D. Marginal Customer Costs

ORA accepts Sierra's calculation of marginal energy and demand costs. However, ORA and Sierra differ over the appropriate treatment of marginal customer costs. With respect to marginal customer costs, ORA recommends the Commission continue to rely on its preferred New Customer Only (NCO) methodology to allocate marginal customer costs. Sierra recommends using the Real Economic Carrying Costs (RECC) approach to measuring marginal customer costs. Sierra's methodology allocates a greater share of costs to residential classes (56.5 percent) than would occur under the NCO method (53.3 percent).¹

Under the RECC approach, the annual customer investment costs- -the transformer, service drop, and meter (TSM)- - are multiplied by an annual economic carrying cost. This yields annual customer related investment costs. Variable costs such as billing, metering, and customer services are then added to the annual investment costs.

Under the NCO method the full lump sum costs of new hook-ups are allocated to each class based on the number of new customers. Specifically, the NCO methodology replaces the RECC factor with a replacement or present value factor. The NCO approach also includes adjustments for billing, metering, and related customer services. Finally, the NCO methodology allocates marginal customer costs to each class based on the number of new hook-ups in each class.

Sierra strongly opposes the use of the NCO method to determine customer cost responsibility. It says that the NCO method is based on the company's expected investment in new and replacement customer hookups each year, which is derived from estimates of new customer growth plus failures of existing hookups. The total annual investment is then allocated among all customers, existing and new, to derive a cost per customer. Sierra believes it is not a cost in any meaningful context of a marginal cost. It argues that the NCO method spreads the expected investment among all customers, new and existing. Efficient pricing dictates that the customer should be exposed to the full cost of his decision to connect to the system. The NCO method does not achieve this when it spreads the investment among all customers. The new customer sees only a fraction of the hookup costs he incurs. Furthermore, it says, the NCO method also includes replacement costs each year, which are not marginal with respect to the addition of a new customer. They would occur whether or not a new customer is connected to the system. Inclusion of these costs in the marginal cost study is not appropriate.

Sierra contends that the NCO methodology breaks down when customer growth is negative. ORA recognizes this limitation of the NCO methodology, but submits that it is not relevant in the present case. ORA has shown, and Sierra does not dispute, that the company's growth factor is not negative. For the 2003 test year, Sierra's estimated customer growth is 1.1%, and was even higher at 1.7% between 2001 and 2002. Sierra's customer growth rates were similar to those experiences by Southern California Edison Company (SCE) and Pacific Gas and Electric Company (PG&E).

Both ORA and Sierra cite economic theory to support their contrary arguments. In this battle of theories played out over the years, we have come down on the side of the NCO analysis. We are not persuaded to change.

In D.96-04-050, we endorsed the NCO method, stating that:

We believe that marginal cost principles dictate that a class with more new hookups, relative to others, should have responsibility for a larger portion of associated marginal costs, just as a class with more coincident peak demand should be assigned a higher proportion of marginal generation costs. The rental method does not reflect this fundamental reality. . . . Second, we find that the rental method is premised on an assumption concerning opportunity value that does not hold for customer hookups.

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Third, we believe that the rental method does not produce a competitive price for customer hookups, and, in fact, significantly overstates the price that would prevail in a competitive market. . . .²

In D.97-04-082, we elaborated on our support for the NCO method:

The NCO method is preferable to the rental method as it improves both the price signal to the customer and costing accuracy. Parties have not presented any new evidence in this proceeding that causes us to change the conclusion we reached in PG&E's last BCAP, D.95-12-053 or Edison's GRC, D.96-04-050.³

Sierra's objection to the NCO method on the ground that it would produce inappropriate costs if the growth of customers were extremely low or negative, is not applicable here. For test year 2003, Sierra is forecasting a customer growth rate of 1.1 percent. Over the period December 2001 to December 2002, Sierra experienced a customer growth rate of 1.70 percent in its California service area. Sierra's customer growth rates are similar to those experienced by SCE and PG&E.