5. Positions of the Parties

5.1. California-American Water Company

Cal-Am contends that it must be made whole for the ongoing cost to finance the project development and construction. The costs will be substantial, and will be financed through equity as well as debt. Cal-Am argues that the Commission has already recognized that Cal-Am will need to obtain financing for this project over several years. Consequently, the memorandum account should include the carrying costs based on Cal-Am's most recent authorized cost of capital, which is based on its cost of debt and equity.

Cal-Am presented a declaration stating that the full, weighted cost of capital would be the appropriate carrying cost for Cal-Am's investment in the San Clemente Dam, in part, because it has utilized both equity and debt to finance this project.² The declaration stated that investors expect a higher rate of return from risky investments, and that the San Clemente Dam investment is more risky than Cal-Am's overall investment in rate base such that investors would expect a rate of return higher than Cal-Am's weighted cost of capital. The declaration explained that regulators may disallow some or all of the San Clemente Dam costs which creates greater risk for recovery of the dam investment than on Cal-Am's previously-approved rate base. The declaration concluded the investors will seek higher returns for investment that will be a risk.

Cal Am also referred to D.04-03-039³ for Southern California Water Company (SCWC), in which the Commission calculated the carrying cost for an AFUDC type memorandum account using the utility's authorized rate of return. That decision, in turn, referred to another SCWC decision, D.00-06-074, in which the utility was authorized to use the authorized rate of return (ROR) as its AFUDC memorandum account cost factor. In that case, there was near certainty that the construction projects would go forward. Plant additions would be required to comply with new Environmental Protection Agency and Department of Health Services rules - even though those rules had not yet become law. The Commission stated, "However, the Commission has no alternative but implement the new standards when they become law. We agree with the recommendation of the settlement that SCWC may seek recovery of these costs through separate applications to be filed when the new rules are promulgated. In the meantime, we will authorize SCWC to accrue these costs in a separate memorandum account, with carrying costs computed using the authorized rate of return, without gross-up for taxes."⁴

Cal-Am also presented a financial analysis showing that the 90-day commercial paper rate (assumed to be 5.2%) adds about $7 million in costs to the estimated $55 million project, and that the authorized rate of return (8.33%) would add about $11.5 million. Cal-Am argues that it is entitled to the $4.6 million difference.

Cal-Am explained that setting the interest rate too low could harm customers by impacting Cal-Am's ability to attract investment. In this way, customers could end up paying higher financing costs due to the increased risk caused by insufficient return.

Cal-Am stated that the Commission's usual practice for water utility construction projects was to allow the costs for uncompleted projects to be included in the CWIP account, which is part of rate base and thus earns the authorized rate of return. Here, however, Cal-Am noted, the Commission has reversed that course and removed the project from rate base, thus creating this relatively novel question of the appropriate carrying cost for construction project costs recorded in a memorandum account.

5.2. Monterey Peninsula Water Management District (MPWMD)

MPWMD stated that there is no reason for the Commission to stray from the accepted and traditional approach to determining carrying costs for water utility construction projects. The Commission has previously determined that predecessor costs⁵ are not actually funds used during construction and should not be subject to the rate of return. Due to the significant cost, length of time in process, and continued uncertainty of whether the project will be completed, MPWMD concluded that the costs are properly treated as predecessor costs and recorded in a memorandum account with interest to accrue at the 90-day cpr.

MPWMD disputed Cal-Am's contention that the Commission's Water Action Policy supports a higher interest rate for this memorandum account. MPWMD explained that one of the objectives of the Water Action Plan is to promote investment "needed to improve water quality." The San Clemente Dam project, however, will only result in "meager" amounts of water, which would "be cost prohibitive and unjustifiable by any standard of measurement."⁶ MPWMD concluded that the project does not fall within the scope of the Commission's Water Action Plan. They argue further that seismic retrofitting of the dam would neither increase water supply nor ensure water quality.

5.3. Division of Ratepayer Advocates (DRA)

DRA stated that the 90-day commercial paper rate is appropriate for the San Clemente Dam Project memorandum account. DRA disputed Cal-Am's assertion that it will be short $4.6 million if it is not granted relief to accrue at the higher rate because Cal-Am has not shown that the $4.6 million is necessary to cover costs related to the San Clemente Dam Project. DRA emphasized that the scope and cost of the project are yet to be determined, and that the costs incurred so far are best categorized as pre-project.

DRA analyzed Commission precedent, especially treatment of Cal-Am's Coastal Water Project, and concluded that the Commission has determined that highly uncertain projects with expected long construction schedules should accrue interest at the 90-day cpr, rather than the authorized rate of return. DRA also disputed Cal-Am's contentions that the lower interest rate would cause investors to seek a higher rate of return due to the increased risk. DRA explained that investors have known about San Clemente Dam for many years and have already incorporated the risk of a reasonableness review into the stock price.

² California-American Water Company August 13, 2007 Opening Briefs page 5, and attached Exhibit C page 2 Declaration of David P. Stephenson.

³ D.04-03-039, 2004 Cal. PUC LEXIS 95.

⁴ D.00-06-074, pp. 20-21, 26.

⁵ Planning costs incurred prior to construction.

⁶ MPWMD Reply Brief at p. 9.