XI. Forecast of Interest Rates

The forecasted long-term debt and preferred stock costs are based on PG&E's actual, or embedded, costs. However, because we establish the cost of capital on a forecast basis each year, future interest rates must be anticipated to reflect projected changes in PG&E's long-term debt and preferred stock caused by the issuance and retirement of long-term debt and preferred stock during the year.

PG&E estimated its long-term debt cost by starting with its March 31, 2000 recorded debt cost. Added to this base was the projected issuance of new debt assumed to cost 7.77% for 2000 and 7.81% for 2001. The projected debt cost was derived from the April 2000 DRI 2000 and 2001 forecast of incremental debt rates for AA rated utility bonds. Its long-term debt cost was then adjusted to reflect scheduled maturity of bond issues, sinking fund purchases, and high coupon debt refunding for 2000 and 2001. PG&E forecasted that its authorized 2000 long-term debt cost would increase from 7.26% to 7.41% in 2001.

PG&E estimated its cost of embedded preferred stock in a similar fashion. PG&E started with its March 31, 2000 recorded preferred stock cost. Unlike its long-term debt cost PG&E kept its embedded preferred stock cost constant through the remainder of 2000 and 2001 because it has no plan to repurchase or issue any preferred stock in the near future. The only change to the cost of preferred stock is a decrease due to the removal of the amortization of a refunding premium associated with the redemption of preferred stock in 1990. PG&E forecasted that its 2000 authorized embedded preferred stock cost would decrease from 6.60% to 6.56% in 2001.

Prior cost of capital proceedings generated a considerable debate on the validity of various interest rate forecasts and on the appropriate methodology for equating forecast utility bond rates to other bond ratings. However, in D.90-11-057,⁵ we recognized that actual interest rates do vary and that our task is to determine the "reasonable" cost of debt rather than an actual cost based on an arbitrary selection of a past figure. We concluded that the latest available DRI forecast should be used to determine the embedded debt cost in cost of capital proceedings. Consistent with this conclusion, the assigned Commissioner's Scoping Memo and Ruling instructed all parties that long-term debt and preferred stock costs should be updated to reflect the October 2000 DRI 2001 long-term debt interest rate forecast.

PG&E appropriately updated its long-term debt and preferred stock costs. This update changed PG&E's 2001 forecasted long-term debt cost from 7.26% to 7.27% and preferred stock cost from 6.60% to 6.56%. No party objected to PG&E's updated estimate of its long-term debt and preferred costs.

PG&E's proposed 7.27% long-term debt and 6.56% preferred stock costs for 2001, which comply with D.90-11-057, should be adopted. Having determined the appropriate long-term debt and preferred stock costs we now address the appropriate ROE for PG&E.