VII. CONCLUSION

We modify D.03-06-072 pursuant to the discussion above in order to clarify the intent of the new revised procedures. The rehearing applicants have failed to demonstrate any factual or legal error in D.03-06-072, as modified, and rehearing is denied.

THEREFORE, IT IS ORDERED THAT:

1. On page 2, delete the first full paragraph, and insert: In this decision, we revise the existing procedures for recovery of balancing accounts existing on or after November 29, 2001, as follows:

(1) If a utility is either within or outside of its rate case cycle and is not over earning, the utility shall recover from the balancing account subject to reasonableness review.

(2) If a utility is either within or outside of its rate case cycle and is over earning, the over earnings will be used as a measure by which recovery of offset expenses in the balancing account will be reduced. For example, if the amount of the over earning is equal to or exceeds the amount of offset expenses to be recovered in the balancing account, those expenses shall be reduced to zero. Any offset expenses collected in the balancing account would be amortized below the line and any offset revenues collected in the balancing account would be returned to ratepayers.

(3) If a utility is within or outside of its rate case cycle and is over earning, but the over earnings are not equal to or greater than the offset expenses accrued in the balancing account, the offset expenses in the balancing account will be reduced by the amount of the over earnings. If there are offset revenues in the balancing account, then these shall also be used to reduce the remaining offset expenses accrued in the balancing account to zero. After the offset expenses in the balancing account are reduced to zero, if any offset revenues remain in the balancing account, such revenues shall be returned to ratepayers. If, conversely, after adjusting offset expenses in the balancing account by the amount of over earnings and offset revenues, offset expenses still remain in the balancing account, such expenses shall be amortized and recovered through a surcharge request in an Advice Letter or a General Rate Case.

2. On page 6, in line 4 from the top of the page, delete the word "state" and insert: stale

3. On page 15, in the first full paragraph, in line 7 after the word "is" insert: over

4. On page 15, in the first full paragraph, in line 8, delete "above its authorized rate of return, recovery of" and insert: , such over earnings shall be used as a measure by which recovery of offset expenses from

5. On page 15, in the first full paragraph, in line 9, delete "by the amount of over earning"

6. On page 17, delete the following phrase from the first full paragraph: "The proposal is not unfairly "one-sided" as claimed." and insert:

It is incorrect for the utilities to argue that the revised procedures cap their recovery of the balancing account so that a utility may achieve, but not exceed, its authorized rate of return. The revised procedures simply require a utility that is over earning to use such over earnings as a measure by which to reduce offset expenses before allowing the utility to recover such expenses from the balancing account. Recovery from a balancing account was never intended to enhance a utility's earnings.

7. On page 17, in the first full paragraph, in line 7, before the word "balancing" insert: offset expenses from the

8. On page 17, in the first full paragraph, in lines 7 and 8, delete the words "amounts in excess of its authorized rate of return"

9. On page 19, in the fourth full paragraph, delete lines 1 to 3, inclusive, in line 4, delete the words "and (3) districts that are outside of their rate case cycles." and insert: We address the following scenarios: (1) districts that are either within or outside of their rate case cycle and are not over earning; and (2) districts that are either within or outside of their rate case cycle and are over earning on an actual (recorded earnings) basis.

10. On page 21, in the fourth full paragraph, in line 1, delete the word "within" and insert: either within or outside of

11. On page 22, delete paragraphs 1 and 2, and insert: If a utility is either within or outside of its rate case cycle and is over earning, the over earnings will be used as a measure by which recovery of offset expenses in the balancing account will be reduced. For example, if the amount of the over earning is equal to or exceeds the amount of offset expenses to be recovered in the balancing account, those expenses shall be reduced to zero. Any offset expenses collected in the balancing account would be amortized below the line and any offset revenues collected in the balancing account would be returned to ratepayers.

12. On page 22, in the third paragraph, in line 1, before the word "Although" insert: The recorded earnings means test shall be used to evaluate earnings for revenue received for all years.

13. On page 25, in paragraph 1, in line 3, delete "within" and insert: either within or outside of

14. On page 25, in paragraph 1, line 5, delete "the utility's recovery of expenses", delete lines 6 to 11, inclusive, and insert: the over earnings will be used as a measure by which recovery of offset expenses in the balancing account will be reduced. For example, if the amount of the over earning is equal to or exceeds the amount of offset expenses to be recovered in the balancing account, those expenses shall be reduced to zero. Any offset expenses collected in the balancing account would be amortized below the line and any offset revenues collected in the balancing account would be returned to ratepayers.

15. On page 27, in paragraph 1, line 5, delete "B" and insert: B1.

Appendix B is deleted and replaced with Appendix B1, contained in Attachment A of this Order.

17. Rehearing of D.03-06-072, as modified, is denied.

This order is effective today.

Dated March 16, 2004 at San Francisco, California.

MICHAEL R. PEEVEY

President

CARL W. WOOD

LORETTA M. LYNCH

GEOFFREY F. BROWN

Commissioners

I dissent.

/s/ SUSAN P. KENNEDY

Commissioner

ATTACHMENT A

APPENDIX B 1

The most recent GRC of the Smallville district of Regulated Water Company (RWC) was in 2002, with test years of 2003 and 2004.

Smallville experienced an increase in power costs in March of 2003 and began tracking them in a balancing account. Smallville was granted an offset rate increase in April of 2003. Subsequently, there were additional increases in power costs and additional offsets were approved.

RWC filed Advice Letter 100 to recover the 2003 power costs in March of 2004.

Advice Letter 100

Step 3.a&b: RWC determines that Smallville district had over earnings⁶ of $36,000 in 2003.

2003 Purchased Power
(a) Month	(b) Recorded Sales (KCcf)	(c) Recorded Power Consumption (Kwh)	(d) Incremental Expense Rate Change ($/Kwh)	(e) Incremental Revenue Rate Change ($/Ccf)	(f) Revenue Component b) x (e) ($)	(g) Expense Component (c) x (d) ($)	(h) Over or (Under) Collection (f) - (g) ($)	(i) Commercial Paper Rate (%)	(j) (Interest) previous (k) x (i)/12 ($)	(k) (Accrual) previous (k)+ (h) +(j) ($)
Jan	240.2	168,600	-	-	-	-	-	4.77	-	-
Feb	237.3	165,600	-	-	-	-	-	4.79	-	-
Mar	234.2	162,400	0.015	-	-	2,436	(2,436)	4.81	-	-2,436
Apr	247.2	178,400	0.015	0.0111	2,744	2,676	68	4.79	-10	-2,378
May	328.6	231,000	0.015	0.0111	3,647	3,465	182	4.81	-10	-2,205
Jun	328.4	235,000	0.025	0.0111	3,645	5,875	(2,230)	4.98	-9	-4,444
Jul	349.3	242,200	0.025	0.0111	3,877	6,055	(2,178)	5.11	-19	-6,641
Aug	342.8	247,000	0.025	0.0193	6,616	6,175	441	5.25	-29	-6,229
Sep	333.2	231,100	0.030	0.0193	6,431	6,933	(502)	5.32	-28	-6,759
Oct	298.0	206,600	0.030	0.0193	5,751	6,198	(447)	5.88	-33	-7,239
Nov	247.3	180,000	0.030	0.0193	4,773	5,400	(627)	5.81	-35	-7,901
Dec	207.6	150,000	0.030	0.0193	4,007	4,500	(493)	5.87	-39	-8,433
			Total Revenue Component		41,492
				Total Expense Comp		49,713

Step 4.a: In this example, the balancing account for purchased power offset expenses has an expense component of $49,713.

Step 4.b: In this example, the over earning amount is $36,000, which is less than the total expense component of $49,713.

Step 4.c: In a new and separate worksheet as shown below $36,000/12 is booked to each month of 2003.

Step 4.d: Interest is applied to the monthly accruals in the adjustment worksheet.

Step 5.a: The accrual in the account consists of three components: the incremental expense, the incremental revenues, and the adjustment to the incremental expense, all with interest. When the incremental expense $49,713 plus interest, which equals $50,627, is reduced by the amount of over earnings plus interest, $36,909, the balance of offset expenses not reduced by the over earnings is ($13,718). We then apply the offset revenues of $41,492 plus interest, which equals $42,198, to the ($13,718), which leaves us with a balance of $28,480 of offset revenues that was over collected and under the revised balancing account procedures will be returned to ratepayers.

Step 5.b: The Advice Letter should request a surcredit be applied to the service charge until the amount in Step 5 (in this example, $28,480) is refunded to ratepayers.

SUMMARY OF EARNINGS

Commissioner Susan P. Kennedy, dissenting:

In D.03-06-072, the Commission required that all balancing and memorandum accounts be reimbursed to companies only if the utility passed a "pro-forma" earnings test. We should set aside submission and reopen the record because there are already substantial indications that D.03-06-072 is producing unanticipated outcomes, adverse to water utilities and adverse to the long-term interest of ratepayers.

D.03-06-072 argued that the balancing account procedures became problematic because they had the effect of enhancing a utility's earnings above a Commission authorized rate of return.

In attempting to understand this, I pored over years of earnings by water utilities, and not only did I find this to be not true, I found that the opposite becomes true when you apply an earnings test in this manner.

First, the Water Division's district-by-district charts supporting the allegations of over-earnings are flat out wrong. For some reason whoever prepared these reports chose to ignore real additions to rate base. Thus, the Water Division calculated earnings using real revenues but failed to look at equally real investments. The Water Division's numbers have two effects: first, by failing to use real investments, its apples to oranges comparison systematically overstates earnings - often in excess of 100 basis points; second, by using the percentage of over- and under-earnings, the Water Division inflates our perceptions of what is actually happening.

For example, the very first number in the Water Division's chart says that SoCal Water's Arden Cordova District in 1996 had revenues 36% under their authorized ROR. This would translate into earnings of

5.9%, 36% below the adopted 9.32%. In fact, the documents filed with the Commission show that the recorded ROR was 5.6% that year - because, of course, you should recognize real investments in ratebase.

Similarly, the 1996 chart of Water Division for SoCalWater shows total company earnings for all districts as 14.5% above authorized. Since the adopted ROR was 9.5%, this suggests that the ROR in 1996 was 10.88%. When, however, we use recorded earnings and recorded ratebase, we find that the ROR was actually 8.79%. Thus, the Water Division's methodology overstates earnings in this case by 209 basis points.

This dynamic is repeated in every year and for every company using Water Division's methodology.

Frankly, if the Commission were as far off in setting rates for these districts as Water Division thinks we were, then every single one of us on this Commission and on staff should be mandated to go to back to rate school. We should compare real earnings with real investments, not real earnings to forecast investments.

But we haven't been off in setting rates. In fact, taking into consideration weather conditions that so uniquely impact the water industry utilities - we've been right on the money. Years where they over-earn balance out years where they under-earn.

And I have to say, I am extremely disturbed that information that is so distorting was given to this Commission - not once, but twice. This Water Division table, which applies the methodology adopted in D.03-06-072 to water districts over many years, totally distorts the earnings of these companies, making it look as if they are systematically over-earning. There is no excuse for this.

D.03-06-072 seriously undermines the regulatory balance that is so critically needed in the water industry today. With the earnings test applied to memorandum and balancing accounts, we guarantee that they will never over-earn. But we don't guarantee that they will never under-earn.

So this policy will, without question, impact their decisions on investment and expenditures in a negative way. Instead of making decisions based on water quality and infrastructure needs - they will have to play the "earnings game". They will have to anticipate and adjust their expenditures - painting water tanks when necessary, and avoiding testing for perchlorate contamination when possible - in order to make sure they come in right at their authorized ROR. Because they know they will never recover the under-earnings any other way, and they know that over-earnings will be taken away.

Look at what the rating agencies are doing to these companies. Just last week, CalWater Service had its debt ratings downgraded. SoCal Water remains on credit watch. In both cases, regulatory uncertainty with regard to rate cases and recovery of capital expenditures is cited - partly because statutory requirements for water quality are pushing the need for capital investments higher. When coupled with regulatory uncertainty of the type we find here, it creates significant financial risk.

If these companies were systematically over-earning or making money hand over fist, do you think they'd be on credit watch? The systematic over-earning is simply a fiction of the methodology we have adopted. Even if this methodology is sufficient to mystify the Commission, it is not sufficient to deceive bond-rating agencies and market analysts.

If the Commission would simply take the time to look at the evidence, you will see that many of these companies are barely earning any ROR in some years, and the earnings test as it is applied in D.03-06-072 systematically overstates earnings and the resulting disallowances produce systematic under-earnings.

A second rationale for the earnings test offered by D.03-06-072 was that at times some utilities would fail to file a GRC application every three years, and over earnings could persist. This implies that these companies stay out on purpose because they are over-earning.

First of all, while that may be true in some isolated cases with small companies - there is no evidence of that being the case generally. In fact, what I found is that the reason some don't come in is because it would cost them more money to file the rate case than they would receive in a rate increase.

But this is a moot point. New legislation now requires each class A water company to have a GRC every three years. Thus, a statute corrects this problem, and the earnings test is not needed.

The Commission should set aside submission and reopen this record to examine these issues in more detail. In my view, the earnings test was a policy innovation that was oversold - it is unclear that the problem it purports to correct actually exists; it fails to work as advertised; it undercuts other policies, such as those that encourage water quality testing or litigation to recover costs from polluters; and it undermines the ability of our utilities to invest in California's infrastructure.

There may be no legal error in D.03-06-072, but there are clearly problems in that decision.

I voted for D.03-06-072, and I'm not afraid to admit that I made a mistake. We should return this matter to Commissioner Brown for further record development and to correct these failing policies.

For all these reasons, I must respectfully dissent.

/s/ SUSAN P. KENNEDY

Susan P. Kennedy

March 16, 2004