6. Operating Expenses

6.1. Escalation Factors

ORA challenged Park's methods for estimating expenses and applying escalation factors to those estimates. Generally, Park first "budgeted" a dollar amount for 2003 for each line item in an expense category, then escalated those expenses for the test years. ORA contended that it was given insufficient information to test the "budgeted" amounts for 2003. Accordingly, ORA developed an average for 2003 line items based on five years of recorded expenses, or it began with 2002 recorded expenses and then escalated from there.

Park contended that ORA's methodology resulted in significantly lower expense estimates than are justified by the record. It notes that ORA accepted "0" estimates for some line items when in fact those line item expenses had been lumped together into other categories in a 1999 accounting change made by Park. These revised entries, Park contends, were excluded from ORA's analysis.

The parties also disagreed on escalation factors. Park for the most park used a 2.5% "inflation factor" to escalate expenses to the test years. ORA exercised its judgment to apply escalation to each line item based on one of four escalation categories: non-labor, labor, composite (60% non-labor/40% compensation per hour), and compensation per hour.

There is merit in both of these approaches to estimating expenses. ORA's method has the advantage of starting with actual recorded expenses per line item, as contrasted with the more speculative "budgeted" numbers used by Park. On the other hand, some line items, like insurance, appear more accurately estimated through the budgeting process, which includes professional guidance on expense trends. We will take these factors into account in evaluating each of the party's estimates.

6.2. Payroll

Park's estimated 2003 payroll is based on its employees' hourly rates in effect at the end of 2002, a 3.2% cost-of-living increase granted for 2003, estimates of merit salary adjustments to be granted during 2003, and overtime and bonus estimates. Park has budgeted about $30,000 for bonus awards. Similar calculations were made for Test Year 2004 and Test Year 2005, although Park revised its estimates to reflect ORA's labor escalation factors.

Contending that Park's method included employees who may or may not remain on the payroll for the periods in question, ORA based its test year estimates on Park's recorded payroll in 2002, escalated to the test years. In testimony at hearing, however, ORA's witness stated that, for consistency, ORA would accept the Commission's then-pending decision on this issue in the general rate case for Park's Apple Valley Ranchos subsidiary. In that decision (D.03-08-069), the Commission concluded that Park's payroll estimates, when adjusted, produced a more accurate preview of likely payroll costs.

In discussions subsequent to the evidentiary hearings, ORA and Park agreed that Park's methodology to estimate its payroll is the same methodology adopted in D.03-08-069. The parties agreed to use Park's original test year estimates revised to reflect ORA's labor escalation factors. While we agree with ORA that the Park methodology makes assumptions about continued employment that are speculative, we also agree with Park that its number of employees is small enough (49 employees in the Central Basin Division) to make such assumptions reasonable. Accordingly, we adopt the payroll estimates recommended by the parties, as follows:

Payroll for Test Year 2004 (in 000s)

Operations 588.0

Customer Accounts 653.3

Maintenance 321.1

Admin. & General 1,171.9

Clearing Accounts 81.7

Payroll for Test Year 2005 (in 000s)

Operations 611.7

Customer Accounts 679.5

Maintenance 333.1

Admin. & General 1,177.3

Clearing Accounts 84.6

Total 2,886.2

As to the category of Payroll Benefits, the original positions of Park and ORA differed because of the payroll expense estimates. Since the expense estimates are resolved, there is no longer a difference in the benefits category.

6.3. Operations Other Expenses - Laboratory
Fees

Laboratory testing for contaminants in water is required both by federal and state agencies. At hearing, ORA introduced Park's laboratory cost workpapers that show the testing schedules required by the Department of Health Services (DHS) and the Environmental Protection Agency (EPA). Park's estimates include a 10% contingency amount for laboratory costs, which the company based on its prior experience with emerging contaminants that require monitoring. The contingency amount covers expenses for future tests that may be required by DHS and EPA for either new substances or changes in testing schedules for existing substances.

ORA adopted Park's budgeted estimates of laboratory costs but excluded the 10% contingency amount on the basis that Park should be able to estimate laboratory costs without building in a contingency amount. On brief, ORA argues that a provision for unknown "contingencies" has no place in a General Rate Case. All adopted expenses are intended to be estimates of future expenses, developed by the utility and by staff based on historical data, experience and expertise. ORA states that if a contingency adjustment is granted here, it could logically be applied to any number of other expense items, adding "catch-all" amounts to rate base. ORA notes that if Park's laboratory fees turn out to be lower than forecast, ratepayers would not be made whole for the excess amount they had funded.

The burden is on Park to show why these fees, unlike others, are uniquely qualified for a contingency addition. That burden has not been met. We disallow the 10% contingency amount. We adopt ORA's estimates for laboratory fees of $131,300 for Test Year 2004 and $171,800 for Test Year 2005.

6.4. Production Expenses - Supply Mix

The parties agree on the total amount of water production of 13,717 acre feet for Test Year 2004 and 13,753 acre feet for Test Year 2005. The parties disagree, however, on the supply mix between lower-cost water pumped from Park's wells and higher-cost water purchased from Central Basin Municipal Water District. Park recommends 1,500 acre feet of well water production. ORA recommends 1,882.88 acre feet of well water production.

Park's witness testified that the company has been gradually reducing its amount of pumped water to reduce its exposure to liability under the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. §§ 9601 et seq., commonly known as Superfund. The witness cited the 2003 case of Castaic Lake Water Agency v. Whittaker Corp. (C.D.Cal, 2003) 272 F.Supp.2d 1053, as standing for the proposition that a water company can be potentially liable under Superfund legislation if it can be shown that excess pumping by the company contributed to the spread of an acquifer's contaminated plume to wells operated by the plaintiff. Park's witness stated that it is known that volatile organic chemicals have been detected in the Central Basin Aquifer, and that pumping can induce their spread.

ORA contends that Park over the past five years has pumped an average of 1,882.88 acre feet of this lower-cost water and that in only one year (1997) has it pumped as little as 1,500 acre feet. ORA states that Park does not provide a reasoned basis for its assertion that 1,500 acre feet is the proper amount to minimize the impact of its pumping on contaminant migration and reduce its exposure to Superfund liability.

We agree with ORA that the likelihood of Superfund litigation seems as likely (or unlikely) on this record at 1,500 acre feet as it does at 1,800 acre feet, especially since the latter amount represents average pumping in the recent past. For ratemaking purposes, it is appropriate to assume that the water supply mix should consist of 1,882.88 acre feet of pumped water. Management, of course, retains discretion as to the actual amount of pumping relative to its supply mix. The adopted numbers follow:

Test Year 2004 (in 000s)

Purchased Water 5,795.7

Purchased Power 172.8

Leased (Pumped) Water 437.9

Replenishment 221.4

Test Year 2005 (in 000s)

Purchased Water 5,812.5

Purchased Power 172.8

Leased (Pumped) Water 446.6

Replenishment 221.4

6.5. Purchased Water Expense

The parties agreed to use the purchased water rate of $467 per acre foot adopted by the Central Basin Municipal Water District for 2004 for Test Year 2004. The parties disagree on the purchased water rates for Test Year 2005 and Attrition Year 2006. Park recommends forecasting purchased water rates of $488 per acre foot for Test Year 2005 and $524 per acre foot for Attrition Year 2006 based on published budgets of the MWD. ORA recommends that, consistent with past Commission practice, the same $467 rate be used for 2005 and 2006, with any subsequent increase in those amounts logged to an account for later recovery through surcharge.

That, says Park, is the rub. In the past, increased costs in purchased power, purchased water and replenishment were recoverable through a balancing account, and forecasts of increased costs were unnecessary. However, in D.03-06-072, dated June 19, 2003, the Commission changed the balancing account to a memorandum type of account in which these cost increases are fully recoverable only if the water utility can show that it did not earn more than its authorized rate of return for the period in question. By using forecasted rates, Park would give itself some protection against increased rates that it would not be able to recover, while at the same time it would still be required to refund to ratepayers under the memorandum account procedure any amounts that did not reach the forecasts.

ORA disagrees. Under D.03-06-072, it argues, Park would not have to forgo recovery of all such expense increases. If the utility has exceeded its authorized rate of return, the amount that it would forgo would be only that amount by which it is over-earning. On brief, ORA states:

More importantly, however, Park's proposal is a masked attack on the Commission's determinations in D.03-06-072. The Commission concluded in that decision that "[t]he revised procedures permit the utility to earn at least up to its authorized rate of return, and even more than the authorized rate of return through any means other than the collection of these balancing-type memorandum accounts." (D.03-06-072, Finding of Fact 11.) In establishing new balancing account procedures, the Commission did not add the qualifier that water utilities would now be able to forecast rates. (ORA Reply Brief, at 8.)

We agree with ORA that the Commission's rationale in D.03-06-072 was that balancing account procedures are intended to be "insurance to protect a utility against failure to earn its authorized earnings due to unanticipated expenses beyond the utility's control," but that those procedures "become problematic when they have the effect of enhancing utilities' earnings above Commission-authorized rates of return." (D.03-06-072, Conclusion of Law 1.) ORA contends that under Park's proposal to forecast higher purchased water rates while still maintaining a balancing-type memorandum account, Park is asking ratepayers for additional money up-front in case it is able to exceed its authorized rate of return.

We do not agree with ORA that Park's approach is a "masked attack" on D.03-06-072. Park's witness was candid in testifying that Park's approach is directly in response to D.03-06-072. He stated that, in his opinion, the decision was wrongly conceived, wrongly decided and was made without hearings and without real opportunity for the industry to raise its objections. Notwithstanding those views, however, we agree with ORA that a utility-specific proceeding like this rate case is not the forum for the kind of generic change in purchased water estimates that Park proposes in light of D.03-06-072. Park has not demonstrated that its needs are unique and that, unlike other water companies, it requires the use of estimated purchased water rates. Park's argument to use rate case resources to reliably forecast purchased water rates would be more persuasive if it also proposed to forgo all protection of the balancing-type memorandum account for those expenses.

We adopt ORA's recommendation. The adopted expenses for purchased water for Test Year 2005 and Attrition Year 2006 are the sum of the unit cost of purchased water ($467) and the supply mix adopted in this proceeding.

6.6. Customers - Other Expense

Park provides forecasts for 10 items in this category, and ORA concludes that the estimates are reasonable in all but two items. As for those two items, ORA excludes $1,406 for meter reading benches that ORA states should have been classified as plant, and it escalates the expenses from 2002 recorded numbers. The parties' estimates are within $1,000 of each other for both test years. We will adopt the ORA estimates, as follows:

6.7. Maintenance - Other Expense

Park agreed to revise its estimates to reflect $8,000 in savings related to Park's 2003 vehicle replacements. Park's revised estimates are based on the 2003 operating budget and reflect maintenance requirements like water tank painting that are not performed annually. ORA's estimates are based on an escalated five-year average of recorded expenses, along with some of Park's budgeted estimates. At hearing, Park's witness demonstrated that at least some of ORA's estimates excluded legitimate expenses because of a Park accounting change in 1999, and that the estimates thus are less than historical averages. Park has made the more persuasive showing in this category, and we adopt its estimates, as follows:

6.8. Clearing - Other Expense

Park agreed to revise its estimates to reflect $8,000 in savings related to Park's 2003 addition of miscellaneous tools. ORA agreed with Park's estimates for 16 of the 18 line items in this account, but it elected estimates based on 2002 recorded expenses for estimated repairs and estimated fuel-transportation. Park's witness testified that the utility has increased its budgeted amount for vehicle repairs because of the aging of its fleet, including several vehicles that were purchased before 1993 and will reach 100,000 miles of use in the test years. Park's estimates also reflect an increase in license fees that at the time of hearing appeared likely to continue in the test years. Park has made the more persuasive showing in this category of expenses, and we adopt the utility's estimates of $315,103 for Test Year 2004 and $324,629 for Test Year 2005.

6.9. Insurance Expense

Park during hearing revised its estimates of insurance expense to incorporate actual premiums in effect for the 2003-2004 policy year. ORA's original estimates were based on a linear trend of recorded 2000 through 2003 data. The remaining differences reflect Park's reliance on an outside insurance agent and on company specifics likely to affect insurance rates. While the differences in estimates are not that far apart, we conclude that Park's estimates are more likely to reflect actual expenses. We adopt the utility's estimates of $786,291 for Test Year 2004 and $919,626 for Test Year 2005.

6.10. Regulatory Commission Expense

Park states that its estimate for the test years of $174,444 (amortized at $54,481 per year) is based on costs incurred in Test Years 1992-1993 rate case for its former Santa Paula Water Works subsidiary (D.92-04-031), escalated to 2003. ORA estimated rate case costs of $150,732 (amortized at $50,241 per year) based on the more recent rate case of Park's Apple Valley Ranchos subsidiary, escalated to the test years. We agree with ORA that its estimates are based on a more recent and similar rate case proceeding, and we adopt those estimates. At the same time, we note the Commission's concern in 1992 about the cost of these rate cases:

We are also concerned about the cost of the process; the per customer costs of litigating this case are distressingly high....With annual costs at this level, we cannot help asking whether the process has become more expensive than can be justified by possible benefits to the public. (Re Santa Paula Water Works, Ltd. (1992) 43 CPUC2d 661, 667.)

We continue to believe that rate case costs are too high, and we encourage water companies and Commission staff to find ways to reduce the time and expense devoted to these cases without sacrificing the clear benefits to ratepayers of a thorough review. In this case, for example, while we believe that more of the small-dollar differences in estimates could have been resolved without continued litigation, we are encouraged that the parties' proposed resolution of cost of capital issues saved at least two days of hearing and reduced what would have been substantial expert witness fees.

6.11. Outside Services

Both Park and ORA have used five-year averages to calculate the test year estimates for outside services, including audit and income tax, legal and consulting. ORA disallowed expenses for the categories of safety consulting and water quality consulting because of a failure of supporting data by the company. At hearing, however, ORA's witness acknowledged that Park has numerous water quality monitoring and safety activities, and it is likely that some consultant fees will be incurred. Based on the record, we adopt Park's revised estimate for Outside Services of $117,739 for Test Year 2004 and $120,494 for Test Year 2005.

6.12. Office Supplies

We adopt Park's estimates for bank fees and expenses other than bank fees of $353,482 for Test Year 2004 and $360,915 for Test Year 2005. Park's witness showed at hearing that ORA's five-year averaging method for expenses other than bank fees was based on years in which Park had less office space, fewer phones, and lower-cost licensing and permit fees. The same witness sponsored an exhibit (Exhibit 20) that showed Park's methodology estimating bank fee expenses is the same methodology approved by the Commission in D.84-05-058 and used in subsequent Park rate cases. The contention by ORA's witness that a superior methodology was used in another utility's rate case is not persuasive.

6.13. Miscellaneous Expense

While the differences in estimate expenses between the parties in this category are not substantial, we find that Park has made the more persuasive case of showing that its estimates reflect current information and costs than does ORA's method of linear averaging of these costs. We adopt Park's revised estimates of $46,019 for Test Year 2004 and $47,096 for Test Year 2005.

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