9. District-Specific Issues

9.1 District Overview

The increases in general office expenses and capital costs discussed above are allocated to each of the districts. Expenses and capital costs for each particular district are also part of the revenue requirement for the district.

The time since the last general rate case varies for the 15 districts from a relatively short two years for Bear Gulch and others to nine years for King City. The time period since the last rate case should be considered when expressing the revenue increase as a percentage. For example, a 10% increase in two years for Bear Gulch is very different from a 10% increase for King City.

Bearing in mind this variation, the record shows that purchased power and general office allocations are the primary factors behind this revenue requirement increases. While the percentage increases vary, both these expense items top the list of cost increases for most districts.

The issues remaining in dispute between ORA and Cal Water regarding each of the districts are: general office allocation of one regulatory analyst and the Board of Directors costs and small main replacements. These issues have been addressed above. In addition, three districts have painting issues, which are discussed immediately below, and several districts have unique issues, which are addressed in turn below.

9.2 Painting Tanks and Reservoirs

In its rebuttal testimony, after ORA had filed its testimony, Cal Water presented its Tank Maintenance Supervisor, a National Association of Corrosion Engineers certified coating inspector, who described Cal Water's inspection and re-painting program. The goal of the program is to proactively maintain these tanks to reduce costs over the life of the tank or reservoir. The Supervisor presented specific analysis of each tank or reservoir and explained in detail the need for prompt re-painting.²¹

9.3 Bear Gulch

Cal Water sought a 15.13% increase for Test Year 2002 in revenue requirement in the Bear Gulch District. ORA recommended a 5.28% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 3.74% increase, and Cal Water's resolution yields a 4.29% increase for Test Year 2002.

Cal Water explained that the primary reasons for the increase in this district are purchased power expenses (56% increase), general office expense allocation (32% increase), and rate base amortization (7% increase). However, a 7% increase in water sales as well as other rate increases since the last general rate case test year of 2000 avoid an even greater increase at this time.

In this district, the Joint Recommendation provides for an advice letter for a capital project to deactivate cryptosporidium. The ORA testimony states that Cal Water intends to select the specific project through a study in 2002 to investigate different methods of treatment and that due to the "uncertainties, size, and cost" the project should be reviewed through the advice letter process. Cal Water estimates $648,000 for this project in Test Year 2003. The Joint Recommendation caps the amount at $648,000 and requires that the equipment be installed no later than January 1, 2005. Subject to these two requirements, the parties expect the advice letter to be accepted.

We are not eager to approve this part of the Joint Recommendation due to the "uncertainties, size, and cost" of the proposed treatment project. The Joint Recommendation provides that Cal Water will resolve these issues in a study yet to be completed. Under typical conditions, a promise for a post-decision study would not be a sufficient basis upon which to authorize so large an expenditure. Here, however, the health implications of failing to promptly deactivate cryptosporidium require that Cal Water proceed immediately. When completed, the study should include the specific information needed for this Commission to conduct a reasonableness review for this project.

The issue remaining in dispute between ORA and Cal Water regarding the Bear Gulch District is customer service center rent. The Bear Gulch Office is located on El Camino Real in Atherton in a rented building where it has been located since 1989. The rent for this building was $3.75 per square foot as of September 2001, based on a 10-year lease in September 1999. ORA stated that since Cal Water entered into this lease there is a "glut" of office space in the area with comparable space as low as $2 per square foot. ORA also testified that Cal Water should attempt to re-negotiate its lease or move to a less expensive location. ORA recommended reducing the amount allowed for office rent to $2.25 per square foot.

Cal Water responded by presenting current rental rates for commercial property in the area, which ranged from $1.50 per square foot to $12. Cal Water stated that the Bear Gulch District serves high cost areas with rapidly appreciating real estate prices. While that market has "softened" since Cal Water last negotiated the lease, Cal Water continues to believe that the current rental rate is reasonable in light of rents for other properties.

Aggressive cost containment by utility management is our goal. Here, both ORA and Cal Water agree that the market for commercial real estate has changed since Cal Water signed the lease, and there is no evidence that Cal Water has attempted to re-negotiate the lease. Cal Water's evidence of other office space available at much higher rates is predominantly composed of Class A office space with amenities such as a "fully equipped health club." Cal Water's own testimony shows that rental rates vary from $1.50 to $12 per square foot, with three properties having rates at or below ORA's recommended rate. Cal Water, like ORA, made no attempt to identify specifically comparable rental properties.

Cal Water's witness testified that he had spoken with the person within the company responsible for "dealing with rental property throughout the company," Richard Schuppe. The witness stated that Schuppe informed him: "this is not a lease that we would be likely to be able to renegotiate." The rate case witness did not know whether Schuppe had spoken directly to the landlord on this topic or had simply formed an "impression" from earlier conversations. This testimony fails to demonstrate that Cal Water has taken all reasonable steps to ensure that the costs it incurs are as low as possible. Cal Water admits that commercial real estate market was "very tight" at the time it signed the 10-year lease and that the market has since "softened quite a bit." Given this change in market circumstances, prudent business practices dictate that Cal Water at least attempt to modify the terms of the lease. However, not even ORA's proposed disallowance of this rent payment sparked Cal Water to action with the landlord, even for the purpose of gathering evidence to support its assertion that the landlord was unwilling to consider modifying the lease.

The burden of proof is on Cal Water to show that the Bear Gulch office rent is reasonable. Here, ORA presented evidence that the rent was too high. Cal Water's rebuttal evidence consisted of a wide range of prices for office space, which included both ORA's and Cal Water's, with no analysis of the data to demonstrate which sites were comparable to the existing office, as well as vague assertions of the landlord's unwillingness to re-negotiate. Cal Water's evidence is insufficient to meet its burden.

We do not substitute ORA's rental rate, however, because ORA did not account for moving expenses or site modifications. We will select the point mid-way between the two amounts, $3.00 per square foot, as reasonable.

9.4 Chico District

Cal Water sought a 21.11% increase for Test Year 2002 in revenue requirement for its Chico District. ORA recommended a 3.19% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 15.84% increase, and Cal Water's resolution yields a 16.95% increase for Test Year 2002.

Cal Water explained that, as with most other districts, the primary reasons for the rate increase are purchased power expenses (28% increase), general office expense allocation (74% increase), and the revenue requirement of rate base (45% increase). The Chico District's last general rate case was for test year 1995.

The issue remaining in dispute between ORA and Cal Water regarding the Chico District is replacement of the customer service and operations center (customer center). This issue includes disputes regarding the cost of the new customer center and the treatment of the proceeds from the sale of the old center.

Cost of the New Customer Center

Cal Water had originally estimated that the new Chico Customer and Operations Center would be a $2,800,000 capital project in 2001, intended to provide greater efficiency and accessibility. ORA recommended that the unspent budgeted portion of the project, $1,391,000, be eligible for inclusion in rate base via an advice letter filing. ORA based its recommendation on the uncertainties, size and cost of the project. ORA also emphasized that Cal Water had not provided sufficient detail on the proceeds it expected to realize from any sale of the old operations center. ORA urged the Cal Water be required to track such proceeds as is required by § 790.

Cal Water, in rebuttal, said that it was scheduled to occupy the new facilities in May 2002. As of the date of serving the testimony, Cal Water had spent $339,600 and projected that the "total cost for the new facilities would be $1,391,000."²² Cal Water stated that it was able to estimate these costs with a high level of certainty, and that the costs should be included in rate base for test year 2002 rather than through an advice letter.

We note that ORA puts the total cost of this project at $2,800,000, while Cal Water claims the total will be $1,391,000. This is a huge discrepancy. Given this discrepancy, we cannot authorize this substantial increase in rate base without a further showing by Cal Water as to the amount actually spent. Moreover, as discussed below, given Cal Water's proposed treatment of the net proceeds from the sale of the replaced Chico operations center, we must carefully review the customer center replacement decision and impose any safeguards needed to ensure that ratepayers benefit from the incentives created by § 790. Consequently, we agree with ORA that the Chico customer center issue should be fully reviewed.

Rate Treatment of Sale Proceeds

Cal Water contended that any amount that may be realized from the sale of the old service center would "not likely impact Cal Water rates." In its brief, Cal Water explained that "[u]nder Cal. Pub. Util. Code § 790, if Cal Water invests at least the amount of its gain from the sale [of the old center] in new water facilities within eight years of the sale, it is permitted to earn a reasonable return on its investments instead of allocating the gain to ratepayers." Cal Water projected that the gain from the sale would be $455,000.

The issue is highly controversial due to the potential ratemaking ramifications of § 790. Cal Water takes the position that § 790, in effect, allocates any and all gain on the sale of the old customer center (or any other real property) to shareholders, provided that the "net proceeds" are reinvested in facilities needed for the utility's water system. To meet the reinvestment requirement of § 790, Cal Water contends that reinvestment of the actual sale proceeds is not necessary so long as the utility invests at least that amount in needed facilities during the same year. Under this reasoning, Cal Water concludes that the actual sale proceeds should be available for immediate distribution to shareholders.²³ Cal Water's statutory interpretation allowing this substitution process results in real property sales proceeds, such as the sale of the old Chico customer center, being allocated exclusively and immediately to shareholders.

In contrast, under ORA's reading of the statute and its preceding statement of legislative intent, Commission must track the sale proceeds to ensure reinvestment of those proceeds in utility infrastructure within eight years.

We have not previously had occasion to review the Water Utility Infrastructure Improvement Act of 1995 (Infrastructure Act), codified at §§ 789 to 790.1.²⁴ We begin our review by referring to the established principles of statutory interpretation. We summarized these principles quite recently:

We look to the well-recognized principles of statutory construction. The California Supreme Court has stated: "To interpret statutory language, the courts must ascertain the intent of the legislature so as to effectuate the purpose of the law." (California Teachers Assn. v. Governing Bd. of Rialto United School Dist. (1997) 14 Cal.4th 627, 632.) In determining the Legislature's intent, they are to "scrutinize the actual words of the statute giving them a plain and commonsense meaning." (People v. Vallodoli (1996) 13 Cal.4th 590, 597.) "In construing a statute, a court may consider the consequences that would follow from a particular construction and will not readily imply an unreasonable legislative purpose. Therefore, a practical construction is preferred." (California Correctional Peace Officers Assn. v. State Personnel Bd. (1995) 10 Cal.4th 1133, 1147.) "In analyzing statutory language, we seek to give meaning to every word and phrase in the statute to accomplish a result consistent with the legislative purpose . . . ." ( Harris v. Capital Growth Investors XIV (1991) 52 Cal.3d 1142, 1159.)

D.02-06-007 citing D.01-11-031.

We must therefore review §§ 789.1 and 790 and determine the Legislature's intent from the plain words of the sections. We are to seek a reasonable and practical interpretation that accomplishes the Legislature's goals.

The Legislature made specific findings and declarations of intent in § 789.1. Subsections (a) through (c) concern the need for new or improved water infrastructure. In subsection (a), the Legislature finds that water corporations are subject to increasing demands for new infrastructure to comply with increasingly strict safe drinking water laws and regulations. Subsection (b) concludes that maintaining and improving the state supply will require investment by water corporations in infrastructure, and subsection (c) finds similar needs for improving fire flow standards for public fire protection purposes. In sum, subsections (a) through (c) describe the infrastructure investment needs of water companies.

Subsections (d) and (e) concern the disposition, in certain circumstances, of water utilities' real property. Specifically, subsection (d) notes that water corporations may own real property that is no longer necessary to provide water service, and that now may be sold. The subsection then announces the policy that water corporations should be encouraged to dispose of such real property and to invest the net proceeds in needed utility infrastructure. Subsection (e) states that the investment of all net proceeds should be included among the water corporation's other utility property, upon which it earns a reasonable rate of return.

Thus, the first portion of the Infrastructure Act states that water utilities are confronted with increasing needs for investment in infrastructure. These utilities also may have no longer needed real property that can and should be sold to fund the needed infrastructure investments. Finally, the investments should be included among other utility property.

The second portion of the Infrastructure Act, codified at § 790, contains the operative portions of the Act. Subsection (a) directs that whenever a water corporation sells any no longer needed real property, the water corporation shall invest any net proceeds in needed water system infrastructure. The water corporation must also maintain records necessary to document the investment of the net proceeds. Subsection (a) further provides that any net proceeds from the sale of no longer needed property will be the water corporation's "primary source of capital" for investment in needed infrastructure.

Subsection (b) states that infrastructure funded by reinvestment of net proceeds should be included among the utility's other property, upon which it earns a reasonable rate of return. Subsection (c) imposes an eight-year limit on the utility's reinvestment period. Any net proceeds remaining after eight years must be allocated to the ratepayers.

Subsection (d) allows a small water corporation to apply to the Commission for an exemption from the requirements of the Infrastructure Act. Subsection (e) states that the "commission retains continuing authority to determine the used, useful, or necessary status of any and all infrastructure improvements and investments." This subsection, and § 851, provide the Commission complete authority to determine whether an asset is "necessary and useful" for a water utility.

In summary, § 790 requires water utilities to sell no longer needed property and to invest the net proceeds in needed infrastructure. These net proceeds are to be the utility's primary source of capital for infrastructure, and the utility must track the investment of the proceeds. The utility has eight years to re-invest the funds, and must include the property among its other utility property.

The directives of § 790 must also be considered in the context of extant Commission authority over water utilities. The Commission maintains complete authority over water utility rates, see, e.g., § 454, and the sale or encumbrance of utility property, § 851. The Legislature has granted the Commission far-reaching authority to "supervise and regulate" utilities in this state as set out in § 701. In adopting § 790(e), the Legislature explicitly recognized the Commission's on-going authority "to determine the used, useful, or necessary status of any and all infrastructure improvements and investments." This authority takes on enhanced importance in the case of rate base assets that the water utility proposes to transfer pursuant to § 790 due to the financial incentives Cal Water believes § 790 creates. Thus, we conclude that the Legislature expected the Commission to continue to exercise its authority over water utilities and to scrutinize sales and purchases proposed by water utilities pursuant to § 790.

Such scrutiny is critical to enable the Commission to meet its statutory obligations. Real property that is "necessary or useful in the performance of a water corporation's duties to the public" would have been included in a water utility's rate base upon which it earned a return. By authorizing the utility to earn a return in its rates on the value of the property, the Commission expects the property to be used to serve the public. The contrary determination, namely, that the property is "no longer necessary or useful" and consequently should not earn a return for the utility, requires that the Commission review how the property was employed in service to the public and how the need will be filled absent the property. The Commission must also determine the ratemaking treatment for assets and expenses associated with the sale of unneeded real property and reinvestment of the net proceeds from the sale.

Cal Water's Chico customer center replacement project does not comport with the statutory provisions, described above, for regulatory scrutiny and ratemaking treatment. First, the project is remarkably vague and the need for the project has not been demonstrated. Cal Water has not presented any objective fact, such as customer growth rates, that would justify this project. Second, the lack of regulatory scrutiny of this project to date cause us even greater concern in light of the ratemaking consequences were we to follow Cal Water's interpretation of the Infrastructure Act. While we need not, for reasons discussed later, decide on the merits of that interpretation, we note that the result of allocating all net proceeds to shareholders creates a powerful financial incentive for water utilities to sell real property. Our research indicates that this purported statutory right to allocate all gain on sale to shareholders is unprecedented in all regulatory jurisdictions in this country. Such a right could encourage water utilities to sell real property without regard to long-term customer service needs, and may even lead to real property speculation by water utilities, relying on rate base treatment to protect shareholders from losses but using § 790 to reap all gains. In short, the interpretation of this statute, and the potential consequences, will need to be fully analyzed and briefed when we address the ratemaking and rate base issues raised by the Infrastructure Act.

For now, however, we note that the Infrastructure Act creates new incentives and that those incentives require even greater regulatory scrutiny of real estate transactions to ensure that the intended benefits to ratepayers materialize. Accordingly, the Commission must carefully review the details of each real property parcel that a water utility proposes to sell pursuant to § 790. The Commission must consider both the history of the property proposed to be sold, its use to provide service to customers, its historic ratemaking treatment, as well as any potential future use to serve customers, whether any replacement property is needed, and such issues as may be specific to each proposed transaction.

Such scrutiny would be most conveniently accomplished in a general rate case, although the application process could also be used. There, the water utility could explicitly identify the properties it considered to be no longer necessary in the performance of its duties to the public, provide a detailed explanation with applicable historical, ratemaking, and future use analysis, and request authorization to treat the properties as being subject to § 790. The Commission would then review the proposals for compliance with applicable law and policy and issue a decision.

The Infrastructure Act requires water utilities to sell unneeded property that "was at any time" included in rate base, and to reinvest the net proceeds in water utility infrastructure. The utility must carefully track all such revenue to ensure that it is so invested. We have previously determined that net gain proceeds over original cost should go into a memorandum account with interest to be accrued for use as a capital fund for infrastructure additions and repairs. Tahoe Park Water Company, 73 CPUC 2d 715, 719 (D.97-08-021).

Therefore, in addition to the requirements set out above, we find that the Infrastructure Act requires that water utilities do the following:




1. Track all utility property that was at any time included in rate base and maintain sales records for each property that was at any time in rate base but which was subsequently sold to any party, including a corporate affiliate.




2. Obtain Commission authorization to establish a memorandum account in which to record the net proceeds from all sales of no longer needed utility property.




3. Use the memorandum account fund as the utility's primary source of capital for investment in utility infrastructure.




4. Invest all amounts recorded in the memorandum account within eight years of the calendar year in which the net proceeds were realized.

Conclusions Regarding Cal Water's Real Estate Issues

In reviewing the issues surrounding the replacement of the Chico customer center, we find that additional review of the facts as well as further evaluation of Cal Water's proposal is required. We observe that, as a threshold matter, § 790 may not even apply to this transaction. Here, Cal Water proposes to charge customers at least $1.4 million²⁵ to build a new customer center, declare the old one "no longer necessary or useful in the performance of [its] duties to the public," and give shareholders all the proceeds from the sale of the old center. Cal Water's proposal fails to recognize that but for the construction of the new center, the old center would be needed to serve customers. Thus, in looking at the entire project, the amount Cal Water expects to realize from the sale of the old center, $455,000, is more than offset by the cost of the new center.²⁶ Consequently, after detailed review of the facts, the Commission could conclude that there are no net proceeds from this transaction to consider allocating to shareholders. Thus, to enable the Commission to scrutinize the replacement of the Chico customer center, Cal Water must file an application with the information discussed above.

We are also concerned that the types of problems we have encountered here maybe recur with other Cal Water properties. In Cal Water's 2001 Annual Report, of which we took official notice elsewhere in today's decision, Cal Water states that it has embarked on a multi-year process to liquidate over $10 million in property:

Real Estate Program. The Company's subsidiaries own more than 900 real estate parcels. Certain parcels are not necessary for or used in water utility operations. Most surplus properties have a low cost basis. A program has been developed to realize the value of certain surplus properties through sale or lease of those properties. The program will be ongoing for a period of several years. During the next four years, the Company estimates that gross property transactions totaling over $10 million could be completed. In 2001, $3.9 million in pretax sales were completed. No transactions were completed during 2000. During 2002, the Company expects to complete sales in excess of $3 million.

Cal Water has not included any details of this program in its showing in this proceeding. We are, therefore, unable to conclusively determine that the properties included in the real estate program are not also subject to § 851²⁷, or to determine the proper ratemaking treatment of the amounts realized from the transactions.

We, therefore, order Cal Water to submit an application fully explaining in detail its real estate program from its beginning to current plans. All properties included in the program shall be specifically identified and the use and regulatory history of each property set out. Cal Water shall state its rationale for removing any property from rate base and provide supporting documentation. Cal Water shall include the accounting history of each property, including original cost and amount realized, for each property as well as the disposition of all proceeds. The Commission staff, after careful review of the proposed transactions for compliance with all applicable statutes and rules, will file and serve a detailed report on its review. The Commission will then issue an order with any further actions as may be necessary. Because all California water utilities may have an interest in our interpretation of § 790, we will also order Cal Water to serve its first § 790 application on all other California water utilities regulated by this Commission.

9.5 Dixon

Cal Water sought a 14.8% increase for Test Year 2002 in revenue requirement in the Dixon District. ORA recommended a 0.72% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 7.82% increase, and Cal Water's resolution yields an 8.09% increase for Test Year 2002.

Cal Water explained that, as with the other districts, the primary reasons for the rate increase are purchased power expenses (15% increase), general office expense allocation (66% increase), and the revenue requirement of rate base (8% increase). Cal Water also sees a large increase in payroll (33% increase). Customer growth of 6% and attrition and other non-general rate case rate increases have kept this increase lower than it otherwise would have been. The Dixon District's last general rate case was for test year 1996.

Issues remaining in dispute between ORA and Cal Water regarding the Dixon District have been addressed above.

9.6 East Los Angeles

Cal Water sought a 9.89% increase for Test Year 2002 in revenue requirement for its customers in the East Los Angeles District. ORA recommended a 4.79% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 7.04% increase, and Cal Water's resolution yields a 7.30% increase for Test Year 2002.

Cal Water explained that the primary reasons for the rate increase are purchased power expenses (54% increase), general office expense allocation (30% increase), payroll (15% increase) and rate base amortization (10% increase). An 8 % increase in water production and attrition and other non-general rate case rate increases keep down today's increase. This district's last general rate case was for test year 2000. The issues remaining in dispute between ORA and Cal Water regarding this district are: general office allocation of one regulatory analyst and the Board of Directors costs, and small main replacements and all have been addressed above.

9.7 Hermosa-Redondo

Cal Water sought a 16.12% increase for Test Year 2002 in revenue requirement for the Hermosa-Redondo District. ORA recommended a 5.4% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 12.61% increase, and Cal Water's resolution yields a 12.84% increase for Test Year 2002.

Cal Water explained that the primary reasons for the rate increase are purchased power expenses (23% increase), payroll (13% increase), general office expense allocation (29% increase), and rate base amortization (14% increase). The Hermosa-Redondo District's last general rate case was for test year 2000.

The issues remaining in dispute between ORA and Cal Water regarding this district are: general office allocation of one regulatory analyst and the Board of Directors costs, small main replacements, and painting of tanks 5B and C and reservoirs 3B and 8A - D. The general office and small main replacement issues have been addressed above.

ORA would reject various painting projects that totalled $42,300 in Test Year 2002, and for Test Year 2003, total $83,600. ORA stated that it had inspected the tanks and determined that coatings "were still OK."

Cal Water's initial testimony did not describe or provide a supporting rationale for this or any specific capital addition project. As discussed above, Cal Water has met its burden of demonstrating that it has a sound inspection program and that these tanks and reservoirs require painting. We will deny ORA's requested removal of these projects.

9.8 King City

Cal Water sought a 26.35% increase for Test Year 2002 in revenue requirement for the King City District. ORA recommended a 1.82% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 15.41% increase, and Cal Water's resolution yields a 15.68% increase for Test Year 2002.

Cal Water explained that the primary reasons for the rate increase are purchased power expenses (20% increase), general office expense allocation (118% increase), and rate base amortization (58% increase). The King City District payroll increase is also notable (52%). Customer growth, a 20% increase in water production and attrition and other non-general rate case rate increases keep today's increase below what it would have been otherwise. The King City District's last general rate case was for test year 1993. The issues remaining in dispute between ORA and Cal Water regarding the King City District are the general office issues, which have been addressed above.

9.9 Livermore

Cal Water sought a 5.7% increase for Test Year 2002 in revenue requirement for the Livermore District. ORA recommended a 5.7% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 1.4% increase, and Cal Water's resolution yields a 1.7% increase for Test Year 2002.

Cal Water explained that the primary reasons for the rate increase are purchased power expenses (134% increase), general office expense allocation (73% increase), and rate base amortization (22% increase). This district's last general rate case was for test year 1998.

The issues remaining in dispute between ORA and Cal Water regarding the Livermore District are: general office allocation of one regulatory analyst and the Board of Directors costs, small main replacements, and painting of station 23 tanks. The general office and small main replacement issues have been addressed above.

In its report, ORA did not object to the painting but rather alleged that Cal Water had revised the amount several times prior to hearing such that ORA could not verify the amount. Cal Water's original 2001 budget for this project was $99,800, but Cal Water later revised the amount to $84,400. Cal Water later reported the project complete in 2001, so ORA included it in its report in the amount of $84,400. Since then, ORA contends that Cal Water has identified the final amount as $100,006.09 and $105,500, and that these latest figures came too late in the process for ORA to confirm.

Cal Water testified that the accepted bid price was $73,900 but that the actual cost was $105,500 due to unexpected costs for inspector time. Cal Water asked the Commission to include the full amount of the project.

We note that this project experienced a 43% cost overrun - bid of $73,900 to $105,500 actual. We understand that even the best-managed bidding processes cannot be expected to foresee each and every cost component in every single bid. At the same time, however, we are concerned that this bid may appear to have been non-binding or "cost-plus." Cal Water provided no testimony on any change order or what explanation it required of its vendor to increase the bid price for the project. Most significantly, because Cal Water provided ORA the actual cost information so late in the process, ORA was unable to evaluate it.

We will include this project at the amount last timely reported to ORA, $84,400. This amount is over the bid price but not the alleged total actual price. We are unable to consider the higher amount advocated by Cal Water due to the lack of timely evidence.

9.10 Los Altos

Cal Water sought a 14.54% increase for Test Year 2002 in revenue requirement for the Los Altos District. ORA recommended a 0.13% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 6.96% increase, and Cal Water's resolution yields a 7.4% increase for Test Year 2002.

Cal Water explained that the primary reasons for the increase include the usual ones such as are purchased water expenses (48% increase since 1996) and general office expense allocation (58% increase), with the cost increases partially offset by a 10% increase in water production as well as other rate increases since the last general rate case for test year 1996.

The issues remaining in dispute between ORA and Cal Water regarding this district include the general office and small main replacements issues discussed above. ORA and Cal Water are also at odds with regard to the forecast for contracted maintenance.

In addition to maintenance performed by its own employees, Cal Water contracts with outside vendors for some maintenance services. To forecast this expense for this proceeding, Cal Water averaged the expenses for five years of recorded inflation-adjusted data, from 1996 to 2000. ORA did the same with four years' data, disregarding 2000, because that year was 80% over the 1999 amount.

In its brief, ORA pointed out that Cal Water proposes to add three new employees for the Los Altos District - one Foreman, one Inspector, and one Operations Maintenance Worker. Cal Water justified these new positions based on improved maintenance, among other things. Cal Water did not, however, adjust its forecast for maintenance expenses to reflect these three new employees.

The impact of the difference between the two forecasts is not large, about $29,000 in revenue requirement for each of the two test years. The Los Altos District's revenue requirement for Test Year 2002 is over $12 million. Cal Water bears the burden of demonstrating that its forecast of contracted maintenance costs is reasonable. ORA persuasively argues that the new employees should reduce such costs and that Cal Water has not accounted for this reduction. We will adopt ORA's requested forecast as a conservative reflection of cost reductions expected from the additional three new employees.

9.11 Marysville

Cal Water sought a 28.06% increase for Test Year 2002 in revenue requirement for its Marysville District. ORA recommended a 9.13% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 19.78% increase, and Cal Water's resolution yields a 20.05% increase for Test Year 2002.

Cal Water explained that the primary reasons for the increase are purchased power expenses (43% increase), general office expense allocation (43% increase), payroll (19% increase) and rate base amortization(20% increase). These increases are also necessary to reflect a 4% decrease in water sales. This district's last general rate case was for test year 1999. The issues remaining in dispute between ORA and Cal Water regarding the Marysville District are the general office allocation and small main replacement issues that have been addressed above.

9.12 Mid-Peninsula District

Cal Water sought a 12.5% increase for Test Year 2002 in revenue requirement for the Mid-Peninsula District. ORA recommended a 0.51% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 5.2% increase, and Cal Water's resolution yields a 5.61% increase for Test Year 2002. The Joint Recommendation also provides that Cal Water will file an advice letter when it completes its new customer operations center.

Cal Water explained that the primary reasons for the increase are purchased power expenses (67% increase since 1994), general office expense allocation (66% increase), payroll (34%), and rate base amortization (22% increase). A 13% increase in water production as well as other rate increases since the last general rate case for test year 1994 keep down today's increase.

The issues remaining in dispute between ORA and Cal Water regarding the Mid-Peninsula District include the general office allocation and small main replacement issues addressed above. In addition, ORA and Cal Water base their respective forecasts of contracted maintenance on different periods.

As in the Los Altos District, Cal Water forecast contracted maintenance by averaging the expenses for five years of recorded inflation-adjusted data, from 1996 to 2000. ORA did the same but with a different five-year period - 1995 to 1999. ORA's witness testified that he disregarded 2000 data for his average because the amount was 100% over the 1999 amount, which is the basis on which ORA disregarded the 2000 amount in the Los Altos District as well.

The contract maintenance issue in this district and the Los Altos District raise the same question: When using historical averages to forecast future expenses, how should data that significantly deviates from the average be treated? Neither Cal Water nor ORA explicitly address this question. Cal Water would include the 2000 data, and ORA exclude it. Cal Water bears the burden of demonstrating that its forecast of contracted maintenance costs is reasonable, and it has not articulated a rationale to support including the 2000 data. Cal Water presented testimony detailing each contracted maintenance project for 2000 in the Mid-Peninsula district, and stated that the amount of contracted maintenance expenses vary due to "the number of main and service leaks, hydrant replacements, and valve replacements," and that the costs for leaks can vary significantly depending on location, time of day or day of week, and amount of excavation required. What Cal Water's rebuttal testimony does not do is provide sufficient evidence that the average of the five-year period 1996 to 2000 is a better predictor of Test Year contract maintenance than the five-year period 1995 to 1999. Cal Water bears the burden of proof and it has not met it. We will therefore adopt ORA's forecast for contracted maintenance.

The Joint Recommendation provides for Cal Water to file an advice letter for recovery of capital costs of a new Mid-Peninsula customer operations center, provided that the amount does not exceed $1,000,000 and that it goes into service prior to January 1, 2005. Cal Water provided no testimony on this capital project. According to ORA's Mid-Peninsula District report, Cal Water determined that its current customer operations center in this district is inadequate for current staff configuration. ORA investigated the proposed new operations center and discovered that there were no definitive plans for the location, size, or cost of the new center, or for the disposition of the current operations center. ORA, therefore, recommended an advice letter filing when the project is completed, due to these uncertainties. ORA's report did not contain any evaluation of the reasonableness of replacing the operations center, or of the alternatives.

The record on this issue is extremely limited, far too limited to support assigning this issue to the advice letter process. The record shows that Cal Water has not made any final plans for replacing the operations center. In fact, Cal Water has presented no justification of any kind in the record for this million-dollar project. The advice letter process is not well suited for the broad review necessary to evaluate the need for this project and the reasonableness of Cal Water's yet-to-be selected components of the project. For this reason, we will reject this portion of the Joint Recommendation.

9.13 Stockton

Cal Water sought an 11.28% increase for Test Year 2002 in revenue requirement for the Stockton District. ORA recommended a 0.46% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 7.94% increase, and Cal Water's resolution yields an 8.23% increase for Test Year 2002.

Cal Water explained that the primary reasons for the increase are purchased power expenses (39% increase), payroll (18% increase), general office expense allocation (57% increase), and rate base amortization (12% increase). This district's last general rate case was in 1997.

The issues remaining in dispute between ORA and Cal Water regarding the Stockton District are: general office allocation of one regulatory analyst and the Board of Directors costs, small main replacements, and painting of tank 3 and reservoirs 10 A and B. The general office and small main replacement issues have been addressed above.

In its report, ORA recommended that the Commission reduce Cal Water's capital budget by $88,300 in Test Year 2002 for painting reservoirs 10 A and B. For Test Year 2003, ORA similarly excluded the costs of painting tank 3 ($96,300). ORA stated that it had inspected the tank and reservoirs and that Cal Water had decided to postpone painting tank 3 until the next rate case. For reservoirs 10 A and B, ORA stated that its inspection showed that the tank was in "fairly good condition" and that only the legs showed "minor deterioration."

As discussed above, Cal Water's Tank Maintenance Supervisor presented specific analysis of tank 3 and reservoirs 10 A and B. Cal Water has met its burden of demonstrating that it has a sound inspection program and that this tank and these reservoirs require painting.

9.14 Visalia

Cal Water sought an 11.70% increase for Test Year 2002 in revenue requirement for the Visalia District. ORA recommended a 4.96% decrease for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in a 5.25% increase, and Cal Water's resolution yields a 5.85% increase for Test Year 2002.

Cal Water explained that the primary reasons for the increase are purchased power expenses (47% increase) and general office expense allocation (28% increase). A 4% increase in customers, a 5% increase in water production, and attrition and other non-general rate case rate increases keep today's increase below what it would have otherwise been. This district's last general rate case was for test year 2000. The issues remaining in dispute between ORA and Cal Water regarding the Visalia District are the general office allocation and small main replacements issues that have been addressed above.

9.15 Westlake

Cal Water sought a 14.86% increase for Test Year 2002 in revenue requirement for the Westlake District. ORA recommended a 2.89% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in an 8.76% increase, and Cal Water's resolution yields an 8.95% increase for Test Year 2002.

Cal Water explained that, as with the other districts, the primary reasons for the rate increase are purchased power expenses (26% increase), general office expense allocation (64% increase), and payroll (19% increase). A 22% increase in water sales and attrition and other non-general rate case rate increases keep down the size of today's increase. This district's last general rate case was in 1996. The issues remaining in dispute between ORA and Cal Water regarding this district are the general office issues and small main replacement issues that have been addressed above.

Also, Cal Water, ORA, Aglet, and North Ranch reached a Joint Recommendation on Reclaimed Water Rates. The Reclaimed Water Joint Recommendation is Attachment C.

The testimony showed that North Ranch purchases approximately 90% of the reclaimed water sold by the Westlake District. Cal Water sells reclaimed water only in one other district, Hermosa-Redondo, where it obtains reclaimed water from a different source, with different prices and facilities. In Westlake, Cal Water purchases the reclaimed water at wholesale from Calleguas Municipal Water District. Cal Water has invested approximately $14,480, less depreciation, for facilities to serve North Ranch. Cal Water incurs virtually no operating costs to deliver the reclaimed water to North Ranch. Cal Water's existing rates, however, provide for a 33% mark up over wholesale costs. Proposed rates would increase the amount North Ranch pays. In its prepared written testimony, North Ranch's expert witness contended that this mark up was excessive.

In the Joint Recommendation, the parties agreed to reduce the reclaimed water rate (both the service charge and volumetric components) proposed by Cal Water in this proceeding by 20%, but only so far as the resulting rate would not be lower than the previously applicable rate. If the rate resulting from applying the discount is lower than the previously applicable rate, then the previously applicable rate shall remain in effect. The Joint Recommendation includes sample calculations.

All active parties have agreed to the Reclaimed Water Joint Recommendation, after having reviewed all direct and rebuttal testimony. The recommendations are the result of significant negotiation and compromise of the parties thereto on issues substantially affecting them, and the parties agree that this is a fair resolution of their differences. The proposed resolution will substantially reduce Cal Water's effective mark up over its wholesale costs as sought by North Ranch, but such a reduction is limited by previously applicable rates, which will provide other Cal Water ratepayers with a contribution to overall operating costs. The Reclaimed Water Joint Recommendation is not procedurally flawed and is not contrary to law or Commission policy.

In sum, the Reclaimed Water Joint Recommendation is a reasonable compromise of this issue. We find, therefore, that it is reasonable in light of the whole record, consistent with the law, and in the public interest.

9.16 Willows

Cal Water sought a 17.10% increase for Test Year 2002 in revenue requirement for the Willows District. ORA recommended a 5.43% increase for the same period. ORA and Cal Water reached a Joint Recommendation on most, but not all, issues affecting this district. ORA's resolution of the disputed issues results in an 11.48% increase, and Cal Water's resolution yields an 11.77% increase for Test Year 2002.

Cal Water explained that, as with the other districts, the primary reasons for the increase are purchased power expenses (28% increase), payroll (40% increase), and general office expense allocation (61% increase). An 8.31% increase in water production plus attrition and other non-general rate case increases since the Willows District's last general rate case for test year 1996 keep down today's increase.

The issues remaining in dispute between ORA and Cal Water regarding the Willows District are: general office allocation of one regulatory analyst and the Board of Directors costs, small main replacements, and painting of tank 1. The general office and small main replacement issues have been addressed above.

ORA would defer $44,600 in capital costs from Test Year 2003 to 2004 but ORA did not identify the project or state a supporting rationale for this deferral in its report. Cal Water's initial testimony did not describe or provide a rationale for this or any specific capital project. As discussed above, Cal Water's rebuttal testimony explained all painting projects, and specifically points out that tank 1 has been in service since 1921 and that primer and rust are exposed in 10-15% of the roof area. Because the dollar amount identified by Cal Water corresponds to that of ORA's deferral, we conclude that the parties are referring to the same project. Cal Water has met its burden of demonstrating that it has a sound inspection program and that this tank requires painting.