11. Water Purchase Agreement

The Water Purchase Agreement is complex and detailed. It specifies the duties and responsibilities of Cal-Am, MCWD, and MCWRA, with regard to ownership, construction, maintenance, and operation of the facilities included in the Regional Project. It also specifies the financing and cost responsibilities of each entity. We summarize the major provisions of the Water Purchase Agreement here, describe DRA and MPWMD's concerns, and discuss our disposition of the objections.

11.1. Ownership and Cost Containment

a. Term: As stated above, the initial term of the agreement is 34 years, with 6 automatic renewal terms of 10 additional years each. As DRA puts it, for an agreement that could be in place for 94 years, it is important to "get it right."

b. Project Facilities:

1) Source Water: MCWRA will design and construct, in consultation with Cal-Am and MCWD, new wells for the extraction of brackish source water, to be owned and operated by MCWRA and located on MCWRA-owned real property. MCWRA will also own and operate existing monitoring wells as Inland Water Monitoring Wells, and if necessary, may design and construct up to seven new inland monitoring wells to monitor the impact of the extraction of the brackish source water on the Salinas Valley Groundwater Basin. MCWRA will also design and construct (in consultation with Cal-Am and MCWD) and will own and operate a series of water conveyance facilities to convey the brackish source water from the wells (each of which will have a brackish source water meter) to the brackish source water receipt point meter. These facilities are known as the MCWRA Brackish Source Water Pipeline.

2) Desalination Plant: MCWD will design and construct, in consultation with Cal-Am and MCWRA, a desalination plant, to be owned and operated by MCWD and located on MCWD-owned real property, for the purpose of desalinating brackish source water such that the resulting treated water is product water. MCWD will own, operate, design and construct, again in consultation with Cal-Am and MCWRA, the brackish source water pipeline to convey the brackish source water from the brackish source water receipt point meter to the desalination plant. These facilities are known as the MCWD Brackish Source Water Pipeline.

MCWD will also design and construct (in consultation with Cal-Am and MCWRA) and will own and operate a series of conveyance facilities known as the MCWD Product Water Pipeline that will convey the desalinated water (or product water) to the Cal-Am delivery point. MCWD will install, maintain, and operate the desalination plant product meter, which will be designed to measure the discharge of product water into the MCWD Product Water Pipeline.

MCWD will also design and construct MCWD outfall facilities in consultation with Cal-Am and MCWRA. MCWD will own and operate these facilities, which are a series of water conveyance facilities to convey reject water from the desalination plant to MRWPCA's outfall.

3.) Cal-Am Facilities: Cal-Am will design and construct its conveyance and distribution facilities in consultation with MCWD and MCWRA, and will own and operate the water delivery system from the delivery point and into the Cal-Am distribution system. None of the facilities owned by Cal-Am and downstream of the Cal-Am Meter located near the Marina/Seaside Border will be part of the project facilities.

c. Coordination of Design, Engineering, Construction, and Permitting of the Regional Project: As proposed, Cal-Am, MCWD, and MCWRA are each responsible for the permitting, design, and construction of the facilities they will own. In order to ensure coordination, the parties plan to jointly select and hire a project manager to manage the permit, design, engineering, and construction process, and to ensure that the proper coordination takes place. Cal-Am, MCWD, and MCWRA will work with an Advisory Committee (described below) to ensure coordination with respect to the permitting, design, and construction of the Regional Project.

d. Cost Management: The Settling Parties request that the Commission approve the estimated initial capital costs of the project facilities (calculated as of March 14, 2010). As described in MCWD's Opening Brief and as shown in Attachment C of Exhibit 301, the capital costs exclude interest during construction and any debt service coverage required to obtain financing for the Regional Project. The requested capital cost cap (escalated to mid-2012) is:

Table 1: Settling Parties' Cost Estimate
(Exhibit C of Water Purchase Agreement)

Item		Estimated Costs, Escalated to 2012
Intake Wells (Slant Wells) and Pipeline		$26,300,000
Desalination Facility		$95,100,000
Product Water Pipeline (To CAW Delivery Point)		$18,700,000
Base Construction Cost		$140,100,000
Post -Effective Date Implementation Costs		$25,500,000
Project Administration and Oversight Expenses		$3,000,000
Start-up and Acceptance Costs		$4,000,000
Pre-Effective Date Costs and Expenses		$14,000,000
MRWPCA Outfall Capacity Charge		$3,000,000
Right of Way Easements and Land Acquisition		$2,000,000
Environmental Mitigation Measures Costs		$2,000,000
Capital Costs (Excluding Contingency)		$193,600,000
Project Contingency (25%)		$46,700,000
Most Probable Capital Cost with Contingency		$240,400,000
Design Development Allowance - High Estimate		42,070,000
Total Overall Estimated Project Facilities Cost		$282,470,000
Reserve Fund Account		$6,000,000
Costs of Obtaining Indebtedness (excludes interest during construction and debt service coverage)		$9,000,000
Total Estimated Costs per Settling Parties' Proposed Capital Cost Cap		$297,470,000

The Settling Parties state that the bidding selection, procurement process, and evaluation of proposals described in Sections 4.2 and 4.3 of the Water Purchase Agreement and the additional cost management features described in Section 4.3 will assist them in ensuring that the Regional Project is as cost-effective as possible. The Settling Parties have agreed to hire a certified Value Engineer to review plans at particular points. As defined, value engineering is a specialized cost control technique in which the owner or operators meet and confer with a Certified Value Specialist to conduct a systematic and creative analysis of the functions of a project or operation to determine how best to achieve the necessary function, performance, and reliability of the project at the minimum life cycle cost.

To the extent that actual costs exceed the total estimated cost cap authorized by the Commission, the Water Purchase Agreement provides for Cal-Am to seek approval of those increased costs at this Commission. Parties include a provision that allows Cal-Am to terminate the Water Purchase Agreement if Cal-Am has diligently pursued the request for approval, approval is denied, or is not fully addressed by the Commission within six months. (Water Purchase Agreement, § 4.3(e).) Prior to such notice of termination, parties must meet and confer in order to consider alternative means of funding the cost overruns so that the Regional Project can continue. The Water Purchase Agreement also requires parties to "endeavor in good faith to administer the Prime Agreements . . . to which it is a party in a manner intended to result in the most cost effective construction and delivery of services considering all factors including the life cycle and functionality of the subject improvements."⁵⁶

In addition to the detailed contracting provisions and cost management goals, the Water Purchase Agreement provides a detailed roadmap for the retention of a Project Manager, preparing preliminary design documents, and obtaining required permits, and establishes milestones for each of the MCWRA-owned, MCWD-owned, and Cal-Am owned facilities. Section 4 also provides for a Constructability Review (§ 4.6) and Inspection and Audit Rights (§ 4.11), as described below:

Constructability Review: The Parties in consultation with the Project manager and the Advisory Committee, in accordance with Best Industry Practices, shall appoint a qualified Person or committee of qualified Persons who is/are independent from any Person or Persons who have designed any portion of the Project Facilities to review each of the Preliminary Design Documents, Procurement Documents and 100% Construction Documents, as appropriate, in order to provide an effective constructability review to assure that (i) the project Facilities as detailed in the Preliminary Design Documents, Procurement Documents and 100% Construction Documents, can be constructed using construction methods, materials and techniques in compliance with Best Industry Practices; (ii) the Preliminary Design Documents and Procurement Documents provide the contractor or contractors, as applicable, with clear, concise information that can be utilized to prepare a competitive cost-effective proposal; (iii) the Regional Desalination Project when constructed in accordance with the Preliminary Design Documents, Procurement Documents and 100% Construction Documents will result in a Regional Desalination Project that can be maintained in a cost-effective manner by the Parties throughout the Term of this Agreement; and (iv) the Project Facilities when constructed shall consider the lowest achievable lifecycle cost to operate and maintain the Project Facilities over their useful life.⁵⁷

Inspection and Audit Rights: Each Party and Project Manager shall have the right to review and audit the progress reports, progress payments, and other related information, including the right to independent inspection of each other Party's work in progress with respect to the Regional Desalination Project. During the progress of the work through Substantial Completion, each Party shall at all times during normal working hours afford the other Parties, their consultants, and Project Manager and appropriate regulatory representatives every reasonable opportunity for observing work in progress by such Party's contractors. . .⁵⁸

11.2. Cost Recovery and Ratemaking
Associated with Product Water Costs

DRA supports the regional desalination project, but contends that it cannot support the Settlement Agreement or the Water Purchase Agreement, because it does not include "effective cost controls, fair representation, or an equitable allocation of costs and risks among beneficiaries."⁵⁹ MPWMD also supports the Regional Project, but opposes aspects of the WPA, particularly regarding ratepayer representation and cost controls. Cal-Am ratepayers will be responsible for the costs of the product water, including the debt service and the O&M costs. To the extent that MCWD is taking Permanently Allocated Water (discussed below), MCWD will contribute an amount equal to its proportional share of debt service and O&M costs;⁶⁰ however, until that time, DRA and MPWMD contend that MCWD is not paying its fair share of costs. DRA explains that these "transfer costs" are "additional water costs that Cal-Am ratepayers will absorb to offset the lower price MCWD will pay relative to the actual cost of desalinated water from the plant."⁶¹ DRA states that such costs are a subsidy from Cal-Am ratepayers to MCWD ratepayers and estimates that these costs are equivalent to $1,000 per acre-foot or $8.8 million. In 2009, parties estimate that MCWD would have paid only $148 per acre-foot, as compared to DRA's estimate of $5,000 per-acre foot of desalination water or $7,500 total cost to Cal-Am customers (including the estimated cost of debt equivalence).⁶²

Prudency of costs is a particularly contentious issue. The Settlement Agreement provides that, all Public Agency costs are deemed to be prudent and reasonable. Section 10 of the Settlement Agreement states that "given the status of MCWD and MCWRA as governmental agencies and the requirements under law that they incur only reasonable and prudent costs and expenses for purposes related to their governmental duties and the fact that such costs and expenses are subject to public review and scrutiny, all Regional Desalination Project costs incurred by MCWD and MCWRA in compliance with the terms of the Water Purchase Agreement shall be deemed reasonable and prudent, and the Commission, by its approval of this Settlement Agreement, shall be deemed to have agreed that such costs are reasonable and prudent."

The Water Purchase Agreement provides as follows in §11.2(d):

All costs of the Parties pursuant to this Agreement shall be reasonably and prudently incurred. All payments made by CAW under this Agreement shall be deemed reasonable and to the extent practicable be included in the cost of Product Water. To the extent not already included in the CAW Product Water Contract approved rate recovery, any CAW costs, fees and expenses incurred under this Agreement that are not CAW Regional Desalination Project Related Expenses or CAW Project Administration and Oversight Expenses shall be included in the O&M Costs and shall be included in and recovered by CAW from the cost of the Product Water.

All costs associated with development and financing of the Regional Project are to be included in the cost of product water. To the extent that the Public Agencies have incurred costs to develop, permit, site, and legally defend these facilities, these are deemed "pre-effective date costs" that are also included in the cost of the product water.

Under the Water Purchase Agreement, the cost of the desalinated water will have two components: the debt service associated with financing the capitalized costs of the MCWD and MCWRA-owned facilities and the costs of operating and maintaining these facilities. Pursuant to the Settlement Agreement, Cal-Am will fund these costs through an escrow account and will then recover the costs from its Monterey District ratepayers through the Modified Cost Balancing Account - essentially a balancing account already established to record and recover in rates the costs of purchased water.

As set forth in the definitions section and § 11.14, MCWD will impose and collect water fees for connection of new facilities within the MCWD service territory and will apply a portion of these fees either to reduce the MCWD indebtedness or as a cash contribution to pay for the cost of the MCWD-owned facilities. The application of such fees to reduce the capital costs of the facilities is subject to a ceiling or "fees limit" of $22 million. This amount could be further reduced by 16.2% of any grant funds obtained by MCWD, prior payments of the principal portion of MCWD's proportional share of debt service, or any prior collected fees used to reduce MCWD's indebtedness or O&M costs.

As we discuss below, DRA and MPWMD are especially concerned about these provisions, because they contend that Cal-Am ratepayers cannot be protected from unreasonable costs, which could simply be passed through to ratepayers. Rather than a capital cost cap, DRA recommends that the Commission impose a per-acre-foot cost cap of $2,200 for all costs associated with the desalinated product water (not including Cal-Am conveyance facilities). DRA maintains that any other approach would be tantamount to providing the Public Agencies and Cal-Am with a "blank check" because all costs would eventually be borne by Cal-Am's ratepayers. DRA contends that we cannot approve the Settlement Agreement and Implementing Agreements because they are unlawful, unreasonable, not in the public interest, and not supported by the record in this proceeding.

DRA strongly maintains that Cal-Am ratepayers should not subsidize MCWD ratepayers, particularly with regard to subsidizing future development of Fort Ord Reuse Authority, the former Fort Ord community. DRA also asserts that approving the proposed Settlement Agreement and WPA will result in rates that cannot be found to be just and reasonable: "The Proposed Settlement Agreement unlawfully prevents the Commission from carrying out its statutory duty to ensure that rates are just and reasonable because its provisions require the Commission to find that all MCWD and MCWRA costs (no matter how high) are reasonable and prudent."⁶³

DRA emphasizes the need to ensure that a realistic cost cap must be in place to encourage cost containment by MCWD. DRA is particularly troubled by the fact that cost cap proposed in the Settlement Agreement is a capital cost cap, and therefore does not establish any limits on the O&M costs, litigation, costs, and other project-related expenses. DRA explains that the O&M costs are usually two-thirds of total costs of desalinated water, with approximately half of this amount allocated to the cost of energy.⁶⁴

DRA recommends that MCWD be required to pay its full 16.2% fair share of costs such as O&M and litigation costs as an incentive to keep those costs reasonable.⁶⁵ DRA explains that the WPA provides that MCWD pays only its share of the costs for pumping and treating groundwater - costs that MCWD pays today and are currently equivalent to $148 per acre-foot. DRA believes that this approach does not result in MCWD acting as a partner in the Regional Project, with a proportional share in the cost and benefits of a regional partnership. Instead, "MCWD will be insulated from the actual costs to produce desalinated water and will have little incentive to control these costs, because it will be safe in the knowledge that actual costs will be borne by a group without voice or recourse under the terms of the agreement - the Cal Am ratepayer."⁶⁶

While MCWD contends that it has no immediate plans to take its Permanent Allocation and therefore has no need for the desalinated water, DRA disagrees. DRA argues that MCWD will eventually need this water to serve the former Fort Ord community, as that area is developed, and points to MCWD's testimony that water planners need to stay one step ahead of the supply. DRA thus recommends that MCWD pay its proportional 16.2% share of project capital costs, reserves, financing, and O&M costs of the Regional Project facilities. The 16.2 % allocation is derived from MCWD's 1700 afy permanent allocation. DRA states that litigation and O&M cost would be capped if the Commission adopts its recommended $2,200 per-acre-foot cost cap, because DRA's proposed cap applies to all costs.

DRA also states that MCWD's contribution to the project via the connection fees it will charge to new connections must not be capped at or limited to $22 million. DRA contends that such an approach is indefensible since MCWD has stated that it would need to spend $42 million in estimated capital costs to construct its own desalination facility.⁶⁷ DRA believes this approach is patently unfair and contends that at a minimum, the Commission must eliminate the pre-determined fees limit in the Water Purchase Agreement of $22 million. MPWMD agrees and argues that a "common doctrine among capital projects with multiple participants is that each party pays costs proportional to their usage of the project output."⁶⁸ Because MPWMD further contends that MCWD is likely to need additional water in the next 10 to 20 years, MPWMD recommends that the MCWD fees limit definition be revised to reflect the fair allocation of costs of indebtedness to MCWD, plus the value of any grants or fees used to reduce the original issuance of indebtedness.

MPWMD also contends that certain existing groundwater wells that currently supply MCWD's customers may be subject to potential contamination from seawater intrusion and groundwater plumes. Because MCWRA will install groundwater monitoring wells, MPWMD contends that MCWD will derive additional benefits from such monitoring. Finally, MPWMD contends that MCWD's participation in the Regional Project will avoid use of groundwater pumping and will therefore reduce the deterioration of its wells.⁶⁹ Again, MPWMD contends that these are benefits to MCWD that have not been quantified or valued.

MPWMD concurs that the Commission must retain its authority to review the reasonableness of the Regional Project financing and expenditures, and that such costs cannot be deemed to be reasonable. MPWMD argues that MCWD is receiving benefits from the Regional Project that it is not paying for. Both DRA and MPWMD explain that because MCWD planned to construct a stand-alone desalination project, and because that project then evolved to the REPOG, which, in turn, led to the Regional Project, the capital cost of that desalination plant should now be considered to be a benefit to MCWD.⁷⁰

DRA also contends that there are ways to reduce the capital costs of the project, based on a study they commissioned from the Bureau of Reclamation BOR. We review the technical issues raised and address these recommendations below. We address recovery of the costs associated with MCWD's proposed stand-alone plant in Section 13.3.1.

11.2.1. Discussion: Cost Controls and Determination
of Reasonable and Prudent Costs

As we stated earlier, there is no doubt that there is a need for replacement water on the Monterey Peninsula. We recognize that the desalinated water will be expensive and acknowledge DRA's recommendation to establish an all-inclusive unit cost cap. Based on the record before us, we cannot find that a $2,200 per-acre-foot cost cap is reasonable or would serve the public interest, because the evidence does not demonstrate that DRA included all necessary costs associated with desalination plants in developing its estimated cost cap.⁷¹ Indeed, we agree with the Settling Parties that such an approach would serve to squelch financing opportunities.⁷²

We are persuaded that the Public Agencies bring benefits to the Regional Project that would not be achieved by Cal-Am ownership of either the Moss Landing Project or the North Marina Project. The preponderance of the evidence demonstrates that MCWD does not need the desalinated water now, nor is it clear when it may be needed. We are further convinced that there are reasonable checkpoints built into the Water Purchase Agreement to ensure that Cal-Am will receive its needed allocation of water. While MPWMD is concerned about expansion of the Regional Project, we are persuaded that this is an issue that can be dealt with adequately in the future. Our initial concerns are ensuring that the Regional Project can be permitted and constructed.

Cal-Am explains that the $297.5 million proposed capital cost cap represents the Settling Parties' diligent and through approximation of the various cost components of the Regional Project facilities.⁷³ The costs set forth in Exhibit C of the WPA are based on the assumption that slant wells will be used as the source water intake facilities - an assumption that DRA recommends. Exhibit 320 sets forth the most comprehensive and updated assessment of costs of the various projects.⁷⁴ The various components of the project have been assessed and analyzed in various forums and the parties - while perhaps not agreeing - have certainly had the opportunity to understand and debate the derivation of the cost components. The following table is useful:⁷⁵Table 2: Comparison of Cost Estimates of Project Alternatives ($2012)

	Regional Project (assumes vertical wells)	Basis of Exhibit C (assumes slant wells)	North Marina	Moss Landing
Escalated Capital Costs
Intake Wells and Pipeline	$17,400,000	$26,300,000	$23,200,000	$2,000,000
Desalination Facility	$95,100,000	$95,100,000	$98,500,000	$119,700,000
Product Water Pipeline (To CAW Delivery Point)	$13,700,000	$18,700,000	$13,700,000	$31,100,000
Base Construction Cost	$126,200,000	$140,100,000	$135,400,000	$152,800,000
Post -Effective Date Implementation Costs	$21,800,000	$25,500,000	$23,400,000	$25,400,000
Project Administration and Oversight Expenses	$3,000,000	$3,000,000	$3,000,000	$3,000,000
Start-up and Acceptance Costs	$4,000,000	$4,000,000	$4,000,000	$4,000,000
Pre-Effective Date Costs and Expenses	$14,000,000	$14,000,000	$14,000,000	$14,000,000
MRWPCA Outfall Capacity Charge	$3,000,000	$3,000,000	$3,000,000	$-
Right of Way Easements and Land Acquisition	$2,000,000	$2,000,000	$2,400,000	$4,800,000
Environmental Mitigation Measures Costs	$2,000,000	$2,000,000	$2,000,000	$10,000,000
Litigation associated with Land Condemnation and Groundwater Transfer out of Zone 2C			$5,000,000
Capital Costs (Excluding Contingency)	$176,000,000	$193,600,000	$192,200,000	$214,000,000
Project Contingency (25%)	$42,300,000	$46,700,000	$46,300,000	$51,800,000
MCWD Buy-In From Fees	$(22,000,000)
Most Probable Capital Cost with Contingency	$196,300,000	$240,300,000	$239,000,000	$266,000,000
Estimated Total Annual O&M	$12,900,000	$12,500,000	$13,300,000	$13,000,000

MCWD's Witness Melton explains that the costs in Exhibit C to the WPA were created to establish an upper cost limit and differ from the costs shown in the cost estimates developed in Exhibit 320:

The basis for the Exhibit C costs is included in the April 15, 2010 Project Cost Comparison. The costs included in Exhibit C assume that the intake facilities will include all slant wells, that there will be a different connection point for introduction of the desalinated water in the MCWD distribution system that requires a 12,750 foot long, 24-inch diameter MCWD tie-in pipeline, that there will be no MCWD buy-in fees, and that the costs will be at the high end of the cost estimating range as established by the Association for the Advancement of Cost Engineering (AACE). The resulting cost estimate included in Exhibit C is $240 million for the most probable cost, and $282 million at the high end of the accuracy range. These costs include all costs of the Regional Desalination Project except the costs of the CAW facilities (i.e., they include the costs to deliver desalinated water to the Delivery Point, or otherwise stated, all project costs upstream of the Delivery Point). The Exhibit C costs in the WPA also include $15 million for the Reserve Fund Payment Account and the costs of obtaining indebtedness, bringing the total Exhibit C costs in the WPA to $297 million.⁷⁶

Although the most probable cost estimate may be $240 million, we believe that it would be more appropriate to set a capital cost cap at the upper cost limit of $297.5 million. We are concerned that adopting a lower cost estimate could constrain the Settling Parties' ability to obtain financing at a reasonable interest rate. Further, despite adopting this upper limit, we anticipate that the ultimate cost for the project will come in lower. For example, as the former Fort Ord community is developed, connection fees shall be applied to offset the indebtedness that Cal-Am ratepayers are funding. As witness Melton stated in Exhibit 319, "The MCWD Buy-in from Fees contribution will serve to reduce the annual debt payment and the associated cost of water to ratepayers. . ."⁷⁷

Table 2 is included to show the estimated costs of each component of the Regional Project facilities. We fully expect that Settling Parties will adhere to the estimated cost projection as outlined.

DRA and MPWMD dispute whether the Regional Project is, in fact, the most cost-effective of the three alternatives studied in the FEIR. Based on the cost to the delivery point (where Cal-Am would receive the desalinated water) and the various scenarios analyzed by all parties using the agreed-on Unified Financing Model,⁷⁸ the cost of desalinated water (excluding the cost of the Cal-Am facilities) ranges from $3,200 to $5,600 per acre-foot for the Regional Project. The scenarios are set forth in Exhibit 113 and are based on varying capital costs ($227.3 million to $297.5 million), debt service coverage (1.0 or 1.25), cost of debt (4.79% to 6%), and length of construction period (3.5 years to 4.5 years). If favorable financing were not obtained, the construction period lasted 4.5 years, and the maximum capital cost is assumed, the Regional Project could cost $8,000 per acre-foot.⁷⁹

The cost for desalinated water for the North Marina Alternative and the Moss Landing Project ranges from $6,992 to $8,208 and $7,580 to $8,930 per acre-foot, respectively. An additional $1,300 to $1,500 per acre-foot for the Cal-Am facilities (depending on whether the costs of those facilities are capped at $95 million or $106.8 million) must be added to each Project for a true cost comparison.⁸⁰

Cal-Am has also asked the Commission to consider the issue of debt equivalence in a separate proceeding. To the extent that an additional increment must be added in for the costs associated with debt equivalence, Cal-Am estimates that amount to be equivalent to $14.3 million.⁸¹ Although we do not consider either the issue or the amount associated with debt equivalence here, DRA recommends that we add $1,600 per acre-foot to truly consider the costs of the Regional Project.⁸² Because we do not know how the issue of debt equivalence will be decided, it is speculative to consider the potential impacts of this calculation. However, even arguendo, if we were to assume that an amount for debt equivalence is authorized and added into this equation, the total estimated costs of the Regional Project range from $5,700 to $8,100 per acre-foot and in a worst-case scenario, could equal over $10,000 per acre-foot, as compared to a total range of $8,492 to $9,708 for the North Marina Alternative (assuming a total cost cap of $106.875 million for the Cal-Am facilities).⁸³

While we cannot agree with the Settling Parties that the Regional Project is clearly the least-cost alternative, we do agree that it is the only feasible project that will ensure a replacement water source in a timely manner, i.e., prior to the enactment of the Cease and Desist Order provisions. Cal-Am no longer supports the Moss Landing Project, because of concerns regarding once-through cooling and how this intake technology would impact permitting. The Settling Parties have consistently referred to problems associated with Cal-Am ownership due to Monterey County Ordinance 10-20, which prohibits private ownership of a desalination plant. MCWD and MCWRA have also pointed out the likely litigation that would ensue if Cal-Am elected to pursue the North Marina Alternative, since MCWD has exercised its option to purchase the land on which the desalination plant would be sited, and MCWRA would have to ensure that the Agency Act is upheld. Because of the terms of the Settlement Agreement and the WPA, the question before us becomes a determination of whether the cost of this major water infrastructure project is so expensive that the ratepayers cannot bear these costs.

The Commission has a constitutional requirement to actively supervise and regulate public utility rates, as well as a statutory requirement under Pub. Util. Code §§ 451, 454, and 728 to ensure that rates are just and reasonable.⁸⁴ As discussed in D.03-12-035, "[t]he regulation of utilities is one of the most important of the functions traditionally associated with the police power of the states."⁸⁵ As the Commission determined in D.03-12-035, the Commission cannot be powerless to protect ratepayers from unjust and unreasonable rates during the term of a settlement. Here, we must determine whether the terms and conditions of the Settlement Agreement and Water Purchase Agreement and the existing processes of the Public Agencies will ensure that rates to be imposed on Cal-Am ratepayers will be just and reasonable. We conclude that a replacement water source must be provided, and that full compliance by the Public Agencies with their contractual and legal obligations in the Implementing Agreements and with the procedural and other legal constraints imposed on them by law, offers reasonable assurance that a just and reasonable, least cost solution will be achieved. In addition, this Commission retains full authority over the activities of Cal-Am, will receive regular reports, and will have an opportunity to review any financing plan, just as the Boards of the Public Agencies will have.

As Public Agencies, both MCWD and MCWRA are subject to the requirements of the Brown Act (Government Code Sections 54950 et seq.) and the California Public Records Act (Government Code Sections 6250 et seq.) The Brown Act guarantees the public's right to attend and participate in meetings of local legislative bodies, including county government agencies, boards and councils, while the California Public Records Act mandates disclosure of governmental records to the public upon request, unless there is a specific reason not to do so. Both of these statutory provisions ensure the transparency of decisions made by these agencies.

Under the Agency Act, MCWRA's budget is subject to public hearings when it is being prepared by the Board of Directors as well as when it is presented to the Board of Supervisors for adoption. This two-step process would allow for the public and Cal-Am ratepayers to participate in the process and challenge costs associated with the Regional Project before they are approved by MCWRA. Similarly, MCWD is required to utilize and "follow a public process involving notice and hearings in adopting rates, fees and charges, and to fix water rates that are reasonable and fair and related to costs."⁸⁶ Additionally, Article XIII, § 6, subd. (b) of the California Constitution establishes the requirements by which MCWD may set its fees or charges for service to its ratepayers. This includes the requirement that the fees or charges only be set at the cost to provide the related service. Further, the Water Purchase Agreement establishes the procedures by which costs shall be determined and contains terms and conditions requiring that these costs be just and reasonable. These requirements, combined with the requirement that MCWD may not discriminate between the rates charged to its ratepayers and Cal-Am ratepayers, ensure that the costs to be imposed on Cal-Am ratepayers are just and reasonable.

The processes and requirements by which MCWD and MCWRA will review and adopt costs associated with the Regional Project are similar to the ones utilized by the Commission. As such, we conclude that if the Public Agencies fully comply with their established processes and with the statutory and constitutional requirements, we deem the resulting costs to be just and reasonable.

While the Settling Parties have stated concerns that establishing a capital cost cap could impact the competitive bidding process and could also impact the cost of financing, they acknowledge that a capital cost cap is one way to ensure that the Settlement Agreement is in the public interest. We concur, and adopt the $297.5 million estimated cost cap presented in Exhibit C of the WPA.

DRA is concerned that such an approach will violate the Commission's requirement to approve just and reasonable rates, as set forth in Pub. Util. Code §§ 451, 454, and 728. DRA contends that a per-acre-foot cost cap is the only approach that will allow the Commission to set just and reasonable rates. Based on the record developed in this proceeding, we do not agree that the cost-per-acre-foot proposed by DRA is reasonable. At this point, we are not setting rates in this proceeding and we have established that the cost allocation and rate design will be assessed in a separate phase. We are quite cognizant of the costs of this major addition to the infrastructure on the Monterey Peninsula, and we will encourage parties to thoroughly assess cost allocation and rate design methodologies that can be considered to protect Cal-Am's customers. Certainly, the Settling Parties have recognized that at a minimum, it may be appropriate to expand the approach to serving low-income customers.⁸⁷ We look forward to developing the record further on this issue and considering proposals to ensure that rates remain affordable for those who can least afford rate increases. Because a significant increase in rates may well affect demand, Phase 3 of this proceeding will be the appropriate forum to consider elasticity of demand and various protections that must be put into place.

It is certainly true that the capital costs, annual operating costs, financing costs, and utilization factor must all be considered in calculating the unit cost of water.⁸⁸ However, we are not persuaded that setting a very low per-acre foot cost cap will appropriately protect ratepayers. Even the lowest-cost scenario developed jointly by the parties estimate a unit cost of $2,600 per acre-foot (excluding Cal-Am facilities, but including the cost of delivery to the Cal-Am receiving point). This amount is based on a capital cost of $204.3 million (which assumes a project cost of $227 million and then deducts the $22 million from MCWD buy-in fees) and is still $400 per acre-foot over the amount proposed by DRA. Excluding the Cal-Am facilities, we note that the $297.5 million capital cost that we impose today will yield a per-acre-foot cost of approximately $6,300, assuming that the Settling Parties can obtain the low-cost financing contemplated (and not including federal grants). Given these scenarios, we do not find that the per-acre-foot cost cap proposed by DRA is viable. If we were to adopt DRA's proposal, we suspect that Cal-Am would soon be before us with a new application seeking relief. While DRA contemplates that such actions are expected, we prefer to start with a realistic view of the capital costs that will lead to viable financing opportunities and timely completion of the Regional Project.

The Commission will take a strict view before allowing cost recovery for amounts greater than $297.5 million. Unforeseen and unknown costs will be the sole burden of Cal-Am unless it is demonstrated that these costs were due to extraordinary circumstances. Since large contingency amounts are already accounted for in the capital cost cap, the burden for recovering any amounts above the cost cap ceiling will be high.

The Legislature has determined that the "state's limited water supply will require investment by water corporations in infrastructure, plant, and facilities to develop new sources of supply, make existing uses of supply more reliable and encourage and implement water conservation measures including water reclamation and reuse." (Pub. Util. Code § 789.1(c).) We find that the infrastructure associated with the Regional Project is required to ensure that Cal-Am can continue to provide adequate water supplies and service to its customers. This approach is also consistent with the requirements of § 1005.5, which we look to for guidance, as DRA suggests. Finally, we find that the cost saving measures proposed by BOR and DRA must also be considered in light of the full report prepared by BOR. We discuss these issues under Technical Requirements, Section 12, below.

DRA and MPWMD also contend that MCWD must contribute 16.2% of the debt service and O&M costs in order for the Regional Project to be fair and equitable to Cal-Am ratepayers. Here, we consider the benefits derived by Cal-Am and MCWD. In MCWD Exhibit 326, witness Berkman testifies:

CAW enjoys cost savings of $127 million on a present value basis by participating in the Regional facility rather than the North Marina project. This savings is attributed to scale economies, lower processing costs and MCWD's capital contribution. This corresponds to Lyndel Melton's Scenario 2 cost estimate⁸⁹. . . Accounting for low cost municipal financing that would not be available absent MCWD participation results in savings of $493 million. Accounting for this financing and State Revolving Fund (SRF) funding and grants, savings grow to $578 million. This corresponds to Lyndel Melton's Scenario 6⁹⁰. . . At the same time, MCWD's savings are very modest. Economies of scale and process savings total about $7 million. Accounting for financing, MCWD's benefits total $27 million.

Overall, MCWD's benefits are much lower than CAW's benefits because MCWD does not need desalination project water for an extended period - perhaps ten years or more - and as a consequence the savings must be discounted accordingly.⁹¹

Berkman concludes that Cal-Am obtains over 90% of the benefits of the Regional Project, as compared with the North Marina Alternative, while MCWD obtains approximately 5% of the benefits from implementing the Regional desalination facilities rather than its stand-alone desalination facility.⁹²

Both DRA and MPWMD dispute this assessment and contend that MCWD should be required to fully pay their proportionate share of debt service, without regard to the sufficiency or limits of the fees. MPWMD suggests that MCWD should contribute a fees "target" rather than a fees "limit." MPWMD calculates that a target on the order of 13 to 15% of the bonded indebtedness is reasonable, assuming that MCWD would need the desalinated water in ten to twenty years.⁹³ DRA recommends that MCWD contribute 16.2% toward project debt service, based on its permanent allocation of 1,700 afy.

Based on MPWMD's analysis, the MCWD fees contribution is approximately 5-7%.⁹⁴ The $22 million estimated amount to be contributed by MCWD approximates the 5% benefit that MCWD enjoys from participating in the Regional Project.⁹⁵ The Settling Parties also agree that the fees limit is "not actually a cap." MCWD states that § 11.4(c) of the WPA is intended to "make it clear that any fees that MCWD collects in the ordinary course of business that were originally earmarked for use towards `water augmentation through capital facilities for desalination' by MCWD will also be applied to reduce the Product Water costs of the Regional Desalination Project (RDP)."⁹⁶ We agree with the concept. The fees to be contributed by MCWD are expected to provide the maximum economically-feasible benefit that is fair and reasonable.

11.3. Financing and Debt Equivalence

MCWD and MCWRA state that they will work assiduously to obtain low-cost financing that may be available to these Public Agencies, and is not available to Cal-Am. Such financing includes tax exempt private activity bonds, State Revolving Fund (SRF) loans, and state and federal grants. This lower-cost financing would be applied to the desalination plant and related facilities, as well as the brackish source wells and associated facilities. Cal-Am will obtain financing for the costs and expenses related to the development, design, permitting, construction, and testing of the Cal-Am facilities. Cal-Am has also committed to expend "reasonable efforts" to obtain the best available financing for the Cal-Am owned facilities.

The Parties to the WPA plan to finance all costs included in the Project Facility Estimated costs, including initial capital costs, pre-effective date costs and expenses, preconstruction development, permitting fees and expenses, and pre-acceptance defense costs. If, however, there is a shortfall, parties will meet and confer to determine whether it would be cost-effective to issue subordinated debt (i.e., unsecured debt or debt that is junior to the primary indebtedness) for a portion of the project.

If there is not a less costly method of obtaining financing of any shortfall, the WPA provides that Cal-Am or an affiliate will loan up to $17.5 million to MCWD or MCWRA. In addition, Cal-Am or an affiliate will make available a credit line of $8 million and a $12 million letter of credit to manage short-term financial liquidity needs of MCWD or MCWRA. The WPA sets forth the terms of each of these financing instruments and states that such financing is unsecured, subordinate indebtedness, but that the credit line is senior to the Cal-Am loan. Neither of these amounts is intended to increase the capital cost cap established in Exhibit C of the WPA.

Section 7.1 (c)(iv) provides that our approval of the WPA establishes that we have authorized the financing and deemed the terms set forth in §§ 7.1(c)(i), (ii), and (iii) as reasonable and prudent. The WPA further provides that to the extent such costs are not recovered in the price of the Product Water, the principal and interest shall be recoverable in rates. In other words, MCWD and MCWRA will repay the loans, but the costs of such repayment will be passed onto Cal-Am's ratepayers.

The Settling Parties also request that the Commission ensure that this transaction does not impact Cal-Am's financial condition or its credit rating and therefore request that the Commission ensure Cal-Am's financial well-being. Cal-Am explains that these findings are necessary to ensure that Cal-Am's "financial viability is not harmed as a result of the project, that the project can move forward, and that the public agencies are able to finance the project at reasonable rates based upon California American Water's stand-alone credit rating."⁹⁷

Cal-Am argues that these findings are required under Pub. Util. Code § 727.5(e), which, in relevant part, provides that in establishing rates for recovery of the costs of used and useful water plant, the Commission is to maintain the reliability of water service, minimize the long-term cost to ratepayers, provide equity between present and future ratepayers, and provide the utility an opportunity to earn a reasonable return on its used and useful investment, to attract capital for investment on reasonable terms, and to ensure the financial integrity of the utility.

Because the Water Purchase Agreement is structured such that Cal-Am essentially commits future cash flows to funding the debt committed to the Regional Project, Cal-Am testifies that the WPA will be considered either a capital lease or an off-balance sheet take-or-pay contract by its external auditors and that rating agencies will impute debt and consider such leveraging in their analysis and rating of Cal-Am.⁹⁸ Cal-Am therefore contends that the increased debt (approximately double the current amount on its books) would lead to higher debt costs on both the Regional facilities and the Cal-Am facilities and that its customers outside the Monterey County District could ultimately be required to pay for the increased cost of capital, if Cal-Am's credit rating is impacted. According to Cal-Am Treasurer Kalinovich, this is so because of Cal-Am's commitment to purchase the majority of product water from the Regional Project, which then leads to Cal-Am being recognized as the primary "off-taker" of the Regional Project by the rating agencies:⁹⁹

In addition to considering the off-taker's credit rating, the rating agencies will consider the impact of the transaction, as either a capital lease or a take-or-pay contract, on California American Water in calculating the credit metrics of California American Water for purposes of financing the project. While the parties to the WPA will use reasonable efforts to obtain the maximum amount of financing on the best terms, it is reasonably possible that the cost of financing the project could range as high as nearly 9 percent. (footnote omitted.) The lenders would likely add a 75 basis point premium to the project financing, consistent with the rating agencies' cap of the overall rating of the project at two notches below the off-taker rating. (footnote omitted.) Thus, "given California American Water's position as the off-taker, the rating agencies would adjust the credit worthiness of the project if California American Water's credit rating is below the typical range, and thus the project financing would depend largely upon California American Water's credit quality."¹⁰⁰ As such, the Settling Parties have recognized that it is critical for the Commission to address the financial viability of California American Water as a result of the transaction."¹⁰¹

Thus, Cal-Am and the Settling Parties argue that the Commission must ensure that the transaction does not impact Cal-Am's financial viability on a stand-alone basis. Without such assurance, Cal-Am contends that the utility could be rated as BB or lower on a stand-alone basis and that the long-term interest rate for the Regional Project could be imputed at 8.67%. Because a bond of this rating is considered "junk" in terms of investment grades, Cal-Am fears that it could lose the ability to reliably access capital markets at reasonable rates. Cal-Am asserts that it cannot rely on the rating of its parent company, American Water Company.¹⁰²

DRA and MPWMD raise strong concerns about the potential cost impact of the debt equivalence issue. While DRA does not object to the use of least-cost financing, DRA is concerned that any advantages that the Public Agencies may obtain by accessing lower cost financing tools may be eroded by a premature assertion that the Commission will guarantee Cal-Am's financial viability. DRA argues that the financing must be reviewed by the Commission, to the extent that such financing leads to costs per acre-foot greater than its recommended $2,200. DRA points out that a finding regarding debt equivalence and financial viability could lead to an additional $14.3 million in revenue requirements, which would equal additional costs of approximately $1,600 per-acre-foot.¹⁰³ MPWMD recommends that the Commission should not affirm Cal-Am's financial viability with regard to the debt equivalence issue, but simply acknowledge that the issue exists and will be litigated in the future.

11.3.1. Discussion re: Financing and
Debt Equivalence

The low-cost financing opportunities that the Public Agencies should be able to access are at the core of the benefits of the Regional Project. We are pleased that DRA and MPWMD do not dispute that these are important provisos of the Settlement Agreement and the WPA, although these parties are concerned about the lack of a financing plan and the potential impacts on costs to Cal-Am ratepayers. We understand that Cal-Am is essentially providing "backing" to the Regional Project while the financing plan is being developed and the Public Agencies are able to access funding sources.

It is reasonable to assign benefits to the Public Agencies' participation in the Regional Project, although those benefits cannot be quantified precisely at this time. The Settling Parties acknowledge that a financing package is not finalized and explain that they are evaluating several options for obtaining a financing package that will reduce the costs of indebtedness: 1) MCWRA and MCWD are exploring issuing Private Activity Bonds through the California Pollution Finance Authority to fund the entire indebtedness necessary for construction of the Project facilities, the interest accrued on indebtedness during the construction period, and the reserve funds required to sell these Private Activity Bonds; 2) the Public Agencies are considering issuing the Private Activity Bonds in tranches as the funds are needed for construction. This approach would result in a reduced level of interest during construction and thus a lower overall cost of desalinated water; 3) the Public Agencies are considering issuing Private Activity Bonds through the California Pollution Finance Authority in an amount necessary to provide initial funding for the Project facilities and would borrow from the SRF loan facility in tranches as the funds are needed (SRF funding could also be used as part of Alternative 2); and 4) the Public Agencies are considering potential use of grant funding under BOR's Title XVI Grant Program. This grant funding could result in a total grant amount of $20 million in grants allocated to both the source water facilities and the desalination facilities.¹⁰⁴

It is our understanding that the Settling Parties intend to analyze the final financing package at the end of 2010 and will advise their Boards to approve a package based on the total amount of funding and the cost of the funding, including interest rate, term, reserve requirements, flexibility, and any restrictions imposed by particular financing alternatives.¹⁰⁵ Use of low-interest SRF loans and federal grants would reduce indebtedness. Any financing alternative that reduces the Project indebtedness will flow through to and benefit Cal-Am ratepayers by reducing the cost of the desalinated water. While use of SRF and grant opportunities are not guaranteed, Cal-Am would not have the ability to access such funding opportunities. This is a potential benefit to ratepayers that we cannot ignore.

Based on the Unified Financing Model the parties jointly developed, Exhibit 113 considers the impact of a single issuance of private activity bonds, issuance of tranches of private activity bonds, and the interaction of such bonds with SRF loans and federal grants, various interest rates, and a length of construction ranging from 3.5 years to 4.5 years for a range of capital costs. We have replicated this model in Appendix D.

The ALJ's Proposed Decision modeled a "best case" and a "worst case" scenario in its analysis of cost-per-acre-foot and revenue requirement. These scenarios are presented in Appendix D. Based on its assumptions, the ALJ's Proposed Decision projected the cost of water to Cal-Am customers to range from $4,814 to $10,592 per acre-foot and incremental revenue requirements for 2015 after the plant addition to range from $ $44.14 million to $95.27 million.

Under the Modified Scenarios considered in this decision, the total cost-per-acre-foot is $ $6,272 and $6,303 based on 3.5 and 4.5 years of construction respectively and the incremental revenue requirement for 2015 will be approximately $57.23 million and $57.51 million respectively. The Modified Scenarios assume the Regional Project facilities are built for the capital cost cap of $297.5 million, the Cal-Am facilities are constructed for the capital cost cap of $106.875 million, debt service coverage is 1.25, and the Public Agencies are able to access the low cost SRF financing.

As DRA points out, the capital cost cap does not include costs associated with interest during construction or the required debt coverage. The drivers in the sensitivity analyses are the length of the construction period, the debt-coverage ratio required by the lender, and the assumed aggregate rate of indebtedness.¹⁰⁶ DRA has assumed a construction period of 4.5 years, an average bond financing rate of 6% (based on the lower of American Water Works Company bond ratings of BBB+ by Standard & Poor's and Baa2 by Moody's), and a debt-coverage ratio of 1.25%. Based on the Settling Parties' requested capital cost estimates and these admittedly conservative assumptions, DRA calculates the first year revenue requirement at approximately $69 million.

The revenue requirement increase associated with the Coastal Water Project will be undeniably costly. When the Regional Project is completed and the costs of product water are charged to ratepayers, the revenue requirement for the Monterey District ratepayers could increase by approximately 81% under the Modified Scenarios, as compared to the anticipated trend in current revenue requirements (without the Regional Project additions).¹⁰⁷ Settling Parties do not dispute the costly nature of this project, although they focus on the best case scenarios in assessing the costs to Cal-Am ratepayers. DRA is understandably concerned about the impact of such costs on ratepayers, and has proposed the cost-per-acre- foot metric in order to ensure that all costs are included and that the cost impact on ratepayers can be minimized.

DRA's concerns are well-taken, but we cannot agree that the proposed cost-per-acre-foot of $2,200 is a viable amount that will allow this project to go forward. We are faced with a difficult choice, but we are persuaded that even the revenue requirement implied by the worst case scenario is likely preferable to the severe water rationing and restrictions that would be imposed by the Cease and Desist Order. However, we cannot delegate our duty to balance the need for additional water and the impact on ratepayers, pursuant to Pub. Util. Code § 701 and the California Constitution, Article 12.¹⁰⁸ As discussed above, if the Public Agencies fully comply with the terms and conditions of the Settlement Agreement and Water Purchase Agreement, as well as the legal and constitutional requirements imposed on them, the processes and disciplines inherent in that process lead us to conclude that costs approved by the Settling Parties will be just and reasonable.

As we observed above, it is our understanding that the Public Agencies will be submitting their financing plans to their respective Boards for approval, which approval process provides for widespread public participation. We require Cal-Am to file and serve that plan in this proceeding. To the extent that these agencies, in exercising their duties to be accountable to their constituencies, find that particular aspects of the Regional Project are not reasonable and cost-effective, then Cal-Am must bring this issue to the Commission for its review and consideration, by filing the appropriate pleading. The assigned Commissioner and ALJ will then determine how to proceed, in order to ensure that the Commission can consider the financing plan in a timely way.

We also agree with DRA and MPWMD that it is premature to weigh in on the debt equivalence issue at this time. Cal-Am needs to obtain more information before it files an application addressing this issue. We understand the importance of the issue, given the financial footprint of Cal-Am and the relative size of the obligations being undertaken, and we are fully cognizant of the need for the investor-owned utilities we regulate to remain financially viable, as set forth with particularity in Pub. Util. Code Sec. 727.5(e):

In establishing rates for recovery of the costs of used and

useful water plant, the commission may utilize a capital structure and payback methodology that shall maintain the reliability of water service, shall minimize the long-term cost to ratepayers, shall provide equity between present and future ratepayers, and shall afford the utility an opportunity to earn a reasonable return on its used and useful investment, to attract capital for investment on reasonable terms and to ensure the financial integrity of the utility.

Because we must balance the needs of ratepayers and shareholders, it is reasonable to consider the issue of debt equivalency when we can develop a full record, as the Settling Parties have acknowledged. Section 5 of the Settlement Agreement provides, in relevant part: "The Parties acknowledge that the financial well-being of CAW is essential to the ability of MCWD and MCWRA to issue bonds. The Parties therefore agree that the Commission should take steps to ensure CAW's financial well-being in a subsequent proceeding. Such proceeding shall only be initiated once CAW determines after appropriate analysis the accounting treatment for its commitment under the WPA."¹⁰⁹ We find that no modifications are required with regard to the debt equivalency issue. When Cal-Am files the appropriate pleading, we will address the debt equivalency issue in detail.

11.4. Governance

As amended by MCWD's reply brief, the Water Purchase Agreement provides for the establishment of an Advisory Committee, consisting of four members, i.e., a representative of Cal-Am, MCWD, MCWRA, and a "Municipal Advisor." As defined in the WPA, the Municipal Advisor refers to two representatives appointed from time to time by the Cities of Carmel-by-the Sea, Monterey, Pacific Grove, Sand City, and Seaside.¹¹⁰ This addition further assures that the interests of the ratepayers are fully heard in the deliberations and that the public perspectives of the project are appropriately weighed. Certain limits are placed on the role of the Municipal Advisor and the Cities, including that they are not deemed to be a third-party beneficiary under the Water Purchase Agreement and have no rights as a party to the WPA. In essence, as proposed by the Settling Parties, the Municipal Advisor is an advisory role and would not act as a decision-maker for purposes of the WPA. MCWD, MCWRA, and Cal-Am state that they amended the WPA to recognize the strong desire of the Peninsula ratepayers to have an enhanced participatory role in the Regional Project.

The purpose of the Advisory Committee is to provide a formal means for the parties to coordinate the design, permitting, construction, operations, maintenance, repairs, and replacement of the various components of the Regional Project, in consultation with the selected Project Manager. The Advisory Committee members commit to consider, among other things, "the best available scientific evidence relevant to the matter including but not limited to data and analysis generated by numeric models that meet prevailing publicly-owned and privately-owned water utility industry standards for accuracy and reliability, and apply Best Industry Practices."¹¹¹

Parties will also strive to arrive at consensus-driven unanimous decisions regarding construction, operation, and maintenance of the Regional Project facilities. To the extent that is not possible, they have provided for appointment of an independent third party to help them work through the issues. If parties cannot agree on a neutral third-party, they have agreed to submit the selection of the independent third-party to a dispute resolution service, such as the Judicial Arbitration and Mediation Services, Inc.

Section 6.7 of the Water Purchase Agreement also provides for the Establishment of a public Community Involvement Forum to discuss regional water supply issues, including but not limited to, test wells, groundwater modeling, source well type and configuration, construction timelines, progress reports, costs, equity among stakeholders, compliance with public heath considerations, environmental laws, consideration of public trust resources, and compliance with the Agency Act. The Water Purchase Agreement provides for quarterly meetings of the Community Involvement Forum, which shall be open to all members of the public, press, governmental agencies, non-governmental agencies, and elected and appointed officials. The public meetings are to be conducted by Cal-Am, MCWD, and MCWRA on a rotating basis, or with the assistance of a contract facilitator, and the Water Purchase Agreement provides that the meetings are to be held at a facility that is available at no cost or at minimal cost.

DRA recommends that the Commission modify the proposed Settlement Agreement and Water Purchase Agreement to ensure that ratepayers are fairly represented on the Advisory Committee. DRA recommends that both MPWMD and the Monterey Peninsula Cities have a decision-making role on the Advisory Committee. DRA states that it is important for these groups to have voting rights and full Party status under the Water Purchase Agreement, because they possess different areas of technical and managerial expertise and can offer varying political perspectives. DRA contends that such an approach will afford Cal-Am ratepayers the protection they need in considering costs, water quality, opportunities for the sale of desalinated water, expansion parameters to serve the former Fort Ord, and the quantity, timing, and quality of water diverted to the ASR system. DRA notes that while Cal-Am has a fiduciary duty to its shareholders and MCWRA must represent the interests of the agricultural community, the constituencies and interest served by MPWMD and the Monterey Peninsula Cities are also Cal-Am ratepayers.

MPWMD explains that it holds express authority to regulate all local water systems, including the Cal-Am system, particularly regarding integrated water management and conservation. Accordingly, MPWMD recommends that the Advisory Committee should consist of one representative from Cal-Am, MCWD, MCWRA, and MPWMD. As MPWMD sees it, this would not be a substantive change, since the version of the WPA that was approved by Cal-Am's parent company on March 26, 2010, the MCWD Board of Directors and the MCWRA Board of Directors on April 5, 2010, and the Monterey County Board of Supervisors on April 6, 2010 included MPWMD on the Advisory Committee.¹¹² After the MPWMD Board voted not to join the Settlement Agreement on April 5, 2010, MPWMD was removed from the Advisory Committee in the Settlement Agreement and Water Purchase Agreement filed with the Commission on April 7, 2010.

MPWMD contends that appropriate governance is needed to protect Cal-Am ratepayers and to address water supply and water management needs of the Monterey Peninsula and the Salinas Valley. Because Cal-Am ratepayers on the Monterey Peninsula directly elect representatives to the MPWMD, the addition of the MPWMD to the Advisory Committee provides the necessary ratepayer protection, in MPWMD's view. In addition, because the Regional Project replaces existing water supply and because MPWMD estimates that approximately 4,500 afy will be needed to meet future water needs in the Monterey Peninsula through 2020, MPWMD contends that it must be on the Advisory Committee to ensure that Monterey Peninsula ratepayers are appropriately represented to ensure that expansion of the Regional Project can be addressed in a viable fashion.

MPWMD also contends that the WPA must be amended to require the Advisory Committee's compliance with the Brown Act (Government Code §§ 54950 et seq.), which provides for open, transparent, participatory public decision-making similar to the Bagley-Keene Act (Government Code §§ 11120 et seq.), which governs the State of California decision-making bodies, such as this Commission. MPWMD recommends that records of the Regional Project must be retained and disclosed in accordance with the California Public Records Act (Government Code §§ 6250 et seq.) Finally, MPWMD recommends that the WPA be revised to require officials making substantive decisions related to the Regional Project to comply with the Fair Political Practices Act (Government Code §§ 81000 et seq.) to ensure disclosure of political contributions, as well as compliance with ethics requirements, and strict financial limitations required by the Fair Political Practices Act.

11.4.1. Discussion: Governance and
Ratepayer Protection

As contemplated by the Settling Parties and set forth in Section 6 of the Water Purchase Agreement, the Advisory Committee would consist of a representative of Cal-Am, MCWD, and MCWRA, each of whom would have full decision-making authority. Consensus would be sought, but to the extent that differences could not be resolved, the parties on the Advisory Committee have the right to seek dispute resolution by a neutral third-party. In its reply brief, MCWD proposed, and Cal-Am and MCWRA supported in their reply briefs, the concept of a Municipal Advisor as an additional member of the Advisory Committee.

The purpose of the Advisory Committee is to ensure a coordinated approach to the construction and operation of the Regional Project. MCWD contends that there is no need to provide MPWMD a seat at this particular table; in fact, Cal-Am, MCWD, and MCWRA are adamant that allowing MPWMD to have party status for purposes of the Advisory Committee and the Water Purchase Agreement would ensure that the Settlement Agreement unravels.

The parties to the Water Purchase Agreement explain that ratepayer interests are adequately represented without including MPWMD. They assert that Citizens for Public Water, recognized by DRA as a ratepayer representative, will help to ensure such protection, because Citizens for Public Water is now a signatory to the Settlement Agreement. In addition, they explain that MCWRA's Board of Supervisors represents citizens within Monterey County, including those within Cal-Am's Monterey service territory. The parties to the WPA also state that the Public Agencies' transparent and open review processes for budget and Regional Project implementation will ensure widespread ratepayer representation and protection.

The Settling Parties also assert that the Community Involvement Forum will provide ratepayers and other members of the community the opportunity to voice their concerns and to participate directly in the Regional Project discussion as the project evolves. As noted, they have now agreed to ensure that the Monterey Peninsula Cities have a role on the Advisory Committee, but decline to give this Municipal Advisor full party status for purposes of decision-making. The Settling Parties state that they wish to foster a cooperative, productive, and long-term association with the Monterey Peninsula Cities, and are "sensitive to the desire of Peninsula ratepayers to have an enhanced participatory role" in the Regional Project.¹¹³

In comments to the proposed revision to Section 6 of the Water Purchase Agreement, the Cities of Carmel-By-The-Sea, Pacific Grove, Sand City, Seaside, and Del Rey Oaks accept this modification and believe it is adequate to protect their interests. DRA, MPWMD, and the City of Monterey contend that the revision does not go far enough. These parties maintain that representation on the Advisory Committee is insufficient for true ratepayer protection; instead, the Municipal Advisor must be defined as a Party for purposes of seeking third-party dispute resolution. As the City of Monterey explains, unequal decision-making power does not provide the Peninsula ratepayers with the necessary transparency, public process, and enhanced participation in the Regional Project that is required.¹¹⁴

DRA and MPWMD concur, although both of these parties assert that MPWMD should be included as a voting member of the Advisory Committee. DRA explains that it is Section 6.6 of the Water Purchase Agreement that gives the Advisory Committee members their power; and under the proposed arrangement, the Municipal Advisor has no rights as a Party under the proposed amendments to Section 6.

While the Commission must consider the Settlement Agreement as a whole, we must also ensure that the various provisions of the Settlement and the Water Purchase Agreement are in the public interest. On balance, we find that adding the Municipal Advisor role to the Advisory Committee is reasonable. We disagree with DRA and MPWMD's arguments that MPWMD should be included as a voting member of the Advisory Committee. We find that by providing the Monterey Peninsula Cities with a meaningful advisory role on the Advisory Committee, together with the public processes to which the parties are required to utilize, provides adequate ratepayer protection. There is no need for duplicative roles and there are obviously some charged dynamics among the various water agencies on the Monterey Peninsula. Elected Peninsula City officials will coordinate on the appointment of the Municipal Advisor and with the overlap of governance between the MPWMD and the Monterey County Board of Supervisors, we are satisfied that MPWMD's concerns with integrated water management will be addressed.¹¹⁵ We fully expect that MPWMD and Cal-Am will continue to coordinate to address water supply and conservation issues on the Monterey Peninsula, as they do now.

Finally, we do not find that the Advisory Committee must be subject to the requirements of the Brown Act and the California Public Records Act. As discussed above, both MCWD and MCWRA are subject to these statutes. The procedures that the Public Agencies must adhere to under the Brown Act and the Public Records Act provide sufficient information for the public and adequate avenues for public participation.

11.4.1.1. Status Reports

The Settling Parties have stated their willingness to provide regular, detailed status reports to the Commission. MCWD explains that, during the construction phase, § 4.5 of the Water Purchase Agreement provides for the Project Manager to submit monthly status reports to each party to the Water Purchase Agreement.¹¹⁶ After construction, during the operational phase of this long-running project, Section 11.13 provides that Cal-Am, in consultation with the Public Agencies, prepare an annual report on the Regional Project that will be posted on Cal-Am's website. The Settling Parties agree that Cal-Am may use the monthly status reports to prepare detailed quarterly reports that will be provided to the Commission's Executive Director and the Director of DWA. DRA prefers that the monthly Project Manager reports be provided without additional, unnecessary reports being prepared. DRA is concerned that details regarding financing may be provided on a confidential basis.

We are pleased that the Settling Parties have agreed to provide detailed status reports to the Executive Director and the Director of DWA.¹¹⁷ We require Cal-Am to also provide a copy of the report to the Director of DRA. This is a reasonable approach to ensuring that the Commission is fully informed as to the progress of the Regional Project. Quarterly reports should be sufficient. Cal-Am has also agreed to meet quarterly with DRA. This is also a very reasonable approach and we direct Cal-Am to include DWA staff in these meetings. This approach is similar to the procurement review groups that are in place for energy utilities and provide an opportunity for informal discussion and resolution of concerns.¹¹⁸

Each status report should specifically delineate details as to the competitive procurement process, value engineering, contracting terms, project management, the constructability review, and the milestones achieved for each aspect of the project. DWA staff should be included in the inspection and audit protocols set forth in Section 4.11, as appears to be contemplated by the WPA. Additionally, we shall require Cal-Am to submit regular filings as to the adequacy of the water received and any issues with respect to adequate ratepayer representation.

Transparency is essential, although there may be particular reasons to submit certain components related to the status reports on a confidential basis. It is premature to address confidentiality concerns at this time. We prefer to wait until the reports have been submitted and staff can review and assess the adequacy of these reports at that time. The quarterly meetings with Cal-Am, DRA, and DWA will provide a viable forum for resolving such concerns.

In sum, we are satisfied with the status report agreements, and see no reason to modify the Settlement Agreement or WPA, since Settling Parties have agreed to comply with this approach.

11.5. Water Supply, Water Delivery, Brackish Source
Water Supply and Management

A major component of the Settlement Agreement and the Water Purchase Agreement is the provision that the Settling Parties will maximize the intake of seawater on a cost-effective basis in a way that ensures compliance with the requirements of the Agency Act. There is no source water on the Monterey Peninsula. All parties seem to agree that maximizing the use of seawater is the preferred approach, but until MCWRA constructs both a vertical and slant test well, the Settling Parties contend that we cannot require that slant wells be incorporated into the design of the Regional Project.

In other words, because a relatively small amount of source water is expected to be pumped from the Salinas Valley Groundwater Basin, that water cannot be exported from the Salinas Valley. Essentially, maximizing the seawater content assists as a proxy for determining whether source water is seawater or groundwater. This approach assists the Settling Parties in preventing exportation of Salinas Basin Groundwater.¹¹⁹ As MCWRA explains, it is important to consider the composition of the brackish water: "Because of the existing geology and hydrology, both components of the brine, groundwater and ocean water, are essentially returned to their natural receiving waters. Therefore, the only water that could be considered as exported out of the groundwater basin is a possible fraction of the brackish source water from the Salinas Basin in the treated water delivered as drinking water to CAW, as water to MCWD is in effect a return to the Salinas Basin. This fraction is lower as the water gets more salty."¹²⁰

At this point, because of seawater intrusion, according to the FEIR, we can assume that the salinity of the seawater and the salinity of the brackish groundwater are approximately equal.¹²¹ The FEIR finds that, as designed and modeled, assuming vertical wells are the source water wells, and assuming that the wells are pumped continuously in the 180-Foot Aquifer, an "extraction barrier" would be created that would prevent future seawater intrusion.¹²² It is important to keep this concept in mind as we discuss the concerns regarding water supply and water allocation below.

Salinity is determined by a calculation of the amount of Total Dissolved Solids (TDS) and chloride levels in the source water. The water to be desalinated is water which has a TDS concentration high enough to make it unsuitable for human consumption or agricultural use unless it is treated. This is the brackish source water, which will be produced by new wells to be owned by MCWRA.¹²³

As set forth previously, Cal-Am requires 8800 afy of desalinated water in a normal year and 10,900 afy in a critically-dry year to replace the water supplies from the Carmel River and the Seaside Basin. The goal of the Regional Project is to satisfy this requirement. Accordingly, MCWRA is charged with taking the necessary steps to both comply with the Agency Act and to deliver brackish source water to MCWD sufficient to produce up to 10 mgd of desalinated water.

As set forth in Exhibit 306, the 10-mgd plant will be operated to produce 10,500 afy of desalinated water in a normal precipitation year, which would then provide 8,800 afy to Cal-Am and up to 1,700 afy to MCWD. MCWD requires 2,700 afy from the Regional Project. The permanent allocation of 1700 afy to MCWD from the desalination plant would be supplemented with the 1,000 afy of recycled water provided to MCWD by the RUWAP project. According to MCWD's consultant, the 10 mgd capacity could still provide Cal-Am's peak needs and meet the simultaneous MCWD demand of 1,700 afy in a drought year, because MCWD could rely on its groundwater well pumping capacity to meet its peak demands during the critically dry portion of the year when Cal-Am requires 10,900 afy. The desalination plant could produce up to 11,200 afy, assuming operation at full capacity.¹²⁴ The more product water that is produced and delivered to Cal-Am, the lower the unit costs of that water.

In order to ensure that groundwater is not exported from the Salinas Valley Groundwater Basin, MCWD, which is located within the Salinas Valley Groundwater Basin, has agreed to take an annual allocation of desalinated water for distribution within its service area (again, within the Salinas Valley Groundwater Basin). As long as this restriction is complied with, the remaining amounts of product water can be conveyed to Cal-Am for distribution to its customers. We discuss the derivation of these calculations below.

The calculations of the amounts of product water that are to be delivered to Cal-Am and to MCWD are based on groundwater and hydrologic modeling, and parties recognize that some variance will occur. Based on this modeling, Settling Parties have determined that the MCWD Agreed Allocation will be calculated by multiplying the amount of desalinated water produced by the desalination plant during a calendar year by the average percentage of the amount of Salinas Basin Water included in the Brackish Source Water. Each calendar year, MCWD will receive its annual allocation of the desalinated water - either the agreed allocation or the permanently allocated water, whichever is greater.

For purposes of determining the MCWD agreed allocation, the average percentage of Salinas Basin water in the source water will be deemed not to exceed 15% during the first five years of operation of the Regional Project. Thus, based on the average production from the desalination plant of 10,500 afy, MCWD is then deemed to receive up to 1,700 afy of product water (defined as the MCWD Agreed Allocation). This approach allows Cal-Am to receive an average of 8,800 afy of water from the desalination plant. The Settling Parties also recognize that Cal-Am requires additional water during peak periods and in critically dry years. After the first five years of operation, the calculation of annual allocations and agreed allocations will be derived according to the formulas in Exhibit E of the Water Purchase Agreement.

Permanently allocated product water refers to the quantity of water needed to satisfy MCWD's customers' demand that cannot be satisfied by MCWD's potable groundwater limits. This term refers to the limits for the withdrawal of water from the Salinas Basin imposed on MCWD for the development of the former Fort Ord. As provided for in Section 9.4(d) of the WPA, MCWD is required to notify Cal-Am when it requires permanently allocated product water:

Unless consented to in writing by CAW, in no event shall MCWD seek or cause to have more than 1,700 AFY of Product Water (at the MCWD Meter) deemed to be MCWD Permanently Allocated Product Water or apply for or seek to obtain or establish any right, title, permit or permission to have more than an aggregate of 1,700 AFY of Product Water (at the MCWD Meter) deemed to be MCWD Permanently Allocated Product Water.¹²⁵

Section 8.2(a) of the Water Purchase Agreement requires that at least one vertical test well and one slant well be drilled and pumped and the water analyzed to obtain more precise data regarding the operation of the wells and the salinity of the water extracted from the wells. Compliance with the Agency Act is within MCWRA's jurisdiction and MCWRA would determine the particular types of wells to drill based on analysis of the data and after consultation with MCWD and Cal-Am. MCWRA would also determine whether the MCWD Agreed Allocation (i.e., up to 1,700 afy based on the assumption of an average of 15% groundwater in the brackish source water) can be delivered and still meet the requirements of the Agency Act. If test well development reveals that Cal-Am will not be able to receive its full allocation of desalinated water, MCWRA must prepare a written report; parties are to meet and confer to develop a plan of action; and Cal-Am may seek additional Commission approval, to the extent that expenditure of additional funds are required. "Upon availability of test well results, if determined to be prudent by the Parties, a Brackish Source Water contingency plan will be prepared by a mutually acceptable engineer."¹²⁶

As set forth in the WPA, the Advisory Committee is to meet at least every quarter to review the prior quarter's quantity of pumped brackish source water, the average TDS and chloride concentrations, and the elevation of the Salinas Basin, and to discuss and recommend the current quarter's pumping and delivery of source water to ensure that both Cal-Am and MCWD receive the proper allocations of desalinated water. The Advisory Committee will also meet quarterly to plan deliveries of product water that ensures that both the Cal-Am and MCWD allocations are fully met, recognizing Cal-Am's need for the full allocation of product water during its peak demand period. The Settling Parties have recognized the need for accurate measurement of the volume of brackish source water deliveries from the wells to the desalination plant and of product water deliveries from the desalination plant to the MCWD meter and the Cal-Am meter, and have spelled out details in the WPA to ensure precise measurement of these quantities.¹²⁷

We have provided a detailed review of the WPA's provisions regarding source water supply and planned deliveries, because DRA and MPWMD have voiced serious concerns as to whether the salinity of the source water will be maximized using vertical wells. Both recommend the use of slant wells to ensure that the salinity of the source water is truly maximized and that Cal-Am actually receives the allocated water that it is paying for.

Based on BOR's report and an analysis of the groundwater modeling, DRA recommends the use of slant wells rather than vertical wells to provide the source water. BOR concludes that: "By orienting the well so that it protrudes toward or under the sea, the ratio of seawater to groundwater extracted by a slant well should be substantially higher than that of a vertical well. This means that for a desalting plant of a given size the volume of groundwater extracted will be considerably lower."¹²⁸

The BOR Report recognizes that there is not much practical experience with slant wells and states that additional information is required to ensure that vertical wells would indeed produce an average of 85% seawater and 15% groundwater. BOR recommends that a test well should be drilled and operated to determine whether slant well or vertical well technology should be utilized and that the test wells should be operated long enough for the water to come to a steady state, by tracking concentrations of various components that appear in significant concentrations in seawater.

DRA contends that the Commission must require the Settling Parties to use slant wells as intake facilities, unless the slant wells are found to be infeasible in the testing stage. DRA argues that requiring the use of slant wells would reduce litigation, maximize the use of seawater as opposed to groundwater, and reduce the subsidy of MCWD by Cal-Am ratepayers. As DRA explains it, the MCWD Agreed Allocation is equal to the average percentage of groundwater in the source water mix. For example, if the average percentage of groundwater (based on salinity) is 16.2%, then MCWD must take the Agreed Allocation, which in this case is also equal to the Permanent Allocation. Here, 16.2% of 10,500 afy (i.e., the total afy to be produced by the desalination plant) is equal to 1,700 afy. This is the amount that MCWD will take so that the groundwater allocation remains in the Salinas Valley basin. DRA and MPWMD are not as concerned if the average percentage of groundwater is 16.2% or less, because then Cal-Am will receive its full allocation of 8,800 afy.

The real concern occurs when the calculation of the groundwater percentage in the source water is greater than 16.2%, based on salinity. In this case, DRA and MPWMD contend that Cal-Am will not receive its full allocation of water and Cal-Am ratepayers will be shortchanged. For example, if the average percentage of groundwater is 6%, DRA explains that the MCWD Agreed Allocation would be 562 afy,¹²⁹ and 1,138 less acre-feet per year would be required to remain in the Salinas Valley basin.

In DRA and MPWMD's views, the more desalinated water that must be left in the Salinas Valley Groundwater Basin (because of the requirements of the Agency Act), then the more Cal-Am ratepayers must pay for the product water. DRA and MPWMD therefore conclude that requiring the use of slant wells would reduce the amount of desalinated water that must be left in the Salinas Valley by 1,138 afy at a savings of $647,000 per year.¹³⁰ If feasible, therefore, DRA states that slant wells should be used because this technology will minimize the potential that Cal-Am will not receive the water its customers are paying for, will avoid costs associated with vertical wells required to ensure that the groundwater percentage is below 16.2%, and will avoid more costly energy costs associated with vertical well operation. Based on Exhibit 108, DRA assumes that the energy cost savings are $382,545 per year. Combined with the savings derived from reducing the amount of groundwater that must be left in the basin, DRA argues that an annual savings of $1.1 million should offset the additional incremental costs of installing slant wells (estimated at $8.3 million for four additional slant wells).

DRA and MPWMD also maintain that limiting the amount of groundwater that must remain in the basin would reduce the chance of potential project failure and the risk of litigation. To the extent that the average percentage of groundwater exceeds 16.2%, DRA argues that Cal-Am may not be able to receive the full 8,800 afy needed to serve its customers. For example, if the source water consists of 20% groundwater (as determined by salinity), then 20% of the product water must remain in the basin: for purposes of this calculation, 20% of 10,500 = 2,100 and Cal-Am could receive only 8,400 afy.

DRA and MPWMD also contend that while there is an assumption that the source water will consist of 15% groundwater during the first five years of the project and there is an additional provision to use a rolling five-year average in determining the percentage of groundwater, these assumptions - while smoothing out the variability concerns - could lead to litigation by entities disputing the compliance of such provisions with the Agency Act. MPWMD questions the very construct of the Settling Parties' characterization of the composition of the source water and fears that all source water could be construed to consist entirely of brackish groundwater, which would then lead to litigation risk and untenable delay.

11.5.1. Discussion: Salinity, Slant Wells,
and Vertical Wells

We will not require the modification of the Settlement Agreement or the WPA to require the use of slant wells, because we find that the test well approach that is carefully outlined in the WPA is adequate. We are not convinced that the salinity issue is as dire as the opposing parties portray. As the FEIR explains, groundwater pumping for municipal and irrigation supply has led to a drop in groundwater levels and concomitant seawater intrusion. This is not a new issue. As the FEIR notes, seawater has been migrating gradually into the Salinas Valley Groundwater Basin since the 1940s and was first documented by the Department of Water Resources in 1946.¹³¹ Here, all parties have elected to use salinity as a proxy for determining the amount of source water that is seawater and the amount of water that is groundwater. We cannot, however, view the salinity calculation in isolation.¹³² We must also focus on the volume of groundwater in the basin.

As explained in the FEIR, pumping the wells (whether vertical or slant wells) will not only draw seawater towards the coast, but the saline-intruded groundwater will also be drawn towards the coast, which in essence reverses the seawater intrusion dynamic and reduces the salinity of the groundwater portion of the intake supply.¹³³ The portion of the intake supply that is of groundwater origin will remain the same, but the water will be less saline. In addition, the existing Castroville Seawater Intrusion Project (CSIP) reduces demand on groundwater and helps to stabilize groundwater pumping. As we have discussed, the CSIP distributes recycled water through the Salinas Valley Recycling Project to agricultural users in the northern Salinas Valley Groundwater Basin and this helps to alleviate groundwater extraction in those areas. The Salinas Valley Water Project (SVWP), which consists of modifying the Nacimiento Dam spillway and reoperating the storage and release schedules of the Nacimiento and San Antonio reservoirs, and the construction and operation of the Salinas River Diversion Facility (SRDF) will direct Salinas River water for delivery to CSIP customers to replace the current use of groundwater that is delivered with the recycled water.¹³⁴ The SRDF became operational in 2010. All of these projects and redistribution of water resources help to provide a form of "in-lieu" groundwater recharge, according to the FEIR analysis.¹³⁵

We are satisfied, therefore, that the volume of water retained in the Salinas Valley Groundwater Basin will be adequate to ensure that Cal-Am receives its full water allocation, even if vertical wells are ultimately determined to be the best source water technology. We see no reason to modify the language in the WPA that describes the test well approach and we see no reason to require the use of slant wells - an admittedly more expensive and untested technology - at this time. In sum, we agree with the Settling Parties: it is premature to determine the configuration of the source wells. We are satisfied that the WPA provides that the test well approach will "supplement existing analyses to provide additional information to allow for a sound basis for selection of the intake well configuration."¹³⁶

We are also satisfied that Settling Parties will ensure that a Water Contingency Plan is developed, to the extent that both slant wells and vertical wells prove to be infeasible, an event that we do not deem to be likely. Because of the Municipal Advisor, the community outreach that is built into the Settlement Agreement and the WPA, the Settling Parties are -as they should be - fully accountable to develop the source wells in the most cost-effective manner. If MCWRA determines that development of the source wells is not feasible for some reason, we will be duly informed. Based on the requirements of the Cease and Desist Order, we have no doubt that Cal-Am will petition for additional relief, if the Regional Project appears to be infeasible.

Given the importance of the water allocation issue, however, it is reasonable to require Cal-Am to submit a report after the first five-year period that provides updated information on the water supply obligations and deliveries addressed in Section 9 of the Water Purchase Agreement. Cal-Am must submit this report to DRA, DWA, and serve all parties in this proceeding.

11.6. Operation and Maintenance Costs

DRA recommends that the Commission consider O&M costs in a separate phase of this proceeding. As DRA explains, the WPA is structured to allow the recovery of O&M costs through the uncapped price of product water. Until MCWD takes its permanent allocation, Cal-Am ratepayers would be responsible for all of these costs. DRA maintains that a fair, equitable, and accountable O&M contract and contractor selection process must be established in order to ensure that cost controls are in place and that ratepayers are protected. DRA contends that because the Settlement Agreement and Water Purchase Agreement do not provide any information related to O&M cost controls, risk mitigation, contractor selection, and performance standards, there is no protection for Cal-Am ratepayers.

The parties estimate total annual O&M costs at $12.9 million, while DRA estimates that the annual costs will be $14.270 million (based on a start date of 2015). These annual costs are significant and because the WPA is anticipated to last for 94 years, developing consumer protections and cost savings for the O&M plant is particularly important, in DRA's view. DRA recommends that the Commission convene a workshop to develop the information to be considered in the O&M phase of the proceeding.

11.6.1. Discussion: O&M Costs

While we agree with DRA that the estimated annual O&M costs are significant, we do not agree with their assertion that there is no protection for Cal-Am ratepayers. As previously discussed, the procedural and other legal requirements imposed on MWMD and MCWRA, along with the terms and conditions of the Settlement Agreement and Water Purchase Agreement, require that annual O&M costs approved by their respective Boards will be just and reasonable.

Section 6.5(h) of the Water Purchase Agreement directs the Settling Parties to review and consent to the reasonableness and prudency of the O&M Costs. As part of our continuing jurisdiction over Cal-Am to ensure that rates are just and reasonable, Cal-Am cannot consent to the O&M costs without first seeking our authorization. Thus, Cal-Am is directed to file a Tier 2 advice letter with the Commission seeking authorization to consent to the O&M costs before it may give its consent or approval under the Water Purchase Agreement. We do not consider this requirement, which is part of our ongoing regulation of Cal-Am, to be a material change to the Water Purchase Agreement. Indeed, our review is similar to the review that will be performed by the Public Agencies' Boards. Rate recovery for any O&M expenditures will not be authorized absent prior Commission approval.

⁵⁶ Exhibit 301, Water Purchase Agreement, § 4.3(f) at 26. The Prime Agreements are construction contracts and service agreements required for the design, permitting, and construction of each Party's facilities (Water Purchase Agreement, § 4.4(b)).

⁵⁷ Exhibit 301, WPA, § 4.6 at 28.

⁵⁸ Id. § 4.11 at 31.

⁵⁹ DRA Opening Brief at 2.

⁶⁰ Exhibit 301, WPA § 11 at 53.

⁶¹ Exhibit 202 at 4-32, Footnote 44, 4-33, and DRA Opening Brief at 13.

⁶² Id.

⁶³ DRA Opening Brief at 6, citing Settlement Agreement at § 10.1.

⁶⁴ DRA Opening Brief at 8, citing Exhibit 204 at 18. Bureau of Reclamation (BOR) points out that annualized capital costs for this project exceed this formula.

⁶⁵ Id.

⁶⁶ DRA Opening Brief at 12.

⁶⁷ DRA Opening Brief, citing Exhibit 201 at i.

⁶⁸ MPWMD Opening Brief at 22.

⁶⁹ Id. at 29.

⁷⁰ Id.

⁷¹ Exhibit 319 at 26-28.

⁷² Exhibit 319 at 29, RT 1059 at 4-7.

⁷³ Cal-Am Reply Brief at 9.

⁷⁴ Exhibit 320 at 2.

⁷⁵ Based on the most probable estimated costs, Exhibit 319 at 13 and MCWD Opening Brief at 44.

⁷⁶ Exhibit 319 at 6-7.

⁷⁷ Exhibit 319 at 23.

⁷⁸ The Unified Financing Model was based on DRA's recommended approach to analyzing revenue requirements and was jointly developed by the parties during the May 2010 workshops.

⁷⁹ In Section 11.3.1, we provide further discussion on the impact of various financing options, based on Appendix D, which is based on the various scenarios in Exhibit 113.

⁸⁰ Exhibit 319 at 24.

⁸¹ Exhibit 202 at 4-34, citing Cal-Am Data Request Response CWP 54-2(a).

⁸² Exhibit 202 at 4-34.

⁸³ DRA argues that the costs included in Table 2 for the Moss Landing Project and the North Marina Project are overstated by $14 million in pre-effective date costs for the Public Agencies, and notes that litigation costs are included only for the North Marina Project. These particular litigation costs appear to be associated with land condemnation and groundwater transfer out of the Salinas Basin (Zone C). If we removed the pre-effective date costs from the North Marina and Moss Landing Projects, the estimated costs of those projects would be reduced to $225 million and $252 million, respectively. If a litigation cost estimate were then added to each project, the estimated cost for the Regional Project with vertical wells would increase to $201.3 million, Regional Project with slant wells would increase to $245.3 million as compared to the North Marina Project ($225 million with adjustments) and the Moss Landing Project ($257 million, with adjustments). As we discuss, we must consider both the feasibility of constructing these projects in a timely way as well as the costs of the project.

⁸⁴ D.03-12-035 at 27, citing Sale v. Railroad Commission (1940) 15 Cal. 2d y07 at 617 and Camp Meeker Water System, Inc. v. Public Utilities Com. (1990) 51 Cal.3d 850 at 861-862.

⁸⁵ Id, citing Arkansas Electric Coop. v. Arkansas Pub. Serv. Comm'n (1983) 461 U.S. 375, 377.

⁸⁶ Exhibit 361 at 4.

⁸⁷ Settlement Agreement, § 10.6 at 16.

⁸⁸ Exhibit 319 at 13-14. Exhibit 204 at 16 discusses the utilization factor and explains that increasing plant utilization (as BOR recommends) is a way to reduce the unit cost of water.

⁸⁹ Exhibit 319 at 23.

⁹⁰ Id.

⁹¹ Exhibit 326 at 4-5.

⁹² Id.

⁹³ Exhibit 600 at 8. If MCWD did not need its permanent allocation until 30 years from the date of operation, then MPWMD estimates that its proportionate share of debt service would be 11%.

⁹⁴ MPWMD Opening Brief at 23.

⁹⁵ MCWD Reply Brief at 9.

⁹⁶ MCWD Reply Brief at 9-10.

⁹⁷ Cal-Am Opening Brief at 52.

⁹⁸ Exhibit 101 at 4, Exhibit 11 at 6-7.

⁹⁹ Cal-Am Opening Brief at 56, citing RT at 1609.

¹⁰⁰ Id. at 57, citing Exhibit 111 at 5.

¹⁰¹ Id.

¹⁰² Id. at 58.

¹⁰³ Exhibit 202 at 4-34.

¹⁰⁴ Exhibit 319 at 16.

¹⁰⁵ Id. at 17. Based on the legal requirements for the Public Agencies, our understanding is that their respective boards must approve the financing plan ultimately recommended for the Regional Project.

¹⁰⁶ Id. at 4-27-28.

¹⁰⁷ Exhibit 202 at 5-38 states that 2009 revenue requirement for the Monterey District is $42.7 million. Based on the 9% revenue growth rate included in the Unified Financing Model assumptions, the revenue requirement without the plant addition is $70.4 million in 2015.

¹⁰⁸ The Commission is not an ordinary administrative agency, but a constitutional body with broad legislative and judicial powers. (Southern California Edison Company v. CPUC (102 Cal.Rptr.2d 684.))

¹⁰⁹ Motion to Approve Settlement Agreement, Exhibit 1, Section 5 at 8.

¹¹⁰ In reply comments to the proposed decision and alternate proposed decision, Cal-Am, MCWD, and MCWRA state that they would not object to the Cities of Carmel-By-The-Sea, Pacific Grove, Sand City, Seaside, and Del Rey Oaks adding the City of Monterey to this group. We encourage the Cities to consider this addition.

¹¹¹ Id. § 6.2 at 35.

¹¹² MPWMD Opening Brief at 10 - 11, citing Exhibit 602 at 15.

¹¹³ MCWD Reply Brief at 28.

¹¹⁴ City of Monterey Comments to Amendment to Section 6 of the Water Purchase Agreement at 1.

¹¹⁵ MPWMD's Board of Directors includes a mayoral representative and a representative from the Monterey County Board of Supervisors, in addition to the directly-elected members of the Board.

¹¹⁶ All status reports should be provided to all members of the Advisory Committee, including the Municipal Advisor.

¹¹⁷ See, e.g., MCWD Opening Brief at 38.

¹¹⁸ D.02-08-071, Finding of Fact 18 at 38; D.07-12-052 at 119 et seq.

¹¹⁹ Exhibit 500 at 13.

¹²⁰ MCWRA Opening Brief at 39.

¹²¹ FEIR, Appendix Q at Q-76.

¹²² FEIR, Appendix Q at Q-7.

¹²³ Exhibit 500 at 14; MCWRA Reply Brief at 20.

¹²⁴ Exhibit 306 at 10-11, 21.

¹²⁵ Exhibit 301 at 49.

¹²⁶ Exhibit 301, §8.2(a) at 45.

¹²⁷ Exhibit 301, §10 at 52-53.

¹²⁸ Exhibit 204 at 6.

¹²⁹ DRA bases this analysis on Exhibit 301, Exhibit E.

¹³⁰ DRA Opening Brief at 29, citing Exhibit 320 which calculates the total cost for energy, chemicals and brine disposal divided by plant production of 10,500 afy to derive $740 per acre-foot estimate. DRA uses the following formula to calculate the annual savings: (1,138 afy * $740/acre-foot incremental cost) - 1,138 * $148/acre-foot to be paid by MCWD) = $647,000.

¹³¹ FEIR at 13.6-2 and 3.

¹³² Exhibit 500 at 7 explains some of the projects that have assisted MCWRA in slowing seawater intrusion in the Salinas Valley Ground Water Basin.

¹³³ See Chapter 13.6 of FEIR.

¹³⁴ FEIR at 5-2.

¹³⁵ FEIR, Chapter 13.6.

¹³⁶ MCWD Opening Brief at 75, citing Exhibit 319 at 32.