2. Background: General Ratemaking and CEMA
To help understand this application, we briefly discuss and contrast the two types of ratemaking that provide necessary background. Historically, the Commission sets rates through general rate cases on the basis of test year forecasts; we call this "general ratemaking" and we discuss it first.
We then discuss CEMA, which responds to some of the limited circumstances where the Commission calculates rates not on a forecast basis as in general ratemaking, but on the basis of recorded costs. We explain CEMA's rationale and trace its exposition in Commission resolution, PG&E's tariff and enactment by the California Legislature.
Finally, we discuss the prohibition against retroactive ratemaking, which limits the circumstances in which the Commission may use previously recorded costs to set rates.
2.1. General Ratemaking
Under general ratemaking principles, the Commission allows a utility such as PG&E to file a general rate case application to recover in base rates a forecast of its operating costs to provide customers safe and reliable service.1 The Commission adopts a test year forecast based on the best information about expected future events and historical trends. By using a prospective forecast methodology PG&E has an opportunity to recover its costs and earn a return (profit) on its investment in plant in service. PG&E is expected to exercise discretion to expertly manage its operations during the test year and adapt as necessary to differences between the forecast and actual events. Included in the test year forecast are allowances for damages to plant, accidents, and general maintenance and repairs. Every subsequent general rate case allows PG&E to reflect its prior actual investment in plant as a part of the forecast for the next test year. Thus, when PG&E spends more money than forecast for capital projects during the prior test-period, it adjusts the next test year forecast to include the actual investment in utility plant.
2.2. CEMA
Following the October 17, 1989 Loma Prieta earthquake, the Commission adopted Resolution E-3238, dated July 24, 1991, which ordered that any utility, as defined by Pub. Util. Code § 216, was authorized to establish a "Catastrophic Event Memorandum Account." (Ex. 4.)2 The resolution described the conditions for invoking CEMA and its general operation. In compliance, PG&E filed Advice Letter 1367-E (for the electric department) on August 7, 1991. PG&E's initial CEMA tariff was effective on August 7, 1991.3
Resolution E-3238 described that the purpose of CEMA is:
... to record costs of: (a) restoring utility service to its customers; (b) repairing, replacing or restoring damaged utility facilities; and (c) complying with government agency orders resulting from declared disasters. (Mimeo., p. 1.)
The resolution discussed the need for an established account which would ensure there was no issue of retroactive ratemaking - that an in-place mechanism would provide a legitimate vehicle to recover eligible costs.
The resolution specifically discussed eligibility:
Because the intent of such [CEMA] is to capture for consideration for later recovery only those costs associated with truly unusual, catastrophic events such as the Loma Prieta earthquake, their use will be restricted to events declared disasters by competent state or federal authorities. Other events not so officially designated are outside the scope and intent of this authority and will not be considered for recovery under this mechanism. (Resolution E-3238, mimeo., p. 2.)
PG&E's current tariff similarly states:
The purpose of the CEMA is to recover the costs associated with the restoration of service and PG&E facilities affected by a catastrophic event declared a disaster or state of emergency by competent federal or state authorities. (Ex. PG&E-2, p. 1-1.)
In 1994, after the Commission first adopted CEMA tariffs for the energy utilities, the California Legislature enacted Senate Bill (SB) 1456 (1994 Legislative Session (Chapter 1156)), which added § 454.9 to the Pub. Util. Code:4
(a) The commission shall authorize public utilities to establish catastrophic event memorandum accounts and to record in those accounts the costs of the following: (1) Restoring utility services to customers. (2) Repairing, replacing, or restoring damaged utility facilities. (3) Complying with governmental agency orders in connection with events declared disasters by competent state or federal authorities.
(b) The costs, including capital costs, recorded in the accounts set forth in subdivision (a) shall be recoverable in rates following a request by the affected utility, a commission finding of their reasonableness, and approval by the commission. The commission shall hold expedited proceedings in response to utility applications to recover costs associated with catastrophic events.
There was a specific need for the Commission to create a CEMA mechanism to avoid retroactive ratemaking issues.
It is a well established tenet of the Commission that ratemaking is done on a prospective basis. The Commission's practice is not to authorize increased utility rates to account for previously incurred expenses, unless, before the utility incurs those expenses, the Commission has authorized the utility to book those expenses into a memorandum or balancing account for possible future recovery in rates. This practice is consistent with the rule against retroactive ratemaking. (43 CPUC 2d 596, 600.)
The courts have recognized this problem and found:
If the prohibition against retroactive ratemaking is to remain a useful principle of regulatory law and not become a device to fetter the commission in the exercise of its lawful discretion, the rule must be properly understood. In [PacTel5] . . . we construed Public Utilities Code section 728 to vest the commission with power to fix rates prospectively only. But we did not require that each and every act of the commission operate solely in futuro; our decision was limited to the act of promulgating "general rates." (Southern California Edison Co. v. Public Utility Commission, 20 Cal. 3d 813 (1978) at 816.)
Under § 728, the Commission is allowed to create various mechanisms that ensure that it meets its obligation to approve costs for recovery as well as to anticipate the unknown.6 Essentially, no utility can recover any cost without Commission approval. This approval takes several forms, for example: adopting forecast costs in general rate cases; adopting a balancing account to allow recovery of actual reasonable costs that cannot be accurately forecast; or in the case of catastrophic events, when we cannot predict when, or the nature of, an event which may happen, establishing a trigger mechanism and a process to recover reasonable costs.
1 The Commission decided PG&E's most recent general rate case in Decision 07-03-044 dated March 15, 2007.
2 A catastrophe is "an event causing great damage or suffering." (Compact Oxford English Dictionary.)
3 PG&E's current CEMA tariff is included in Ex. PG&E-2, pp. 1-1 and 1-2.
4 All statutory references are to the Pub. Util. Code, unless otherwise stated.
5 Pacific Telephone & Telegraph Co. v. Public Utilities Commission, 62 Cal. 2d 634.
6 "Whenever the commission, after a hearing, finds that the rates or classifications, demanded, observed, charged, or collected by any public utility for or in connection with any service, product, or commodity, or the rules, practices, or contracts affecting such rates or classifications are insufficient, unlawful, unjust, unreasonable, discriminatory, or preferential, the commission shall determine and fix, by order, the just, reasonable, or sufficient rates, classifications, rules, practices, or contracts to be thereafter observed and in force." Pub. Util. Code § 728.
