VI. Ratemaking Issues

In her March 12, 2003 ruling, the assigned ALJ directed Cal-Am to serve testimony clarifying the ratemaking treatment sought in its motion, and further describing the current ratemaking treatment for past and future costs of environmental review, development, permitting and other required approvals. Cal-Am complied on April 1, 2003. The ALJ allowed parties to prepare responsive written testimony and scheduled evidentiary hearings to examine the testimony on May 14, 2003. The ORA was the only party to serve testimony.

Cal-Am's ratemaking request covers three categories of costs:

1. Costs incurred or yet to be incurred in connection with the Carmel River Dam project;

2. Costs incurred associated with development of Plan B; and

3. Costs expected to be incurred in connection with the Coastal Water Project.

A. Carmel River Dam Costs

Costs in this category are related to initial, preliminary engineering studies, environmental studies, analysis of necessary permitting requirements, and development of cost estimates. This category includes costs associated with environmental review by the District of Cal-Am's Carmel River Dam project. Cal-Am's witness indicated that $3,279,161 in costs have been incurred to date (Exhibit 1, 3:22) but that at least two invoices from the District have not been paid by Cal-Am and others may be submitted for payment in the future. (TR 234:20-25.) Under cross-examination, Cal-Am's witness indicated that he was unaware of additional activities by the District or Cal-Am that might cause additional costs to be incurred in connection with the Carmel River Dam project. (TR 235:17-236:4.)

Decision (D.) 03-02-030 adopted ratemaking treatment for certain costs associated with the Carmel River Dam project. Costs incurred prior to 2002 ($2,852,900) are classified as Construction Work In Progress (CWIP) and included in ratebase, earning Cal-Am's authorized rate of return. Cal-Am expects that once a long term water supply project is put in service, these costs will be included as part of the total project construction cost. (Exhibit 1, 4:7-9.) D.03-02-030 authorized an additional $750,000 in CWIP for the Carmel River Dam project in 2002 through 2004.

Cal-Am considers these authorized funds to be in support of a long-term water supply solution for its Monterey District, not only available for the Carmel River Dam project. Accordingly, Cal-Am expects that costs associated with initial, preliminary engineering studies, environmental studies, analysis of necessary permitting requirements, and development of cost estimates for the Coastal Water Project will be treated the same way as these authorized costs for the Carmel River Dam project were in D.03-02-030. (TR 236:24-237:13.) Cal-Am asks that any costs incurred above the total amount authorized by D.03-02-030 ($5,102,900) be booked in a deferred debit account earning an Allowance For Funds Used During Construction (AFUDC) at Cal-Am's authorized rate of return. Cal-Am argues that it should be allowed to earn on these expenditures at its authorized rate of return because it is consistent with past precedent and pursuit of either project is mandated by government.

ORA initially proposed that the Carmel River Dam funds authorized in D.03-02-030 be removed from CWIP and instead be amortized over three years. (Exhibit 10, 3.) However, in subsequent testimony, ORA modified that position and now proposes that there be no change to the rate design authorized in D.03-02-030 at this time. (Exhibit 11, 2.) Instead, ORA recommends that the Commission state that in the next General Rate Case it will remove any Carmel River Dam costs incurred after May 14, 2003 from CWIP.² ORA also recommends that the Commission remove any dollars authorized, but not expended by Cal-Am, for the Carmel River Dam project from CWIP, and any expenditures in excess of those authorized by D.03-02-030 be disallowed.

D.03-02-030 adopted ratemaking treatment for Carmel River Dam project costs, not any project. Although we agree that the Coastal Water Project and the Carmel River Dam are potentially alternative water solutions, the adopted ratemaking treatment was solely for Carmel River Dam project costs. We will not modify the ratemaking treatment adopted in D.03-02-030, but in its next general rate case, Cal-Am should adjust its revenue requirement request to remove from CWIP any amounts adopted in D.03-02-030 that were not spent on the Carmel River Dam project. We will not adopt a specific date cut off by which we expect costs will no longer occur, as proposed by ORA, because it is possible that there will be additional costs associated with the ongoing review of the Carmel River Dam project or winding down of that review process in light of Cal-Am's new project proposal. This ratemaking treatment will allow a clean separation of costs between Cal-Am's old project (the Carmel River Dam) and new project (Coastal Water Project).

B. Plan B Costs

In Resolutions W-4131 and W-4237, the Commission authorized the expenditure of $1.75 million for development of an alternative water supply solution to the Carmel River Dam.³ Cal-Am was authorized to establish a memorandum account to track payments for this effort. Interest in this account accrues at the 90-day commercial paper rate. Cal-Am was directed to seek recovery of these costs by advice letter after full payment was made to the Commission. Cal-Am has also booked costs spent in connection with holding public meetings, notifying customers of public meetings and Commission proceedings, Cal-Am's legal and consultant fees to review Plan B, and accrued interest. As of May 9, 2003 (the date Cal-Am served its rebuttal testimony), Cal-Am indicated the Plan B expenditures (including the costs just described) totaled $1,761,751.57.⁴

Cal-Am indicates that as of April 1, 2003 (the date it served its testimony), it had recovered $554,992 through a surcharge. (Exhibit 1, 6:17-18.) The surcharge has since expired, but Cal-Am proposes to institute another surcharge to recover its remaining costs (Commission Plan B costs and other costs it booked to the memorandum account) as soon as Rulemaking (R.) 01-12-009 is resolved.

Cal-Am indicates that all Plan B related costs, including the costs of holding public meetings, notifying customers of public meetings and Commission proceedings, Cal-Am's legal and consultant fees to review Plan B, plus interest should be reimbursed, even if the resolutions authorizing the memorandum account did not specify these additional Cal-Am incurred costs. Cal-Am stated under examination by the ALJ that the costs booked to the memorandum account associated with holding public meetings and notifying customers of public meetings and Commission proceedings were required by the ALJ in the proceeding, although the witness could not identify particular rulings that required these expenditures. (TR 263:12-264:18.)

ORA opposes recovery of any costs booked by Cal-Am to the Plan B memorandum account beyond the costs authorized by W-4131, W-4205, and W-4237. Thus, ORA opposes recovery of the costs of holding public meetings, notifying customers of public meetings and Commission proceedings, and Cal-Am's legal and consultant fees to review Plan B. ORA did agree that the accrued interest should also be recovered. (TR 287:25-288:1.) ORA recommends that to the extent that Cal-Am does not seek timely recovery, by advice letter, of the costs that are properly booked to the Plan B memorandum account, that interest should no longer accrue. Under examination by the ALJ, ORA agreed that lack of resolution of R.01-12-009 could be considered a mitigating factor in why Cal-Am has not filed an advice letter for recovery of the outstanding Plan B costs. (TR 288:28-289:12.)⁵

There are two primary issues outstanding with respect to recovery of costs associated with Plan B. First, should Cal-Am's costs beyond the Commission's Plan B costs be allowed to be booked into the Plan B memorandum account for recovery? Second, should interest on the amounts in the memorandum account continue to accrue interest at the 90-day commercial paper rate until recovered? We address these issues one at a time.

1. Booking of Cal-Am Costs Beyond Commission Plan B Costs

We have reviewed Resolutions W-4131, W-4205, and W-4237 which approved the establishment of the ratemaking accounts⁶ to book Commission Plan B costs. Resolution W-4131 states in Ordering Paragraph 1 that "Cal-Am shall reimburse the Commission for the costs of consulting services for the preparation of the long-term contingency plan and environmental assessments for its Monterey Division." This language does not contemplate that the account established will include any costs beyond Commission incurred costs. Resolution W-4237 increased the amount to be recovered from Cal-Am and again the ordering paragraph limited the costs to "the costs of consulting services to prepare the long-term contingency plan and environmental assessments" and for "payments to the Commission." (See Ordering Paragraphs 1 and 2.) Although Cal-Am states that it has incurred approximately $80,000 in connection with public meetings, customer notices, legal fees, and other expenses, the language of the resolutions regarding Plan B development costs simply does not provide for such Cal-Am costs to be booked to the ratemaking accounts authorized by those resolutions. Cal-Am argues that it was directed to incur these costs by the Commission, and thus they should be allowed recovery. However, Cal-Am did not identify under questioning by the ALJ or in its brief when the Commission, Assigned Commissioner, or Assigned ALJ directed it to incur these costs it now seeks to recover. Cal-Am simply relies on the fact that the Commission held numerous public meetings to gather information as a reason why these costs should be recovered. Given the clear language of the resolutions authorizing booking and recovery of Plan B costs, Cal-Am's additional costs cannot be found recoverable as Cal-Am proposes.

2. Continuation of Interest Accrual

With respect to accrual of interest, ORA suggests that interest no longer accrue on the memorandum account after the last Plan B expense was incurred. ORA argues this provides Cal-Am with an incentive to seek timely recovery of the remaining amounts in the memorandum account. Cal-Am counters that it must await the conclusion of R.01-12-009 until it seeks recovery of these costs through a surcharge.

Although we understand ORA's desire to have these costs recovered in a timely matter, it is inappropriate to suspend interest accrual once the final Plan B related cost is booked. Instead, as is standard practice, interest shall continue to accrue at the 90-day commercial paper rate until the costs are fully recovered by a new surcharge. We have reviewed R.01-12-009 and find that the purpose of that rulemaking does not extend to the type of reimbursable Commission costs we address here and find that Cal-Am should promptly file an advice letter to propose a surcharge for recovery of the outstanding costs properly booked to the Plan B memorandum account.

C. Coastal Water Project Costs

As described above, Cal-Am proposes that costs associated with initial, preliminary engineering studies, environmental studies, analysis of necessary permitting requirements, and development of cost estimates for the Coastal Water Project, up to the amount authorized in D.03-02-030, be treated as CWIP at Cal-Am's authorized rate of return. For costs incurred above the level authorized in D.03-02-030, Cal-Am proposes that those expenditures be booked in a deferred debit account accruing AFUDC at Cal-Am's authorized rate of return. (Exhibit 1, 6:1-8.) Cal-Am expects to propose in its next general rate case to transfer accumulated expenses in the deferred debit account to CWIP. (Exhibit 1, 7:18-23.)

ORA opposes Cal-Am's proposed ratemaking treatment. ORA proposes that all costs incurred related to the Coastal Water Project be booked in a memorandum account and accrue interest at the 90-day commercial paper rate. (ORA Brief, p. 12- 13.) ORA states that this treatment is consistent with the ratemaking treatment for long-term construction projects that do not earn their authorized rate of return until placed in service. ORA argues that the Coastal Water Project is unique from typical water projects because of its scale and lead time and thus should not earn at the full rate of return until placed in service. (Exhibit 10, 7.) ORA indicates that in D.00-03-053, the Commission adopted this ratemaking treatment (AFUDC at 90-day commercial paper) for the costs of the Carmel River Dam project.

Cal-Am also proposes to recover costs associated with a public information campaign it plans to undertake in support of its Coastal Water Project. Cal-Am proposes that these costs be booked to a deferred debit account and accrue AFUDC at the authorized rate of return and then recovered as a surcharge on rates in the future. ORA states that Cal-Am has provided insufficient information regarding the public information campaign for these costs to be considered a legitimate expense. In addition, ORA states that the Commission has traditionally disallowed funding for public relations or advertising, and thus ORA would not allow recovery of these costs.

1. Coastal Water Project Ratemaking Treatment for Development Costs

As we described above, because the ratemaking treatment in D.03-02-030 relates specifically to the Carmel River Dam project, we decline to automatically treat any costs associated with initial, preliminary engineering studies, environmental studies, analysis of necessary permitting requirements, and development of cost estimates for the Coastal Water Project, as CWIP at Cal-Am's authorized rate of return. Cal-Am and ORA agree that cost should be booked but differ as to the rate at which interest or AFUDC should accrue on these costs.

ORA argues that the type of ratemaking treatment proposed by Cal-Am is generally adopted for construction costs relating to capital expenditures that are underway but are not yet used and useful. ORA is concerned that there is significant risk that these costs (which are preliminary engineering and other costs prior to even beginning construction) will never be associated with a capital investment that is used and useful and thus should not earn the utility's authorized rate of return at this time. Cal-Am argues that the Commission typically grants water utility investments for and related to capital projects the company's authorized rate of return. ORA counters that this approach was adopted for the water industry because water utilities generally had few long-term construction projects and that the average water construction project took four months. (See Exhibit 10, pp. 7-8.) Because the Coastal Water Project clearly does not meet these criteria, ORA recommends that its costs be handled like other long-term construction projects, i.e., earning interest at the 90-day commercial paper rate. ORA likewise favors use of a memorandum account over a deferred debit account because items tracked in a memorandum account are clearly subject to review for reasonableness.

As we previously held in D.94-08-031, water utilities:

"are uniquely able to seek construction work in progress (CWIP) accounting to recover the cost of financing plant under construction but not yet used and useful. Other utilities must rely on the less immediate `allowance for funds used during construction' (AFUDC) accounting method, which defers recovery of construction financing costs until after the plant is placed in service. Water utilities are authorized to seek CWIP accounting because of a perception that water utility construction projects are generally shorter than other utility construction projects, and because CWIP accounting may cost ratepayers less than AFUDC accounting." (See D.94-08-031, 1994 PUC LEXIS 474 at *7, note 2.)

Thus, we must evaluate whether or not the costs at issue here are related to a water utility construction project of generally short duration to determine whether or not the CWIP or AFUDC at authorized rate of return ratemaking treatment Cal-Am seeks is appropriate. Because the Coastal Water Project will clearly require a significant period of time for construction, distinguishing it from typical water utility construction projects, we conclude that it is not entitled to the specialized CWIP ratemaking treatment offered to short duration water projects. In addition, the costs at issue here are predecessor costs to construction costs, in other words, construction work is not underway on the project and thus they are not funds used during construction. It remains unclear at this time when (or whether) any plant construction will commence. Therefore, allowing these preliminary costs to earn the utility's authorized rate of return now carries with it significant risk that the ratepayers may never receive the benefits of these expenditures.

For these reasons, we conclude that the most appropriate manner to track these costs is for Cal-Am to establish a memorandum account to books costs associated with initial, preliminary engineering studies, environmental studies, analysis of necessary permitting requirements, and development of cost estimates for the Coastal Water Project. The memorandum account shall accrue interest at the 90-day commercial paper rate. As the status of the proposed project becomes more certain (for example, if a CPCN is granted or construction is underway), we will consider modifying this ratemaking treatment upon application by Cal-Am.

2. Public Information Campaign Costs

Regarding public information costs, ORA raises legitimate concerns regarding the nature of the costs that Cal-Am proposes. Cal-Am has not provided sufficient information to allow us to determine whether these costs serve a legitimate public education function, which might be allowed, or are more in the nature of an advocacy effort that should not be funded by ratepayers. We will allow Cal-Am to track these expenditures in a memorandum account, and to accrue interest at the 90-day commercial paper rate. We utilize the 90-day commercial paper rate because these costs are expenses that are not typically capitalized and do not typically earn a utility's authorized rate of return. In its next general rate case, Cal-Am may make a reasonableness showing for the recovery of these expenditures and recover the reasonable costs through a surcharge in addition to the rate adopted in that general rate case.