8. Ratemaking Treatment

This section addresses the reasonableness of the ratemaking proposal to recover the reasonable costs of the 2003 Wildfires. Included in this section are two of UCAN's proposals.

UCAN argues that SDG&E inappropriately categorized various support costs totaling about $7.2 million as expense rather than allocating the costs between expense and capital expenditures includable in rate base. UCAN uses an allocation factor of labor costs and calculates that 15.8% should be expensed and 84.2% should be capitalized.46 According to UCAN, SDG&E used the too literal assumption that meals and lodging are consumed and should be expensed. UCAN objects to SDG&E's accounting interpretation that environmental support costs ($1.2 million of the total) were not incurred as a part of new construction. UCAN also argues that some environmental costs were clearly for pole replacement and reconductoring projects, but for simplicity it did not compute a separate environmental allocation. UCAN proposes to allocate these costs in proportion to direct labor. The effect of UCAN's recommendations is to allocate a larger share of the support costs to capital which results in rate recovery through depreciation over a longer period of time.

SDG&E's proposal to expense these overheads is based on its interpretation of the applicable accounting standards that these costs were "consumed" concurrently47 and should not be capitalized as a part of the costs of installing new long-lived assets. SDG&E's witness testified, however, that this was an interpretation and could not cite a specific pronouncement or interpretation in any of the prepared testimony's general references to generally accepted accounting principles (GAAP), the Code of Federal Regulations (explained to be intended as the applicable uniform system of accounts) or SDG&E's own internal accounting practices.48

Our well-established ratemaking practice is consistent with the matching principle or concept in accounting. That principle requires costs incurred for current service to be "expensed" in a single year and all of those costs that are necessary to provide service over many years to be "capitalized" and recovered over the useful life of the underlying asset. In this proceeding, many physical assets, poles, wire, transformers, etc., that were destroyed by the Wildfires were capitalized when they were originally placed in service. The full cost of replacing those assets should likewise be capitalized.

Looking first to the overhead costs including meals and snacks, etc., we believe that SDG&E has applied a very literal interpretation of current consumption and chooses to focus on the fact that employees ate or drank (currently consumed) the commodity rather than examine why the cost was incurred. SDG&E could have restored service more slowly at a much lower cost without mutual aid crews from other utilities, without additional contractor employees, without incurring double-time and without the provision of food and shelter to these workers. But, in order to restore service at extraordinary speed, it incurred all of these costs, restoring service to great praise for itself49 and to the overall benefit of all customers. The only way to have reduced the capital costs would have been to incur lower costs by working more slowly (avoiding double-time, meals, etc.).

As discussed under the management of the project, we found SDG&E to be reasonable in its many decisions, big and small, on how to reasonably restore service. That finding does not automatically extend to the ratemaking consequences. Under SDG&E's interpretation of consumption, more costs are recovered quickly by including them in the current amortization portion of the Wildfire Account (i.e., "expensing" the costs). But that interpretation misrepresents the full capital costs incurred. SDG&E's decision to expedite service restoration resulted in the utility paying overtime, providing meals on site, and providing accommodation to extra workers, all of which directly increased the cost to install new plant. We accept that SDG&E's decision to expedite was reasonable and it was in the public interest to restore service quickly. Such a decision by SDG&E led directly to incurring higher and additional costs compared to the cost of restoring service more slowly and at great hardship to ratepayers. While agreeing that these costs should be recorded, UCAN contends that this approach resulted in higher construction costs for long-lived assets which UCAN believes should be capitalized and recovered over the useful lives of the assets just like the direct costs of the poles, wires, transformers and the normal labor costs. UCAN argues that the split should be 15.8% of support costs to expense and 84.2% to capital.50 UCAN argues the costs should follow the allocation of internal and external labor.

We do not agree with SDG&E's interpretation to expense all support costs, including meals and accommodations, and we direct SDG&E to capitalize its support cost overheads in proportion to the split of direct costs between expense and capital. This decision does not preclude SDG&E from recovering all of its reasonable costs, but it does allocate a larger portion to capital.

With respect to the environmental costs, UCAN argues that SDG&E failed to allocate appropriate environmental support costs to capital projects. The record clearly shows that SDG&E recorded $1.320 million in environmental costs to operating and maintenance expense and only $0.003 million to capital. SDG&E only capitalized $3,000 for environmental costs out of the total $25,605,000 that is capitalized by SDG&E.51 UCAN suggests using the labor cost allocation as a proxy to allocate the environmental costs. We agree that SDG&E's allocation of all support costs, including environmental costs, almost exclusively to operating and maintenance expense is arbitrary and does not reflect a reasonable allocation of costs between expense and capital. SDG&E does not offer a detailed analysis that would support the conclusion that environmental costs were overwhelmingly expense-related and not capital related. We will direct SDG&E to allocate environmental costs between expense and capital in proportion to the direct costs, i.e., 15.8% of support costs to expense and 84.2% to capital.

SDG&E requests a 12-month amortization for the expense portion of the Wildfire Account beginning January 1, 2005. UCAN proposes that the amortization should be doubled to 2 years, citing the impact of rate changes likely in A.02-12-028 for a test year 2004 as well as any attrition allowance for 2005. There are other likely rate impacts too.52

In fact this decision will not be implemented in time to begin amortization on January 1, 2005. A reasonable compromise is readily available to us to begin amortization on October 1, 2005 for 15 months through December 2006. This will conveniently allow amortization to begin shortly after this decision is adopted and its end will coincide with the next base margin adjustment likely to occur on January 1, 2007.53

46 Ex. UCAN-151, pp. 8-9, relied on Ex. 4, Exhibit G-9, G-12 and H-13 for the support costs, and Ex. SDG&E-3, Exhibit D-1 for the labor costs to calculate the split.

47 Ex. SDG&E-4, p. CAS-3, lines 10-18.

48 Transcript, pp. 112-113.

49 Ex. SDG&E-1, pp. 9-11 citing numerous public accolades.

50 Ex. UCAN-1, p. 9.

51 Ex. SDG&E-4, attached Exhibit J, pp. 1 through 3. Incremental environmental costs as included by SDG&E in the Wildfires Account.

52 SDG&E noted in the evidentiary hearing that in another proceeding there is a proposal to substantially increase SDG&E's allocation of costs for energy contracts held by the Department of Water Resources.

53 See D.04-12-015, p. 10 orders an application for test year 2004. Phase 2 is pending on A.02-12-028 addressing post-test year 2004 ratemaking. Annual adjustments have been consistently allowed in the past.

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