XV. Comments on Draft Decision
The draft decision of the ALJ in this matter was mailed to the parties in accordance with Pub. Util. Code § 311(g)(1) and Rule 77.7 of the Rules of Practice and Procedure. Comments were filed on January 5, 2006 and reply comments were filed on January 17, 2006.
We respond to the comments here, in no particular order. Where necessary, we make changes to the draft decision. Where we do not make a change, it is because we have rejected the suggested changes.
1. Land Return Based on Historical Cost
Park Water, SDG&E and others claim that utilities receive rates that are lower than they should be because such rates are based on the historical cost - rather than present value - of their land holdings. They appear to claim that we should give shareholders a greater gain on sale to compensate them for this under-recovery. However, rates in California have always been based on the historical cost of land, and if utilities oppose such ratemaking practices, their avenue is to challenge how we set rates. The gain on sale test is not the place to address this ratemaking matter.
We are not persuaded otherwise by assertions (e.g., Park Water Comments at 13) that failure to give utilities a return on the current land value will cause them to churn property not otherwise appropriate for sale in order to increase the basis on which to earn a rate of return. Such churning would be irresponsible (and potentially unlawful), and is not a valid basis for setting policy.
2. Risk as Determinant of Allocation
Several parties challenge our determination that risk is the proper determinant of how to allocate gains on sale, and our conclusion that ratepayers bear much of that risk. We do not change the outcome of this assessment, as we believe it to be correct. If we rejected risk as the principal basis on which to allocate gains, we would give utilities and the marketplace the incentive to allocate capital inefficiently. If we were to require ratepayers to bear most of the risks of utility investments, cover the costs of the investment, and guarantee the utility a rate of return, the utility would buy more assets than would be economically efficient, and certainly more than they would buy if they were constrained by the rigors of the market. Allocating too much of the gain to shareholders would therefore cause inefficiency.
Several utilities reiterate that they need compensation for extraordinary such as the energy crisis and Hurricane Katrina. As the draft decision amply points out, the gain on sale mechanism is not the place to address these risks. As for more ordinary risks - contamination, water supply shortages, forecast errors, new competition - the utilities recover these amounts in rates and should not recover them a second time in the gain on sale.
3. Time In/Out of Rate Base - Who Bears Burden
All parties agree with our conclusion that the time in and out of rate base should affect who receives the gain on sale. If a utility sells property that was for a time in rate base and for the rest of its life out of rate base, the gain on sale allocation we adopt in this decision should only apply to the time in rate base.
However, ORA/TURN ask that we put the burden on the utility to demonstrate when the property was in and out of rate base. We agree that the utility selling the property should bear this burden, and add an ordering paragraph to this effect. Utilities shall bear the burden of proving time out of rate base where there is a gain on sale, and of proving time in rate base where there is a loss on sale.
4. Allocation Percentages
Several utilities, as well as TURN/ORA, challenge the draft decision's 75%-25% allocation formula. Indeed, SDG&E and PG&E originally claimed that the formula for depreciable property such as buildings should be 100%-0%, with 100% of the gain/loss allocable to ratepayers.100 TURN/ORA seek a 90%-10% ratepayer-shareholder split.
We are not persuaded to change the OIR's risk analysis and our finding that the rewards should go to those who bear the actual costs and burdens of the risks. However, the utilities in their comments raise risks that shareholders face from investing money in the utility. Though ratepayers bear the major portion of the risks associated with such property, a 50% - 50% split is a fair and reasonable outcome, partly to compensate for some financial risk borne by the utility, and partly as an incentive to utility management to manage its assets wisely.
We modify the allocation in response to comments as follows:
· 100% of gains from depreciable assets to ratepayers.
· 50% - 50% allocation of gains from non-depreciable assets to ratepayers and shareholders.
5. Taxation
ORA/TURN assert that the draft decision errs in its discussion of the effect of taxation on gains and losses. We add language to clarify that gains and losses should be allocated to ratepayers on a net after-tax basis, grossed up to a revenue requirement. Allocating gains and losses to ratepayers on this basis ensures that any tax benefits or detriments that were previously borne by ratepayers are appropriately reflected into the allocated gain or loss amount.
6. Routine Retirements/Salvage of Depreciable Assets
Several parties urge us not to extend our gain on sale formula to routine retirements of depreciable assets. We agree that the rules should apply principally to high value assets such as land, buildings and water rights. Gains or losses of poles, wires, equipment and other materials that utilities routinely retire from service as they wear out are already taken care of through normal depreciation accounting mechanisms. Ratepayers receive all gains for the normal retirement of depreciable property through normal depreciation accounting, and also bear the risk of any loss on the retirement, such as when the cost of removal exceeds the depreciated value of the asset (net book value). (This amount is termed the property's "negative salvage value.") We do not intend to alter the existing mechanism in this decision.
7. At-Risk Activities by Utilities
Certain utilities seek assurance that the gain on sale rules do not apply to "at-risk" activities by utility shareholders. We do not intend for the rules we adopt here to apply to property never held in rate base. Thus, if a utility engages in a venture with property purchased entirely by shareholders that does not use or affect ratepayer funded property, and on which the utility does not earn a rate of return guaranteed in rates, the shareholders may retain all gains (and shall bear all losses) associated with the sale of such property.
8. Cases in Which Gain on Sale Determination Deferred
To the extent we deferred gain on sale determinations for any case not listed in Appendix A to this decision, or finally determined the gain on sale allocation elsewhere, we provide additional guidance. For any case on which we deferred the gain on sale issue - whether listed in Appendix A or not - the general rule set forth in the draft decision shall apply: "The parties bound by this decision shall file Advice Letters within 60 days of this decision's mailing indicating how they will comply with the rules set forth herein for each of those past sales."
We add language indicating that, "Any party objecting to the proposed treatment of any deferred gain on sale determination may file an Advice Letter protest within the normal Advice Letter protest period."
9. Water issues
a. Developer Contributions in Aid of Construction
Park Water claims that the draft decision errs with regard to the allocation of gains on property that developers contribute to water utilities as part of construction projects. The draft decision correctly concludes that these developer Contributions in Aid of Construction (CIAC) should be covered by § 790. Thus, water utilities must reinvest gains from the sale of such property in water utility infrastructure. They may not pay such proceeds to shareholders (unless the eight-year period set forth in the statute lapses). Utilities may receive a "reasonable rate of return" on such gains, but we defer for future consideration whether such "reasonable rate of return" should be the same amount as it is for other utility property in rate base.
b. Section 851 Requirements
The water companies oppose the draft decision's requirement that they file § 851 applications seeking Commission approval of their sales of property that is no longer used and useful. The draft decision reasons that it should be up to the Commission to verify water companies' claims that the property they are selling is truly no longer useful. It expresses concern that leaving this determination entirely to water companies may allow them to sell property (including water rights) necessary to service without any Commission intervention.
As the draft decision points out, the Commission is currently trialing a program that allows parties seeking to sell property governed by § 851 (used and useful property) to do so by advice letter rather than application. The water companies seek either to be covered by this program, or to be exempted from any review requirement at all.
We are not prepared to exempt water utilities from any filing requirement. It is reasonable to require an entity other than the utility itself - which stands to gain from property sales - to verify that property proposed for sale is no longer used and useful. Section 851 gives us discretion to review such applications. By the same token, we are persuaded that requiring a § 851 application for every sale would be cumbersome.
We modify the decision to require that water companies regulated by this Commission provide 30 days' advance written notice to the Director of the Commission's Water Division, as well as to the Director of ORA (now DRA) when they propose to sell land, water rights, buildings, or all or a portion of a water system that they determine are no longer used or useful. This notice will give the Commission the opportunity to respond to the proposed sale and prevent sales of property that is obviously used and useful.
However, Commission silence in response to the notice should not be interpreted as consent to the sale. At a later time, such as the water company's general rate case, the Commission may nonetheless inquire into the propriety of water company asset sales.
We acknowledge that we are requiring that water companies to provide notice that we do not require of other utilities. We believe that the different
treatment of water utility gains on sale under § 790 justifies this result. Because all proceeds under § 790 go to the utility - rather than its ratepayers - water companies may be more eager to sell property than they otherwise should. A notice requirement at least gives the Commission the opportunity to review such sales in advance.
c. Condemnation
The water companies challenge our assertion that condemnations are not covered by § 790. We defer this issue for further input.
1. Certain parties described herein should be dismissed from the proceeding: SBC/Pacific Bell, Verizon California, SureWest, Frontier, Wild Goose Storage and Lodi Gas Storage.
2. Depreciable assets for purposes of this decision include, but are not limited to, buildings, equipment, machinery, materials and vehicles.
3. Non-depreciable assets for purposes of this decision include, but are not limited to, land, water rights and goodwill.
4. A utility receives a gain on sale when it sells an asset such as land, buildings or other tangible or intangible assets at a price higher than the acquisition cost of the non-depreciable asset or the depreciated book value of the depreciable asset.
5. Depreciable and non-depreciable assets are treated differently when determining whether there is a monetary gain from the sale of these assets.
6. Land, water rights and goodwill are not depreciable because they need not be replaced, unlike buildings, machinery or other depreciable assets. Ratepayers bear costs associated with a non-depreciable asset because the entire cost of the asset is put into rate base and the shareholder receives a return on that amount for as long as the asset is in rate base. Ratepayers also pay for carrying costs such as maintenance, taxes, insurance, administrative costs and interest expense for the asset.
7. We cannot anticipate in advance all types of losses for which we should conduct a case-by-case analysis.
8. Ratepayers compensate utilities for costs related to assets dedicated to utility use.
9. The gain on sale calculus should not take into account extraordinary risks such as the recent California energy crisis. The crisis did not arise because of electric utilities' ownership of land, buildings or other assets.
10. The general, ordinary risks utilities and their ratepayers face should determine the gains allocation outcome.
11. Generalized risks, not specific to any particular asset purchase, are resolved in two areas: in the market value of the utility's stock, and the allowable rate of return assigned by the Commission in the utilities' cost of capital proceedings.
12. While forecasts may understate true costs in a given year, in the long run these forecasts of utility costs and earnings necessary to cover those costs will ensure that utilities are adequately compensated.
13. Ratepayers bear the risk that forecasts will overstate needed utility rates of return in a given year.
14. The Commission often allows utilities to true up their forecasts with their actual costs.
15. The risks that forecasts will understate true costs are negligible compared with the risks borne in the private sector that revenues will be inadequate and the firm will need to go out of business.
16. Utilities acquire depreciable and non-depreciable assets to serve their utility customers with the understanding that they will place the assets in rate base and be compensated with a reasonable rate of return. Ratepayers will cover the utilities' operational costs (maintenance, repairs, depreciation where applicable, taxes and other carrying costs). Utilities are guaranteed customers and a revenue stream in the form of rates.
17. Landlords operate in a competitive market. In such markets, customers are not captive to the monopoly and may move away. The market, not the regulator, determines rental prices. The apartment owner is at risk of losing his investment, or at least not covering his full costs, due to loss of customers or falling rental prices, which are both beyond his control. A landlord's property may remain vacant in times of slack demand, so the property owner has no guaranteed stream of revenue. The whims of the market control the value of a landlord's investment.
18. The terms under which utilities and private property owners operate are different. A utility acquires property dedicated to public use, and receives a rate of return and payment for maintenance and repair, with the understanding that it will return gains to ratepayers when the property is no longer necessary for utility operations.
19. We are not holding that ratepayers hold legal title to utility property by virtue of bearing costs related to the property.
20. The large IOUs agree that 100% of gains/losses from depreciable property should be allocated to ratepayers.
21. 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.
22. Our system of original cost ratemaking represents a careful balancing of interests and is not weighted unfairly toward either ratepayers or shareholders.
23. Ratepayer ownership of property is not necessary in order for ratepayers to be entitled to gains on sale.
24. The USOA is not determinative of the proper allocation of gains on sale.
25. The USOA dictates how utilities maintain their accounts for regulatory purposes. It ensures uniform accounting policies across utilities.
26. The Commission has consistently maintained that the accounting provisions contained in the USOA are not controlling as to the ratemaking policies which this Commission may determine to be reasonable and necessary.
27. The FERC adopted USOA is really a record keeping system, and is not a ratemaking treatise that is controlling on how to allocate the gain on sale.
28. We have held in connection with energy, water and telecommunications asset sales that the USOA is not determinative of how to allocate gains on sale.
29. We have no evidence that stock and bondholders rely on the USOA for gain on sale allocation.
30. Given our long line of cases holding that the USOA accounting categories should not determine ratemaking allocations such as gain on sale, it would be unreasonable for investors to assume that the USOA would determine gain on sale allocations.
31. The motive for high profits - especially in a real estate market as volatile as California's - may unduly skew management decisions regarding valuable real property holdings.
32. Allocating all net proceeds to shareholders could create a powerful financial incentive for utilities to sell real property without regard to long-term customer service needs, and may even lead to real property speculation by utilities.
33. Shareholders should have an incentive for prudent investment in and continued ownership of property that is necessary for utility service, but they should not be given incentives for unnecessary and speculative investment.
34. Shareholders should be given appropriate incentive to dispose of properties that have been rendered unnecessary by change of circumstances, and management should be encouraged to obtain a reasonably high price for the sale.
35. The shareholders should be allocated a portion of the gain from sale, partly to compensate for financial risk borne by the utility and partly as an incentive to utility management to manage its assets wisely.
36. Taxes reduce or alter the amount of gains and losses available for allocation to shareholders and ratepayers.
37. Setting the "major facility" definition too high for purposes of Pub. Util. Code § 455.5 could cause significant ratepayer harm.
38. We do not have an adequate record on how to define a "major facility" in § 455.5, but believe the term should be defined based on the size of the utility.
39. Issues regarding interpretation of Pub. Util. Code § 851 are by and large outside the scope of this proceeding.
40. The parties do not offer a consistent definition of term "abandoned plant."
41. Water utility regulation is unique because there is a specific statute governing gain on sale allocation, the Infrastructure Act.
42. The April 5, 1995, analysis provided for the California Senate floor when it was considering passage of the Infrastructure Act explained that the statute was designed to ensure uniform allocation of gains on sale and to limit Commission discretion in allocating such gains.
43. In enacting the Infrastructure Act, the Legislature was attempting to create a uniform standard that would flow all gains on the sale of no longer used and useful water utility real property back to the owners for the specified use of improvements in infrastructure and then after a period of years, the proceeds would be allocated to ratepayers.
44. Settlement proceeds paid to water utilities in connection with contamination of water supplies do not involve sales of real property, so the Infrastructure Act does not apply. Nor are such proceeds gains on sale. Thus, such proceeds are outside the scope of this proceeding.
1. Where a utility incurs unusual or catastrophic losses from sale of a depreciable or non-depreciable asset, any party should be able to request that we analyze the loss on a case-by-case basis.
2. Incidence of risk is the best determinant of how to allocate gains and losses on sale.
3. The Commission has discretion to adopt a gain or loss allocation methodology that reflects the regulatory compact into which utilities enter.
4. In routine sales of depreciable assets, ratepayers should receive 100% of the gain.
5. In routine sales of non-depreciable assets, ratepayers should receive 50% of the gain or loss and shareholders should receive the remaining 50% of the gain or loss.
6. We should not set gain on sale rules to anticipate extraordinary losses having nothing to do with the risks related to holding utility assets. Such a practice could over- or under-compensate ratepayers, by basing rules on non-recurring and unusual events.
7. We need not alter our risk-based calculus based on forecast risk.
8. We should continue to apply the principles of our Redding II decision in the narrow circumstances to which they were designed to apply. Thus, where (1) a public utility sells a distribution system to a governmental entity, (2) the distribution system consists of part or all of the utility operating system located within a geographically defined area, (3) the components of the system are or have been included in the rate base of the utility, and (4) the sale of the system is concurrent with the utility being relieved of, and the governmental entity assuming, the public utility obligations to the customers within the area served by the system, then the gains or losses from the sale of the system should be allocated to utility shareholders, provided that the ratepayers have not contributed capital to the distribution system and remaining ratepayers are not adversely affected by the transfer of the system.
9. We have not been presented with an adequate record to justify broadening or narrowing Redding II's scope.
10. We have no basis to return to the ratepayer indifference test we adopted in D.90-04-028 - and promptly rejected within the year in D.90-11-031.
11. Ratemaking bodies are not legally required to give utility shareholders a rate of return based on the "present fair value" of utility property. The utility is not entitled of right to have its rate base established at the value that the assets would command on the current market, although that market value exceeds original cost.
12. Our Suburban Water Company decision found that original cost ratemaking did not support allocation of the gain to ratepayers in a narrow circumstance. 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.
13. Pacific Telephone v. Eshleman, 166 Cal. 640 (1913), 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.
14. The law and good regulatory policy do not require that we set the shareholder portion of gain on sale at a high level in order to achieve prudent property management.
15. The Commission's ordinary policy is to require flow-through, or cash-basis tax accounting.
16. Gains or losses from property that is partially in rate base and partially out of rate base should be allocated proportionately to the percentages in and out of rate base. Utilities should bear the burden of proving the time an asset was out of rate base if there is a gain on sale, and the time the asset was in rate base if there is a loss.
17. Pub. Util. Code § 455.5 does not require that sales of major facilities be barred or voided if the utility fails to meet its reporting requirements under that provision.
18. Electric utilities should allocate gains on sale of transmission property according to the FERC rules, rather than the rules we develop here.
19. It is appropriate in most cases to allocate gains or losses on property held out of rate base to shareholders. Where property is never in rate base, all gains or losses should accrue to shareholders.
20. The Infrastructure Act limits Commission discretion in how it allocates gains on sale for water utilities.
21. To interpret statutory language, the courts must ascertain the intent of the legislature so as to effectuate the purpose of the law. Thus, it is appropriate to examine the legislative analysis to determine what the Legislature intended in enacting the Infrastructure Act.
22. Water utilities must invest net proceeds from the sale of formerly used and useful water utility real property in new water infrastructure. They need not refund such proceeds to ratepayers, but they may not pay the funds out to shareholders in the form of dividends or other earnings either.
23. The Commission has exclusive authority to determine the used, useful, or necessary status of any and all water utility infrastructure improvements and investments.
24. Any water utility property that a utility disposes of that does not meet the Infrastructure Act's three criteria - (1) that an asset be sold, (2) that it no longer be used and useful, and (3) that it be real property - shall be accounted for in accordance with our general 100% and 50% - 50% percentage allocations.
25. Regarding developer contributions of water infrastructure in aid of construction, absent special agreements between the developers that might bind water companies to a different result, water companies should invest such proceeds in new water infrastructure. The proceeds must result from a sale of formerly used and useful real property, because the statute only applies to such property. Water companies may earn a reasonable rate of return on the infrastructure the gains purchase, but we defer to a future proceeding the question of whether a reasonable rate of return should be the same for CIAC property as for other water utility property.
26. Only if the water company fails to make such investment within the statutory eight-year period should the proceeds revert to ratepayers.
27. Water utilities may not pay out sales proceeds in dividends or other profit to shareholders. Rather, they must place the proceeds in a memorandum account approved by the Commission and meet the other tracking requirements we imposed in D.03-09-021 and reiterate here.
28. We should impose certain reporting and application requirements to ensure that water companies act in compliance with § 790 and invest sales proceeds from formerly used and useful utility property into new infrastructure.
29. Because the Infrastructure Act may incent water companies to sell used and useful property prematurely, safeguards against "churning" are appropriate.
30. We will require that water companies provide the Director of the Water Division of the Division of Ratepayer Advocates 30 days' advance written notice whenever they plan to sell land, buildings, water rights, or all or part of a water system. This notice requirement applies to water company assets that are used and useful and assets the company believes are no longer used and useful. The 30 days' advance notice will give the Commission an opportunity to assess whether companies are selling off key portions of their asset base. Notice will not preclude later review of such sales in a water company's GRC or a later proceeding. The notice shall include the following heading in at least 16 point bold type: "Notice under Rulemaking 05-06-040. Commission staff must respond within 30 days." The notice must include the name, address, phone and email address of the potential purchaser(s). If the Commission staff objects to the proposed sale, it may send an objection in any form to the seller and proposed purchaser(s). Mailing of such an objection shall prevent the proposed purchaser from claiming it is a bona fide purchaser of the property at issue until the issues raised in the objection are resolved.
31. Our default rule relating to gains on sale shall apply to water utility sale assets, except where the asset sold is real property that is no longer used and useful. In the latter instance, the proceeds shall be reinvested in accordance with the Infrastructure Act.
32. The rules we develop here should apply to after-tax gains and losses.
IT IS ORDERED that:
1. Except as noted below, utility ratepayers shall receive 100% of gains on sale of depreciable utility assets. Ratepayers shall receive 50% of gains or losses on sale of non-depreciable utility assets. The utilities' shareholders shall receive the remaining 50% of gains or losses on sale of non-depreciable assets. We will call the allocations in this ordering paragraph the "percentage allocation rule."
2. Depreciable assets for purposes of this decision include, but are not limited to, buildings, equipment, machinery, materials and vehicles, except that this decision does not apply to routine retirements of minor utility assets that are no longer used or useful.
3. Non-depreciable assets for purposes of this decision include, but are not limited to, land, water rights and goodwill.
4. The percentage allocation rule applies to routine asset sales where the sale price is $50 million or less and the after-tax gain or loss from the sale is $10 million or less.
5. The percentage allocation rule does not apply where the asset sale price exceeds $50 million or the after-tax gain or loss exceeds $10 million.
6. The percentage allocation rule does not automatically apply to the following situations: sales of assets that are extraordinary in 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.
7. Where a utility or other party believes assets 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 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.
8. We do not expect many cases to fall into the "exception" categories noted in the previous two paragraphs.
9. If an asset causes a utility an after-tax loss greater than $50 million, the utility shall automatically seek case-by-case determination of how to allocate the loss. In cases involving losses of $50 million or less, the utility may seek allocation of the loss according to the allocation percentage rules we adopted here (100% for depreciable assets; 50%-50% for non-depreciable assets). If any party, including ORA, contends that the Commission should allocate the loss, in whole or part, to utility shareholders, the party should seek case-by-case treatment in a protest to the utility application.
10. We will continue to apply the principles of our Redding II decision, Decision 89-01-016, 32 CPUC 2d 233 (1989), in the narrow circumstances to which they were designed to apply. Thus, where (1) a public utility sells a distribution system to a governmental entity, (2) the distribution system consists of part or all of the utility operating system located within a geographically defined area, (3) the components of the system are or have been included in the rate base of the utility, and (4) the sale of the system is concurrent with the utility being relieved of, and the governmental entity assuming, the public utility obligations to the customers within the area served by the system, then the gains or losses from the sale of the system should be allocated to utility shareholders, provided that the ratepayers have not contributed capital to the distribution system and remaining ratepayers are not adversely affected by the transfer of the system.
11. We do not have an adequate record on which to define "major facility" under § 455.5. The parties shall file comments in this regard within 90 days of the effective date of this decision, and may file reply comments within 30 days of receipt of the opening comments. Before filing such comments, all non-telecommunications parties who filed comments shall meet and confer in an attempt to reach agreement on standard definitions of major facilities based on utility size. The parties shall report the results of their meet and confer session to the assigned administrative law judge before filing comments. At a minimum, parties shall assume that the following rules will govern their negotiations and/or written proposals: (1) The statute applies only to electrical, gas, heat or water corporations' generation or production facilities. The parties should try to agree upon a common definition of "generation" and "production" that is based on either the USOA or another rational interpretation of the terms. (2) The statute applies to facilities as well as portions of facilities.
12. Interpretation of Pub. Util. Code § 851 is by and large beyond the scope of this proceeding.
13. Electric utilities shall allocate gains on sale of transmission property according to the rules of the Federal Energy Regulatory Commission rules, rather than the rules we develop here. This conclusion is not intended to be a general one with respect to this Commission's jurisdiction over transmission issues.
14. We adopt a rebuttable presumption regarding allocation of gains on sale for property that has moved in and out of rate base over time. An applicant (or other party) may assume that the gain allocable to shareholders directly mirrors the time the property was out of rate base. Thus, for example, if the property is in rate base for 20 years and out of rate base for 20 years, shareholders should receive 50% of the gain/loss, and the remainder should be allocated according to the percentage allocation rule applicable to property in rate base. However, if there is evidence that demonstrates that most of the property's appreciation (or depreciation) occurred while the property was in (or out of) rate base, evidence of such variance may be submitted to rebut the presumption. In all cases, the utility bears the burden of proving the assets time in and out of rate base. Where there is a gain on sale, the utility bears the burden of proving time out of rate base, and when there is a loss, the utility bears the burden of proving time in rate base.
15. A special rule allocating gains on sale from "abandoned plant" is not warranted.
16. Water companies shall use the gains on sale from sales of formerly used and useful utility real property to invest in new water infrastructure. These proceeds may not be used to reduce rates or otherwise be returned to ratepayers unless the water companies fail to reinvest the proceeds within the eight-year period contained in the Water Utility Infrastructure Act of 1995, Pub. Util. Code § 789 et seq. (Infrastructure Act).
17. Because the Infrastructure Act may give water companies incentives to sell used and useful real property prematurely, safeguards against "churning" are appropriate. All water utilities we regulate shall comply with the following requirements in accordance with the Infrastructure Act:
Track all utility property that was at any time included in rate base and maintain sales records for each property that was at any time in rate base but which was subsequently sold to any party, including a corporate affiliate.
Obtain Commission authorization to establish a memorandum account in which to record the net proceeds from all sales of no longer needed utility property.
Use the memorandum account fund as the utility's primary source of capital for investment in utility infrastructure.
Invest all amounts recorded in the memorandum account within eight years of the calendar year in which the net proceeds were realized.
18. We will take up claims regarding Proposition 50 funds and other government bond funds, including how to allocate gains on sale, in our Proposition 50 proceeding, Rulemaking (R.) 04-09-002, or in such proceedings as the Commission designates for consideration of such funds.
19. Water companies shall provide the Director of the Water Division and the Director of the Division of Ratepayer Advocates 30 days' advance written notice whenever they plan to sell land, buildings, water rights, or all or part of a water system. This notice requirement applies to water company assets the company believes are no longer used and useful. The 30 days' advance notice will give the Commission an opportunity to assess whether companies are selling off key portions of their asset base. Notice will not preclude later review of such sales in a water company's GRC or a later proceeding. The notice shall include the following heading in at least 16 point bold type: "Notice under Rulemaking 05-06-040. Commission staff must respond within 30 days." The notice must include the name, address, phone and email address of the potential purchaser(s). If the Commission staff objects to the proposed sale, it may send an objection in any form to the seller and proposed purchaser(s). Mailing of such an objection shall prevent the proposed purchaser from claiming it is a bona fide purchaser of the property at issue until the issues raised in the objection are resolved.
20. Our percentage allocation default rule (100% depreciable and 50% - 50% non-depreciable) relating to gains on sale shall apply to water utility sale assets, except where the asset sold is real property that is no longer used and useful. In the latter instance, the proceeds shall be reinvested in accordance with the Infrastructure Act.
21. Water companies may earn a reasonable rate of return on real property purchased with gains on sale from sales of developer contributions in aid of construction (CIAC). We defer for future consideration the question whether "reasonable rate of return" on reinvested gain from the sale of CIAC property should be the same as (or different from) the rate of return the water utility earns on other property.
22. The parties bound by this decision shall file Advice Letters within 60 days of this decision's mailing indicating how they plan to comply with the rules set forth herein for each of the past asset sales (if deferred to this proceeding and listed in Appendix A to this decision), and any other asset sales on which the Commission deferred a decision regarding allocation of gains or losses on sale. Any party objecting to the proposed treatment of any deferred gain on sale determination may file an Advice Letter protest within the normal Advice Letter protest period.
23. We dismiss Pacific Bell Telephone Company, dba SBC California, Verizon California Inc., SureWest Telephone, and Citizens Telecommunications Company from this proceeding so that the Commission may address their gain on sale issues in R.05-04-005. All other telecommunications carriers the Commission regulates are bound by this decision.
24. We dismiss Wild Goose Storage Inc. and Lodi Gas Storage, L.L.C. from this proceeding because they are largely unregulated by this Commission.
25. The rules we develop here shall apply to after-tax gains and losses.
26. This decision does not apply to routine retirements of minor utility assets that are no longer used and useful such as utility poles, transformers, and vehicles, which are governed by other Commission depreciation rules and schedules.
This order is effective today.
Dated, May 25, 2006, at San Francisco, California.
GEOFFREY F. BROWN
JOHN A. BOHN
RACHELLE B. CHONG
Commissioners
We will file a joint dissent.
/s/ MICHAEL R. PEEVEY
President
/s/ DIAN M. GRUENEICH
Commissioner
APPENDIX A
List of Cases in Which Gain on Sale Question
Deferred to This Proceeding
D.06-04-032
D.06-01-021
D.05-02-048
D.05-02-037
D.05-01-041
D.04-11-020
D.04-03-036
D.04-03-024
D.04-02-045
D.03-12-056
D.03-12-006
D.03-03-008
D.02-10-022
D.02-09-024
D.02-09-027
D.02-07-027
D.02-07-026
D.02-04-005
D.01-10-051
D.01-03-064
D.00-12-047
D.00-12-023
D.00-06-017
D.99-12-019
D.99-10-001
ND OF APPENDIX A)
APPENDIX B
Summary
Gain on Sale Decision - R.04-09-003
Summary of Decision
· Applies to IOUs,101 water companies, and small LECs.102 Transfers issue for large LECs (SBC/Verizon/SureWest/Frontier) to URF.103 Dismisses gas storage facilities.
· Definition of gain on sale: A utility receives a gain on sale when it sells an asset such as land, buildings or other tangible or intangible assets at a price higher than the acquisition cost of the non-depreciable asset or the depreciated book value of the depreciable asset.
o Non-depreciable assets - land, water rights and goodwill
o Depreciable assets - buildings, machinery, equipment, materials or vehicles
· Percentage allocations: Allocates gains on sale for depreciable assets 100% and for non-depreciable assets to 50% to ratepayers and 50% to shareholders.
· Special rule for water companies based on statute. Pub. Util. Code § 790 - if water utility 1) sells 2) used/useful 3) real property, all gains are reinvested in water utility infrastructure. (Further discussion of water below.)
· Risk primarily with ratepayers; hence they receive lion's share of gain.
· Exceptions to percentage allocations above:
o Redding II - sale of entire distribution system - allocation of gain to shareholders in limited circumstances104
o Sale price is > $50 million or after-tax gain or loss > $10 million
o Utility sales of assets of extraordinary character
o Sales of nuclear power plants
o Where a party alleges the utility engaged in highly risky and non-utility-related ventures
o Where a party alleges the utility grossly mismanaged the assets at issue
o FERC property not covered by decision
· Taxation. Apply percentages to after-tax gains
· Water. Water Utility Infrastructure Improvement Act, Pub. Util. Code § 789 et seq. creates special requirements for water companies
o No allocation of gain to ratepayers or payment to shareholders. Gain on sale of real property reinvested in water infrastructure only.
o Government grants. Addressed in separate Prop. 50 proceeding
o Developer contributions in aid of construction (CIAC). Section 790 applies, and reasonable rate of return is payable on re-invested gains. Decision defers definition of reasonable rate of return.
o § 790 not applicable to proceeds from contamination lawsuits.
o The Commission defers for further input issues regarding § 790's applicability to condemnation.
o Decision does not exempt small water companies.
· No change to § 851 requirements. Defer to Resolution ALJ-186 (re streamlining of § 851 requirements)
o Exception for water companies. 30 days' advance notice to Water Division and Division of Ratepayer Advocates.
· Pub. Util. Code § 455.5 issues deferred. Statute requires reporting for facilities taken out of service. Need additional record on where to set reporting threshold.
(END OF APPENDIX B)
100 Comments of SDG&E, filed November 3, 2004, ("Any gain/loss on sale of depreciable property should be allocated 100% to ratepayers"); Comments of PG&E, filed November 3, 2004, at 12 ("[t]he Commission should affirm its general policy of allocating the proceeds from the sale of depreciable assets to ratepayers".)
101 Investor-owned utilities.
102 Local exchange (telephone) companies.
103 Uniform Regulatory Framework proceeding (telecommunications carriers).
104 "Where (1) a public utility sells a distribution system to a governmental entity, (2) the distribution system consists of part or all of the utility operating system located within a geographically defined area, (3) the components of the system are or have been included in the rate base of the utility, and (4) the sale of the system is concurrent with the utility being relieved of, and the governmental entity assuming, the public utility obligations to the customers within the area served by the system, then the gains or losses from the sale of the system should be allocated to utility shareholders, provided that the ratepayers have not contributed capital to the distribution system and remaining ratepayers are not adversely affected by the transfer of the system."
