Earnings Sharing

SDG&E's proposed symmetrical earnings sharing mechanism is designed to incorporate a self-calibrating feature to the rate setting formula. Rather than providing customers with a one-time adjustment based on the outcome of the sharing mechanism, SDG&E proposes to adjust the next year's indexing of rates. The actual net operating income is compared to that of the authorized rate of return. The difference is then subject to earnings sharing. The proposed mechanism contains a symmetrical 100-basis-point deadband, i.e., shareholders are responsible for the first 100 basis points (1%) over or under the authorized rate of return. Outside the deadband, in the liveband, 20% of any gains or losses is flowed through to the customer through an adjustment to the next year's rates.

The deadband is designed to account for gains and losses associated with routine operation of the company. SDG&E acknowledges that its proposed deadband is larger than that adopted for either Edison (50 basis points around Edison's authorized return on equity) or SoCalGas (25 basis points above SoCalGas' authorized rate of return ). SDG&E argues that its deadband should be wider than Edison's because 1) short-run temperature-based sales fluctuations are more volatile for gas customers than electric customers, 2) the deadband should account for changes in throughput resulting from electric industry restructuring, and 3) removing generation and transmission from the PBR means that the earnings sharing component operates on lower overall net operating income. Because SoCalGas did not eliminate the Core Fixed Cost Account, SDG&E contends that the Commission explicitly adjusted SoCalGas' deadband downward to account for the reduced risk of routine operations. SoCalGas' deadband is also adjusted to account for a declining rate base.

SDG&E explains that the self-calibrating nature of its proposed sharing mechanism justifies the low 20% it proposes to "share" with customers. According to SDG&E, the 20% adjustment in rates would be carried forward indefinitely and would compound through the term of the PBR mechanism. The savings compound over time, because the prospective adjustments to rates are permanent. SDG&E maintains that such adjustments ensure that shareholders and ratepayers won't have to pay taxes on the difference between what would have been collected under more traditional earnings sharing mechanisms and the proposed mechanism. SDG&E admits that the power of the earnings sharing mechanism is inextricably tied to the term of the mechanism. The proposed sharing rate of 20% of actual returns above deadband is associated with the proposed five-year initial term for the mechanism. Due to the compounding effect, if a longer term were adopted, SDG&E states that a lower sharing percentage would achieve the same effect. If a shorter term were adopted, a higher sharing percentage would be required to achieve the same impact. SDG&E recommends that the sharing mechanism be symmetrical, i.e., any losses outside of the deadband would be reflected in permanent increases in rates using the same self-calibrating approach.

SDG&E believes that a "utility's best incentive to pursue productivity-enhancing investments would be to allow the utility to retain 100% of the benefit of those investments." (Exhibit 8, p. PBR5-5.) While acknowledging that this approach is unlikely to be implemented, SDG&E recommends that a symmetrical sharing mechanism with a reasonably large deadband makes sense according to economic theory and in terms of equity because the deadband is sized to the amount of risk absorbed by the utility and still allows customers to share in the efficiency gains. Thus, the proposed earnings sharing mechanism is neither progressive nor regressive. While recognizing that the bulk of the benefits accrue to the utility, SDG&E believes this is counteracted by compounding the customers' share of the gains in future years.