III. DISCUSSION

Contemporaneously with the present proceeding, the U.S. Court of Appeals for the Eight Circuit reviewed certain FCC regulations that had been promulgated to implement the interconnection agreement provisions of the Telecom Act, including the FCC's TELRIC rule at 47 CFR § 51.505.² This review followed a remand order of the U.S. Supreme Court.³ The Eighth Circuit concluded that while the use of a forward-looking pricing methodology was consistent with the Telecom Act, part of the FCC's rule "violates the plain language of the Act" because it permits prices to be based on hypothetical assumptions using the "most efficient telecommunications technology" available.

The court emphasized that to meet the statutory standard at Section 252(d)(1)(A)(i) of the Telecom Act, UNE prices must represent the actual costs of the ILEC's specific facilities and equipment. (Iowa Utilities Board II, 219 F.3d, at 750-751.)

"Congress . . . expressly said that the ILEC's costs of providing those facilities and that equipment were to be recoverable by just and reasonable rates. . . .

"It is the cost to the ILEC of providing its existing facilities and equipment either through interconnection or by providing the specifically requested existing network elements that the competitor will in fact be obtaining for use that must be the basis for the charges." (Iowa Utilities Board II, 219 F.3d, at 750-751.)⁴

The Eighth Circuit, therefore, vacated and remanded to the FCC for reconsideration a subsection of the FCC's TELRIC regulation at 47 CFR §51.505(b)(1). (Ibid.) It also vacated the FCC's proxy prices at 47 CFR §51.513 on the grounds that the U.S. Supreme Court had explained that the FCC's role was to resolve "general methodological issues," while the State commissions were to use their discretion in establishing the specific prices.⁵ However, the court reaffirmed the basic elements of the TELRIC methodology, as described in other parts of the FCC's regulations, on the basis that it reasonably promotes the competitive environment sought by Congress. (Iowa Utilities II, 219 F.3d, at 752.)

Subsequently, on September 22, 2000, the Eighth Circuit stayed part of Iowa Utilities Board II pending the results of petitions for certiorari filed by the FCC, WorldCom, Inc., and AT&T Corp. with the U.S. Supreme Court. The petitions seek review of the Eighth Circuit's order vacating the FCC's regulation permitting UNE prices to be based on a hypothetical, most efficient network. (47 CFR § 51.505(b)(1).) The petitions do not seek review, however, of the Eighth Circuit's order vacating the FCC proxy prices.

With respect to the matter before us, the uncertain status of the particular regulation regarding the use of a hypothetical, most efficient network in TELRIC is not critical. Also, our present decision is not dependent on the elimination of the FCC proxy prices by the Eighth Circuit. Iowa Utilities Board II remains significant because it leaves intact, as had the U.S. Supreme Court in AT&T Corp., certain critical sections of the FCC's TELRIC regulations. As we shall discuss, we rely here on Section 252(d)(1)(A)(i) of the Telecom Act and the FCC's TELRIC pricing regulations at 47 CFR §51.505(a)(c)(d) and (e), which have survived the scrutiny of the U.S. Supreme Court and of the Eighth Circuit, and are not subject to further challenges.

To begin with, 47 CFR § 51.505(e) states:

"An incumbent LEC must prove to the state commission that the rates for each element it offers do not exceed the forward-looking economic cost per unit of providing the element, using a cost study that complies with the methodology set forth in this section and § 51.511 of is part." (Emphasis added.)⁶

Equally important is the FCC's regulation at 47 CFR §51.505(d), which prohibits the inclusion of embedded costs, retail costs, opportunity costs, and revenues to subsidize other services in calculating the TELRIC. Further, 47 CFR §51.505(e)(1) provides that when a State commission relies on a proxy to set a price, the proxy must be based on the FCC's TELRIC methodology, which as noted excludes the costs proscribed by 47 CFR §51.505(d).

Upon reconsideration of these regulatory provisions, we conclude that we cannot accept Roseville's cost study by which it derived the multiplier of 2.19 and applied it to Pacific Bell's final UNE prices. According to Roseville's witness, the multiplier reflects a comparison of the "total business costs of both businesses" (i.e., Roseville and Pacific Bell), including embedded costs, such as investment in plant, buildings, and land, as well as retail costs. (R.T. 176:15-16; 177: 13-17.)⁷ In addition, the written testimony of Roseville's witness indicates that the business costs that were compared included retail costs, such as product advertising and sales expenses, and that the derivation of the 2.19 factor reflected the rates of return for Pacific Bell and Roseville. (Exhibit 7, Testimony of R.L. Scholl, February 8, 2000, Attachment C.)

The fundamental factor in Roseville's cost study, therefore, was derived by comparing the kinds of costs which, pursuant to FCC regulation, may not be considered in calculating the forward-looking economic cost of a network element. (47 CFR §51.505(d)(1)(2).) The derivation of the 2.19 multiplier is also not consistent with the Telecom Act, which provides, at 47 U.S.C. §252(d)(1)(A)(i), that the costs shall be "determined without reference to a rate-of-return or other ratebased proceeding."

In addition, the need for specificity casts doubt on the UNE pricing results because the same 2.19 factor was applied to every Roseville UNE. We are, therefore, persuaded by Covad's argument that Roseville's methodology does not derive costs sufficiently specific to Roseville and specific to each element. (Application for Rehearing, at 2-3.) One of Roseville's witnesses, moreover, testified: "You know, everything that Roseville does isn`t going to cost it 2.19 times what it cost Pacific." (R.T. 176:22-23.) Although applying the same factor across the board may have been the least complicated calculation, upon reconsideration we are not assured it has lawfully determined Roseville's costs for providing the specifically requested network elements that Covad will in fact be obtaining for use. We also find, after reviewing the record, that Roseville did not successfully refute Covad's claim that the price of $25.62 per 2-wire local loop per month would prohibit Covad from entering the Roseville area market at this time as a DSL provider.⁸ Accordingly, we must grant rehearing and modify the UNE prices set forth in D.00-06-080 to establish fair and reasonable UNE prices that balance the interests of Covad and Roseville.

The Commission believes that it would be just and reasonable if we adopted as a proxy for interim use Pacific Bell's deaveraged local loop prices that we have approved on an interim basis in D.00-08-011. In this decision of August 2000, the Commission adopted the Final Arbitrator's Report regarding the interconnection agreement between Pacific Bell and AT&T Communications of California, Inc. (AT&T). The approved agreement includes interim, deaveraged UNE prices that were based on the final UNE prices the Commission previously adopted for Pacific Bell, pursuant to a completed TELRIC cost study, in D.99-11-050.

As we shall discuss further, Pacific Bell's interim deaveraged local loop prices are appropriate proxies for Roseville on an interim basis, and subject to true up, with interest, when final prices for Roseville are approved. The Pacific Bell prices derive from a TELRIC cost study and reflect a good faith attempt to comply, at least on a temporary basis, with the FCC regulation requiring the geographic deaveraging of UNE prices. Most importantly, Pacific Bell's interim local loop prices are deaveraged in relation to three geographic zones, one of which, Zone 2, we find is comparable to the Roseville wire centers.

The following summarizes the development of the Pacific Bell interim local loop prices. In D.99-11-050, the Commission approved final UNE prices for Pacific Bell after completion of a TELRIC cost study. However, these prices were based on a systemwide average, and the Commission indicated that the prices would be subject to change upon completion of the proceeding it would establish comply with FCC regulations requiring geographical deaveraging. (D.99-11-050, at 16-17, Findings of Fact 51-53, Conclusions of Law 1-2.) That proceeding was opened with an Order Instituting Investigation (OII 00-03-002), mailed March 9, 2000. It announced that the investigation was to develop deaveraged UNE rates for Pacific Bell based on three geographic zones. The OII also explained that geographic deaveraging was required by the FCC's regulation at 47 C.F.R. §51.597. (OII, at 1-2,7.) This proceeding is now pending.

However, in the interim, in a February 16, 2000 letter, Pacific Bell notified competing local exchange carriers that as of May 1, 2000, it would offer, in interconnection agreements, geographically deaveraged local loop prices on an interim basis, subject to true-up upon the Commission's adoption of final deaveraged prices.

The Pacific Bell basic 2-wire local loop prices were stated as follows:

Zone 1 - $10.03

Zone 2 - $13.51

Zone 3 - $23.53

Pacific Bell appended to its letter a list of its wire centers with corresponding zone designations.

Shortly thereafter, the geographically deaveraged local loop prices offered by Pacific Bell were approved by the Commission in the arbitration of the interconnection agreement between Pacific Bell and AT&T Communications of California, Inc. (AT&T). The Final Arbitrator's Report explained that Zone 1 corresponded to conditions of metropolitan areas, Zone 3 represented rural areas, and Zone 2, called "ex-urban," consisted of conditions between metropolitan and rural areas. (A.00-01-022, Final Arbitrator's Report, June 13, 2000, at 208.) The Commission approved this report (D.00-08-011, at 2, 8) and the resulting interconnection agreement between Pacific Bell and AT&T, which was filed on August 14, 2000. The interim local loop prices of the agreement are the same as those Pacific Bell had offered in its February 16, 2000 letter: Zone 1 - $10.03, Zone 2 - $13.51, Zone 3 - $23.53.

This letter became part of the record in the present Roseville/Covad proceeding as Exhibit 8. Also received in evidence is a map indicating the location, by zone, of some of the wire centers listed by Pacific Bell in the attachment to its letter. (Exhibit 9.) The map was prepared by Covad, and was used during the hearing in the cross-examination of Roseville's expert witness. The questioning drew attention to the fact that Pacific Bell operates wire centers in areas contiguous to the Roseville service territory in the Sacramento region. (R.T. 142-149:1-18.) Pursuant to the map, and the cross-examination of Roseville's witness, the Commission finds that Pacific Bell's Zone 2 wire centers appear to be most comparable to Roseville's. Conversely, from the evidence before us at this time, it would be reasonable to conclude that Roseville's local loops are not in geographic areas that are either predominantly metropolitan (Zone 1), or predominantly rural (Zone 3).

Therefore, based on this record, and on our taking official notice of the interim deaveraged local loop prices approved for the Pacific Bell/AT&T interconnection agreement, the Commission concludes that for the purpose of establishing a reasonable interim price, the appropriate proxy for Roseville's 2-wire local loop should be the Pacific Bell's Zone 2 price of $13.51. In addition, to the extent access to Roseville's local loops other than the 2-wire loop is requested, the "Loop/Link" interim prices by zone as set forth in Attachment 8 of the Pacific Bell/AT&T interconnection agreement, filed August 14, 2000, shall apply.

At this time, however, with respect to network elements other than the local loop, we can only take official notice of Pacific Bell's final UNE prices as approved in D.99-11-050. Presently, we have not approved deaveraged UNE prices for elements other than the local loop. Nonetheless, we believe that the Pacific Bell UNE prices set forth in D.99-11-050 are relatively more just and reasonable than the prices derived from the Roseville cost study. Pacific Bell's prices were developed from a lawful TELRIC cost study. On the other hand, as we have discussed, Roseville's UNE prices, dependent on the 2.19 multiplier, were derived by a means, which does not comply with applicable Telecom Act standards, FCC regulations, and case law.

The Commission must implement reasonably and expeditiously the overall purpose of the network access provisions of the Telecom Act, which is to open competitive telecommunications markets. On balance, therefore, we find that using Pacific Bell's local loop deaveraged prices and the final prices approved for Pacific Bell's other UNEs in D.99-11-050 as proxies for Roseville's interim UNE prices is fair to both parties. Covad can timely offer its DSL services in Roseville's region in reliance on its own business judgment as to the risk of Roseville's final local loop prices ultimately being higher than the interim price we have approved in this decision. At the same time, the provision for a true up of the interim prices, with interest, assures Roseville that it will be appropriately compensated when its cost study is completed and final UNE prices are approved.

We have not forgotten, of course, Roseville's claim that it would require $2 million and two years to complete a TELRIC cost study comparable to that of Pacific Bell. However, we have not ordered that every TELRIC study employ all of the same complex modeling and computations that comprised the Pacific Bell cost study. Roseville also may be aided by the methods and findings of OII 00-03-002 in which Pacific Bell's final deaveraged UNE prices are being developed. In addition, Covad and Roseville are not precluded from resuming negotiations regarding an acceptable cost study or UNE prices.