VI. Implementation of Surcharges

A. Position of CalAm

CalAm requests that both surcharges be implemented commencing January 1, 2007. CalAm argues that, under its proposal, Monterey District customers will actually pay less for preconstruction items than they would under more traditional rate recovery methods. First, by paying for preconstruction costs now, rather than after the Coastal Water Project is completed, customers avoid paying years of interest on these costs. Since preconstruction costs will be in the millions, this represents significant savings. Second, under its proposal, CalAm would treat preconstruction costs as reimbursed expenses rather than additions to CalAm's ratebase. CalAm points out that keeping preconstruction costs out of ratebase means that customers will only have to reimburse CalAm for expenses (and interest) incurred and will not have to contribute to a return on its preconstruction investments.

CalAm submits that the proposed surcharges are consistent with the Commission's policy objectives for water utilities as set forth in the December 2005 Water Action Plan, calling for new methods and approaches that may be necessary to enable water utilities to undertake major capital projects with minimal impact on ratepayers. (See Water Action Plan, pp. 20-22.)

B. Position of DRA

DRA opposes allowing CalAm to begin recovery of preconstruction costs before the Commission issues a CPCN for the Coastal Water Project and before such costs are reviewed for reasonableness. DRA, however, is willing to allow CalAm to begin recovery of these costs before the plant is placed into service and has been determined to be used and useful to help mitigate the eventual rate shock that would likely occur if recovery of both preconstruction and construction costs happened all at once.

DRA notes that the Commission has provided guidance on when re-evaluation of the ordered ratemaking treatment of Coastal Water Project preconstruction costs should occur. The Commission stated: "[a]s the status of the proposed project becomes more certain (for example, if a CPCN is granted or construction is underway) we will consider modifying this ratemaking treatment." (D.03-09-022, p. 22, emphasis added.) DRA believes that the Commission should continue to adhere to the ratemaking treatment provided in D.03-09-022 and deny CalAm's request to begin recovering preconstruction costs before the Commission grants CalAm a CPCN for the Coastal Water Project.

DRA argues that shareholders, not ratepayers, should bear the risk of preconstruction costs for a project that has not and may not be approved. While DRA does not propose delaying recovery of preconstruction costs under the Special Request 1 Surcharge until the project is used and useful, it does recommend that the Commission proceed carefully when departing from traditional ratemaking. DRA cautions that even if the Commission issues CalAm a CPCN for the Coastal Water Project, or approves an alternative long-term supply solution, it is still possible that the project may never be built. DRA points out that numerous other agencies, including the California Coastal Commission, will need to approve the project, several environmental groups oppose this project, and there is no evidence that ratepayers are willing to have their rates doubled to pay for this project despite CalAm's public outreach campaign. Thus, DRA contends that allowing CalAm to recover preconstruction costs before the project is in service shifts significant risks from shareholders to ratepayers for what could turn out to be an abandoned project.

Nevertheless, DRA sees some merit in allowing CalAm to begin recovering some preconstruction costs after a CPCN is issued but before the final project is placed into service to address the potential rate shock that could exist if recovery is deferred until the project is completed. However, DRA believes this departure from traditional ratemaking should only occur if all costs are thoroughly reviewed for reasonableness before allowing recovery.

With regard to CalAm's proposed Special Request 2 Surcharge to pre-collect funds for the project to be approved, DRA opposes CalAm's request to implement this surcharge in January 2007. DRA recommends that this surcharge not be implemented until the project is permitted and construction has begun.

C. Position of Intervenors

MPWMD and IRWUG, (as does DRA), argue that the Commission should wait until a CPCN is issued before authorizing any surcharge. PSMCSD, the proponent of the competing desalination project, recommends that the Commission order CalAm to wait until it completes the Coastal Water Project to implement both surcharges. The intervenors share DRA's concerns regarding shifting project risk to ratepayers.

D. Discussion

There appears to be general acceptance that, sooner or later, a surcharge is necessary to avoid rate shock that will result if the total project cost of a long-term water supply solution is included in rates at one time. Therefore, the real issue before the Commission is the implementation dates for the proposed surcharges. We note that under CalAm's proposal, the combined surcharge would initially be 19% (4% under Special Request 1 and 15% under Special Request 2), and if CalAm's proposal is approved, both surcharges would commence on January 1, 2007. Our concern is that at the same time Monterey District ratepayers would have recently received a significant rate increase resulting from the recent General Rate Case (GRC) proceeding. We believe that adding a combined 19% surcharge to the GRC increase would be excessive. Therefore, CalAm's surcharge proposals need some adjustment to moderate rate shock to customers, who face potentially high rates.

On the other hand, we agree with CalAm that the sooner the Commission allows CalAm to implement the proposed surcharges the more it will be able to mitigate the rate impact of a long-term water supply solution on Monterey District customers. As stated previously, the environmental review and CPCN phase for a long-term water supply solution is progressing on a separate track from the interim rate request phase. As matters now stand, (1) environmental review has taken significant time, (2) $8.7 million in preconstruction costs have been booked through 2005, and (3) it could be a year at least before the Commission issues a CPCN or adopts an alternative long-term water supply solution in this proceeding. If the Commission delays implementing the surcharge until a CPCN is issued, this means one year at least of: (1) additional interest charges accruing on preconstruction costs; (2) cash-flow issues related to the carrying cost for the preconstruction costs; and (3) lost revenue that will not be available to offset the capitalized cost of the project. Moreover, any delay will unfairly shift a larger portion of the cost burden on to future customers rather than to current customers, who should begin paying for the water supply solution being pursued for their benefit.

On balance, we conclude that the Special Request 1 Surcharge should be implemented effective January 1, 2007, as proposed by CalAm. However, implementation of the Special Request 2 Surcharge should be delayed until the CPCN is issued for the Coastal Water Project, or alternative long-term supply solution. Staggering introduction of the surcharges will allow CalAm to gradually ramp-up rates to moderate rate shock that will otherwise be severe, and prepare customers for future rate increases. The surcharges are carefully designed to introduce necessary rate increases gradually and will also allow customers an opportunity to change their consumption habits, if necessary, to control their own bills. The surcharges will impact both existing and future ratepayers which is appropriate given that the Coastal Water Project is a project to replace existing supplies, necessitated by SWRCB Order 95-10.

We appreciate DRA's concern that PSMCSD has a competing desalination project and CalAm's project could turn out to be an abandoned project. However, it is CalAm, not Monterrey County or PSMCSD, that is subject to SWRCB Order 95-10, and is subject to major fines if there is no action towards compliance. Therefore, CalAm cannot simply stand by and wait for Monterey County or PSMCSD to develop a desalination plant that will fulfill CalAm's obligations. As CalAm points out, although PSMCSD actively participated in this proceeding, it has provided no evidence to date that its proposed regional project is viable and can meet the objectives and needs of CalAm. Also, MPWMD admits that its own project has been put on hold by the MPWMD Board. We believe that, in the meantime, the Commission has a responsibility to enable CalAm to comply with SWRCB Order 95-10 and the Endangered Species Act. Furthermore, in authorizing the proposed surcharges, we emphasize that the Commission has not foreclosed a regional solution to the water supply needs of CalAm's Monterey District. If project ownership is shared or sold, the Commission, after hearing, will ensure that ratepayers are compensated for their contributions collected by CalAm under the proposed surcharges.

Our decision to grant CalAm's Special Request 1 Surcharge commencing January 1, 2007 prior to completion of the reasonableness review, reflects the fact that CalAm did provide the Commission with a complete showing to support its request for interim rate relief, and as discussed below it is not CalAm's fault that the reasonableness review of costs through 2005 was not completed.