4. Partial Settlement Agreement
4.1. Standard of Review
On February 26, 2007, Cal Water and DRA filed a joint motion to approve a settlement agreement. The standard of review for this settlement is the criteria found in Rule 12.1(d) of the Commission's Rules of Practice and Procedure. This rule provides that, prior to approval, the Commission must find a settlement, whether contested or uncontested, "reasonable in light of the whole record, consistent with law, and in the public interest." Cal Water and DRA state that they have entered into the settlement agreement on the basis that the Commission's adoption should not be construed as a precedent or statement of policy of any kind except as it relates to the current and future proceedings addressed in the settlement.
Pursuant to Rule 12.1(b), all parties in the proceeding received notice of the settlement conference. Section 1.14 of the settlement states that the parties have not settled the Westlake district issue raised by North Ranch.
4.2. Terms of the Settlement
The settlement is Attachment 1 to this decision. It covers all eight districts and resolves all but five contested issues.12 Cal Water's applications contain significant rate increases for each district. The primary causes of the requested increases are new plant investment and a higher requested rate of return; these remain the primary causes of the proposed settlement rate increases.
Of note, many of the plant projects have been removed from the settlement's revenue requirement and placed in separate advice letter filings that will come in during the upcoming GRC period. These AL authorizations contain a dollar cap for each project and cannot be filed until the project is completed.
The parties state they have used the AL process for projects that at this time have uncertainty regarding the time of completion and/or the cost. The AL process, as adopted in D.07-01-024, will require the projects to be completed within the cost caps established here prior to submission to the Commission, and the ALs will be subject to public review and protest and require final action by the Commission.13
This section of the settlement, Section 3.0, contains Cal Water and DRA's agreement on numerous long-term capital plant additions. We separately discuss the settlement's provisions for each district.
Following the mandates of our Water Action Plan, we first examine the adequacy of Cal Water's planning for its plant additions, particularly its need for further action to ensure timely infrastructure replacement. We then examine another Water Action Plan objective, the deployment of advanced meters.
In our Water Action Plan, the Commission adopted six objectives, one of which is to promote water infrastructure investment. The Commission states that water utilities should augment their existing Water Management Program that is filed in each GRC, to include a long-term procurement plan, which should "include planning for major investments required to upgrade or replace existing water utility infrastructure, accelerate cost-effective conservation investments, fund installation of water meters capable of measuring water use by individual users, and where appropriate the installation of Advanced Metering technologies."14
In revising the RCP for Class A water utilities, the Commission implemented this objective by adopting a requirement that each GRC application on or after July 1, 2008 contain a long-term, 6-10 year Water Supply and Facilities Master Plan to identify and address aging infrastructure needs, and that this plan be consistent with the General Accounting Office's (GAO) March 2004 Report, GAO 04-461: Water Infrastructure: Comprehensive Asset Management has Potential to Help Utilities Better Identify and Plan Future Investments.15 We adopted the GAO's capital asset management planning requirements after the conclusion of hearings in this proceeding. Therefore, we do not make a finding of compliance here, but rather discuss what Cal Water can do as it goes forward with its planning studies in the coming three years.
Cal Water testifies that it began to take a long-term look at capital needs only in the last few years. Prior to this, it performed capital improvements on a reactive basis and it does not have a Water Supply and Facilities Master Plan (Master Plan) in place for most of its districts.16 As an example, Cal Water testifies that approximately one-third of its 600 wells are over the industry standard for design life.17
In its applications, Cal Water requests funding for a Master Plan for seven of its districts, at approximately $300,000 per district.18 In the settlement with DRA, Cal Water agrees to include funding for master plans in this GRC cycle for Bakersfield, Selma and King City and defer to the next GRC cycle master plans for Oroville, Willows, Westlake, and Dixon.19
At the request of the ALJ, Cal Water and DRA prepared a three-page document that details the work that will be done in the new master plans, including an inventory and assessment of system facilities condition and capacity, and the need for infrastructure replacement; this document is Exhibit 79. In testimony, DRA describes Cal Water's studies as integrated resource management plans and distinguishes this from the comprehensive asset management planning process proposed in the March 2004 GAO report. DRA testifies that the difference between Cal Water's current planning and the GAO's comprehensive asset management planning is that comprehensive asset management planning looks at life cycle costs for utility assets, with a focus on maintenance programs as well as replacement.
DRA testifies that it is important that the Commission direct water utilities to move in the direction of comprehensive asset management programs as well as integrated resource management planning.20 Cal Water testifies that it has a maintenance department that is focused on moving from a reactive program to a proactive maintenance program but it is not yet fully implemented.21 Cal Water submitted Exhibit 81 as a late-filed exhibit. In Exhibit 81, Cal Water addresses whether the planning studies currently underway meet the GAO criteria. Cal Water states that its current requests for proposals for the master plans authorized here do not meet the GAO criteria. Asset management software compatible with the 2004 GAO study is planned to be installed company-wide by 2009 in order to meet Rate Case Plan filing requirements by the time of 2009 GRC filings.
We commend Cal Water for the planning process it has begun, while also recognizing that Cal Water needs to further refine and integrate its planning efforts in order to meet the GAO standards for comprehensive asset management planning. We find that Cal Water needs a more aggressive schedule than that proposed in Exhibit 81 in order to meet the new RCP filing requirements.
For this proceeding, we direct Cal Water to examine if the master plan process currently underway for the Bakersfield, Selma and King City districts can be augmented, either by a revised Request for Proposal or with in-house resources, to meet our new master plan requirements. Cal Water should make a compliance filing within 90 days of a final decision in this proceeding on the status and scope of possible revisions to its proposed master plans for Bakersfield, Selma, and King City.22
As part of the Commission's objective to strengthen water conservation programs, the Water Action Plan promotes metered water service and encourages the deployment of automated meter reading (AMR) equipment. We state:
Promote metered water service to encourage conservation.
One major conservation incentive is the elimination of flat-rate and un-metered water service. Metering water is essential to send a clear price signal and give the customer a financial incentive to conserve. In addition, installation of Automated Meter Reading (AMR) equipment can provide accurate real time water usage information, reduce labor costs associated with meter reading, and provide more detailed data of customer usage. Section 781 of the Public Utilities Code requires a showing that the metering will be cost-effective, results in a significant reduction in water use, and will not impose unreasonable costs. The CPUC will work to ensure that such a showing is made as often as possible in future water cases, and will then require metered water service. This will be accompanied by appropriate rate designs, as discussed below. (Id. at 7.)
In the settlement, Cal Water and DRA agree that the company may begin a major water meter installation program for the Bakersfield district. This program would authorize $8,190,000 over the coming three years, with an anticipation that these spending levels would continue for another 12 years in order to comply with Assembly Bill 2858's requirement that all flat rate customers be metered by the year 2025.
Under the settlement, Cal Water is budgeting $1,000 per home to do the metering installation, with only $25 of this amount being spent on the meter itself.23 The metering plan does not include any AMR deployment.
We have strong concerns with this proposal. Cal Water testifies that it questions whether the $25 meters it plans to install are cost-effective and estimates AMR would add $150 to the price of an installation. It states that water costs for residential customers are much less than energy costs, water does not have peak hour costs similar to energy, and that the meter penetration in existing Bakersfield neighborhoods is "spotty," thereby requiring many streets to still require a meter reader to visit. Neither Cal Water nor DRA recommend installing meters with any electronic or automated features because the parties do not think advanced metering technology would be cost effective or reliable.
Cal Water estimates that adding AMR equipment to a meter would increase installation costs for each residence by $150, and Cal Water's internal studies do not show that this would be cost effective.24 DRA testified that its research showed an AMR meter would cost approximately $250 and have an error rate of about 20 percent; it also did not find this cost effective.25
On March 29, 2007, the ALJ asked the parties to explore further this issue in light of our Water Action Plan objective to promote advanced metering. In particular, the ALJ cited a recent article in the Water Efficiency Journal on the use of radio-read meters. This article discusses the benefits of the advanced meters, particularly the ability to improve leak detection; the article provides statistics on the rapid rate of deployment of these advanced meters, with 21% of U.S. water customers now having them, compared to 16.4% two years ago.26
In later testimony, Cal Water states that Pacific Gas and Electric Company (PG&E) has contacted them regarding its new advanced metering program for gas customers and discussions had begun about a combined program with water agencies in the Bakersfield area. Cal Water has an employee who is responsible for metering and is working on this coordination.27
We find that a more thorough analysis of advanced water metering should take place before Cal Water proceeds to install new meters. By taking the time to further study this issue, there may also be opportunities to consider new technology or a combined program with PG&E that could prove cost-effective and capable of reliably meeting our water conservation goals. For instance, published reports from Nogales, Arizona and Santa Fe, New Mexico state that these cities have begun programs to install a FIREFLY automatic meter reading interface device that costs $94/box, can be installed on both new and existing meter connections, and is reported to be reliable, cost-effective, and helps to conserve water.28
Therefore, we direct Cal Water to make a compliance filing within 90 days of this decision discussing whether the $8,190,000 in funding for meter installation will be spent on new meters that are compatible with future deployment of advanced metering technology and, specifically, with the advanced metering being deployed by PG&E in the Bakersfield district.
We do not reject the settlement's provision of $8,190,000 AL authorization for meter installations in the next Bakersfield GRC cycle, rather we require further analysis and support for the manner in which meter installation takes place.
We turn now to a review of ratebase for individual districts.
The parties settled disagreements on 26 plant items or programs, with $134,000 in vehicle replacements remaining outside the settlement. The major changes from Cal Water's initial application are that the settlement eliminates two projects, proposed to total $3,240,000, and reduces four other projects by $335,900. Eight other projects, totaling $11,817,700, are handled through the AL process. The settlement also lowers the contingency fees included for projects, and uses these lower percentages in other districts.29
The parties settled all five disputed plant issues. The major change from Cal Water's application is that its $225,000 request for a Water Supply and Facilities Master Plan has been deferred to the next GRC cycle.
The parties settled all six disputed plant issues with only minor changes to Cal Water's initial requests.
Cal Water and DRA settled all five disputed plant issues. Three of the projects involve supplying water to the Oroville treatment plant. DRA agreed to AL filings for two of the projects, with a cap of $458,200 and for the third project, reconstruction of flume F of the Powers Canal, at an estimated cost of $326,200. Cal Water agreed to do further review and report to the Commission in a subsequent GRC. For its requested master plan, Cal Water agreed to defer this project to the next GRC.
Finally, as with the other districts, Cal Water and DRA agreed to apply a ten-year adjusted average of recorded nonspecifics and to use this amount or Cal Water's original proposed budget, whichever is less. For Oroville, Cal Water's original budget is less.
The parties settled all five disputed plant issues with minor dollar adjustments to two projects. Several large projects are handled through the AL process.
The parties settled all disputed plant issues except $94,100 in vehicle replacement policy. Generally, DRA agreed to Cal Water's original requests, provided the projects were subject to AL filings and capped at the proposed amounts.
Cal Water and DRA settled seven of the disputed issues, with $58,000 in vehicle replacement, a disputed issue outside the settlement. For replacement of the Harris reservoir, Cal Water proposed five projects. The parties agreed two of the projects have estimated completion dates outside this GRC period and are therefore removed. The parties settled on the remaining three projects being authorized through advice letter filings, two with cost caps totaling $1,117,500, an amount $27,500 above Cal Water's initial request, and one project requiring a Commission resolution because cost estimates are not available.
Cal Water requested $300,000 for a master plan and hydraulic model. As discussed earlier, it agreed to defer its master plan to the next GRC and both parties agreed to include $100,000 for the hydraulic model.
Cal Water and DRA settled all eight disputed plant items, with approximately $200,000 in dollar reductions. The largest adjustment was to defer the 2008 proposed master plan and hydraulic model to the next GRC.
We find the rate base section of the settlement reasonable provided Cal Water (1) reexamines the Bakersfield metering program, as discussed above, (2) performs a further review of its master planning process authorized here, and (3) notifies its customers of the potential rate impacts of the AL filings we authorize here.
We turn now to the other sections of the settlement.
Cal Water and DRA differ in the number of customers in King City and Selma, the sales per customer for some classes of customers, and differences in unaccounted for water in King City and Dixon districts. The two parties have agreed to accept the recommendations of DRA, and state that in doing so they correct for a calculation error in the application and reflect more recent information. We find this reasonable.
Section 2.2 of the attached settlement details the parties' agreements on 14 disputed expense categories, with Bakersfield and King City having the most disputed items. The parties generally agree to use Cal Water's method for calculating expenses and provide reasonable explanations for doing so. For personnel, DRA agrees to eight new positions in Bakersfield in the test period and one new position each in the King City, Oroville, and Selma districts; Cal Water agreed to not include three new positions in Bakersfield and one new position in King City. The parties agree to estimates that are between their original positions for transmission and distribution expenses, customer accounting, stores, and contract maintenance.
We find this section of the settlement reasonable.
Cal Water initially requested an early, ex parte order to increase the special facilities fees charged new development connections for the Bakersfield, Dixon, King City, Selma, and Willows districts. These fees are set forth in Rule 15 of Cal Water's tariffs. The company requested $1,000 per equivalent one-inch service connection for four districts and $1,500 for Bakersfield. The amount requested is based on the per-service cost of special facilities less the district's per-service rate base.
DRA developed its recommendation based on the full cost of special facilities, arriving at a higher special fee. Both approaches were based on the Commission's policy that existing customers should not pay for customer growth.
In the settlement, the parties agree to a $1,500 special facilities fee for Dixon, King City, Selma, and Willows and a $2,000 special fee for Bakersfield; all fees are effective beginning July 1, 2007. For Bakersfield the fee would increase to $2,250 on July 1, 2008 and $2,500 on July 1, 2009.
We find this a reasonable resolution provided the effective date is the effective date of this decision.
The parties had no disagreement to resolve on capital structure and cost of debt.30 In the settlement, Cal Water and DRA reached agreement for a return on equity (ROE) of 10.20% for the coming GRC period. The settlement states that this ROE is reasonable as it is within the range of DRA's model results, and excludes Cal Water's request for a 45 basis point adjustment above its own modeling results to reflect what it characterizes as unique risk factors. Cal Water's most recently authorized ROE is 10.16%, adopted in D.06-08-011 for its Antelope Valley district.
At the hearing, the ALJ requested the parties update the forecasts of GRC period interest rates used in their ROE models and that Cal Water provide for the record its latest Securities and Exchange Commission (SEC) Annual Financial Report (Form 10-K), and the latest equity research reports by companies that report on Cal Water. This information is found in Exhibits 75 through 78.
The updated 2007-2009 average interest rate forecasts for 30-year Treasury Bonds is 5.12-5.23% and for 10-year Treasury it is 5.07-5.23%. This represents a 37-48 basis point reduction to the forecasted 30-year Treasury average used by DRA in its risk premium ROE model and a 19-35 basis point reduction in the forecasted 10-year Treasury rate used.31 The Commission generally uses the most current financial forecasts available in establishing an ROE for the upcoming period; use of these updated figures would result in a significant downward adjustment to DRA's risk premium ROE model.
Reviewing the six equity reports prepared by AG Edwards, Baird, Brean Murray Carret, Edward Jones, Janney Montgomery Scott, and Stanford Group Company in February - March 2007, we find that all view Cal Water as a high quality utility and rate its shares as hold or buy. The reports view the major potential risk factors for Cal Water to be wet weather, a rise in long-term interest rates, and adverse regulatory decisions.32
Cal Water Service Group's 10-K report for 2006 contains a five-year performance graph that shows the company outperforming the S&P 500 and AG Edwards Water Utility Index for the changes in cumulative shareholder return on common stock. In compliance with SEC regulations, the comparison assumes $100 was invested on December 31, 2001, in California Water Service Group's common stock and in each of the foregoing indices and assumes reinvestment of dividends.33
Based on the record evidence, we are concerned that the parties did not update the interest rate forecasts prior to reaching a settlement. The updated forecasts would lower DRA's risk premium model ROE by 0.19% to 0.48%. This is a substantial change and we should take this into consideration in weighing the settlement as a whole. The weight of our concern is lessened by the parties' argument that the settlement's ROE (10.20%) falls within DRA's model results. The ROE would still fall within DRA's model results if the updated interest rate forecasts were applied.34
We find the ROE of 10.20% at the top of a reasonable range, and not a cause for rejecting the settlement as a whole.
4.3. Action on the Proposed Settlement
Based on our review of the settlement, we have concerns with three areas: the scope of the master plans authorized to be completed in this GRC period, the meter installation program in Bakersfield, and the notice to customers of the AL filings authorized for this GRC period.
We have given specific direction on the master planning and metering programs. For the customer notification issue, we direct Cal Water to provide direct notice to its customers of the rate offset filings, as provided under GO 96-B general rule 4.2 rather than the lesser notice allowed under Water Industry Rule 3.1. We make this change due to the magnitude of the AL potential rate increases contained in the settlement.
With the refinements discussed above, we find the settlement to be reasonable in light of the whole record, consistent with the law, and in the public interest.
12 The contested issues are addressed separately in the next section of the decision. The combined contested issues, if all decided in Cal Water's favor, would increase rates 1.67% for the Bakersfield district, 1.30% for Dixon, 1.50% for King City, 0.25% for Oroville, 1.39% for Selma, 1.01% for South San Francisco, 0.78% for Westlake and 2.25% for Willows.
13 See D.07-01-024, mailed January 29, 2007, mimeo., at pages 21 and 46.
14 Water Action Plan, issued December 15, 2005, page 12.
15 See Appendix A, page A-28 of D.07-05-062, mailed May 30, 2007.
16 Tr. Vol. 12 at 387.
17 Id. at 418.
18 The funding for Bakersfield is less as it is only to update and augment an existing master plan. There is no request for South San Francisco as its master plan is almost complete.
19 Section 3.1 of the settlement and Tr. Vol 12 at 385-6. A portion of Westlake's plan, the hydraulic-model, is included in this GRC and the Bakersfield project is reduced to $207,000 to reflect some value for the previous plan.
20 Tr. Vol. 13 at 499.
21 Id. at 499.
22 Cal Water testified that the Bakersfield and Selma plans are currently being worked on and the King City plan is scheduled to begin later. See Tr. Vol. 12 at 385.
23 Tr. Vol. 12 at 423. The record is somewhat confusing. In Exhibit 100, at page 7-23, DRA states that Cal Water provided higher estimates for meter costs in earlier data requests and also included "automation" estimates.
24 Tr. Vol. 12 at 423-430.
25 Id. at 431.
26 Tr. Vol. 13 at 486. "Tuning in to Water Radio" by David Engle at www.waterefficiency.net.
27 Id. at 487.
28 See "Automated Meter Reading" at www.cityofnogales.net/amr and January 15, 2007 article "Santa Fe to check for water leaks with techno device" in Albuquerque Tribune at www.abqtrib.com/news/2007/jan/15/santa/fe/check/water/leaks-techno-device/.
29 The settlement adopts a 12.5% contingency fee for 2006 projects; 17.5% for 2007 projects; and 22.5% for 2008 projects.
30 See Exhibit 100, Table 1-1 at page 1-2.
31 See Exhibit 108 August 2006 forecasts for GRC period at 2-14 and 2-15 and Exhibit 75 December 2006 - March 2007 forecasts for the GRC period.
32 See Exhibits 77 and 78.
33 See Exhibit 76 at 27.
34 In Exhibit 100, DRA's Discounted Cash Flow model yielded an ROE of 8.30% and its Risk Premium model yielded a range of 10.53% to 11.15%.
