XIV. Automatic Trigger Mechanism

Sierra has requested authority to replace its annual cost of capital filing with an automatic trigger mechanism to free up its annual staff resources and lessen litigation costs, which occur over a seven to eight month period from the filing of its ROE application to a decision.

The automatic trigger mechanism being proposed by Sierra would adjust the authorized ROE when 10-year Treasury note rates change by more than 150 basis points, based on the average yield of U.S. Treasury 10-year notes from September 1 of one year to August 31 of the following year. If a ROE change were triggered, the cost of debt and preferred stock would also be recalculated to reflect the actual embedded costs and the authorized weights of these components would be adjusted if they changed by more than 5%. An advice letter filing would make revenue requirement changes and implementation of the appropriate electric rate changes. Sierra also recommends that this automatic trigger mechanism continue in effect for a three-year test period to determine the viability of the mechanism.

ORA agrees with Sierra that ROE regulation should be more objective and less expensive. However, ORA opposes approval of Sierra's automatic trigger mechanism unless specific changes are made to improve the mechanism and to make it consistent with similar mechanisms approved for Southern California Edison Company (Edison) and SDG&E. ORA recommends that the benchmark be based on AA utility bonds and triggered upon a change of at least 100 basis points instead of U.S. Treasury 10-year notes and a 150 basis points trigger. It also recommends that the ROE be updated by 50% of the change in interest rates when the trigger is exceeded. ORA recommends that the interest rate measurement period be April to September of the same year instead of September 1 of one year to August 31 of the following year. In regards to resetting the ROE when economic conditions change dramatically, ORA recommends the establishment of a 260 basis point offramp. Finally, ORA recommends that a formal cost-of-capital application be required every five years, regardless of whether or not an automatic trigger mechanism offramp is reached. Sierra agrees that the trigger mechanism modifications proposed by ORA are fair and reasonable, and should be adopted.

PG&E also recommend approval of an automatic adjustment mechanism incorporating ORA's proposed changes. PG&E believes that AA utility bonds are a more stable reference point than Sierra's proposed 10 year treasuries to adjust energy utilities' cost of common equity, and that ORA's proposed 100 basis point trigger is more sensitive than Sierra's proposed 150 basis point trigger.

Aglet initially opposed a trigger mechanism because Sierra did not explain why it is reasonable or how it would protect ratepayers against unreasonable rates of return. However, based on its comparison of costs and risks, Aglet determined that the impact of annual ROE litigation cost exceeds $2.00 per customer and may run as high as $5.00 per customer. Aglet also found that the annual ROE litigation cost could reduce Sierra's actual California earnings by 30 basis points.

Aglet now concludes that litigation cost savings justify adoption of a trigger mechanism for Sierra but does not agree with Sierra or ORA regarding all of the details of the trigger mechanism. For example, Aglet recommends a four-year duration of the mechanism before a ROE application is required, the use of 10 year Treasuries, and a 200 basis points offramp. Aglet also recommends that the interest rate measurement be based on the DRI forecast of 10-year Treasury rates relative to the October forecast from the previous year. Aglet further recommends a deadband of 15 basis points from a change in the DRI forecast of 10-year Treasury rates or 10 basis points from a change in the ROE.

Similar to Aglet, API opposed the automatic trigger mechanism being proposed by Sierra and reconsidered its opposition because of the evidence placed into the record during the evidentiary hearing. API included in its opening brief the results of an analysis it conducted subsequent to the evidentiary hearing to determine whether an automatic trigger mechanism would be beneficial for Sierra's ratepayers. API addressed the cost-effectiveness if litigation costs were to be split equally between shareholders and ratepayers and the impact of changes that would have been made to Sierra's allowed ROE if ORA's recommended automatic trigger mechanism had been in place since 1991. Based on this analysis, API concluded that an automatic trigger mechanism is not appropriate for Sierra.

Although API used data in the evidentiary record to conduct its analysis, the data pertained to PG&E's allowed return on equity, and did not reflect any impact from Sierra's allowed ROEs predominately authorized via settlements. However, we note that there is no difference upon comparing Sierra's 11.60% ROE, which has been authorized since 1996 to API's 11.60% calculation of ROE under ORA's automatic trigger mechanism for each year since 1996. Because the analysis conducted by API was not subject to examination during the evidentiary hearings we have no basis to accept API's results as being reliable and thus accord at little weight.

Except for API, the parties seek to streamline the regulatory process by replacing the annual cost of capital proceeding with an automatic trigger mechanism through annual advice letter filings. Such trigger mechanisms are already in place for the major California energy utilities including SDG&E and Edison. Sierra, with approximately 44,000 California electric customers or eight percent of its total electric operations, should be afforded the same opportunity as the major energy utilities to benefit from a streamlined regulatory process. We find that the adopted trigger mechanism should be a fair balance between shareholders' interests and ratepayers' interest and should also provide Sierra the opportunity to earn a fair rate of return as set forth in the 1923 Bluefield decision.19

We concur with the majority of parties that it is fair and reasonable to adopt an automatic trigger mechanism for Sierra that would replace the subjectivity of the current methods used to establish a fair ROE with objective financial data while streamlining the annual ROE process. The changes proposed by ORA establish a fair balance between shareholders' and ratepayers' interest and are intended to make Sierra's automatic trigger mechanisms consistent with the automatic trigger mechanisms in existence for the major California energy utilities.

Aglet's proposed changes would conflict with the automatic trigger mechanism of the major California energy utilities in existence or currently being considered in other proceedings. We will adopt Sierra's automatic trigger mechanism as modified by ORA and set forth in Chapter 3 of Exhibit 9.

Aglet raised the issue of whether an adjustment to the automatic adjustment mechanism should be established in test year 2002 to reflect the unbundling of Sierra's distribution function. Although there was no testimony on this issue, Sierra should address as part of its 2001 automatic trigger mechanism advice letter filing whether a one-time ROE adjustment related to a distribution risk discount or unbundling adjustment should be included in its automatic trigger mechanism.

Comments on Proposed Decision

The principal hearing officer's proposed decision on this matter was filed and served pursuant to Public Utilities Code Section 311(d) and Rule 77.2 of the Commission's Rules.

Findings of Fact

1. Sierra is a public utility electric and gas corporation subject to the jurisdiction of this Commission.

2. Sierra seeks authority to change its authorized ROE for its electric distribution system in 2001.

3. Sierra provided notice of its cost of capital application to its customers, and to the cities, counties, and the state affected by its application.

4. The legal standard for setting the fair rate of return has been established by the United States Supreme Court in the Bluefield and Hope cases.

5. There is no dispute over the reasonableness of Sierra's proposed capital structure.

6. There is no dispute over the reasonableness of Sierra's proposed cost of long-term debt and preferred stock.

7. The ROE recommended by individual parties ranged from 10.50% to 12.00%.

8. CAPM, DCF, and MRP are the quantitative financial models commonly used as a starting point to estimate a fair ROE.

9. Although the quantitative financial models are objective, the results are dependent on subjective inputs.

10. The individual parties' use of quantitative financial models resulted in a broad ROE range from 9.30% to 12.90%.

11. There is a 28 basis points reduction in the 2001 DRI interest rate forecast for AA utility bonds between April 2000 and October 2000.

12. It is the application of informed judgment, not the precision of quantitative financial models, which is the key to selecting a specific ROE.

13. Sierra's rates have been frozen since 1996.

14. There is no dispute over Sierra's 2001 $91,620,000 total California ratebase set forth in late filed Exhibit 22, of which $16,245,000 is applicable to generation, $13,904 to transmission, and $61,371 to distribution, as detailed in Sierra's PBR application.

15. D.96-12-084 required Sierra to file cost of capital and PBR applications for implementation January 1, 2001.

16. D.97-12-093 modified Sierra's rate freeze to conform with Assembly Bill 1890.

17. Sierra seeks authority to replace its annual cost of capital filing with an automatic trigger mechanism.

18. Annual costs of capital trigger mechanisms are in place for the major California energy utilities, including SDG&E and Southern California Gas Company.

Conclusions of Law

1. Sierra's proposed capital structure for test year 2001 should be adopted.

2. Sierra's 2001 proposed long-term debt and preferred stock costs are reasonable and should be adopted.

3. A 10.80% ROE is just and reasonable for Sierra.

4. The 10.80% ROE should be applied to Sierra's authorized rate base for California.

5. Sierra should adjust its rate components associated with the decreased revenue requirement resulting from the ROE being adopted by this order through an advice letter filing.

6. Sierra's annual cost of capital filing requirement should be replaced with an automatic trigger mechanism.

7. A one-time ROE adjustment related to a distribution risk discount or unbundling adjustment should be addressed in Sierra's first automatic trigger mechanism filing.

8. The application should be granted to the extent provided for in the following order.

ORDER

IT IS ORDERED that:

1. Sierra Pacific Power Company's (Sierra) cost of capital for 2001 is as follows:

2. Sierra shall adjust its authorized revenue requirement to reflect the Return on Equity (ROE) being adopted in this decision and to adjust its rate components associated with the change in revenue requirement by an advice letter filing thirty-days after the effective date of this order.

3. An automatic trigger mechanism for Sierra's ROE shall be adopted and replace the annual cost of capital filing as set forth in the body of this decision and summarized as follows.

4. As part of its 2001 automatic trigger mechanism advice letter filing, Sierra shall address whether a one-time ROE adjustment related to a distribution risk discount or unbundling adjustment should be included in its automatic trigger mechanism.

5. Application 00-05-018 is closed.

This order is effective today.

Dated    , at San Francisco, California.

APPENDIX A

TABLE OF ACRONYMS AND ABBREVIATIONS

(END OF APPENDIX A)

19 Bluefield Water Works & Improvement Co. v. Public Service Commission of West Virginia, 262 U.S. 679 (1923).

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