Background
In Decision (D.) 04-03-069, the Commission found that SCWC violated Public Utilities Code Section 851 when it failed to seek the Commission's approval for its 1994 permanent lease of 5,000 acre feet per year (AFY) of water rights in the American River to the City of Folsom (Folsom). For that reason, the lease was voided; a penalty of $1,095,000 was assessed, of which $915,000 was suspended; and SCWC was ordered to credit ratepayers with 70% of the total lease revenues accrued from the inception of the lease through the effective date of the decision, plus 7% interest. The Commission also determined that while Folsom acted in "good faith for value," Folsom was entitled only to retrospective protection of its lease of water rights, pending further record development on the issue of Folsom's prospective rights under the voided lease. Folsom then filed a petition to modify D.04-03-039, indicating that serious and immediate effects had occurred because the Commission did not preserve its prospective rights under the lease. In D.04-04-069, after a review of new information provided by Folsom, the Commission concluded that § 851 protects Folsom's acquired interest in the water both with respect to the past and to the future, notwithstanding the voiding of the lease as to SCWC. This determination is not changed by today's decision.
The Commission also ordered SCWC to file an application to address the following topics:
1. How SCWC will obtain water sufficient to serve its customer base without the 5,000 acre-feet per year leased to Folsom?
2. What is the proper accounting and ratemaking treatment of future lease revenues under the Folsom lease?
3. What measures are appropriate to ensure ratepayers are not adversely affected by the lease of water rights to Folsom?
On July 8, 2004, SCWC filed this application to address these three issues, and obtain § 851 approval for the Folsom transaction. The Commission's Office of Ratepayer Advocates (ORA)2 protested the application on July 8, 2004. A prehearing conference was held on October 14, 2004. The Assigned Commissioner issued a scoping memo, which adopted a procedural schedule calling for testimony and evidentiary hearings, and designated the assigned Administrative Law Judge as the principal hearing officer. The scoping memo stated that the Commission had already defined the scope of the proceeding in D.04-04-069 as being the three questions set out above.
Evidentiary hearings were held on June 14, 2005. SCWC presented two witnesses and ORA presented one for cross-examination. To accommodate the procedural schedule for SCWC's then-pending general rate case, briefing was delayed to October and November 2005. The proceeding was submitted for consideration by the Commission on November 23, 2005.
Resolution of Issues
SCWC and ORA presented evidence on each of the three issues, which we resolve below, followed by our determination of whether this transaction meets our standards for approval pursuant to § 851.
Issue 1: How SCWC will obtain water sufficient to serve its customer base without the 5,000 acre feet per year leased to Folsom?
SCWC stated that it serves about 15,027 customers in the Arden-Cordova Service Area, which is comprised of the unconnected Arden and Cordova water systems. The Arden system cannot receive water from the American River system and is therefore not affected by the transfer to Folsom. The Cordova system currently has 13,240 customers, and SCWC predicts that full "build out" of the service area in 2022 will result in about 15,500 customers. SCWC forecasts that water demand will be about 22,200 acre-feet per year, with maximum daily demand about 25,325 gallons per minute.
SCWC states that it has sufficient ground water and surface water to meet this projected demand. SCWC explained that the Cordova system has 13 active wells with a total system design capacity approximately equal to 32,941 acre-feet, more than enough to meet projected 2022 demand. SCWC admits, however, that groundwater contaminants threaten up to nine of its wells. SCWC further explained that remediation by the polluters, including providing replacement water, will ensure an adequate supply of groundwater. In addition to its groundwater, SCWC stated that it possesses rights to divert up to 5,000 acre-feet of water per year from the American River, and has entered into a five-year water transfer agreement with the Sacramento Municipal Utility District for 10,000 acre-feet of water.
ORA countered that SCWC will be relying heavily on the risky strategy of purchases from third parties to meet the needs of its customers. ORA stated that that the 5,000 acre feet of water rights transferred to the Folsom are an important source of good quality water that SCWC controls from the source to the point of delivery. ORA concluded that the Folsom water rights, as compared to potential future purchases, are a superior source of water for SCWC's customers.
Discussion
SCWC has demonstrated that it currently has sufficient water supplies to meet the needs of its customers. ORA, however, has raised substantial questions about SCWC's ability to economically meet its customers' needs in the future. These questions cannot be answered at this time. Customers are simply at risk that future supplies may be more costly, or, under the direst circumstances, not available at all. We address this risk below.
Issue 2: What is the proper accounting and ratemaking treatment of future lease revenues under the Folsom lease?
SCWC argues that no dollar value for the water rights was recorded in SCWC's rate base, and thus ratepayers have no claim to the water rights or proceeds from the sale thereof. SCWC provided accounting documentation showing that all costs of the acquisition were allocated among the other assets transferred and recorded in SCWC's rate base plant accounts. At no time were the water rights included in rate base. SCWC also cited to D.00-07-018 as supporting an allocation to shareholders of 70% of the proceeds.
ORA pointed to D.04-03-039 as dispelling SCWC's contention that the water rights were not included in rate base. ORA reads that decision as concluding that the cost of the acquisition, including the water rights, was included in rate base. Consequently, the ratepayers are entitled to all revenue from the sale. ORA recommended that all revenues for the lease of water rights to Folsom which were not addressed by D.04-03-039 be credited to regulated account No. 607, Sales to Government Agencies by Contracts.
SCWC opposed ORA's allocation of all revenues to ratepayers and contended that ORA provided no justification of such an allocation. SCWC stated that ORA did not draw any analogy to the Commission's precedent on gain on sale or allocation of revenues from excess capacity.
Discussion
In D.04-03-039, we thoroughly reviewed all aspects of the SCWC's 1964 acquisition of the Natomas Water Company and the subsequent lease to Folsom of 5,000 AFY. We addressed the ratemaking treatment of the proceeds retrospectively from the date of that decision. While today's decision addresses the prospective revenues, certain of the factual and legal determinations made in that decision continue to apply:
We now turn to the ratemaking issue. SCWC argues that the water rights were never in rate base, are non-utility/non-regulated property of SCWC and therefore the lease proceeds should accrue only to shareholders.
We do not accept that proposition. When SCWC purchased the Natomas Water Company in 1964, the transfer of water rights was included in the transaction. As even SCWC admits, certain amounts of those rights were exercised previously by the Natomas Water Company and subsequently by SCWC. The entire cost of the Natomas Water Company purchase, which included 32,000 AFY was borne by the ratepayers. Shareholders were not separately responsible for recovery of any of the costs. We see no reason to assign the full benefit of the water rights to shareholders merely due to the fact that as SCWC states, "At that time - 1963 - it was common practice to attach no monetary value to water rights and therefore SCWC acquired these water rights for free."3 The fact that the parties may not have assigned a particular line item value to the water rights does not mean those rights were free, especially since Natomas had obtained a benefit from the exercise of some of those water rights. Notwithstanding the lack of a separate itemization of the value of the acquired water rights, it is clear that the value of those property rights was included in the overall purchase price paid by SCWC. We determine that the entire amount of water rights was utility property at the time of the purchase. After the 1967 sale to Folsom, the entire remaining 10,000 AFY, which includes the 5,000 AFY being leased to Folsom, continued to be utility property.
SCWC has offered us no reason to alter our previous determination. In additional support of this determination, we observe that SCWC's argument that the water rights were transferred without cost amounts to a contention that the sellers intended to make a gift4 to shareholders, and the record contains no evidence supporting such intentions. We therefore conclude that the cost of acquiring the water rights was included in the sales price for the system assets purchased by SCWC, and that such costs were included in rate base.
In D.04-03-039, we divided the retrospective revenue from the lease between the ratepayers and shareholders, 70/30, respectively. To arrive at this sharing, we first noted that ratepayers had paid the costs associated with acquiring the water rights, and that shareholders had not borne any costs whatsoever. We then observed that the water rights would probably have been underutilized and that the shareholders should be rewarded for leasing this asset to a third party:
Based on the fact that ratepayers, not shareholders, have borne the cost of obtaining the water rights at issue as part of the purchase price of Natomas, it is reasonable to allocate most of the benefits of the lease to the ratepayers from the inception of the lease. Further supporting the assignment of most of the lease revenues to ratepayers is the fact that the revenues are not the product of capital investment in plant or facilities by SCWC. This was an investment in preexisting water rights, funded by ratepayers. On the other hand, it is appropriate to assign shareholders a minority of the lease revenues in order to provide some reward for the leasing of an asset that probably would have been underutilized for most of the period from 1994 to the present had it not been leased. Based on these considerations and the unique facts of this case, we determine that 70% of the lease revenues should be assigned to ratepayers and 30% to shareholders. This apportionment should apply to any lease revenues accrued from the inception of the lease through the date of this decision.
We now consider the prospective revenues from the lease of the water rights to Folsom. The ratepayers continue to bear the costs of acquiring these water rights, and the shareholders have invested no capital. These facts have not changed.
We cannot, however, conclusively determine that the water rights will not be useful to SCWC at some point in the future. Consequently, we are in no position to find that shareholders merit a "reward" for this transaction.5 As discussed in more detail below, we find that the transaction subjects SCWC's customers to significant risk and that the terms of the lease do not meet our § 851 standards. We conclude that our sole justification in D.04-03-039 for allocating any portion of the revenue to shareholders is no longer applicable. SCWC has presented us with no other rationale to support a similar "reward" for the prospective revenue. Therefore, all revenue from the lease of water rights to Folsom received by SCWC since the effective date of D.04-03-039 shall be recorded in Account No. 607, Sales to Government Agencies by Contracts, for the benefit of ratepayers.
2 ORA subsequently changed its name to Division of Ratepayer Advocates. For clarity of the record, we will use ORA.
3 SCWC Opening Brief, p. 19.
4 Black's Law Dictionary (1991) defines "gift" as: "a voluntary transfer of property to another made gratuitously and without consideration."
5 This same analysis undermines SCWC's contention that water rights are and will always be "surplus," and pursuant to D.00-07-018 (the "excess capacity" decision) ratepayers would receive 30% of the revenue and shareholders 70%.
