V. Long-Term Debt and Preferred Stock Costs
Long-term debt and preferred stock costs are based on actual, or embedded, costs. Future interest rates must be anticipated to reflect projected changes in a utility's cost caused by the issuance and retirement of long-term debt and preferred stock during the year. This is because the ROE is established on a forecast basis each year.
We recognize that actual interest rates do vary and that our task is to determine "reasonable" debt cost rather than actual cost based on an arbitrary selection of a past figure.22 In this regard, we conclude that the latest available interest rate forecast should be used to determine embedded debt cost in ROE proceedings. Consistent with this conclusion, the assigned Commissioners' Scoping Memo and Ruling allowed the utilities to update their long-term debt and preferred stock costs to reflect September 2005 Global Insight forecasted interest rates. That update was submitted on September 20, 2005 as Late-Filed Exhibits 48, 49, and 50 by PG&E, SCE and SDG&E, respectively.
A. PG&E
PG&E projected a long-term debt cost of 6.05%, a reduction from its currently authorized 6.10% rate. This decrease in cost results from the net impact of PG&E decreasing its credit support costs which is offset by increasing its Pollution Control (PC) bonds short-term interest costs. The PC bonds carry a very low cost because their interest costs are tax-exempt and their rates are set daily based on interest rates which track the Federal Fund rate. PG&E updated its long-term debt costs to reflect the most recent forecast of interest rates. That update results in its long-term debt cost being further decreased to 6.02% from 6.05%. This revised rate is eight basis points lower that the 6.10% long-term debt cost authorized in PG&E's test year 2005 ROE proceeding.
PG&E projected a preferred stock cost of 5.87%, a 55 basis point reduction from its currently authorized rate of 6.42%. This decrease in cost is due largely to the end of a ten-year amortization period over which PG&E was amortizing the redemption costs of certain preferred stock redeemed in 1995. PG&E does not project any new issuances or redemptions of preferred stock in 2006. Hence, the updated forecast of interest rates did not impact its test year preferred stock cost.
B. SCE
SCE projected its test year 2006 long-term debt cost to be 6.53% based on a simple average of its projected year end 2005 and year end 2006 long-term debt forecasts. That 2006 forecast provides for the issuance of $700 million in new long-term debt and $330 million in PC bonds. Based on its late-filed exhibit that updated the impact of the most recent forecasted interest rates, SCE lowered its forecasted long-term debt cost to 6.17% from 6.53%. This revised rate is 79 basis points lower than the 6.96% long-term debt cost authorized in its test year 2005 ROE proceeding.
SCE used that same method to calculate a preferred stock cost of 6.43%. Its forecast provided for the issuance of $115 million of traditional preferred stock in 2006. Based on its late-filed exhibit that updated the impact of the most recent forecasted interest rates, SCE lowered its forecast to 6.09% from 6.43%. This revised rate is 64 basis points lower than the 6.73% preferred stock cost SCE was authorized in its test year 2005 ROE proceeding.
C. SDG&E
SDG&E projected its test year 2006 long-term debt cost to be 5.99% based on a simple average of its projected year end 2005 and year end 2006 long-term debt forecasts. That 2006 forecast provides for the issuance of $320 million in new long-term debt. Based on its late-filed exhibit that updated the impact of the most recent forecasted interest rates, SDG&E lowered forecast to 5.75% from 5.99%. This revised rate is 15 basis points lower than the 5.90% long-term debt cost authorized in its 2004 Market Index Capital Adjustment Mechanism (MICAM) and 89 basis points lower than its 6.64% long-term debt cost authorized in its test year 2003 ROE proceeding.23
SDG&E used that same method to calculate a preferred stock cost of 7.15%. Its forecast provided for a $40 million issuance of traditional preferred stock in test year 2006 to coincide with its Palomar power plant acquisition. This cost is also impacted by a required 50,000 share redemption plus the anticipated exercise of an option to redeem an additional 50,000 shares of SDG&E's $1.7625 Preference Series. Based on its late-filed exhibit that updated the impact of the most recent forecasted interest rates, SDG&E lowered its forecast to 6.83% from 7.15%. This revised rate is 62 basis points lower than the 7.45% preferred stock costs authorized in its 2004 MICAM true-up and 68 basis points lower than the 7.51% authorized in its test year 2003 ROE proceeding.
D. Discussion
No party disputes the long-term debt or preferred stock costs being proposed by the utilities. We have reviewed the undisputed costs, which have been updated to reflect the most recent forecasted interest rates, September 2005, and find that the following long-term debt and preferred stock costs for the utilities are consistent with the law, in the public interest and should be adopted.
Rates |
PG&E |
SCE |
SDG&E |
Long-term Debt |
6.02% |
6.17% |
5.75% |
Preferred Stock |
5.87% |
6.09% |
6.83% |
Having determined the appropriate long-term debt and preferred stock costs, we address the appropriate ROE.
22 38 CPUC2d 233 at 242 and 243 (1990).
23 Exhibit 15, p. 1.
