Background - The Current PBR Mechanism

Edison's current PBR mechanism applies to the rates that Edison charges for electric distribution services. In D.96-09-092, the Commission adopted an Edison transmission and distribution PBR. The Edison transmission and distribution PBR was implemented on January 1, 1997 and the basic form of the PBR is scheduled to operate through December 31, 2002. Beginning in 1998, with the implementation of electric restructuring, the Edison PBR became applicable only to the distribution component of Edison's rates. Thus, the PBR mechanism now applies only to these distribution rates and charges. (68 CPUC2d 275.)

Edison's PBR mechanism makes an annual adjustment to rates. The new rates result from applying the percentage change in the CPI, less the Commission-established productivity factor (X) to last year's distribution rates and charges. The annual change in CPI is measured from one middle-of-year value to the next middle-of-year value. Annual values for the productivity factor were set in Edison's PBR decision as follows: 1.2% for 1997, 1.4% for 1998, and 1.6% for 1999 and later years.³

Each year, Edison calculates the ROE that results from distribution operations and sales in the previous year. The current PBR mechanism contains a "Net Revenue Sharing Mechanism" that shares with Edison's customers those net revenues above and below the Benchmark ROE, which is currently 11.6%.

The Revenue Sharing Mechanism has the following features:

· Shareholders bear 100% of the gains and losses relative to the Benchmark ROE within 50 basis points of the Benchmark ROE.




· There is a "progressive sliding scale" in the range between 50 basis points and 300 basis points around the Benchmark ROE. At 50 basis points, ratepayers receive 75% of the incremental gains or losses and their share declines to zero at 300 basis points.




· Between 300 basis points and 600 basis points, shareholders again bear 100% of the gains or losses.




· There is a potential off-ramp if earnings fall 600 basis points below the Benchmark ROE. There is a mandatory off-ramp if earnings exceed the Benchmark ROE by 600 basis points.

In addition to the mechanism for changing rates to assure the reasonableness of earnings, D.96-09-092 creates a second mechanism that alters the Benchmark ROE.⁴ Changes in the authorized ROE are triggered when the last 12 months of Moody's Aa utility bond index (averaged from October through September of each year) show a cumulative change of 100 basis points from the index's base value, currently 7.5% (set in September 1996). D.96-09-092 establishes a deadband of plus or minus 100 basis points from the starting value, so the current trigger deadband is 8.5% on the upside and 6.5% on the downside.

If, at the end of September in a given year, the value of the trigger index lies within the deadband, both the Benchmark ROE and the trigger value remain the same. If the value of the trigger index lies outside the deadband, the Benchmark ROE is adjusted by one-half of the difference between the current value of the 12-month trailing average of Moody's Aa utility bond rate and the value of the trigger index. A new value for the trigger index is then set at the then-current value of the index.

If the trigger mechanism results in a change in the ROE, a PBR rate change is made that corresponds to the revenue requirement change associated with the change in the benchmark ROE. Activation of the trigger mechanism does not alter either the embedded costs of long-term debt and preferred stock, nor the authorized ratemaking capital structure.

Finally, in addition to the operation of mechanisms for adjusting prices, reviewing earnings and adjusting the ROE from year-to-year, the PBR mechanism contains a number of elements that either reward or penalize Edison's performance in specific areas. Currently, these incentive programs focus on four areas of Edison's service quality: customer satisfaction, duration of outages, frequency of outages, and employee health and safety. In general, each mechanism establishes a method for measuring Edison's performance and a benchmark for that performance. In each mechanism, there is a deadband around the benchmark in which realized performance is neither rewarded nor penalized. Outside the deadband performance that is incrementally better or worse is rewarded or penalized. Each mechanism also contains a dollar limit on the maximum reward or penalty. We will discuss the details of each mechanism below.