7. Assignment of Proceeding
John A. Bohn is the assigned Commissioner and Michael J. Galvin is the assigned Administrative Law Judge in this proceeding.
1. The average AA utility Moody's rate at month-end from October 2006 to September 2007 is 5.87% and Baa utility rate is 6.20%.
2. The capital structures and ROEs of major energy utilities were traditionally addressed in GRC applications.
3. Review of SCE, SDG&E, and PG&E's capital structures and ROEs was transferred from GRC applications to annual cost of capital applications effective in 1990.
4. SDG&E was relieved of its obligation to file annual cost of capital applications upon adoption of a MICAM in 1996.
5. SDG&E participated in the last four annual cost of capital proceedings as an active party to litigate its authorized cost of capital.
6. SDG&E is currently required to file a complete cost of capital application every five years.
7. SCE and PG&E are required to file annual cost of capital applications.
8. SDG&E actively participated in each of the last four annual costs of capital proceedings and, upon its request, received a waiver from filing a test year 2007 filing.
9. Capital structure is but one component of determining a fair and reasonable ROE.
10. SDG&E sought to include an adjustment to long-term debt only if it was required by the IRS to retire or refinance its low interest IDB bonds.
11. Long-term debt and preferred stock costs were addressed in the first phase of this proceeding.
12. Under the CCM that we adopt in this decision, a range of change in interest rates that may occur without automatically triggering a change in embedded long-term debt and preferred stock costs and ROEs.
13. The size of a deadband affects the frequency at which an adjustment mechanism is activated.
14. A 75-basis point deadband under PG&E's proposal would have been triggered about half of the years between 1998 and 2006.
15. A 100-basis point deadband under SDG&E's proposal triggered only once during the past 10 years.
16. The purpose of an interest rate benchmark is to gauge changes in interest rates that also indicate changes in the equity costs of utilities.
17. Moody's monthly utility bond interest rate averages are available through subscription services from Moody's and Bloomberg.
18. Moody's monthly utility bond interest rate averages are available from the Mergent Bond Record at no cost from some of the public libraries.
19. An adjustment ratio is the percentage of the change in interest rates that should be reflected in the return on equity.
20. A one-half to two-thirds range is normally used by this Commission to adjust authorized ROEs in response to updated interest rate projections.
1. Absent meaningful long-term experience it would behoove us to proceed with caution and gain results and experience with a shorter-term mechanism prior to adopting a longer-term mechanism.
2. Consistent with a majority consensus, complete cost of capital applications should be required every third test year.
3. The current May 8 filing date for cost of capital applications should be moved back to April 20.
4. Capital structure and ROE should not be addressed independently.
5. A loss of IDB tax exempt status for issued and outstanding bonds could trigger an application pursuant to Section 818 and may disproportionally impact SDG&E's common equity risk.
6. The utilities have a right to file a cost of capital application outside of the CCM process upon an extraordinary or catastrophic event that materially impacts their respective cost of capital and/or capital structure and impacts them differently than the overall financial markets.
7. A deadband needs to strike a reasonable balance between triggering too often and not triggering often enough.
8. A 100-basis point deadband was adopted for SDG&E's MICAM on a basis that the deadband would not be too volatile.
9. A 100-basis point deadband should be adopted having a 12-month ended September measurement period to mitigate any seasonal impact of interest rate changes.
10. Consistent with our use of utility bond interest rates in ROE, PBR, and MICAM proceedings and desire to use an index that more likely correlates and moves with utility industry risk, utility bonds should be adopted for the CCM index.
11. Moody's Aa utility bond interest rates should be used for those utilities having an AA credit rating or higher, Moody's A utility bond interest rates should be used for those utilities having an A credit rating, and Moody's Baa utility bond interest rates for utilities having a BBB credit rating or lower.
12. The initial Moody's AA benchmark is 5.87% and Baa benchmark is 6.21%.
13. The utilities should make available and provide Moody's Bond interest rate averages to parties reviewing CCM filings upon request and at no cost.
14. A 50% equity adjustment ratio should be adopted and applied only when the 100-basis point deadband is exceeded to compensate for major changes in interest rates that impact equity investments.
15. The 50% equity adjustment should be applicable to the entire difference between the old benchmark and new benchmark to mitigate the volatility impact of interest rates on equity investments.
IT IS ORDERED that:
1. A uniform cost of capital mechanism (CCM) is adopted for Southern California Edison Company (SCE), San Diego Gas & Electric Company (SDG&E), and Pacific Gas and Electric Company (PG&E). The first full cost of capital application shall be due on April 20, 2010 for test year 2011 returns on equity (ROE). That first complete filing under the CCM should address the parties' experience with the CCM and whether modifications to the mechanism are warranted. The CCM shall be based on:
a. A full cost of capital application due on April 20 of every third for the following test year.
b. Capital structure is the most recently adopted.
c. Long-term debt and preferred stock cost is the most recently adopted.
d. Deadband is equal to 100-basis points.
e. Index is Moody's Aa utility bonds for AA credit-rated utilities or higher and Moody's Baa utility bonds for BB credit-rated utilities or lower.
f. Data source is Moody's or Mergent Bond Record.
g. Measurement period is the average 12-month October through September period.
h. Adjustment ratio is 50%.
2. In any year where the difference between the current 12-month October through September average Moody's utility bond rates and the benchmark exceeds a trigger of 100-basis points, an automatic adjustment to the utilities' ROE shall be made as follows:
a. ROE is adjusted by one-half of the difference between the Aa utility bond average for AA credit-rated utilities or higher and Baa utility bond average for BBB credit-rated utilities or lower and the benchmark.
b. Long-term debt and preferred stock costs are updated to reflect actual August month-end embedded costs in that year and forecasted interest rates for variable long-term debt and new long-term debt and preferred stock scheduled to be issued.
c. Authorized capital structure is not adjusted.
d. On October 15 of such year, a Tier 2 advice letter is filed that updates the ROE and related rate adjustments to become effective on January 1 of the following year.
e. In any year where the 12-month October through September average Moody's utility bond rates triggers an automatic ROE adjustment, that average becomes the new benchmark.
f. Workpapers outlining the calculations required as set forth in Ordering Paragraphs 2(a), 2(b), and 2(e) shall be submitted with the advice letter to the Energy Division and active parties to this proceeding, and shall be made available to any party upon request.
3. This consolidated proceeding remains open to address a violation of Rule 13.1 of the Commission's Rules of Practice and Procedure.
This order is effective today.
Dated May 29, 2008, at San Francisco, California.
MICHAEL R. PEEVEY
President
DIAN M. GRUENEICH
JOHN A. BOHN
RACHELLE B. CHONG
TIMOTHY ALAN SIMON
Commissioners
APPENDIX A
COST OF CAPITAL MECHANISM
IMPACT BASED ON THREE SCENARIOS
|
|
Weighted | |
Long-Term Debt |
43.00% |
6.40% |
2.75% |
Preferred Stock |
9.00% |
6.10% |
.55% |
Common Equity |
48.00% |
11.50% |
5.52% |
Return on Rate Base |
8.82% | ||
BASIC ASSUMPTIONS
1. A planned long term debt issuance at month-end August of the second year would not change the capital structure but would reduce the August 6.40% embedded rate to 6.30%.
2. No change in preferred stock ratio or cost.
3. No change in common equity ratio.
4. Initial benchmark interest rate of Moody's Aa utility bonds was 6.50%
5. Trigger is 100-basis points between the benchmark interest rate and twelve-month actual October through September Moody's Aa utility bond rate.
SCENARIO #1
Assumption: New actual October through September Moody's average Aa utility bonds was 6.80%.
Result:
1. Difference between the new benchmark (6.80%) and the initial benchmark (6.50%) is only 30-basis points. This is less than the trigger of 100-basis points.
2. Therefore, there is no change.
a. Long-term debt remains 6.40% for purpose of calculating a return on rate base.
b. No change in preferred stock rate of 6.10%.
c. No change in common equity return of 11.50%.
d. Authorized return on rate base remains 8.82%.
SCENARIO #2
Assumption: New actual October through September average Moody's Aa utility bonds was 5.00%.
Results:
1. Difference between the 6.50% initial benchmark and 5.00% average 12-month Moody's Aa utility bonds new benchmark was 150-basis points, or 50-basis points higher than the 100-basis point deadband, triggers an adjustment.
2. Long-term debt cost is adjusted to 6.30% from 6.40%.
3. No change to preferred stock ratio or cost.
4. A downward 75-basis point change (half of the 100-basis point deadband and half of the 50-basis points that exceeded the 100-basis point deadband) in the 11.50% cost of common equity.
5. New authorized return on common equity is 10.50%.
6. New authorized rate of return on rate base is 8.30%.
7. New Benchmark is 5.00%.
Trigger Impact: The overall authorized return on rate base would decrease 52-basis points to 8.30% from 8.82% as shown below.
Ratio |
Cost |
Cost | |
Long-Term Debt |
43.00% |
6.30% |
2.71% |
Preferred Stock |
9.00% |
6.10% |
.55% |
Common Equity |
48.00% |
10.50% |
5.04% |
Return on Rate Base |
8.30% | ||
SCENARIO #3
Assumption - New actual October through September average Moody's Aa utility bonds was 8.00%.
Results -
1. Difference between the 6.50% initial benchmark and 8.00% average twelve-month Moody's Aa utility bonds new benchmark was 150-basis points, or 50-basis points higher than the 100-basis point deadband, triggers an adjustment.
2. Long term debt cost is adjusted to 6.30% from 6.40%.
3. No change to preferred stock ratio or cost.
4. A upward 75-basis point change (half of the 100-basis point deadband and half of the 50-basis points that exceeded the 100-basis point deadband) in the 11.50% cost of common equity.
5. New authorized return on common equity is 12.25%.
6. New authorized rate of return on rate base is 9.14%.
7. New benchmark is 8.00%
Trigger Impact: The overall authorized return on rate base would increase 32-basis points to 9.14% from 8.82% as shown below.
Ratio |
Cost |
Cost | |
Long Term Debt |
43.00% |
6.30% |
2.71% |
Preferred Stock |
9.00% |
6.10% |
.55% |
Common Equity |
48.00% |
12.25% |
5.88% |
Return on Rate Base |
9.14% | ||
(END OF APPENDIX A)
