X. Assignment of Proceeding and
Procedural Matters
Geoffrey F. Brown is the Assigned Commissioner and Michael J. Galvin is the assigned Administrative Law Judge (ALJ) in this proceeding.
The utilities requested that their respective ROE application be classified as a ratesetting proceeding within the meaning of Rule 5(c). By Resolution ALJ 176-3134, dated May 27, 2004, the Commission preliminarily determined that the applications of SCE and PG&E were ratesetting proceedings and that hearings were expected. This ratesetting classification was subsequently affirmed in the Assigned Commissioner Brown's July 15, 2004 Scoping Memo and Ruling.
That Scoping Memo and Ruling, among other matters, designated ALJ Galvin as the principal hearing officer, established an evidentiary hearing schedule and determined the issues of this proceeding. Those issues encompassed all estimates, including debt equivalence, upon which the utilities proposed capital structure and rate of return for the test year 2005 were based on and PG&E's true-up of its 2004 cost of capital, including hedging.
An evidentiary hearing was held on September 13, 2004 and continued through September 16, 2004. Each of the utilities, Aglet, and ORA submitted testimony and evidence. The proceeding was submitted upon the receipt of October 5, 2004 reply briefs.
1. Applicants are public utilities subject to the jurisdiction of this Commission.
2. SCE seeks to maintain its test year 2005 ROE at 11.60%.
3. PG&E seeks to true up its year 2004 capital structure with an 11.22% ROE and to increase its test year 2004 ROE to 11.60%.
4. SCE and PG&E's applications were consolidated pursuant to Rule 55.
5. The issue of debt equivalence was included in this proceeding pursuant to D.04-01-050. SDG&E presented testimony on the impact of debt equivalence policy.
6. Debt equivalence is a term used by credit analysts for treating long-term non-debt obligations, such as PPAs and leases, as if they were debt in assessing an entity's credit rating.
7. Credit rating agencies have long recognized debt equivalence risks.
8. Credit rating agencies impute debt from long-term energy procurement contracts in their credit analyses of California utilities.
9. Debt equivalence associated with long-term PPAs can affect utility credit ratios and credit ratings.
10. The rating agencies, Fitch, Moody's, and S&P did not participate in this proceeding.
11. SCE has investment grade credit ratings of A-3 from Moody's and BBB from S&P.
12. PG&E has an investment grade rating of BBB- from S&P.
13. The inclusion or exclusion of PPA debt equivalence impacts did not adversely impact the SCE or PG&E's interest coverage or cash flow to debt results presented in this proceeding.
14. SDG&E provided no information on its current credit ratings and insufficient information to enable us to assess the debt equivalence impact on its overall credit ratings and capital structure.
15. SCE requested a 2005 capital structure consisting of 43.00% long-term debt, 9.00% preferred stock, and 48.00% common equity.
16. PG&E requested a true up 2004 capital structure of 48.20% long-term debt, 2.80% preferred stock, and 49.00% common equity.
17. PG&E's proposed capital structures are consistent with the implementation of its Chapter 11 exit financing and capital structure provision set forth in its MSA.
18. We recognized in D.90-11-057 that actual interest rates do vary and that our task is to determine reasonable debt costs rather than actual cost based on an arbitrary selection of a past figure.
19. SCE submitted late-filed Exhibit 34 and PG&E late-filed Exhibit 35 to reflect the most recent forecast of interest rates, September 2004 Global Insight forecasted interest rates.
20. PG&E's 2005 long-term debt cost is based in part on its forecast in cost of debt changes that would occur and in part on its expected implementation of DRC financing.
21. The DRC proceeds that PG&E expects to receive would be used to pay off existing debt and to buy back common stock so that PG&E can achieve and maintain a target capital structure containing 52% common equity.
22. PG&E included approximately $44 million in interest rate hedging cost as a component of its test year 2005 long-term debt.
23. There was no dispute on SCE's cost of long-term debt or on PG&E's costs of long-term debt and preferred stock.
24. ORA's forecast of SCE's preferred stock cost was based on the issuance of a type of preferred stock that SCE would not be issuing.
25. A Commission Financing Team reviewed PG&E's hedging analysis and supported the terms of the hedges and PG&E's strategy for executing hedges.
26. The legal standard for setting the fair ROE has been established by the United States Supreme Court in the Bluefield and Hope cases.
27. An ROE is set at a level of return commensurate with market returns on investments having corresponding risks, and adequate to enable a utility to attract investors to finance the replacement and expansion of a utility's facilities to fulfill its public utility obligation.
28. Quantitative financial models are commonly used as a starting point to estimate a fair ROE.
29. Although the quantitative financial models are objective, the results are dependent on subjective inputs.
30. It is the application of informed judgment, not the precision of quantitative financial models, which is the key to selecting a specific ROE.
31. The individual parties' use of quantitative financial modes resulted in a broad test year 2005 ROE range from 7.89% to 13.72% for SCE and 9.20% to 12.67% for PG&E.
32. Two important components of the Hope and Bluefield decisions are that the utilities have the ability to attract capital to raise money for the proper discharge of their public utility duties and to maintain creditworthiness.
33. Our consistent practice has been to moderate changes in ROE relative to changes in interest rates in order to increase the stability of ROE over time.
34. The September 2004 Aa utility bond interest rate forecast for test year 2005 is 6.69%, a 10 basis points increase in interest rate from the April 2004 forecast of 7.62%.
1. The capital structures proposed by SCE and PG&E should be adopted because they are balanced, attainable, and intended to maintain an investment grade rating and attract capital.
2. The long-term debt and preferred stock costs being proposed by the utilities are consistent with the law, in the public interest, and should be adopted.
3. Debt equivalence does not have a material impact on either SCE or PG&E's credit ratios or capital structure presented and considered in this proceeding.
4. SDG&E should be required to file a test year 2006 cost of capital application.
5. SDG&E should file a test year 2006 ROE application by May 9, 2005, along with SCE and PG&E, so that we may properly assess what impact, if any, that debt equivalence has on its credit ratings and capital structure, including mitigation recommendations.
6. To the extent that SDG&E believes that debt equivalence may have a material impact and recurring drain on its credit ratios or ratings, SDG&E should consider modifying its MICAM settlement agreement so that it may resolve that concern through yearly ROE applications.
7. The utilities should include debt equivalence impacts as part of their ROE applications.
8. Debt equivalence should be considered with other financial, regulatory, and operational risks in setting a fair ROE and balanced capital structure reasonably sufficient to assure confidence in the financial soundness of the utility to maintain and support investment grade credit ratings.
9. Risks being experienced by the utilities warrant the ROEs being adopted in this proceeding at the upward end of an ROE range found just and reasonable.
10. The latest available interest rate forecast should be used to determine embedded long-term debt and preferred stock costs in ROE proceedings.
11. PG&E should be authorized to recover its hedging costs as part of its long-term debt.
12. PG&E's costs of long-term debt and preferred stock for true up year 2004 and test year 2005 should be adopted.
13. SCE's costs of long-term debt and preferred stock for test year 2005 should be adopted.
14. An upward trend in interest rates warrants an upward adjustment in ROE.
15. A test year ROE range from 10.40% to 11.40% is just and reasonable for SCE based on financial model results.
16. A test year 2005 ROE of 11.40%, which results in an overall 9.07% return on rate base should be adopted as just and reasonable for SCE based upon all of the evidence considered in this proceeding.
17. A test year 2005 ROE range from 10.01% to 11.01% is just and reasonable for PG&E based on financial model results; however, that ROE is lower than the 11.22% ROE approved in PG&E's bankruptcy proceeding, as part of the MSA, which prevents adoption of the lower figure.
18. A true up year 2004 and test year 2005 ROE of 11.22% ROE resulting in an overall 8.53% and 8.77% return on rate base, respectively, is consistent with the MSA should be adopted as just and reasonable for PG&E.
19. The utilities ROE applications should be granted to the extent provided for in the following order.
IT IS ORDERED that:
1. Southern California Edison Company's (SCE) cost of capital for its test year 2005 is as follows:
Capital Ratio |
Cost Factor |
Weighted Cost | |
Long-Term Debt |
43.00% |
6.96% |
2.99% |
Preferred Stock |
9.00 |
6.73 |
0.61 |
Common Stock |
48.00 |
11.40 |
5.47 |
Total |
100.00% |
9.07% |
2. Pacific Gas and Electric Company's (PG&E) cost of capital for true up year 2004 electric and gas operations is as follows:
Capital Ratio |
Cost Factor |
Weighted Cost | |
Long-Term Debt |
48.20% |
5.90% |
2.84% |
Preferred Stock |
2.80 |
6.76 |
0.19 |
Common Stock |
49.00 |
11.22 |
5.50 |
Total |
100.00% |
8.53% |
3. PG&E's cost of capital for its test year 2005 electric and gas operations is as follows:
Capital Ratio |
Cost Factor |
Weighted Cost | |
Long-Term Debt |
45.50% |
6.10% |
2.78% |
Preferred Stock |
2.50 |
6.42 |
0.16 |
Common Stock |
52.00 |
11.22 |
5.83 |
Total |
100.00% |
8.77% |
4. PG&E's hedging cost incurred as part of its Commission approved financing plan to exit Chapter 11 was reasonable and is recoverable over the life of the debt that was hedged.
5. SCE and PG&E shall implement the revenue requirement changes authorized by this decision as set forth in the body of this order. If the Energy Division Director suspends any tariffs, such tariffs shall become effective upon the date the Energy Division Director confirms that the tariffs are in compliance.
6. The utilities, as part of their annual cost of capital applications shall include testimony on credit ratios, credit ratings, and capital structure impacts, including mitigation recommendations, of debt equivalence on their PPAs. Information to be provided shall include current credit ratings from Moody's and S&P; expected impact of its credit ratings due to debt equivalence; capital structure and return on equity with and without debt equivalence; debt to capital, interest coverage, and cash flow to debt financial ratios with and without debt equivalence; and, pre and post-tax financial ratios.
7. San Diego Gas & Electric Company shall file a test year 2006 cost of capital application by May 9, 2005. That application shall include testimony on the impact that debt equivalence has on its current and projected credit ratings, capital structure, and return on equity.
8. Application (A.) 04-05-021 and A.04-05-023 are closed.
This order is effective today.
Dated , at San Francisco, California.
APPENDIX A
SCE AND PG&E
TEST YEAR 2005 CREDIT RATIOS
DEBT EQUIVALENCE IMPACT ON S&P's BENCHMARKS
|
Utility |
PPAs |
Equity Return |
Debt to Capital |
Interest Coverage |
Cash Flow/Debt |
SCE 1/ |
Excluded Included |
10.20% 10.20% |
51.9% 55.6% |
5.18x 4.23x |
23.4% 20.1% |
SCE 2/ |
Excluded Included |
11.60% 11.60% |
5.40x 4.40x |
24.0% 21.0% | |
SCE 3/ |
Excluded Included |
11.60% 11.60% |
4.60x 4.40x |
22.0% 21.0% |
S&P BENCHMARKS
A Range (BOLD NUMBERS) 40% - 48% 5.2x - 4.2x 35% - 28%
BBB Range (ITALIC NUMBERS) 48%-58% 4.2x - 3.0x 28% - 18%
PG&E 4/ Excluded 11.22% 47.4% 6.3x 25.7%
Included 11.22% 50.5% 5.1x 22.5%
1/ Based on a Preferred Stock ration of 4.0% (Exhibit 7, p. 2). 2/ Based on a Preferred Stock ratio of 4.0% (Exhibit 3, p. 21). 3/ Based on a Preferred Stock ratio of 9% (Exhibit 3, p. 25). 4/ Exhibit 12, p. 6-29.(END OF APPENDIX A)
APPENDIX B
SOUTHERN CALIFORNIA EDISON COMPANY
RESULTS OF FINANCIAL MODELS
CAPM |
DCF |
MRP | |
SCE |
10.33% - 13.72% |
7.89% - 12.06% |
11.35% |
Aglet |
11.27% - 12.67% |
9.50% - 10.16% |
11.20% - 11.24% |
ORA (Did not apply the Financial Models) | |||
(END OF APPENDIX B)
APPENDIX C
PACIFIC GAS & ELECTRIC COMPANY
RESULTS OF FINANCIAL MODELS
CAPM |
DCF |
MRP | |
SCE |
- |
9.20% - 10.10% |
10.80% - 11.40% |
Aglet |
11.27% - 12.67% |
9.50% - 10.16% |
11.20% - 11.24% |
ORA |
10.67% - 11.10% |
8.99% - 9.86% |
9.53% - 11.15% |
(END OF APPENDIX C)
