6. Productivity Factor

An X-factor reduction to the post-test year rate adjustment has been included in the past ratemaking for SoCalGas and SDG&E as an incentive for management to improve corporate performance over time. The companies describe it as a "mandated" offset to inflation and customer growth.³⁴ An additional "stretch" factor in prior ratesetting has provided a boost to the incentive by pushing SoCalGas and SDG&E to outperform the industry's
X-factor by some increment.

a. X-Factor

Ex. 153 and 154 demonstrate the survey results that derive a Total Factor Productivity index for the gas and electric distribution companies studied, and the 1992-2002 average annual growth rates, as determined by these studies, are 1.16% for gas and 0.47% for electric distribution operations.³⁵ An X-factor reduces the increase otherwise made to rates to reflect changes in productivity.

No party opposes the econometric derivation of the 1.16% and 0.47% gas and electric X-factors, although they did not always explicitly support their inclusion. ORA replicated the survey results and has determined that the productivity rates are reasonable if the Commission adopts the MPC method proposed by SoCalGas and SDG&E.³⁶ We see no reason to limit the inclusion of an X-factor to the MPC; the concept of an incentive to spur improved performance is equally applicable to a revenue adjustment or the MPC.

A couple of clarifying observations are in order. The studies were not based on samples; in fact the data was the entire population of available data for large gas and electric utilities, excluding only the smallest companies.³⁷ There was not any consideration or differentiation of companies that have any incentive ratemaking that might affect the data.³⁸ For example, a company with some form of a financial incentive might outperform how it would otherwise behave without any incentive; if we did not expect this outcome we should not adopt any incentive mechanisms. They are the best available data as a base for a productivity factor. Therefore we will adopt an X-factor as a positive step towards ensuring efficient operations.

b. Stretch Factor

From 1998 through 2002 SoCalGas had stretch factors of 0.6% increasing to 1.0% in 2002 and 2003³⁹ and SDG&E had stretch factors of 0.55% adopted in
D.99-05-030.⁴⁰ In this proceeding, SoCalGas and SDG&E oppose inclusion of any stretch factors. Essentially SoCalGas and SDG&E argue that after the prior years' obligations to achieve the stretch factors they have captured all efficiencies to meet the requirement. The companies state that after the merger to form the holding company they were required to pass through the merger's savings to customers. Merger savings are avoided costs that were already captured in the development of the test year. These savings are not relevant to the improvement of efficiency of the ongoing operations of the companies.

Inherent in the use of any X-factor is the collective effect of the differences in the population of the index and the target(s) SoCalGas and SDG&E. A stretch factor removes some element of the worse-performers' impact on the index; otherwise we target average performance rather than best performance. If the productivity study had removed the worse performers, or weighted the better performers, or could more specifically identify the companies most like SoCalGas and SDG&E, then the study results alone could be a reasonable target. It was clear on the record that the studies did not exclude the worst or find the best matches; they relied on the largest population with sufficient data. TURN describes the SoCalGas and SDG&E proposal as one that would "reward mediocrity by setting productivity on an average basis with no stretch factor and to ignore the actual performance of the utilities that are being regulated."⁴¹ We agree. We find the inclusion of an appropriate stretch factor to be necessary and reasonable because it encourages the utilities to operate as efficiently as possible on a continuing basis.

TURN proposes stretch factors of 0.5% to 1.0% per year, which are in the range of past stretch factors, but TURN provided no analytical support for the factor to use now. TURN argues that an "academic" measurement of productivity ignores the efficiency of a specific entity instead of assuming efficient operation of the entity.⁴² SoCalGas and SDG&E ask for X-factors of 1.16% for gas and 0.47% for electricity, respectively. The effect of a stretch factor would change the index formula by including a factor to increase the X-factor (or as a further offset to the inflation factor):

MPC_t = MPC_t-1 (1 + Inflation_t - X-Factor_t - Stretch)

Including a stretch factor of 0.5% in the illustration of the index formula for MPC that was discussed earlier would change the illustrative 2006 MPC from $206 to $205⁴³ and the illustrative 2006 Total Base Margin would change by $5 million, from $1.081 billion to $1.076 billion.⁴⁴

It is clear on the record that without a stretch factor the proposed
X-factor includes the offsetting effects of the worst performers in the sample. TURN's 0.5% low-end recommendation would double the impact of the electric X-factor of 0.47% and this is too great an adjustment. We find that 0.25%, which is about half the size of the 0.47% electric X-factor, would be consistent with using TURN's 0.5% stretch factor for gas because it is approximately half the size of the gas X-factor of 1.16%. In the next proceeding SoCalGas and SDG&E should demonstrate that either the proposed X-factor is adjusted to reflect good to excellent performance (by excluding poor performance) or propose an appropriate stretch factor to encourage continuing efficiencies. This is one important goal of incentive ratemaking.

c. Conclusion

As discussed above, we will adopt the proposed X-factors of 1.16% for gas operations for SoCalGas and SDG&E, and 0.47% for electric distribution for SDG&E. We will adopt a 0.5% stretch factor for the gas operations for both SoCalGas and SDG&E and a 0.25% stretch factor for electric operations for SDG&E. The actual revenue impact in 2006 and subsequent post-test years will depend on the actual MPC_t-1, the Index, and the constant
X-factors and stretch factors.

³⁴ Ex. 151, p. JVL-22, line 1.

³⁵ See Ex. 153, Table 2 X factor Calibration for Southern California Gas Company - Productivity Results: Gas Distribution, and Ex. 154, Table 2, X factor Calibration for San Diego Gas & Electric Company - Productivity Results: Power Distribution.

³⁶ Ex. 333, p. 3-1.

³⁷ Transcript, p. 2356, lines 8-25.

³⁸ Transcript, p. 2358, lines 21-28, and p. 2359, lines 1-16.

³⁹ Ex. 151, p. JVL-22, lines 8 & 9.

⁴⁰ Ex. 152, p. JVL-17, line 8.

⁴¹ Ex. 561, p. 13.

⁴² Ex. 561, pp. 11-12.

⁴³ $200(1 + 0.04 - 0.01 - 0.005) = $205

⁴⁴ ($205 * 5.2 million) + $10 million = $1.066 billion + 0.010 billion = $1.076 billion.