VI. Operation and Maintenance Expenses

A. Supply Cost Expenses

1. Unmetered and Unaccounted for Water

Unmetered and unaccounted for water is a factor used to derive the total water supply needs from the sales forecast; thus, it also affects determination of both water costs and purchased power expense. San Gabriel forecasts 6.8%, based on a five-year average. ORA recommends 3.7% because it believes that a low level of water loss can be maintained by prudent management. We find that a drastic reduction of water losses, such as ORA recommends, is not reasonably feasible. For example, other than pipeline leaks which should be fixed, water is lost through flushing of mains and testing fire hydrants, and such losses vary from system to system. We adopt San Gabriel's forecast based on a five-year average of 6.8% since it is within a reasonable range for such losses.

2. Reclaimed Water

San Gabriel estimates no sales of reclaimed water during the test years. ORA estimates that 7,000 acre-feet of reclaimed water at $150 per acre-foot would be used in each of the test years. ORA's assumption is based on an e-mail from a City of Fontana employee that suggests reclaimed water is available but recognizes that facilities first must be built to transport the water. San Gabriel points out that not only are the needed transmission and distribution facilities not built or even planned yet, but there are no known customers who have expressed an interest in purchasing reclaimed water or who have on-site facilities available to receive reclaimed water. We adopt San Gabriel's estimate since it is unlikely that there will be facilities in place for distribution of reclaimed water during the test years. However, we expect San Gabriel to actively pursue this matter with City and provide the Commission with a report in its next NOI filing, detailing the effort it has made in this area.

3. Water Purchases from Cucamonga County Water District

ORA estimates the purchase of an additional 5,000 acre-feet of water from CCWD (beyond San Gabriel's forecasted 5,000 acre-feet) during the test years based on previous year purchases. According to San Gabriel, CCWD has stated by letter that it cannot guarantee San Gabriel the same amount of water will be available in the future. We adopt San Gabriel's estimate since there is no guarantee that the additional water will be available.

4. Water Costs

San Gabriel forecasts increases in water costs by applying non-labor escalation rates to current supplier prices. San Gabriel's forecasts are based on the availability of water from each individual source, using the most economical source first and using forecasts of the quantities that may reasonably be available from each source. ORA did not allow for any price increase and simply applied the year 2002 recorded expense. We find San Gabriel's estimating process more reasonable since it is based on usage of the most economical source first. However, we adjust San Gabriel's estimate to reflect current supplier prices without any escalation. As is customary, San Gabriel should recover additional costs due to price escalation through its Water Production Balancing Account.

5. Purchased Power Costs

San Gabriel forecasts its purchased power expense based on recorded 2002 billing information, site-specific energy forecasts, and the actual tariffs of Southern California Edison Company (Edison). As with its estimate of water costs, ORA used 2002 recorded (non-weather-normalized) expenses. ORA then applied ratios based on water consumption and Edison's average rate decrease effective August 1, 2003. We adopt San Gabriel's forecast since it is based on the pumping requirements at specific facilities and the applicable Edison tariffs.

6. Chemicals Expense

San Gabriel forecasts test year Chemicals Expense by starting with a five-year average of recorded expenses and applying non-labor escalation rates. In addition, San Gabriel made separate adjustments for: (1) forecasted water supply, (2) the additional flow of SWP water through the Sandhill Treatment Plant, and (3) chemicals needed for new wellhead treatment facilities. ORA averaged three of five recorded years and did not adjust for identifiable increases in chemicals usage. We adopt San Gabriel's estimate since it better reflects expected usage during the test years.

7. Plant F10 Treatment Plant Reimbursements

Fontana customers directly benefit from the Mid-Valley Settlement Agreement, under which San Bernardino County must reimburse San Gabriel for all ongoing Operation and Maintenance (O&M) expenses for operating the F10 Treatment Plant to remove volatile organic compounds from the groundwater produced at that site and Plant F49. San Gabriel bills the County monthly for those expenses, and the reimbursements are recorded in Account 614, Other Water Revenues. San Gabriel updated its test year estimates for Plant F10 treatment O&M expenses and made corresponding estimates of Other Water Revenues in the same amounts so that treatment expenses are revenue-neutral for rate-making purposes. ORA adopted the County's projected annual reimbursements to San Gabriel of $531,800 and $447,300 for Test Years 2003 and 2004 as Other Water Revenue but failed to include corresponding amounts in O&M expenses. We adopt San Gabriel's estimates since they are appropriately revenue neutral.

8. Labor Costs - New O&M Positions

San Gabriel requests authorization of 13 new positions in its Fontana Division over the three-year period covered by its application. Nine positions are classified as O&M, and four positions (discussed later) are classified as Administrative and General (A&G). The nine O&M positions, fully described in Exhibit 10, comprise two customer servicemen, one field meter repairman, five water treatment operators, and one plant maintenance man "B." San Gabriel states that the two customer servicemen are needed to maintain a high level of customer service; the field meter repairman is needed to assist the existing one repairman; and the five water treatment operators are needed for the extensive monitoring and water quality sampling now required and for operating the Sandhill Treatment Plant, which will be upgraded. ORA opposes San Gabriel's request on the grounds that existing staff is sufficient and San Gabriel has yet to build the new facilities for which it has requested additional personnel.

We approve San Gabriel's request for nine new O&M positions subject to certain conditions. San Gabriel's request is reasonable considering the growth (over 1,000 connections per year) the Fontana Division is experiencing, its complex system of 34 wells and five pressure zones that require careful management, its perchlorate and nitrate contamination problem, and the proposed new wellhead and surface water treatment plant upgrades it expects to construct. However, ORA has valid concerns that in the past San Gabriel has not filled positions allowed in rates, and the plant for which additional personnel has been requested, is not yet built. Therefore, we will not allow these positions in rates at this time, but will require San Gabriel to file an advice letter to include the expenses for these positions in rates after San Gabriel has hired these personnel. The advice letter filing will be allowed only once a year.

B. Other O&M and A&G Expenses

1. Materials & Supplies (M&S) Expense

M&S expense is a subaccount within various O&M and A&G accounts. San Gabriel uses a five-year average escalated by non-labor escalation rates. ORA's estimates are based on recorded amounts for the past five years after dropping the lowest and highest recorded figures, increased by ORA's inflation factors. ORA provides no justification for dropping the highest and lowest recorded five-year figures. We adopt San Gabriel's estimate because its method of estimating test year expense is more reasonable.

2. Transportation Expense

San Gabriel uses a five-year recorded average of transportation expense escalated by non-labor escalation rates. ORA's estimate is based on the average amounts recorded for this account for the past five years, after dropping the lowest and the highest recorded figures, increased by ORA's factors of inflation. ORA provides no justification for dropping the lowest and highest recorded five-year figures. We adopt San Gabriel's estimate because its method of estimating test year expense is more reasonable.

3. Outside Services Expense - Other Than Legal Expenses

ORA's estimates are $163,900 and $166,000 and San Gabriel's estimates are $210,300 and $232,000, for Test Years 2003 and 2004, respectively. ORA's estimates are based on the average amounts recorded for the past five years, after dropping the lowest and the highest figures, increased by ORA's factors of inflation. ORA provides no justification for dropping the lowest and highest figures. San Gabriel's estimates are based on a combination of five-year average, recorded 2001 and a special forecast. Because the expense levels in certain accounts vary with the amount of physical plant, San Gabriel forecasted these expenses using 2001 recorded information and adjusted for the forecast amounts of plant as well as inflation. We adopt San Gabriel's estimate because its method of estimating test year expense is more reasonable.

4. Outside Services - Legal Expenses

Outside Legal Expense consists of two components: litigation issues not related to perchlorate contamination and perchlorate contamination-related litigation issues. These two categories of expense typically receive different ratemaking treatment.

a) Non-Perchlorate-Related Legal Expenses

San Gabriel estimates $479,644.23, $495,952,15, and $515,294.28, for Estimated Year 2002 and Test Years 2003 and 2004, respectively, for outside legal expenses unrelated to perchlorate groundwater contamination. San Gabriel analyzed its outside legal costs over a 10-year period to develop an average, normalized estimate applicable to Fontana Division. ORA estimates the non-perchlorate-related test year expense by averaging the two years of lowest recorded expense. ORA offers no explanation for selectively averaging the two lowest years of recorded expense. We adopt San Gabriel's estimate because San Gabriel's estimating procedure is more reasonable.

b) Perchlorate-Related Legal Expenses

San Gabriel estimates expenditures for outside legal costs for perchlorate contamination-related issues based on a forecast of its share of the Perchlorate Task Force legal fees and costs. ORA excludes all perchlorate contamination-related expense in the test years because it believes such expenses should be dealt with separately in a memorandum account.

The issue here is whether test year ratemaking or memorandum account treatment should be applied. We conclude that, as recommended by ORA, costs of outside legal services related to perchlorate contamination should be excluded from test year expense and be recorded in a memorandum account. A final accounting is necessary after payments are received from condemnation suits to determine the proper allocation of these payments between ratepayers and shareholders. San Gabriel may provide such an accounting and ask for settlement of the issue in its next GRC proceeding. We adopt ORA's recommendation of memorandum account treatment of perchlorate-related legal expenses.

5. Utilities and Rents Expense

This sub-account consists primarily of purchased power expense for the lighting, cooling, and heating of office buildings and service facilities. Because of significant changes in Edison tariffs in 2001, San Gabriel based its forecast on 2001 recorded information and non-labor escalation rates. ORA accepts San Gabriel's forecast but such acceptance was apparently limited only to Operations Expense. We likewise adopt San Gabriel's forecast of Utilities and Rents Expense since San Gabriel derived its forecast using the same methodology that ORA accepted for Operations Expense.

6. Employee Pensions & Benefits

Account 795, Pensions & Benefits, consists chiefly of Vacations, Holidays, Sick Leave, Pensions, insurance, and other minor expenses. We will adopt San Gabriel's estimates for uniforms and for life and long-term disability insurance, as those estimates are undisputed. The other items are discussed below.

a) Vacation, Holidays, Sick Leave, and Pensions

Differences between forecasts by San Gabriel and ORA are due to payroll and escalation rate issues discussed in other sections of this decision. We adopt San Gabriel's estimate since we are adopting its estimate of employees.

b) Health Insurance

San Gabriel's forecast is based on known premium increases through June 2002, projected employment levels through the test years, and estimated 15.37% and 22.34% increases in 2003 and 2004, respectively. San Gabriel's witness provided documentation to support these forecasted increases. ORA accepted that premiums increased by 14.02% in 2002, but applied non-labor escalation rates of 1.80% and 1.81% to arrive at test year estimates. ORA's estimate of $189,486 for Test Year 2003 is far less than the recorded $306,241. San Gabriel's estimates are $383,781 and $442,500 for the test years. We adopt San Gabriel's estimates since they appear to be more reasonable than ORA's.

c) Dental Insurance

San Gabriel's forecast is based on recorded 2002 expense and estimated 14.97% and 16.33% increases in 2003 and 2004, respectively. ORA estimates a Test Year 2003 expense of $23,420, which is about 30% lower than recorded 2002 expense of $34,485. We adopt San Gabriel's estimates since they appear to be more reasonable than ORA's.

d) Business, Property and Umbrella Liability Insurance

San Gabriel's business, property, and umbrella liability premium for 2002 ($243,263) was known at the time the application was prepared. Based on discussions with its insurance brokers, San Gabriel projected a 38% increase for 2003 and a 10% increase for 2004. These estimates were updated in San Gabriel's rebuttal testimony to reflect the actual 2003 premium ($436,916 - an 80% increase over 2002) and an additional 20% increase for 2004. San Gabriel witness Nicholson explained how the expiration of a three-year rate guarantee, starting in 2000 at a very favorable premium, along with subsequent events such as the September 11 attack that caused insurance rates to "skyrocket," contributed to a substantial premium increase experience for Test Year 2003. According to Nicholson, the insurance broker now estimates a further 20% increase in 2004.

ORA's estimate is significantly lower. ORA started with the same $243,263 premium in 2002 but escalated this premium by 1.80% for Test Year 2003 and 0.40% for Test Year 2004. ORA used non-labor escalation rates to estimate the test year expense even though ORA's escalation memorandum explicitly states that non-labor rates should not be applied to insurance.

An issue specific to umbrella insurance is the allocation of the premium among San Gabriel and its non-utility affiliates. San Gabriel negotiates a single umbrella policy covering the water utility and its affiliated companies in order to achieve greater buying power and lower overall premium cost for San Gabriel and each of its affiliates. However, each affiliate, including San Gabriel, is separately billed by the insurance broker. ORA, alleging that San Gabriel has some control over the allocation of the total premium to each affiliate because the invoices are issued by the insurance broker rather than by the insurance company, allocated 45% of San Gabriel's premium expense to the affiliates. We adopt San Gabriel's estimate since it more reasonably reflects actual increases in insurance costs, and there is no evidence of wrongdoing by the insurance broker.

e) Workers' Compensation Insurance

San Gabriel based its forecast of Workers' Compensation insurance premium on rates in effect on July 31, 2002, ($292,686) and estimated mid-year increases of 30% in 2003 and again in 2004. However, the actual increase in San Gabriel's premium effective July 1, 2003, was significantly higher than forecast. San Gabriel also had not made any upward adjustment to its forecast for growth in the number of employees. ORA adjusted San Gabriel's original forecast downward to reflect ORA's proposed 13.62% decrease in overall payroll for year 2002, and allowed only the non-labor escalation factor of 1.8% for Test Year 2003 and 0.4% for Test Year 2004. We adopt San Gabriel's estimate because it is more consistent with actual premiums that have to be paid.

7. Regulatory Commission Expense

San Gabriel's estimate of $70,050 is based on a recorded five-year average (approximately $2,500/year) plus the estimated cost of retaining Dr. Zepp and consulting engineer Wildermuth to provide expert testimony. San Gabriel requests amortization of these costs over the three-year term of this rate case. San Gabriel did not include its legal fees for this proceeding, which at the conclusion of hearings exceeded $100,000, because it did not anticipate the complexity of this case (e.g., an unprecedented number of contested issues, motions, depositions, and hearings over three weeks in two cities).⁶ ORA recommends disallowing 50% of San Gabriel's requested allowance for outside expert costs because it considers San Gabriel's request to be an enormous burden on Fontana ratepayers. We find San Gabriel's request reasonable given its recent experience. We adopt San Gabriel's estimate of $70,050 amortized over three years.

8. Labor Costs - New A&G Positions

San Gabriel seeks approval of four new A&G positions, namely, Assistant General Manager, Engineer/Draftsman, Water Quality Specialist, and Human Resources Clerk. San Gabriel justifies the positions as follows. The Assistant General Manager is needed to help with the workload because the General Manager devotes a great amount of time dealing with the groundwater contamination problem. The Engineer/Draftsman is needed to deal with the backlog and to work with developers and regulatory agencies regarding construction projects. The Water Quality Specialist is needed to review all laboratory results for compliance with safe water record keeping for the appropriate regulatory agencies. The Human Resources Clerk is needed in Fontana Division because the two current employees in the Los Angeles Human Resources Department cannot cope with the Fontana Division workload.

ORA opposes these four new positions on the grounds that the General Manager has sufficient numbers of staff, the General Engineering Department can provide sufficient engineering and drafting services, and the Water Quality Superintendent should coordinate with the Production Superintendent and the Production Foreman at Fontana Division. Similarly, ORA faults San Gabriel for not providing a study showing the need for the requested Human Resources position.

We authorize the four new positions since Fontana Division has had to cope with significant growth in the last several years and the growth is expected to continue. However, as pointed out by ORA, in the past San Gabriel has taken its time to fill authorized new positions. Therefore, after San Gabriel has filled an authorized position, it may file an advice letter to include in rates the cost related to the filled position. Such advice letters will be allowed only once a year.