XV. Comments on Draft Decision
The draft decision of the ALJ in this matter was mailed to the parties in accordance with Pub. Util. Code § 311(g)(1) and Rule 77.7 of the Rules of Practice and Procedure. Comments were filed on ____________________, and reply comments were filed on ________________.
1. Certain parties described herein should be dismissed from the proceeding: SBC/Pacific Bell, Verizon California, SureWest, Frontier, Wild Goose Storage and Lodi Gas Storage.
2. Depreciable assets for purposes of this decision include, but are not limited to, buildings, equipment, machinery, materials and vehicles.
3. Non-depreciable assets for purposes of this decision include, but are not limited to, land, water rights and goodwill.
4. A utility receives a gain on sale when it sells an asset such as land, buildings or other tangible or intangible assets at a price higher than the acquisition cost of the non-depreciable asset or the depreciated book value of the depreciable asset.
5. Depreciable and non-depreciable assets are treated differently when determining whether there is a monetary gain from the sale of these assets.
6. Buildings, machinery, equipment, materials and vehicles may be depreciated on the utility's regulatory financial statements.
7. Land, water rights and goodwill are not depreciable because they need not be replaced, unlike buildings, machinery or other depreciable assets. Ratepayers bear costs associated with a non-depreciable asset because the entire cost of the asset is put into rate base and the shareholder receives a return on that amount for as long as the asset is in rate base. Ratepayers also pay for carrying costs such as maintenance, taxes, insurance, administrative costs and interest expense for the asset.
8. We cannot anticipate in advance all types of losses for which we should conduct a case-by-case analysis.
9. Most of our decisions allowing asset sales over the last several years have involved fairly routine utility assets that do not meet the threshold we establish here (applying the 75-25% rule where the after-tax sale price is $50 million or less, or where the gain or loss from the sale is $10 million or less).
10. Ratepayers fully compensate utilities for costs related to assets dedicated to utility use.
11. The 75-25% rule ensures mitigation of the minor risks we acknowledge shareholders face in holding property, but awards most of the gain to the major risk-holder - the ratepayer.
12. Rewards should go to those who bear the actual costs and burdens of the risks engendered by particular economic actions, such as the purchase of assets.
13. Many of the risks the utilities raise in their comments have nothing to do with the specific act of holding assets such as land, buildings and other utility assets; rather, they relate generally to risks of being in the utility business.
14. The gain on sale calculus should not take into account extraordinary risks such as the recent California energy crisis. The crisis did not arise because of electric utilities' ownership of land, buildings or other assets.
15. The general, ordinary risks utilities and their ratepayers face should determine the gains allocation outcome.
16. Generalized risks, not specific to any particular asset purchase, are resolved in two areas: in the market value of the utility's stock, and the allowable rate of return assigned by the Commission in the utilities' cost of capital proceedings.
17. The "risk of municipalization" is the risk that a portion of a distribution system will be condemned under eminent domain powers. This is just another utility risk, dealt with through the market price of stock and the general rate case process. It is not a risk that requires extra compensation to utility shareholders through the gain on sale mechanism.
18. A utility's risk of municipalization or regulatory change has nothing to do with the value and risks associated with its utility assets.
19. While forecasts may understate true costs in a given year, in the long run these forecasts of utility costs and earnings necessary to cover those costs will ensure that utilities are adequately compensated.
20. Ratepayers bear the risk that forecasts will overstate needed utility rates of return in a given year.
21. The Commission allows utilities to true up their forecasts with their actual costs.
22. The risks that forecasts will understate true costs are negligible compared with the risks borne in the private sector that revenues will be inadequate and the firm will need to go out of business.
23. Utilities acquire depreciable and non-depreciable assets to serve their utility customers with the understanding that they will place the assets in rate base and be compensated with a reasonable rate of return. Ratepayers will cover the utilities' operational costs (maintenance, repairs, depreciation where applicable, taxes and other carrying costs). Utilities are guaranteed customers and a revenue stream in the form of rates.
24. Landlords operate in a competitive market. In such markets, customers are not captive to the monopoly and may move away. The market, not the regulator, determines rental prices. The apartment owner is at risk of losing his investment, or at least not covering his full costs, due to loss of customers or falling rental prices, which are both beyond his control. A landlord's property may remain vacant in times of slack demand, so the property owner has no guaranteed stream of revenue. The whims of the market control the value of a landlord's investment.
25. The terms under which utilities and private property owners operate are vastly different. A utility acquires property dedicated to public use, and receives a rate of return and payment for maintenance and repair, with the understanding that it will return gains to ratepayers when the property is no longer necessary for utility operations.
26. We are not holding that ratepayers hold legal title to utility property by virtue of bearing costs related to the property.
27. The utilities do not argue against allocating all gains/losses from depreciable property to ratepayers.
28. The allegation that original cost is the upper bound of the losses ratepayers face does not and should not mean that the gains to which they are entitled should be limited to original cost as well.
29. Our system of original cost ratemaking represents a careful balancing of interests and is not weighted unfairly toward either ratepayers or shareholders.
30. Ratepayer ownership of property is not necessary in order for ratepayers to be entitled to gains on sale.
31. Depreciable and non-depreciable assets do not require different gain on sale allocations.
32. The USOA is not determinative of the proper allocation of gains on sale.
33. The USOA dictates how utilities maintain their accounts for regulatory purposes. It ensures uniform accounting policies across utilities.
34. The Commission has consistently maintained that the accounting provisions contained in the USOA are not controlling as to the ratemaking policies which this Commission may determine to be reasonable and necessary.
35. The FERC adopted USOA is really a record keeping system, and is not a ratemaking treatise that is controlling on how to allocate the gain on sale.
36. We have held in connection with energy, water and telecommunications asset sales that the USOA is not determinative of how to allocate gains on sale.
37. We have no evidence that stock and bondholders rely on the USOA for gain on sale allocation.
38. Given our long line of cases holding that the USOA accounting categories should not determine ratemaking allocations such as gain on sale, it would be unreasonable for investors to assume that the USOA would determine gain on sale allocations.
39. The motive for high profits - especially in a real estate market as volatile as California's - may unduly skew management decisions regarding valuable real property holdings.
40. Allocating all net proceeds to shareholders could create a powerful financial incentive for utilities to sell real property without regard to long-term customer service needs, and may even lead to real property speculation by utilities.
41. If management is incented perversely by the prospect of windfall shareholder returns from the sale of property that is in rate base, draws a rate of return, and is necessary for utility service, ratepayer service may suffer.
42. It is not good public policy to give utilities large incentives to sell property in rate base that is not necessary or useful for utility service. The law bars utilities from receiving a rate of return on such property, and it would send the wrong message to compensate shareholders for simply following existing law.
43. Taxes reduce or alter the amount of gains and losses available for allocation to shareholders and ratepayers.
44. Setting the "major facility" definition too high for purposes of Pub. Util. Code § 455.5 could cause significant ratepayer harm.
45. We do not have an adequate record on how to define a "major facility" in § 455.5, but believe the term should be defined based on the size of the utility.
46. Issues regarding interpretation of Pub. Util. Code § 851 are by and large outside the scope of this proceeding.
47. The parties do not offer a consistent definition of term "abandoned plant."
48. Water utility regulation is unique because there is a specific statute governing gain on sale allocation, the Infrastructure Act.
49. The April 5, 1995, analysis provided for the California Senate floor when it was considering passage of the Infrastructure Act explained that the statute was designed to ensure uniform allocation of gains on sale and to limit Commission discretion in allocating such gains.
50. In passing the Infrastructure Act, the Legislature was attempting to create a uniform standard that would flow all gains on the sale of no longer used and useful water utility real property back to the owners for the specified use of improvements in infrastructure and then after a period of years, the proceeds would be allocated to ratepayers.
51. We lack a record to determine whether government funding agencies are in a position to receive reimbursement for sales proceeds traceable to property purchased with government loans or grants.
52. Settlement proceeds paid to water utilities in connection with contamination of water supplies do not involve sales of real property, so the Infrastructure Act does not apply. Nor are such proceeds gains on sale. Thus, such proceeds are outside the scope of this proceeding.
53. Property taken by condemnation - inverse or direct - is not necessarily property that is no longer used and useful. A condemning body may take property that the water utility otherwise would continue to use to provide water service.
1. Where a utility incurs unusual or catastrophic losses from sale of a depreciable or non-depreciable asset, any party should be able to request that we analyze the loss on a case-by-case basis.
2. Incidence of risk is the best determinant of how to allocate gains and losses on sale.
3. The Commission has discretion to adopt a gain or loss allocation methodology that reflects the regulatory compact into which utilities enter.
4. In routine sales of depreciable and non-depreciable assets, ratepayers should receive 75% of the gain, and shareholders should receive the remaining 25%.
5. We should not set gain on sale rules to anticipate extraordinary losses having nothing to do with the risks related to holding utility assets. Such a practice could over- or under-compensate ratepayers, by basing rules on non-recurring and unusual events.
6. We need not alter our risk-based calculus based on forecast risk.
7. We should continue to apply the principles of our Redding II decision in the narrow circumstances to which they were designed to apply. Thus, where (1) a public utility sells a distribution system to a governmental entity, (2) the distribution system consists of part or all of the utility operating system located within a geographically defined area, (3) the components of the system are or have been included in the rate base of the utility, and (4) the sale of the system is concurrent with the utility being relieved of, and the governmental entity assuming, the public utility obligations to the customers within the area served by the system, then the gains or losses from the sale of the system should be allocated to utility shareholders, provided that the ratepayers have not contributed capital to the distribution system and remaining ratepayers are not adversely affected by the transfer of the system.
8. We have not been presented with an adequate record to justify broadening or narrowing Redding II's scope.
9. We have no basis to return to the ratepayer indifference test we adopted in D.90-04-028 - and promptly rejected within the year in D.90-11-031.
10. In the case of most depreciable asset sales, we should require a 75-25% allocation of after-tax gains from such sales to ratepayers and shareholders, respectively.
11. Ratemaking bodies are not legally required to give utility shareholders a rate of return based on the "present fair value" of utility property. The utility is not entitled of right to have its rate base established at the value that the assets would command on the current market, although that market value exceeds original cost.
12. Our Suburban Water Company decision found that original cost ratemaking did not support allocation of the gain to ratepayers in a narrow circumstance. In granting the gain on sale to shareholders, the Commission made clear that the holding was limited to that case only, and should not serve as precedent.
13. Pacific Telephone v. Eshleman, 166 Cal. 640 (1913), had nothing to do with ratemaking or gains on sale, but rather dealt with whether rival local telephone companies could attach to Pacific Telephone's lines.
14. We should adopt the same rule of thumb - a 75%/25% ratepayer/shareholder split - for non-depreciable assets as we do for depreciable assets.
15. The law and good regulatory policy do not require that we set the shareholder portion of gain on sale at a high level in order to achieve prudent property management.
16. The Commission's ordinary policy is to require flow-through, or cash-basis tax accounting.
17. Gains or losses from property that is partially in rate base and partially out of rate base should be allocated proportionately to the percentages in and out of rate base.
18. Pub. Util. Code § 455.5 does not require that sales of major facilities be barred or voided if the utility fails to meet its reporting requirements under that provision.
19. Electric utilities should allocate gains on sale of transmission property according to the rules of the FERC rules, rather than the rules we develop here.
20. It is appropriate in most cases to allocate gains or losses on property held out of rate base to shareholders. Where property is never in rate base, all gains or losses should accrue to shareholders.
21. The Infrastructure Act limits Commission discretion in how it allocates gains on sale for water utilities.
22. To interpret statutory language, the courts must ascertain the intent of the legislature so as to effectuate the purpose of the law. Thus, it is appropriate to examine the legislative analysis to determine what the Legislature intended in enacting the Infrastructure Act.
23. Water utilities must invest net proceeds from the sale of formerly used and useful water utility real property in new water infrastructure. They need not refund such proceeds to ratepayers, but they may not pay the funds out to shareholders in the form of dividends or other earnings either.
24. The Commission has exclusive authority to determine the used, useful, or necessary status of any and all water utility infrastructure improvements and investments.
25. In the absence of a specific agreement between a water company and a government funding agency regarding return of grant or loan monies (other than those governed by Proposition 50) upon the sale of assets funded by those monies, we should default to our general premise that sales proceeds from water company real property in rate base must be reinvested in infrastructure pursuant to § 790. Such proceeds must come from the sale of real property that is no longer used and useful, because the statute only addresses such property.
26. Any water utility property that a utility disposes of that does not meet the Infrastructure Act's three criteria - (1) that an asset be sold, (2) that it no longer be used and useful, and (3) that it be real property - shall be accounted for in accordance with our general 75%-25% rule.
27. Regarding developer contributions of water infrastructure in aid of construction, absent special agreements between the developers that might bind water companies to a different result, water companies should invest such proceeds in new water infrastructure. The proceeds must result from a sale of formerly used and useful real property, because the statute only applies to such property.
28. Only if the water company fails to make such investment within the statutory eight-year period should the proceeds revert to ratepayers.
29. Water utilities may not pay out sales proceeds in dividends or other profit to shareholders. Rather, they must place the proceeds in a memorandum account approved by the Commission and meet the other tracking requirements we imposed in D.03-09-021 and reiterate here.
30. We should impose certain reporting and application requirements to ensure that water companies act in compliance with § 790 and invest sales proceeds from formerly used and useful utility property into new infrastructure.
31. Because the Infrastructure Act may incent water companies to sell used and useful property prematurely, safeguards against "churning" are appropriate.
32. A party may not make its own determination of whether property it intends to sell is necessary or useful in accordance with § 851. Because § 790 may create incentives for water companies to sell property that is still useful for utility service, water companies should seek Commission authorization when they propose to sell real property covered by § 790.
33. Our 75%-25% default rule relating to gains on sale shall apply to water utility sale assets, except where the asset sold is real property that is no longer used and useful. In the latter instance, the proceeds shall be reinvested in accordance with the Infrastructure Act.
34. The Infrastructure Act does not cover property taken by condemnation because the statute only applies to "real property that once was, but is no longer, necessary or useful in the provision of water utility service . . . ." § 789.1(d). If, at the time of condemnation, the property continues to be used and useful, the fact of condemnation is not sufficient to change the pre-condemnation character of the property.
35. Only water utility property that at the time just before the sale is no longer used and useful is covered by the statute. Any other interpretation could encourage water companies to sell property that is used and useful and that should continue to be used for water service. It is the use just prior to the sale or condemnation that one must examine to determine whether the Infrastructure Act applies.
36. The Infrastructure Act is not applicable to involuntary conversions due to condemnation.
37. The rules we develop here should apply to after-tax gains and losses.
IT IS ORDERED that:
1. Except as noted below, utility ratepayers shall receive 75% of gains on sale of utility assets, both depreciable and non-depreciable. The utilities' shareholders shall receive the remaining 25% of the gain on sale. We will call this rule the "75-25% rule."
2. Depreciable assets for purposes of this decision include, but are not limited to, buildings, equipment, machinery, materials and vehicles.
3. Non-depreciable assets for purposes of this decision include, but are not limited to, land, water rights and goodwill.
4. The 75-25% rule applies to routine asset sales where the after-tax sale price is $50 million or less, or where the gain or loss from the sale is $10 million or less.
5. The 75-25% rule does not apply where the after-tax asset sale price exceeds $50 million or the gain or loss exceeds $10 million. If an asset causes a utility an after-tax loss greater than $50 million, the utility shall automatically seek case-by-case determination of how to allocate the loss.
6. The 75-25% rule does not automatically apply to the following situations: sales of assets that are extraordinary in character; sales of nuclear power plants; where a party alleges the utility engaged in highly risky and non-utility-related ventures; or where a party alleges the utility grossly mismanaged the assets at issue.
7. Where a utility or other party believes assets are extraordinary in character, or where losses result where there are allegations of highly risky, non-utility-related ventures or gross utility mismanagement, the utility or party may ask us to except the transaction from our general rule. The Commission will determine how to evaluate cases where a utility or party requests an exception.
8. We do not expect many cases to fall into the "exception" categories noted in the previous two paragraphs.
9. In cases involving losses of $50 million or less, the utility may seek allocation of the loss to ratepayers. If any party, including ORA, contends that the Commission should allocate the loss, in whole or part, to utility shareholders, the party should seek case-by-case treatment in a protest to the utility application.
10. For losses that do not exceed $50 million, or for which no party seeks case-by-case treatment, the 75-25% rule will apply.
11. We will continue to apply the principles of our Redding II decision, Decision 89-01-016, 32 CPUC 2d 233 (1989), in the narrow circumstances to which they were designed to apply. Thus, where (1) a public utility sells a distribution system to a governmental entity, (2) the distribution system consists of part or all of the utility operating system located within a geographically defined area, (3) the components of the system are or have been included in the rate base of the utility, and (4) the sale of the system is concurrent with the utility being relieved of, and the governmental entity assuming, the public utility obligations to the customers within the area served by the system, then the gains or losses from the sale of the system should be allocated to utility shareholders, provided that the ratepayers have not contributed capital to the distribution system and remaining ratepayers are not adversely affected by the transfer of the system.
12. We do not have an adequate record on which to define "major facility" under § 455.5. The parties shall file comments in this regard within 90 days of the effective date of this decision, and may file reply comments within 30 days of receipt of the opening comments. Before filing such comments, all non-telecommunications parties who filed comments shall meet and confer in an attempt to reach agreement on standard definitions of major facilities based on utility size. The parties shall report the results of their meet and confer session to the assigned ALJ before filing comments. At a minimum, parties shall assume that the following rules will govern their negotiations and/or written proposals: (1) The statute applies only to electrical, gas, heat or water corporations' generation or production facilities. The parties should agree upon a common definition of "generation" and "production" that is based on either the USOA or another rational interpretation of the terms. (2) The statute applies to facilities as well as portions of facilities.
13. Interpretation of Pub. Util. Code § 851 is by and large beyond the scope of this proceeding.
14. Electric utilities shall allocate gains on sale of transmission property according to the rules of the Federal Energy Regulatory Commission rules, rather than the rules we develop here. This finding is not intended to be a general one with respect to this Commission's jurisdiction over transmission issues.
15. We adopt a rebuttable presumption regarding allocation of gains on sale for property that has moved in and out of rate base over time. An applicant (or other party) may assume that the gain allocable to shareholders directly mirrors the time the property was out of rate base. Thus, for example, if the property is in rate base for 20 years and out of rate base for 20 years, shareholders should receive 50% of the gain/loss, and the remainder should be allocated according to the 75-25% rule applicable to property in rate base. However, if there is evidence that demonstrates that most of the property's appreciation (or depreciation) occurred while the property was in (or out of) rate base, evidence of such variance may be submitted to rebut the presumption.
16. A special rule allocating gains on sale from "abandoned plant" is not warranted.
17. Water companies shall use the proceeds from sales of formerly used and useful utility real property to invest in new water infrastructure. Such proceeds may not be used to reduce rates or otherwise be returned to ratepayers unless the water companies fail to reinvest the proceeds within the eight-year period contained in the Water Utility Infrastructure Act of 1995, Pub. Util. Code § 789 et seq. (Infrastructure Act).
18. Because the Infrastructure Act may give water companies incentives to sell used and useful real property prematurely, safeguards against "churning" are appropriate. All water utilities we regulate shall comply with the following requirements in accordance with the Infrastructure Act:
Track all utility property that was at any time included in rate base and maintain sales records for each property that was at any time in rate base but which was subsequently sold to any party, including a corporate affiliate.
Obtain Commission authorization to establish a memorandum account in which to record the net proceeds from all sales of no longer needed utility property.
Use the memorandum account fund as the utility's primary source of capital for investment in utility infrastructure.
Invest all amounts recorded in the memorandum account within eight years of the calendar year in which the net proceeds were realized.
19. We will take up claims regarding Proposition 50 funds, including how to allocate gains on sale, in our Proposition 50 proceeding, Rulemaking (R.) 04-09-002.
20. A utility may not make its own determination of whether property it intends to sell is necessary or useful in accordance with § 851. Because § 790 may create incentives for water companies to sell property that is still useful for utility service, water companies must seek Commission authorization when they propose to sell real property covered by § 790.
21. Our 75%-25% default rule relating to gains on sale shall apply to water utility sale assets, except where the asset sold is real property that is no longer used and useful. In the latter instance, the proceeds shall be reinvested in accordance with the Infrastructure Act.
22. The parties bound by this decision shall file Advice Letters within 60 days of this decision's mailing indicating their compliance with the rules set forth herein for each of the past asset sales deferred to this proceeding listed in Appendix A to this decision, and any other asset sales on which the Commission deferred a decision regarding allocation of gains or losses on sale.
23. We dismiss Pacific Bell Telephone Company, dba SBC California, Verizon California Inc., SureWest Telephone, and Citizens Telecommunications Company from this proceeding so that the Commission may address their gain on sale issues in R.05-04-005. All other telecommunications carriers the Commission regulates are bound by this decision.
24. We dismiss Wild Goose Storage Inc. and Lodi Gas Storage, L.L.C. from this proceeding because they are largely unregulated by this Commission.
25. The rules we develop here shall apply to after-tax gains and losses.
This order is effective today.
Dated , at San Francisco, California.
APPENDIX A
List of Cases in Which Gain on Sale Question
Deferred to This Proceeding
D.04-03-024
D.04-02-045
D.03-12-056
D.03-12-006
D.03-03-008
D.02-10-022
D.02-09-024
D.02-09-027
D.02-07-027
D.02-07-026
D.02-04-005
D.01-10-051
D.01-03-064
D.00-12-047
D.00-12-023
D.00-06-017
D.99-12-019
D.99-10-001
(END OF APPENDIX A)
