IV. Calculation of the Net Revenue
on Which Line Extension Allowances are Based
A. Positions of Parties
The utilities generally support the existing methods of calculating net revenue. However, the Commission's Division of Ratepayer Advocates (DRA), The Utility Reform Network (TURN) and other parties have proposed changes to that calculation.
DRA
DRA states that the current calculation of net revenue is based on gross distribution revenue and, therefore, includes revenues needed to cover costs other than costs directly attributable to line extensions. DRA argues that existing customers subsidize new customers because use of gross distribution revenue as the basis for the line extension allowance calculation means that new customers will not pay for distribution costs that are not directly related to line extensions.
DRA bases its recommendations on the following language from Decision (D.) 97-12-098:
"applicants should receive such free allowances only to the extent that the revenue expected to be received from the load to be served matches the utility's investment...ratepayers will not be overpaying in those allowances for revenues that will never materialize."
DRA states that this language leads to the following rules that lay the foundation for its recommendation:
1. Line extension allowances should be granted only for revenues which match the utility's investment; and
2. Existing ratepayers should not overpay for allowances when compensatory revenues do not materialize.
DRA proposes that only those revenues directly associated with line extensions should be included in net revenue. DRA recommends that the way to calculate the revenues that directly support line extensions is to subtract the following from average gross distribution revenues per customer:
1. Long-term customer marginal service costs: costs associated with meter reading, billing, and meter services.
2. Upstream distribution marginal costs: capital costs associated with facilities between the substation and those facilities within Rules 15 and 16 (line and service extensions).
3. Primary distribution marginal costs: capital costs associated with the broad distribution system.
DRA states that it used the above marginal costs instead of embedded costs because average gross distribution revenue per customer is just sufficient to recover each customer's allocation of embedded costs. Thus, the use of embedded costs would lead to a net revenue of zero.
DRA proposes that line extension allowances should be considered during general rate cases (GRCs) or Biennial Cost Allocation Proceedings (BCAPs) rather than advice letters, due to the greater complexity and controversial nature of its recommendations.
TURN
TURN proposes inclusion in net revenue of only those revenues that directly support line extensions. TURN argues that the way to calculate the revenues that directly support line extensions is to subtract the following from average gross distribution revenues per customer:
1. Marginal customer service costs: expenses associated with meter reading, billing, and the like.
2. Marginal demand costs: costs associated with facilities between the substation and the line and service extensions.
TURN states that its proposed removal of marginal customer costs and marginal demand costs from net revenues reflects embedded costs and does not change the net revenue calculation to a marginal cost methodology because TURN does not propose to remove the Equal Percentage Marginal Cost (EPMC) scalar.7
TURN opposes PG&E's request to include local gas transmission revenue in the net revenue calculation because these transmission lines do not directly serve new customers and the costs are not directly attributable to providing service to new customers.
TURN recommends the gas allowance for water and space heating be combined, and that no allowance for either use be given unless the customer uses gas for both purposes. TURN states that this would eliminate uneconomic single use gas extensions and the uneconomic substitution of electric space heat for gas space heat.
TURN recommends removal of downstream customer costs from gas net revenues for the same reasons that marginal customer service costs should be removed from electric net revenues. In addition, TURN recommends that downstream customer costs be removed from the gas allowance after all of the individual components are calculated rather than from any single end use because such costs are the same regardless of the number of end uses.
MID
The Modesto Irrigation District and the Merced Irrigation District (collectively MID) state that rate or line extension cost discounts lead to subsidization by other ratepayers. MID says that this is especially important when the revenue effects of discounts have not been taken into consideration in the net revenue calculation on which those discounts are based. Therefore, MID recommends that a customer-specific discount should be calculated for customers who will receive a rate or line extension cost discount to ensure that the discount is revenue justified.
MID states that PG&E has not shown that provision of allowances in areas served by POUs would result in a positive net contribution to margin that is necessary to justify such allowances.
MID states that utility shareholders should be required to share the cost of any ratepayer subsidy created by provision of allowances in areas served by POUs.
CBIA
The California Building Industry Association (CBIA) states that upstream distribution costs should not be deducted from net revenue or charged to new customers because such facilities serve other customers as well.
CBIA states that local gas transmission revenues should be included in net revenue because the utilities provide higher pressure gas services to distributed generation and cogeneration facilities. CBIA also states that public purpose program costs that benefit new customers should be included in net revenues.
PG&E
PG&E proposes to calculate average residential electric usage as total residential distribution revenue divided by the number of customers. PG&E states that this will better reflect electricity usage in its service territory. PG&E also proposes to retain its existing methodology for calculating gas net revenue.
PG&E proposes to include local gas transmission revenue in gas net revenues because they serve the same function as high pressure gas distribution lines. PG&E states that SDG&E and SCG (collectively Sempra) include revenues supporting high pressure distribution lines in net revenues.
PG&E states that DRA's and TURN's proposals to use marginal costs would understate the actual revenues contributed by new customers, inhibit PG&E's ability to attract new load (resulting in higher rates), and result in higher housing prices. PG&E also points out that some of the marginal cost information necessary to implement DRA's and TURN's recommendations is not readily available for PG&E and does not exist for SCE and SDG&E.
SCE
SCE recommends that it be allowed to continue using its current method of calculating net revenues except that it is willing to base net revenues on the residential revenues and number of customers adopted in its most recent GRC rather than basing it on its TOU-D-1 rate schedule.
SCE states that it excludes rate discounts from its net revenue calculation because the lost revenues due to discounts received by one group of customers are recovered from other customers. For example, it excludes the California Alternative Rates for Energy (CARE) discount and the CARE surcharge.
SCE states that DRA's proposal, which SCE characterizes as being based on a standard of ratepayer indifference, is inconsistent with the Commission's policy of basing net revenues on distribution revenues. SCE argues that if the Commission meant ratepayer indifference to be the standard, it would have included other revenues (generation and transmission) to evaluate the overall effect on ratepayers.
SCE states that basing the net revenue calculation on marginal costs would be difficult to implement because not all of the utilities have the data readily available and, due to the controversial nature of marginal costs, would be difficult to implement using a streamlined advice letter process.
Sempra
Sempra recommends continuation of its current calculation methodology for electricity and gas.
Sempra recommends that the average household gas usage be calculated based on a recent conditional demand analysis similar to one recently completed by the CEC using the 2003 RASS.
Sempra does not reflect discounts in its net revenue calculation (similar to SCE).
Sempra includes local gas high-pressure distribution revenues, but not transmission or storage revenues, in its net revenue calculations.
Sempra opposes DRA's proposed use of marginal costs in the net revenue calculation because it would be biased against new customers since all units of demand are marginal whether from new or existing customers.
Sempra states that upstream distribution costs (costs for facilities upstream of the line extension) should be excluded from costs associated with the line extension because such costs are common to and benefit all customers.
B. Electric Net Revenues-Current Status
Currently, the net revenue is calculated as the average residential distribution revenue per customer less revenue cycle service (RCS) credits.8 The only difference between the utilities' net revenue calculation methodologies is how the average residential distribution revenue per customer is calculated.
In calculating electric net revenues, PG&E currently calculates average residential revenue as average household usage times the average residential distribution rate. The average household usage is taken from a usage survey by the United States Department of Energy (DOE) which provides average residential usage for California as a whole.
SDG&E currently calculates average electric distribution revenue per customer as the total distribution revenue divided by the number of customers.
SCE currently calculates average electric residential distribution revenue per customer using the distribution component of the TOU-D-1 rate schedule times average residential usage. SCE states that the TOU-D-1 rate schedule reflects the average residential distribution rate.
C. Discussion-Electric
Costs related to distribution facilities, including line extension allowances, are recovered only through distribution rates. Therefore, distribution revenues are the appropriate starting point for determining net revenue. Since the average distribution revenue per residential customer is the average amount of revenue that can be expected to be received from the average residential customer, it is the amount available to pay for the allowance. Therefore, the net revenue cannot exceed the average distribution revenue per residential customer. The issue is then what should be subtracted from the average distribution revenue per residential customer to determine net revenues.
In D.94-12-026, the Commission defined net revenue as: "That portion of the total rate that supports the utility's extension costs and excludes such things as fuel costs and other energy adjustment costs that do not support the extension costs."9 The Commission also determined that the allowances should be "revenue-based." That is, the allowances "would be based on the expected supporting revenues from the loads to be served by the extension."10
In D.97-12-098, the Commission determined that line extension allowances should be "revenue-justified." That is, allowances should be set such that the revenue expected to be received from the load to be served "matches" the utility's investment. The Commission also decided that the allowance should be distribution-based to reflect the unbundling of utility rates.
In the above referenced decisions, the Commission did not precisely define what it meant by revenues that "support" line extension costs or "match" the utility's investment. As a result, there is no precise definition of what net revenues should include. However, these decisions establish the Commission's overall policy that the allowance should be revenue justified based on distribution revenues expected to be received from the residents of new dwellings.
DRA and TURN argue that new customers will never pay the cost of providing the allowance, much less all of the other costs of providing distribution service and, therefore, will be subsidized by existing customers. DRA's and TURN's references to "new customers" appear to refer to customers residing in new dwellings and/or developers. To eliminate this subsidy, DRA and TURN recommend calculating net revenues by subtracting from average distribution revenues per customer those costs not directly associated with line extensions.
The term "subsidy" is commonly defined as a grant of money by the government to an entity in support of an enterprise regarded as being in the public interest. In the case of line extensions, the line extension allowance is a subsidy of the applicant paid for by ratepayers. However, the mere existence of this subsidy does not mean it is disadvantageous to ratepayers. Therefore, a more appropriate question is whether there is an unreasonable subsidy.
In order for there to be an unreasonable subsidy, the costs of the allowance must exceed its benefits. The allowance is paid for by residential ratepayers. The record shows that the primary direct beneficiary of the allowance is the developer. The question is to what extent ratepayers receive a benefit.
Only two possible ratepayer benefits have been identified in the record. The first benefit would be a positive contribution to margin, on average, due to the addition of new dwellings.11 The second benefit would be due to a reduction in housing prices (new dwellings and the housing market as a whole). It is not reasonable to assume that provision of the allowance is the sole reason that a new dwelling will be built. Therefore, only some portion of the contribution to margin, if any, generated by the addition of a new dwelling would be due to the allowance. Nothing in the record demonstrates what the contribution to margin would be, much less how much of any positive contribution would be due to the allowance. That leaves the second possible benefit.
A possible benefit of the allowance to the owner of a new dwelling would be a reduction in the cost of the dwelling. If the dwelling is rented, the only direct benefit to the renter would be a reduction in the rent due to a reduction in the cost of the dwelling. It is reasonable to assume that the allowance reduces the total cost to construct a dwelling.12 However, the record does not indicate that prices charged by developers for new dwellings are strictly cost-based. Thus, the record does not indicate what benefit the owner of a new dwelling will actually receive from the allowance. The record also does not indicate that the rent charged for a new dwelling will be strictly cost-based. Therefore, the record does not indicate what benefit the renter of a new dwelling will actually receive from the allowance. Likewise, the record does not demonstrate that the allowance will have a material effect on the overall price of housing. Thus, the record does not indicate what benefit customers residing in existing dwellings will receive. Overall, the record does not indicate whether there is a significant benefit to ratepayers due to a reduction in new and/or existing housing prices, much less what the value of any benefit would be.
As discussed above, the record is insufficient to determine what benefits ratepayers receive from the allowance. Thus, the ratepayer benefits of the allowance cannot be compared to the costs of providing the line extension allowances. In addition, the record does not address whether there are other unquantified benefits that would make the subsidy reasonable. Therefore, the record does not demonstrate that an unreasonable subsidy exists. The Commission's current formula was previously determined by the Commission to be reasonable. For the Commission to revise its formula, as recommended by DRA and TURN, we would have to determine that there is an unreasonable subsidy and that TURN's and/or DRA's recommendations would reduce or eliminate the unreasonableness of the subsidy. DRA and TURN have not demonstrated either that there is an unreasonable subsidy or that their recommended subtraction of specified costs from the net revenue calculation would rectify the situation. Thus, they have not demonstrated their recommendations to be more reasonable than the Commission's current methodology.
In D.98-09-070, the Commission directed PG&E, SCE, and SDG&E to propose changes to the line extension rules that remove revenues associated with unbundled revenue cycle services for direct access customers from the line extension allowance calculation. As a result, in D.99-12-046, the Commission removed the RCS credit from the electric line extension allowance calculation.
Direct access electric service is not currently available to new customers, but may be resumed at some point.13 Therefore, the customer residing in a new dwelling may eventually take direct access service. Thus, future revenues from direct access customers may be reduced by the amount of the RCS credits. As discussed above, the Commission's policy is that the allowance should be revenue-justified. DRA and TURN recommend subtraction of marginal customer costs from average residential distribution revenues rather than RCS credits. However, the issue is the revenues that will be lost due to direct access, not the cost of providing revenue cycle services. RCS credits are appropriate for exclusion from the net revenue calculation because they represent the lost revenues. Thus, we do not adopt DRA's and TURN's recommendation to subtract the utility's marginal customer cost, rather than RCS credits. In addition, since we do not adopt DRA's and TURN's recommendations as discussed above, we need not limit allowance changes to GRCs and BCAPs.
The electric net revenue is calculated based on average residential distribution revenues per customer. The calculation should reflect factors, such as rate discounts, that may impact revenues because customers residing in new dwellings may receive such discounts. The use of total residential distribution revenues divided by the number of customers would reflect average revenue per customer including baseline usage, discounts, etc. Therefore, electric net revenue should be based on the average distribution revenue per residential customer calculated as the total residential distribution revenue divided by the total number of residential customers.
The cost of a residential distribution rate discount, such as the CARE discount, is usually recovered from residential customers through residential distribution rates or a surcharge. If the cost of a discount is not included in residential rates, but recovered separately from residential customers through a surcharge, the revenue effect of the discount on residential customers is not fully reflected in distribution rates. To make sure it is fully reflected in the net revenue calculation, if the cost of the discount is not recovered through the distribution rate, the revenue reduction due to the discount should be excluded from total distribution revenues.
MID recommends calculation of a customer-specific allowance for customers who will receive a rate or line extension cost discount to ensure that the discount is revenue justified. Most new dwellings are built by developers who are the recipients of the line extension allowances. The customer who will live there can not be identified until the dwelling is sold. Whether that customer will receive a rate discount will likely be unknown when the allowance is provided to the developer. In addition, subsequent residents of the dwelling may or may not receive a rate discount.
As to discounts applicable to residential line extensions, the record indicates that developers are eligible to receive from the utilities 50% of the line extension costs in excess of the allowance rather than refunds based on additional services or line extensions subsequently connected to the applicant's line extension.14 Whether this comprises a discount to the developer depends on whether additional services and/or line extensions are subsequently connected to the applicant's line extension, which will not be known at the time the allowance is calculated. For the above reasons, MID's proposal is not feasible and we do not adopt it.
D. Gas Net Revenues-Current Status
Gas line extension allowances are based on appliance usage in the residence. The four types of usage are space heating, water heating, cooking and clothes drying. The allowance for each residential dwelling is based on which of the four usages it will have. No equivalent of the electric RCS credits is subtracted.
PG&E calculates the net revenue as the average household usage in California for the particular end use times the average residential distribution rate. The average household usage in California is taken from a DOE residential energy consumption survey.
Sempra calculates the net revenue as the average household usage in their service territories for the particular end use times the average residential distribution rate. They currently calculate the average household usage using the results of a 1999 conditional demand analysis based on customer residential appliance usage.
E. Discussion-Gas
TURN recommends removal of downstream customer costs (costs associated with meter reading, billing and meter services) from gas net revenues. This is essentially the same as TURN's recommendation that marginal customer service costs be removed from electric net revenues instead of RCS credits, and TURN's reasoning is essentially the same.
RCS costs were removed from electric net revenues due to the unbundling of revenue cycle services. Since revenue cycle services have not been unbundled for gas, no revenues will be lost. No gas equivalent of the RCS credit has been established for gas utilities as a whole and we have not required that such a credit be deducted from gas net revenues.15 Therefore, we do not adopt TURN's recommendation.
The appliance usages used to determine the allowance should reflect the usages in each utility's service area, rather than aggregate California usage as used by PG&E. The RASS is implemented at the direction of the CEC to determine appliance saturation and usage for each of the participating utilities. Since PG&E and Sempra participate in the RASS, it should be used to determine average household usage for each type of use.
The average residential rate is multiplied by the appliance usages to determine the net revenue. The average residential rate should reflect factors, such as rate discounts, that may impact revenues because customers residing in new dwellings may receive such discounts. Thus, the rate should be calculated as total residential revenues divided by total residential usage.
The cost of a residential rate discount is usually recovered from residential customers through residential distribution rates or a surcharge. If the cost of a discount is not included in residential rates, but recovered separately from residential customers through a surcharge, the revenue effect of the discount on residential customers is not fully reflected in distribution rates. To make sure such discounts are fully reflected in the net revenue calculation, if the cost of a discount is not included in residential rates, but recovered separately from residential customers through a surcharge, the discount should be excluded from the average rate calculation.
PG&E proposes to include local gas transmission revenue in gas net revenues because they serve the same function as high pressure gas distribution lines. Local gas transmission costs are not recovered in distribution rates. Therefore, inclusion of such revenues in the net revenue calculation would not be revenue justified. Thus, we do not adopt PG&E's proposal.
7 The EPMC scalar is used to convert marginal costs to embedded costs.
8 Under direct access, revenue cycle services (metering, billing and related services) are not provided by the utility. Therefore, the direct access customer receives the RCS credit for the costs of those services.
9 Appendix B, p. 14 (regarding gas mains) and p. 45 (regarding electric extensions).
10 D.94-12-026, footnote 2.
11 A positive contribution to margin occurs when revenues from the customer exceed the variable costs to serve the customer, thus providing recovery of some of the fixed costs.
12 The record demonstrates that the allowance comprises about 0.19% of the cost of a new dwelling costing $650,000.
13 Direct access was suspended by D.01-09-060. The Alliance for Retail Energy Markets filed a petition for rulemaking (P.06-12-002) on December 6, 2006, which requests that the Commission consider a process for lifting the suspension of direct access.
14 This option is not within the scope of this proceeding.
15 An avoided cost credit was established for PG&E gas in D.00-05-049. However, no such credit has been established for Sempra.
