The calculation has to allow for a full recovery including collecting from all customers the amount otherwise uncollectible from a few, plus the franchise fees SDG&E must pay on the total. SDG&E calculates44 the gross-up factor as: 1 / 1 - (3.67% + 0.266%) = 1.041. The revenue requirement request after "grossed-up" is $15,300,000 x 1.041 = $15,927,000.

UCAN withdrew its testimony without further explanation following SDG&E's rebuttal.45 After reviewing SDG&E's calculation we agree that it has made the correct calculation for recovery of the franchise fee and otherwise uncollectible revenues. We will use this method as a part of the calculation of the final revenue requirement authorized in this decision.

UCAN argues that SDG&E has been removing large numbers of trees as a result not only of the Wildfires but also due to the bark beetle infestation that killed many trees and led to a programmatic removal of affected trees. UCAN points out that a tree inventory before October 6, 2003, i.e., prior to the Wildfires, showed 145,575 trees. A September 2004 inventory showed 145,661 trees, an increase of 86 trees. UCAN is concerned that after the removal of numerous trees due to the Wildfires and the bark beetle, the inventory tally should have clearly fallen, and that SDG&E needs to explain this anomaly.

SDG&E explains in rebuttal that many scorched trees are retained in the inventory until they determine whether or not the tree will survive. Additionally, SDG&E added scorched trees outside the rights-of-way and not in the previous inventory because they may fail and could subsequently fall into the overhead lines.

SDG&E's explanation is reasonable and no further action is necessary at this time.

22 Ex. SDG&E-3, p. 15.

23 Ex. ORA-1, pp. 2-4, 3-3, 4-3, 6-3, 7-2, and 8-2.

24 Ex. ORA-1, pp. 1-4 and 1-5.

25 Transcript, pp. 155-183. UCAN questioned ORA's witness on the criterion used by ORA in its testimony to derive its opinion that the costs were reasonable.

26 Ex. ORA-1, p. 7-2.

27 See, for example, Transcript pp. 128-129.

28 Ex. ORA-1, p. 7-2.

29 D.01-02-075, p. 11.

30 This would equate to the "cost reduction" standard included in D.01-02-075.

31 Ex. UCAN-151, pp. 2-3, compared to data in Ex. SDG&E-2, p. 30.

32 Ex. UCAN-151, p.3, citing to UCAN Data Request (DR) 3, Question (Q) 12, and DR 1, Q 2.

33 UCAN adds 7.75% for sales tax and then deducts a 10% discount from the total. UCAN initially calculated an adjustment of $738,400, corrected at hearing by the witness.

34 UCAN does not say SDG&E should have done "snack-runs" to COSTCO, only that SDG&E was charged too much by the vendors it used for food services.

35 Ex. SDG&E-4, pp. 2-3.

36 Ex. SDG&E-4, p. 8.

37 Transcript, p. 29.

38 UCAN Opening Brief, p. 7, and shown in detail in footnotes 63 and 64 on p. 23.

39 Ex. UCAN-151, p. 6, see also UCAN DR 3, Q 15, and DR 3, Q 18.

40 Ex. UCAN-151, pp. 6-7. (1,235 poles @ $34.29 = $42,348.)

41 Ex. SDG&E-5 p. 2. (Rebuttal.)

42 Ex. SDG&E-5, p. 2.

43 Ex. SDG&E-3, attached Exhibit D-4. (SDG&E captioned attachments to testimony as "exhibits," thus Ex. 3 contains attachments also titled as exhibits.)

44 Ex. SDG&E-5, p. 6.

45 Transcript, p. 115, deleting Section B. Franchise Fees and Uncollectibles, in Ex. UCAN-1 at p. 10.

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