18. Rate Base - Other than Plant in Service

SCE proposes that its fuel inventories be split into permanent and temporary components with separate ratemaking for each. The permanent component would be included in rate base and treated as a long-term asset financed with a combination of debt, common equity and preferred equity. SCE's test year estimate for the permanent fuel inventory to be included in rate base is $88,107,000.

SCE recognizes that in its 1995 GRC, the Commission denied a similar request.95 However, SCE submits that circumstances have changed since that decision was issued that allow for the inclusion of permanent fuel inventories in rate base. In the 2003 GRC decision, the Commission found that a permanent level of customer deposits was available for working capital. The Commission now requires SCE to rely on customer deposits as a permanent source of financing for a portion of rate base. SCE argues that since the Commission has changed its policy regarding the use of customer deposits, it's only proper to now revisit the fuel inventory issue. It is SCE's position that, if customer deposits are to be considered a credit to rate base, it is reasonable and fair as a matter of policy to provide parallel treatment for the permanent portion of fuel inventories and permanently finance them by adding them to rate base.

In support of its position, SCE notes that the Commission continues to treat natural gas inventories held by gas distribution companies using the same method SCE proposed for it fuel inventories. Also, FERC policies include in rate base the fuel inventories at issue in this proceeding.

Currently all of SCE's fuel inventory costs are recovered annually through ERRA proceedings. According to ORA, SCE's current cost recovery method for fuel inventory through annual ERRA proceedings, results in a total cost of $7 million, while under SCE's proposed fuel inventory cost recovery method of permanently adding a portion of fuel inventories to rate base, the total cost would be $14.9 million. ORA opposes SCE's proposal to rate base a permanent portion of inventory given the historical treatment of the costs and that SCE's proposal increases cost with no benefit.

Regarding SCE's claim of changed circumstances, ORA states that there is no direct link, within the policy regarding customer deposits, to justify altering the handling of fuel inventories.

We are not persuaded to change the current ratemaking treatment for fuel inventory. There is a long history to this issue.96 Following are a few excerpts from relevant decisions.

In D.85-12-107, the Commission first addressed the question of proper rate treatment of fuel inventory for SCE.

Edison no longer shall be allowed to charge ratepayers the cost of carrying fuel oil in inventory at the authorized rate of return. There are several reasons for this. First, the authorized rate of return includes equity and long-term debt. The cost of using equity rather than debt is higher to the ratepayer because of the income tax that must be recovered with a return on equity. Second, the balancing account associated with the ECAC expense was not designed to reward the company with its rate of return on a non-rate base item but to shield the company from wide swings in fuel expenses. Finally, the low-risk nature of fuel oil inventories call for a different ratemaking approach.97

The Commission concluded:

Fuel oil inventory is low risk. Unlike rate base assets, fuel oil inventory is subject to balancing account treatment. In effect, Edison (SCE) has been guaranteed recovery of its rate of return on a low-risk asset. This result was never intended to occur through ECAC procedures.98

In D.87-12-066, the Commission extended the above holding to SCE's coal and nuclear fuel inventories. The Commission stated:

Although Edison (SCE) points out that the operating and life cycle characteristics of nuclear fuel are not the same as coal, gas, and oil, we believe that this is not enough to warrant a different ratemaking treatment. In fact Edison (SCE) proposes to finance nuclear fuel with a combination of short and intermediate-term debt. While this might indicate that there is a need to factor in the cost of intermediate debt in deriving the carrying cost associated with nuclear fuel, it does not justify rate base treatment.99

The Commission further stated it preferred the use of short-term debt instruments to determine carrying charges on fuel. Because fuel "is a commodity that can be used as collateral for financing and is distinguishable from fixed plant and land...fuel should not be afforded rate base treatment, regardless of its characteristics."100 The Commission directed SCE to calculate carrying costs on its unspent nuclear fuel and coal reserves using the cost of short-term debt, and continue to include these costs in its former ECAC (now ERRA) balancing account.

In D.96-01-011, the Commission denied SCE's previous proposal to split fuel costs into permanent and temporary portions and disagreed with the permanent inventory level concept, stating it did not believe the increased risk SCE was willing to assume was significant enough to justify a change in financing. The Commission also stated:

We believe it more efficient to include determinations of the reasonableness of fuel inventory levels in the ECAC proceedings. That proceeding engages fuel experts who review the utility's fuel purchasing policies as a whole. Taking out one piece of that puzzle for general rate case review may result in an incomplete analysis of fuel practices.101

SCE has not provided sufficient reason for us to change the current ratemaking policies for fuel inventory as described and justified above. SCE does state that the Commission's decision, in SCE's 2003 GRC, to include customer deposits as a rate base deduction is reason to reconsider the issue in this proceeding. We disagree. In D.04-07-022, we stated the following:

SCE contends that TURN's proposed treatment of customer deposits is inconsistent with the Commission's treatment of fuel inventory working capital. When SCE carried large amounts of fuel oil inventory, it requested that some minimum level of inventory be considered permanent. The Commission rejected this position, and SCE received only short-term interest rate recovery for its fuel oil inventory. However, in rejecting SCE's proposal to rate base a portion of fuel inventory, the Commission held that "the risk Edison is offering to assume [of a change in value of the inventory] is not significant enough to justify a change in financing of the carrying costs." (64 CPUC 2d 241, 382, Finding of Fact 110-111.) SCE has not demonstrated to our satisfaction that the circumstances that led the Commission to reject SCE's proposal to rate base fuel inventory are equivalent to the circumstances attendant to TURN's proposal for customer deposits.102

Nothing has changed. The reasons why we rejected rate base treatment for fuel inventory has nothing to do with the reasons why we included customer deposits in the operational cash requirement analysis. Fuel inventory was excluded from rate base because of the cost to ratepayers, the balancing account treatment for fuel expenses and the low risk nature of fuel inventories. Inclusion of customer deposits in the operational cash requirement is not new. Non-interest bearing customer deposits have always been included. SCE however pays interest on customer deposits, so prior to D.04-07-022, its customer deposits were excluded in developing the operational cash requirement. The Commission, in D.04-07-022, instead compensated SCE for the interest it pays on customer deposits and estimated a balance of funds that would be available to offset the operational cash requirement. The result was reduced overall costs to ratepayers, while SCE was fully compensated for the interest costs that it paid.

The Commission's determinations regarding fuel inventory and customer deposits are consistent, in one respect. That is, changes were made to existing practices, which resulted in reduced rates while still providing SCE a fair opportunity to recover its costs. These results are consistent with our responsibilities, in general, and we see no reason to alter the currently adopted ratemaking associated with either issue.

For Materials and Supplies (M&S), SCE used an inventory turnover method to forecast the balances for this GRC cycle. This methodology is based on the level of material-related expenditures flowing through the M&S inventory and the inventory turnover rate. SCE developed different turnover rates for T&D M&S and Generation and Base M&S. SCE indicated that the T&D M&S inventory turned over at a rate of about 4.4 times per year. SCE then applied this turnover rate to the annual M&S expenditures flowing through inventory to estimate test year 2006 M&S inventory level attributable to Transmission and Distribution projects. SCE determined that its generation related M&S inventory had lower turnover rates than T&D and the balances were expected to be more stable, with a slight annual decrease projected for the GRC period. SCE's resultant test year estimate of $146,677,000 also reflects its agreement with TURN's proposed adjustment to reflect sales tax deferrals associated with Edison Material Supply, LLC.

Because the Commission, in SCE's last GRC, determined that SCE could not establish any direct and proportional relationship historically between the M&S inventory level and plant additions, and because SCE's M&S inventory appeared to drop from $139,504,000 in 2003 to $131,419,000 in 2004, ORA recommends that the Commission reject inventory turnover as a appropriate method to estimate the test year 2006 M&S balance. ORA recognizes SCE's increasing efforts to optimize M&S inventory and increasing resources, such as the Material Management System, to do so. Because of this, ORA expects the M&S inventory level to decline in the future years as opposed to SCE's growth forecast. ORA computed a 5-year (2000 - 2004) average of recorded weighted average M&S balances and used that as the foundation for its test year 2006 estimate. ORA states this is consistent with the methodology adopted in the last GRC in D.04-07-022. The ORA estimated test year 2006 Materials and Supplies Inventory is $129,511,000, which is $17,166,000 lower than the SCE's estimate.

SCE disagrees with ORA's assumption that the M&S balance decreased from 2003 to 2004. SCE asserts that ORA mistook the 2004 weighted average balance as the year-end balance. Also, in its rebuttal testimony, SCE provided corrected M&S balances to reflect sales tax deferrals associated with Edison Material Supply, LLC, which shows the M&S weighted average balance increased from $126,163,000 in 2003 to $131,419,000 in 2004.

SCE has provided sufficient evidence to show that the M&S balance increased from 2003 to 2004. The corrected historic weighted average balances are as follows:

1999 $111,955,000

2000 $113,956,000

2001 $116,652,000

2002 $119,339,000

2003 $126,163,000

2004 $131,419,000

The average annual percent change is 3.3%. It appears the M&S inventory is continuing to grow as SCE increases its capital and project expenditures in the TDBU. However, in revising it M&S forecast to reflect the corrected historic information, SCE forecasts a 2004 weighted average balance of $137,317,000 which is 8.8% above the recorded 2003 balance and 4.5% above the recorded 2004 balance. This indicates there may be a problem with SCE's inventory turnover method. It is possible that increasing efforts and resources to optimize M&S inventory have not been fully factored into SCE's forecast.

To forecast the test year M&S balance, we will instead use the 2004 recorded balance of $131,419,000 and increase that amount by 3.3% per year, the average annual increase from 1999 to 2004. This results in an adopted test year balance of $140,236,000.

SCE forecasts customer advances for construction (CAC) based upon the recorded 2003 amount and a five-year average incremental change through 2004 and construction cost inflation to project 2005-2008 balances. TURN recommends that CAC be calculated by using the 2004 year-end balance and applying construction cost inflation to project 2005-2008 balances. SCE estimates the test year 2006 weighted average CAC balance to be $66,051,000, while TURN estimates the amount to be $72,864,000.

The difference between the SCE and TURN methodologies is in the determination of the 2004 amount upon which the cost inflation is applied. SCE forecasts the 2004 balance by applying a five-year average incremental annual change in CAC to the 2003 recorded balance. Since the recorded annual incremental CAC changes have increased in the more recent years,103 SCE's methodology for determining the 2004 balance appears to be deficient. SCE's end-of-year forecasts of $63,052,000 for 2004 and $67,007,000 for test year 2006 are both less than the 2004 recorded amount of $69,555,000. TURN's use of the recorded 2004 balance provides a more reasonable forecast for the test period, and its methodology will be adopted. We note however that the use of cost escalation from 2004 forward, to estimate CAC balances, may be insufficient to properly reflect the more recent recorded incremental changes to CAC balances. If appropriate, modifications to this aspect of the methodology should be explored in future rate cases.

SCE uses a five-year average of the recorded years 1999-2003 balances to estimate the permanent level of customer deposits. The estimated amount for test year 2006 is $114,919,000. SCE's methodology is consistent with that adopted in its last GRC. The use of the calculated average in light of the increasing trend in the recorded balances was a proxy to reflect the permanent level, as opposed to total level, of CAC available for financing rate base. Aglet calculated customer deposits as a percentage of average revenues for the prior two years, a proxy for deposits as a function of bills sent 12 to 24 months earlier. Aglet recommends a test year 2006 level of customer deposits equal to 1.94% of average revenues for 2004 (recorded) and 2005 (estimated), or $139,979,000. TURN supports Aglet's recommendation; but, if it is not adopted, TURN and Aglet alternatively propose that the five-year average be updated to include 2004 recorded information, resulting in a test year estimate of $127,443,000.

Aglet's methodology appears to be an alternative to forecasting the total customer deposit balance, rather than the permanent level available to offset other rate base costs. In D.04-07-022, we recognized that the full balance of customer deposits was unavailable as permanent capital and adopted a five-year historical average as a reasonable determination of the permanent level. Without discussion or support, Aglet's proposal runs counter to the notion that certain funds are not available for financing rate base costs. For this reason, it will not be adopted. Absent any other proposals for determining the relationship between the total customer deposit balance the permanent balance available to finance rate base, we will continue to use the five-year average methodology adopted in D.04-07-022. Use of more recent 2004 recorded information in the average, as alternatively recommended by TURN and Aglet is reasonable in light of the continuing upward trend in the recorded customer deposit balances. We will therefore adopt the amount of $127,443,000 as the test year customer deposit balance.

TURN recommends that SCE include the reserve for workers' compensation claims and the reserve for injuries and damages other than workers' compensation claims as offsets to rate base, thus reducing rate base by $142,790,000. ($109,968,000 for workers' compensation ands $32,822,000 for injuries and damages.) TURN explains that these reserves constitute capital not supplied by investors, as they are funds paid as expenses, through rates, in advance of when Edison makes payments to workers. The reserves should be removed from rate base, consistent with the direction supplied by Standard Practice U-16, which allows for accounts held by SCE that do not earn interest to be counted as an offset to rate base. The reserves constitute a source of permanent capital for Edison.

TURN states that, if the Commission does not adopt TURN's recommendation, then to be consistent, the Commission should also recognize that these costs are largely not cash expenses for SCE, but are provisions to a reserve account on which ratepayers would be earning no return and therefore do not belong in the lead-lag study at all. TURN's alternative recommendation would increase lag days by 0.553 days and reduce rate base by about $8,395,000.104

SCE states that TURN wrongly assumes that SCE's total recorded reserve balance represents ratepayer contributions. Consistent with prior GRCs, SCE has requested annual provisions for workers compensation that represents accruals set aside for anticipated future obligations. This annual provision accumulates in SCE's reserve for workers compensation as a liability to the company, until such time as the payments are made. SCE states that, to the extent that actual liability payments exceed the authorized annual provisions accumulated to the workers compensation reserve, additional accrual provisions above and beyond the authorized levels are recorded to the reserve at shareholder expense. SCE indicates that significant increases in workers compensation liabilities have resulted in SCE making payments that have far outstripped the currently authorized levels.105 For this reason the recorded accumulated workers compensation reserve represents amounts that have been funded by shareholders, not ratepayers, and SCE argues that TURN's recommendation to offset rate base should be rejected.

On the other hand, SCE agrees with TURN's alternative proposal to remove the injuries and damages and workers compensation accruals from the lead-lag determination component of working cash. Under current accounting for workers compensation accruals, SCE believes that ratepayers should not be required to pay for the timing lag between when shareholders bear the costs of funding the future obligations to when revenues are received. SCE states it will reduce the 2006 working cash request by $8,395,000 to account for this.

We will adopt TURN's recommendation. In principle, TURN is correct in asserting that workers' compensation costs are included in rates, the reserve does not earn interest, and the reserve is not segregated in its own fund to earn a return. It is reasonable to include it as a rate base offset, since it provides a source of capital for the company. This is consistent with Commission Standard Practice U-16 and similar to how SCE and other utilities reflect accrued vacation.

Regarding its argument that the reserve was funded by shareholders, SCE asserts that from 1995 to 2002 actual payments exceeded authorized accruals. However, authorized accruals were not zero during that timeframe. Also, there may not have been any reason for shareholders to help fund the reserve or actual payments prior to that timeframe either, if other funds provided by ratepayers could be used to offset the higher worker's compensation costs. As we stated earlier, the general concept of test year ratemaking is to authorize a rate level based on a reasonable forecast of various revenues and costs. Once rates are set, the utility has the discretion and responsibility to spend its funds in the most cost effective manner to proved safe and reliable service. This also holds for the PBR environment in which SCE was operating during much of the 1995 to 2002 timeframe. When billions of dollars are being expended, the question of whether shareholders funded costs for a single item, such as the workers' compensation reserve, without even considering variances in the recorded rate of return compared to authorized levels is not meaningful. We cannot rely on SCE's related argument as a reason to reject TURN's recommendation. Without convincing evidence to support the contrary, we assume costs included in rates are funded by ratepayers.

Although TURN identified two reserves, one for workers' compensation and one for injuries and damages, SCE focused its response on workers' compensation. It is not clear if SCE objects to the injuries and damages recommendation for the same reasons. If so, we accept TURN's recommendation for the same reasons that we accepted its recommendation related to workers' compensation. Therefore, rather than reducing the lead/lag working cash results by $8,400,000, we will reduce the working capital element of rate base by $142,790,000 to reflect TURN's recommendation for both reserves.

TURN recommends the inclusion of uncollectible reserves for other accounts receivable aside from claims, which would result in a $2,600,000 reduction to working cash. SCE indicates that it has not requested recovery of the "atypical" uncollectible accounts receivable for non-claims in its test year request and has not included it in its lead-lag study. Since this particular uncollectible amount is not funded in rates, it should not be included as an offset to working cash. We will not adopt TURN's recommendation to do so.

95 See D.96-01-011, mimeo, page 226.

96 D.96-01-011, 64 CPUC2d 241, 356, provides a detailed history of the ratemaking treatment of SCE's fuel inventory carrying costs.

97 D.85-12-107, 20CPUCd 111,112, as modified in D.86-05-095, slip op. at page 2.

98 Id, at page 3.

99 D.87-12-066, 26 CPUC2d 392.

100 Id.

101 D.96-01-011, 64 CPUC2d 241.

102 D.04-07-022, mimeo, 254-255.

103 From 1997 to 2001 the year end balances for CAC increased from $31,619,000 to $41,270,000, or $2,413,000/year. From 2001 to 2004 the year end balances increased from $41,270,000 to $69,555,000, or $9,428,000/year. (See D.04-07-022, mimeo, p. 241 and Exhibit 899, p. 434).)

104 See, Comparison Exhibit, page 52.

105 SCE indicates that recorded accruals have exceeded authorized accruals by $111 million more than the entire workers' compensation reserve since 1995. (SCE, Transcript V. 21, page 2087.)

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