VIII. Components of Rate Base

A. Plant Additions -- Overview

As discussed earlier, we have generally approved San Gabriel's construction plan subject to the rate base cap. Below, we discuss the key features of San Gabriel's plan.

1. Wellhead Treatment Facilities and Surface Water Treatment

In its Priority List of capital projects (Exhibit 54), San Gabriel substituted upgrades to the Sandhill Treatment Plant (estimated to cost $9.8 million), which will allow full use of its 20 mgd capacity, in place of the near-term development of the new West-Side Treatment Plant (estimated to cost $17.0 million). All parties appear supportive of the proposed upgrades to the existing Sandhill Treatment Plant.

All parties agree the costs of perchlorate removal treatment ought to be borne by the polluters. San Gabriel states that as directed by the Commission in Resolution W-4089 (January 21, 1998) and Resolution W-4094 (March 26, 1998), San Gabriel is actively pursuing those polluters.

Contending that less expensive alternatives are available, City, School District and ORA oppose San Gabriel's plan to install wellhead treatment plants. However, San Gabriel argues that construction of seven wellhead treatment plants (each costing about $1.75 million) cannot be put on hold awaiting the outcome of litigation and receipt of funds from third-party sources, which may take many years to achieve. According to San Gabriel, it urgently needs the restoration of lost production capacity now, so the treatment systems must be built now even though the costs have not yet been recovered from the polluters. Therefore, the tasks of cleaning up the contaminated ground water and pursuing the polluters for reimbursement are being conducted concurrently. As it has already done in its Los Angeles County Division, San Gabriel proposes maintaining a memorandum account to record the proceeds already received and future possible recoveries of treatment plant costs and operating expenses from polluters and possible grants from state or federal sources so the cost borne by the customers can be mitigated. We agree with San Gabriel's plan to immediately construct wellhead treatment plants and to implement a memorandum account since the record supports such a course of action.¹⁰

2. Wells

The Chino Basin is the only reliable source of water currently available to Fontana Division. Accordingly, San Gabriel proposes to drill three new wells (F51A, F51B, and F51C) in Test Year 2003 and one new well (F7B) in Test Year 2004. San Gabriel witness Black testified that without restoring contaminated wells and drilling new wells, Fontana Division will likely not be able to meet peak summertime demands. We agree with San Gabriel's plan to drill new wells to meet peak summer time demands since the record shows that Fontana Division had difficulty meeting those needs in the summer of 2003.

3. Reservoirs

San Gabriel plans to construct six reservoirs in Test Years 2003 and 2004 at a cost of $4.55 million. ORA acknowledges that one reservoir is necessary but proposes that the other five reservoirs be disallowed. ORA argues that the proposed increase in storage capacity far exceeds the increments in such additions during the prior 15 years, and that compared to another [unspecified] Class A water company, Fontana Division has enough storage capacity.

We reject ORA's recommendation because there is no logical relationship between historical increases to capacity and the additions to storage capacity that are presently needed. ORA also fails to explain why the water storage capacity of another water utility is relevant to Fontana Division's water storage needs. Accordingly, we adopt San Gabriel's plan for new reservoirs since the current rate of growth supports such additions.

4. Booster Stations

San Gabriel plans booster stations at five sites to deliver water produced from lower elevations in the Chino Basin to higher pressure zones within the system. ORA agrees that a new booster station should be built for plant F-16 at a cost of $395,000, but believes additional details need to be provided to the Commission before this item is included in rates. ORA does not state what additional information is needed. We adopt San Gabriel's plan for booster stations since the record supports San Gabriel's need for flexibility to pump water to its five pressure zones.

5. SCADA System

San Gabriel budgeted $1.2 million to design and construct a new SCADA system to control and monitor wells, booster pumps, reservoirs, treatment plants, and disinfection facilities, as well as gather and store production data, system pressures, and flows. Fontana Division's existing telemetering system is not computerized, cannot be expanded, and is more than 35 years old. According to San Gabriel, the new SCADA system will allow continuous monitoring of all facilities and promote more efficient operations. ORA recommends exclusion of this investment on the basis that San Gabriel has not made an adequate showing and there is no urgent need for a SCADA system.

We approve San Gabriel's plan to install a computerized control system. We find that Fontana Division needs to be better able to manage its complicated system of 34 wells and five pressure zones, and the existing system has outlived its useful life.

6. Security Equipment

San Gabriel budgeted $1 million for security equipment to be installed at 20 sites. ORA recommends that no expenditure be approved. San Gabriel provided justification of the need for this equipment to prevent unauthorized tampering with or disruption of the water system.

We adopt San Gabriel's plan for installing security equipment. Following the events of September 11, 2001, and the recently enacted Public Health and Bio-Terrorism Act signed by President Bush into law in June, 2002, it is necessary that San Gabriel develop a security plan in conformance with industry guidelines.

7. Emergency Generators

San Gabriel proposes to install four emergency generators at a cost of $400,000 to operate its wells, booster pumps, and treatment plants when electrical outages occur. ORA opposes the installations on the premise that the existing emergency generators have not been used. San Gabriel responds that the emergency generators were used during the recent fires in the Fontana area when electrical power was interrupted. We approve San Gabriel's request. The recent fires underscore the need for emergency power. Sound water system operations and planning, particularly in Fontana Division with its five different pressure zones and high-fire risk, requires that it be prepared for severe, if infrequent, outages.

8. Water Treatment and Distribution Mains

ORA agrees with San Gabriel's 2003 capital budget for water transmission and distribution mains, but contends that the $7.47 million required for Test Year 2004 is excessive and unsupported. We adopt San Gabriel's plan for additional mains because the system growth being experienced in Fontana Division justifies such expenditures.

9. Vehicles

San Gabriel budgeted $270,000 in each of the test years for transportation equipment. ORA used an average of 2000 and 2002 recorded expenditures for its $69,107 estimate, dropping the much higher level of expense San Gabriel incurred for such equipment in 2001. San Gabriel states that it replaces vehicles at the earlier of 120,000 miles or 10 years of age, and that it adds vehicles required for certain new employees or for replacing vehicles damaged beyond repair. The record supports San Gabriel's plan for new vehicles, and we approve its budget request.

10. Tools & Equipment

San Gabriel budgeted $125,000 for Test Year 2003 and $5,000 for Test Year 2004. ORA recommends the recorded 1999-2001 average of $10,771, leaving out the substantially higher expense incurred for these items in 2002, amounting to $56,900. We adopt San Gabriel's estimate since it is based on actual expected needs.

11. New Building

San Gabriel initially budgeted $3 million to replace Fontana Division's administrative and operations offices. San Gabriel states that these facilities are now housed in seven old, overcrowded, and unsafe structures. During the course of these proceedings, San Gabriel revised the estimated cost to $6 million. San Gabriel submits that a new building will provide a safer and more efficient working environment than the existing array of very old facilities, and therefore should be approved. City, School District and ORA oppose this new facility on the basis that it is not needed or that it is a luxury the ratepayers cannot afford.

A new office building may enable Fontana Division to operate more efficiently, but it should be deferred to the next GRC filing, given the rate impact of the other plant additions we are authorizing in today's decision. However, we will allow San Gabriel to purchase the land for a new office building and include the cost in rate base, since land for such a facility in a suitable location may not be available later. If in its next NOI filing, San Gabriel requests authorization to proceed with the new building, it should provide a complete justification and address the ratemaking treatment of the proceeds from the sale of the existing facility.

B. Materials & Supplies (M&S)

San Gabriel's M&S balances are primarily determined by the level of its construction activities. For its test year forecasts, San Gabriel escalated the most recent recorded average M&S balance by both the forecasted increase in average plant and by non-labor escalation factors. ORA based its estimate on a comparison with other water utilities that are not experiencing a level of development and construction activity comparable to Fontana Division's current situation. We adopt San Gabriel's estimate of M&S because it better reflects the current level of construction activity in Fontana Division.

C. Construction Work in Progress (CWIP)

ORA incorporated recorded December 2002 Plant into its test year estimates but, without explanation, applied the recorded December 2001 balances of CWIP as a deduction from that account. Amounts recorded as CWIP ultimately are transferred to Plant, and it is inappropriate to mix recorded data as ORA has done, to calculate test year rate base. Therefore, we adopt San Gabriel's estimate of CWIP.

D. Contributions in Aid of Construction (CIAC)

CIAC recognizes amounts contributed by developers and customers for plant needed solely for their projects. The utility does not earn on contributed plant. ORA excluded from Plant the cost of treatment facilities reimbursed from polluters and government agencies but retained as CIAC the funds provided by those third parties. We adopt San Gabriel's estimate since the mismatch in ORA's estimate is inappropriate for purposes of calculating test year rate base.

E. Fontana Union Water Company Stock

San Gabriel's proposed rate base includes $747,800, which represents its investment in Fontana Union Water Company (Fontana Union), the primary source of its water supply. ORA excluded this investment from its calculation of rate base claiming that Fontana Union had paid dividends to San Gabriel. San Gabriel witness Michael L. Whitehead, an officer and director of Fontana Union for more than 20 years, testified that Fontana Union does not pay dividends, and the only occasion on which Fontana Union ever made a distribution to shareholders occurred in 1989 over San Gabriel's objection and with full disclosure to the Commission. He further testified that the distribution was accounted for in Account 523 and, in the next rate case, applied as a credit to the purchased water balancing account. We find no justification for reversing the historical rate base allowance for San Gabriel's investment in Fontana Union Water Company. Accordingly, ORA's proposed rate base adjustment is rejected.

F. Working Cash

The function of working cash as a component of rate base is to compensate San Gabriel's shareholders for funds provided by them which are permanently committed to the business for the purpose of paying operating expenses in advance of receipt of revenues from customers and to maintain minimum bank balances. Taking into consideration certain proposed ratemaking adjustments that are unrelated to the function of working cash, ORA estimates of negative working cash needs are (-$20.99 million and -$21.852 million). San Gabriel's estimates are positive $0.631 million and positive $0.739 million for the Test Years 2003 and 2004, respectively. San Gabriel's working cash estimate is consistent with the method adopted by the Commission in its prior rate cases. San Gabriel disputes ORA's reduction of San Gabriel's working cash estimate by certain liability accounts, contending that ORA has applied only reductions, but failed to apply all additions to working cash required by Standard Practice U-16. We find that, even after adjusting ORA's estimate by the proposed negative $15.1 million disallowance discussed below, San Gabriel's estimate appears more reasonable. We adopt San Gabriel's estimate of working cash since it has better supported its estimate.

G. Plant Sales/Condemnation Proceeds

The issue of "proceeds from sales and condemnations" was the most hotly contested issue in this proceeding. ORA proposed a $15.1 million reduction to Fontana Division rate base through a reduction in working cash allowance "pending the resolution of these missing or unaccounted proceeds." ORA states that between 1996 and 2001, San Gabriel had a significant amount of utility plant sales and received proceeds from utility plant abandoned because of contamination. According to ORA, for plant sales and condemnations, San Gabriel was paid about $17,430,754, but only accounted for $2,320,909 leaving a balance of $15,109,845 that is "not accounted for." ORA contends that most of the utility plant was still used and useful at the time of condemnation or sale; therefore, Pub. Util. Code § 790¹¹ is not applicable. Further, ORA argues that D.93-01-025 requires San Gabriel to have disclosed proceeds from sales and condemnation in its Application, but that it failed to do so.

San Gabriel responds that D.93-01-025, which applied to California Water Service's sale of a system, does not apply here. San Gabriel points out that in this case, San Gabriel has not sold its system, nor has it been relieved of its public utility obligations to its customers (see D.93-01-025, 47 CPUC2d at 599). San Gabriel submits that even if the Commission had such criteria back in 1993, Section 790, which became effective in 1996, controls the property sales at issue here, and supersedes any inconsistent prior Commission policy. San Gabriel submits that it already has provided evidence that it complied with the requirements of Section 790.

San Gabriel's position is that all the sales and condemnation proceeds at issue here are subject to Section 790, because at the time of sale, condemnation, or involuntary conversion, the properties were no longer necessary or useful in the performance of its obligations as a public utility.

San Gabriel explains that the $15,109,845 amount is comprised of four categories of transactions: (1) funds for facilities sold to governmental agencies under threat or imminence of condemnation ($547,785); (2) plus funds for inverse condemnation from service duplication ($3,814,528); (3) plus funds for involuntary conversion relating to groundwater contamination ($11,071,396); and, (4) minus the amount of facilities reported in data requests but not eligible for tax deferral in the tax return schedules ($323,874). According to San Gabriel, its rebuttal testimony (Exhibit 8) shows that all property sales and condemnation proceeds were properly accounted for as prescribed by the Uniform System of Accounts (Utility Plant Accounts, Instruction 12F, Utility Plant Sold), by precedent set in previous general rate case decisions, and by Section 790.

ORA also contends that San Gabriel did not account for several thousand dollars of interest income from the condemnation proceeds. San Gabriel responds that any interest would be de minimis since the proceeds were invested in utility plant in the same year that they were received. San Gabriel refers to Attachment D of ORA's Report (provided by San Gabriel to ORA) which shows investment in utility plant far exceeding the net proceeds received by San Gabriel; thus, San Gabriel claims that any interest was invested in the specified assets.

Further, San Gabriel states that contrary to ORA's assertions that Section 851 requires San Gabriel to obtain Commission approval for sales or transfers of utility plant, a large portion of the proceeds received by San Gabriel relate to inverse condemnation claims or service duplication damages caused by third parties that did not involve the physical taking or selling of utility plant facilities. According to San Gabriel, these are involuntary conversions of its property rights and, thus, San Gabriel would not have occasion to request Commission approval for a taking or damaging of its property or rights that has already occurred.

We reject ORA's proposed $15.1 million rate base reduction. While the burden of proof is on the utility, much of the confusion on this issue, as evident from the record, was due to ORA's characterization of this issue as a Working Cash issue, which it is not, and ORA's claim that there are "missing or unaccounted proceeds."

We find, in fact, that the money is accounted for, at least as to source. However, to ensure proper disposition of sales and condemnation proceeds, this matter should be addressed more thoroughly in Fontana Division's next GRC, where a full record needs to be developed. We require San Gabriel to provide, in its next NOI filing, a complete listing and description of all sale and condemnation proceeds received from 1996 onwards with detailed accounting of any reinvestment of sales or condemnation proceeds in rate base, and of any other disposition of funds. San Gabriel must also provide supporting justification for future proposed ratemaking treatment. Since the Commission addresses the usefulness of property and gain on sale on a case-by-case basis, San Gabriel should address each individual transaction separately.

In reviewing San Gabriel's sales and condemnation proceeds, and the appropriate ratemaking treatment of such proceeds, parties should keep in mind the following principles.

Public Utilities Code Section 851 requires utilities to seek Commission approval before selling or otherwise disposing of facilities or other property necessary or useful in the performance of the utility's duties to the public, and provides that any transaction made contrary to such approval is void. Section 851 applies to sales made under threat on condemnation, and applications for approval of such sales are common. (See, e.g., D.94-01-028.) It also applies to transactions involving property that is not actually currently being used by the utility, but is simply useful to the utility in some fashion.

Public Utilities Code Section 790 provides that when a water utility sells real property that once was, but no longer is, necessary or useful, the net proceeds must be reinvested in utility infrastructure, plant, facilities, and properties that are necessary or useful in the performance of its duties to the public.¹² Such infrastructure, etc., if used and useful to the utility, must be included in rate base. If the net proceeds are not reinvested within eight years, they go to ratepayers, with interest. Section 790 notes that the Commission retains continuing authority to determine the used, useful, or necessary status of any and all infrastructure improvements and investments. Section 790 only applies to sales of real property that is no longer necessary or useful. It does not apply to sales of other property, or to transactions that are not sales.

To the extent that San Gabriel properly determined that real property was once, but is no longer, necessary or useful in providing utility service, sold that real property at a profit and re-invested the net proceeds in utility plant that is necessary or useful within eight years of the sale, the utility may well be in compliance with Section 790. The problem thus far is that because the utility did not bring its sales and reinvestments to the Commission's attention, the Commission has had no chance to evaluate the utility's determination regarding necessity and usefulness prior to sale, or the prudence of its reinvestment. By not seeking prior review of property sales, San Gabriel runs the risk that we will find it violated Section 851 by selling or otherwise disposing of necessary or useful utility property without our consent. (See, e.g., D.04-03-049.)

Unless new utility plant was purchased with proceeds from the sale of real property no longer necessary or useful, the new plant cannot be automatically included in rate base under Section 790. Any new plant that San Gabriel bought with proceeds from inverse condemnation settlements or transactions that did not involve the actual sale of real property is not entitled to the automatic rate base treatment afforded by Section 790.

The limited scope of Section 790 does not mean that plant purchased with proceeds that do not qualify for Section 790 treatment must be kept out of rate base. Rate base treatment may be given necessary or useful plant prudently purchased with other funds, provided that shareholders rather than ratepayers were the source of the funds.

If further proceedings demonstrate that Section 790 is applicable to certain of the proceeds at issue, then necessary or useful plant prudently purchased with those proceeds should be included in a rate base account.

If further proceedings demonstrate that Section 790 is not applicable to specific proceeds, either because the transaction resulting in the proceeds was a sale, but not a sale of real property, or because the transaction was not a sale of any sort, then additional analysis would be required before the Commission could properly determine whether plant bought with the proceeds should be included in rate base. First, the Commission must determine whether the proceeds accrue to shareholders, or to ratepayers. Second, the Commission must determine whether the investment in utility plant was reasonable and prudent, and whether the plant is necessary or useful to the utility in performing its duties to the public.

We grant City's motion for an audit of San Gabriel's sale and condemnation proceeds because of the confusion surrounding this issue. We will in this decision order Water Division staff to perform an audit prior to Fontana Division's next GRC. In reviewing San Gabriel's sales and condemnation proceeds, and the appropriate ratemaking treatment of such proceeds, staff should review our discussion of Section 790 in D.03-09-021 and D.04-01-052 (granting limited rehearing of D.03-09-021) and our discussion of ratebase reductions or other adjustments related to sales and condemnation proceedings (see, e.g., D.92112 and D.92273).

H. Plant F-10

As a result of contamination originating in the Mid-Valley Landfill operated by the County of San Bernardino (County), San Gabriel was required to take certain wells out of production. Under a 1998 settlement agreement (Exhibit 24), the County paid San Gabriel $8.6 million in settlement of (1) San Gabriels' claim of property damage to its water rights, and (2) the cost of restoring lost well production. At a cost of $2.6 million, San Gabriel constructed a treatment facility at its Plant F-10 and restored the contaminated wells to service. San Gabriel claims that pursuant to Section 790, the $2.6 million cost of the plant should be included in ratebase as a shareholder investment.

City and School District point out that, as reflected in the settlement agreement, the intent of the County's settlement payment was to restore lost well production. They argue that under San Gabriel's approach, its shareholders receive a windfall, while ratepayers are made worse off as a result.

We reject San Gabriel's argument that Section 790 applies to the $2.6 million cost of the treatment facility reimbursed by the County. As stated in the settlement agreement, the $8.6 million settlement payment includes the cost of a treatment facility to restore lost well production. Thus, the $2.6 million reimbursement for a new treatment facility needed to restore lost well production is not a Section 790 sale of real property that was no longer necessary or useful in the performance of the water corporation's duties to the public. Furthermore, there are no shareholder funds invested in the new treatment facility since San Gabriel was fully reimbursed by the County for the cost. For ratemaking purposes, we will treat the $2.6 million amount as a Contribution in Aid of Construction. Accordingly, we reduce ratebase by the $2.6 million reimbursement for the cost of the treatment plant, and will place that amount in the memorandum account related to such contamination costs. As we stated before, the record in this proceeding is insufficient to address the ratemaking treatment of the remaining $6.0 million San Gabriel received from the County. That should be addressed in the next GRC proceeding along with the other sale and condemnation proceeds received by San Gabriel since 1996 onwards. Revenues related to these sale and condemnation proceeds will be subject to refund.

I. Water Management/Engineering Report

Considerable hearing time and effort was expended by all parties in trying to ascertain the basis for San Gabriel's request for major plant additions. As San Gabriel is well aware, it has the burden to support its request with a clear and convincing showing - which it did not provide in this proceeding. To avoid a repeat in its next GRC proceeding, we expect a report from San Gabriel analyzing the need for all proposed major projects for which San Gabriel seeks authorization.

The report should provide a complete description of the Fontana system, list expected pump outputs under drought conditions, address system capability to handle peak-day and fire-flow requirements, and include a copy of the most recent DHS report. San Gabriel may enlist the services of a consulting engineer and request recovery of reasonable costs in its GRC filing.

Whenever a water corporation sells any real property that was at any time, but is no longer, necessary or useful in the performance of the water corporation's duties to the public, the water corporation shall invest the net proceeds, if any, including interest at the rate that the commission prescribes for memorandum accounts, from the sale in water system infrastructure, plant, facilities and properties that are necessary or useful in the performance of its duties to the public. . . . . (Pub. Util. Code § 790(a), emphasis added.)