5. The Settlement Agreement Between ORA and Cal-Am

A. Cost of Capital

One of the most important provisions in the settlement agreement between Cal-Am and ORA is the provision relating to cost-of-capital. For example, on the question of capital structure, Cal-Am originally advocated a long-term debt ratio of 46 to 49% (increasing from 2005 to 2007), whereas ORA had advocated a ratio of 57 to 58%. In their settlement agreement, the parties agreed upon a ratio of 55% long-term debt to 45% common equity for both the Coronado and Village Districts for all three years. Cal-Am had also advocated a return on equity (ROE) of 10.50% for each of the three years, while ORA had advocated an ROE of 9.34%; in their settlement agreement, the parties agreed to use an ROE of 10.10% for both districts for each of the three years.

The stipulations regarding cost of capital had a significant effect on the parties' ultimate agreement as to revenue requirement. For example, David Stephenson of Cal-Am testified that about half of the $641,000 difference between Cal-Am's original position on the 2005 Village District revenue requirement and the figure the company ultimately accepted was accounted for by the stipulation reducing ROR. (August 16 Transcript, pp. 133-34.)⁷

The table below shows each party's original position on revenue requirement, along with the figures they ultimately agreed to:

	Cal-Am	ORA	Settlement
	$ (000s)	$ (000s)	$ (000s)
Coronado
2005	12,707.0	12,275.0	12,483.0
2006	12,680.4	12,284.0	12,510.0
2007	12,652.0	12,251.1	12,520.78
Village
2005	18,463.3	17,693.7	17,822.3
2006	18,574.5	17,883.7	18,042.3
2007	18,579.2	17,712.2	18,084.39

B. Noteworthy Provisions Concerning Coronado in the ORA Settlement Agreement

For the Coronado District, a small part of the difference between what Cal-Am originally sought as a revenue requirement and what it stipulated to are accounted for by certain adjustments to Operations and Maintenance (O&M) and Administrative and General (A&G) expenses. Although Cal-Am generally accepted ORA's estimates of O&M and A&G expenses for Coronado, there were certain departures from this pattern. The departures are described in paragraphs 4.1-4.3 and 5.1-5.2 of the settlement agreement with ORA.

Two off-setting items concerning plant additions deserve mention. In its application, Cal-Am had proposed to spend $150,000 to construct a building at the Third and Calla Street station in Imperial Beach. In the settlement discussions, Cal-Am agreed with ORA that because the project cannot be completed in 2007 due to the time needed for regulatory approvals and building permits, the project should be considered beyond the scope of this application. (ORA Settlement Agreement, ¶ 7.1.) However, ORA ceased opposing the inclusion of $150,000 in costs for installing 530 feet of 8-inch water main on Palm Avenue in Coronado, because ORA accepted Cal-Am's position that water pressure in the area currently falls below Commission standards from time to time. (Id. ¶ 7.2.)¹⁰

Another issue between the parties was how a sale of land containing a tank should be accounted for. The land was sold in 2000, but had been classified as non-operating property in 1982. ORA took the position that as a result of the sale, Cal-Am should be required to increase its contributions owing to net plant gain. In the settlement agreement, Cal-Am agrees that because this general issue is likely to be considered in the recently-instituted proceeding concerning gain-on-sale, Rulemaking (R.) 04-09-003, Cal-Am will reduce its 2005 and 2006 ratebase, for purposes of this ratecase only, by $86,600. (Id. ¶ 7.4.)

As noted in the introduction, one of the major issues for the Coronado District in future years will be the development of additional water supplies. To address this, Cal-Am proposed to establish a memorandum account to track the costs of its participation in a study of supply alternatives for the San Diego region (which is known as Region 4) being promoted by the Metropolitan Water District (MWD). ORA opposed the request, partly because ORA believed the expenses of the study did not meet the criteria for memorandum accounts set forth in D.02-08-054. In their settlement, the parties have agreed that all charges related to the regional study will be accounted for as "preliminary survey and investigation" and not included in rates at this time. (Id., ¶ 6.1.) However, in response to questioning by the ALJ, David Stephenson stated that Cal-Am would be free under the settlement agreement to seek recovery of the costs associated with the Region 4 water supply study in future rate cases. (Tr., pp. 128-29.)

The parties reached a somewhat different result with respect to the memorandum account Cal-Am had requested to cover additional purchased water expense in the event that San Diego (which has not read its meters in several years) were to back-bill Cal-Am for additional water. ORA had opposed this request, partly on the ground that Cal-Am's existing balancing account for purchased water costs was sufficient. In their settlement, the parties agreed to use a 0.54% water loss factor, and also agreed that Cal-Am could establish a separate memorandum account to track additional purchased water expense above the 0.54% factor. However, the amount that the can be booked in the new account is capped at 1.54%; i.e., 100 basis points over the water loss factor that the parties have otherwise agreed to. (ORA Settlement Agreement, ¶ 6.2.)

Apart from the issue of rate assistance for low-income customers (a question discussed separately below), the only other point in the Coronado settlement that needs to be mentioned is the parties' agreement on how franchise fees should be treated. In its application, Cal-Am had requested as a special condition that the franchise fee it now pays to Imperial Beach (and the one it expects will soon have to be paid to San Diego) should no longer be treated as part of the utility's revenue requirement, but should instead be treated as a surcharge and shown as a separate line item on customer bills. (Coronado Application, pp. 6-7.) In its report, ORA opposed the request, arguing that it was contrary to long-standing Commission policy. In the settlement agreement, ORA agreed to Cal-Am's proposal, owing to the use of this approach elsewhere in the company, and to the fact that only two of the three jurisdictions in the Coronado District charge franchise fees. (ORA Settlement Agreement, ¶ 11.1.)

C. Noteworthy Provisions Concerning the Village District in the ORA Settlement Agreement

With a few exceptions, ORA and Cal-Am resolved their differences over the Village District application by using the same approaches employed in the Coronado settlement. For example, the parties agreed to the same cost-of-capital provisions described above, and also agreed that the Village District would treat franchise fees as a surcharge on customer bills, rather than treating them as part of the revenue requirement. (ORA Settlement Agreement, ¶¶ 2, 20.1.) Cal-Am also accepted ORA's estimates for expenses, except for the matters set forth in ¶¶ 15.1 to 15.5, where Cal-Am provided ORA with more up-to-date information.¹¹

Two items concerning plant additions deserve special mention. First, ORA had opposed Cal-Am's proposal to replace 1.9 miles of 12-inch main along Price Road serving the Los Pasos area. ORA argued that in view of estimated annual repair costs of $24,000, the $1,350,000 price tag for a new main could not be justified. (Exhibit 13, ¶ 5.3.) In his rebuttal testimony, Benjamin Lewis of Cal-Am argued that this was short-sighted, in view of the possible loss of electric power, large quantities of mud and other problems that a serious break in the existing main could create. (Ex. 11, pp. 5-6.) In the settlement agreement, ORA agreed that replacement of the main along Price Road was reasonable, and that upon completion of the project, Cal-Am could file an advice letter for no more than $1,350,000 to cover the costs of the project. (ORA Settlement Agreement, ¶ 16.2.)

Cal-Am also proposed spending $150,000 in 2005 to create an interconnection with Thousand Oaks at the eastern end of the El Dorado Zone, so that fire flow could be increased to 1,000 gallons per minute (gpm) from the current 600 gpm. In their settlement agreement, the parties agreed that in view of Cal-Am's tentative agreement with Thousand Oaks to exchange the Conejo Oaks and Academy service areas, the interconnection project is not needed at this time. (Id., ¶ 16.3.)

D. The Parties' Settlement Concerning Rate Assistance for Low-Income Customers

In D.02-12-068, the Commission conditionally approved a settlement agreement that had the effect of transferring control of Cal-Am's corporate parent, the American Water Works Company, to RWE Aktiengesellschaft, a German industrial company that is an international provider of water, gas, electricity and other utility services. One of the conditions approved in D.02-12-068 was a commitment by Cal-Am to spend $50,000 of shareholder funds per year for five years to help establish a low-income assistance program for its ratepayers. (Mimeo. at 21-23.)

To help meet this commitment, Cal-Am proposed the same low-income assistance program for the Coronado and Village Districts that it has proposed for other districts. Eligibility for the program would be limited to water end-users (a broader group than Cal-Am customers) with incomes not exceeding 175% of federal poverty guidelines. In cases where the user was a Cal-Am customer, the company proposed that the program would work as follows:

"[T]he user would receive a reduction in their monthly water bill equal to the lower of their monthly basic service charge, or $10. This amount would be shown as a reduction on their bill. Any user on a flat rate service (primarily in Cal-Am's Sacramento District) would receive a reduction of half of their monthly service charge, or $10, whichever is greater." (Stephenson Direct Testimony, Ex. 1, p. 28.)

In cases where the water user was not a direct Cal-Am customer because the user rented a home or apartment that was individually metered, Cal-Am proposed that the program work as follows:

"These users would receive a credit against their rent. Their credit would be equivalent to the lower of the monthly service charge paid by a 5/8" metered Cal-Am customer in this district, or $10. Users on a flat rate service will receive half of that monthly charge, or $10, whichever is greater. The user would need to get an agreement with the landlord to lower their rent and then provide Cal-Am with a certified statement to that [e]ffect. The Company would then lower the water bill to the landlord by the appropriate amount. This certification would need to be renewed annually." (Id. at 29.)

In cases where the low-income user rented an apartment in a master- metered complex without submetering, Cal-Am proposed that the program work in the same way, except that it would be the landlord's water bill that would be lowered by the appropriate amount, with the landlord being obliged to pass this reduction on to the tenant. (Id.) Cal-Am also proposed that users taking advantage of its low-income assistance program be required to install conservation kits, including toilet dams and faucet flow reducers. (Id. at 32.)

In its July 6, 2004 reports on the Coronado and Village applications, ORA opposed Cal-Am's proposal as overly complex and burdensome. ORA suggested that Cal-Am would be taking on too many additional burdens by having to identify all qualified non-customer users, verifying the validity of landlord-tenant agreements, distributing and tracking assistance coupons to eligible users, and ensuring that promised decreases in rent were actually passed on to tenants. ORA was also concerned that the additional costs of conducting these activities could dramatically increase the costs of the low-income assistance program, costs that would have to be borne by higher-income customers. (Ex. 12, ¶¶ 13.6-13.10; Ex. 13, ¶¶ 9.20-9.22.)

As an alternative, ORA proposed the same low-income assistance program it had advocated in Application (A.) 03-07-036. Under this program, customers of Cal-Am with incomes no greater than 175% of the federal poverty guidelines would receive a 15% discount on their bill. The discount would also be available to low-income consumers residing in mobile home parks or multi-unit complexes where the Cal-Am customer was the landlord, but tenants were billed for their individual water usage through sub-meters. ORA's program would not be available for low-income consumers living in multi-unit dwellings that were not individually sub-metered, since ORA thought that situation presented too many complexities. ORA's program did not require any conservation measures by customers, since ORA thought the program was unlikely to induce additional consumption. ORA also proposed the creation of a memorandum account in which revenue shortfalls associated with the program would be booked, with Cal-Am being free to seek rate recovery of these amounts later. (Ex. 12, ¶¶ 13.11-13.18; Ex. 13, ¶¶ 9.24-9.30.)

In their settlement agreement, the parties agreed to adopt ORA's proposal, but made clear this was done only as an interim expedient:

"[Cal-Am] agrees to this proposal as a pilot project for this proceeding only, and the acceptance of it here does not limit [Cal-Am's] ability to request modification, alteration or elimination of this program in the future. The Parties agree that an industry-wide program is preferable and should be the subject of further discussions and investigations." (ORA Settlement Agreement, ¶¶ 12, 20.2.)