7. Ratemaking Treatment

There are two major issues that we must decide: one is how the gain-on-sale of the EPTC Facilities should be apportioned¹¹: all to shareholders of SCE; all to the ratepayers; or some sharing between the two stakeholders. The other issue is: what, if anything, should be done to address the fact that SCE's electric ratepayers have paid, and are still paying, the operating costs of the FOP Facilities since August, 1999 when the CALISO determined that back-up fuel oil would be no longer necessary.

The gross sale price of SCE's FOP Facilities is $152.9 million for the EPTC
System Facilities and $5.3 million for the Station Facilities. The net gain-on-sale of the EPTC System Facilities is $47.4 million and $3.2 million for the Station Facilities.

7.1. SCE's Ratemaking Position

SCE proposes to treat the gain from the sale associated the ETPC System Facilities in accordance with what it characterizes as the long-standing "enduring enterprise" principle governing the ratemaking treatment of gains on sale, articulated by the Commission especially in D.89-07-016 (regarding the City of Redding) and D.92-03-094 (regarding SoCalWater). SCE notes that in the latter decision, the Commission summarized the principle as follows:

The "enduring enterprise" principle is neither novel nor radical. It was clearly articulated by the Commission in its seminal 1989 Policy decision on the issue of gain-on-sale, D.89-07-016, 32 Cal. P.U.C. 2d 233 (Redding). Simply stated, to the extent that a Utility realizes a gain-on-sale from the liquidation of an asset and replaces it with another asset or obligation while at the same time its responsibility to serve its customers is neither relieved nor reduced, then any gain-on-sale should remain within the utility's operation.¹²

SCE goes on to state that the Commission denied allocation to shareholders of the gain on sale from SoCalWater's former General Office, on the grounds that SoCalWater's utility obligation had not been reduced. However the Commission also expressly noted that:

[T]he gain-on-sale will accrue to the benefit of shareholders in the future if and when the utility's operations are liquidated and its obligation to serve is dismissed.¹³

SCE continues and notes the Commission's statement in the earlier Redding Decision:

"...we note that we have always allocated to the shareholders the gains or losses from the total liquidation of a public utility."¹⁴

SCE states that the principle set forth in the Redding and SoCalWater cases should apply, as the proposed sale of the FOP Facilities is just such a liquidation event for SCE. Although a Commission-jurisdictional pipeline corporation (Pacific Terminals) will continue operating the facilities, SCE is completely liquidating its interest in the pipeline utility and withdrawing from the business, and its obligation to serve pipeline utility customers will terminate.

SCE contends that the fundamental underlying principle supporting the results in those cases is equally applicable here. SCE argues that it is only the shareholders who have put their capital at risk, and that shareholders should reasonably receive all of the return on that capital. SCE further states that the ratepayers received their full "return"on the expenses borne by them through the assets' provision of services to the ratepayers. This "return" was further supplemented since 1994 by a share of EPTC's gross revenues.

In addition, SCE proposes to return to the ratepayers $28.7 million of decommissioning costs it has collected from the ratepayers to pay for decommissioning of the FOP Facilities. SCE proposes to retain an additional $9.3 million for the decommissioning of SCE's remaining fuel oil-related facilities that were excluded from the sale. SCE also proposes to return to the ratepayers any portion of the $9.3 million amount that SCE has not spent within five years.

7.2. ORA's Ratemaking Position

ORA supports the proposed sale. Its concern is the Applicants' proposed accounting of the gain-on-sale. ORA recommends allocating 86% of the gain associated with the EPTC facilities sale to the ratepayers, the balance to the shareholders. ORA states that its 14% allocation to the shareholders is in recognition of the fact that, since 1994, shareholders have made substantial improvements to the facilities and have been solely responsible for the associated costs.

ORA proposes that the EPTC facilities should be treated like other generating assets which were divested with the gain going to the ratepayers. ORA notes that as part of the electric restructuring pursuant to AB 1890, SCE divested the generating plants that had relied on the EPTC facilities for emergency backup service. Under the provisions of AB 1890, any gain on the sale of these generating plants was credited to the Transition Cost Balancing Account (TCBA) as an offset to transition costs.

ORA notes that while D.01-02-059 found that the EPTC facilities were no longer used and useful from the perspective of electric ratepayers, the ratepayers continued to pay for them as though they were still providing a generation-related service.

ORA states that under the unique circumstances of the energy crisis, the fact that SCE was near bankrupt, led to the Settlement Agreement between the Commission and SCE, which obligated SCE's ratepayers to $3.2 billion in procurement related liabilities. These cost are recorded in the Procurement Related Obligations Account (PROACT). ORA believes that fairness dictates that the facilities should be treated like other generation assets which were divested pursuant to AB 1890 with the proceeds from the sale of the facilities used to the offset ratepayers' obligation under the Settlement Agreement to pay off the $3.2 billion balance. ORA points out that this is the same treatment SCE proposes for the smaller $3.2 million gain associated with sale of the Station Facilities. ORA also points out while the facilities are not longer generation-related, this should not alter its recommendation.

ORA also notes that while the facilities are not currently providing a generation related service, SCE's ratepayers continue to pay for them as if they were still providing a generation-related service. ORA estimated in its July 10, 2002 report (Exhibit 601) that since August 1999, the time period in which CAISO declared that back up fuel oil facilities would no longer be required, that ratepayers have contributed over $60 million in support of facilities, which were no longer providing a service. ORA estimates that the annual revenue requirement for these facilities supported by the ratepayers is $20 million.

ORA also believes the shareholders' share of the gain-on-sale should be limited to SCE's authorized rate of return, 11-12%, rather than its estimate of 150% rate of return if it receives all the gain-on-sale.

ORA does not believe the two cases cited by SCE support SCE's position for 100% of the gain-on-sale to accrue to the shareholders of SCE. ORA believes the cases are significantly different. ORA cites the four (4) part test of the Redding II line of cases in determining whether the gain-on-sale goes to the shareholders, and concludes, at best, that SCE does not meet the requirements completely. It states that even if Redding II is the appropriate standard, ratepayers are entitled to a substantial part of the gain based on the fact that since mid-1999 the ratepayers have been effectively contributing capital to the third party business, the pipeline customers.

ORA cites D.94-09-032, 56 CPUC 2d, 4, a case involving California Water Service Company, which was decided after Redding II. In that case the Commission addressed a situation in which a water company was selling 26 parcels of land that were no longer used and useful but which had improperly remained in ratebase long after losing their usefulness. ORA believes that situation is quite similar to the one here, since the assets being sold lost their usefulness in August 1999 and are still in ratebase. Under those circumstances the Commission found that the gain should be split 50/50 between ratepayers and shareholders. Id., p. 15-16.¹⁵

ORA also recommends that the $28.7 million decommissioning costs be returned to the ratepayers, but recommends that of the $9.3 million that SCE has retained for decommissioning of the fuel oil-related facilities not included in the sale be returned with interest at the end of the five-year period.

7.3. CUE's Position on Ratemaking

CUE believes that the Commission should reject SCE's proposal that the entire gain on sale from the EPTC System Facilities be allocated to SCE's shareholders. CUE maintains that SCE requests this treatment even though the entire EPTC System Facilities have been supported by electric ratepayers over their entire, 50-year existence and continue to be supported by electric ratepayers to this day, and despite the fact that SCE argues that the EPTC System Facilities ceased to be used and useful to electric ratepayers in August 1999. CUE recommends at a minimum, that the Commission should require SCE to allocate a portion of the gain-on-sale for the sale to ratepayers to cover all O&M and A&G costs that ratepayers have contributed to the EPTC System Facilities from September 1999 to the close of sale.

CUE states that SCE's witness Kelly acknowledges the EPTC assets have not performed any service for the electric ratepayers since the CALISO made its decision in August of 1999. CUE calculated, because Kelly was unable to provide a breakdown, that SCE will have received $34,250,040 from electric ratepayers since September 1999 through 2002 in O&M and A&G costs for facilities that are neither used nor useful to them.¹⁶

CUE notes that according to witness Kelly,

[t]hat's the nature of forward-looking test-year ratemaking. That's the nature of frozen rates in California. ...In the same symmetrical sense that Edison would typically not be allowed to recover from ratepayers many millions of dollars of unexpected or unforecasted expenditures for other operating or capital expenses until the next rate case.¹⁷

CUE states, however, that Mr. Kelly overlooks at least four significant facts, and based on those facts that the Commission should return to ratepayers at least all O&M and A&G costs paid by ratepayers since September 1999. Those four facts are as follows:

· SCE's approach violates the terms of the Settlement Agreement authorizing third-party use of the EPTC facilities. The Agreement states that:

Implementation of the Agreement does not require any recovery through electric customers' rates other than the costs or expenses normally associated with Necessary Electric Utility Uses.¹⁸

The settlement defines Necessary Electric Utility Uses as:

[t]hose uses of the existing System which are necessary for the safe and reliable transportation and storage of fuel oil for Edison's electric generating units.¹⁹

CUE states SCE claims that the EPTC facilities have not been "necessary for the safe and reliable transportation and storage of fuel oil for Edison's electric generating units" since August 1999 at the latest.²⁰ CUE concludes that under the Commission-approved settlement agreement, SCE was not entitled to recover any costs and expenses for electric customers since that time.

· Second, CUE claims that neither the Commission nor SCE can ignore California law, which requires every electrical corporation to "immediately notify the Commission when any portion of [its generation] facility has been taken out of service for nine consecutive months" (Pub. Util. Code § 455.5(b)) so that the Commission can "determine whether to reduce the rate of the corporation to reflect the portion of the electric ... generation ... facility which is out of service." (Id., § 455.5(c).) CUE goes on to state that performance-based ratemaking (PBR) does not and could not alter this requirement of California law. It states that because SCE is seeking to sell the facilities, now is the time for the Commission to make this adjustment, by ensuring that ratepayers recover in gain-on-sale the funds needlessly expended since September 1999.

· Third, CUE states that Mr. Kelly implies that both SCE and ratepayers will win some and lose some under the PBR benefit-of-the-bargain. However, CUE notes that SCE did not sit back quietly and accept its loss when the procurement costs bargain that it struck came crashing down on its head; moreover, ratepayers are now retroactively covering most of SCE's losses under that bargain through the PROACT account.

· Fourth, CUE claims that Mr. Kelly acknowledges that SCE seeks a true-up of SCE's "many millions of dollars of unexpected or unforecasted expenditures for other operating or capital expenses" in the next general rate case." (RT pp. 12-13, lines 25-1.) CUE believes that this is the opportunity for the Commission to seek that true-up (if it approves the sale), through allocation of the gain-on-sale.

CUE also recommends that a refund is required by Pub. Util. Code § 455.5(c), a provision of the code pertaining to ratemaking treatment of utility generating facilities that have gone "out of service." CUE believes that SCE's electric ratepayers , under Section 455.5(c), are entitled a refund.

7.4. Ratemaking Discussion

We are troubled by the fact that from August 1999 to date, SCE collected in rates amounts estimated to be as high as $60 million to cover the operating costs of the FOP Facilities. SCE witness Kelly testified that this was all right, because Performance Based Ratemaking (PBR), the basis of which SCE electric rates are currently set, allows for the over and undercollecting due to changes not forecast originally when rates were set. We don't think it is quite that simple, as SCE in effect has had its rates frozen since 1998 as a result of AB 1890. We do know that under PBR there is some risk to ratepayers and shareholders alike. Simply stated, if revenues are higher than anticipated while expenses are less, the shareholders benefit, and conversely so for the ratepayers plus or minus a productivity factor. We do not think the August 1999 order by CALISO was so insignificant an event. Unfortunately at that time this event did not trigger an investigation as to whether a rate decrease would be appropriate. We recognize that there are always differences between the forward-looking estimates we use to adopt rates for the future test periods. Nonetheless, we know that sometimes things change, as they did for SCE and the whole energy industry with runaway wholesale energy costs which caused SCE to request an increase in electric rates.

Having said this, we unfortunately are forced to conclude that the operating costs to provide for the back-up fuel oil facilities when SCE's revenue requirement was set were at the time reasonable, and still are unless we institute an investigation (OII) at this time, to find otherwise. It is our view that any adjustment made now to recapture those operating costs would constitute retroactive ratemaking.

We do recognize the fact that ratepayers did and still do receive 12 ½% of the gross revenues that SCE receives from it oil pipeline customers.²¹

Section 455.5 is plainly not applicable in this case. CUE has misinterpreted the section. First, we have found that these facilities are no longer "generation-related facilities." Second, the provisions of Section 455.5 do not call for a refund unless or until an investigation by the Commission is made. No rate reduction is statutorily mandated, and the statute does not provide for any rate reduction retroactive to the date of the initiation of the Commission's investigation.

We should note as SCE points out that its witness, Mr. Kelly, testified to the fact that SCE was unable to sell and move out all of the fuel oil that was used for back-up fuel until January 2001. SCE argues that if the Commission makes an adjustment to recognize the collection of operating costs associated with the provision of the back-up fuel facilities which were no longer required, which it does not believe is appropriate in the first place, that the adjustment should only be from January 2001, not from August 1999.

SCE proposes to keep all the $47.4 net gain-on-sale from the $152.9 sale of the FOP Facilities to Pacific Terminals. In support of its position, SCE cites two decisions where the gain on sale accrues to the shareholders.

SCE proposes that the ratepayers receive the net gain of $3.1 million from the Station Facilities sale of $5.3 million. Again the two sales total $158.2million. SCE states in its reply brief that the ratepayers benefit from the sale as follows:

· Ratepayers receive $3.1 million from the sale of the Station Facilities;

· Ratepayers have returned to them approximately $28.7 million in decommissioning costs; and

· Ratepayers receive the full recovery of the remaining undepreciated net ratepayer investment in the EPTC and Station Facilities of some $10.9 million.

SCE contends these benefits to the ratepayers total at least $42.7 million. We agree and accept SCE's estimate of $3.1 million from the sale of the Station Facilities and SCE's decommissioning cost estimate of $28.7 million based on year end 2001. But we have not seen SCE's $10.9 million "benefit" discussed to any extent in the record by SCE, ORA or CUE. SCE now proposes to flow through to the ratepayers the "remaining undepreciated net ratepayer investment in the EPTC and Station facilities ($10.9 million).

It appears to us that SCE is not so generous as it would have us believe as it is only giving back to the ratepayers monies they have already paid to the company, that is, returning the decommissioning expense that ratepayers have paid for and the undepreciated ratepayer contributed investment in EPTC and the Station Facilities,²² and the $3.1 million from the sale of the Station Facilities to Pacific Terminals. Nonetheless, under SCE's proposal, ratepayers net approximately $42.7 million. The equivalent benefits to the SCE's shareholders are $106.6 million²³ as derived by SCE.

CUE did not address the gain-on-sale issue other than to suggest that ratepayers should be credited with some amount for all the EPTC operating costs collected from them since the CAISO decision.

ORA while agreeing in principle with CUE points out areas of disagreement with the Commission decisions that SCE relies upon. We read all these citations and find that there are enough differences between them and this case that we cannot rely upon them as precedent setting here. Those differences are:

· In ORA's California Water Service Co., D.94-09-032. 56 CPUC 2d, 4, a case after Redding II the Commission split the gain-on-sale 50/50 for the sale of 26 parcels of land that were no longer used anduseful. However, the Commission did say that decision applied only to water utilities.

· Regarding Redding II, ORA notes that here is a case of an asset where ratepayers are paying for an underutilized asset while receiving a share of the gross revenues from a third-party business.

· This differs from Redding II because the electric ratepayers that were served by these assets will not be served by the acquiring utility.

ORA states in Exhibit No. 601, p. 10-11 that it would be entirely reasonable to allocate all the net proceeds to reduce SCE's Procurement-Related Obligations Account (PROACT), and thus reduce the ratepayer burden by 1.5% of the $3 billion account. At the same time ORA states that it recognizes that SCE did engage in at-risk investment to develop these facilities. Based on SCE's capital structure ORA concludes that the return based on this sale is 150% to SCE and consequently recommends a 14% allocation to SCE and an 86% of the net gain to the ratepayers via credit to PROACT. SCE contends that this is unreasonable and violates the Settlement Agreement between it and the Commission.

We are left with the task of determining a reasonable allocation of the net gain-on-sale of $47.4 million. We do not believe it is reasonable to allocate the whole gain to the ratepayers on the basis that the plant was once "generation-related assets" as ORA suggests. We do not know why SCE did not dispose of these assets as it did its power plants pursuant to AB 1890. But it did not do so, and those assets are no longer "generation-related assets." They are the assets of a regulated pipeline company; therefore, we will not treat them as "generation-related assets."

In making our decision we are guided by the facts underlying D.94-10-044, A.94-02-049 CPUC 2d, pp. 642-680. In that decision the Commission authorized SCE to transform its oil pipeline system into a third-party long-term oil transportation pipeline, making it a pipeline corporation, subject to Commission jurisdiction. In this decision, the Commission adopted the "Gross Revenue Approach" for ratemaking. It noted that SCE will pay all third-party related costs from its share of the gross revenues. Ratepayers will receive 12 ½% of gross revenues and will continue to accept the risk and costs of the existing pipeline system. Now this entrepreneurial endeavor of SCE's is being sold or liquidated. We see this as liquidation of an enterprise and see no reason not to allocate the proceeds on the same basis as the gross revenues are allocated between shareholders and ratepayers, that is, 87 ½% to the shareholders and 12 ½%to the ratepayers. We will apply these same percentages to the gross proceeds, $152.9 million, from the sale. The $152.9 million is the gross revenues from FOP Facilities and equates to the $47.4 million net-gain-on sale. The resulting allocation provides $19.1 million²⁴ to the ratepayers or approximately a 40.3%/59.7%, ratepayer/shareholder split. We believe that this is fair to both shareholders and ratepayers as the ratepayers supported this endeavor from inception. This allocation is fair to the shareholders as they receive a net gain $28.3 million.

We will direct that the ratepayers' share of the net gain, $19.1 million, be credited to the PROACT or to the Electric Distribution Revenue Adjustment Balancing Account if the PROACT has been eliminated at the time of crediting.

SCE contends in its reply brief on pp. 16-17 that any adjustment to the PROACT would be a violation of the Settlement Agreement between it and the Commission. It cites Section 2.9, which reads in part as follows:

[i]t is the intent of the Parties that SCE actually recover Procurement Related Obligation recorded in the PROACT, without offset, as rapidly as possible....[Emphasis added by SCE in italics; bold by us.]

It strikes us as rather strange that on one hand SCE proposes to credit the PROACT with the ratepayers net gain-on-sale from the Station Facilities,²⁵ but on the other hand claims that it would be a violation of the Settlement Agreement if any of the net gain-on-sale from the EPTC Facilities is allocated to the ratepayers and credited to the PROACT. If we put the emphasis on "as rapidly as possible," it would seem that we are accomplishing that goal by directing the ratepayers' net gain-on-sale that we calculate to be $19.1 million.

SCE also argues in its reply brief that ORA's proposed 86%-14% split of the net gain (to make up for the supposedly unbalanced impact of the Settlement Agreement) is essentially a request that the Commission now unilaterally amend the Settlement without SCE's consent, which is impermissible under the Settlement.²⁶ First, we are not adopting ORA's recommendation, and second, we fail to see the applicability of that settlement provision to our determination to credit the PROACT with the ratepayer net gain-on-sale.

With regard to CUE's recommendation that a refund is required by Pub. Util. Code § 455.5(c), because these are utility generating facilities that have gone "out of service," we find that Section 455.5 (c) is plainly not applicable in this case. CUE has misinterpreted the section. First, we have found that these facilities are no longer generation facilities. Second, the provisions of Section 455.5 (c) do not call for a refund unless or until an investigation by the Commission is made. No rate reduction is statutorily mandated, and the statute does not provide for any rate reduction retroactive beyond the date of the initiation of the Commission's investigation.

As to the issue of the residual $9.3 million decommissioning cost related to the fuel oil facilities not included in the sale, we agree with SCE that the shareholders are bearing the risk if the decommissioning costs exceed $9.3 million or extend beyond five years. SCE notes that if the costs are less than $9.3 million at the end of five years, then the ratepayers will receive the remaining unspent amount. SCE's plan is fair.

7.5. Other Ratemaking Issues

SCE has proposed removing the EPTC System Facilities cost from its revenue requirement by the filing of an advice letter to reduce PBR Distribution rate by approximately 0.0289 cents/kWh. That is reasonable.

SCE also proposes to return the decommissioning costs to the ratepayers by recording the amount to the SRBA, thereby reducing the amount of Recoverable cost during the month in which it makes the credit. Then in the month that the refund is recorded, it will be an increase in the amount of Surplus applied against the PROACT balance. SCE proposed to handle the Station Facilities $3.1 million gain-on-sale in this manner, and we will direct them to do likewise with the ratepayers' $19.1 million portion of the EPTC System Facilities gain-on-sale.

Other than ORA's issue regarding interest on the as yet refunded decommissioning costs, no party opposed SCE's refund proposals.