Background

SDG&E has been operating under a base rate PBR mechanism since 1994. Edison operates under a distribution PBR mechanism, as described in D.96-09-092, D.98-07-077, and D.98-08-015. SoCalGas also operates under a PBR mechanism, as described in D.97-07-054. As approved in D.98-03-073, SoCalGas and SDG&E are now operating entities within the holding company of Sempra Energy, Inc., as a result of the merger of Enova Corporation and Pacific Enterprises, the parent companies of SDG&E and SoCalGas, respectively. We will briefly review the design of each of these mechanisms.

The process of developing an effective PBR mechanism begins with selecting an appropriate starting point for revenue requirements. In this proceeding, we have approved a settlement for this amount, as discussed in D.98-12-038. Revenue requirements or rates are then adjusted annually to account for inflation and productivity, using indexing methods. Taken together, inflation with the productivity offset is commonly described as "Consumer Price Index (CPI) minus X" or the "update rule." Incentives are then developed to ensure that utility decision-makers are motivated to achieve cost savings.

Earnings sharing mechanisms track actual earnings and share with ratepayers any earnings or losses that fall above or below a certain threshold. Generally, earnings sharing mechanisms have deadbands in which there is no sharing; i.e., ranges in which only shareholders are at risk for the earnings variations. A live band is the range of an applicable PBR performance indicator against which the compared utility performance may result in varying rewards or penalties. Adopting an effective PBR mechanism requires a balance between providing appropriate incentives to utilities with adhering to our stated goals of providing an equitable sharing of the benefits. In addition, our objective of encouraging the utilities to operate more effectively in a competitive marketplace suggest that these benefits must be shared with ratepayers.

Earnings sharing mechanisms may be either progressive or regressive. A regressive mechanism is one in which the utility's share decreases as cost savings increase. In contrast, a progressive mechanism is one in which the utility's share increases as cost savings increase. Finally, "Z" factors apply to exogenous or unforeseen events that are beyond the utility's control and that have a material impact on the utility's costs. In D.94-06-011, we adopted nine criteria for determining whether the cost impact from these unexpected events should be included in the utility's revenue requirements. In sum, the formula describing PBR regulation is as follows:

R_n = (r *(esc -X)) + Z

where:

R = rates or revenue requirements in years following initial period

n = year for which rates or revenue requirements are determined

r = starting point rates or revenue requirements

esc = escalation or inflation measure

X = productivity measure

Z = any one-time unforeseen costs that must be accounted for

In addition, each PBR mechanism has various performance indicators. These performance indicators are designed to ensure that the utility's service quality, customer service, reliability, and safety do not deteriorate under PBR regulation. The utility's performance is reviewed according to certain criteria and either earns a reward or suffers a penalty. These rewards and penalties are in addition to any earnings or losses achieved under the earnings sharing component of the mechanism.

SDG&E's Base Rate PBR Mechanism

SDG&E's initial PBR mechanism was adopted on September 1, 1994 and applied to the period 1994 through 1998. This base rate PBR mechanism required a sales forecast and the 1993 GRC revenue requirements were adopted as the starting point for this mechanism, as escalated to 1994 using specific PBR formulas for operation and maintenance (O&M) costs and net plant additions. Different inflation components were applied to labor O&M costs (the SDG&E labor escalation factor), non-labor O&M costs (the DRI national inflation index), and plant additions (the Handy Whitman inflation index). The productivity component was fixed at 1.5% and was applied only in O&M formulas. A customer growth factor was incorporated in both O&M inflation factors and the plant additions inflation factor.

There is no earnings sharing up to 100 basis points⁴ above the authorized rate of return. The 100 basis points consist of a deadband. From 100 to 150 basis points above the authorized rate of return, a regressive sharing mechanism was adopted in which 75% accrues to shareholders and 25% accrues to ratepayers. From 150 basis points above authorized rate of return, sharing is 50/50. There is no downside risk to ratepayers. No specific Z-factor treatment was adopted, but parties had the ability to file petitions for modification. No specific exclusions were accounted for, but SDG&E could apply to request exclusion of certain material external events above $500,000. A midterm review was required, with reports on annual performance and annual escalation updates. Offramps to the PBR mechanism were built in at 150 basis points below the authorized rate of return and 300 basis points above and below the authorized rate of return.

During the period 1994 through 1997, SDG&E has earned approximately $136 million in after-tax dollars from its earnings sharing mechanism. In 1994, SDG&E earned 94 basis points above its authorized rate of return, which is within the deadband. In 1995, SDG&E earned 130 basis points above the authorized rate of return, which is 30 basis points above the deadband area. In 1996, SDG&E earned 152 basis points above its authorized rate of return, or 52 basis points above the deadband. In 1997, SDG&E earned 153 basis points above its authorized rate of return, or 53 basis points above the deadband.⁵ SDG&E also accrued net performance rewards of approximately $18.7 million through 1997. As adjusted by Resolution E-3512, ratepayers' share of earnings above authorized rate of return equaled $6.8 million through 1996. Ratepayers' share in 1997 is expected to equal approximately $4.4 million for a total of $11.2 million over the four-year period.

Edison's Distribution PBR Mechanism

Edison's initial PBR mechanism was adopted in D.96-09-092, to be effective for the period 1997 through 2001. This electric distribution base rate PBR mechanism does not require a sales forecast and the 1996 GRC revenue requirements, as separated transmission and distribution components, were adopted as the starting point for this mechanism, as escalated to 1997 using the "CPI - X" formula applied to rates. The inflation component consists of the Consumer Price Index. The productivity component ramps up from 1.2% in 1997 to 1.4% in 1998 and 1.6% in 1999, 2000, and 2001. No customer growth factor is incorporated.

There is no earnings sharing up to 50 basis points (.5%) above the authorized return on equity. The 50 basis points equal the deadband. This is a progressive sharing mechanism, with ratepayers earning a range of 75% to 0 as the return on equity increases from 50 basis points to 300 basis points above the authorized return on equity. Similarly, shareholders earn a range of 25% to 100% over the same range. Ratepayers share in the downside risk in the same percentage. The Commission adopted specific Z-factor criteria for Edison, as previously approved for telephone utilities, with a $10 million deductible. Generation, special one-time amortization accounts, hazardous waste, research, design and development, demand-side management, and low-emission vehicle expenditures were all excluded from this PBR mechanism. A midterm review is required in 1999, with reports on annual performance and annual escalation updates. The PBR mechanism will trigger an offramp at 600 basis points above or below the benchmark return on equity.

In 1997, Edison's actual return on equity was 13.62%, 202 basis points above the authorized return on equity. Ratepayers earned approximately $42.6 million from this sharing mechanism, with shareholders earning about $36.3 million.⁶ Edison also accrued a $5 million reward for its health and safety performance indicators.

SoCalGas' PBR Mechanism

SoCalGas' PBR mechanism was adopted in D.97-07-054, to be effective for the period 1998 through 2002. This base rate revenue requirement PBR mechanism requires a sales forecast and the 1997 revenue requirements were adopted as the starting point for this mechanism, as escalated to 1998 using the "CPI - X" formula applied to revenue requirement per customer. The inflation component consists of a weighting of the DRI inflation factors for labor O&M, non-labor O&M, and capital additions. This weighting is based on the three California gas utilities. Then overall productivity component ramps up from 2.1% in 1998 to 2.5% in 2002. The productivity factor includes a stretch factor and takes into account declining rate base. The SoCalGas PBR incorporates customer growth in a revenue requirement per customer adjustment.

There is no earnings sharing up to 25 basis points (.25%) above the authorized rate of return. The 25 basis points equals the deadband. The SoCalGas PBR includes a progressive sharing mechanism, with ratepayers earning a range of 75% to 0 as the rate of return increases from 25 basis points to 300 basis points above the authorized return. Similarly, shareholders earn a range of 25% to 100% over the same range. There is no downside risk for ratepayers. The Commission adopted the same specific Z-factor criteria for SoCalGas as was previously approved for Edison, with a $5 million deductible. Several programs are excluded from the PBR mechanism. A midterm review is required in the next Biennial Cost Allocation Proceeding (BCAP), with reports on annual performance and annual escalation updates. If earnings are either 300 basis points above the authorized rate of return or 175 basis points below the authorized rate of return for two years in a row, this will trigger an offramp review of the PBR mechanism. No results have been reported yet for SoCalGas' PBR mechanism.