IX. Components of Rate Base
San Gabriel's Fontana Division serves approximately 43,000 customers with approximately 46,000 acre-feet per year. The system has 37 water production wells with a peak available production of 71 mgd, 12 storage reservoirs with an aggregate usable storage capacity of 28.4 million gallons, one water filtration plant (Sandhill) with a capacity of 17 mgd, and approximately 3.4 million feet of distribution and transmission pipelines. It has a summer peak day demand of approximately 67 mgd and a fire flow storage requirement of approximately 2.5 million gallons. It has been experiencing an average growth of approximately 1,300 new customers per year and expects this growth rate to continue.
Most of the controversy affecting rate base estimates concerns San Gabriel's planned investments in utility plant. Assessing the need for these investments depends on understanding the current water supply system serving Fontana Division customers and the extent to which utility plant additions are required to meet base load and peak demand reliably and efficiently and in compliance with CDHS Safe Drinking Water Act requirements.
The Fontana Division is confronted with increased demand throughout its service area as the result of rapid new development. Recognizing the need for an updated plan to address the growing demands on its water supply and distribution system, in October 2003, San Gabriel retained an engineering firm that specializes in water system design to prepare a comprehensive Water Master Plan. That Master Plan includes a water demand forecast model and a hydraulic water distribution system model to analyze future system demands and corresponding infrastructure requirements. The analysis identified areas within the Fontana Division's service area that will require new sources of water supply, additional storage to provide operational flexibility and to provide for peak demands and/or fire flow requirements, and new booster plant facilities.
The Master Plan reviewed existing sources of supply and the ability to comply with current and proposed state and federal drinking water requirements, including revisions to the federal Safe Water Act, the federal Unregulated Contaminant Monitoring Rule (UCMR), development of a vulnerability assessment, development of an emergency response plan, the Disinfectant/Disinfection By-product Rule (D/DBPR), State UCMR, the Drinking Water Source Assessment and Protection (DWSAP) Program and the interim Enhanced Surface Water Treatment Rule (ESWTR).
The Master Plan addressed the rapid growth in the undeveloped northerly portions of Fontana Division's service area and additional industrial growth in the southerly areas, both of which will require additional water supplies to meet customer demand and increased fire flow requirements. The increased water demand in these areas will require new wells along with new reservoirs (for fire flow requirement and peak demand), booster pumps, and transmission and distribution pipelines to provide necessary flows at appropriate pressures.
According to the Master Plan, approximately 25 mgd of additional groundwater supply is needed by the year 2010 in order to meet increased demands and to increase the reliability of the system. The Master Plan recommends that the Fontana Division increase its water service reliability during emergency situations when wells are unexpectedly taken out of service. Emergency situations can include contamination and extended power outages, which can cause up to three wells to be placed out of service. The Master Plan recommends that the Company have redundant well capacity for at least three 2,000 gpm wells. The Master Plan recommends a total of eight new groundwater production wells (including three wells to provide redundant well capacity), each with a capacity of approximately 2,000 gpm, for a total capacity of approximately 16,000 gpm, be installed prior to 2010.
In the short term, the Master Plan includes budgeting for the installation of groundwater production wells, reservoirs, boosters, a complete Supervisory Control and Data Acquisition (SCADA) system, groundwater treatment facilities, and improvements to the Sandhill plant to maintain and improve water service reliability. The Fontana Division's most reliable source of supply is groundwater produced from the Chino Basin. Emphasis was placed on this source of supply to address anticipated water demands. A complete SCADA system will improve operation efficiency and reliability. Individual projects are discussed below.
The Master Plan concluded, among other things:
· That the Fontana Division has a current deficiency of 19 mgd under drought conditions, requiring construction of new and replacement wells that will produce at least 25 mgd as well as construction of a 7 mgd perchlorate treatment facility that will treat three contaminated wells, in order to overcome the current deficiency, meet year 2010 maximum day demands under drought conditions, and provide sufficient redundancy during emergency interruptions.
· That evaluation of required storage capacity to meet pressure and supply equalization, fire suppression, and emergency needs indicates current capacity shortages in the Baseline and Highland Zones, which will grow by 2010 to 4.5 mg and 1.4 mg, respectively.
· That construction of new reservoirs at six specified sites, some of which will provide backup when primary reservoirs are shut down for repair and maintenance, will overcome storage shortages projected for 2010 and will provide effective storage reliability in the Highland, Baseline, and Alder Zones.
DRA recommends that: costs for seven of the eight requested new wells be disallowed along with the associated plant additions; five of the nine requested new reservoirs be disallowed along with the associated plant additions; the Sandhill plant project costs included in plant by San Gabriel beginning in 2005 be removed from plant; the 2008 perchlorate treatment costs be excluded from Company funded plant and included in plant when it is known and measurable as contributed plant; and the proposed cost for mains be adjusted to reflect an historical level of expenditures.
The basis for DRA's recommendation is that "the Company's request for additions to plant appears to be structured on the Company's need to meet its peak day demand. While the Company must have sufficient resources to meet its peak day requirements, it is not appropriate for ratepayers to fund facilities to produce that requirement on a daily basis. A system that produces the peak day demand would have excess capacity that is not used and useful to ratepayers over the rate period. Alternative sources of supply, such as the outside purchases and emergency purchases relied on in the past, should be incorporated in the Company's forecast." (DRA Opening Brief, 37-38.)
DRA notes that the Company's Master Plan estimates a peak demand requirement of 73.8 mgd, which is well in excess of the 2005 peak demand of 66 mgd. Based on the Master Plan, the available supply from wells was 59 mgd, to which DRA adds the wells back in service that increase supply by 17.4 mgd, plus 2.9 mgd for the well which DRA recommends be allowed, resulting in a total supply from wells alone of approximately 79.3 mgd. This supply from wells does not include the supply from Lytle Creek flow or purchases. The supply exceeds the Master Plan requirement of 73.8 mgd by 5.5 mgd. DRA concludes that the Company's supply is sufficient to meet its requirements at this time. Thus, seven of the eight additional wells requested and the upgrade to the Sandhill plant are currently not required.
The District asserts that the Company's own evidence shows that it has sufficient capacity to adequately serve all its customers. Further, growth can be accommodated by adding one well a year. Therefore, the maximum expansion which can be justified for the three years involved with this GRC is three wells. The District says that the current well capacity of San Gabriel equals 87.83 mgd and the entire water production capacity totals 100 mgd. The largest maximum demand for any single day is 66 mgd. San Gabriel's expert witness testified that the system should have a redundancy factor added to peak demand to accommodate wells lost to drought, electrical outages, etc. He recommended 8.6 mgd. Therefore, the total capacity needed to serve the existing customers is 74.6 mgd. Consequently, San Gabriel already can meet its current demand of 66 mgd and still have a reserve of 34 mgd.
The City supports the water supply system analysis of the District. The City emphasized that San Gabriel's proposed system upgrades of $89,500,000 would be in addition to the current rate of about $71,000,000, which would create an intolerable burden on the ratepayers, especially the residential ratepayers.
The Commission adopted its Water Action Plan in December 2005. Among other objectives the plan seeks to maintain the highest standards of water quality.
We said:
Water quality is vital to the health of consumers. Delivering safe water requires a reliable infrastructure. We will bolster our current collaborative relationship with the enforcers of water quality standards, the Department of Health Services and the Federal Environmental Protection Agency, so that problems are identified and acted upon as quickly as possible. (Plan, p. 25.)
. . .
The water infrastructure in California needs significant improvement. We will provide financial incentives and direction to encourage investment in infrastructure needed to improve water quality. (Plan, p. 3.)
The Water Action Plan identified policy objectives that will guide the Commission in regulating investor-owned water utilities and highlights the actions the Commission anticipates or will consider taking in order to implement those objectives. The objectives are: (1) maintain highest standards of water quality; (2) strengthen water conservation programs; (3) promote water infrastructure investment; (4) assist low-income ratepayers; (5) streamline regulatory decision making; and (6) set rates that balance investment, conservation, and affordability. Since San Gabriel's instant application was filed before the adoption of the Water Action Plan, it did not specifically make any request to implement the objectives of the Water Action Plan. However, the utility should request the Commission to implement those objectives soon.
The CPUC requires each Class A water utility to file a Water Management Program with each GRC filing. D.90-08-055 requires all Class A utilities to submit, in each GRC, a Water Management Program with a 20-year horizon. The Water Management Program forecasts supplies and demand side management impacts out to a 20-year horizon. We use these Water Management Programs as a basis for pre-approval of major water supply projects that require a long term commitment, i.e., longer than the three-year GRC time frame.
San Gabriel has summarized how it developed its long range forecast. It retained Stetson Engineers in October 2003 to prepare a comprehensive analysis of the Fontana Division's needs for major water supply, storage, and delivery projects in both the near and longer term. The Fontana Water Company Water System Master Plan was completed in April 2005. (Ex. 13.) Nearly 300 pages in length (excluding appendices) with over 100 tables and more than 50 figures and maps, the Water System Master Plan reviews relevant legal and regulatory requirements, assesses historical water production trends and forecasts water demand for the Fontana Division in the short term (through 2010) and long term (through 2025), considers opportunities for regional water cooperation, reviews available water supplies and water supply facilities, evaluates water treatment needs, provides a hydraulic analysis of the water pumping, storage, and distribution system, and assesses the condition of the Fontana Division's water mains. On the basis of these analytic elements, the Master Plan then recommends a set of detailed priorities for implementing facilities and improvements, proposes an implementation schedule, and forecasts the relevant budgetary needs.
We have reviewed the Master Plan and find that it meets the standards of our Water Action Plan. Although we do not endorse every aspect of the Master Plan, we have analyzed, as set forth below, those facilities which are in controversy.
B. Plant Additions
San Gabriel calculated utility plant in service for TYs 2006-2007 and 2007-2008 based on construction budgets, estimated advances for construction, contributions in aid of construction (CIAC), and items to be retired. The construction budgets include provisions for several capital projects which are expected to improve the system's ability to meet customer demands for safe, reliable water service, consistent with the guidance provided by the Water System Master Plan. These projects include plans to construct eight reservoirs and eight new wells over the next four years as well as upgrade the Sandhill plant to allow it to treat State Water Project (SWP) water and to enhance its capacity to treat water from Lytle Creek.
The calculations of proposed test year utility plant in service exclude investments after 2005 in two projects, the Sandhill plant upgrade project and the new headquarters complex, which are proposed to be added to rates by advice letter. These additional investments in utility plant and their proposed ratemaking treatment are discussed below in the context of each project.
The forecasted company-funded capital expenditures are $28.3 million in 2005, $28.3 million in 2006, $18.5 million in 2007, and $14.7 million in 2008. (Ex. 9, p. 20.) San Gabriel expects to meet its capital budget requirements by a combination of internally generated funds, bank borrowing, and new mortgage bonds.
Rather than approving specific projects, we believe the most equitable way to provide for capital improvement recovery in rates is to continue the solution found reasonable in D.04-07-034 to limit rate base growth to 10% per year. (D.04-07-034, p. 66.) We are not disposed to dictate to San Gabriel which plant will be constructed in which order; that is a management decision. However, as discussed below, the investment in the Sandhill Surface Water Treatment Plant is excepted from this 10% rate base cap. We will resolve "used and useful" issues in its next GRC, at which time a major concern will be whether the Company has maximized its efforts to obtain contributions from developers and others to pay for plant needed to meet growth. The need for various infrastructure improvements is discussed below.
However, we have some concerns about the use of a rate base cap as part of our ratemaking. This novel regulatory approach was first established in D.04-07-034. We have had very little experience with this cap prior to the opening of this proceeding just one year later. In the next GRC we will reevaluate the rate base cap. Any party wishing to continue a rate base cap in the next GRC should make arguments supporting its continuation. Absent compelling evidence that the rate base cap is an effective ratemaking tool, we will discontinue its practice.
The Sandhill plant is a "diatomaceous earth filtration system for surface water" that began operation in 1965. The plant relies on surface water diversions from and is unable to use that surface water during (and often for months following) storms and periods of heavy snow melt, when Lytle Creek has high levels of turbidity that exceed the current treatment capability of the Sandhill plant. The other source of supply for the Sandhill plant is SWP water that must be blended with Lytle Creek surface water before it can be treated. These blending requirements restrict the capacity of the Sandhill plant to the availability of useable Lytle Creek surface flow. The Sandhill plant must be operated in compliance with increasingly stringent state and federal safe drinking water regulations, including regulation governing Cryptosporidium, Giardia, and byproducts of the disinfectants used to control those organisms. Lytle Creek surface water flow is San Gabriel's lowest cost water. Thousands of acre-feet each year are lost because of impurities in the water. Hence, the upgraded Sandhill surface water treatment plant.
Prior to 1960, the only treatment provided for Fontana Division's surface water supply from Lytle Creek was at Fontana Union Water Company's (Fontana Union) afterbay, where screens removed large debris such as twigs and moss, and water was chlorinated as it entered a Fontana Union transmission pipeline. In 1960, San Gabriel joined with Fontana Union to build a surface water treatment facility including a microstrainer and chlorination facilities owned by San Gabriel. Upon notification by CDHS in 1962 that the microstrainer provided inadequate treatment, San Gabriel selected diatomaceous earth (DE) filtration as a replacement and in 1965 completed installation of a 10 mgd DE surface water filtration treatment plant, later expanded to 20 mgd, which CDHS approved in 1968 as adequate for treating Lytle Creek surface water but not SWP water.
After several years' operation, the limited capacity of DE filtration to deal with high turbidity became apparent. The passage of clay through the DE filters caused effluent turbidity to rise to the maximum level permitted under federal and state regulations, making it necessary under such circumstances to shut down the plant. The required shutdown of surface water processing through the Sandhill plant has deprived the Fontana Division of thousands of acre feet of low-cost surface water, including over 25,000 acre feet just in the first five months of 2005.
In 2002, laboratory tests showed that clay can easily be reduced or removed by a pretreatment process of coagulation, flocculation, and sedimentation, making the Lytle Creek surface flows filterable under high turbidity conditions. These factors, plus the fact that thousands of AFY of available low-cost surface are lost due to clay, led San Gabriel to design and install upgrades and modifications to the existing DE treatment process to add the necessary pretreatment facilities.
CDHS has authorized San Gabriel to treat SWP water at the Sandhill plant, but with the restriction that the untreated SWP water must be blended with Lytle Creek surface water at a ratio not exceeding 80% SWP water and not less than 20% Lytle Creek water.
The result is that when Lytle Creek flows are low, particularly during summer months when the demand for water is greatest, the company can only treat correspondingly small quantities of SWP water. Even when rainfall is ample, the Lytle Creek flows are often unusable, due to excess turbidity, and, although the Sandhill plant's theoretical rated capacity is 20 mgd, its useful capacity is reduced to a maximum of about 17 mgd because the backwash cycle requires taking filters off-line and using a substantial amount of water for that function.
The planned upgrades and pretreatment facilities will permit the Sandhill plant to treat 100% Lytle Creek surface water, 100% SWP water, or any blend of the two. This will restore the full usefulness of the Sandhill plant even when Lytle Creek surface water is unavailable or too muddy, because the plant will be able to process SWP water.
The Water System Master Plan recommends modifying the Sandhill plant to eliminate the need for blending, to expand plant capacity from 17 to 29 mgd, and to obtain additional access to SWP water, in order to allow San Gabriel greater flexibility in managing its water supply sources both in the short and long term. The San Bernardino Valley Municipal Water District (Muni) has agreed to increase its commitment to provide SWP water to the Fontana Division from the current allowance of 3,000 up to 5,000 AFY, and the Inland Empire Utilities Agency also has committed to provide SWP water for use at the Sandhill plant once the planned upgrades are completed.
San Gabriel expects the Sandhill plant upgrade project to cost approximately $35 million, to which must be added staffing and maintenance.
San Gabriel's cost-benefit analysis indicates that the Sandhill plant upgrade project will pay for itself in two years. Among the project's significant benefits is that additional water supplies are made available in the northern portion of the system, closer geographically to customer demands and readily transported by gravity, which will allow San Gabriel to reduce the quantities of far more costly Chino Basin supplies having to be boosted to higher elevations in the distribution system at substantial energy cost.
DRA argues that the company's own witnesses do not agree whether the supply can be relied on the in the summer to meet peak demands and there are no formal contractual commitments for providing additional supply. DRA believes that supply exists to meet the average requirements and if the Sandhill plant cannot provide supply to meet peak demands, there is insufficient justification to allow the addition in rates. DRA recommends the advice letter treatment be denied and the cost and used and usefulness of the plant determination be deferred until the next GRC.
DRA says that San Gabriel's testimony indicates that the plant start-up date is August of 2007. The plant is not used and useful in 2005, will not be used and useful in 2006, and may be used and useful in late 2007, which is after the TY 2006 - 2007. In A.02-11-044 (D.04-07-034), San Gabriel requested that it be allowed to upgrade the Sandhill plant at an estimated cost of $9.8 million. In two years, the cost has escalated to $35 million.
DRA's primary concern with San Gabriel's proposed Sandhill plant upgrade is that San Gabriel has reflected $12 million of the estimated $35 million cost in plant in service and is proposing to collect the remaining $23 million through advice letters. As an alternative, DRA recommends that the projected $12 million of cost in 2005 be removed from plant. The plant upgrade will not be in service in 2005. The next GRC is the proper time to make a determination whether the final cost is appropriate and to determine the actual increase in capacity that will occur as a result of the upgrade.
The Sandhill plant's primary function will be as a baseload unit, operating as nearly as possible on a 24-hour, seven-days-per-week basis to make maximum possible use of San Gabriel's most economical source of supply- Lytle Creek surface water plus SWP supply purchased through Muni. Delivering those supplies into San Gabriel's distribution system near the highest point in the Company's service area not only will maximize use of inexpensive supplies, but also will minimize the cost of power for pumping water to the point of use. It is needed and should be completed.
The record indicates that when compared to the non-Sandhill option that the net benefits to ratepayers over the 30-ear life of the Sandhill plant will be approximately $52 million. We find the evidence of the cost-effectiveness of the plant to be compelling when compared to the cost of the alternative of additional production of water from Chino wells.
The annual revenue requirement of the Sandhill upgrade is estimated to be $12.9 million in 2007 rising to 14.8 million in 2036. San Gabriel estimates that the revenue requirement for the "No-Project" alternative would be $12.6 million in 2007 rising to over $42 million per year by $42.3 million in 2036. An analysis shows that by the end of the third year after the project is in operation that the net benefit to consumers is $292,000 in current dollars. After 2.3 years,the construction of the Sandhill facility will result in lower overall costs.
San Gabriel performed several analyses to demonstrate the sensitivity of the cost-effectiveness of the plant to certain assumptions. (SG-8 -Attachment B, p. 5.) We note that these sensitivity analysis showed the plant to be cost effective under the various scenarios. The cost effectiveness varied from $19 million net present value to $98 million under the various scenarios. These scenarios demonstrated that the cost-effectiveness was very sensitive to the assumption as to the amount of inflation in O&M costs for the no-project alternative. However, even if one assumes that cost for O&M under both scenarios increases at the same 3% per year, the present value of the net benefits to consumers was $19.3 million over the life of the project, with net benefits beginning to accrue to consumers in five years.
Looking at the marginal cost of an AF of water, upon its completion, the water from Sandhill will be a low-cost source of water for the company, regardless of the source of water it treats. When the source of water is Lytle Creek water the company will save $309/AF. If the source of water is Muni water the savings per AF is $277.20. Even if the company has to utilize Sandhill to treat its most expensive source of water, the water from MWD (priced at $335/AF) the savings are estimated to be $68/AF. Assuming a mix of water from these sources that is 49% from Lytle Creek, 19% from Muni and 32% MWD supplied water the average savings per AF is $182.76 per AF or about $1.3 million annually.
A significant portion of these savings are the result of significantly lower costs associated with the electricity required to be purchased by San Gabriel. Our analysis of the company's evidence presented in (EX-SG-9 at pages 16 and SG-8-Attachment B, p. 5) indicates that the power consumption of the Sandhill Upgrade is just 10% of the power that would otherwise be needed to utilize water pumped from the Chino wells. Every Acre/Foot of well water that production from the Sandhill upgrade displaces results in an energy savings of 1,299 kwh (1.3 Mwh) for San Gabriel. This results in a savings of about 9,400 Mwh annually to San Gabriel assuming a 20 MG/day output of the plant.
We find the Sandhill treatment facility to be needed and building it is reasonable.
The most difficult issue to resolve regarding the Sandhill plant project is how the cost should be passed into rates. DRA proposes to disallow rate base treatment of investments already made until San Gabriel's next GRC three years from now. San Gabriel's proposal would allow rate base treatment of the year 2005 investment while reflecting succeeding years' investments in rates advice letter filings effective July 1, 2007 and January 1, 2008, and 2009.
While we have elsewhere established a limit on the growth in rate base, in part to avoid determining the timing of specific investments and to leave to management discretion the order in which these needed investments will be made over the next three years, we exempt the ratebase increases caused by investment in the Sandhill facilities from this cap. We do this because this investment is a large single investment that will necessarily go into ratebase over multiple years. We will allow rate base treatment of the year 2005 investments and will allow succeeding years' investments to be added to rate base by advice letter filings filed by November 15 to be effective January 1, 2008 and subsequently by November 15, 2008 to be effective January 1, of the following year. The costs of the Sandhill project should be capped at $35 million.
We will review the reasonableness of the construction costs associated with the Sandhill facilities in the next GRC or, if the company prefers, in a separate application seeking a finding that the costs included in ratebase are reasonable. Costs are capped at $35 million. Until such time as a final determination is made as to the reasonableness of the construction costs, the revenues increases associated with the Sandhill project included in rates via advice letter shall be subject to refund. San Gabriel shall track, in a memorandum account the revenue increases resulting from the inclusion of the Sandhill project in ratebase via advice letters.
The Water System Master Plan recommends construction of a total of eight new Chino Basin wells located to provide supplemental water to specific pressure zones to help meet fire flow requirements. The new well at Plan F7 is required to meet projected increased customer demand and fire protection requirements. The Master Plan recommends that four existing wells be replaced based on advanced age and remaining service life projections. The wells are at least 75 years old.
San Gabriel's proposed construction plan differs slightly from the Master Plan. It proposes to construct eight wells over the next four years, seven in the northern and western portions of the service area where additional supply is needed and one in the southern portion to replace an existing damaged well. These plans encompass seven of the eight new wells recommended by the Master Plan. San Gabriel plans for only one of the replacement wells called for by the Master Plan to be drilled in 2007. San Gabriel said it needs these new wells to pump into reservoirs now under construction, which will enhance San Gabriel's ability to provide effective disinfection and to adjust flows from the reservoirs into the distribution system in accordance with customer demands, and to provide water for fire suppression purposes without causing an abrupt pressure loss or water outage.
DRA says that the Company's request to add eight wells is based on the perceived need for additional supply, which DRA claims is not needed. DRA recommends that only one well, constructed in 2005, be allowed in rates. DRA points out that in A.02-11-044, the Company requested and was allowed three wells that were not put in service as projected in 2003 and are again being requested in this case. According to the Master Plan, the water demands under normal weather conditions are estimated to be 54,000 AFY in the short-term (2010), while the production available as of April 11, 2005 was 66,246 AFY. DRA concludes that the current system has sufficient supply to meet and even exceed the projected short-term needs of 54,000 AFY without the added supply from surface water and emergency purchases. DRA recommends that only one well be allowed in rates at this time. The removal of the seven wells reduces plant by $700,000 in TY 2006-2007, and $700,000 in escalation year 2007-2008.
We have discussed San Gabriel's need for new facilities, which includes new wells and other plant. The issue is not need, but who pays. It is apparent that the need is clear and timing is important. Facilities take time to construct, test, and train staff to operate. Meeting 2010 requirements requires starting now. Because new wells are needed to meet the demands of new customers, those new customers should be contributing to provide the plant necessary to serve them. San Gabriel has planned well to provide a first class water system, but sadly lacks a first class plan to pay for it.
The Master Plan recommends installing a treatment facility at Plant 25 to remove perchlorate from groundwater produced at three wells in close proximity to each other, all of which are currently contaminated above the notification level of six micrograms per liter. The Master Plan recommends use of the same resin-based ion exchange process (which is best available treatment technology) presently in use. San Gabriel plans to construct the wellhead treatment facility in 2008.
DRA is concerned that the Company's requested addition in 2008 of the treatment facility ignores the fact that the cost of the facility should be borne by the parties responsible for the contamination. DRA says that in A.02-11-044, San Gabriel contended that it could not put on hold the construction of treatment plants while waiting for litigation proceeds because it urgently needed the restoration of lost production capacity. DRA argues that the Commission approved the Company's request for seven facilities in A.02-11-044, but no facilities were constructed. DRA submits that San Gabriel's conception of urgency varies from the ordinary sense of the word. How can the Commission be confident it will actually build the facility in 2008 when it failed to do it over the past three years despite the alleged exigency of restoring this source supply? DRA recommends the $2 million of cost for the treatment facility be removed from plant additions because the cost is projected far enough into the future that we can determine the responsible parties' obligations prior to its in-service data. According to DRA the cost of this project should be reflected as contributed plant if the plant is ultimately constructed.
DRA has not carefully read D.04-07-034. In that decision, we did not approve a request for seven facilities. What we did do was impose a rate base cap and said:
"10. San Gabriel needs flexibility within the rate base cap to make its own decisions about the need for and timing of projects, and to make changes and substitutions as necessary to its proposed construction program." (D.04-07-034, Finding of Fact 10, p. 66.)
We do agree with DRA that the costs of this facility should be treated as CIAC, if the company recovers funds from its contamination lawsuits. But, in the meantime, the facilities are needed and should not be delayed pending the outcome of litigation. Preliminarily, costs should be recorded in construction work in progress (CWIP).
San Gabriel plans to construct eight new reservoirs over the next four years to improve system reliability, provide needed storage for operating, emergency, and fire fighting purposes, and to increase storage capacity in each of the Company's five pressure zones. Two of these projects were planned for construction during 2005. Three are planned for 2007 and three for 2008. Water stored in reservoirs is used for normal operations and to satisfy peak demands and fire flow requirements that otherwise would need to be provided from additional wells and booster facilities. The Master Plan identifies several portions of the service area that may be vulnerable in the event existing storage facilities are not available due to maintenance needs or shortage of supply. The Master Plan recommends that new reservoirs be added in the Baseline, Highland, and Alder pressure zones. New reservoirs are needed to serve proposed new wells. New reservoirs are needed in the northern portion of the Fontana Division service area to serve new residential development.
DRA recommends that three of the eight proposed reservoirs not be allowed in rates. DRA would reduce TY 2006-2007 plant by $727,500 and TY 2007-2008 plant by $1,527,000. DRA's recommendation rests on its perceived lack of need for additional capacity. DRA reasons that according to the Master Plan, San Gabriel currently has 30.28 mg of useable storage capacity. Based on the requirements for equalization, fire suppression, and emergency, the Company's total storage requirement is 22.65 mg. By the year 2010 and 2025, the projected requirement is expected to be 24.81 mg and 31.12 mg, respectively. The current existing capacity exceeds the current and short-term needs of the Company and is approximately 1 mg short of the long-term requirements. DRA believes that the addition of the requested reservoirs and other facilities is excessive and could be related to future growth. To the extent that any addition to plant is growth-related, the cost of the added facilities to serve that growth should be contributed by developers.
We have previously discussed our reasons to accept San Gabriel's proposed improvements to its water system. The remaining issue is source of funds. We believe San Gabriel has not emphasized developer funds to provide new facilities for new customers. The need for reservoirs arises not only to serve current ratepayers, but also to serve new customers. We agree with DRA that new customers should contribute toward new facilities. We need not decide at this time which facilities will serve new customers. In San Gabriel's next GRC, we can sort that out. We are confirming our rate base cap of 10% per year, and we will review which part of that 10% was used and useful.
San Gabriel requests that we approve rate base amounts that include projected investments in booster stations, security equipment, emergency generators, and transmission mains associated with the wells and reservoirs that may be constructed.
DRA would disallow the equipment associated with the wells and reservoirs which it recommends be disapproved. We prefer to allow San Gabriel to choose the facilities it deems necessary under our rate base cap. We note that DRA has no objections to the SCADA system and security equipment San Gabriel expects to install.
The Fontana Division currently has two emergency interconnections, with a total capacity of 2,500 gpm, with the Cucamonga Valley Water District (CVWD) to provide water during emergencies and water system outages, but the ability to use these interconnections is limited. The Master Plan recommends installing a replacement 10,000 gpm interconnection to maximize deliveries during emergencies. San Gabriel explained that an improved emergency interconnection with CVWD will provide an alternative source of water to the elevated Hunters Ridge portion of the service area, and will help meet potential fire fighting demands during emergencies that may cause shortages in other sections of the Company's water system. San Gabriel has arranged for CVWD to design a 10,000 gpm connection and has budgeted $2.2 million in 2007 for installing 8,800 feet of pipe and a booster station to deliver water from CVWD. DRA reluctantly considered a $2.2 million investment in the CVWD emergency interconnection to be reasonable, and included it as a rate base addition. DRA's concern is that the connection cannot be relied upon during peak summer days when CVWD's demand also peaks. We do not share DRA's concern. The connection is not expected to meet peak demand, but to meet emergency demands on San Gabriel's system.
San Gabriel has planned the construction of a new office/warehouse for its Fontana operations. DRA toured the current facilities which will be replaced by the new complex and agrees that a new facility will provide a more conducive work environment. DRA is concerned about the acquisition of the property. First, San Gabriel acquired the property for the new facility on December 30, 2004 for $1,102,233 from Rosemead Properties, Inc. (Rosemead), an affiliate company of San Gabriel. The acquired parcel was part of an 8.72 acre parcel originally acquired by Rosemead on July 8, 2003 for $1,075,000. DRA recommends that the cost of the land acquired for the office building be reduced based on the cost paid by San Gabriel's affiliate Rosemead.
San Gabriel's witness calculated the purchase price of the property for Rosemead to be $126,000 per acre and the price to San Gabriel for the property to be approximately $234,000 per acre. The witness testified that an independent appraisal showed the property appreciated that much in a year and a half. He testified that Rosemead bought the land to hold for investment, and that San Gabriel purchased the land from Rosemead because the land suited San Gabriel's needs. He said that San Gabriel's personnel went through a long process to determine whether the Rosemead property was a site that made sense for San Gabriel's offices. Rosemead cooperated with San Gabriel in ways that a third-party seller would not have done, selling San Gabriel the exact amount of land needed for its facilities and in the configuration San Gabriel required.
We will allow $591,250 in rate base calculated on the ratio of the size of the parcel Rosemead sold to San Gabriel to the size of the larger parcel of which it was a part. The parcel size and cost are not crystal clear on the record, but the evidence persuades us that the parcel San Gabriel purchased was 4.81 acres (San Gabriel O.B. p. 85); the Rosemead purchase was 8.72 acres (Ex. 23); the Rosemead price was $1,075,000. (Tr. p. 282, L.5.) We find that San Gabriel should have been charged 55% of $1,075,000, or $591,250 for the land.
Rosemead is owned by United Resources, Inc. (United Resources). United Resources also owns San Gabriel. Rosemead purchased the property during the time that San Gabriel was seeking land on which to construct a new office building. The land was expected to go into rate base. When the land was sold by Rosemead to San Gabriel in December of 2004 it occurred during a process characterized by San Gabriel's vice president:
"Q. Well, there wasn't really any negotiation, was there?
"A. Well, it's essentially the same parties, so there's not negotiation per se, but the - well, no, there was not negotiation." (R.T. 284, L 22-26.)
The purchase agreement on the part of the seller was signed by R. H. Nicholson, Jr., the President of Rosemead and the Chairman of the Board of San Gabriel. The purchase agreement on the part of the buyer was signed by Mike Whitehead, President of San Gabriel. Mr. Whitehead reports to Mr. Nicholson.
San Gabriel estimates that cost to construct the new facility will be $6,000,000 and that the cost be included in rates through an advice letter. DRA disagrees.
The proposed new office complex of 40,658 square feet is approximately twice the size of the facilities (20,827 square feet) it is designed to replace. San Gabriel maintains that it still needs to retain a building on the existing site for a satellite customer service office. The new office complex includes approximately 11,548 square feet of office space for employees that previously occupied 4,719 square feet of space.
In its last rate case, A.02-11-044, San Gabriel first requested $3 million for the construction of a new office, and later during the proceeding increased to $6 million. The Commission deferred the request to this GRC filing. The decision stated that if the Company were to request authorization to proceed with the new building, it should provide complete justification for the building and it should address the ratemaking treatment of the proceeds from the sale of the existing facilities. (D.04-07-034, p. 40.) DRA contends the Company has not addressed the ratemaking treatment for the existing facilities as ordered or even committed to disposing of the existing facilities.
DRA argues that the proposed facility is excessive when compared to the facilities to be replaced; the $6 million request exceeds the $4.9 million cost to refurbish the existing facilities; the Company has not provided any justification for the cost of the new office/warehouse; nor has it addressed the ratemaking treatment for the existing facilities or committed to their dispositions.
DRA recommends that 50% of the proposed cost of $6 million be phased into CWIP during the years 2006 and 2007. San Gabriel should also be required to dispose of the facilities that are to be replaced via an arms-length transaction to an unrelated third party, with the benefit of the sale going to ratepayers. For ratemaking purposes, the recommended amount for the new facility should remain in CWIP to allow the Company an opportunity to earn a return on the cost of the portion of the facility that may be found to be used and useful. In its next rate case, costs should be reviewed for prudence and the facility's size evaluated to determine whether the entire facility is used and useful. All gains derived from the sale of the existing facilities should be returned to ratepayers by offsetting the cost of the new facilities.
While we do not doubt that more office space is needed by San Gabriel, it has not convinced us that its proposed size is reasonable. We will authorize San Gabriel to phase in up to $4.9 million, the cost of refurbishing the existing facility, in CWIP during the years 2006 and 2007. For ratemaking purposes, this amount should remain in CWIP to allow the Company an opportunity to earn a return on the cost of the portion of the facility that may be found used and useful. In its next rate case, costs should be reviewed for prudence and the facility's size evaluated to determine whether the entire facility is used and useful. Should the final amount of the new facility placed into rates exceed that amount for which CWIP was allowed, the balance plus an allowance for funds used during construction should be placed into ratebase. We decline to allow inclusion of this investment in ratebase by advice letter as requested by the company.
We are also concerned about the disposition (or lack thereof) of the existing facilities. San Gabriel shall remove from ratebase the existing HQ facilities except half of the land where Plant F-25 is located once it is no longer used and useful or upon the inclusion of the New Headquarters building in ratebase, whichever comes sooner. We note that the increase in ratebase caused by the construction of the new facilities is offset, at least in part by the reduction in rate base of the existing facilities.
We caution San Gabriel that we are concerned that the transfer of this property to an affiliate will raise significant concerns about the valuation of the property. We would prefer that any sale be an arms length transaction with a third party. Further we note that a transfer from one affiliate to another may not constitute a sale under the meaning of Section 790.
CWIP is reflected in rate base (for water companies) as a means of allowing the utility to recover the financial carrying cost of investments in capital projects before they go into service. In the present circumstances, the Fontana Division's recent year-end CWIP balance is higher than normal, due to major projects the Company has under construction. The Company utilized the CWIP balance as of December 31, 2004 in each rate year. The December balance was higher than the historical CWIP balance because of the major projects currently being developed, which included the Sandhill plant modification, the new office complex, and the SCADA system. DRA points out that each of the projects included in CWIP are projects the Company has included in its requested plant additions. DRA believes inclusion of the cost in CWIP and in plant represents a double count of a portion of the requested plant costs.
The Company has estimated $7.7 million for CWIP for TY 2006-2007 and the same for TY 2007-2008. DRA has estimated an average of $5.5 million for TY 2006-2007 and $6.6 million for TY 2007-2008. (Ex. 45, 8-24, 25.)
The rate base cap of 10% includes plant in service plus CWIP. The capital budgets on which San Gabriel based its calculations of plant additions reflect only amounts to be spent in calendar years since 2004, the year upon which current rates are determined. We would expect a higher CWIP for TY 2006-2007 because of the major projects under construction. We find that the Company's CWIP is probably low, but reasonable. There is no double count.
San Gabriel determined its projected material and supplies by calculating a five-year average of historical materials and supplies in 2004 dollars. The Company then increased the average for the percentage increase in plant projected and the non-labor inflation rate. DRA disagrees with San Gabriel's calculated projection because the application of the growth rate in plant is not justified. The average plant balance increased approximately 10% in 2004, but the average materials and supplies decreased by approximately 16%. The average plant balance in 2003 was approximately 11% higher than 2002, and the average materials and supplies for 2003 was approximately 3% higher than 2002. DRA asserts San Gabriel's growth factor is not justified. (Ex. 45, p. 10-3.)
DRA recommends that the five-year materials and supplies balance be adjusted for inflation only, using the updated inflation factors previously discussed. DRA's recommendation results in a reduction to materials and supplies included in rate base of $238,300 in TY 2006-2007 and $326,200 in escalation year 2007-2008. (Ex. 45, pp. 10-3 - 10-4). The resulting materials and supplies balance to be included in rate base is $766,300 in TY 2007-2008 (Ex. 45, pp. 10-7 and 10-8).
San Gabriel disagreed with DRA's position, discounting DRA's emphasis on variations over a single year. San Gabriel emphasized that the materials and supplies balance increased by 56% over the last five recorded years, while utility plant increased by 48%, demonstrating a strong relationship between the rate base balances for utility plant and materials and supplies. We find reasonable San Gabriel's forecast method for materials and supplies, reflecting plant growth as well as general inflation (using updated inflation factors).
San Gabriel reflected in its plant balance the same amount of advances for construction that is being reflected in the projected advance credit balance that offsets rate base. The additions to the advance account for the past five years averaged $3 million. The additions projected for 2005-2008 average $2 million. DRA accepts San Gabriel's estimate, but comments that the Master Plan attributed the additional plant requirements to growth in the Fontana Division. The growth that creates the need for additional plant should be either advanced or contributed by developers. We agree with DRA's comment. As with CWIP, we find the Company's advance estimate is low, but reasonable.
San Gabriel reflected the same amount of contributions that are being reflected in the projected contributions credit balance that offsets rate base. The additions to the contributions in aid construction for the past five years averaged $1.3 million. The Company's additions projected for 2005-2008 average $850,000. Historically, the $1.3 million represented approximately 11% of the $11.677 million average of gross plant additions. The projected $850,000 average for contributions is approximately 5% of the $18.379 million average plant additions estimated for the years 2005-2008. The difference between the actual and the estimates suggests that San Gabriel understated the projected contributions. We will adopt the historical average for contributions of $1.3 million. We do not understand how San Gabriel can project above average increases in plant while predicting a lower rate of CIAC. It appears the Company is maximizing its investment, which earns a return, rather than seeking contributions, which do not.
D. Working Cash
There are two main elements to the calculation of a working cash allowance: an operational cash requirements and a lead-lag study. San Gabriel's witness testified that San Gabriel prepared the working cash component of rate base consistent with the method used by the Commission in prior rate cases. The witness explained that San Gabriel's method complies with the detailed basis for computing revenue lag and expense lead/lag as stated in the Commission's Standard Practice U-16. He summarized the minimum balances comprising the operational cash requirement.
DRA objected to several aspects of the Company's working cash calculations. DRA claimed to find an understatement in San Gabriel's lead-lag study of the lag for power costs. Reviewing San Gabriel's bills from Southern California Edison Company (SCE), DRA used a weighted average payment lag of 33.8 days as compared to 19 days used by the Company. DRA also criticized San Gabriel for ignoring working cash on hand not supplied by shareholders, including taxes collected for advances and contributions, advances not yet reflected as rate base offsets, and pending refunds. DRA contends that these adjustments justified a $6,595,574 reduction in San Gabriel's working cash - producing a negative working cash allowance of ($5,717,074).
Standard Practice U-16 does not mandate a single methodology for calculating working cash. Rather, it "serves a guide to the staff engineer or analyst" based on current staff practices that the engineer or analyst should consider in determining the working cash allowance. Standard Practice U-16, Paragraph 8 under Section D - Working Cash Component of Rate Base states, "for practical reasons, the method of determining the working cash allowance varies with the size, nature, and the operation of the utility."
Regarding the lag days for power costs, San Gabriel's witness explained SCE issues one monthly invoice to San Gabriel for facilities that are read on many different meter reading cycles. San Gabriel is billed and makes payment on a single 30-day billing cycle, to which the Company's 19-day lag calculation applies. He said San Gabriel calculated the operational cash requirement by a simplifying convention consistent with the purpose of the working cash allowance and approved in past GRCs, including minimal cash balances required to be maintained in its customer service office cash drawers, petty cash, minimal balances in its regular checking and return checking bank accounts, and one-half of its postage account maintained at the post office. The total of these items is $26,000.
Responding to DRA's assertion that San Gabriel's working cash calculation ignores non-investor supplied cash, he explained that Standard Practice U-16 provides for calculating an operational cash requirement as well as deductions from the operational cash requirement, and that it would be consistent with the Standard Practice U-16 to combine the operational cash requirement from which those deductions are taken. The witness testified that DRA's results "grossly understate the operational cash requirement."
We agree with San Gabriel's working cash estimate. It was done in accordance with Standard Practice U-16. DRA has completely misconstrued Standard Practice U-16; DRA has ignored the operational cash requirement. Negative working cash in the millions of dollars makes no sense. We have discussed this in detail in our recent discussion (D.06-06-036) in the rehearing of D.05-08-041 in A.02-11-044. San Gabriel's estimate is adopted.
E. Depreciation
San Gabriel's depreciation reserve, accruals, and expense for recorded years 2000 through 2004, estimated year 2005, and TYs 2006-2007 and 2007-2008 were accepted by DRA subject to differences regarding estimates of utility plant in service and advances during the relevant years, and subject to correction of a mathematical error in San Gabriel's calculation of net plant retirements. We adopt the same methodology in determining the depreciation expense based upon our adopted estimates of utility plant.
