COM/GFB/sid DRAFT Agenda ID #5106

Quasi-Legislative

2/16/2006

Decision DRAFT DECISION OF COMMISSIONER BROWN

(Mailed 11/15/2005)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Order Instituting Rulemaking on the Commission's own motion for the purpose of considering policies and guidelines regarding the allocation of gains from sales of energy, telecommunications, and water utility assets.

Rulemaking 04-09-003 (Filed September 2, 2004)

OPINION REGARDING ALLOCATION OF

GAINS ON SALE OF UTILITY ASSETS

TABLE OF CONTENTS

Title Page

OPINION REGARDING ALLOCATION OF

GAINS ON SALE OF UTILITY ASSETS 2

I. Summary 2

II. Dismissal of Certain Telecommunications Carriers and Gas Storage Providers from Proceeding 4

A. SBC/Pacific Bell and Verizon California 5

B. SureWest Telephone and Frontier Communications 6

C. Wild Goose Storage and Lodi Gas Storage 7

III. Definition of Gain on Sale 7

IV. Questions Posed in the OIR 8

A. General Gain on Sale Questions 8

B. Water Gains on Sale - Pub. Util. Code § 789 10

C. Notice of Utility Assets Taken Out of
Service - Pub. Util. Code § 455.5 12

D. Commission Approval of Sales 13

V. Rule Applicable to Both Gains and Losses 13

A. Comments - Same Rule for Gains/Losses 13

B. Discussion - Same Rule for Gains/Losses 14

VI. Allocation Dependent on Risk 15

A. OIR Proposals - Risk 15

1. Risk as Primary Determinant of Gain/Loss Allocation 15

2. Other Tests 17

a) Redding II Ratepayer Harm Test 17

b) Southern California Gas Headquarters Sale - Ratepayer Indifference Test 18

B. Comments - Risk as Primary Determinant of Gain/Loss Allocation 19

1. Differing Views of Who Bears Risk 19

2. Renter Analogy 22

3. Other Tests 24

a) Redding II Ratepayer Harm Test 24

b) Ratepayer Indifference Test 25

C. Discussion - Risk Analysis 26

1. Summary 26

2. Risk Analysis Based on Economics of Utility Regulation 27

3. The Energy Crisis and Other Extraordinary Losses 27

4. Forecasts 29

5. Renter Analogy 29

6. Other Tests 31

a) Redding II Ratepayer Harm Test 31

b) Ratepayer Indifference Test 32

VII. Depreciable vs. Non-Depreciable Assets 32

A. OIR Questions 32

B. Comments on Treatment of Non-Depreciable Assets vs. Depreciable Assets 33

1. Ratepayer Advocates 33

2. Utilities - Depreciable Assets 33

3. Utilities - Non-Depreciable Assets 34

C. Discussion - Treatment of Non-Depreciable Assets vs.
Depreciable Assets 36

1. Depreciable Assets 36

2. Non-Depreciable Assets 37

VIII. Uniform System of Accounts Not Determinative of Proper
Allocation of Gain on Sale 40

A. Comments on Applicability of USOA to Gain on
Sale Determination 40

B. Discussion - USOA 41

IX. Allocation as Incentive for Prudent Asset Management 43

A. Comments - Incentives 43

B. Discussion - Incentives 45

X. Only After-Tax Gains Considered 47

A. Comments - Taxation 47

B. Discussion - Taxation 49

XI. Notice of Utility Assets Taken Out of
Service - Pub. Util. Code § 455.5 50

A. Comments - Pub. Util. Code § 455.5 50

B. Discussion - Pub. Util. Code § 455.5 52

XII. Other Issues 54

A. FERC Jurisdictional Property 54

1. Comments - FERC Jurisdictional Property 54

2. Discussion- FERC Jurisdictional Property 54

B. Gains/Losses on Non-Utility Assets 56

1. Comments - Non-Utility Assets 56

2. Discussion - Non-Utility Assets 57

C. Section 851 Issues 58

1. Comments - Section 851 58

2. Discussion - Section 851 58

D. Abandoned Plant 60

1. Comments - Abandoned Plant 60

2. Discussion - Abandoned Plant 60

XIII. Water Specific Issues - Water Utility Infrastructure Improvement Act of 1995, Public Utilities Code § 789 et seq. 61

A. OIR Questions - Water 61

B. General Interpretation of Infrastructure Act, Pub. Util. Code
§ 789 et seq. 62

1. Comments - General Interpretation of Infrastructure Act 62

2. Discussion - General Interpretation of Infrastructure Act 63

C. Shareholder-Purchased Assets vs. Other Assets 67

1. Government Funding 67

a) Comments - Government Funding 67

b) Discussion - Government Funding 68

2. Developer Contributions in Aid of Construction 69

a) Comments - Developer Contributions in Aid of Construction 69

b) Discussion - Developer Contributions in Aid of Construction 70

3. Contamination Proceeds 71

a) Comments - Contamination Proceeds 71

b) Discussion - Contamination Proceeds 71

D. Churning 72

1. Comments - Churning 72

2. Discussion - Churning 74

E. Reconciliation of § 851 and § 790 76

1. Comments - § 851 and § 790 76

2. Discussion - § 851 and § 790 78

F. Condemnations/Involuntary Conversions 78

1. Comments - Involuntary Conversions 78

2. Discussion - Involuntary Conversions 79

G. Small Water Companies (Class B, C and D) 81

1. Comments - Small Water Companies 81

2. Discussion - Small Water Companies 82

XIV. Assignment of Proceeding 82

XV. Comments on Draft Decision 82

Findings of Fact 82

Conclusions of Law 89

ORDER 94

APPENDIX A - List of cases in which gain on sale issues deferred

OPINION REGARDING ALLOCATION OF

GAINS ON SALE OF UTILITY ASSETS

I. Summary

This decision adopts a process for allocating gains on sale received by certain electric, gas, telecommunications and water utilities when they sell utility land, assets such as buildings, or other tangible or intangible assets formerly used to serve utility customers. In most cases, utility ratepayers should receive 75% of the gain, based on our finding that ratepayers bear most of the risk associated with owning such property. The utilities' shareholders should receive the remaining 25% of the gain on sale.

This rule of thumb will apply 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. Most ordinary asset sales that come before this Commission for approval should meet these criteria.

The rule we develop here will not apply where the after-tax asset sale price exceeds $50 million or the gain or loss exceeds $10 million. The rule also does not apply to utility sales of assets of extraordinary 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. We cannot predict in advance every extraordinary circumstance to which our general rule will not apply. However, most of our decisions allowing asset sales over the last several years have involved fairly routine utility assets that do not meet the foregoing thresholds.

We have deferred allocation of the gain in many past cases (see Appendix A). 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 those past sales.

Where a utility or other party believes asset values exceed the foregoing dollar thresholds; 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 other 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. If the Commission so rules, then it may evaluate how to allocate gains or losses without applying the general rule. We do not expect many cases to fall into this "exception" category, and urge parties to be judicious in their invocation of the exception.

Pursuant to Pub. Util. Code § 455.5,¹ this decision also requires electric, gas, and water utilities to report annually to this Commission whenever any portion of an "electric, gas, heat, or water generation or production facility" is out of service, and immediately when a portion of such facility has been out of service for nine consecutive months. This reporting requirement applies only to major electric, gas, heat, or water generation or production facilities. We believe the threshold for defining a "major facility" should vary with the size of the utility, but do not have an adequate record to define such facilities across utilities. We prescribe next steps to develop such a record.

This decision does not change the circumstances under which utilities must file applications seeking Commission approval of such asset sales. Those circumstances are governed by § 851, and any procedures the Commission adopts to implement § 851's mandates. Therefore, we do not now act on the proposal in our initial order instituting this proceeding to prohibit any public utility from selling any capital asset for which it has not filed an Advice Letter and to render void any sale not complying with this rule. A determination of the process a utility must file to obtain our permission to sell assets is beyond the scope of our inquiry into how to account for gains on sale. The Commission has recently adopted a pilot program (Resolution ALJ-186) designed to streamline its review of certain § 851 transactions, and has indicated that it will take additional steps to review how it handles § 851 generally. We need not duplicate those efforts here.

Finally, we provide interpretation of the Water Utility Infrastructure Act of 1995, § 789 et seq. We find the Legislature intended the Act to give water companies certainty on how to allocate gains on sale, and to limit Commission flexibility in allocating such gains. However, the statute does not limit our ability to impose record keeping requirements on the water companies to ensure they invest proceeds from the sale of formerly used and useful utility property in new infrastructure, and we impose such requirements here. We also discuss the treatment of proceeds attributable to property purchased with funds that did not come from the water company, such as developer funds, government loans, and contamination litigation proceeds.

¹ All statutory references cite the Pub. Util. Code, unless otherwise noted.