Comments on Alternate Decision

Comments on the Alternate Decision were filed by SDG&E, UCAN, NRDC, and ORA. Based on SDG&E's comments, we have adjusted the ramp up of the stretch factor to apply over three years instead of four because the update rule only applies in years 2000, 2001, and 2002. We have also revised the termination date of the GFCA and incorporated other minor clarifications and corrections throughout the order.

Findings of Fact

1. We have long considered incentive-based ratemaking superior to command-and-control regulation and have established several goals to be addressed by incentive regulation for energy utilities.

2. Performance-based regulation can provide stronger incentives for efficient utility operations and investment, lower rates, and result in more reasonable, competitive prices for California's consumers.

3. Performance-based regulation can simplify regulation and reduce administrative burdens in the long term, without sacrificing service, safety, and reliability.

4. Incentive regulation can prepare utilities to operate effectively in the increasingly competitive energy utility industry.

5. Incentive regulation should provide a reasonable balancing of risks and rewards, with an equitable sharing of the benefits that reform is intended to achieve.

6. The adopted regulatory program should maintain or improve quality of service, reliability, safety, and customer satisfaction despite expected cost reductions, and should avoid or minimize unintended consequences in interplay among various regulatory programs.

7. SDG&E has been operating under a base rate PBR mechanism since 1994.

8. As approved in D.98-03-073, SoCalGas and SDG&E are now operating entities within the holding company of Sempra Energy, Inc.

9. Once a starting point is selected, PBR mechanisms adjust revenue requirements or rates annually to account for inflation and productivity.

10. 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.

11. Performance indicators are designed to ensure that the utility's service quality, customer service, reliability, and safety do not deteriorate under PBR regulation.

12. Under its base rate PBR mechanism, SDG&E earned approximately $136 million in after-tax dollars from its earnings sharing mechanism during the period 1994 through 1997.

13. Ratepayers' share of earnings is expected to total approximately $11.2 million during the period 1994 through 1997.

14. SDG&E, ORA, UCAN, FEA, CCUE, the City of San Diego, Farm Bureau, and NRDC filed a joint motion seeking Commission approval of a settlement resolving performance indicators addressing safety, reliability, customer satisfaction, and call center responsiveness, as well as certain customer service guarantees cost of service issues in this proceeding.

15. There is no known opposition to approving the settlement, and no need to hold a hearing on these issues.

16. The settlement satisfies the Commission criteria for an all-party settlement, as set forth in our Rules of Practice and Procedure and D.92-12-019.

17. No party disputes SDG&E's proposed escalation measure, which is based on historical and forecasted industry-specific data, published quarterly. Separate escalation factors are used for electric and gas. Each index is designed to measure changes in price levels of labor, nonlabor and capital inputs purchased by California utilities.

18. Cost of capital will continue to be addressed in cost of capital proceedings and through the MICAM mechanism.

19. Adopting a PBR mechanism modeled after that adopted for SoCalGas in D.97-07-054 and Edison in D.96-09-092 allows both the shareholders and the customers to benefit.

20. The revenue requirement used as the starting point for SDG&E's PBR mechanism is $563.4 million for electric distribution and $201.5 million for gas base rate revenues, as approved in D.98-12-038.

21. The term of the adopted PBR should be 1999 through 2002, with provisions for a comprehensive review.

22. SDG&E must file a 2003 cost of service study no later than December 21, 2001.

23. UCAN's proposal to implement separate PBR mechanisms for electric wires, electric metering and billing, gas pipes, and gas metering and billing is premature.

24. NRDC's proposal to establish a performance indicator for distributed generation is premature.

25. Under a rate indexing approach, SDG&E would have a direct interest in increasing electricity usage and gas throughput since its base rate revenues would increase with increases in usage.

26. The revenue-per-customer approach would increase revenue requirements as the number of customers increases but does not allow additional revenue recovery due to sales increases.

27. Adopting the rate indexing formula is simpler, more relevant to SDG&E's circumstances, and more compatible with an emerging competitive market.

28. It is reasonable to eliminate the GFCA with a rate indexing methodology. GFCA components other than base cost balancing component should continue to be recorded in a new account.

29. It is reasonable to terminate the GFCA when balance next approaches zero.

30. An adjustment to the sharing mechanism can counteract the potential windfall effect of sales increases which are likely to occur without effort on SDG&E's part. Environmental concerns arising from an incentive to increase sales are mitigated by other state policies, including targeted energy efficiency and renewable energy programs.

31. A Total Factor Productivity (TFP) index measures the ratio of its output quantity index to its input quantity index and compares the growth trend in the unit cost of the industry to the trend in prices of labor, capital services, and other production inputs.

32. SDG&E asserts that no stretch factor is necessary, despite the fact that its proposed productivity factors are less than those adopted for other energy utilities.

33. The premise of incentive regulation is that competitive companies are more efficient and productive.

34. It is important to apply a stretch factor to the productivity factor to ensure that the utility to which it is applied is "stretching" to achieve efficiency gains.

35. Edison's historical productivity factor of 0.9% is close to the productivity factor of 0.92% calculated by Christensen Associates for SDG&E.

36. SDG&E's O&M productivity growth under its current PBR mechanism was a modified 1.5% and SDG&E easily exceeded its authorized rate of return.

37. It is reasonable to ramp up the stretch factor incrementally over the term of the PBR, which recognizes both that productivity improvements will not occur all at once and that SDG&E's escalation factor is lower than the CPI.

38. Certain perverse incentives are inherent in SDG&E's rate calibration proposal, because SDG&E may have a disincentive to continue lower costs, knowing that rates will decrease on a permanent basis, since rate reductions will make it more difficult to achieve a favorable rate of return.

39. SDG&E's proposed deadband is approximately four times that adopted for Edison or SoCalGas; therefore, gains or losses would have to be relatively large before being shared with customers.

40. Relatively few of SDG&E's earnings have been shared with ratepayers under SDG&E's current PBR mechanism, due to the 100 basis point deadband and the low 25% sharing with ratepayers in the first tier.

41. Under the calibration method, decreases in rates one year would have a negative impact on net operating income the following year, which could lead to a lowered incentive to continue to reduce costs, contrary to a primary goal of PBR regulation.

42. The 20% sharing calibration method and 100 basis point deadband does not comport with our regulatory goals, because there is not an equitable sharing of benefits.

43. SDG&E's proposed 100 basis point deadband is intended to account for gains and losses associated with routine operations, including sales and throughput fluctuations.

44. SDG&E acknowledges that its proposed deadband is wider than than adopted for either Edison or SoCalGas.

45. The progressive sharing mechanism creates a "win-win" for both shareholders and ratepayers, because SDG&E has unlimited upside potential to retain earnings above 300 basis points above the benchmark.

46. A progressive sharing mechanism protects ratepayers because it corrects for the potential of adopting a productivity factor that turns out to be too low and allows equitable sharing of benefits of SDG&E's cost reduction efforts.

47. A progressive sharing mechanism provides the proper incentives by allowing shareholders to retain progressively greater amounts of its earnings as higher rates of return are achieved.

48. The cost of service settlement identified $1.43 million in PBOP overcollections to be refunded for the years 1993-1997.

49. The GFCA should be eliminated to eliminate balancing account treatment for sales volatility.

50. Adopting a 150-basis point voluntary offramp and a 300-basis point mandatory offramp for earnings below the authorized rate of return ensures that there is a mechanism to protect ratepayers and shareholders from significant deviations in earnings.

51. The adopted PBR mechanism provides increasing incentives to SDG&E, because SDG&E retains 100% of earnings for increments above 300 basis points above the benchmark.

52. Monitoring and evaluation are particularly important in determining whether a PBR mechanism is effective, i.e., is providing the desired incentives and results.

53. Monitoring and evaluative criteria must be developed so that each goal and objective can be measured.

54. The comprehensive review provides an appropriate forum for SDG&E to present the data collected regarding maintenance, repair, and replacement of major electric distribution facilities.

55. The Energy Division should conduct the comprehensive review of the PBR mechanism.

Conclusions of Law

1. In R.94-04-031 and I.94-04-032, we stated our intention to replace cost-of-service regulation with performance-based regulation and directed the utilities to file applications requesting distribution PBR mechanisms.

2. The performance indicator settlement is an "uncontested settlement" as defined in Rule 51(f).

3. The performance indicator settlement is reasonable in light of the whole record, consistent with law, and in the public interest, and should be approved.

4. Adopting SDG&E's proposed distribution PBR mechanism will not serve the public interest nor achieve our broadly stated goals related to PBR regulation.

5. It is reasonable and prudent to base SDG&E's distribution PBR mechanism on the PBR adopted for SoCalGas in D.97-07-054 and the PBR adopted for Edison in D.96-09-092.

6. It is reasonable to adopt SDG&E's proposed escalation methodology, which no party disputed.

7. It is reasonable to review the issue of distinguishing between monopoly and competitive services, and possible cross-subsidies, during the comprehensive review and to develop monitoring and evaluation criteria to track such possibilities.

8. Performance indicators related to distributed generation should be established after we develop a particular approach for distributed generation in R.98-12-013.

9. Adopting a rate index approach may lead to a windfall for SDG&E due to projected sales increase unrelated to management efforts, and there should be an adjustment to the sharing mechanism to account for this.

10. It is reasonable to adopt the base historical productivity figures proposed by SDG&E as a starting point in determining productivity factors.

11. Adopting a productivity factor that includes a stretch factor of 0.4% ramping up to 0.7% is appropriate, reasonably consistent with the productivity factors adopted for SoCalGas and Edison, and provides incentive to SDG&E to stretch beyond average productivity gains.

12. It is reasonable to eliminate the base cost balancing component of the GFCA when the balance next approaches zero. The SDG&E proposal for a new account to record costs and revenues associated with the carrying costs of storage inventory, the recorded transportation charges billed to SDG&E by SoCalGas, and amounts collected for the recovery of franchise fees and uncollectibles was unopposed, is reasonable, and should be adopted.

13. SDG&E should file an advice letter the month before it forecasts the GFCA balance will next approach zero, but no later than November 1, 1999.

14. PU Code § 728 imposes a duty upon us to ensure that utility rates are maintained at a level that is just and reasonable; therefore, under incentive regulation, profits and thus rates must be maintained at reasonable levels.

15. Consistent with our regulatory goals, adopting an aggressive productivity factor and a progressive sharing mechanism ensures that ratepayers will be at least as well off under the PBR as under traditional ratemaking.

16. Z-factor treatment should be applied only to those costs successfully meeting the nine criteria previously adopted in D.96-09-092 and D.97-07-054:

17. It is reasonable to adopt the exclusions recommended by the cost of service settlement approved in D.98-12-038.

18. No Z-factor treatment was adopted for PBOPs in SoCalGas' PBR mechanism and PBOP recovery does not conform to the Z-factor criteria adopted in this decision.

19. It is reasonable to adopt the reporting requirements proposed by SDG&E and UCAN.

20. The term of the PBR mechanism should be 1999 through 2002, consistent with the cost of service settlement adopted in D.98-12-038.

21. Because of the changing regulatory environment, it is reasonable to develop rigorous evaluative criteria, so that we will better understand the effect of incentives.

22. Should Energy Division determine that it is necessary to hire an independent consultant, it is reasonable that the cost be capped at $400,000 and that ratepayers and shareholder share the cost equally.

23. This order should be effective today, so that SDG&E's distribution PBR mechanism can be implemented on a timely basis.

24. This proceeding should be closed.

O R D E R

IT IS ORDERED that:

1. The Joint Motion for Adoption of Settlement Agreement on PBR Performance Indicators in the San Diego Gas & Electric Company (SDG&E) Application (A.) 98-01-014 is granted.

2. The Settlement Agreement is attached to this decision as Appendix B and is adopted as reasonable in light of the whole record, consistent with the law, and in the public interest.

3. SDG&E shall use a rate indexing methodology for its PBR. The "starting point" for electric distribution and gas rates will be the 1999 authorized rates as determined in the Cost of Service portion of this proceeding in D.98-12-038. In subsequent years, through 2002, electric distribution and gas rates will be determined by multiplying the "update rule" formula, i.e. 1 + inflation - productivity, by the previous year's rates. This formula will be applied to each electric distribution and gas transportation rate and rate component, as described in Exhibit 82, pg. PBR13A-2. Adjustments, due to such factors as revenue sharing, or PBR performance rewards or penalties, will be made as one-time adjustments. SDG&E shall file an advice letter by October 1 of each year to implement the rate adjustment. SDG&E shall file an advice letter to terminate the GFCA when the balance next approaches zero. The advice letter should be filed the month before SDG&E forecasts a zero balance, but no later than November 1, 1999.

4. SDG&E shall implement a distribution performance-based ratemaking (PBR) mechanism using the revenue requirements adopted in Decision (D.) 98-12-038 as a starting point. The PBR shall use a rate indexing approach, the adopted escalation methodology (Attachment 1), and a progressive earnings sharing mechanism as described in this decision. SDG&E shall apply a stretch factor that increases over the term of the PBR mechanism, resulting in an X factor on the electric side of 1.32% in 2000, 1.47% in 2001, and 1.62% in 2002. On the gas side, SDG&E shall apply an X factor of 1.08% in 2000, 1.23% in 2001, and 1.38% in 2002.

5. SDG&E shall construct the progressive sharing mechanism with a deadband of 25 basis points above the benchmark rate of return. Shareholders shall receive 100% of earnings up to the level of 25 basis points above the benchmark rate of return and an increasing percentage in steps from 25 to 300 basis points, above which level shareholders will also receive 100% of the earnings.

6. SDG&E shall construct the progressive sharing mechanism with eight bands between 25 basis points above the benchmark rate of return and 300 basis points above the benchmark rate of return. The first band shall be from 25 to 75 basis points above the benchmark. Shareholders shall receive 25% of the marginal revenues in this band and ratepayers shall receive 75% of the marginal revenues. Each of the next five successive band shall increase the incremental share allocated to shareholders by 10% and decrease the incremental share allocated to ratepayers by 10%. The sixth band shall fall between 175 and 200 basis points above the benchmark, with shareholders receiving 75% and ratepayers 25%. The seventh band shall be between 200 and 250 basis points above the benchmark, with shareholders receiving 85% and ratepayers 15%. The eighth band shall be between 250 and 300 basis points above the benchmark, with shareholders receiving 95% and ratepayers 5%.

7. When a potential Z-factor event occurs, SDG&E shall promptly advise us of its occurrence by advice letter and shall establish a memorandum account for the event. The notification shall provide all relevant information, including a description, amount involved, timing, and how the event conforms to the nine adopted criteria. All such events shall be reviewed in the comprehensive review. For each event, SDG&E's shareholders shall absorb the first $5 million per event of otherwise compensable Z-factor adjustments. This deductible shall be separately applied to each Z-factor event. The deductible shall be a one-time deductible per Z-factor event, even if the costs associated with the event are incurred in more than one year.

8. SDG&E or ORA may file a motion for voluntary suspension if SDG&E reports net operating income that is at least 150 basis points below its authorized rate of return. If SDG&E reports net operating income indicating a return of 300 or more basis points below its authorized rate of return, the PBR mechanism shall be automatically suspended and SDG&E shall file an application which will lead to a formal review of the mechanism.

9. For the duration of the PBR period, the following items, which are included in 1999 authorized revenues, shall be excluded from the indexing mechanism before SDG&E calculates its annual escalation of revenue requirements:

10. For the duration of the PBR period, the following items shall be excluded from recorded PBR base rate revenues and/or expenses before SDG&E calculates its actual earned rate of return for revenue sharing purposes:

11. By February 15 of each year, SDG&E shall file an annual electric distribution report that addresses the performance indicators and earnings sharing results for the previous calendar year. This report shall be filed by advice letter with the Energy Division. Within 45 days after the end of each calendar quarter, SDG&E shall submit quarterly reports to the Energy Division and interested parties that address the 12-month-to-date sharing and year-to-date performance indicator results.

12. SDG&E shall file an application to develop evaluation criteria for the comprehensive review by June 30, 2000. The evaluation process shall begin in mid-1999 with workshops facilitated by the Energy Division. The Energy Division shall file and serve a workshop report by year-end 2000.

13. If a consultant is hired to conduct an independent evaluation, the Energy Division shall develop and issue the Request for Proposal (RFP), administer the selection process, and administer the contract. The cost of an independent consultant shall be shared equally between the ratepayers and shareholders. SDG&E and interested parties may submit evaluative reports at the same time other parties or the independent consultant submit their reports.

14. The Energy Division shall work with other parties to develop measurable evaluation criteria based on the following goals outlined in this decision:

15. SDG&E is authorized to implement the distribution performance-based ratemaking mechanism described in this decision. SDG&E shall file a compliance advice letter implementing all required tariff changes necessitated by this decision within 10 days of the effective date of this decision. SDG&E shall include in its advice letter which implements this decision the establishment of a new account to record costs and revenues for the carrying cost of storage inventory, the recorded transportation charges billed to SDG&E by SoCalGas, and amounts collected for the recovery of franchise fees and uncollectibles.

16. SDG&E shall file an advice letter after the new sales forecast is adopted in A.98-01-031 to update the gas sales forecast in the PBR.

17. SDG&E shall file an application with a comprehensive cost of service study for the year 2003 no later than December 21, 2001, which will trigger a cost of service review in 2002.

18. Application 98-01-014 is closed.

This order is effective today.

Dated May 13, 1999, at San Francisco, California.

I will file a dissent.

/s/ HENRY M. DUQUE

TABLE OF CONTENTS

Title Page

OPINION REGARDING SAN DIEGO GAS & ELECTRIC

COMPANY'S DISTRIBUTION PERFORMANCE-BASED

RATEMAKING MECHANISM ....................................................................2

Findings of Fact 66

Conclusions of Law 71

O R D E R 74

Appendix A - List of Appearances

Appendix B - Settlement Agreement on PBR Performance Indicators

Attachment 1 - Escalation

Attachment 2 - Earnings Sharing Mechanism

(See Formal Files for Appendices A and B.)

ESCALATION

SDG&E's escalation measure is based on historical and forecasted industry-specific data. Separate escalation factors are used for electric and gas. These escalation factors are designed to measure changes in price levels of labor, non-labor and capital inputs purchased by California utilities.

The escalation factors are developed using national-level utility-specific cost indices obtained from the Standard & Poor's DRI/McGraw-Hill Economic and Utility Cost Forecasting Services (DRI). The component national level utility cost indices are combined into electric distribution and gas escalation factors using expenditure weights developed from historical expenditures by electric and gas utilities located in California. The electric utilities are SDG&E, Southern California Edison, and Pacific Gas and Electric Company (PG&E). The gas utilities are SDG&E, Southern California Gas Company, and PG&E.

Labor O&M Cost Index

Average hourly earnings for electric, gas, and sanitary services are used as the basis for the labor cost index for both electric distribution and gas. Referred to as AHE49NS by DRI, historical data for this data series is reported by the United States Bureau of Labor Statistics (BLS). This data is used as the basis for the DRI labor cost index, and forecasts of AHE49NS are available from DRI.

Non-Labor O&M Cost Indices

Separate non-labor cost indices are developed for electric distribution and gas. The index for electric distribution non-labor O&M expenses utilizes five DRI cost indices: total distribution plant O&M cost index (JEDOMMS), customer accounts operation cost index (JECAOMS), customer service and information operation cost index (JECSIIOMS), sales operation cost index (JESALOMS), and total administrative and general O&M cost index (JEADGOMMS).

The index for gas non-labor O&M expenses is the DRI total gas utility non labor O&M cost index (JGTOTALMS).

Capital-Related Cost Indices

The cost index for capital related electric distribution costs is based on an estimate of the rental price of electric distribution utility structures, which is estimated from three data series obtained from DRI: rental price of capital - nonresidential structures-public utilities (ICNRCOSTPU); chain type price index - investment in nonresidential structures - public utilities (PCWICNRPU), and the Handy-Whitman electric utility construction cost index -total distribution plant, Pacific Region (JUEPD@PCF). All of these indices are obtained from DRI. The rental price of capital for electric distribution utility structures (ICNRCOSTPUED) is calculated as follows:

ICNRCOSTPUED = ICNRCOSTPU*( JUEPD@PCF/PCWICNRPU)

The cost index for capital related gas costs is based on an estimate of the rental price of gas utility structures, which is estimated from three data series obtained from DRI: rental price of capital - nonresidential structures-public utilities (ICNRCOSTPU); chain type price index - investment in nonresidential structures - public utilities (PCWICNRPU), and the Handy-Whitman gas utility construction cost index -total plant, Pacific Region (JUG@PCF). The rental price of gas utility structures (ICNRCOSTPUG) is calculated as follows:

ICNRCOSTPUG = ICNRCOSTPU*( JUG@PCF/PCWICNRPU)

A three-year moving average of the rental price of utility structures is used to calculate the capital -related cost indices.

Weighting Factors

The escalation factors for electric distribution and gas are each a weighted average of the component cost indices for labor, non-labor, and capital-related expenses. The weights used to construct the weighted average are based on average state-level electric distribution expenditures or gas utility expenditures expressed in real 1996 dollars for the period 1992 - 1996. These weights are shown below:

Labor 0.179216 0.234234

Non-Labor 0.312008

Distribution 0.062799

Customer Accounts 0.028032

Customer Service 0.043102

Sales 0.001225

Admin. & General 0.109725

Capital 0.575900 0.453757

Total 1.000000 1.000000

Annual Escalation Calculation

Starting in the year 2000, the percentage changes in the weighted cost indices will be used in the PBR indexing formulae to adjust the electric distribution and gas base rates for changes in the cost of inputs purchased by the utility. In mid-August 1999, one-year ahead projections of the cost indexes and the percentage changes in these indexes will be estimated. These estimates will be based on the most recent historical and forecast data available from Standard and Poor's DRI/McGraw-Hill Economic and Utility Cost Information Services. In mid-August of every year starting in the year 2000, historical and forecast cost indexes and percentage changes in these indexes will be estimated from the most recent historical and forecast data available from DRI. The historical and forecast percentage changes will be used in the rates indexing formulae to obtain rates for the next year. Both forecast and historical percent changes back to 1999 are required to true-up rates to the most recent and accurate cost escalation estimates available after 1999. The updated historical and forecast percentage changes should capture all revisions in the DRI data used to compute the cost indexes.

(END OF ATTACHMENT 1)

EARNINGS SHARING MECHANISM

The earnings sharing mechanism we adopt in this decision is illustrated below:

Shareholder and Ratepayer Percentage Share of Revenues

Associated with Rate of Return (ROR) Above Authorized

Shareholders % Ratepayers % Above Authorized ROR

*If SDG&E reports an ROR which is 150 basis points or greater below the authorized ROR, SDG&E or ORA may file for voluntary suspension of the PBR mechanism. If SDG&E reports an ROR which is 300 basis points or more below its authorized ROR, the PBR mechanism will be automatically suspended, and SDG&E will be required to file an application which will lead to a formal review of the mechanism.

(END OF ATTACHMENT 2)

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