VII. Depreciable vs. Non-Depreciable Assets
A. OIR Questions
In introducing the OIR, we asked parties to comment on whether there should be a difference for the purpose of allocating the gain in the treatment of depreciable assets such as buildings, machinery and other assets, and non-depreciable assets such as land. The OIR tentatively concluded that there should be no difference in the treatment of depreciable and non-depreciable assets.
We acknowledged that land is treated differently on a utility's books from other assets in a section of the OIR entitled "The special case of land." We stated: "Because it needn't be replaced, land is not depreciated, as in the case of buildings or machinery." Nonetheless, we noted that ratepayers still bear significant costs in association with utility land: "the entire acquisition cost of the land is put into rate base and the shareholder receives a return on that amount for as long as the land is in rate base. Ratepayers still pay for carrying costs such as maintenance, taxes, insurance, administrative costs and interest expense for the land."
B. Comments on Treatment of Non-Depreciable Assets vs. Depreciable Assets
ORA and TURN agree that the Commission should have consistent rules for both depreciable and non-depreciable assets on the theory that ratepayers bear the risk of utility assets, regardless of whether the asset is depreciable or non-depreciable. Aglet asks us to come up with a standard outcome, with 50-95% of gains and losses assigned to ratepayers, for the sale of non-depreciable assets (predominantly land) and depreciable assets for which gains or losses do not exceed $10 million. Thus, Aglet too seeks equal treatment of non-depreciable and depreciable property.37
For the most part, the utilities do not argue against assigning the gain from depreciable assets to ratepayers. SCE notes that depreciation rates for such assets fully compensate utility shareholders for the cost of service, "with any gains or losses on individual assets continuing within the utility as the responsibility of ratepayers."38 SDG&E states that, "any gain loss on sale of depreciable property should be allocated 100% to ratepayers."39 PG&E contends that, "gains on sale of depreciable property, with certain exceptions, should flow to ratepayers through the depreciation reserve."40 PG&E explains that depreciation allows utility shareholders to recover the cost of the depreciable property from ratepayers over the depreciable property's useful life. SDG&E/SoCalGas agrees: "Any gain/loss on sale of depreciable property should be allocated 100% to ratepayers."41
The utilities are unanimous in their opposition to a rule that treats land and buildings in the same way for purposes of the gain on sale. IOUs claim that for land (and not buildings or other depreciable assets) the risk analysis we set forth in the OIR is unfair, because utilities earn a rate of return on the land's original cost, rather than on its appreciating value. This "original cost" assertion is the key distinction, they claim, between land and buildings or other depreciable assets.
SDG&E/SoCalGas state that gain or loss on sale of non-depreciable property should be allocated 100% to utility shareholders. They explain that while such assets are in service, "shareholders are allowed to recover in rates a return on their investment in the assets (at their original cost) but recover none of the capital cost of the assets."42 They ask that if the asset is no longer necessary or useful to provide utility service, shareholders "simply get their asset back and ratepayers stop paying a return on it." If the asset is sold, SDG&E/SoCalGas assert, the value of the asset when sold is the property of shareholders.
SDG&E/SoCalGas' key point is that ratepayers pay the authorized rate of return on the land only at its original cost of acquisition by the utility. They assert that this situation creates the potential that ratepayers will pay a return on an amount far less than the current market value of the land. "[I]f utility shareholders are allowed to retain from sale proceeds on land only their original cost, they will be receiving back only a small fraction of the real value of their original investment."43
With regard to non-depreciable property, PG&E claims that shareholders bear the financial risks because "Commission-authorized rates do not include any component to recover the cost of acquiring the land."44 PG&E notes that shareholders pay the acquisition cost of non-depreciable property.
Park Water Company (Park) makes the same argument, noting that shareholders do bear a financial risk with regard to land. "If the value of the land subject to regulation increases, the rates may not rise to reflect that increase given that rates are typically tied to costs not to current estimations of value."45
C. Discussion - Treatment of Non-Depreciable Assets vs. Depreciable Assets
As noted above, the consumer advocates support a consistent approach to non-depreciable and depreciable assets sales, while the utilities support allocating all gains/losses from the sale of depreciable assets to ratepayers. While a consistent approach is the easiest, the parties' comments persuade us to allocate depreciable and non-depreciable gains differently. As the large IOUs acknowleged in their original comments, we have traditionally allocated 100% of gains (and losses) from depreciable property sales to ratepayers. We adopt that allocation. As for non-depreciable assets, we will adopt a 50-50 allocation between ratepayers and shareholders.
We reject an approach that allocates most (or all) of the gains on sale of land and other non-depreciable property to utility shareholders. The utilities' key argument in favor of a large shareholder allocation is that they only receive a rate of return on the original cost of land. Any appreciation in the value of the land, they claim, should therefore pass to shareholders.
The United States Supreme Court long ago held that ratemaking bodies need not give utility shareholders a rate of return based on the "present fair value" of utility property.46 The Democratic Central Committee court explained the Hope Natural Gas holding as making it "clear that the utility is not entitled of right to have its rate base established at the value which the assets would command on the current market, although that market value exceeds original cost."47
In our Redding I decision,48 we cited both Democratic Central Committee and Hope Natural Gas in support of the proposition that original cost ratemaking does not dictate that shareholders receive gains on sale from land. The Commission concluded that, "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."49 Similarly, we found in D.90-11-031, our SoCalGas headquarters sale decision, that, "Our system of original cost ratemaking represents a careful balancing of interests and is not weighted unfairly toward either ratepayers or shareholders."50 The utilities' claims that their shareholders should receive the gain because ratepayers pay a return only on the original cost of the property are therefore not persuasive.
While SDG&E and SoCalGas cite our Suburban Water Company decision in support of their original cost assertion, that case merely found that original cost ratemaking did not support allocation of the gain to ratepayers in a narrow circumstance.51 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.52
Nor are we persuaded by arguments that utility shareholders are entitled to all of the gain because they "own their own property . . . ."53 While it is true that payment of rates does not transfer ownership of property to ratepayers, such ownership is not necessary in order for ratepayers to be entitled to the gain. Thus, cases such as Pacific Telephone v. Eshleman, 166 Cal. 640 (1913)54 are not meaningful in the gain on sale context. That case 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. Thus, we reject the claim that original cost ratemaking dictates that the value of land when sold should be the property of shareholders.55
We expect most land sales to follow the 100%-0% and 50-50% rules of thumb, but once again allow for case-by-case analysis in unusual situations. Such unusual situations include asset sales where the sale price is more than $50 million, or where the after-tax gain or loss from the sale is more than $10 million, as Aglet proposes.
37 As noted elsewhere in this decision, Aglet advocates case-by-case treatment for major facilities (power plants - especially nuclear plants), pipelines, office buildings and assets with a sale price that exceeds $50 million or a gain or loss that exceeds $10 million. We adopt these recommendations with modification.
38 SCE Comments at 22.
39 SDG&E Comments at 11.
40 PG&E Comments at 10 (heading).
41 SDG&E/SoCalGas Comments at 11.
42 SDG&E/SoCalGas Comments at 6.
43 Id. at 8.
44 PG&E Comments at 7.
45 Park Water Company Comments at 13.
46 Federal Power Commission v. Hope Natural Gas Company, 320 U.S. 591, 599-600 (1944).
47 Democratic Central Committee, 485 F.2d at 802.
48 D.85-11-018, 19 CPUC 2d 161 (1985), 1985 Cal. PUC LEXIS 958.
49 1985 Cal. PUC LEXIS 958 at *22. Even though our Redding II relied on a test different from that we adopted in Redding I, that change did not alter applicable court precedent.
50 1990 Cal. PUC LEXIS 1015, conclusion of law 4, at *118.
51 In Suburban Water Company, rate base property was sold under threat of condemnation.
52 D.94-01-028, 53 CPUC 2d 45 (1994), 1994 Cal. PUC LEXIS 45, conclusion of law 1, at *25.
53 See California Water Association Comments at 5, and cases cited there.
54 See id. at 5.
55 See SDG&E and SoCalGas Comments at 6.
