VII. Ratesetting
In addition to its request for a CPCN, Casmite also seeks ratesetting to establish the initial authorized rates for the utility. Most of the ratesetting information is set forth in the Supplement to Casmite's application. However, an error in double-counting an item of equipment was noted at the evidentiary hearing. Casmite was granted leave to file corrections now set forth in Exhibit No. 3. These corrections resulted in modest changes to depreciation, the depreciation reserve, expenses, and net operating income-all of which are reflected in the discussion below.
The following discussion is organized around the three main components of cost-based ratemaking: net operating income, rate base, and rate of return. This is followed by a discussion of the utility's revenue requirements and rate impact on customers. The schedules necessary to effectuate these ratesetting decisions and other determinations made in this decision are attached as Appendices A and B.
Net operating income is gross operating revenue less operating and maintenance expenses, depreciation, income taxes, and other operating taxes. For test year 2004, Casmite estimates operating expenses of $70,967, depreciation of $2302, and taxes of $1319, or a total of $74,588. Ex. No. 3, Workpaper H, Sheet 1 (revised; depreciation corrected). At current rates, Casmite estimates only $22,436 in operating revenues during test year 2004, producing a net operating loss of $51,152. Workpaper F, Sheet 1, Supplement to Application (May 7, 2004). The Water Division agrees that the company's proposed expenses are reasonable. Water Division, Findings and Recommendations at 7. With a minor change for taxes ($519 instead of $1319), we accept $73,788 as the operating expenses for test year 2004.
Casmite does not have any employees and all labor is either obtained under contract or provided by Unocal. Workpaper B, Sheet 11, Supplement to Application (May 7, 2004); Tr. 15:18-16:17 (Aldinger, Sept. 13, 2004). Casmite's insurance is also provided by Unocal. Id. at Sheet 17; Tr. 18: 16-23 (Aldinger, Sept. 13, 2004). Other operating expenses incurred by Unocal for Casmite's benefit are allocated to Casmite on at least an annual basis. Tr. 15:18-16:17 (Aldinger, Sept. 13, 2004).
The Casmite physical plant is fully depreciated except for improvements made in 2001 and following periods. These improvements include new water storage tanks installed in 2003 ($15,731), a new well pump purchased in 2004 ($10,121), and 4200 feet of replacement water main being installed in 2004 ($70,000). This results in an estimated average depreciation reserve for test year 2004 of $92,633 and an average rate base of $75,616. Ex. No. 3, Workpaper C, Sheet 1. The Water Division does not dispute these figures. The sum of $35,000, however, will be deducted from the rate base for the reasons discussed in Part V, supra.
At present rates, Casmite would be receiving a negative 68% return on rate base (net operating loss of $51,152 ÷ average rate base of $75,616). The Water Division does not challenge this figure. One of the few contested legal issues is the appropriate rate of return for such a small company. Citing D.92-03-093, Financial and Operational Risks of Commission-regulated Water Utilities, 43 CPUC 2d 568 (Mar. 31, 1992), Casmite presents two different rate of return possibilities using the alternative rate of return methodologies authorized by that decision. Referencing the recommended rate of return range there authorized (13.9%-14.4%), as periodically updated by the Water Division, Casmite suggests 13.75%. Using the operating ratio method authorized in the decision, Casmite suggests a margin of 20% over operating and maintenance expenses. Since that decision indicates the higher result should be selected, see 43 CPUC 2d at 586, Casmite argues for use of the 20% operating ratio method.
The record, however, is deficient in supporting the 20% margin. Upon cross-examination, Casmite's accountant testified that as a result of the 1992 decision, "the Commission identified the operating ratio method as an alternative in the rate calculation and used 20 percent in their example. It's not guaranteed." Tr. 29:27-30:2 (Aldinger, Sept. 13, 2004). The witness is correct that the decision does not guarantee 20% or another margin. In fact, the decision makes no reference to 20% or any other margin. The witness may have been confused by the Commission's finding that "[t]he operating ratio method of ratemaking would produce a higher rate of return than cost-of-service regulation in only about 20% of small water companies." 43 CPUC 2d at 591. Because of applicant's failure to establish the appropriate percentage margin for application of the operating ratio method, we will start by calculating the rate of return using the recommended range authorized in D.92-03-093. However, as indicated below, the rate of return will be modified to mitigate the rate shock to customers resulting from Casmite's operation without a CPCN and avoiding rate review for at least a decade.
Casmite's previous operations may have benefited its customers by providing water and apparently adequate service for many years while collecting revenues far below costs; however, in another respect, the company has not done itself or its customers any favors. Had Casmite been subject to the Commission's ratesetting authority during this period, rates would have gradually risen over time providing more revenues to the company and enabling customers to adjust their water use and budgets accordingly. Also, through its monitoring of other water providers, the Commission's Water Division would have had more opportunities to facilitate the acquisition of Casmite by another water provider.
In its July report, the Water Division approved Casmite's proposed revenues based on use of the operating ratio method. However, in testimony at the evidentiary hearing, the Water Division's expert witness, Sazedur Rahman, indicated that the Water Division had changed its rate of return position both as to Class D water companies, in general, and as to Casmite, specifically. Rahman testified that the Water Division's position now was that Class D providers should recover 13.75%, regardless of the method used. Upon cross-examination, Rahman indicated that this new policy had been developed over the last two months, was evidenced only by an internal memo, and was not necessarily final. Tr. 92:14-15 (Rahman, Sept. 13, 2004). Because of questions about the formal status of this "new" policy, the Water Division's argument is rejected as uncertain.3
Another of the Water Division's new recommendations at hearing was to grant Casmite the same rate of return as a typical Class A water company. Rahman argued that since Casmite was wholly owned by Unocal and had received money from the parent corporation in the past, "it should be treated like a part of a big corporation, like, for example, a part of a Class A water utility." Id. at 88:28-89:2. Class A water utilities, Rahman's argument continued, recently have received a rate of 8.9% return on rate base and a rate of return on equity of 9.7% (citing D.03-10-005, In re California Water Service Co., 2002 Cal. PUC LEXIS 1026 (Oct. 2, 2003)). Rahman concluded that 9.7% is the appropriate rate of return figure.
Rahman's analogy between a Class A water company and Casmite (owned by Unocal, which normally is not in the business of operating water utilities) is unconvincing, but we agree that 9.7% under the circumstances is a constitutionally acceptable, reasonable, and just rate of return for Casmite. As we indicated with reference to Class D water utilities in D.92-03-093, the "[r]ate of return may be set at a level above or below this range if facts so warrant in a particular case." 43 CPUC 2d at 592.
Casmite's longstanding operation without a CPCN and periodic ratesetting is responsible for the potential rate shock to customers (and accompanying negative community impacts) as rates are increased to produce a fair rate of return. To further sanction Casmite for its impermissible operation without a CPCN (see Part V, supra), mitigate rate shock, and reduce adverse community impacts, we accept the Water Division's recommendation that the rate of return be phased-in over a four-year period. Water Division, Opening Brief at 4 (Oct. 18, 2004). The rate increase for the first year (test year 2004) will be calculated to cover expenses only (0%). The rate of return for the second year will be 3.26%. The rate of return for the third year will be 6.52%. The rate of return for the fourth year will be 9.7%. As the Water Division indicates, "This phase-in is the maximum relief that the Commission can provide to avoid rate shock and ensure sufficient revenues to cover costs, while avoiding a negative rate of return.
To enable the Commission to actively monitor the condition of this water system after the fourth year, Casmite is ordered to apply for ratesetting for the fifth year.
In closing, it is useful to remember that we are under no constitutional obligation when ratesetting to ensure that a utility actually earns a reasonable rate of return-only that the utility is afforded a reasonable opportunity to do so. Nor are we required to ensure that the utility earn a specific rate of return each and every year-only that the utility is afforded a reasonable opportunity to do so over a reasonable holding period. See Public Service Comm'n of Montana v. Great Northern Utilities Co., 289 U.S. 130, 135 (1933) (due process clause of Fourteenth Amendment "does not assure to public utilities the right under all circumstances to have a return based upon the value of the property so used").
Using test year 2004 figures accepted by the Water Division, Casmite has estimated operating expenses of $70,967 and revenues of $22,436. The company estimates it needs $51,152 in additional revenue just to break even (without factoring in any rate of return).
Prior to Casmite's application, Casmite was charging its customers $20 per month or $1.24 per 100 cubic feet consumed, whichever was greater. Complaint of Casmalia Community Services Dist. at 2 (Sept. 2, 2003). At hearing, Casmite proposed to recover $92,902 in operating revenues using a rate design that would impose a monthly service charge of $73.16 per month for the basic 5/8" x ¾" meter plus a commodity charge of $4.63 per 100 cubic feet. The commodity charge would increase 269%. The monthly service charge for Casmalia's 2" meter would be $585.28. Ex. A, Revised Workbook at p. 17, Supplement to Application (May 7, 2004).
As indicated above, we adopt the Water Division's recommendations and authorize a 0% rate of return for the first year. Casmite still must be authorized rates to raise sufficient gross revenues to meet estimated operating expenses of $71,000 (2004 figures); however, these rates will be lower than requested.
Casmite has proposed a rate design based on our criteria for water utilities, as implemented by the Water Division. See In re Water Rate Design Policy, D.86-05-064, 21 CPUC 2d 158 (1986). We approve the proposed rate design, modified as necessary by other determinations made in this decision. For test year 2004, we adopt a monthly service charge of $55.08 for the basic 5/8" x ¾" meter plus a commodity charge of $3.71 per 100 cubic feet. The details of the rates and rate design are set forth in Appendix B.
Based on our determinations in this part, Casmite shall file an advice letter and tariff with the Water Division effectuating these rates.
3 On March 17, 2005, after the record had closed in this proceeding, the Commission adopted Resolution W-4524 regarding the rate of return and rate of margin for Class C and D water utilities.
