XI. Revenue Recovery Issues
A. Advice Letter Treatment
San Gabriel seeks to phase into rates by advice letter filings the capital costs for its planned new headquarters complex ($3 million in the 2005 capital budget and $3 million in the 2006 capital budget) and for the post-2005 portion of the Sandhill plant upgrade project ($18 million in 2006 and $4 million in 2007). San Gabriel believes that advice letter treatment will temper the rate impact on customers by implementing necessary rate increases in smaller increments. While rate changes for the test year and escalation years are intended to be effective as of July 1, San Gabriel proposes to schedule rate increases related to these advice letter projects for January 1 of each year, when water usage tends to be lower than in the summer.
San Gabriel proposes to include the $12 million budgeted for expenditure in 2005 for the Sandhill upgrade project in TY 2006-2007 rate base, but to track other capital expenditures on Sandhill and the headquarters complex, adding an allowance for funds used during construction (AFUDC) or interest during construction (IDC) if not reflected in test year CWIP. It would submit advice letters by November 15 of each year to effect rate increases on the following January 1 reflecting inclusion of those investment and interest amounts in rate base.
DRA recommends that the cost of the Sandhill plant upgrade be removed from plant in service, and that the proposed advice letter treatment for the incremental costs be disallowed. It argues the next GRC is the proper time to make a determination of whether the cost of the upgrade is appropriate, since by that time the new plant should be operational and its capacity can be readily determined. The Company can accumulate charges so that its investment is protected until such time as a final determination on the project can be made.
We disagree with DRA. We have found that the plant is needed and have established a cap of $35 million for construction costs. We will allow San Gabriel to place its completed portions into ratebase by advice letter. San Gabriel may file an advice letter to place its investment in the Sandhill facility into ratebase by November 15, 2007 to be effective January 1, 2008 and shall further file an advice letter by November 15, 2008 to be effective January 1, 2009 if necessary.
However, the request to use an advice letter filing for the headquarters building is denied. The New Headquarters building shall be counted against the ratebase cap.
However, DRA recommends that San Gabriel be allowed recovery via advice letter of the new Water Treatment Operator III positions after the Sandhill water treatment plant upgrade is in service and the positions are actually filled by San Gabriel. As we discussed earlier in this opinion, those Water Treatment Operator III positions will have to be filled well in advance of the Sandhill upgrades being placed in service, so the new employees can be trained and become familiar with the plant as built. DRA's proposal to use the advice letter process to cover the expense associated with these positions after the Sandhill plant upgrades are placed in service is denied.
Early in 2002, in response to the loss of regular service from seven wells that were contaminated with perchlorate, San Gabriel realized the Fontana Division was facing an increase in water quality litigation costs. San Gabriel responded by opening a Water Quality Litigation Memorandum Account in March 2002 to record outside legal expense related to water quality litigation for the Fontana Division. By D.04-07-034, we authorized a 12-month amortization of the July 2003 balance of $1.0 million, which was completed in July 2005. San Gabriel seeks to amortize the balance recorded in the Water Quality Litigation Memorandum Account as of June 30, 2006. In October 2005, the account balance stood at over $2 million.
DRA agrees that water quality litigation costs should continue to be subject to a memorandum account and the expenses associated with water quality litigation should be excluded from base rates. DRA, however, takes issue with the timing of the amortization of the costs contained in the account. DRA recommends that recovery of the costs be deferred until the amount of recovery from third parties can be determined. DRA says it is obvious the Company anticipates that the costs of water quality litigation will result in significant recoveries, which are anticipated to exceed the costs incurred. Therefore, it is wrong to charge current ratepayers with the costs by annually amortizing the memorandum account in rates when it is the future ratepayers who will receive the benefit of the costs. DRA recommends that these expenditures be deferred to be matched up with the future benefits. The Company is not harmed by the deferral as the memorandum account accumulates interest.
San Gabriel objects to deferral of cost recovery. It argues that water quality litigation has become an ongoing Company responsibility with no end in sight. Since San Gabriel is the plaintiff in pursuing the polluters, there is no prospect of recovering its litigation expenses from the Company's insurers. Meanwhile, interest accrues on unrecovered litigation costs. Just as the Commission has urged water utilities to actively pursue the polluters, the Commission should set rates that allow recovery of the costs incurred in that process on a current or near-current basis. Allowing relatively current recovery of accrued litigation costs will not prevent ratepayers from fully benefiting from all recoveries and certainly will not diminish the Company's incentive to seek recoveries from polluters.
We agree that a prompt amortization of the June 30, 2006 balance in the account is appropriate. The lawsuits are for current damages to wells that are, or were, in service for current customers. We believe San Gabriel is actively pursuing polluters and prompt amortization of legal costs will encourage continued pursuit. However, the record is not clear regarding the details of this account. Therefore, we will require the Company to file a new advice letter authorizing the amortization to be approved by the Water Division. The advice letter shall include a detailed description of the services provided by San Gabriel's outside counsel. The amount approved shall be recovered by surcharge.
DRA recommends that San Gabriel be allowed to continue to maintain a WQMA, so that amounts received from polluters or grants received from government agencies may benefit future ratepayers. The WQMA was established in the last GRC, with the intention that any funds received in the future from lawsuits against polluters and from grants would be included in that account and ultimately invested in remediation efforts in a way that would shield ratepayers from bearing the costs to the extent such funds were available. Some settlements have been treated as contributions toward the capital cost of facilities, thereby reducing rate base.
This account is a benefit to ratepayers. But it is only a benefit to the extent that San Gabriel accurately accounts for funds received. Our discussion of the use of such funds, set forth below, causes us great concern. Funds have been diverted from benefiting ratepayers to benefiting shareholders.
C. Net-to-Gross Multiplier
A key element in calculating revenue requirement is the net-to-gross multiplier, a factor applied to the forecast net income to calculate tax consequences of the required test year and attrition year revenue requirement. San Gabriel's proposed net to-gross multiplier is 1.800324. DRA proposed 1.77286 as the net-to-gross multiplier, the difference being DRA's use of an uncollectibles rate of 0.1951% and a deduction for qualified production activities under the Jobs Act, both items discussed above. We find the net-to-gross multiplier to be 1.772805 based on the resolution of those issues.
D. Calculation of Escalation Year Rates
In accordance with the RCP, year 2007-2008 is a test year for items related to rate base and an escalation year for all other revenue requirement components, and TY 2008-2009 is an attrition year for rate base items and an escalation year for other components. We have followed the RCP requirement for test year, escalation, and attrition factors to produce revenue requirement and rate increase calculations for escalation years 2007-2008 and 2008-2009.
