7. Sharing Mechanism
SoCalGas and SDG&E propose a symmetrical sharing mechanism whereby the companies and the customers would share either the excess earnings or losses on an annual basis. This is a change to the mechanism last adopted for SoCalGas in D.97-07-05445 and SDG&E also requested the identical mechanism.46
The threshold question for the Commission must be whether or not there is a ratepayer benefit to authorizing any sharing mechanism. This was emphasized in the April 2, 2003 Assigned Commissioner's Ruling Establishing Scope, Schedule and Procedures for Proceeding (Scoping Memo) and the May 22, 2003 Ruling Clarifying the Scoping Memo and Modifying the Schedule (Scoping Clarification) that called for supplemental testimony on incentives.47 SoCalGas and SDG&E have requested a specific bundled package of ratemaking programs, that they identified as PBR, including a sharing mechanism as well as more overt financial incentives for safety and performance. Sharing in excess earnings or recouping shortfalls is a significant departure from the ratemaking convention of granting only an opportunity to earn a reasonable return; such a mechanism, whether symmetrical or not, is clearly a departure from traditional cost-of-service ratemaking. It is true that SoCalGas and SDG&E have been authorized such a departure in the past and we must decide whether or not to extend the exception.
No party challenges the concept of a sharing mechanism; ORA and TURN propose different mechanisms. ORA proposes the retention of an asymmetrical system that it then expands.48 TURN proposes a different sharing rate and to use the last adopted mechanism for SDG&E for both companies.49
An asymmetrical mechanism can only be reasonable if there is a comparable asymmetry in the degree of control or influence among the parties. It is true that the applicants have the ability to make numerous decisions big and small that can affect the operating costs in the short term and sway the impacts of a sharing mechanism. But we do not want shortsighted decisions by the utilities. The asymmetrical sharing adopted by D.97-07-054 only shared earnings that were 25 basis points50 above the authorized rate of return.51 There was no ratepayer sharing of a shortfall. One perverse incentive created by this approach is that the utilities may avoid expenses if the result would be to drive earnings below authorized levels. In addition, finding and identifying these detailed managerial discretionary decisions, and then determining whether or not these are imprudent actions would be a problematic regulatory exercise.
SoCalGas demonstrates that in 1998 it absorbed a shortfall $12.2 million but between 1999 and 2002 "shared" excess earnings with ratepayers and returned to ratepayers $54.4 million.52 On a straight-up comparison (without considering the rate of sharing) SoCalGas saw no offset of the earlier loss against later gains.
SoCalGas and SDG&E propose that the sharing should be symmetrical - at least as they define symmetrical.
SoCalGas and SDG&E Litigation Proposal | |||
Bands |
Basis Points Above/Below Authorized Rate of Return |
Company |
Customer |
Inner |
0-25 |
100% |
0% |
1 |
25-50 |
25% |
75% |
2 |
50-75 |
35% |
65% |
3 |
75-100 |
45% |
55% |
4 |
100-125 |
55% |
45% |
5 |
125-150 |
65% |
35% |
6 |
150-200 |
75% |
25% |
7 |
200-250 |
85% |
15% |
8 |
250-300 |
95% |
5% |
Outer |
More than 300 |
100% |
0% |
In the companies' proposal, they get significant relief at the first recoverable levels of losses; 75% of anything between 25 and 50 points below authorized is reimbursed by ratepayers, but ratepayers also receive 75% of the first band of higher earnings. Based on the proposed approach to be reimbursed by ratepayers, the applicants appear to be highly adverse to losses. As we have demonstrated, it is difficult to determine that the deferral of expenses that would avert the losses otherwise absorbed by shareholders is imprudent.
SoCalGas and SDG&E argue that sharing was a product of the adoption of PBR packages. They argue if the ratemaking mechanisms proposed by Aglet, ORA and TURN are adopted, there would be no sharing. SoCalGas and SDG&E consider the intervenors' proposals to be similar to the proposals made for PG&E and Edison in the recent GRCs.53
a. Option to Decline Sharing
SoCalGas and SDG&E argue that sharing is only lawful as a part of an agreed upon54 PBR mechanism, and that otherwise a sharing would be retroactive ratemaking.55 We are substantially adopting the various mechanisms, with some modifications, that SoCalGas and SDG&E included in the applications; indexing, sharing, certain performance incentives, etc. We will, however, allow SoCalGas and SDG&E the opportunity to decline the sharing mechanism we otherwise adopt in this decision. SoCalGas and SDG&E must make their choice in the compliance advice letters filed to implement this decision. Declining the sharing mechanism in no way alters or modifies any other aspect of the post-test year ratemaking adopted in this decision.
b. Sharing in the Base Margin Settlement
The Base Margin Settlement proposal would adopt sharing both above and below the authorized rate of return for up to 300 basis points (3%). After a 300 point spread, SoCalGas and SDG&E would trigger an automatic suspension and "a formal review by the Commission of that utility's PBR mechanism." At 175 points, the utility has the "option" to suspend the mechanism and file an application.56 However, the utility can always file an application (without regard to the outcome) and we believe this approach is one-sided; for example, ORA could not - within the limits of the settlement - obtain an automatic review if, after two years, both companies earned 175 points above the authorized return.
Base Margin Settlement Proposal | |||
Bands |
Basis Points Above/Below Authorized Rate of Return |
Company |
Customer |
Inner |
0-50 |
100% |
0% |
1 |
51-100 |
25% |
75% |
2 |
101-125 |
35% |
65% |
3 |
126-150 |
45% |
55% |
4 |
151-175 |
55% |
45% |
5 |
176-200 |
65% |
35% |
6 |
201-300 |
75% |
25% |
Outer |
More than 300 |
Suspend |
|
Because of the nature of the settlement we have no idea why the number of bands were shortened or why the one-sided escape clause was added.
If we were to adopt the additional feature of sharing losses as well as gains, it would relieve SoCalGas of such risk as it absorbed in 1998 with a $12.2 million loss. For SDG&E the impact is greater: it had losses57 of $262,000 in 2000, $25,392,000 in 2001, and $51,753,000 in 2002.58 Sharing is far more important, in terms of prior results, to SDG&E with over $75 million in losses.
Our practice of adopting one-way balancing accounts is strictly limited by circumstances, by the expectations where we are more often concerned that all of the revenues included in rates will not be spent for the intended purpose, rather than harboring any uncertainty about whether the funding is sufficient.59 We have in the past treated sharing as a one-way mechanism with ratepayers having only the up-side opportunity to share in savings.
c. Adopted Sharing Mechanism
We have no current record that shows why one-sided sharing is fair. We will adopt with one modification the litigated SoCalGas and SDG&E's proposed symmetrical sharing allocation for both gains and losses compared to the authorized return without an automatic or discretionary reopening in the adopted sharing mechanism. SoCalGas and SDG&E have shown that symmetrical sharing may benefit ratepayers or shareholders, and that it provides a positive incentive for the company to manage its costs efficiently. By sharing a loss the companies may make necessary expenditures they might otherwise avoid.
We will therefore use the adopted revenue requirements to calculate the Base Margin from Phase 1 for the earnings sharing start-point with one adjustment, to excluded the various balancing accounts adopted in Phase 1.
In light of the three-year trend of below-authorized return for SDG&E, we want to ensure that the mechanism is only a safety net for significant over- or under-performance and so we will enlarge the inner band with zero-sharing. If the SDG&E below-authorized losses in 2000 through 2002 had been subject to sharing, they would have been one point below with no sharing for 2000 and 131 points and 253 basis points60 below the authorized returns for 2001 and 2002, respectively. SDG&E would have only absorbed 65% and 85% of the losses and ratepayers would have paid $8.887 million in 2001 and $7.763 million in 2002.61
Authorized Sharing | |||
Bands |
Basis Points Above/Below Authorized Rate of Return |
Company |
Customer |
Inner |
0-50 |
100% |
0% |
1 |
50-75 |
35% |
65% |
2 |
75-100 |
45% |
55% |
3 |
100-125 |
55% |
45% |
4 |
125-150 |
65% |
35% |
5 |
150-200 |
75% |
25% |
6 |
200-250 |
85% |
15% |
7 |
250-300 |
95% |
5% |
Outer |
More than 300 |
100% |
0% |
d. Sharing in 2004
One of the Phase 2 issues is whether the incentives and sharing apply to 2004. The proposed Base Margin Settlement said no.62 The parties in their litigation positions focused on the nature of the mechanism and did not address 2004 explicitly. Although the adopted revenue requirement is lawful,63 the legality of a 2004 sharing mechanism has not been addressed. As is true with most settlements, which is why it is hard to selectively adopt portions and not the whole agreement, we do not know what parties traded in exchange for no sharing in 2004. Therefore, we do not know from the settlement whether the parties could agree on the legal issue, or whether the outcome was a pragmatic exchange of one issue for another.
We find that sharing is not reasonable for 2004. SoCalGas and SDG&E asked for 2004 sharing in their applications and argued at the time it was a continuation of the existing PBRs. In the opening brief, they expressed a concern that adopting only upside sharing would be retroactive ratemaking and that it would be unlawful to require them to share 2004 earnings based on a decision adopted after the start of the test year.64 We need not resolve the first issue because we adopt both upside and downside sharing. We also need not find whether it would be retroactive to adopt 2004 sharing after the start of the test year. We earlier found the Phase 1 adoption of the final test year revenue requirement was not retroactive ratemaking when it was made subject to refund in the interim Phase 1 decision, D.03-12-057. Here, we determine that applying sharing to 2004 would not be reasonable because of the uncertainty that was inherent in adopting a final revenue requirement significantly after the start of the test year. We are not comfortable with the reverse incentives that could result from this delay. If actual expenses in 2004 are higher than adopted, SoCalGas or SDG&E could incur a loss. But if the companies were exceptionally cautious, perhaps avoiding necessary expenditures because of the uncertainty, there could be a windfall gain. Sharing up to 300 basis points may not exactly offset the actual differences between 2004 expenditures and the adopted revenue requirement, nor would it be reasonable to share a chance gain or loss by SoCalGas and SDG&E when they were not in a position to exercise management discretion that would affect whether 2004 earnings were above or below the authorized rate of return. In this case the final decision on 2004 revenue requirements was adopted extremely late in the year. The practical fact is that SoCalGas and SDG&E could not react and manage to a final revenue requirement. We will not authorize a sharing mechanism for 2004.
45 Ex. 151, pp. JVL-34 ff.
46 Ex. 152, pp. JVL-34 ff. (Ex. 151 and 152 are sequential exhibits sponsored by the same witness that differ only to the particular history or circumstances of the two companies.)
47 Scoping Memo Ruling No. 2, and Scoping Clarification mimeo pg. 14.
48 Ex. 333, pp 2-2 to 2-7 as cited in the Comparison Exhibit.
49 Ex. 561, pp. 14 and 15 as cited in the Comparison Exhibit.
50 A basis point is one-hundredth of a percentage point, i.e., there are 100 basis points in 1 percentage point.
51 As described in Ex. 151, p. JVL-34.
52 Drawn from table JVL-6 in Ex. 151 - SoCalGas did not directly argue for an offset, this illustrated the proposal to share in both directions.
53 Sempra Opening Litigation Brief, p. 57.
54 "SDG&E and SoCalGas have consented in the past to sharing earnings in excess of authorized ROR as a Commission condition for application of the general PBR base rate ratemaking that the two utilities have proposed and advocated. This was a "price" at their expense that they were willing to bear in order to have PBR ratemaking applied to them, something that they believed would benefit both ratepayers and shareholders." Sempra Opening Litigation Brief, p. 56.
55 "A long-standing fundamental proposition of general ratemaking under California law is that revenue requirements may not be authorized retroactively. This position is based on the wording of Public Utilities Code Section 728, and has been explained and enforced by the California Supreme Court in two leading cases: Pacific Telephone & Telegraph Co. v. Pub. Util. Comm'n., 62 Cal.2d 634 (1965) and City of Los Angeles v. Pub. Util. Comm'n., 7 Cal.3d 331 (1972)." Sempra Opening Litigation Brief, p. 56.
56 Base Margin Settlement p. 12. We note that this approach assumes the presumption that the adopted rate setting mechanisms would be the SoCalGas and SDG&E PBR bundle of mechanisms, as settled.
57 Loss is used here to reflect the shortfall between actual return on equity and the authorized return, even though the companies had real positive earnings overall.
58 Ex. 152, p. JVL-35.
59 See the vegetation-management tree-trimming account in Phase 1
60 Ex. 152, Table JVL-3.
61 For 2001, ($25,392,000 x (1-.65)) = $8,887,000 and for 2002, ($51,753,000 x (1-.85)) using the SoCalGas and SDG&E proposed sharing.
62 Base Margin Settlement, p. 12.
63 D.03-12-057 granted interim rate relief to SoCalGas and SDG&E by establishing memorandum accounts to track any eventual difference in current rates and any increase or decrease adopted for TY 2004.
64 "SoCalGas and SDG&E have not agreed to be subject to upside earnings sharing for 2004, which would be required under the holding of the Pacific Telephone decision cited above. Given that the Commission did not create a balancing account for costs or otherwise provide notice of the application of an earnings sharing mechanism applicable to 2004 before the start of that year, it would clearly constitute unlawful retroactive ratemaking for a decision in Phase 2 to require SoCalGas and SDG&E to refund any above-authorized returns they might earn in 2004." Sempra Opening Litigation Brief, pp. 57-58.
