V. Rate Reduction Bond Issues

Pursuant to § 841 et seq. and D.97-09-057 (Financing Order) SDG&E issued $658 million in rate reduction bonds in December of 1997 in order to finance a 10% rate reduction for eligible customers over the anticipated four-and-a-half year rate freeze period. According to the terms outlined in the Financing Order, the bonds will be fully repaid by 2007 and a charge to repay the bonds appears on the customer bill until that time. The Financing Order also required SDG&E to establish a Rate Reduction Bond Memorandum Account (RRBMA). When SDG&E ended its rate freeze early on July 1, 1999, the mandated 10% rate reduction for residential and small commercial customers also ended, leaving these ratepayers with unrealized savings. The Financing Order requires that any excess RRB proceeds be returned to ratepayers. SDG&E states that currently there is $423 million in excess RRB proceeds.

In this proceeding, SDG&E has made two proposals concerning the unrealized savings. The first is to return the money to ratepayers at the interest rate of 9.52% (reduced pre-tax rate of return on transition cost assets) rather than the 12.6% (SDG&E's authorized pre-tax rate of return) mandated by the Financing Order.³³ The second proposal is to return the money to customers over a shorter period than the life of the bonds.

SDG&E argues that the bonds were issued under the assumption that the rate freeze would last until March 31, 2002. In essence, SDG&E contends that imposing a 12.6% rate of return on excess bond proceeds penalizes SDG&E shareholders for their efforts in ending the rate freeze early. Further, SDG&E argues that pursuant to newly-enacted § 846.2 (Senate Bill (SB) 418 Stats. 1999, Ch. 683), this Commission has the discretion to change the interest rate by deeming it "fair and reasonable." SDG&E maintains that residential and small commercial customers are better off under this proposal. The Financing Order assumed that benefits to ratepayers equaled $126 million in net present value (NPV). Under this proposal, SDG&E states that customers will receive $398 million in NPV benefits. At the time the Financing Order was issued, no party contemplated that the rate freeze would end early; therefore, SDG&E maintains that it was reasonable to assign a higher interest rate to the surplus proceeds. However, SDG&E now contends that it is inequitable to impose this requirement.

If the Commission does not alter the interest rate, SDG&E wishes to amortize the funds more quickly, e.g., over a nine-month period. However, if the interest rate is reduced, SDG&E will amortize the funds over a two-year period. SDG&E contends that this would synchronize the use of the remaining RRB funds with the originally intended term and use. SDG&E argues that the second proposal provides ratepayers with the highest net present value of all the proposals on the table

TURN, UCAN, Edison, FEA, and ORA object to both of SDG&E's proposals and argue that excess RRB proceeds should be refunded to ratepayers at SDG&E's authorized pre-tax rate of return throughout the life of the bonds. TURN, ORA, and UCAN argue that SDG&E was not required to issue bonds to fund the 10% rate reduction, but it chose to do so. They also argue that SDG&E was not required to take the riskier approach of issuing all the bonds at once, but rather could have issued them when necessary as the rate freeze progressed. Finally, TURN and UCAN state that the Financing Order was explicit regarding the terms and conditions of the bonds, including the risk if too many bonds were issued. SDG&E understood the risks fully. Parties argue that not only were the conditions completely understood, but the Legislature gave the UDCs veto power over the terms of the financing order in § 841(b):

A financing order...shall become effective in accordance with its terms only after the electrical corporation files with the commission the electrical corporation's written consent to all terms and conditions of the financing order.

ORA, TURN, and UCAN argue that SDG&E had full discretion to use the bond revenue in any manner it chose to. The only issue of importance is that SDG&E understood the risks of over issuance of the bonds and accepted those terms. It had the opportunity to mitigate that risk and chose not to do it. SDG&E should comply with the terms that it agreed to.

UCAN refutes SDG&E's argument that it could not have known that the rate freeze would end early and that its fossil plants would sell higher than book value. UCAN maintains that SDG&E either ignored the impact of the generation sale on the length of the rate freeze or assumed a market value of zero. SDG&E states in response to UCAN's data request that "the estimated market value of the generating assets played no role either directly or indirectly in the revenue reduction bond calculations." (Ex. 82.) TURN and UCAN argue that if SDG&E had made reasonable estimates of generation asset values, it would likely have issued fewer rate reduction bonds.

TURN, UCAN, FEA, and ORA oppose the shorter amortization of the bond refunds because they contend that this approach would enable the UDC to skirt its interest obligations under the Financing Order. More importantly a shorter amortization period would be inequitable to future ratepayers that will continue to pay for the costs of the bonds but will not receive an offsetting credit. Current ratepayers would receive a windfall profit in the present but would continue to pay for the bonds. New SDG&E customers would be paying the bond cost without the offsetting credit.

Edison argues that SDG&E's proposal is unlawful. However, SDG&E contends that since SB 418 became law, this Commission has the discretion to alter the Financing Order. SDG&E argues that the opposing parties' position does not meet the "fair and reasonable" provision of Section 846.2, because it is not "fair" to shareholders.

We agree with UCAN, TURN, ORA, Edison, and FEA that the unrealized savings resulting from the excess RRB proceeds must be refunded to ratepayers at SDG&E's authorized pre-tax rate of return throughout the life of the bonds.

The Financing Order reads:

Balances that are to be credited to rate payers in respect of issuance of rate reduction bonds that subsequently were determined not to be necessary in order to finance a 10% rate reduction for rates in effect on June 10, 1996 should bear interest at SDG&E's authorized rate of return (D.97-09-057, Conclusion of Law 33, Ordering Paragraph 19).

SDG&E argues that multiple issuances of asset-backed securities would have increased transaction costs and could have resulted in higher interest costs for customers. But the fact is that SDG&E did issue all the bonds in a lump sum, a riskier approach than issuing them as the rate freeze progressed. SDG&E does not deny that it understood and agreed to the terms and stated risks embodied in the Financing Order. Despite the protection built into D.97-09-054 to safeguard consumers against bond over-issuances, SDG&E now states that its shareholders should not be held responsible for decisions that were made and the terms agreed upon. We see no reason why SDG&E should not be held to the same level of accountability for its business decisions as any other entity that enters into an agreement.

We addressed the concerns regarding excessive bond issuances in

D.97-09-054.

Requiring Applicants to bear full rate of return interest rates on unneeded rate reduction bonds issuance proceeds, rather than the rate of interest for the rate reduction bonds, is necessary to prevent a windfall to Applicants. The risk that Applicants might have to repay a short-term loan at long-term rates has the beneficial effect of making Applicants careful in sizing the transaction. (D.97-09-054, mimeo., at p. 23.)

SDG&E states that § 846.2 gives the Commission discretion to alter the interest rate provisions of the Financing Order to make it fair and reasonable to shareholders. Section 846.2 states:

Notwithstanding subdivision (c) of Section 841, for any electrical corporation that ended its rate freeze period described in subsection (a) of Section 368 prior to July 1, 1999, the Commission may order a fair and reasonable credit to ratepayers of any excess rate reduction bond proceeds.

"Excess rate reduction bond proceeds," as used in this section, means proceeds from the sale of rate reduction bonds authorized by commission financing orders issued pursuant to this article that are subsequently determined by the commission to be in excess of the amounts necessary to provide the 10 percent rate reduction during the period when the rates were frozen pursuant to subdivision (a) of Section 368.

SB 418 clarifies that the Commission has the authority to address the issues raised by SDG&E and order an alternative disposition of the excess bond proceeds, if appropriate. However, SB 418 does not require the Commission to accept SDG&E's preferred solution. We cannot agree that SDG&E's proposal for a reduced interest rate, which would result in reduced refunds to ratepayers, is fair or reasonable. SDG&E accepted the terms and conditions of the Financing Order, which provided that ratepayers would receive a specific return if the utility issued an unnecessary amount of bonds. To change the terms of that agreement is not reasonable or fair to the ratepayers that provided SDG&E with $658 million in bond revenues at the beginning of the transition period. Certainly, SDG&E enjoyed the benefits provided by the lump-sum issuance of the bonds.

We do not agree with protesting parties that a shorter amortization period is unnecessary. On the contrary, we believe it is appropriate to give customers their money back as soon as possible. Therefore, we will order SDG&E to place a credit for the appropriate amount to reflect the unrealized savings resulting from excess rate reduction bond proceeds on applicable customer's bills in the next feasible billing cycle and/or to send a check for this amount to those customers. This is a fair and reasonable outcome of this matter, in compliance with § 846.2, because ratepayers will receive a credit of overpayments as soon as possible and therefore reach finality at the earliest possible date. Further, we note that a one-time refund or credit will minimize the impact on competitive energy service providers and demand responsiveness.

In accordance with our past practice, the refund or credit should reflect customer energy usage since bond revenues are collected from customers on a usage basis. As ORA recommends, the refund or credit is to be confined to the electric portion of the customer's bill and shall not apply to gas charges. SDG&E shall issue a bill credit, provide a refund check, or both on applicable customers' bills in the next feasible billing cycle, reflecting an immediate amortization of the Rate Reduction Bond Memorandum Account and the unrealized savings resulting from excess rate reduction bond proceeds. Within 15 days of the effective date of this decision, SDG&E shall submit a report informing the Energy Division, ORA, and all parties to this proceeding as to how the credit or refund will be implemented.

We recognize that this will result in certain future customers paying bond costs without the benefit of the offsetting credit. However, AB 1890 recognized that bond costs would be paid by certain future customers well after the benefits from rate reduction bonds were realized. To the extent that this specific outcome is inequitable to future ratepayers, we defer to the overall wisdom of the Legislature in balancing the overall benefits and costs of restructuring.