STATE OF CALIFORNIA Arnold Schwarzenegger,, Governor

PUBLIC UTILITIES COMMISSION

505 VAN NESS AVENUE

SAN FRANCISCO, CA 94102-3298

August 12, 2004 Agenda ID # 3523

TO: ALL PARTIES OF RECORD IN APPLICATION 01-02-024 ET AL.

RE: NOTICE OF AVAILABILITY OF REVISED PROPOSED DECISION
OF ADMINISTRATIVE LAW JUDGE DUDA

Consistent with Rule 2.3(b) of the Commission's Rules of Practice and Procedure, I am issuing this Notice of Availability of the above-referenced revised proposed decision. An Internet link to this document was sent via e-mail to all the parties on the service list who provided an e-mail address to the Commission. An electronic copy of this document can be viewed and downloaded at the Commission's Website ( www.cpuc.ca.gov).

The revisions address comments filed and served on June 1, 2004, and reply comments filed and served on June 7, 2004, to the initial proposed decision dated May 3, 2004. The revised proposed decision is on the Commission's August 19, 2004 meeting agenda. As a courtesy to the parties, even though it is not a requirement under Commission rules, the ALJ will accept a further round of comments on the revised proposed decision. The ALJ will request the Commission to hold the item to consider the comments.

When the Commission acts on the revised proposed decision, it may adopt all or part of it as written, amend or modify it, or set it aside and prepare its own decision. Only when the Commission acts does the decision become binding on the parties.

This matter was categorized as ratesetting and is subject to Pub. Util. Code Section 1701.3(c). Pursuant to Resolution ALJ-180, a Ratesetting Deliverative Meeting (RDM) to consider this matter may be held upon the request of any Commissioner. If that occurs, the Commission will prepare and mail an agenda for the RDM 10 days before hand. When an RDM is held, there is a related ex parte communications prohibition period.

Parties to the proceeding may file comments on the revised proposed decision as provided in Article 19 of the Commission's "Rules of Practice and Procedure." These rules are accessible on the Commission's website at http://www.cpuc.ca.gov. Comments are due on August 25, 2004, and reply comments are due September 1, 2004. Comments are limited to 15 pages, and reply comments to 8 pages. Parties should limit comments to factual technical or legal errors in the revised portions of the decision, and should refrain from rearguing positions taken in prior comments because these have already been considered.

In addition to service by mail, parties should send comments in electronic form to those appearances and the state service list that provided an electronic mail address to the Commission, including ALJ Duda at DOT@cpuc.ca.gov. Finally, comments must be served separately on the Assigned Commissioner, and for that purpose I suggest hand delivery, overnight mail, or other expeditious methods of service.

/s/ Angela K. Minkin

Angela K. Minkin, Chief

Administrative Law Judge

ANG/avs

Attachment

ALJ/DOT/avs* DRAFT Agenda ID #3523

Ratesetting

8/19/2004 Item 83

Decision PROPOSED DECISION OF ALJ DUDA (Mailed 5/3/2004; Revised and Mailed 8/11/04)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Joint Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Switching in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 01-02-024 (Filed February 21, 2001)
Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Loops in Its First Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 01-02-035 (Filed February 28, 2001)
Application of The Telephone Connection Local Services, LLC (U 5522 C) for the Commission to Reexamine the Recurring Costs and Prices of the DS-3 Entrance Facility Without Equipment in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-031 (Filed February 28, 2002)

Application of AT&T Communications of California, Inc. (U 5002 C) and WorldCom, Inc. for the Commission to Reexamine the Recurring Costs and Prices of Unbundled Interoffice Transmission Facilities and Signaling Networks and Call-Related Databases in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-032 (Filed February 28, 2002)
Application of Pacific Bell Telephone Company (U 1001 C) for the Commission to Reexamine the Costs and Prices of the Expanded Interconnection Service Cross-Connect Network Element in the Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-02-034 (Filed February 28, 2002)
Application of XO California, Inc. (U 5553 C) for the Commission to Reexamine the Recurring Costs of DS1 and DS3 Unbundled Network Element Loops in Its Second Annual Review of Unbundled Network Element Costs Pursuant to Ordering Paragraph 11 of D.99-11-050.	Application 02-03-002 (Filed March 1, 2002)

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK
ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY
DBA SBC CALIFORNIA

TABLE OF CONTENTS

Title Page

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY DBA SBC CALIFORNIA 55

I. Summary 55

II. Background 1010

A. 2001 UNE Nominations 1111

B. 2002 UNE Nominations 1212

III. Applicable Standards 1515

A. The Consensus Costing Principles 1515

B. The TELRIC Standard 1616

C. Supreme Court Review of TELRIC Standard 1717

D. Recent Updates to TELRIC 1818

E. Commission Cost Modeling Criteria 1818

F. Burden of Proof 1919

IV. Overview of Cost Models 2020

A. HM 5.3 2020

B. SBC-CA Models 2323

V. Both HM 5.3 and the SBC-CA Models Are Flawed 2525

A. Flaws in the SBC-CA Models 3131

1. LoopCAT Flaws 3434

a. Reliance on Embedded Network Data 3434

b. LoopCAT's Network Configuration 4444

c. Modeling of Multiple Dwelling Units 4848

d. Integration of Loop Studies 4848

2. SICAT Flaws 4949

3. Transport and High Capacity Loop Study Flaws 5151

4. Annual Cost Factors and Expenses 5555

a. Auditing and Modifying ACFs 5555

b. Shared and Common Costs 5757

c. Elimination of Miscellaneous Expenses 6060

i. Non-regulated Expenses 6161

ii. Affiliate Transaction Expenses 6262

iii. Project Pronto Expenses 6363

iv. Transition Benefit Obligation (TBO) Expenses 6565

v. Land and Building Factors 6666

d. Inflation and Productivity 6868

e. Summary of Annual Cost Factor and Expense Modeling Issues 7171

5. Summary of SBC-CA Modeling Flaws 7171

B. Flaws in the HM 5.3 Model 7373

1. Engineering and Design Standards 7474

2. Loop Modeling and Customer Location 8181

a. Transparency of the Clustering Process 8484

b. Accuracy of Customer Locations 8686

c. Sensitivity to Clustering Changes 9191

d. Cluster Size 9393

e. Summary of Loop Modeling Criticism 9595

2. Expert Judgments 9696

3. Switching, Interoffice Demand, and Provisioning High Speed Services 100100

4. Spare Capacity 104104

5. Expenses 105105

6. Validation of HM 5.3 Results 106106

7. Summary of HM 5.3 Flaws 111111

C. Adherence to Commission Modeling Criteria 112112

D. Determination of UNE Rates 114114

1. Rates Based on HM 5.3 115115

2. Description of HM 5.3 and SBC-CA Model Runs 125125

VI. Modeling Inputs 133133

A. Asset Lives and Depreciation 133133

1. SBC-CA Proposal 133133

2. DOD/FEA and Joint Applicant's Proposal 135135

3. Discussion 138138

B. Cost of Capital 141141

1. SBC-CA Proposal 143143

2. Joint Applicants' Proposal 145145

3. Proposals of XO, Z-Tel and ORA/TURN 146146

4. Discussion 146146

a. Proxy Group 148148

b. Cost of Equity 149149

i. DCF Analysis 150150

ii. Market Risk Premium in CAPM 154154

iii. Risk Free Rate 158158

iv. Beta 159159

v. CAPM Summary and Resulting Cost of Equity 160160

c. Qualitative Risk Issues 161161

d. Cost of Debt 167167

e. Capital Structure 169169

f. Summary of Weighted Average Cost of Capital 172172

C. IDLC/UDLC 173173

1. Modeling Proposals 173173

2. Discussion 175175

D. DLC Costs 178178

1. JA Approach 178178

2. SBC-CA Approach 179179

3. Discussion 180180

E. Fill Factors in Loop Model 183183

1. Copper Distribution Fill 186186

a. JA Proposal 187187

b. SBC-CA Proposal 188188

c. Discussion 190190

2. Copper Feeder 193193

3. Fiber Feeder 195195

4. DLC Common Equipment 198198

5. DLC Plug-In Equipment 200200

6. SAI Equipment Fill 202202

7. Premise Termination Equipment 203203

8. Correlation of Fill Factors and Maintenance Costs 206206

F. Structure Sharing 210210

G. Plant Mix Assumptions 212212

H. Labor Cost Assumptions 214214

1. HM 5.3 214214

2. SBC-CA Models 215215

3. Discussion. 217217

I. Crossover Point 219219

J. Switching Inputs 220220

1. Switch Vendors 220220

2. Percentage of New, Growth and Replacement Lines 223223

3. Vertical Features Costs 225225

a. JA Position 226226

b. SBC-CA Position 227227

c. Discussion. 228228

4. Rate Structure 231231

a. JA Position 232232

b. SBC-CA Position 237237

c. PacWest Position 239239

d. Discussion 241241

5. Switch Fill Factors 244244

VII. DS-3 Loop Rates 246246

VIII. Further UNE Reexamination Proceedings 247247

IX. Assignment of Proceeding 248248

X. Comments on Proposed Decision 248248

A. Rates Based on the Midpoint of HM 5.3 and SBC-CA Models 249249

B. Adopt Rates Based on the HM 5.3 Model 251251

C. Adopt Rates Based on the SBC-CA Models 252252

D. Corrections Were Ignored 253253

E. The True-Up of Interim Rates 254254

F. Price Squeeze Arguments 255255

Findings of Fact 256256

Conclusions of Law 270270

ORDER 287287

APPENDIX A Adopted UNE Rates

APPENDIX B Comparison of Proposed and Adopted UNE Rates

APPENDIX C Switching Rates Based on Minute of Use

APPENDIX D Glossary of Acronyms

APPENDIX E List of Appearances

OPINION ESTABLISHING REVISED UNBUNDLED NETWORK
ELEMENT RATES FOR PACIFIC BELL TELEPHONE COMPANY
DBA SBC CALIFORNIA

I. Summary

This proceeding, known as the "UNE Reexamination," was initiated following formal requests by carriers interconnected with Pacific Bell Telephone Company d/b/a SBC California (hereinafter SBC-CA)¹ for the Commission to reexamine certain prices that SBC-CA charges competitors who purchase "unbundled network elements" (UNEs).² By purchasing UNEs, competitors are able to use portions of SBC-CA's network to offer competitive local exchange services.

In this decision, the Commission adopts updated and final rates for the following UNEs: loops (including deaveraged rates for 2-wire, DS-1 and DS-3 loops), switching, dedicated transport, signaling system 7 (SS7) links, and the DS-3 entrance facility without equipment.³ The newly adopted rates for the most frequently discussed UNEs are:

Table 1

Adopted UNE Rates

UNE	Adopted Rate4
Average 2-wire Loop	$10.16
Average DS-1 Loop	$49.73
Average DS-3 Loop	$571.44
2-wire port	$2.80
UNE-Platform5	$14.18

The rates in today's order replace interim rates for loops and switching that were set in Decision (D.) 02-05-042.⁶ The rates in today's order for other UNEs, namely dedicated transport, SS7 links, and the DS-3 entrance facility without equipment, replace rates originally adopted in D.99-11-050.

In adopting today's rates, the Commission considered two divergent cost models offered by the parties to this proceeding. SBC-CA proposed updated UNE rates based on a series of cost models that it has developed for use in the 13 states in which its parent corporation, SBC, operates. AT&T Communications of California, Inc. (AT&T) and WorldCom, Inc. (WorldCom, now known as

"MCI")⁷ (hereinafter referred to as "Joint Applicants" or "JA") proposed updated UNE rates based on the latest version of the HAI Model, known as HM 5.3. The proposals of the parties differed greatly from each other and from the interim UNE rates currently in place as seen in the table below.⁸

Table 2

Comparison of Proposals

UNE	SBC-CA Proposal	JA Proposal	Interim Rate9
Average 2-wire Loop	$23.86	$5.24	$9.82
2-wire Port	$3.13	$1.28	$0.83
Switching Usage	$3.34	$1.57	$3.28
UNE-P	$30.33	$8.09	$13.93

After careful review of the competing cost models filed by SBC-CA and JA, the Commission finds that although both models are flawed, the SBC-CA models fail our modeling criteria to such a significant extent that we cannot reasonably rely on them to set UNE rates. The principal flaws with SBC-CA's models are that they rely too heavily on SBC-CA's embedded network configuration and costs and that we are not able to modify many of the models' inputs to overcome this flaw. When we attempt to modify certain inputs in the SBC-CA models, the lack of flow through from one model to the other necessitates extremely time-intensive manual manipulation that is prone to error, and produces varying results that cannot easily be replicated with a reasonable level of certainty. The principal flaws with HM 5.3 are that we did not agree with certain of its input assumptions, particularly those related to clustering of customers into distribution areas, certain labor inputs, and the interoffice transport network. We were unable to modify these particular input assumptions.

It was not possible, given the time constraints and the resources required by this proceeding, to fix all of the flaws identified in either model. Because both models were flawed, we initially found we could not rely on either model by itself to establish UNE rates. To the extent possible, the Commission modified both models to run with common inputs. As we modified these models and their inputs to resolve the many disputes and to bring the models in line with Commission precedent, federal requirements, and additional rationale we develop herein, we found that the resulting cost outputs of the models converged. In a few cases, the results converged to the point of becoming nearly the same.

Following comments on the Proposed Decision, we made appropriate adjustments to both HM 5.3 and the SBC-CA models to correct what we agree were errors and to make necessary adjustments. During this process, we determined the SBC-CA models are unduly burdensome to operate because they require extremely time-intensive manual manipulation to make input modifications, the models are prone to input errors due to extraordinarily complex input modification requirements, and the model results were erratic, counterintuitive, and difficult to replicate. It is not reasonable to rely on the SBC-CA models because they produce such varying results that are difficult to replicate in a reasonable time frame, even after repeated attempts to do so. We cannot rely on the SBC-CA models to derive UNE rates with an acceptable level of confidence. Therefore, the rates we adopt in this order are based solely on HM 5.3.

Some of the key modeling inputs used for the Commission's model runs include a 9.44% cost of capital, asset lives based on those adopted by the Federal Communications Commission (FCC), and a 51.6% copper distribution fill factor. The Commission's model runs include several inputs and assumptions proposed by SBC-CA, including plant mix, labor rates, Lucent and Nortel switch vendor assumptions, the weighting of switch line prices between new and growth lines, and a 12,000-foot crossover point. Furthermore, today's order adopts a flat-rate structure for the switching UNE wherein all switching costs are incorporated into one flat monthly port price, as proposed by JA.

As set forth in D.02-05-042 and D.02-09-052, SBC-CA must adjust, or "true-up" the interim rates it charged for its UNEs to the new rates adopted in this order. In other words, SBC-CA must calculate whether the previous interim rates were higher or lower than these newly adopted rates, and whether it has over or under-collected the appropriate revenues for any UNEs it sold at interim rates. This order stays the effective date of any true-up until its amount can be calculated and further proceedings held to determine payment options or consider other mitigations to minimize negative financial effects of the true-up on competitive carriers.

Finally, this order modifies the annual nomination process originally established in D.99-11-050 to suspend further review of SBC-CA's UNEs until February 2007.