II. BACKGROUND

In the summer of 2001, several water utilities filed advice letters seeking offset rate increases to compensate for recent increases in the costs of purchased power that were not anticipated in the utilities' last general rate case (GRC). The Office of Ratepayer Advocates (ORA) protested the request to raise the rates of 20 districts of California Water Service Company (CWS), arguing that: (1) the Commission should not authorize offset rate increases for CWS districts because the utility was "over earning," that is, it was earning a rate of return greater than that authorized in the utility's last GRC; and (2) the Commission should not permit water districts that are outside their rate case cycle to utilize balancing account treatment.² (D.03-06-072, pp. 3-4.)

In response, the Commission's Water Division drafted Resolution W-4294 (Reso. W-4294), dated November 29, 2001, which researches the history, rationale, and procedures for implementing offset rate relief and related balancing accounts. The Water Division staff concluded that: (1) ORA's protest raises serious issues of first impression warranting full Commission consideration; and (2) the Commission should consider ORA's recommendations on an industry-wide basis. We agreed with staff's recommendations and issued an Order Instituting Rulemaking (OIR). (D.03-06-072, p. 4.)

In the OIR, we evaluated existing practices and policies for processing offset rate increases and balancing accounts for water utilities and determined that new procedures or policies were needed. Respondents to written inquiries in the OIR included the Class A water and sewer system utilities and ORA. In our interim decision, Decision (D.) 02-12-055, we retained the existing balancing account procedures for processing accounts existing prior to November 29, 2001, but reserved the issue of whether the rules should change prospectively (i.e., on or after November 29, 2001) for the final decision. (D.03-06-072, pp. 4-5.)

After completing the OIR, we issued our final decision, D.03-06-072, on June 19, 2003, revising the existing procedures for recovery of balancing accounts existing on or after November 29, 2001. In D.03-06-072, we found that a revision to the existing procedures was necessary in order to effectively correct distorted results. We reasoned that the existing procedures for recovery of under and over collections in balancing accounts, which the Commission suspended as of November 29, 2001, were originally established for the utilities to recover unanticipated increases in electricity costs³ between GRCs, without the need to file an additional rate case application. The procedures also served the purpose of protecting shareholders from having to finance large unanticipated expenses until the next GRC. These procedures served, in effect, as insurance to protect a utility against its failure to earn its authorized rate of return due to significant unforeseen expenses beyond the utility's control. Thus, we found that offset balancing account recovery should only occur when the utility fails to earn up to its authorized rate of return due to significant unforeseen expenses beyond its control that are the subject of the balancing account. To the extent a utility is over earning, such over earnings shall be used as a measure by which recovery of offset expenses from the balancing account should be reduced since the event insured against (i.e., the failure to earn its authorized rate of return) has not occurred. (D.03-06-072, pp. 14-15.)

We found that the balancing account procedures became problematic when they had the effect of enhancing utilities' earnings above the Commission-authorized rates of return. The Commission found that it is unreasonable and unnecessary to permit the utilities to pass through to ratepayers the dollar-for-dollar costs accumulated in their balancing accounts when these same utilities are earning more than their authorized rate of return. To permit such recovery would be to grant the utilities an unanticipated windfall at ratepayer expense. (D.03-06-072, p. 15.)

Moreover, we found another related problem with the existing balancing account procedures occurred when a utility failed to file a GRC application every three years, yet continued to seek balancing account treatment beyond the rate case cycle, thus depriving us of scrutiny over the assumptions used to determine the rate structure. Because general ratemaking is conducted prospectively, the utility's revenue requirement relies upon estimates of costs and capital investment expected to occur in the future years for which rates are being set. "Adopted sales quantities" are used in this estimation. The 1983 revised balancing account procedures addressed the use of GRC adopted quantities. Adopted quantities are used to estimate the reasonable cost pass-through to be allowed in offset rate increases when a utility experiences new costs in offsettable expenses. "Stale adopted quantities" refers to adopted sales quantities that are part of an aged GRC, and are unreliable because they do not accurately reflect or predict the relevant changes in a utility district's conditions since the last GRC. Use of such quantities with the pro-forma test could render the pro-forma test an unreliable measure of a utility district's earnings and provide utilities with undeserved income. (Reso. W-4294, p. 10.) While we anticipate that this problem will be addressed by subdivision (c) of Section 455.2, requiring water utilities subject to the rate case plan to file rate cases every three years, that section permits the three-year filing requirement to be waived, as specified. (D.03-06-072, p. 16.)