5. Ratemaking Treatment of PRP Payments
After the discovery of MTBE in the Charnock Basin groundwater, the City and SCWC independently began negotiating with the PRPs to obtain compensation for the loss of use of the Basin. Both the City and SCWC negotiated temporary settlement agreements with some of the oil company PRPs in 1998. In 1999, the oil companies terminated the agreements, contending in SCWC's case that it held no meaningful groundwater rights in the Basin and was entitled to little or no reimbursement for the loss of Basin water.
In anticipation of the termination of the interim settlement agreements, the EPA issued an administrative order against one of the PRPs to continue paying the City and SCWC for the loss of use of Basin groundwater. Under the EPA order, SCWC received compensation for the loss of use of 577 acre-feet per year of Basin groundwater. The 577 acre-feet represented SCWC's use of groundwater in 1995, the last full year of groundwater pumping in the Basin.
Since 1998, SCWC has collected approximately $5 million from the PRPs. Under the EPA order, SCWC continues to receive $21,974 per month from the PRPs, and these payments are to extend to the year 2005.
SCWC has booked $4.2 million of these payments as a credit in its Account 704, which records costs for purchased water. Approximately $800,000 has been booked to Account 798 for legal expenses that SCWC incurred in its contamination and water rights litigation. The PRP payments are not reflected in SCWC's rate base and were not addressed its most recent general rate case for the Culver City region in 1998.
5.1 Positions of the Parties
SCWC maintains that the PRP payments were designed to compensate for damage done to SCWC's water rights, and therefore the money should be retained by SCWC and not shared with ratepayers. SCWC's financial witness stated that SCWC has borne the cost of acquiring, maintaining and defending its Charnock Basin water rights, and ratepayers have contributed nothing toward those efforts. He stated that Basin water rights have never been included in rate base, that ratepayers have paid nothing toward the remediation of the MTBE contamination, and that SCWC has paid all of the costs associated with the water rights and MTBE lawsuits.
On brief, SCWC argues that ratepayers should be indifferent to the PRP payments since they have no effect on rates. SCWC asserts that ratepayers have incurred no added costs because SCWC's last two rate cases for the Culver City district relied entirely on purchased water and included no mix of groundwater. SCWC cites Great Oaks Water Co. (1993) 49 CPUC2d 116 for the proposition that allocating settlement payments to ratepayers in such circumstances is inappropriate because doing so "would place them in [a] better position than if the contamination had not occurred." (49 PUC2d at 123.)
ORA's witness testified that since 1996 SCWC ratepayers have been paying more for purchased water than would otherwise have been required had Basin groundwater been available. He stated that ratepayers also have been paying depreciation and a rate of return on the refurbished wells and other facilities at the Basin that would have increased the use of pumped water but now cannot be used because of the contamination. On brief, ORA argues that allowing SCWC to retain the money it receives from the PRPs is a "windfall" for shareholders, since the increased costs for purchased water have already been recovered in rates.
ORA urges that the Commission direct that the net proceeds from the PRP payments be transferred from Account 704 (purchased water) to Account 704.02 (purchased water balancing account). When the balancing account is netted out in March of each year, the amount in excess of that actually spent on purchased water would be refunded to ratepayers. ORA states that SCWC should be permitted to retain PRP proceeds sufficient to cover legal and other expenses that SCWC has paid in dealing with PRP issues and litigation.
5.2 Discussion of Ratemaking Treatment of
PRP Proceeds
There is little precedent in Commission decisions for dealing with the ratemaking treatment of damage awards in contamination lawsuits and settlements. The Commission has approached the issue on a case-by-case basis, with the facts of each case determining the result.
Thus, in Re Great Oaks Water Company (1993) 49 CPUC2d 116, we remanded for further hearing the issue of how to deal with $2.3 million in contamination proceeds that were not needed to clean up contamination. We commented then:
The company was willing to have the entire $2.5 million [of the contamination award] treated as a contribution (and not included in rate base) if it was spent to remedy contamination. Thus, on the one hand, we can envision an equitable argument, or one based on Civ. Code § 1882.6 [authorizing the Commission to take excess damage awards into account in setting rates], that any surplus should benefit ratepayers, either as a contribution or in some other manner. On the other hand, we also can see an argument that this money represents damages to the corporation, a legal entity, and the corporation should be free within reasonable bounds to treat the funds as it desires. (49 CPUC2d at 123.)
On remand, the parties in Great Oaks reached a settlement agreement in something of a precursor to Pub. Util. Code § 790. The parties agreed that the contamination proceeds would be booked to a memorandum account for investment in utility infrastructure, with 50% deemed a contribution not affecting rates or rate base and 50% treated as additions to rate base. (Re Great Oaks Water Company (1993) 51 CPUC2d 366.)
In Re Del Este Water Company (1995) 60 CPUC2d 418, we stated the general principle "that the Commission, when dealing with contamination settlements or awards, generally seeks first to make ratepayers whole for amounts that they have paid in rates because of contamination." (60 CPUC2d at 423.) However, we noted that the principle applied only when contamination proceeds exceeded the cost of correcting the contamination. In Del Este, the evidence showed that contamination cleanup costs were likely to far exceed litigation proceeds, and the Commission allowed the proceeds to be retained by the company for that purpose.
Interestingly, SCWC was a major player in the seminal and somewhat analogous case dealing with disposition of the gain on sale of the utility's headquarters. In Re Southern California Water Company (1992) 43 CPUC2d 596, the Commission articulated the theory of the "enduring enterprise" as the principle by which it would examine gain on sale for cases with a similar fact situation. There, SCWC recorded a $1.2 million gain in the sale of its former general office building. In declining to follow earlier "ratepayer indifference" and "risk-sharing" theories set forth in Re Southern California Gas Company (1990) 36 CPUC2d 235, modified on rehearing, 38 CPUC2d 166, the Commission declined to award the gain directly either to shareholders or ratepayers. Instead, it ordered SCWC to retain the gain in the utility's operation but apply it to reduce the utility's rate base, stating:
Ratepayers will benefit over the long term through a reduction in rate base by the amount of the gain-on-sale and the consequent reduction in the return on the reduced rate base. By not using the gain-on-sale as a direct offset against the utility's revenue requirement, but rather as a reduction to rate base, the gain-on-sale will remain in the utility's operation. As such, the gain-on-sale will accrue to the benefit of shareholders in the future if and when the utility's operations are liquidated and its obligation to serve is dismissed. (43 CPUC2d at 604.)
The facts of the case before us differ from the facts in these earlier cases. Here, SCWC has received some $5 million from PRPs for damage to an asset (its right to use the Basin groundwater) that SCWC is transferring to the City. Unlike Del Este Water Company, SCWC faces no further costs of cleanup of the Basin supply. Unlike the gain-on-sale case involving its headquarters, SCWC is not replacing one asset (former headquarters) with another equivalent asset (new headquarters).
Moreover, SCWC within five years stands to receive $5.9 million or more in net proceeds in the sale of its Basin groundwater rights and facilities to the City. The settlement agreement with the City removes a risk that part of the money obtained from PRPs might have to be refunded because the City agreed to indemnify SCWC against PRP claims of over-payment under an initial settlement agreement.
If the PRP payments stood alone, without the sale of the Charnock rights to the City, our assessment of how to deal with the contamination proceeds would take a different direction. First, we would have to quantify the likely additional costs that SCWC would face in seeking to clean and reopen the Basin supply. We also would have to deal with the several millions of dollars the record shows would be spent on attorney and consultant fees for the contamination and the water rights lawsuits. As we did in the Great Oaks case, we would give more weight to the argument that this money compensates the company for damage to an asset, and the company should be free within reasonable bounds to use the money to remedy the damage.
That is not the case here. It is difficult to assess any damage to SCWC's Basin rights and assets that will not be ameliorated by the sale to the City. The higher cost of purchased water to replace Basin water has been borne by ratepayers in the past two general rate cases and likely will continue to be borne for the foreseeable future. The $5.9 million sale price to the City will be used pursuant to § 790 to repair and replace infrastructure upon which ratepayers will pay depreciation and a rate of return. Ratepayers have, until now, paid depreciation and a rate of return on the Basin wells and treatment facilities that have been useless since 1996.
While many of the cost estimates in this case were filed under seal because of the pending lawsuits, one can discern from the public settlement awards and estimates that ratepayers since 1996 have paid millions of dollars in rates because of the loss of Basin groundwater. So long as the district must rely solely on purchased MWD water, rates will continue to be higher than they would be if uncontaminated groundwater were available to add to the water mix.
Under these circumstances, we believe that our task under the principles set forth in Great Oaks and Del Este is to seek to make ratepayers whole for the amounts that they have paid (and will continue to pay) in rates because of the MTBE contamination. SCWC argues that ratepayers have incurred no costs because their last two rate cases relied entirely on purchased water and included no mix of groundwater. There is no question, however, that had uncontaminated Basin water been available, SCWC had made substantial investments in facilities and was prepared to continue using Basin water. SCWC's tariffs witness acknowledged that pumped water is less costly than water purchased from MWD, and he testified that historically Culver City has been served with a mix of about 35% pumped water (from Charnock Basin and other basins) and 65% purchased water.
Finally, as pointed out by ORA, SCWC's interim settlement agreement with the PRPs and the later EPA order requiring PRP payments are intended to reimburse SCWC for the costs (primarily of purchased water) it would not have incurred but for the MTBE. Indeed, the EPA order directs PRPs to provide SCWC with 577 acre-feet of "water replacement" per year for a period of five years beginning on January 7, 2000. Alternatively, PRPs are permitted to make "water replacement payments" in lieu of water replacement. (EPA Order 99-085, Attachment A, p. 3.) Had PRPs elected to deliver 577 acre-feet of water to SCWC instead of money, the water would have been added to SCWC's mix and rates would have reflected a substantial decrease in the cost of purchased water.
Under these circumstances, we agree with ORA that PRP payments, less SCWC's legal and other expenses related to the litigation that resulted in the PRP settlement and EPA order, should go to ratepayers to reimburse them for the higher rates they have paid and will continue to pay because of the MTBE contamination of the groundwater. While the rules governing the purchased water balancing Account 704.02 do not normally permit a utility to add contamination payments to that account, our order today makes an exception to those rules and directs SCWC to transfer those contamination payments from Account 704 to Account 704.02, for eventual refund to ratepayers. SCWC is to continue booking such payments to Account 704.02 while such payments continue.
