Cost of Capital

Step and Attrition Increases

Water company general rate cases typically authorize a set of rates for the first test year, and step increases to those rates for the second test year and third (attrition) year. The Commission's longstanding practice for large water utilities has been to apply a pro-forma earnings test at the beginning of the second and third years to determine whether the utility has been earning more than its authorized return, and if it has, to deny or reduce the step increases. In this case, ORA and CalAm each propose modifications to the way that practice has been implemented, and each opposes the other's change. ORA advocates using commercial customers' recorded sales rather than adopted sales in calculating revenues for the pro-forma earnings test. CalAm advocates changing the Commission's practice of comparing a company's pro-forma return to the lower of that company's most-recently authorized return for the year in question, or the return authorized in the decision that granted the step increase. We will not repeat all of their arguments for and against here. Instead, we reject both proposals based on the reasoning CalAm sets forth for opposing ORA: "The current procedure for processing rate increases, including step rates, may not be perfect, but it has proven effective for a number of years. Any change in the current procedures needs to [be] open to formal discussions with all water utilities and members of Staff. Changes in these longstanding procedures should not be made in one company's rate case application."65 That is not to say that we would decline in every general rate case to consider making changes in that case only, but neither party has made a persuasive argument for its proposed change here.

ORA and CalAm each made an additional step increase-related request that would not have policy implications for other companies. First, ORA recommended that the Commission in this decision eliminate Monterey Division's TY2004 step increase, based on ORA's reading of the proposed settlement that was pending in CalAm's A.02-01-036 proceeding to merge with RWE at the time. As CalAm points out, ORA appears to have misread the proposed settlement, and, in any case, it is not part of the record in this proceeding. It is neither necessary nor advisable to attempt to impose a tentative RWE merger-related settlement provision here. Second, CalAm points out that it has pending with the Commission four general rate case applications66 for its former Citizens districts, and the rate of return to be determined in those proceedings may be based on a different capital structure than that for its non-Citizens districts, including Monterey. CalAm contends that it would not be appropriate to apply the rate of return resulting from those applications in the pro-forma earnings test for the Monterey Division's 2004 step rate or 2005 attrition rate filings. ORA has not directly addressed this topic on the record. We agree with CalAm.

Rate Design

By D.00-03-053 as modified by D.01-10-014 in CalAm's last GRC, we approved the current per-capita rate design to promote conservation. For residential customers, the per-capita rate design has five sharply ascending blocks, and for others, two ascending blocks. The Hidden Hills and Ryan Ranch area and the Ambler Park and Bishop area do not draw on the same water supply sources as the remainder of CalAm's Monterey customers and have rate designs different from Monterey's.

CalAm proposes to continue the per-capita rate design where it now applies. ORA concurs. The Department of Defense and Federal Executive Agencies (DOD) concurs but seeks minor modifications as explained below. No party disagrees, nor do we.

For the heavily residential Hidden Hills and Ryan Ranch area, CalAm proposes a four-block rate design. CalAm states that it is in danger of exceeding MPWMD-imposed water production limitations in the area, and absent a conservation-promoting rate design there may come a time in the near future when it is unable to serve the remaining residential lots. ORA concurs with CalAm's proposal, and no party objects. We will authorize CalAm's Hidden Hills and Ryan Ranch rate design proposal.

Ambler Park and Bishop are currently under separate tariffs. CalAm proposes to combine them into one tariff with the increase based on the general increase to Ambler Park tariff rates. They are geographically near to one another, draw from the same aquifer, and would have similar rates once recent Ambler Park plant additions are reflected in rate base. ORA believes CalAm's request is reasonable and will reduce administrative costs. No party is opposed. We adopt CalAm's proposal.

DOD, while concurring generally with CalAm's rate design proposals, seeks three modifications: a small increase to the lowest block in the residential per-capita rate design; a different method of recovering WRAM balancing account balances; and a greater increase than CalAm proposes for temporary water sales.

The pricing formula for the per capita rate design sets the rate for the first block at 50% of the second block rate. At the company's A.02-04-022 requested rates, DOD maintains that the first block rate falls about 3% below CalAm's overall variable commodity cost. DOD suggests the first block rate be increased about 9% to recover the variable costs and provide some contribution to fixed costs. CalAm, while not commenting on the analysis, resists the change on the basis that the highly inverted per-capita rate design was implemented to produce a much needed conservation response, and has done so. The second and higher blocks provide an increasingly strong contribution to fixed costs, and only those customers who are the very lowest users fall exclusively into the first block. While DOD's suggestion is perhaps sound from a standard ratemaking viewpoint, we are not inclined to alter what has been shown to be a simple and effective rate structure, and particularly not so when it works to reduce conservation incentives. We will not order the change.

CalAm and ORA take no position on DOD's suggestion to recover WRAM balancing account undercollections exclusively from residential customers. DOD would not limit its recommendation to prospective surcharges, but would also have the Commission order refunds to non-residential customers (e.g., commercial, industrial and public authority users, notably including the Presidio of Monterey represented by DOD) for approximately $500,000 in WRAM surcharges they have paid since July, 2000. The record is not sufficiently clear as to the mechanics of the WRAM balancing account to assure us that residential customers are solely responsible for WRAM undercollections. What is clear is that residential customers pay commodity rates ranging as high as 400% of the standard rate, while non-residential customers' highest rate tops out at 200% of the standard rate. It can hardly be said that the per-capita rate design favors residential customers over others, and we are not inclined to shift such a large portion of the revenue requirement to them as DOD requests. We will not adopt DOD's suggestion.

We do adopt DOD's third modification: a greater increase than CalAm proposes for temporary water sales. Temporary sales are normally made from hydrants or standpipes, for example, construction water. We agree with DOD that this could be considered a premium service. Temporary sales are today charged at the standard rate, which is the first and lowest non-residential rate block. DOD suggests they should be charged 50% to 100% more. We will adopt its suggestion and direct that all sales under the temporary service tariffs be priced at 150% of the standard rate (other non-residential usage in the second block is priced at 200%). Not only will this produce additional revenue to help contain other rates, but it will provide an added conservation incentive for temporary service users.

Service Quality

ORA and MPWMD contend that CalAm's Monterey Division service has deteriorated to an unacceptable level. ORA cites customer service problems as support for its proposed 2.50% rate of return penalty. MPWMD's service presentation is more directed at showing a general deterioration in the quality of CalAm's management of its Monterey Division and system, thus bolstering its justification for the "extraordinary requests" discussed in the next section.

On brief, ORA cites what it calls two objective standards demonstrating service problems: "dramatic increases in the number of complaints received at the Commission, and the number of boil orders against CalAm's main system." In addition, ORA's testimony pointed to statistics showing a rise in the number of customer inquiries (which ORA characterized as complaints) CalAm has received each year since 1996.

The number of complaints CalAm customers have submitted to our CAB has indeed increased recently: There were 77 complaints during the first seven months of 2002, compared to 24, 27, and 28 for all of 1999, 2000 and 2001 respectively.67 The great bulk of those complaints (55 of the 77 total complaints in 2002), and of the increase in complaints during 2002, was categorized by CAB as "disputed bill." By relating the CAB complaints to what was happening in CalAm during the first half of 2002 (which ORA apparently did not do), CalAm was effective in refuting ORA's conclusions. As CalAm points out, 60,700 former Citizens customers were added to its 106,000-customer system in January 2002, a 57% increase. With the transition from Citizens to CalAm, those customers were exposed to a billing format that was new to them and could be expected to generate a higher number of inquiries and complaints. CalAm also points out that its parent company opened a new national call center in mid-January 2002. Former Citizens customers were routed to the call center in January, and other CalAm customers in April. CalAm cites statistics showing that CAB complaints rose in March and April, peaked in May, and decreased significantly thereafter. CalAm implies that complaints should be returning to more normal levels as startup problems in the call center are worked out, and as former Citizens customers have their concerns addressed and become more familiar with their new bill format.

MPWMD's witness testified that there were eight "boil orders" in CalAm's main system through approximately August 2002, compared to two for all of 2001.68 MPWMD attributes the increase to the loss of key employees "experienced with CalAm's aging and inadequate distribution system." Further, according to MPWMD, the Department of Health Services (DHS) has issued a compliance order requiring CalAm to take long-term action to make the Monterey system more reliable and eliminate the outages that lead to boil orders. ORA cites these boil orders and the DHS compliance order as further evidence of inadequate service. Only one boil order was in any way described: power failure to a pump allowed a tank to drain and a portion of the system near Carmel to lose pressure. While boil orders and DHS compliance orders can be indications of serious system problems, there is no further information on the record relating to them, so we are unable to assign causes or firmly connect them to either MPWMD's or ORA's claims of deteriorating service.

ORA also cited statistics attempting to show a dramatic rise in the number of customer complaints CalAm itself received during January through July 2002. On further examination, however, it became clear that the most recent figures were not accumulated on a basis consistent with those from earlier. What ORA characterized as complaints in fact included other customer contacts as well, and it made no attempt to separate complaints from routine contacts. The inconsistency and need for analysis is most clearly illustrated in the figures for "other customer inquiries" ORA cites for 1998 through 2002: 1800, 52, 18, 26, and 5946 respectively.

We take CAB complaints and DHS compliance orders seriously; when properly analyzed and presented, they can be strong evidence of inadequate service. While there are indications in the record that all may not be well in CalAm's Monterey Division, no party has made a competent showing of what the underlying problems might be, or how they should be corrected. Other than imposing a 2.50% rate of return penalty, ORA's only suggestion was, "ORA is concerned with the increase in complaints and CalAm should improve its level of customer service." We decline to adopt a 2.50% rate of return penalty. We deal separately with MPWMD's requests, which are arguably marginally related to its customer service allegations, in the following section.

MPWMD's "Extraordinary" Requests

In addition to the positions MPWMD took on the GRC issues addressed above, it is requesting the Commission grant what it characterizes as "extraordinary relief to recognize the unique condition of the CalAm system, and to promote rapid and cost-effective solutions to the water supply problems affecting the Monterey Peninsula." MPWMD's brief listed that extraordinary relief as:

An order directing CalAm to share available data in a timely manner with the District and other public entities.

An order that CalAm coordinate its Carmel Valley operations and activities with management and regulatory requirements set by the District and other state or federal regulatory agencies.

An order directing CalAm to develop and participate in a formal process designed to promote cooperation and to cause early resolution of disputes relating to the issues of conservation, provision of data, ASR (Aquifer Storage Recovery) project implementation, and resource management.

An order clarifying that expenditures aimed at obtaining water rights for CalAm's own benefit are not recoverable from ratepayers.

It is apparent from the testimony in this proceeding that relations between CalAm and MPWMD are frayed. We need not describe each charge MPWMD advances here, but underlying most or all of them seems to be its belief that CalAm is attempting to thwart feasibility testing for MPWMD's ASR project. According to MPWMD, CalAm's actions and expenditures are motivated by CalAm's desire to obtain for itself (as opposed to public ownership through MPWMD) all water rights for the project. Each of MPWMD's extraordinary requests bears some relation to that conflict. CalAm's response confirms that a contest over water rights, and perhaps a differing approach to solving the area's water supply problems, lies at the heart:


The problem is not lack of cooperation. The problem is not changes in CalAm personnel. The problem is that the Company disagrees with the District over ownership and control of CalAm's valuable water rights. The problem is that the District is very unhappy and upset with the fact that CalAm is determined to solve the long-term water supply issue in its Monterey Division over the District's long history of unsuccessful efforts and that in order to accomplish that goal Applicant is committed to protecting and preserving and continuing to pursue and to own the necessary and valuable water rights.... That CalAm philosophy runs directly [] contrary to the goals of the strong "no growth" majority of the MPWMD Board of Directors.


* * *


It is totally inappropriate for the District to seek to use this ratemaking forum as leverage to improve its legal position against the Company. CalAm has legitimate legal issues with the District and in the best interest of its ratepayers must now oppose the District's continuing flawed efforts on the subject of water rights and imbedded opposition to a long-term water supply solution. The SWRCB, not this Commission, is the appropriate forum to resolve water rights disputes. The Commission's interest, if any, can and will be fully explored in A.97-03-052.69

At the outset of this decision, we gave a brief overview of the Monterey Peninsula's longstanding water supply problems. The Commission, through A.97-03-052 and other proceedings in the recent past, has been deeply involved in CalAm's efforts to meet its customers' water supply needs. The orders MPWMD would have us issue through its "extraordinary requests" are outside the intended scope, and not sufficiently supported by the record, of this GRC proceeding. We make no judgment here whether those would be appropriate requests in A.97-03-052, but rather leave that determination to the assigned Commissioner and ALJ in that proceeding if and when MPWMD chooses to advance them there.

65 Exhibit CA-22, pages 38 and 39.
66 A.02-09-030, -031, -032, and -033.
67 These CAB statistics are for all of CalAm. ORA did not attempt to break out the figures for Monterey Division.
68 Boil orders result when a water distribution system loses pressure, possibly permitting contamination to enter. Customers are advised to boil the water they consume until the system has been tested and once again declared safe.
69 CalAm brief, page 84. Emphasis in original.

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