IX. Operating and Maintenance Exenses

A. Summary of O&M Expenses

PG&E's forecast of Operating and Maintenance (O&M) expenses reflects the costs to operate and maintain PG&E's gas transmission, storage, and gathering facilities for 2004, and costs for related customer service activities. PG&E's forecast of O&M expenses are set forth in Chapter 9 of Exhibit 3. For 2004, PG&E's forecast of O&M expenses in 2004 dollars is $90.959 million.

PG&E's O&M forecast was developed using recorded expenses for 2001 as the base. Adjustments were made to the base for unusual and non-recurring items to provide an adjusted year 2001 recorded base forecast. Incremental adjustments were then made to the adjusted year 2001 recorded base to determine the 2004 forecast.

One of the incremental adjustments that PG&E made for 2004 is for computer system modifications that are needed to support the new and modified services that are reflected in PG&E's proposals. PG&E estimates these modifications to cost $1.769 million in 2001 dollars. Table 9-2 of Exhibit 3 lists the various computer system modifications that PG&E believes necessary.

Another incremental adjustment is for work related to the Pipeline Safety Improvement Act of 2002. This legislation was signed into law on December 17, 2002. (Public Law 107-355.) The law requires that pipeline owners or operators complete baseline integrity assessments and inspections of all gas transmission pipelines located within high consequence areas within seven to ten years, depending on the assessment method used. PG&E estimates that 2200 miles of its gas transmission pipeline will be affected by this law. In order to comply with the law, PG&E estimates it will have to assess 150 to 220 miles of pipeline each year for 10 years.

Much of this assessment will be done by "smart pigging,"⁴¹ the costs of which are discussed in the capital expenditures section. PG&E estimates that the other assessments will likely be done by direct assessment⁴² and the associated physical excavations. In 2004, PG&E plans to conduct direct assessment on 200 miles of pipeline, and estimates that 100 physical excavations will be made to inspect sections of the pipeline. PG&E estimates that this will result in O&M costs of $4.416 million for 2004.

PG&E also forecasts an increase in Non-Reimbursable Relocations. Non-Reimbursable Relocations are costs to relocate pipelines that are in conflict with Public Works projects such as sewer and storm drain lines. PG&E estimates expenses of $250,900 for 2004.

Adjustments for 2004 were also made for O&M work related to the storage system. An increase of $194,000 was included to perform an evaluation of Line 57B and the stability of the Mildred Island levees, which the pipeline crosses.

B. Positions of the Parties

1. Mirant

Mirant points out that ORA, which normally takes the lead in analyzing and responding to revenue requirement issues, had only limited resources in this proceeding. As a result, ORA did not perform any detailed cost or policy analyses of PG&E's proposals. Although Mirant and other parties tried to explore a number of revenue requirement issues through the cross-examination of PG&E's witnesses, this is not a substitute for a thorough examination of the books and accounts that are normally conducted by ORA.

Several parties probed the reasonableness of PG&E's revenue requirement calculations, giving particular attention to PG&E's estimates of operation and maintenance expenses and capital expenditures. These efforts have raised concerns about the sufficiency of PG&E's cost of service analysis, and the associated revenue requirement.

The greatest increase in PG&E's O&M expense forecast for 2004 is the cost of pipeline integrity inspections. Between the date that PG&E served its testimony in December 2002, to its update filing of March 2003, PG&E's estimate of this expense rose from $600,000 to $4.4 million. PG&E also expects that these costs will continue to increase in future years. Without the benefit of a broader review by ORA staff, Mirant contends that the reasonableness of PG&E's O&M expense estimate is unconfirmed.

Mirant recommends that PG&E's cost of service study, and the revenue requirement conclusions that flow from the study, should not be implemented because they have not been comprehensively reviewed by ORA. The Commission should allow no more than the Gas Accord's annual escalation factor of 2.5%, pending a full rate review for year 2005.

2. Palo Alto

Palo Alto supports TURN's adjustments to PG&E's cost of levee restoration at Mildred Island, the Non-Reimbursable Relocation costs, and the costs to modify PG&E's computer systems. This has a 2004 revenue requirement effect of $113,200, $100,000, and $1,070,000, respectively.

Palo Alto believes that these amounts should be excluded from the 2004 O&M costs because these activities were not identified as scoping memo issues.

3. TURN

TURN has identified three areas in which PG&E's gas O&M expenses could be reduced by a total of $1,255,000 for 2004.

PG&E proposes to recover $1,769,000 in computer system change costs related to implementing new provisions of the Gas Accord in 2004 rates. TURN recommends amortizing the total system change costs of $2,098,000 over three years, reducing the revenue requirement by $1,070,000.

PG&E replied that the computer system change costs are related to programming work, and not the purchase of hardware, and therefore are not subject to amortization under Generally Accepted Accounting Principles (GAAP). TURN contends that while GAAP is a guide, they do not control accounting for ratemaking purposes. TURN points out that the Commission has approved capitalizing software costs based on the amount of software development costs and the expected useful life of the project. In PG&E's last general rate case, the Commission adopted a fifteen year service life for capitalized computer plant, including both hardware and software.

TURN's second O&M change is to amortize the $242,500 total cost of the Mildred Island Levee stability project over three years. This would reduce the 2004 revenue requirement by $113,200. PG&E replied that since this project involved "remediation work on the levee," rather than capital plant, that it was not subject to amortization under GAAP. TURN contends that the GAAP guidelines are not controlling, and that these types of labor costs may be capitalized over three years.

TURN's third O&M change is to use a six-year average of recorded data instead of the three-year average of 1999, 2000 and forecast 2002 data that PG&E used to forecast the 2004 Non-Reimbursable Relocations. PG&E did not use 2001 data because it claimed that there was an unusually low level of non-reimbursable relocations. TURN's use of six years of recorded data results in a forecast of $178,500 while PG&E's forecast results in $250,900.⁴³ TURN contends that PG&E has provided no argument or data indicating that the 2001 data is a statistical anomaly that should be excluded.

4. PG&E

PG&E's testimony presented estimates of the expenses that PG&E expects to incur in operating and maintaining PG&E's gas transmission system. These forecasts of operating and maintenance expenses involve activities related to gas transmission, gas storage, gas gathering facilities, and customer service for 2004. Except for the concerns of Mirant and TURN, which are addressed below, PG&E contends that the proposed funding levels for all other expense categories were unopposed and should be adopted.

TURN has proposed three reductions to reduce gas O&M expenses. First, TURN recommends amortizing the costs associated with computer system changes to implement the Gas Accord II-2004 provisions over a three-year period, which would reduce the revenue requirement by $1.07 million. Second, TURN proposes amortizing the $242,500 total cost associated with the Mildred Island Levee Stability Project over three years, which would reduce the 2004 revenue requirement by $113,200. And third, TURN proposes that the 2004 forecast for Non-Reimbursable Relocations be lowered from $250,900 to $178,500.

PG&E states that TURN's proposal to amortize the costs associated with computer system changes should not be adopted. The System Development Work involves programming effort instead of the purchase of hardware or off-the-shelf software. To amortize programming expenses, which are not capital investments, is contrary to Generally Accepted Accounting Principles (GAAP). Since these expenses are planned and estimated to be incurred in 2004, they should be treated as an expense and recovered in 2004.

PG&E also states that there is no basis for amortizing the costs associated with the Mildred Island Levee Stability Project because the work does not involve capital plant. The project involves remediation work on the levees to ensure that issues with cover and stability do not present a risk to PG&E's Line 57B. To amortize this cost would be improper under GAAP. Since these expenses are estimated to be incurred in 2004, they should be recovered in the same year.

As for TURN's proposal that the 2004 forecast for Non-Reimbursable Relocations be lowered, PG&E contends that its forecast is more accurate than TURN's because it uses more current data (1999, 2000 and 2002),⁴⁴ and excludes the expense for 2001 ($42,900) which were unusually low. PG&E says it is clear from examining the recorded data that non-reimbursable relocations have been growing and that it is more appropriate to use recent data in preparing a 2004 forecast.

Mirant stated that without the benefit of a broader review of the Pipeline Integrity Program Expenditures by ORA, the reasonableness of PG&E's O&M expense estimate is unconfirmed. PG&E points out that Mirant has made no showing whatsoever to challenge the accuracy of the Pipeline Integrity expense forecast, and ORA's opening brief raised no specific opposition to PG&E's O&M forecast. The PG&E witness explained that the increased spending for the pipeline expenses were based on the most current information available, and it is anticipated that work in 2005 and 2006 will be greater than 2004.

C. Discussion

PG&E advocates that since no one objected to most of the O&M expenses that were forecast for 2004, the uncontested expenses should be approved, and that the challenges to the other expenses should be resolved in PG&E's favor. Mirant, and some of the other parties assert that there has not been a careful review of the O&M expenses and capital expenditures, and that the cross-examination revealed only a sampling of possible adjustments. Mirant suggests that if the Commission does not postpone the costs and rates portion of this proceeding, expenses should only be escalated by 2.5% for 2004, the same cost escalation factor in the Gas Accord.

We agree with Mirant and others that a comprehensive review of PG&E's expenses should be done. However, given the time and resource constraints of all the parties, such a review was not performed. Although such a review was not done, that does not mean PG&E's forecasted O&M expenses, and other expenses that it is requesting, should be summarily approved. The testimony, cross examination, and argument were able to highlight some areas of possible adjustments, as discussed below and in the capital expenditures section. A more thorough review by ORA may have uncovered additional adjustments.

We note that the rates adopted in this proceeding are only for 2004. ORA will have the opportunity to comprehensively review PG&E's expenses in early 2004 for rates to be set in 2005. ORA should make plans to allocate resources accordingly.

Mirant raised concern about the forecasts of O&M expenses in 2004 for the Pipeline Safety Improvement Act of 2002 (Pub. Law 107-355, Dec. 17, 2002).⁴⁵ In 2004, PG&E forecasts the amount at approximately $4,415,800. According to PG&E's workpapers, these expenses were $20,700 and $630,700 in 2002 and 2003, respectively. (Ex. 39, p. 9; Ex. 40, p. 10; Ex. 1, p. 9-9.)

As described by PG&E, and our review of the Pipeline Safety Act, the expenditures in 2002 and 2003 are fairly low because the law was not enacted until December 17, 2002. However, the deadlines set forth in Section 14 of the Pipeline Safety Act provides for the Secretary of Transportation to "issue regulations prescribing standards to direct an operator's conduct of a risk analysis and adoption and implementation of an integrity management program ...." These regulations are to be issued by December 17, 2003. The law also provides that:

"The regulations shall require an operator to conduct a risk analysis and adopt an integrity management program within a time period prescribed by the Secretary, ending not later than 24 months after such date of enactment. Not later than 18 months after such date of enactment, each operator of a gas pipeline facility shall begin a baseline integrity assessment described in paragraph (3)."

Our reading of the above deadlines suggests that work associated with this law will occur in 2004. There is no doubt that expenses and capital expenditures will occur to comply with the Pipeline Safety Act. The question is when will these costs be incurred, and how much the costs will be.

The issue of when the costs will be incurred is known. The baseline integrity assessment must begin not later than June 17, 2004, and the risk analysis and adoption of an integrity management program must begin no later than December 17, 2004.

The costs to be incurred are more of a variable. The work for baseline integrity assessments, risk analysis, and the adoption of an integrity management program will start up in 2004. However, the deadlines in the Pipeline Safety Act does not require the baseline integrity assessment to begin until mid-year of 2004. The regulations for the Pipeline Safety Act have not been issued yet, so the risk analysis may not occur until later in 2004. The O&M expenses that PG&E forecasts for 2004 are $4,415,800 in 2001 dollars. Using the escalation factors provided by PG&E, the O&M expense for the Pipeline Safety Act in 2004 dollars is approximately $5,005,953.

We have no doubt that PG&E will incur O&M expenses for work associated with the Pipeline Safety Act. However, the deadlines in the law allow for much of this work to occur in the second half of 2004. Since PG&E estimates $11 million per year in capital expenditures for the Pipeline Safety Act, we use the $5,005,953 as the one-year estimate for O&M in 2004. Since much of the work associated with the law is not required to begin until mid-2004, it is appropriate to reduce the O&M expense of approximately $5,005,953 by half, to reflect six months of expenses. This adjustment to the O&M expense is reflected in Table 2 of Appendix A of this decision.⁴⁶

We have reviewed the reductions that TURN has proposed for the computer system change costs to implement its proposals, the Mildred Island Levee stability project, and the Non-Reimbursable Relocations. The computer system change costs and the Mildred Island costs is a question of whether the costs should be expensed or capitalized. The examples provided by TURN and PG&E lead us to adopt PG&E's position, and to expense these two costs. We note that the computer system costs could have been reduced somewhat because not all of the planned computer programming will be needed in light of which proposals we adopt in today's decision.

On the Non-Reimbursable Relocations, we adopt PG&E's position. We believe that the more recent data for this expense item reflects a more accurate forecast than the six-year average that TURN used.

We adopt PG&E's forecast of O&M expense for 2004, less the adjustment to the O&M costs for the Pipeline Safety Act. PG&E shall be directed to make this adjustment to the O&M expense.

⁴¹ Smart pigging is the term that is used to refer to the process of sending a data gathering instrument through an operating pipeline to measure steel pipe wall thickness, and to look for corrosion, metal loss, voids, defects, and dents. PG&E notes some pipelines may have to be retrofitted to allow for smart pigging, and that there may be cost uncertainties associated with this retrofitting work, especially in urban areas. ⁴² Direct assessment is the industry process of verifying pipeline integrity by analyzing physical data on the pipeline (age, type of girth welds, wall thickness, coating, operating safety factor) and the results of electronic surveys and tests taken on the ground above the pipeline. Physical excavations of various segments of the pipeline are performed in order to validate the accuracy of the direct assessment data and model. ⁴³ If PG&E's methodology is accepted, PG&E's amount should be reduced by $12,700 based on recorded 2002 data. (Ex. 52, p. 8, fn. 11.) ⁴⁴ The average for these three years was $250,900. ⁴⁵ Hereinafter referred to as the "Pipeline Safety Act." ⁴⁶ It is our intent that PG&E's forecast O&M expense of $4,415,800 for 2004 in 2001 dollars, adjusted for 2004 dollars using the escalation factors, shall be used to calculate the adjustment. The revenue requirement that we adopt today for 2004 shall serve as the maximum cap. That is, should the O&M adjustment, or other adjustments made in today's decision, result in a higher number than what we have calculated, which would increase the revenue requirement amount, the adopted revenue requirement amount shall not be changed. Should the adjustments result in a lower revenue requirement amount, the adopted revenue requirement amount shall apply.