Comments on Proposed Decision

The proposed decision of ALJ Sullivan was mailed to the parties in accordance with § 311(d) of the Pub. Util. Code and Rule 77.1 of the Rules of Practice and Procedure. Comments and replies were filed by Southwest, the County, and ORA.

Southwest's comments on the PD argue that it has committed no managerial error because a goal of gas-cost minimization drove its storage policies and that gas-cost minimization is Commission policy. As a consequence, Southwest argues that the proposed decision (PD), by considering price stability, retrospectively penalizes Southwest and misapplies the Commission's three-step reasonableness review standard. In addition, Southwest's comments argue that the Commission should use its injection/withdrawal analysis in calculating a disallowance, if one were assessed. Further, Southwest identifies an arithmetical error in the proposed decision's calculation of a disallowance. Finally, Southwest notes in its reply comments that its average net income for the three-year period of 1999, 2000, and 2001 was $1,698,705 as reported to the Commission's Energy Division on Form No. 2. (Southwest notes that the figures for 1999, 2000, and 2001, respectively are $2,162,019, $3,986,366 and a loss of $1,052,270).

Southwest's comments demonstrate that it has fundamentally failed to comprehend Commission policy. Commission policy places primacy on promoting low prices, but does not exclude promotion of stable prices.75 As evidence, we noted above that hedging is a strategy long accepted by the Commission, both to promote low prices by avoiding the need to buy gas during "pricing spikes" and to promote price stability. Moreover, as the facts of this case make clear, Southwest's strategy actually achieved neither low nor stable prices, nor did Southwest demonstrate that one could have reasonably expected its strategy to achieve such an outcome. Indeed, a prudent managerial strategy that sought to achieve a balance between low prices and stable prices would have better complied with Commission policy and have achieved both lower and more stable prices than the procurement strategy pursued by Southwest. Thus, the PD commits no legal error - it applies the correct policy, it does not retrospectively penalize Southwest by use of a new policy, nor does is misapply the Commission's three-step reasonableness review standard. Further, the PD makes clear that Southwest's proposed methodology for calculating a disallowance is flawed. Finally, we have revised the PD to correct the arithmetical error identified in the PD's calculation of the disallowance.

The County's comments support the PD's legal reasoning that leads to the disallowance. The County's comments argue that the PD lacks a basis for basing the disallowance on a 50% use of storage. The County instead argues that the record shows that Southwest, if it had made economic injections during the spring of 2000, would have filled 92% of its storage. Finally, the County argues that ORA's disallowance methodology is flawed because it uses Southwest's average gas procurement costs instead of market prices.

The County's comments fail to note the reasonable basis for the conclusion that Southwest should have filled its storage to at least 50%. The record in this proceeding completely documents the unprecedented price levels and price volatility prior to the winter of 2000-2001. In the face of this uncertainty, we find that a simple (and prudent) managerial strategy would reduce price risks by storing at least as much gas as Southwest had done in the past, particularly since other gas utilities were following such a strategy. Hence, we conclude that Southwest should have filled its storage to at least 50%, its lowest use of storage in the four prior heating seasons.

Similarly, the evidentiary record is not clear that economic criteria would have induces Southwest to fill 92% of its contracted storage capacity. The record shows that such a result depends critically on assumptions concerning the timing of storage decisions and the level of market prices over which reasonable people can disagree. Lastly, the County's criticism fails to note that there is no evidence that Southwest consistently paid market prices for gas. As ORA notes in its reply comments, "actual prices," not market indices, "better reflect the cost of gas that could have been avoided through withdrawals."

ORA's comments note that the PD "properly find[s]" that Southwest "was imprudent in its storage utilization strategy in the summer of 2000." ORA notes that it supports the use of a 5-year historic average in calculating a disallowance. Further ORA notes that it is not necessary to find that Southwest should modify its storage guidelines to ensure it enters winter season with storage at least half full.

As noted above, basing a disallowance on a 50% use of storage is reasonable. In addition, although we concur with ORA that it is "not necessary" for our adoption of a disallowance to find that Southwest ensure that it enters the winter season with storage at least half full, we believe that it is reasonable to adopt this minimum target.

Findings of Fact

1. From December 1997 to December 2000, Southwest's gas procurement rate for its Southern Division was $2.21 per Dth.

2. On December 1, 2000, Southwest increased its rate for procured gas to $8.62 per Dth.

3. In January, February, and March 2001, Southwest increased its rate for procured gas to $12.96 per Dth, $15.76 per Dth, and $15.76 per Dth, respectively.

4. The Commission opened this investigation into the natural gas procurement practices of Southwest on June 28, 2001 in order to examine the reasonableness of managerial actions concerning gas procured in the period from June 1, 1999 through May 31, 2001.

5. There is no dispute among the parties to this proceeding concerning the applicable precedents for determining the standard of review in an investigation into the reasonableness of a utility's actions.

6. The historic range for gas prices in California was from $2.00 to $5.00 per MMBtu.

7. During the Summer of 2000, gas prices reached a high of $7.00 per MMBtu.

8. Southwest holds rights to store up to 1.5 Bcf of natural gas.

9. In the Summer of 2000, Southwest stored .17 Bcf, or 11% of its contracted storage capacity.

10. Southwest stored 1.4 Bcf of gas in 1999 (93% of capacity), 1.4 Bcf in 1998 (93% of capacity), 1.1 Bcf in 1997 (73%), and .75 Bcf in 1996 (50%).

11. Southwest's storage of only .17 Bcf of natural gas in the Summer of 2000 left it largely dependent on monthly and daily spot market prices for flowing gas in the Winter of 2000-2001.

12. Southwest did not use financial instruments such as futures contracts to hedge the price of winter gas during the Summer of 2000.

13. Currently, Southwest secures all of its gas from California gas markets.

14. The Commission sets gas storage targets for SoCalGas, SDG&E, and PG&E.

15. Southwest's tariffed gas costs were lower than SDG&E's in 17 of the 24 months of the period under review.

16. SoCalGas's tariffed gas costs were almost 50% lower than Southwest's tariffed costs during the energy crisis months December 2000 through May 2001.

17. Commission policy places the highest priority on low cost gas and makes price stability a secondary goal.

18. Southwest's gas procurement strategy in 2000-2001 failed to achieve the goal of providing low cost gas.

19. Southwest's gas procurement strategy in 2000-2001 failed to provide stable customer prices.

20. Unlike Southwest, wholesale customers including SDG&E, and the City of Long Beach made extensive use of gas storage in the Summer of 2000.

21. Southwest failed to show by a clear and convincing evidence that its gas procurement actions in the Summer of 2000 were reasonable.

22. The decision of Southwest to not fill at least 50% of its contracted storage or to secure futures contracts covering an equivalent amount of gas constitutes imprudent managerial action.

23. ORA's methodology reasonably estimates the gas costs that Southwest could have avoided by increasing its storage of gas in the Summer of 2000.

24. Using ORA's methodology, we calculate that if Southwest had filled its storage to 50% of its contracted storage capacity, Southwest could have avoided $2,691,675 in gas procurement costs during the Winter of 2000-2001.

25. The methodology proposed by the County for calculating disallowances makes operating assumptions that managers could follow only in an approximate way.

26. The index methodology proposed by the County for calculating the cost that Southwest could have saved through the use of storage overstates the potential savings because the methodology fails to reflect Southwest's demonstrated ability to purchase gas at prices below the index.

27. The methodology proposed by Southwest to calculate disallowances rests on unrealistic assumptions concerning the timing of gas purchases and gas use that understate the savings that stored gas can produce.

28. Southwest introduced new evidentiary material in its reply brief that it should have offered earlier in the proceeding.

29. Acceptance of the evidentiary material introduced by Southwest in its reply brief would be unfair to other parties to this proceeding.

Conclusions of Law

1. Utilities are held to a standard of reasonableness based upon the facts that are known or should be known at the time of decision.

2. As the Commission has previously concluded, a utility must demonstrate that its actions are reasonable through clear and convincing evidence.

3. As the Commission has previously concluded, the term "reasonable and prudent" means that at a particular time any of the practices, methods and acts engaged in by a utility follows the exercise of reasonable judgment in light of facts known or which should have been known at the time the decision was made.

4. As the Commission has previously concluded, a decision may be found to be reasonable and prudent if the utility shows that its decisionmaking process was sound, that its managers considered a range of possible options in light of information that was or should have been available to them, and that its managers decided on a course of action that fell within the bounds of reasonableness, even if it turns out not to have led to the best possible outcome.

5. Southwest was imprudent when it failed to fill at least 50% of its contracted storage in the Summer of 2000 or, in the alternative, to secure an equivalent supply of gas through futures contracts.

6. The Commission should disallow the recovery of $2,691,675 in gas procurement costs of Southwest because of imprudent managerial actions during the review period of June 1, 1999 through May 31, 2001.

7. Southwest should rebate $2,691,675 to its customers based on their consumption during the period November 2000 through March 2001.

8. The Commission should grant the County's Motion to Strike in part by striking Appendix 1 of Southwest's reply brief and the related sentences on pages 33 and 34 identified herein.

9. This proceeding should be closed.

ORDER

IT IS ORDERED that:

1. Southwest Gas (Southwest) shall reduce its Purchased Gas Account by $2,691,675 to reflect our disallowance of unreasonable gas procurement costs.

2. Southwest shall rebate $2,691,675 plus interest at the prevailing rate in Southwest's Purchased Gas Account to its core customers as a bill credit based on each customer's usage over the year from November 2000 through March 2001.

3. Southwest shall file an advice letter no later than 15 days following the effective date of this decision to provide a refund plan to implement this bill credit.

4. The County's motion to strike portions of Southwest's reply brief is granted to the extent described herein.

5. This proceeding is closed.

This order is effective today.

Dated August 22, 2002, at San Francisco, California.

I will file a concurrence.

/s/ GEOFFREY F. BROWN

We will file a joint concurrence.

/s/ LORETTA M. LYNCH

/s/ CARL W. WOOD

Commissioner Geoffrey F. Brown, Concurring:

In the course of discussion of the Southwest Gas Company case, there seemed to be considerable confusion about the standard to be employed in evaluating the reasonableness of a business decision. Many had sought to apply a restitution-type formula whereby the disallowance would be measured in terms of the harm caused by what they believed was an unreasonable business decision. Others sought to mitigate the disallowance given the high cost it represents to the company.

1) What were the goals the company hoped to achieve, and whether that goal was reasonable? In this case the company sought to provide low-cost gas.

2) What was the outcome of effort to achieve that goal? Clearly the company failed. It was subjected to huge wholesale charges on the open market.

3) Would a reasonable and prudent utility have taken other steps to achieve these goals? ALJ Sullivan compared Southwest's reserves in the Summer of 2000 against other utilities in the same position. No other utility exposed itself to the risk Southwest did. In doing that Southwest was abandoning a policy of significant storage of reserves - an average of 77% between 1996 and 1999 and "running bare". It kept reserves at 11% of its storage capacity in the face of rising gas prices. It operated on the assumption that the rise was temporary based on historical patterns. However it left little room for itself if the assumption proved to be wrong.

In determining whether its action were reasonable, the utility carried the burden of proof to demonstrate with clear and convincing evidence that its action were within a range of acceptable options. D.90-09-088 (37 CPUC2d 488,y99, [1990]) It was not required to demonstrate that it made the best possible choice, but instead, that a prudent manager might have chosen the particular option it ultimately implemented.

I do not believe that Southwest has successfully satisfied this rather high standard of proof. The question then becomes what amount of disallowance we should assign to a loss that otherwise would be imposed on ratepayers. The Proposed Decision correctly applied the formula: re-create the set of facts that would have been a minimally acceptable response to Southwest's knowledge that gas prices would rise. ALJ Sullivan did that: Southwest would have been minimally prudent had it filled its reserves up to 50% or had it secured an equivalent amount through future contracts. This would have been consistent with the goal of achieving stability in gas prices and low prices. ALJ Sullivan based this 50% figure on the lowest storage percentage in the years between 1996 and 1999. The extent a 50% reserve would have blunted the eventual gas prices represents the amount of the disallowance. (crediting, of course, the 11% they did hold reserve)

Should this amount be higher? Should the Commission adopt ORA's position and use 77% capacity as the benchmark? Undoubtedly, Southwest would have been better off with 77% capacity than 50%. However, Southwest would not have been unreasonable by placing 50% in the ground and procuring the rest on the open market. After all, what ultimately happened was unprecedented. It is important not to confound hindsight with prudence.

/s/ GEOFFREY F. BROWN

GEOFFREY F. BROWN

Commissioner

San Francisco, California

August 22, 2002

SOUTHWEST GAS INVESTIGATION CONCURRENCE OF

LORETTA LYNCH AND CARL WOOD

The company used only 11% of the storage volumes it had available going into the winter. ALJ Sullivan concluded that the company should be held accountable for the results of its having failed to hedge its price by more fully using its storage assets. The question is, how should the Commission identify the resulting unreasonable expenditures? The ALJ looked at the company's past storage practices and noted that during the prior five years, Southwest did not use less than 50% of its available capacity. Applying a very conservative approach, the ALJ assumed that it would have been reasonable for the company to use 50% of its available capacity during the winter of 2000-2001. He calculated his disallowance by applying that assumption to a computational methodology proposed by ORA. The resulting proposed disallowance is $2.7 million.

We supported an alternative approach for calculating the disallowance, in an alternate that expressed agreement with all aspects of the ALJ's analysis, except for the assumption that a 50% fill rate is reasonable. The fact that Southwest achieved any particular fill level in past years does not provide evidence that its past practices were reasonable or that it would have been reasonable to achieve the same levels during the year in question. Instead, the alternate expressly acknowledged that we cannot, even with the benefit of hindsight, conclude that any particular fill level would have been reasonable. As a proxy for what storage levels Southwest might have achieved if it had pursued a more comprehensive hedging strategy for the winter of 2000-2001, we would have applied an average of the percentage of storage attainment over the preceding five years. The resulting disallowance would have been $5.6 million.

We trust that all of my colleagues would join me in concluding that this would be an absurd result. The company remains obligated to do the prudent thing based on conditions in any given year. Southwest is still responsible for developing an appropriate strategy on a year-to-year basis.

While we support the conclusion that Southwest was imprudent in its procurement practices during the review period, we think it is important to recognize that the company did take extraordinary steps to mitigate the impacts of those procurement decisions on its customers during the last winter. At the company's request, this Commission approved a rate reduction intended to provide emergency relief during the last months of the heating season. Southwest voluntarily absorbed the impact of delaying recovery of those costs, by forgoing interest on the undercollection. Southwest clearly does care about its customers, which is why we have confidence that it will endeavor to improve its procurement practices going forward.

/s/ LORETTA M. LYNCH

Loretta M. Lynch

  

President

  

/s/ CARL WOOD

Carl Wood

  

Commissioner

  

San Francisco, California

August 22, 2002

75 As mentioned above, D.99-03-050 notes that the Commission "relegated the goal of price stability to a secondary priority." We note that the language explicitly retains price stability as a "goal" and assigns it a "secondary priority."

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