II. Recent Commission Treatment of Gain on Sale

The Commission currently allocates gain on the sale of a utility asset on a case-by-case basis. We rely on such factors as how long the asset was in ratebase, who bore the actual financial risk of the investment, how different allocations might affect various management and investor incentives, whether the asset is depreciable or nondepreciable, the type of asset sold, the circumstances leading to its sale, constraints embedded in the Uniform System of Accounts (USOA),² and judicial or Commission precedent. We have made it clear in each decision, however, that the result is not meant to be generally applicable to future asset sales and that the present case is judged on its own merits.

The Commission has issued only a few decisions that discuss in detail the appropriate principles to be used in allocating gains and losses, and even these cases have limited application. We will discuss these decisions below, but briefly outline them here. A 1985 decision gave the entire gain from the sale of an electric distribution system to ratepayers, using a "risk theory of allocations." We pointed out that, unlike in the private sector, the risk of the investment was borne by ratepayers and that any gains should therefore accrue to them. However, we reversed this conclusion in 1989, saying that the important criteria were whether the ratepayers were harmed by the transaction, and whether they had contributed capital to the acquisition of the distribution system. If ratepayers were not harmed and they had not contributed capital, we decided that the gain should go to shareholders.

In 1990, we decided that the gain realized on the sale of a utility's headquarters building should be shared between ratepayers and shareholders. We applied a "ratepayer indifference" analysis and determined that (1) ratepayers should receive enough of the gain to compensate for the difference between what the old building would have cost had it continued in ratebase and what the new asset will actually cost, and (2) shareholders should receive the rest "as a reward and incentive" for putting the property to its best economic use. In a subsequent decision we decided to replace this "ratepayer indifference" principle with the "traditional risk and incentive analysis" approach, and said that to give too much of the gain to shareholders would provide a perverse incentive to utility management. In all of these cases we emphasized that our conclusions were limited to the specific asset sale and were not to be broadly applied.

For large telecommunications carriers, prior to our adoption of the New Regulatory Framework (NRF) price cap regulation in 1994, we generally allocated all of the gain on the sale of land to ratepayers. Under NRF, we decided to allocate the gain on land between shareholders and ratepayers based on the time that the property had been in utility ratebase. For sales after 1997, we have allocated 50% of the gain to ratepayers and 50% to shareholders.

For buildings and other depreciable assets, we have generally had the telecommunications carriers allocate the gain to ratepayers through a credit to the asset's salvage value. However, in 1997 we allocated the gain from the sale of a line of business equally between ratepayers and shareholders. Again, we stressed that the conclusions we reached should be limited to the specific circumstances of that case and should not be applied broadly.

For water companies, we argued prior to 1995 that ratepayers had borne most of the risk and costs of the utility investments, and thus deserved a portion of the gain. To encourage further investment in infrastructure we also found we should allocate some gain to shareholders. We therefore allocated gains on the sale of these assets equally between ratepayers and shareholders. In 1995, Pub. Util. Code §§ 789 et seq. was enacted, which provides that a water corporation shall invest the "net proceeds" of the sale of real property in water system infrastructure that is necessary or useful for utility service. This rule effectively allocates the entire gain from the sale of an asset to shareholders if it is reinvested toward a public purpose. The gain is added to the utility's ratebase on which the shareholders earn a rate of return through rates paid by the ratepayers.³

We believe further effort to interpret the water statute is merited. This Commission has not previously considered how to reconcile the Water Utility Infrastructure Act with the requirement that rates be just and reasonable pursuant to Public Utilities Code § 451.