VI. Gas Distribution Utility Return on Equity and Rate of Return

We are also determining the rate of return for PG&E's and SDG&E `s gas local distribution company (LDC). All parties agree that determining ROR for an LDC is significantly different from that of the UDC because there is no dispute over a risk adjustment. All agree that the existence of public companies with business risks comparable to the natural gas distribution business and the relative stability currently prevailing in the natural gas industry simplify the cost of capital estimation procedure relative to what the Commission faces for the UDC. Therefore, the issues for the LDC rate of return are limited to financial modeling issues tempered by judgment.

Just as there was controversy with financial modeling to estimate the UDC cost of capital, the process of modeling the cost of capital for the LDC has led to controversies about inputs and assumptions, models and comparable groups. For instance, the parties modeling the LDC have developed different proxy groups, differences in growth rate assumptions for the DCF model, the same controversies over what MRP should used, the same debate over interest rate adjustments to the modeling results, and the same arguments over adjusted versus unadjusted betas. As usual, judgment is critical.

The parties' choices of comparable gas distribution companies is not determinative of the cost of capital for the LDC. Each of the parties to this case used different comparable groups for the LDC analysis. SDG&E `s witness used the Value Line group of local natural gas distribution companies. PG&E's witness started with the Value Line natural gas distribution category and then applied selection criteria to identify those companies which better approximated "pure plays" on the LDC. He eliminated companies in financial distress or involved in merger activities. ORA's witness used PG&E's comparable group. FEA's witness used a combination of ORA's and SDG&E `s comparable groups. C and K used a broad group of companies. All of these comparable groups are reasonable proxies to use for modeling in this case.

The parties who used the CAPM for modeling the UDC also used it for modeling the LDC. And the differences in the parties' inputs and assumptions for the CAPM electric utility modeling are the same for the parties' CAPM gas distribution modeling. Thus the questions of how to adjust the modeling results for subsequent changes in the risk free rate, which MRP should be used, and whether the gas proxy group's beta should be unadjusted or adjusted are the same for LDC modeling as they are for UDC modeling.

TURN did not perform financial modeling for the LDC. Instead TURN's witness stated his belief that the business risk differences between electric and gas distribution operations are small because (1) major determinants of business risk, the state of the economy, and California regulation, are largely the same for both, and (2) the Commission in the past has authorized only small ROE differences between electric and gas utilities. He then recommended an ROE for the LDC of 10 basis points over his recommendation for the UDC.

The issues involving the LDC in this case are fewer than for the UDC because there is no need to develop a restructuring adjustment. Otherwise, all the other financial modeling issues are present and in controversy.

For convenience, we repeat the recommendations found in Tables 1 and 2.

Table 1

ROE RECOMMENDATIONS

Recommendations A /
Party	Electric	Gas	Basis Points for Electric Distribution Risk (included in ROE)
PG&E	12.10	12.10	+ 100
SDG&E	12.00	12.00	+ 20 to + 100
Edison	11.60	NA	0
FEA (all)	10.85	10.85	0
Knecht-Czahar (all)	10.80	10.80	0
Weil-TURN-PG&E	9.00	9.10	- 30 to - 124
-SDG&E	9.10	9.20	- 30 to - 124
-Edison	8.80	NA	- 30 to - 124
ORA (all)	8.64	9.32	- 49

^A/ Before adjusting for the October 1998 DRI forecast.

Table 2

Current Authorized ROE
Party	Electric	Gas
PG&E	11.20	11.20
SDG&E	11.60	11.60
Edison	11.60	-
CPUC Historical BenchmarkB/	9.47	9.47

^B/ October 1998 DRI forecast 30 year T-Bonds 4.71 + 4.76 (the average Commission authorized risk premium as computed by ORA).

We do not understand why PG&E and SDG&E recommend an ROE for their LDC operations at the same level as their ROE recommendation for their UDC operations. As shown on Table 2, PG&E's and SDG&E `s current authorizations are the same for integrated electric utility operations and LDC operations. In D.93-12-022 we eliminated differences in ROE between major electric and gas companies (D.93-12-022, mimeo., 43, 52 CPUC2d 390, 412). That has been continued for PG&E (D.97-12-089) and SDG&E (D.96-11-060). We see no reason to deviate from that policy. SDG&E in its brief says "the risks associated with SDG&E `s electric distribution business will exceed the risk of the local gas distribution business" (SDG&E , O.B., p. 7). Yet SDG&E seeks the same ROE. PG&E's expert is of the opinion that LDCs represent a reasonable proxy or benchmark for stand-alone UDCs (PG&E, O.B. p. 43), that is, the risks for the LDC are similar to the risks of the UDC. He would add two or three percentage points to the LDC's cost of capital, as he did for the UDC. As we have rejected that premium for the UDC, a fortiori, we reject it for the LDC.

Having found no adjustment to be necessary for the ROE for the UDC, and applying our policy of parity between gas and electric companies, we find that the reasonable return on equity for PG&E's and SDG&E `s LDC operations is 10.6%. The rate of return for the LDC is the same as for the UDC.