Discussion

It is a well-established principle of this Commission that ratemaking is done on a prospective basis. The Commission's practice is not to authorize increased utility rates to account for previously incurred expenses unless, before the utility incurs those expenses, the Commission has authorized the utility to book those expenses into a memorandum or balancing account for possible future recovery in rates.⁴

By its reply to ORA's protest, Cal-Am withdraws its request to include the additional capital costs identified in its application. Such exclusion of capital costs reduces the amount to be included in the memorandum account from $2,068,000 to $821,000.

Cal-Am also uses its reply to clarify that the additional expense costs are not one time costs. Rather, such expense costs are being incurred on an ongoing basis. With the withdrawal of capital costs and clarification of ongoing expense costs, the retroactive ratemaking issue becomes moot, Cal-Am believes. However, the need for the proposed memorandum remains at issue.

We find that the reliance Cal-Am places on specific government recommendations and mandates does not justify the establishment of a memorandum account. The FBI Statement before Congress says that, although it is possible for a water supply to be contaminated with a biological agent that causes illness or death of victims, it is not probable; moreover, the contamination of a water reservoir with a biological agent would likely not produce a large risk to public health because of the dilution effect, filtration, and disinfection of the water.⁵

The other government documents that Cal-Am relied on also fail to provide a basis for establishing a memorandum account to track extraordinary expenses for security measures. Presidential Executive Order 13228 merely lists the functions of the newly created Office of Homeland Security and the FERC Statement of Policy assures energy companies, not water companies, that the FERC will approve recovery of "prudently incurred costs" necessitated by security measures.⁶

ORA also contends that the proposed memorandum account does not comply with Commission threshold requirements for establishing such accounts because the expenditures fail to satisfy the third condition. That condition requires the expenditures to be of a substantial amount of money. ORA compares the estimated security expense costs for 2002 to forecasted annual operating expenses, Tab E to the application. This comparison shows that the estimated security expense costs amounts to 1.1%⁷ of estimated annual expenses, a percentage considered by ORA to be insignificant.

With the subsequent clarification from Cal-Am that those additional expense costs are ongoing, we add the 2001 expense costs to the 2002 expense costs to arrive at a 1.4%⁸ impact on the ongoing annual expenses of Cal-Am. This latter result, without reflecting tax benefits to be derived from the additional expense costs, would impact the average customer's monthly bill by less than $0.40. ⁹

According to ORA, Cal-Am has or will shortly have General Rate Cases (GRCs) before the Commission for five of its districts comprising more than 47% of the utility's total annual revenue generated in California. ORA contends that, to the extent such expenditures are approved and the GRCs are completed on a timely basis, those security expenditures would be reflected in base rates as of January 1, 2003. ORA concludes that Cal-Am should seek recovery of those security expenditures in its upcoming GRC filings on a prospective basis.

Cal-Am subsequently acknowledged that several of its districts are undergoing GRCs. However, it asserts, without providing any details, that a sizeable portion of the expenses are being incurred in districts not the subject of current GRCs.

To assess the need of Cal-Am for establishing the Security Memorandum Account we briefly review our ratemaking process for water utilities. The recovery of expenditures through rates for water utilities is based on future test year rate of return ratemaking.¹⁰ This means that the rates of Cal-Am are based on estimated rate base and expenditures for a future test year. Actual rate base and expenditures can and do change between the time rates are set and the time events occur.

There is no requirement of the utility to spend exactly, or only, the projected amount on each rate base or expenditure component used to set rates. Similarly, there is no requirement or guarantee that the utility earn its authorized rate of return. In other words, if a utility fails to earn its authorized rate of return, ratepayers are not assessed the short-fall, and if the utility earns more than authorized, it does not rebate the excess to ratepayers.¹¹

We leave the fine-tuning of a utility's operation to the discretion of its management. Management discretion is exercised in allocating total dollars for capital and expense items to those areas where the capital and expense is most necessary, as dictated by constantly evolving priorities. This discretion also affects whether the utility realizes its authorized rate of return.

As previously discussed, memorandum accounts are available to track specific expenditures for future consideration of their recovery in rates. Based on the criteria used by Cal-Am, those expenditures recorded in a memorandum account for future recovery are: caused by an event of an exceptional nature outside of the utility's control; not reasonably foreseen in the utility's last GRC; substantial in the amount of money involved; and, beneficial to the customers.

Clearly, the terrorists' activities of September 11, 2001, satisfy the exceptional nature and not reasonably foreseen criteria. However, irrespective of whether government recommendations and mandates required Cal-Am to incur additional security expenditures, the amount of expenditures involved is not a substantial amount. Here, we find that the additional expenditures are not clearly required (at least on the bases cited by Cal-Am) and constitute less than 2.0% of projected operating costs. Our ratemaking assumes that utility management can and will reassess its priorities to deal with developments of this magnitude. Specifically, Cal-Am may utilize management discretion to allocate funds for capital and expense items to those areas where the expenditure is most necessary, and also to attain its authorized rate of return.

Cal-Am has not substantiated the need to establish the Security Memorandum Account. To the extent Cal-Am wishes to pursue recovery of additional security costs, the issue should be addressed in upcoming GRCs. The request of Cal-Am for authority to establish the Security Memorandum Account is denied.