a) Conservation Coordinator

In June, 2006, Valencia joined the California Urban Water Conservation Council (CUWCC) and signed the Memorandum of Understanding Regarding Urban Water Conservation in California (MOU). The Commission's Water Action Plan encourages water utilities to pursue water conservation through cooperation with other water agencies and provides for recovery of conservation expenses in their GRCs.⁷⁰ Valencia's RO Report explained in detail the work required to implement the CUWCC's list of 14 best management practices (BMPs) and the expenses associated with that work. In the case of BMP 12, which calls for the hiring of a Conservation Coordinator, Valencia noted that the administrative payroll cost of a Conservation Coordinator was "already part of its normal operations."⁷¹ Valencia's Capital Investment Plan provided a detailed discussion of the need for the new Conservation Coordinator, in order to achieve Valencia's conservation goals.⁷²

Noting that Valencia created and filled the Conservation Coordinator position in 2006, DRA's RO Report proposed to disallow all Test Year payroll expense for the Conservation Coordinator because Valencia "did not make a request to the Commission for the position," the Commission "did not authorize the position into rates," and, while Valencia's workpapers include the expense for this position in its estimate, "the application does not contain a request for this position."⁷³

As in the case of the 2004 salary survey, DRA does not challenge the wisdom of Valencia's decision to hire a Conservation Coordinator, nor the timing of that hire, nor the salary paid. Rather, DRA criticizes Valencia for not having obtained prior authorization from the Commission to create such a position and for not expressly requesting the position in this case.

While Valencia was not obligated by BMP 12 to designate a Conservation Coordinator until July 1, 2007, Valencia hired its Conservation Coordinator sooner because Valencia wanted to ramp up its conservation work as quickly as possible. Valencia's witness Milleman testified that the conservation work was too much for him to handle in addition to his other duties and that Valencia's ratepayers will bear none of the cost of compensating

the Conservation Coordinator prior to July 1, 2007.⁷⁴ Given that the Commission's Water Action Plan encourages water utilities to join the CUWCC and to implement the 14 BMPs, it would be perverse to deny Valencia recovery for the cost of doing so or to punish it for moving quickly to implement the BMPs. As with the salary increases for existing employees, Valencia had no obligation to seek prior approval to create a new employee position; nor is such approval a pre-condition for including the cost of the position in the calculation of revenue requirement for a future Test Year. The sole test for recovering the expense in future rates is whether the expense is reasonable. DRA does not argue that the budgeted salary for the Conservation Coordinator is excessive. Since this salary is not excessive and was incurred by the utility as part of its compliance with the Commission's Water Action Plan, we deem it to be reasonable and we approve its inclusion in Test Year rates.

b) Water Quality Technicians

DRA also proposes to disallow the payroll expenses associated with two Water Quality Technician positions Valencia created and filled in 2005. According to DRA, Valencia "did not make a request to the Commission for these two positions," the Commission "did not authorize these two positions into rates," and, while Valencia's work papers include the expense for this position in its estimate, "the application does not provide explanation and justification to support these positions."⁷⁵

Once again we are dealing with positions that Valencia did not have to seek prior approval to create.⁷⁶ Whether or not the expenses may be included in Test Year rates turns on whether they are reasonable. Valencia witness Alvord explained that the need for additional Water Quality Technicians arose from a change in Valencia's operational environment. Valencia's water wholesaler, Castaic Lake Water Agency (CLWA), changed its disinfection method from chlorine to chloramines, obliging Valencia to hire two new Water Quality Technicians in 2005 "in order to meet additional sampling and flushing requirements associated with using the purchased chloraminated water."⁷⁷ Valencia conducted a number of studies to determine how to respond to CLWA's plans to switch to chloramine disinfection. These studies were compiled into Valencia's Chloramination Conversion Plan, which was submitted to and approved by the California Department of Health Services (DHS) in April 2005. Hiring the two Water Quality Technicians was part of the most cost-effective alternative considered in the Plan, which was provided to DRA in response to a data request. Had Valencia not hired the additional technicians promptly, the additional sampling and flushing requirements associated with use of chloraminated water could not have been achieved.

c) New Positions in 2007 and 2008

Valencia's estimate of payroll expense for Test Year 2007-2008 included estimated salaries for a new Customer Service Representative (CSR) to be added in 2006,⁷⁸ a new Field Service Coordinator to be added in 2007, and a new Operator, Level 1, to be added in 2008. DRA challenged the need for each of these positions, supporting only the conversion of an existing part-time CSR position to full-time. Valencia witness Milleman testified that Valencia's ratio of employees to customers is substantially lower than that of either of the other water service providers in the Santa Clarita Valley.⁷⁹ The new positions are designed to address this situation.

New Customer Service Representative. Valencia employs one Customer Service Manager, four full-time CSRs and one half-time CSR that was added in 2005 to cover for lunches and breaks for the rest of the staff. Except for that new half-time position, Valencia has added no new CSR positions since 1998 while the number of customer accounts has increased by approximately 50% in that time. Implementation of new technology, automation, and outsourcing have enabled Valencia to avoid adding new CSR positions, but the present staff are unable to keep up with the increased call volume and walk-in traffic from customers and vendors.⁸⁰

DRA proposed to disallow the payroll expense for the new CSR position, claiming that Valencia failed to justify its proposal by documenting the increased call volume and increase in walk-in traffic. DRA also relies on evidence of customer satisfaction with Valencia's customer service as a basis to deny the need for an additional CSR - supporting only the conversion of the existing part-time position into a full-time one.⁸¹

Valencia admitted that it does not have a record of the number of customer calls or the amount of walk-in traffic handled by the existing CSRs and has not estimated the number of calls and walk-ins the new CSR will be required to handle. However, current CSRs are working to capacity and Valencia anticipates adding another 2,500 new customers during this three-year GRC cycle.⁸² Witness Milleman testified that it is not Valencia's policy to wait until customer service is unacceptable before adding staff to address such concerns: "[w]e don't want to have to wait until we get a bunch of complaints telling us we're doing a bad job before we move to provide people and resources to provide that service."⁸³

New Field Service Coordinator. The responsibilities of a new Field Service Coordinator, to be added in 2007, include additional programming and data entry into the billing system as the company continues to change out meters to the radio read style, data entry for the company's flushing and valve maintenance programs and as-built information, and updating of service area maps.⁸⁴ Valencia stated that the new Field Service Coordinator was needed to meet increasing field service demands for serving a customer base that has grown significantly since 2000. DRA witness Matsuoka argued that Valencia failed to provide detail of the increased programming and data entry into the billing system as a result of the change in meters or of the increased data entry workload for the company's flushing and valve maintenance or of the updating of service area maps, stating that the company should have "numbers . . . physical numbers in front of them which would aid them in making a business decision that they needed a new Field Service Coordinator or a Customer Service Rep or an Operator."⁸⁵

Valencia witness Alvord testified that Valencia has installed some 6,000 radio meters since 2003, and likely will increase such installations as customer growth accelerates during 2008-2010 with the construction of new real estate developments. He also testified that, in response to Department of Health Services Draft Waterworks Regulations, "Valencia will be flushing dead end mains and routinely exercising water main valves," while installing new meters to meet anticipated customer growth and replacing 1,500 old meters per year.⁸⁶

Operator Level I. The responsibilities of the additional Operator, to be added in 2008, are to help meet the increasing demands of the utility's operation and maintenance programs due to more stringent regulations - including DHS guidelines for exercising all valves 4" and larger and for routinely flushing dead ends and fire hydrants.⁸⁷ Valencia explained that its need for an additional Operator position also results from past and anticipated future growth in Valencia's customer base.⁸⁸ DRA proposed disallowance of the payroll expense associated with the new Operator position, because Valencia "fails to justify its reason by providing a detail of the increase in stringent regulations."⁸⁹ Through its witness Matsuoka, DRA later focused on the "draft" status of the DHS regulations as the basis for the recommended disallowance.

As with the other payroll expense items, this dispute between the Company and DRA comes down to a dispute between those that would anticipate future problems and take steps to avoid or minimize them today, and those who would wait and see whether the anticipated problems materialize. We conclude that it is incumbent on Valencia to meet a high standard in operating and maintaining its valves and mains and it is wise for Valencia to be prepared for the likely adoption of draft DHS regulations.

In the exercise of its business judgment the utility has determined that additional staff positions are needed to implement new programs, maintain service levels and adequately manage future growth. DRA's objections to adding these positions have been mostly procedural and have not demonstrated that these positions are unnecessary or that proposed salaries are unreasonable. Accordingly, we will approve inclusion of the appropriate portion of the payroll expense associated with those positions in the Test Year revenue requirement.

E. Outside Services Expense

Outside services expense includes primarily the cost of attorneys, accountants, and consultants who are not permanent employees of the utility but are retained to perform particular services, such as prosecution or defense of legal claims, financial audits, and special studies. The company and DRA disagree on the best method of estimating future outside services expense. Valencia proposes to use the most recent five-year average of payments made for outside services adjusted for inflation as the forecast of future expenses; DRA proposes to exclude from the calculation amounts paid by Valencia to outsiders in connection with litigation and other matters that have now concluded. Valencia's position is that while individual litigation matters come and go, the volume of litigation is relatively predictable. DRA's position is that "non-recurring" expenses are not properly included in the forecast of future outside expenses.

Because we base public utility rates on future test years, it is necessary for utilities to forecast customer growth, usage, capital additions, expenses, and other factors as part of their GRC applications. The goal is to make reasonable estimates that will allow the utility the opportunity to earn a fair return on its rate base. For operation and maintenance expenses, it has been the general practice to compute adopted amounts based on inflation-adjusted, trended, recorded expenses when such results appear to be reasonable. Exceptions are made for extraordinary expenses and changed circumstances that imply significant increases or decreases in forecasted future expenses.

Valencia calculated outside services expense for Test Year 2007-2008 by the conventional method of averaging the past five years' expenses and applying DRA's Escalation Factors to convert that average to a Test Year amount.⁹⁰ The amount included in Test Year revenue requirement excludes outside services costs associated with perchlorate litigation, which are separately tracked in Valencia's Water Quality Litigation Memorandum Account.⁹¹

DRA's witness Matsuoka excluded the majority of Valencia's base period outside services expenses, resulting in a recommended disallowance of more than two-thirds of Valencia's proposed Test Year expenses ($248,000 out of $380,000).⁹² The basis stated for this disallowance was that particular elements of the base period expense record were "non-recurring."⁹³

Company witness Milleman testified that, over the past five years, Valencia has had to incur more than $360,000 per year in outside services expense and that recent legislation (SB 610 and SB 221) requires Valencia to prepare and submit water availability assessments, creating a new and incremental risk of legal challenges and costly litigation.⁹⁴ Over the past decade Valencia has continually been challenged by various environmental activist groups and has continually incurred substantial legal and consulting expenses to defend itself.⁹⁵ While Valencia so far has prevailed in these cases, it is prudent to assume that such challenges to its operations will continue to arise as an increasing population puts increasing demands on a finite water supply. Valencia's approach to budgeting for these predictable events is actuarial in nature; while the company cannot predict specifically which disputes will arise in a given GRC cycle, it can predict with some accuracy the general level of outside expense it will incur in dealing with the disputes that do arise.⁹⁶ In contrast, DRA's position confuses non-recurring events with non-recurring expenses and, if adopted by us, would almost certainly lead to an inadequate allowance for the expenses Valencia will incur in Test Year 2007-2008. Accordingly, we reject DRA's recommended disallowances.

DRA also recommended that Valencia consider requesting permission to track its expenses related to a recently initiated challenge to its 2005 Urban Water Management Plan (UWMP). The company opposed this recommendation. Having concluded that Valencia's future litigation costs (as reflected in the proposed Test Year allowance for Outside Services expense) are reasonably foreseeable, we see no reason to require a separate memorandum account for future recovery of expenses related to UWMP litigation. However, we note that if the UWMP litigation should prove to be extraordinary in scope or duration, we reserve the right to require memorandum account treatment of this expense category in the future, as we have done with the company's perchlorate litigation.

F. Interest Deduction

Having rejected DRA's proposed capital structure in favor of Valencia's actual capital structure, it follows that Valencia's income tax expense for Test Year 2007-2008 should be calculated based on the interest Valencia actually will pay.

G. BMP Implementation Costs

As noted above, Valencia joined the CUWCC and signed the MOU in June 2006, in response to the Commission's Water Action Plan, adopted in December 2005. Among Valencia's commitments in taking these steps was a duty to implement the BMPs prescribed in the MOU. Valencia submitted its best estimates of the costs to implement the BMPs in its GRC application, but subsequently learned that its costs of implementing BMPs 1 and 2 (concerning residential water audits and plumbing retrofits) would be far greater than the $23,000 estimate included in the Application. Through supplemental testimony addressing implementation of the Water Action Plan, Valencia requested an additional allowance of $80,000 to cover these costs as projected for Test Year 2007-2008.⁹⁷ The lowest competitive bid Valencia received for the work associated with implementing BMPs 1 and 2 was $103,000, as reported to DRA in a supplemental data response in September 2006. Valencia cannot postpone implementing BMPs 1 and 2 until its next GRC without failing in its commitments as a CUWCC member.

The Commission's Water Action Plan encourages water utilities to participate in the CUWCC and to implement the BMPs, providing specifically for them to seek recovery of expenses related to these efforts in their GRCs.⁹⁸ In order to facilitate Valencia's prompt adoption of BMPs 1 and 2, we approve an allowance of $103,000 to cover implementation costs in Test Year 2007-2008.

H. Base Revenue Memorandum Account

In response to the Water Action Plan, Valencia has proposed a method of decoupling water sales from utility revenue, described as a Base Revenue Memorandum Account (BRMA).⁹⁹ The purpose of the BRMA is to eliminate financial disincentives for the Company to pursue demand side management, i.e., water conservation, and to stabilize earnings over periods of increased or decreased water sales. The BRMA would be credited or debited on a monthly basis by the net reduction or increase, respectively, in pre-tax earnings, and would be processed in the same manner as other production cost memorandum (or balancing) accounts. DRA opposed consideration of Valencia's BRMA proposal at this time,¹⁰⁰ but Valencia urges that it be approved and implemented without further proceedings. Valencia's proposal responds to the Commission's invitation, in the Water Action Plan, to present proposals for decoupling water utility sales from earnings in order to eliminate current disincentives for pursuing conservation.

Although we believe that a revenue adjustment mechanism such as that proposed by Valencia in this case is a simple and appropriate way to insure that water conservation goals are met, we will omit consideration of Valencia's proposal in this GRC because this issue was not included in the scoping memo. See Section VII, below. Instead, we will direct Valencia to file a separate application for its proposed BRMA, together with a proposed escalating block rate design.

I. Escalation Factor Unspecified Test Year Expenses

The final disputed issue is the choice of escalation factors to be used in calculating test year expenses that were the subject of stipulation between Valencia and DRA but for which the parties did not agree upon a specific amount. This was recognized as a disputed issue only at the close of evidentiary hearings, when Valencia's counsel explained this difference between the parties as follows:

[T]he company understood that the parties had agreed to use the most recent escalation factors in the DRA Energy Cost of Service Branch Escalation Memorandum of June 30, 2006, as DRA had referenced it in its RO report[,] for adjustment of all expense accounts that had not been the subject of specific negotiation in the settlement discussion, whereas it's the company's understanding that DRA intended to go with the company's calculation of escalation factors for those accounts which were based on the December 31, 2005, DRA Energy Cost of Service Branch Escalation Memorandum.

And so there was a misunderstanding in that regard which leaves that as an issue that's in controversy, that is, which set of escalation factors to apply to those expense accounts with respect to which the negotiation between the parties did not result in [stipulation to] a specific number.¹⁰¹

DRA counsel agreed with that statement of the issue.¹⁰²

All the accounts at issue in this regard are either payroll or operation and maintenance (O&M) expense accounts. It is standard practice for both DRA and the utilities to calculate a normalized average amount for each expense account or sub-account based on five years of recorded data, and then to escalate the calculated average using escalation factors published by the DRA Energy Cost of Service Branch (Energy Branch) to produce estimated Test Year expense amounts. It also is standard practice for DRA, in its RO Report, to update the escalation factors, using the factors most recently published by Energy Branch.

In this proceeding, DRA has taken the position that Valencia's expense amounts not be adjusted to reflect the most recent escalation factors. In the case of O&M accounts not specifically determined by stipulation, DRA applied the Test Year expense amount filed by the Company as a "ceiling" when escalating expenses. This effectively resulted in DRA not escalating these expense amounts by the most recent June 30th escalation factors.

DRA's approach is inconsistent with past DRA practice and with numerous past Commission decisions approving the standard practice. It also contradicts DRA's own statement, in its RO Report, confirming that Valencia used escalation factors published by Energy Branch in December 2005, while DRA used more recent escalation factors provided by Energy Branch in June 2006.¹⁰³ The effect of using the earlier escalation factors is to lower the estimated expenses of the Test Year. For the entire set of accounts to which this issue is relevant, the total impact of DRA's choice not to update its Escalation Factors is approximately $87,000.¹⁰⁴

DRA has provided no reason for its departure from the long-standing practice of using updated Escalation Factors in Class A Water Company rate. Accordingly, we rule that such factors shall be used to calculate allowed amounts not otherwise specifically stated in this GRC.

J. Stipulated Memorandum Account

Pursuant to the stipulation between Valencia and DRA, Valencia is directed to establish a memorandum account to track any future Regulatory Commission expense it incurs as a result of an application for rehearing, petition for modification, or other participation by interveners in this GRC.

⁷⁰ Exhibit 1 (Milleman), at 3-2 to 3-3.

⁷¹ Id. at 5-10.

⁷² Exhibit 3 (DiPrimio), at 6.

⁷³ Exhibit DRA-7 (Matsuoka), at 3-7

⁷⁴ Tr. 97:18-98-10 (Milleman).

⁷⁵ Exhibit DRA-7 (Matsuoka), at 3-7; see also Tr. 128:11-28 (Matsuoka).

⁷⁶ DRA witness Matsuoka admitted that the new positions were added after Valencia's last GRC decision, and that there was no procedure in place for Valencia to request Commission approval to create and fill the new positions until this GRC was filed. Tr. 129:1-10 (Matsuoka). Valencia could not have known about the need to create these positions when it filed its last GRC in 2002.

⁷⁷ Exhibit 26 (Alvord), at 2.

⁷⁸ In Exhibit 1, Valencia indicated that the new CSR would be added in 2006, but in a data response furnished to DRA on August 1, 2006, Valencia clarified its intention to hire the new CSR in January 2007, upon completion of a Data Center Relocation project, which had been delayed.

⁷⁹ Exhibit 25 (Milleman), at 7.

⁸⁰ Id.

⁸¹ Exhibit DRA-7 (Matsuoka), at 3-7 to 3-8.

⁸² Exhibit 25 (Milleman), at 8.

⁸³ Tr. 98:13-22 (Milleman).

⁸⁴ Exhibit 1 (Johnson), at 5-2.

⁸⁵ Tr. 144:2-9 (Matsuoka).

⁸⁶ Exhibit 26 (Alvord), at 4.

⁸⁷ Because the Operator position will not be filled until 2008, only 50% of the associated annual payroll expense is included in Valencia's Test Year 2007-2008 revenue requirement, but the full amount ($35,677) should be included in succeeding years.

⁸⁸ See Exhibit 31 (Matsuoka), at 2 and Attachment; see also Exhibit 26 (Alvord), at 6.

⁸⁹ Exhibit DRA-7 (Matsuoka), at 3-8 to 3-9.

⁹⁰ Tr. 148:9-23 (Matsuoka).

⁹¹ Exhibit 1 (Milleman), at 5-7; Exhibit 25 (Milleman), at 12; see also Tr. 151:16-21 (Matsuoka).

⁹² See Exhibit DRA-7 (Matsuoka), at 3-14 to 3-17; Tr. 148:24-28 (Matsuoka).

⁹³ Id. at 3-15 to 3-16.

⁹⁴ Exhibit 25 (Milleman), at 13. Notably, the recent legal challenge to Valencia's 2005 Urban Water Management Plan includes a new claim that Valencia has failed to give adequate consideration of the effects of global climate change. Tr. 98:23-99:14 (Milleman).

⁹⁵ A. Kidman and M. Hanif Nernat, "Win Some. Lose Some. Will It Ever End? The War Over Water Supply in the Santa Clarita Valley," CALIFORNIA LAW & POLICY RPTR., April 2005, at 179-83.

⁹⁶ In a similar fashion, a life insurance company cannot predict which of its insured will die in the next 12 months but can predict, with remarkable accuracy, how many of them will do so.

⁹⁷ Exhibit 23 (Milleman), at 9-10.

⁹⁸ CPUC, Water Action Plan, adopted December 15, 2005, at 8.

⁹⁹ Exhibit 23 (Milleman/VWC), at 6-7.

¹⁰⁰ Tr. 59:3-9 (Statement of DRA Counsel).

¹⁰¹ Tr. 288:25-289:14 (Statement of Valencia counsel).

¹⁰² Tr. 289:23-24.

¹⁰³ DRA attached the two Energy Branch memoranda presenting the June 2006 Escalation Factors as Appendix A to its RO Report, Exhibit DRA-7.

¹⁰⁴ The supporting calculations were attached as Attachment A to the Opening Brief of Valencia Water Company.