V. The Salinas District GRC

Cal Water sought a 12.42% increase for Test Year 2002 in revenue requirement for the Salinas District. Cal Water explained that the primary reasons for the increase are purchased power expenses (96% increase), general office expense allocation (77% increase), payroll (46% increase), and rate base amortization (46% increase). However, the Salinas District has seen a 22% increase in customers, a 49% increase in water production, and attrition and other non-GRC rate increases that greatly reduce the size of the increase. This district's last GRC was for test year 1995. ORA recommended a 4.61% decrease for the same period.

ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. The rate case issues that remained in dispute for the Salinas District (general office cost forecasts and small main replacements) were resolved in D.03-09-021. With the exception of the return on equity issue discussed below, we will adopt the Joint Recommendation, as modified by D.03-09-021, for the Salinas District. Regarding ROE, we reduce the Joint Recommendation by 50 basis points, as discussed below.

Cal Water, without the requisite Commission authorization, acquired two water systems and consolidated them within its existing Salinas District. We find that Cal Water's misconduct in the acquisitions and consolidation should affect how we exercise our discretion in setting Cal Water's ROE for the Salinas District. There are two reasons for our finding.

First, customers in the existing Salinas District were harmed by Cal Water's misconduct. The rates and charges we last authorized for this district were predicated on higher levels of service and investment, and lower levels of revenue, compared to the actual operation of the Salinas District with the unauthorized acquisitions. The fine we impose on Cal Water does not mitigate this harm, and we have already rejected reparations to these customers. If we recognize Cal Water's misconduct, however, by setting a ROE at the lower end of the range of reasonableness, we provide some relief to the existing Salinas District customers, and we also provide an incentive to Cal Water to improve its service in the district and thereby persuade us to later restore its ROE to a level in line with that authorized for its other districts.

Second, the courts have long recognized that ratesetting involves considerable discretion, and that the regulator has latitude to set rates within a range of reasonableness. See, e.g., Permian Basin Area Cases, 390 U.S. 747, 767 (1967). On several prior occasions, we have exercised that discretion, in light of utility misconduct or resistance to regulatory direction, to expressly lower that utility's ROE. As explained in Southern California Edison Company, (1991) 42 CPUC 2d 645, 738, such negative adjustments to ROE result from offenses or actions contrary to statute, order, rule instruction, or express policy. For example, in D.82-12-055, the Commission found that Southern California Edison Company (Edison) had shown a "continuing pattern of disregard for the Commission's avoided cost policy of the past three years" in pricing of certain contracts, and the Commission reduced Edison's ROE by 10 basis points. In D.91107, 2 CPUC 2d 596, 728 (1979), the Commission found that Pacific Gas and Electric Company's (PG&E's) "poor performance" in promoting the development of cogeneration merited a reduction in ROE of 20 basis points.

In the current proceeding, Cal Water has displayed a similar inattentiveness, or resistance, to regulatory direction. Cal Water's misconduct regarding the Indian Springs and County Meadows acquisitions is not isolated. There is parallel misconduct in Cal Water's acquisition of Olcese (consolidated with the Bakersfield District.) And there are aggravating factors: All three unauthorized acquisitions took place after yet another group of unauthorized Cal Water acquisitions prompted D.97-03-028, which set forth the Commission's clear directives to Cal Water on the proper process by which it could acquire these and similar systems. The directives themselves were the product of an MOU between Cal Water and our staff, so Cal Water cannot plead ignorance of the directives, nor can we accept Cal Water's characterization of its failure to follow the directives as an "honest mistake."

Cal Water acted not only in disregard of our procedural directions but also in disregard of substantive policy direction. Official state policy requires that the Commission set water rates that "provide appropriate incentives to water utilities and customers for the conservation of water resources." § 701.10. Cal Water agreed to provide Indian Springs and Country Meadows residential customers unmetered service at flat rates for specified periods. This type of rate structure provides customers no incentive to conserve water because the customers pay the same monthly price regardless of amount used.⁸ In the Indian Springs and Country Meadows agreements, Cal Water made rate commitments at odds with the statutory policy to conserve water resources. These agreements were reformed to require the installation of meters as part of our review of Cal Water's ALs. Similarly, our rate review showed that Indian Springs customers' rate had to be increased by 67% to bring the rate into line with the prevailing Salinas rate. See Res. W-4462 at p.7.

In sum, we find that Cal Water's management has failed to coordinate its acquisition activities with its statutory and regulatory obligations, i.e., the corporate right hand did not know what the corporate left hand was doing. Our goal in imposing a negative adjustment to ROE is to direct management's attention to these issues.

We find Cal Water's pattern of violating statutory and decisional requirements to be more serious than Edison's and PG&E's failure to "vigorously pursue" certain types of resources. Cal Water had the benefit of a specific Commission decision approving the 1997 MOU with ORA that set out precisely the actions required of Cal Water. Only eight weeks after signing the MOU and six days before the Commission approved it, Cal Water violated the MOU. Cal Water went on to violate the MOU again two years after signing it and again at three years.

The PG&E and Edison adjustments applied company wide, rather than to one out of 24 districts, as with Cal Water. Specifically, the PG&E adjustment ordered in 1979 applied to electric rate base of $4.5 billion, see 2 CPUC 2d at 627, whereas the Cal Water adjustment applies only to rate base in the Salinas District of about $30 million.⁹ Thus, in terms of dollars, each negative basis point for PG&E had an impact that is orders of magnitude greater than each negative basis point for Cal Water's Salinas District.

The Indian Springs acquisition agreement itself shows that Cal Water has the capacity to conform to Commission requirements. Section 3.3 provides that non-residential customers will be metered and billed in accord with the Commission-approved Salinas District tariff. Cal Water has not explained its decision to deviate from this approach for residential customers.

We conclude that a ROE adjustment greater than those imposed on Edison and PG&E is warranted on the facts of this case. We will adopt an adjustment of 50 basis points. The revenue requirement effect of this ROE adjustment will be to lessen slightly the rate increase authorized today for all Salinas District customers. This slight change will be in line with the "small, at best" adverse impact that the acquisitions had on the other Salinas District customers.

Setting Cal Water's ROE for the Salinas District at 9.2% results in a return which is 50 basis points lower than the multi-district ROE contained in the Joint Recommendation but still 10 basis points higher than the 9.1% at the low end of ORA's analysis. Targeting the adjustment to the Salinas District is appropriate in light of Cal Water's unapproved acquisitions and unlawful rates affecting that district.¹⁰

Finally, we stress that the fine and the reduced Salinas District ROE serve distinct purposes. The fine punishes five distinct violations and deters other utilities from similar misconduct. The reduced ROE mitigates the harm done to Salinas District customers, but more importantly provides an incentive for Cal Water's management to better coordinate its business objectives with its obligations as a public utility.

Comments on Proposed Decision

The proposed decision of Administrative Law Judge (ALJ) Maribeth A. Bushey in this matter was mailed to the parties in accordance with Public Utilities Code Section 311(d) and Rule 77.1 of the Rules of Practice and Procedure. Comments were filed on ___________ and reply comments were filed on ____________.