5. Discussion

Rule 51.1(e) of the Commission's Rules of Practice and Procedure establish the legal standard applicable to our review of the settlement agreements:

"The Commission will not approve stipulation or settlements, whether contested or uncontested unless the stipulation or settlement is reasonable in light of the whole record, consistent with law, and in the public interest."

Accordingly, in the sections that follow we consider whether the settlement agreements are consistent with this standard. First, we review the record in this proceeding regarding the evaluation and verification of the utilities' pending earnings claims. Next, we address WEM's protest. Finally, we discuss our conclusions regarding the reasonableness of the proposed settlement agreements.

5.1. The Record on Reasonableness of Earnings Claims

The record in this proceeding includes a broad range of independent evaluations of the utilities' earnings claims. Some of these evaluations were performed by ORA's consultant, others by CEC staff and still others by the consultant hired by Energy Division at the direction of the Commission. We summarize the record on these activities, below.

5.1.1. Pre-1998 Earnings Claims Under Shared-Savings Mechanism

In considering the record on earnings claims associated with the pre-1998 shared-savings mechanism, it is important to keep in mind that important verification issues associated with these claims have already been addressed in our previous AEAPs. For example, for the second earnings claims submitted in the 2000 AEAP for program year 1998 activities, the Commission has already reviewed the estimates of program costs and program participation underlying the utilities' lifecycle earnings claims, and has made any appropriate adjustments to those estimates during its evaluation of first-year earnings claims in an earlier AEAP. For most of the third and fourth earnings claims submitted in this consolidated proceeding, the Commission has also reviewed the results of ex post studies on first-year load impacts in earlier AEAPs, when the utilities' second earnings claims were filed and considered. For these submittals, the AEAP review focuses on whether estimates of lifecycle earnings need to be further revised based on ex post retention studies (also called measure life or persistence studies). Retention studies gather information from homes or businesses in which the measures were installed to determine how long the measures operated and whether the measures are being removed earlier than expected-a difference that would affect the program's value. In this way, the record in this consolidated proceeding builds upon the record and findings of the Commission in prior AEAPs.

To build upon this record, ORA's consultant completed a total of 37 reports related to the earnings claims associated with the pre-1998 shared savings mechanism: 11 verification reports on the second earnings claims (load impact studies), 20 reports on the third earnings claims (retention studies) and 6 reports of fourth earnings claims (retention studies). ORA's consultant also independently reviewed first year claims for pre-1998 programs that were filed in the 2000 and 2001 AEAPs. As discussed above, these represent pre-1998 program commitments that resulted in measure installations during 1998-2001. Table 2 presents the verification documentation completed by ORA's consultant during the 2000/2001 AEAPs. The consultant's review process is summarized below:¹⁷

· For first earnings claims, ORA's consultant evaluated each application for the presence of necessary documentation such as invoices, coupon payments, etc. The files were then examined for consistency with the earnings claim filing for that application, including the data on measure types, project costs, incentive payments and load impact calculations.

· For second earnings claims, ORA's consultant evaluated 11 load impact studies by conducting verification reports, which attempt to replicate the findings of the load impact study.¹⁸ The verification report process includes the assessment and replication of the sampling, billing data, and modeling procedures used in the utility study or a detailed replication of engineering-based, project-specific calculations used in the study.

· For third and fourth earnings claims, ORA's consultant verified retention studies supporting those claims by: 1) evaluating the data, documentation and programming codes used in the modeling process and 2) replicating and assign the analytical procedures used in the study.

Based on this review, ORA originally recommended that PG&E's lifecycle earnings request for program year 1999 be adjusted downwards from $11.185 million to $7.441 million, for an earnings adjustment of $3.74 million. This adjustment was based on issues ORA identified with respect to the engineering calculations, customer file information and program participation documentation for PG&E's first-year claim in the 2000 AEAP. During further discussions and information exchange, ORA and PG&E reached agreement to reduce PG&E's claim from $11.185 million to $9.971 million, for a lifecycle earnings adjustment of $1.2 million.¹⁹ ORA recommended no other adjustments to pre-1998 earnings claims in its 2000/2001 testimony.

During 1998 and 1999, the California Demand-Side Management Advisory Committee (CADMAC) Persistence Subcommittee contracted to conduct a series of statewide studies to measure the technical degradation of energy efficiency measures included in the utilities' earnings claims. These studies evaluate how program savings are affected over time by changes in the technical performance of efficient measures compared to the technical performance of the standard measures that they replace. ORA sponsored one of its consultants to participate on the Persistence Subcommittee. Therefore, ORA did not focus its verification effort on these technical degradation studies during the 2000-2001 AEAPs, but did review the utilities' implementation of the technical degradation factors from those studies.

The record in this proceeding also includes ORA's explanation of why PG&E's third earnings claim for 1995 programs (submitted in the 2000 AEAP) was so substantially higher than the first and second claims in earlier AEAPs. In particular, PG&E's incremental third year claim was $33.8 million, or approximately $20 million (145%) higher from PG&E's incremental second claim authorized during the 1997 AEAP. At the request of the assigned ALJ, ORA supplemented its testimony with an independent investigation of the factors contributing to this large increase, in order to verify its accuracy. ORA reported most of the large jump in PG&E's third earnings claim was the result of the statewide technical degradation studies. These studies conclude that PG&E assumed much faster "persistence decay" in its original lifecycle estimates than the ex post studies now indicated. Coupled with the fact that the ex post expected useful life (EUL) estimates from the retention studies were not statistically different from the ex ante assumptions used by PG&E, the net result was to substantially increase its third-year claim.

In addition, PG&E had a large industrial customer install a gas energy savings project in 1995. This customer subsequently left PG&E's system, using their own source of energy, and PG&E did not claim energy savings for this customer in the following AEAP. In February of 1998, however, this customer returned and continued service with PG&E. As a result, PG&E included the energy savings associated with this customer in its program year 1995 third earnings claim.

ORA's consultants also conducted an extensive review of PG&E's third earnings summary tables ("E-tables"), and found that (1) PG&E's E-tables were properly constructed and consistent with previous E-tables submitted as part of its second earnings claims and (2) PG&E's approach to revising the calculation of life cycle savings was consistent with the methodology stated in the protocols.²⁰

In D.03-04-055, the Commission requested a third-party review of the retention/persistence studies and the program milestone accomplishments submitted by the utilities in support of the pending AEAP earnings claims. Energy Division issued a Request for Proposal and selected Skumatz Economic Research Associates Inc. (SERA) to lead the review. SERA worked with a project team that included Summit Blue Consulting, LLC, Quantec, LLC (Quantec), Global Energy Partners, EMCOR Energy and Technology and the Northwest Research Group. As described in Section 2 above, SERA's final reports on the review of retention/persistence studies, including technical degradation factors, were submitted on October 20, 2004. The detailed review analyzed the approach, data, methods and conclusions associated with 54 reports representing 94 studies. Six percent of the studies were third year studies, 47% were fourth year studies, 25% were sixth year studies and 23% were ninth year studies. Eighteen covered agricultural measures, 22 covered commercial, 25 covered industrial and 35 covered residential measures, and some studies covered more than one sector.

The review evaluated the following: (1) conformance with Commission-adopted protocols, (2) sampling approach, sample sizes and data collection procedures, (3) modeling approach, estimation method, and consideration of alternative models, and (4) results and implications. The analysis yielded eight studies where adjustments to EULs are recommended. These results are summarized in Table 3. Computations of claim dollars at risk were also provided in the report. As indicated in Table 3, these computations indicate that approximately $399,000 in SDG&E's shareholder earnings claim dollars were affected by the findings, with the "net" being potentially higher claims for SDG&E. The report identified zero claim dollars at risk for PG&E, SCE or SoCalGas.

In addition, SERA and Quantec reviewed the CADMAC statewide technical degradation studies that were used, among other things, to support PG&E's large third-year earnings claims. SERA and Quantec reviewed and evaluated the methodology of the studies in detail, as well as the use of secondary sources. Overall, they found that the studies provided credible estimates of technical degradation. However, there were two measures for which the Technical Degradation Factor (TDF) analysis received a low score based on their evaluation, and would have an impact on the pending earnings claims. For "Measure 3" (Oversized Evaporative Cooler Condenser) they found that the TDF resulting from the studies would potentially underestimate savings and associated earnings. For "Measure 20" (Agricultural Pump Repair/Replacement), they found that the TDF resulting from the studies would potentially overestimate savings and associated earnings.

The net impact of substituting a TDF of 1.0 (no difference in technical degradation relative to the standard measure) for the study values for these two measures is presented in Table 4. As indicated in that table, these measures do not have a large combined impact on the pending AEAP claims, however the net direction of the impact would be to increase the claim. The use of the study TDF values led to lower claims on the order of $0 to $43,000 for each utility. SERA and Proctor conclude that the associated claims could have been (minimally) higher for at least PG&E, and the potential level of adjustments to past claims would be very small.

As described above, the record in this proceeding provides an extensive review of the pre-1998 earnings claims. No aspect of this review refutes the reasonableness of these claims and, in fact, the SERA reports indicate that the utilities may have slightly underestimated the lifecycle savings associated with these energy efficiency programs, and therefore underestimated their earnings claims.²¹

5.1.2. Post-1997 Earnings Claims Under Milestone-Based Mechanisms

As described in Attachment 4, the Commission shifted from shared-savings to milestone-based incentive mechanisms for post-1997 energy efficiency activities. By 1999, the shared-savings mechanism was completely phased out, and all utility earnings were based on milestone accomplishments. From 1999 through 2001, the utilities pursued a variety of different milestone types, each with a unique set of measurement metrics and award mechanisms. As described in Attachment 4, the milestones can be categorized into three major groups: (1) Expenditure-based, (2) Energy savings and (3) Miscellaneous.

Expenditure-based milestones are dependent upon the utilities spending most or all of the approved program budgets (including "commitments" that reserve funds for later payment to program applicants). Beginning in program year 2001, Energy savings milestones were also defined for each relevant energy savings category (kW, kWh and therms) within the residential, non-residential and new construction program areas. The maximum award for these milestones could be earned for meeting the goals, and a minimum award equal to 50% of the maximum could be earned for achieving 80% of the primary target. Awards for intermediate achievements were determined through linear interpolation as approved by the Commission. The utilities were also eligible to earn a "bonus" energy savings award if they met all of their program area and kWh, MW and therm savings targets.

The miscellaneous category includes all those milestones classified as "administrative," "base," "activity" or "market effects" milestones. Administrative, base, and activity milestones depend on the accomplishment of a certain goal within a specified time frame. Examples of these milestones are: "Complete a statewide energy booklet for small commercial and industrial customers by July 30 (for superior award) or September 30 (satisfactory award)" and "Conduct 6 workshops for duct and window training by May 31 (for superior award) or June 30 (satisfactory award)." Market effects milestones concentrate on the achievement of a measurable market impact and are tied to specific performance requirements of key programs. An example of a market effects milestone is "Increase the ratio of high efficiency water heaters sold by 5% over current level. Award scales from 2% (satisfactory) to 5% (superior)."

As discussed in Attachment 4, the incentive mechanism in place during 1999 and 2000 emphasized expenditure-based milestones and those described above under the miscellaneous category, whereas in 2001, the Commission shifted to a milestone incentive mechanism that relied predominantly on energy savings accomplishments.

During the course of the 2000/2001 AEAP proceeding, the CEC provided substantive testimony on verification issues related to a selected number the utilities' milestone-related earnings claims for program year 1999 and 2000 program accomplishments. CEC's review focused on approximately 75 milestones applicable to those program years. Taking into account the utilities rebuttal testimony and subsequent discussions and exchange of documentation, CEC and the utilities reached agreement on the contested issues. The Case Management Statement lays out the basis for agreement on a milestone-by-milestone basis. This process resolved all of the issues raised by CEC in its testimony, and resulted in minor adjustments to the 1999/2000 milestone performance award claims of PG&E and SDG&E.²²

Per D.03-04-055, the record on post-1997 earnings claims in this proceeding was augmented by Energy Division's independent review of milestone accomplishments for program years 1999, 2000 and 2001. SERA managed the project team consisting of SERA staff, in association with Summit Blue Consulting LLC and Global Energy Partners, LLC.

As described in SERA team's report, there were more than 400 individual milestones between the four utilities for program years 1999-2001, worth more than $65 million in potential earnings. The SERA team prioritized milestones for detailed evaluation and conducted detailed assessments on 125 individual milestones worth more than $32 million. In particular, the SERA team selected all of the "aggressive implementation" and "performance adder" expenditure-based milestones for detailed assessment, since these milestone types accounted for a significant portion of all claims (typically 10-20% of annual claim dollars). In addition, the SERA team evaluated all energy savings milestones (which were for program year 2001 only), since these milestones accounted for 80% of the value of award claims in program year 2001. For miscellaneous measures (of which there were 350 over the three year period), the SERA team selected a sample that was prioritized based on dollar value, and spanned all program areas.

Table 5 summarizes the results from this detailed assessment of claim values potentially at risk for program years 1999-2001, by utility and milestone category. The SERA team defines claims potentially "at risk" as those for which supporting documentation provided by the utilities may not be sufficient to warrant payment of the related milestone incentive awards. The SERA team's analysis of PG&E and SCE documentation concludes that only about 4% (PG&E) and 6% (SCE) of the claimed dollars were potentially at risk. For SoCalGas and SDG&E, a total of 11% of the claim value for each of the utilities may be potentially at risk, based on the SERA report. Overall, the SERA team found that 94% of the $65.5 million in earnings claims were supported by their assessment of the documentation provided, leaving 6%, or $4.1 million, potentially at risk.

In addition to the issue of whether the utilities achieved the milestones established for their programs, ORA raised several issues related to the policy rules that governed post-1997 programs. At the PHC for the 2003 AEAP, ORA expressed the view that ex post program cost-effectiveness, commitments true-ups and other policy rules could affect the milestone incentives, and should be considered by the Commission. The utilities presented a different interpretation of these policy rules. The Assigned Commissioner directed the utilities and ORA to compile and review the relevant rules, hold a public workshop on the issues raised by ORA, and submit a post-workshop joint report on any remaining areas of disagreement.²³

As a result of this review and further workshop discussion, ORA reported that there were no longer any differences in interpretation of the policy rules that would require Commission resolution. In particular, based on the language of the relevant rules, ORA and the utilities agreed that the cost-effectiveness rules applicable to the post-1997 program years applied only prospectively (or ex ante). In other words, the policy rules did not require an ex post true-up of program or portfolio cost-effectiveness based on subsequent studies, except to verify the level of program participation. ORA and the utilities presented their compilation of the policy rules and conclusions in a Joint Report on September 22, 2003.²⁴

At the direction of the assigned ALJ, on January 14, 2004 the utilities submitted a summary of the record concerning the milestone incentives for program years 1999, 2000 and 2001. The summary provides a tabular crosswalk presenting information in the Case Management Statement, the SERA report and blueConsulting audit,²⁵ and the September 22, 2003 Joint Report. ORA concurs with this presentation. With respect to the issue of truing up commitments, ORA and the utilities reached agreement that "based on the results of both the blueConsulting and SERA reports that the commitment and true-up issues have no impact on the earnings associated with the outstanding milestones claims...."²⁶

Attachment 5 presents the Milestone Incentive Crosswalk tables, by utility.

5.1.3. LIEE Earnings Claims Under Performance Adder Mechanism

The settlement agreements also include amounts earned under the performance adder mechanisms applicable to LIEE. The amount claimed in the pending AEAPs for 1999-2003 associated LIEE earnings totals $616, 748 for SDG&E, $2,100,290 for SoCalGas, $1,368,000 for SCE and $1,544,000 for PG&E, not including interest and FF&U. (See Table 1.)

Attachment 3 describes the LIEE performance adder mechanisms adopted by the Commission for these programs. As described in that attachment, the utilities' LIEE earnings claims are recovered over a two-year payout period: The first earnings claim (50% of the total award) is paid out upon verification of measure installations and expenditure data, as well as the review of the earnings calculations for mathematical accuracy. The second earnings claim for certain program years (for which a load impact study is required) is contingent upon completion of that study.

By D.03-08-028, the Commission addressed the LIEE earnings claims submitted by the utilities in their 2000, 2001 and 2002 AEAPs, which encompassed the second-year claims for program year 1998 program activities, first and second-year claims for program year 1999 and 2000 program activities and first year claims for program year 2001 program activities. In reviewing the record for those claims, the Commission found that ORA had reviewed and verified the number of installations claimed by the utilities for program years 1999 and 2001 to its satisfaction. With respect to the second year claims, the Commission found that the utilities completed their load impact studies for program years 1998, 2000 and 2001 in compliance with the protocol requirements, and therefore had met that contingency.

However, because of the structure of the experimental performance adder mechanism in place for program year 2000, the Commission found that ORA's review approach for measure installations was not sufficient for that program year. In addition, the Commission found that the utilities' expenditure data for program years 1999, 2000 and 2001 required further examination. As a result, the Commission authorized recovery of the utilities' 1998 second year claims, but deferred consideration of the pending 1999-2001 claims until Energy Division could verify LIEE installations for program year 2000 and expenditure data for program year 1999, 2000 and 2001. Because of resource limitations, Energy Division has been unable to commence this work.

In sum, the record in this proceeding to date is limited with respect to information concerning the reasonableness of the pending LIEE earnings claims. However, we note that overall level of these claims is relatively small, amounting to approximately 2% of the total pending claims.²⁷

5.2. WEM's Comments in this Proceeding

WEM submitted comments during two different stages of this consolidated proceeding. First, WEM submitted comments in response to the utilities' 2000/2001 AEAP applications and supplemental testimony. Second, WEM submitted comments in response to the PG&E motion for approval of a settlement agreement with ORA. We discuss these two sets of submittals, below.

5.2.1. WEM's Comments in Response to 2000/2001 AEAP Applications

WEM submitted preliminary comment/testimony on September 4, 2001 in response to the utilities' 2000/2001 AEAP applications. We note that this submittal makes no individual recommendations regarding the appropriate level of those claims. Instead, much of it recounts conversations with Commission personnel detailing the difficulties WEM encountered because the Commission's filing system is kept by application and advice letter number, and not be subject matter. The rest of the submittal consists of (1) quotes from a 15-year old book about the complexities of the regulatory process, (2) references to other intervenors in past program planning proceedings, raising program issues in those proceedings, and (3) accusations concerning the utilities' handling of energy efficiency funds and other matters. PG&E filed a point by point response to WEM's submittals on September 28, 2001. We concur with PG&E's assessment that WEM's September 4 2001 submittal is not responsive to the issues in this proceeding and has not contributed to the record. We find WEM's November 16, 2001 comments on the utilities' supplemental testimony to be similarly unresponsive to the issues addressed in that testimony. Accordingly, we give these WEM submittals no weight in our deliberations over the settlement agreements before us today.

5.2.2. WEM's Response to the ORA/PG&E Settlement Agreement

WEM's comments on the ORA/PG&E settlement agreement do not address the validity of ORA or SERA's review of the studies underlying PG&E's pending earnings claims, but rather asks us to reject the settlement terms based on (1) the results of other studies concerning energy savings assumptions, (2) inaccuracies in the calculation of PG&E's earnings claims and (3) a recent financial audit of PG&E's management of energy efficiency programs. We find no merit to WEM's objections, for the reasons discussed below.

5.2.2.1. Recent Studies and DEER Updates

WEM references the results of the 2003 Express Efficiency Program Evaluation²⁸ to argue that the PG&E/ORA settlement relies upon savings and persistence data which "is already recognized as being inaccurate." We note that this study was submitted to the Commission in March 2005, and covers installations made in program year 2003, for which there are no shareholder incentives. Hence, the settlement agreements being considered today do not include any earnings claims for the programs covered by this study. Moreover, we are persuaded by the arguments of ORA and PG&E that this study has very little relevance to the savings impacts of PG&E's pre-1998 program activities.

First, we note that PG&E's residential CFL program was exclusively an information-only program, designed to educate residential customers about this technology. Second, with respect to non-residential programs, ORA and PG&E explain that the CFLs installed during the program years included in the ORA/PG&E settlement agreement have significant technological differences and applications from those included in the studies that WEM cites²⁹:

"CFLs installed during the program years covered by the earnings claims in the Settlement Agreement were mostly expensive, modular screw-in lamps, where the ballast and lamp are separate component, and hardwired fixtures common at the time that averaged only about two percent of the total program energy savings. The energy crisis brought a flood of new CFL screw-in technologies to the California market in 2001, including many lamps where the ballast and lamp were a single, disposable entity. The study for Program Year 2003 that WEM cites primarily included integral screw-in CFLs (lamp and ballast combined in one unit). The different technologies for each kind of CFL would result in different assumptions and results about the lights, especially the effective useful lives (EULs)."³⁰

"The 2003 Express Efficiency program evaluations, which included a task for collecting CFL hours of use from a small sample size of the population, mainly examined CFL installations in hotels. In contrast to previous years, where CFLs were mostly installed in hotel lobbies and other high-use areas, by 2003 they were becoming so commonplace they now were being installed in hotel rooms which have significantly lower operating hours."³¹

Moreover, as PG&E and ORA point out in their reply comments, the 2003 Express Efficiency Evaluation applies to a limited population of 60 sites. We conclude that this study is too limited in scope and uses a different mix of CFL technologies for different purposes to be relevant to PG&E's pending earnings claims.

More generally, WEM argues that the data "just now coming available" to update DEER inputs on savings persistence should be considered and used in evaluating the PG&E/ORA settlement agreement.³² In particular, WEM points to PG&E's presentation of the impacts of DEER changes to useful life estimates for CFLs on future program energy savings as evidence that the pending earnings claims are inflated. However, we concur with PG&E and ORA that these updates are not applicable to the earnings claims being considered today. As ORA and PG&E acknowledge, CFLs have become a large enough portion of overall program savings to result in the percentage reductions presented recently by PG&E to its advisory group members for prospective programs. However, it does not follow, as WEM asserts, that these reductions (on the order of 39-49% for residential applications and 20-23% for non-residential applications compared to 2003-2004 program projections) are applicable to the pre-1998 program savings estimates, where CFLs composed less than 2% of the energy savings. Moreover, even if WEM's argument were correct in the extreme with respect to PG&E's 1999-2001 energy milestone-related claims--i.e., that we should attribute zero savings from all CFL installations in those years-PG&E calculates that the impact on these earnings claims would only be on the order of $2.6 million.³³

With respect to the recent DEER updates to non-CFL useful lives, we similarly find no basis for setting aside the record in this proceeding based on those updates, as WEM's comments suggest. Attachment 6 specifically compares the updated DEER non-EUL values with (1) the values contained in the previous version of DEER and (2) the ex ante EUL assumptions contained in the EM&V protocols established for pre-1998 program activities. These updates are based on the review of recent ex post persistence studies--including the ones reviewed by SERA in this proceeding.³⁴

Contrary to WEM's assertions, these updated EUL assumptions do not suggest that PG&E's pending earnings claims are based on unrealistic savings persistence assumptions. Again, WEM draws inappropriate conclusions from the data. The bulk of the earnings claims presented in the pending AEAPs were based on the EUL assumptions contained in the pre-1998 EM&V protocols, and not those contained in the previous version of DEER. With few exceptions, the 2005 updated EUL assumptions for non-CFL energy efficiency measures have generally remained the same or increased relative to those used to calculate savings and associated net resource benefits for the AEAP earnings claims. (See Attachment 6.)

In sum, we find that WEM's objection to the ORA/PG&E settlement agreement based on the results of recent 2003 program evaluations and DEER updates is without merit.

5.2.2.2. PG&E's Calculation of Earnings Claims

In its comments, WEM contends that PG&E's calculation of a $206.7 million earnings claims is inaccurate because it does not reflect the benefit of the time value of money. In particular, WEM argues that the reference point for the settlement agreement should be $182.897 million. We disagree.

As the ORA/PG&E settlement agreement notes, the 10% discount of the total claim for settlement purposes is intended to reflect both the benefit of the time value of money associated with collecting some earnings claims before their scheduled recovery period and uncertainty about future recoveries.³⁵ WEM's calculations imply that the benefit of the time value of money alone should have produced a settlement amount that was 12.6% lower than PG&E's claim. However, upon closer inspection, we find that WEM's calculations are based on unsupported assumptions.

To understand the basis for WEM's calculations, it is important to keep in mind that PG&E's claim of $206.7 million is made up of two components: (1) Earnings claims already submitted for recovery in the pending AEAPs and (2) Earnings claims associated with pre-1998 programs that would have been recovered in future AEAPs (e.g., the 4^th installment associated with 1996 and 1997 program activities).

Earnings claims already submitted by PG&E for recovery amount to approximately $143 million. This calculation includes accruing interest for historic payments due through 2004. In AEAPs, the utilities are permitted to earn interest on their shareholder incentives, calculated at the 90-day commercial paper rate, beginning on July 1 of the year following the program year. For example, for the 3rd claim for the 1995 program year in the 2000 AEAP, interest began accumulating as of July 1, 1996. There is no apparent disagreement over this interest rate calculation.

Earnings claims associated with later installments for pre-1998 programs are calculated at $63.579 million in the settlement document. This calculation also includes an interest carried forward to the projected year when the claim would be made

Based on the settlement worksheets, the timing for recovery of the full $63.579 million would be as follows:

	Amount
AEAP	(Million $)
2005	32.753
2006	13.044
2007	13.743
2008	0.071
2009	3.035
2010	0.933
Total:	63.579

WEM and PG&E/ORA disagree over the present value of the $63.579 million associated with these future earnings installments. The critical difference between them concerns the timing of the payments. WEM assumes that payments will not be made until 2010, and that the future payment will be discounted at 8.5%. This assumption results in a significant reduction for the time value of money since it assumes that the bulk of the payments that are due to PG&E in early years accrue interest at a relatively low rate, less than 1.4% per annum, while they are discounted at a relatively high rate, 8.5%.

WEM provides no basis for the underlying assumption that the earnings installments due in each of the years between 2005 and 2010 will not be recovered by PG&E until the end of 2010. Although the Commission's processing of AEAP applications in recent years has been delayed due to the energy crisis and other unanticipated factors described in Section 2, this is certainly not the norm nor a reasonable expectation for the future. We agree with PG&E and ORA that a more reasonable assumption would be that the AEAPs would be processed each year as expected. Therefore, the present value of the $63.579 million should be calculated from the end of the year in which the installment is due, back to the end of 2004.

In addition, WEM provides no basis for using a discount rate of 8.5%. We agree with PG&E and ORA that the discount rate applied to utility cash flow streams, the weighted cost of capital, should be used instead. For PG&E, the weighted cost of capital is currently 7.9%.

If PG&E's future claims had been discounted, using a proper starting time and the appropriate discount rate, the total claim would have been $198.574 million. As indicate in Table 1, applying the proper discounting approach to the nominal earnings claims reveals that the settlement amounts for all utilities are lower than the resulting discounted claims, contrary to WEM's contention. Moreover, we note that the utilities will be amortizing the authorized earnings over time without adding interest as these amounts are amortized.³⁶ This will dampen the time value of money benefit associated with the settlements that these discounting calculations attempt to capture.

5.2.2.3. Results of Financial and Management Audit

The "Financial and Management Audit of Utility Public Goods Charge Energy Efficiency Programs from 1998-2002" (audit) prepared by blueConsulting was issued on July 9, 2004.³⁷ We ordered this comprehensive audit in D.03-04-055 for the purpose of (1) verifying Public Goods Charge (PGC) collections and expenditures on energy efficiency-related programs and services, (2) investigating and verifying the level of administrative expenditures associated with PGC-funded programs, and (3) assessing the effectiveness of oversight, accounting and financial funds management.

In its comments on the ORA/PG&E settlement agreement, WEM alleges a number of conclusions from the audit without reference to or citation to specific pages of the audit. Based on these conclusions, WEM argues that the Commission should set aside the settlement agreement in order to evaluate how the audit results should impact on shareholder incentives. In particular, WEM asserts that the audit found: (1) widespread negligence in contract oversight; (2) failure to meet energy savings targets; (3) failure to track and report "commitments," resulting in inflated savings claims; (4) excessive administrative costs and confusion over what constitutes those costs; and (5) refusal to provide auditors with adequate, timely information. WEM simply lists these points as a summary of the audit findings, without any further elaboration or reference to the audit documents.³⁸

Before addressing the merits of WEM's allegations, we note that it is far from clear how the audit findings could or should impact the pending AEAP earnings claims, given the specific scope and timeframe of the evaluation. The purpose of the audit was to provide forward-looking recommendations to the Commission in order to "improve the effectiveness of PGC fund management and expenditures by the utilities."³⁹ The audit examines expenditure data and management/financial systems in place for program years 1998-2002. WEM provides no explanation of how the audit results relate to the specific earnings claims in this proceeding, which encompass a much broader timeframe. In contrast, the activities we described under the "AEAP-related studies" that we also authorized in D.03-04-055 clearly relate to the review of the utility earnings claims. As described in that decision, these activities consist of the independent verification of milestone achievements and the independent review of retention and persistence studies, and cover a timeframe that encompasses all pending AEAP claims.⁴⁰

In short, even if some or all of WEM's allegations concerning the audit findings were accurate, it does not necessarily follow that the ORA/PG&E settlement agreement should be set aside, as WEM urges. We note, in particular, that ORA takes the position based on a comprehensive review of the applicable policy rules, and the results of both the blueConsulting audit report and SERA reports on milestone accomplishments that the issue of truing up commitments would actually have no impact on the earnings associated with the outstanding milestone claims in this proceeding. (See Section 5.1.2 above.)

Moreover, we have reviewed the ORA/PG&E joint rebuttal to WEM's comments, and agree with their assessment that WEM mischaracterizes the audit findings. In particular, the auditor found PG&E to be adequate and reasonable in contract oversight. The report specifically lists two findings (conclusions #5 and #6) directly addressing contractor oversight. (Executive Summary, page I-17.) Conclusion #5 states that "PG&E's policies and procedures over the contractor selection process provide a reasonable level of assurance that such contractors are selected in accordance with sound business practices." Conclusion #6 states that "PG&E has adequate processes to monitor and control contractor activities and to verify work performed by contractors."

Contrary to WEM's assertions, the auditor found no discrepancies regarding commitments in any program except Savings By Design (SBD) for program year 1999 only (conclusion #13, page I-19). The auditor also concluded that the audit only "identified possible instances of non-compliance in the enforcement of commitment terms for program year 1999" (page IV-32, conclusion C-13, volume II). Upon further examination they found that the SBD projects in question were actually completed within the appropriate timeframes of the program (third bullet, page IV-34).

With respect to administrative costs, the auditor found that the utilities received very limited guidance regarding the classification of administrative costs. Consequently administrative costs cannot be compared from utility to utility (page I-23, Executive Summary, conclusions 1 through 5) or to other programs throughout the country. In our view, this does not constitute "confusion" nor does it imply PG&E's costs are "excessive." In fact, the auditor found that PG&E correctly accounted for these costs (page I-23, Executive Summary, conclusions 6 through 9).

We also could find no basis for WEM's objection to the ORA/PG&E settlement because of "refusal to provide auditors with adequate, timely information." PG&E did not refuse any of the auditor's requests and even made space available to them in our offices and allowed them access to our computer systems. As noted on page I-1 of the Executive Summary, PG&E answered all of the data requests from the auditors. Some of the requests were for data or files up to 6 years old (1998 program files asked for in 2004) which had to be retrieved from off-site storage.

Finally, with respect to WEM's assertion that the audit found "failure to meet energy savings targets," we note that the auditor did not even audit this aspect of the programs and, therefore, drew no such conclusion. In sum, contrary to WEM's assertions, we find nothing in the audit findings to suggest that the ORA/PG&E settlement agreement is unreasonable and should be rejected by this Commission.

5.3. Conclusions

The utilities and ORA have presented us with settlements on pending AEAP earnings claims that would award a total of approximately $315 million to the four utilities combined, including accrued interest and FF&U. Overall, the settlement amounts represent a level of awards to utility shareholders that is approximately $37 million lower than these pending earnings claims. Our consideration of the record in this proceeding convinces us that this level of discount from the pending claims is reasonable and in the public interest. In particular, we note that the record in this proceeding provides considerable support for awarding the full amount of the earnings installments due under the pre-1998 shared-savings mechanism, and close to the full amount for 1999-2001 milestone-related earnings.

With respect to the shared-savings earnings claims, ORA's review of earnings documentation and measurement studies resulted in few disputes, all of which were resolved during the Case Management Statement process. The resulting downward adjustments to PG&E's 1999 first year claim is already reflected PG&E's total shared-savings earnings claim. SERA's analysis of the retention and persistence studies submitted in this proceeding, including results pertaining to technical degradation factors, fully support ORA's conclusions that the savings levels underlying the pending shared-savings claims are reasonable. The only adjustments that SERA's analysis suggests are small increases to the shared-savings earnings claims. More specifically, the SERA report presents a net adjustment of +$398,802 in shared-savings earnings for SDG&E, +$42,702 for PG&E and +$1,000 to +$2,000 for SCE. SERA's report does not present any adjustments to the shared-savings earnings claims for SoCalGas. (See Table 6.)

SERA's review of the shared-savings claims did not encompass the last round (related to the fourth earnings installment) of persistence/retention studies that will be submitted for some of the program years in future AEAPs. However, it seems unlikely that the results would be so dramatically different from the first round (third installment) studies that they would result in major downward adjustments to current estimates. This is one risk, however, that should be considered in reviewing the terms of the settlement. On the other hand, there is also the possibility that an additional round of studies would conclude that assumptions for technical degradation and other measure retention parameters actually underestimate savings persistence to a greater degree than SERA's analysis of current studies has found.

With respect to the 1999-2001 milestone-related earnings claims, we note that the earnings claims in Table 1 already reflect downward adjustments made to those claims for SCE, PG&E and SDG&E during the development of the Case Management Statement. However, SERA's analysis suggests that additional downward adjustments would be supported by the record. In particular, netting out the adjustments already reflected in Table 1, SERA's evaluation produces the following earnings claims at risk: $1,247,000 for PG&E, $262,000 for SCE, $873,072 for SDG&E and $655,312 for SoCalGas. (See Table 6.)

In sum, the record in this proceeding with respect to the pre-1998 shared savings and 1999-2001 milestone-related earnings claims suggests, at most, downward adjustments in earnings of approximately $1.2 million for PG&E, $260,000 for SCE, $474,270 for SDG&E and $655,312 for SoCalGas. In addition, as noted in Section 5, even if WEM's argument regarding CFL savings persistence were correct in the extreme-i.e., that we should attribute zero savings from PG&E's CFL installations during the more recent program years (1999-2001), the impact on PG&E's earnings for the milestone-related claims would only be on the order of $2.6 million. Even deducting this additional amount from PG&E's earnings claims, the settlement amount would still be significantly lower than the resulting calculation-by over $23 million in nominal dollars.

If we also assume in the extreme that all LIEE pending earnings claims are potentially at risk pending the results of Energy Division's verification efforts, the settlement amounts would still be significantly less than the adjusted earnings claims, both in nominal and discounted dollars for each of the utilities. Moreover, Energy Division's verification of the LIEE claims could also result in higher earnings for the utilities, if actual installations in 2000 were higher and/or if recorded costs for 1999-2001 were lower than originally projected at the start of each program year.

Therefore, based on the whole record, we conclude that the utilities are settling for significantly less than would likely be due them for energy efficiency and LIEE activities undertaken through program years 2001 and 2003, respectively. This represents a real cost savings to ratepayers or, put another way, allows ratepayers to retain a larger share of the net benefits from energy efficiency than anticipated.

Moreover, the settlement agreements address concerns over potential rate impacts by proposing rate recovery mechanisms that will amortize these earnings over time or consolidate them with other rate changes, in order to minimize or completely eliminate the need for any rate increases. In addition, the utilities have clarified that no additional interest will accrue as these earnings are amortized for rate recovery purposes. As noted in the settlement agreements, each AEAP application before us to date has included a forecast of the total future incentives for the affected program years, and the gross cost of these future claims has been explicitly considered in this record. We also presented a forecast of these amounts and considered them in our interim opinion, D.03-10-057.⁴¹ Hence, there are no "surprises" in either the existence or amounts of the future claims that are now being included in the AEAP settlements for recovery in rates.

In addition, the settlement agreements eliminate any risk of the utilities not performing future tasks that would be a prerequisite for collection of the final incentive payments. Under those agreements, the utilities will still perform the various measurement and evaluation studies required under the pre-1998 protocols and established by Commission decisions.

Finally, the settlement agreements are fully consistent with law and prior Commission decisions, which have endorsed settlements as an "appropriate method of alternative ratemaking" and express a strong public policy favoring settlement of disputes if they are fair and reasonable in light of the whole record.⁴² As we have acknowledged in the past, this policy supports many goals, including not only reducing the expense of litigation, and conserving scarce Commission resources, but also allowing parties to reduce the risk that litigation will produce unacceptable results.⁴³ Implementing the terms of the settlement agreements before us today will also allow this Commission to consider future risk/reward incentive mechanisms for energy efficiency unencumbered by the remnants of past incentive mechanisms and associated earnings claims.

For the reasons stated above, we find the settlement agreements to be in the public interest and approve them in their entirety. The shareholder earnings that we authorize today via the settlement agreements total $271.6 million for the four utilities combined, not including interest and FF&U. Conservatively, we estimate that the energy efficiency programs undertaken to generate this level of earnings have produced $670 million in total net resource benefits to all ratepayers, i.e., resource benefits minus costs. This level of net resource benefits is derived by applying the shared-savings formula to the pending earnings claims associated with programs subject to the pre-1998 shared-savings mechanism. It does not reflect the savings or net resource benefits associated with the pending low-income energy efficiency programs or non-low income energy efficiency programs subject to milestone incentives from 1999-2001.⁴⁴ In keeping with the concept of a shared-savings incentive mechanism, the utility earnings we authorize today via the settlements are much less than the savings ratepayers have already received by deferring or avoiding more costly supply-side investments with energy efficiency.

Today's decision resolves all outstanding issues in the above-captioned proceedings. Therefore, by order today, we close this consolidated docket.

Based on the earnings we authorize today, the utilities are required to present updated calculations of total net resource benefits and the benefits to ratepayers over and above program costs and the payout of shareholder incentives from these past energy efficiency activities. In D.03-10-057 (Attachment 4), we presented a format that facilitated these calculations for program activities implemented or initiated during the 1994-1997 period. This same format may be useful with respect to programs subject to the shared-saving incentive mechanism.⁴⁵ The utilities should jointly file and serve the updated calculations together all underlying work papers as a compliance filing in R.01-08-028 within 30 days from the effective date of this decision. The assigned ALJ will provide further direction to the utilities on how to report this information in a consistent format, and may for good cause modify the filing date for this information.