Discussion

The parties brought up a wide range of arguments why CalAm's proposal is or is not in the public interest, and advocated several alternative proposals to address the impact of Felton's postponed general rate increase. We have considered all of their arguments and list and discuss the more significant points below.

Rate Consolidation Guidelines

In 1992 the Commission's Division of Ratepayer Advocates (ORA's predecessor) and the Class A water companies jointly developed a set of policy guidelines to be considered in district rate consolidations.⁶ Those guidelines establish four criteria: proximity, rate comparability, water supply, and operation.

1. Proximity: The districts must be within close proximity to each other. It would not be a requirement that the districts be contiguous as it is recognized that present rate-making districts consist of separate systems which are not connected. It was suggested that districts within 10 miles of each other would meet the location criteria.

2. Rate Comparability: Present and projected future rates should be relatively close with rates of one district no more than 25% greater than rates in the other district or districts. To lessen the rate impact of combining districts it may be necessary to phase in the new rates over several years.

3. Water Supply: Sources of supply should be similar. If one district is virtually dependent upon purchased water, while another district has its own source of supply, future costs could change by a greater percent for one district versus the other. This could result in significantly different rates in the future even if present rates were quite similar.

4. Operation: The districts should be operated in a similar manner. For example, if a single district manager presently operates two or more districts and the billing system is common to the same districts, such an operation would support the combination of the districts.

It was agreed that no districts would be combined for the express purpose of having one district subsidize another.

Although these criteria remain relevant to our consideration, we have previously stated, and reiterated in the Felton District decision that led to today's proceeding,

[W]e believe that Branch's reliance on our Water Division's 1992 guidelines for combining water utility districts is misplaced. As the testimony at hearing showed, the guidelines were intended then, and continue today, to set criteria for single tariff pricing that, when met, establish prima facie reasonableness of the proposed consolidation. A number of rate consolidations have been approved pursuant to the guidelines without opposition by the Commission's advocacy staff. The guidelines, however, implicitly permit proposals for broader rate consolidations, with the understanding that such proposals are likely to be protested by the advocacy staff in order that a full record can be developed for Commission consideration.⁷

Regarding these guidelines, CalAm and ORA both make statements we agree with and accept for our purposes here. From ORA, "When the DRA Guidelines are not met there is no prima facie reasonableness and thus the burden of showing that the advantages of consolidation outweigh the disadvantages falls upon the applicant."⁸ And from CalAm, "[T]he Commission may approve a consolidation proposal even though it does not exactly meet the criteria set forth in the Guidelines.... Although the DRA Guidelines are not dispositive, they are still helpful in evaluating California American Water's rate consolidation proposal."⁹ With these considerations in mind, we review this proposal's relationship to each criterion.

CalAm concedes that combining Felton and Monterey Districts does not meet the proximity criterion.¹⁰ Instead, CalAm argues that advances in communications and connectivity mean that proximity is no longer necessary. CalAm urges the Commission to think of this as the first step in a consolidation of all of CalAm's districts throughout the state, in which case distance is irrelevant. ORA emphasizes that these districts are approximately 45 miles apart, in different watersheds, in different counties, and there is no indication that either system is equipped with technology of a type that would relieve CalAm from having to continue to operate it locally. Moreover,

Water is a scarce resource, like land. It is important that when people choose where to live and industry chooses where to locate that the true environmental costs be reflected in the costs of the land and water. If water is subsidized, more people will choose to live in unsustainable areas. Local control, environmental impacts and growth are intricately linked. Severing the link between rates and costs will adversely impact local land-use planning. The proximity criterion reflects more than the ability to remotely manage an area like an absentee landlord.¹¹

We agree with ORA. While not determinative, the proximity criterion is nonetheless relevant for the reasons ORA outlines and for others.

Combining Felton and Monterey Districts does not meet the rate comparability criterion, but may come close depending on how and when the percentage is measured, which rate design is used, and what customer usage level is assumed. Taking revenue requirement as a surrogate for rates overall avoids the need to choose which Monterey rate design and what level of customer usage to apply for the comparison.¹² CalAm's corrected application figures (Table 1, following section) show that Felton would need a subsidy equivalent to approximately 20% of its revenue requirement to move from today's approved (but not implemented in rates) revenue requirement to a fully combined rate structure in 2005. ¹³ The subsidy would remain there through 2009, then step up to about 25% each year for the following decade. Under CalAm's general rate case proposed rates for test year 2006 and beyond, the annual subsidy needed would be about 28% of Felton's revenue requirement in 2006 and drop slowly to about 25% over the following decade (Table 2).¹⁴ Since moving Felton customers to the combined rates entails a smaller subsidy than would moving them to the even slightly lower standard Monterey rates, we can conclude with confidence that Felton's rates overall are more than 25% above Monterey's by all of these measures. Felton and Monterey do not meet the rate comparability criterion for consolidation.

With respect to water supply, we previously noted in D.04-05-023 that Felton relies on ample supplies from its creeks and springs, whereas CalAm's Monterey water supply comes primarily from wells and dams on the Carmel River and wells elsewhere and is fraught with complication and subject to great uncertainty over the coming years. ¹⁵ The evidence in this case reconfirmed that conclusion: The two districts do not meet the water supply criterion.

We also noted in D.04-05-023 that the districts are operated in a similar manner in that they share common upper management, sources of capital, and billing and accounting resources. Each uses its own local personnel for day-to-day operations on site but relies on the same out-of-state personnel for customer service functions. Again, the record in this proceeding confirms our earlier conclusion. Combining Monterey and Felton does meet the operation criterion.

Thus, CalAm's proposed consolidation meets only one of the four rate consolidation criteria. Were we to rely solely on the guidelines, we would reject CalAm's proposal.

Rate and Revenue Requirement Impacts

CalAm cites as precedent for this consolidation one earlier decision in which the Commission approved a Southern California Water Company proposal to introduce single tariff pricing for eight water districts comprising a single region in the Los Angeles area.¹⁶ In rejecting CalAm's consolidation proposal in D.04-05-023, we noted the earlier decision and the fact that we had sufficient information in that proceeding to examine the Southern California Water proposal and its short and long-range effects in great detail, including the average annual water bill it would produce in each district at stand-alone rates and the proposed regional rates over the following fifteen years. In contrast, the record on which we based D.04-05-023 was much less complete. CalAm has attempted to cure that in this proceeding by providing estimates of each district's stand-alone and combined revenue requirement and rates each year from 2005 through 2019. The rate comparisons are not meaningful, however, because they were based on the Monterey standard rate design that few if any Monterey customers pay, and because the customer effects would vary greatly depending on what consumption levels are assumed.

The revenue requirement comparisons are less sensitive to these assumptions and are therefore more enlightening. The following two tables show CalAm's estimates of the annual revenue requirement shift (i.e., the subsidy) in dollars and what that shift represents as a percentage of each district's stand-alone annual revenue requirement. Table 1 draws on the data CalAm presented in the application (and later corrected) before the new Monterey and Felton general rate cases were filed. Table 2 assumes CalAm's general rate case proposed application requests were granted in full.¹⁷

Table 1

Proposed Annual Subsidy (Before Pending Rate Cases)

Year	Monterey to Felton Subsidy	% of Revenue Requirement
		Monterey	Felton
2005	$250,000	0.68%	19.92%
2006	283,000	0.71	21.54
2007	288,000	0.59	20.64
2008	305,000	0.48	20.74
2009	317,000	0.37	20.53
2010	397,000	0.45	24.46
2011	418,000	0.47	24.59
2012	440,000	0.48	24.77
2013	463,000	0.50	24.94
2014	486,000	0.52	25.10
2015	512,000	0.53	25.38
2016	534,000	0.55	25.45
2017	557,000	0.56	25.56
2018	582,000	0.58	25.67
2019	608,000	0.59	25.87

Table 2

Proposed Annual Subsidy (Including Pending Rate Cases)

Year	Monterey to Felton Subsidy	% of Revenue Requirement
		Monterey	Felton
200618	526,000	1.20	28.52
2007	534,000	1.00	28.13
2008	543,000	0.89	28.49
2009	539,000	0.57	26.34
2010	557,000	0.53	25.35
2011	548,000	0.53	25.71
2012	566,000	0.54	25.62
2013	583,000	0.56	25.50
2014	600,000	0.57	25.42
2015	617,000	0.58	25.32
2016	633,000	0.59	25.18
2017	650,000	0.59	25.05
2018	670,000	0.60	25.02
2019	683,000	0.60	24.79

Tables 1 and 2 show that under either scenario (considering or not considering CalAm's pending general rate increase requests), under a combined rate structure Monterey customers would provide Felton customers significant and increasing subsidies in the coming years. What these tables do not show, but the underlying data do, is that Monterey customers would be providing these subsidies at the same time CalAm projects Monterey's stand-alone revenue requirement to climb more than 130%, from $40 million in 2006 to $94 million in 2010. Meanwhile, Felton customers' stand-alone revenue requirement would climb 15% over the same period.¹⁹ The largest part of the disparity is due to CalAm's proposal here to hold separate Monterey's looming water supply infrastructure development bill and to charge that bill to Monterey customers alone. CalAm's proposal thus could widen, rather than narrow, today's rate disparity between these districts after the first few years.

CalAm's response to the parties' criticism on this and other points was to urge the Commission to judge its Felton and Monterey consolidation proposal not entirely on its own merits, but rather as the first step in a new and totally different proposal not mentioned in the application. For the first time in its rebuttal testimony (CalAm prepared no direct testimony to support its application), CalAm described its Monterey and Felton consolidation proposal as a short-term solution with short-term benefits, one that would be a necessary first step toward statewide rate consolidation.²⁰ On cross-examination, CalAm's witness elaborated, describing a longer term plan under which Monterey and Felton would be consolidated for ratemaking now, Sacramento and Larkfield Districts would be brought in with Felton within three to five years, and all of CalAm's California districts would be combined for ratemaking within five to seven years. Monterey would be the exception. At some unspecified point in that seven-year consolidation process, Monterey would once again be cut loose from Felton and all of CalAm's other districts to stand on its own for ratemaking.²¹

As CalAm sees it, a primary purpose of consolidation is to provide a benefit to its ratepayers in the form of rate equalization and long-term water affordability. Assuming CalAm's long-term objective is indeed statewide consolidation of all districts except Monterey to achieve these ends, to begin by consolidating Monterey with Felton, only to have to split Monterey back out in, at most, seven years because of its water affordability problems, is extraordinarily unhelpful. Thus, CalAm's vision of a long-term, statewide consolidation does nothing to strengthen its case here.

Operational Efficiencies

One factor we would give considerable weight in evaluating this consolidation is any operating efficiencies the two districts combined would have over the two operating separately. In this case, there would be no net operating efficiencies generated.

CalAm's presentation does indeed cite cost savings as a consolidation benefit. "A combined rate schedule can lower operation, maintenance, administrative and regulatory costs...."²² On closer examination, however, these are not savings in costs, but shifts in cost allocations from Felton customers to Monterey. CalAm characterizes these two districts as "fully integrated" from the perspective of operations and control, with Monterey personnel providing backup support for Felton and all of Felton's operations personnel being managed from Monterey.²³ Although there are specific operations personnel assigned to each separate district, the management staff and specialists within CalAm's Coastal Division are already assigned to both districts. As CalAm states, "[T]he requested consolidation will not modify any of California American Water's operations or the number of personnel in the Felton and Monterey Districts."²⁴ Thus there are no efficiencies to be gained in that area. Likewise, the two districts already share the same billing system. ²⁵ CalAm claims as benefits reduction of administration costs.²⁶ However, any claims of improved accounting and administrative efficiencies must be weighed against this CalAm statement:

To address any concerns regarding accounting of costs and revenues for the Felton District, California American Water will continue to track the revenue requirements of the Monterey and Felton Districts both in combined form and separately. California American Water will not do anything to change the way it records data on the books.²⁷

There is, in fact, evidence to show that at least some costs will actually increase as a result of consolidation. As Santa Cruz points out, CalAm has proposed a highly complex consolidation which will require segregating and accurately accounting for a large array of Monterey District expenses and investments to ensure they are correctly allocated to the proper sets of customers, Monterey or Felton. CalAm's witness' testimony in response to cross-examination made clear what a challenge that will be for CalAm.²⁸ We believe that CalAm will have to invest more effort, not less, in ensuring costs are accurately segregated between districts, and thus its costs in this area will be higher than without consolidation. CalAm claims that regulatory costs would decrease, but we believe they will increase, as we will discuss in the Regulatory Impacts section following.

Service Impacts

FLOW indicated in the prehearing conference that it intended to show service quality in the Felton District is inadequate. In response, the ALJ cautioned the parties that service quality per se in the Felton District would not be an issue in the proceeding, but if parties could demonstrate that consolidating the districts would cause a degradation of service quality, that would be relevant. ORA limited its position to stating that CalAm's proposal would not bring service improvements; it did not claim that service would deteriorate.²⁹

FLOW spent considerable time and effort developing its position. It presented anecdotal evidence of several Felton District customer service problems, described them in great detail, and attributed them to ownership and management deficiencies. According to FLOW, Felton's service problems have worsened since Citizens Utilities Company of California departed and first American Water Works and then RWE Aktiengesellschaft took ownership.

What FLOW did not demonstrate, however, was any credible connection between its quality of service showing and this consolidation proposal. Despite FLOW's claims,³⁰ there is little or no evidence in the record to show that consolidating Felton and Monterey for ratemaking as CalAm proposes will have any effect, either positive or negative, on service quality in either district. CalAm states that it will continue to operate both districts as it does today, using the same upper management, the same district and regional operating personnel, the same billing system, and the same customer service center, a claim that went largely unchallenged and that we accept for our purposes here. We conclude that CalAm's proposed consolidation would not affect service quality provided to either district.

Regulatory Impacts

CalAm claims that this consolidation would reduce regulatory costs. "...[W]e have shown a variety of benefits beyond subsidization, including... lower costs of rate cases (only one application)...."³¹

ORA sees the opposite. "Contrary to reducing regulatory burdens on the Commission, this proposal would add to them by requiring careful scrutiny of which costs are separate and which are combined. While a portion of the rates would be consolidated, CalAm also proposes district specific rate components, requiring more complex work when reviewing future rate cases."³² Indeed, CalAm proposes to segregate out and insulate Felton customers from Monterey's source of supply, water production and water treatment costs, Monterey's past or future State Water Resources Control Board order-related costs, and Monterey's past, present and future dam strengthening or decommissioning costs. All of this additional accounting complexity will burden CalAm, the intervening parties and the Commission when evaluating rate increase requests.

The fact that CalAm would be able to file a single general rate increase application instead of two for these districts is of no consequence; the Commission already consolidates multiple districts from the same company into one proceeding when they are filed for the same test period. And, in any case, ORA and CalAm concur that consolidation, if approved, will require double regulatory accounting. In the only earlier decision CalAm cites as precedent, we required Southern California Water Company to continue to calculate its revenue requirements separately for each of the eight districts consolidated for ratemaking, and directed that each be subject to the same regulatory and community review as before in general rate cases.³³ If the Commission were to approve consolidating Monterey and Felton, ORA recommends the Commission impose those same requirements on CalAm.³⁴ CalAm seconds this recommendation and has indicated it would track the revenue requirements for the districts in both combined and separate forms.³⁵

For its part, Santa Cruz doubts that CalAm is capable of handling the accounting burden it promises to undertake.

In addition to the other negative impacts on ratepayers cited by ORA in its testimony, Cal-Am lacks the capacity to consistently segregate costs and maintain proper accounting. In both this application and Cal-Am's simultaneously filed application to consolidate its Sacramento and Larkfield districts, Cal-Am made significant errors in its applications that caused asymmetry in the amount of the subsidy from the larger district and the corresponding benefit to the smaller district. Notably, both of these errors were in Cal-Am's favor, and were detected, not by Cal-Am, but by the CPUC and intervening parties.

Cal-Am has proposed a highly complex consolidation which will require segregating and accurately accounting for a large array of Monterey district expenses.... Cal-Am has not demonstrated that it has the aptitude to do this correctly.... Considering that Cal-Am cannot even get its CPUC consolidation applications right, Felton and Monterey ratepayers should not be placed in the precarious position of having to perpetually oversee the allocation of costs as between these two districts.³⁶ [citations omitted.]

CalAm did make the errors with which Santa Cruz charges it. CalAm minimizes their importance, but Santa Cruz' point is well taken. CalAm would have to step up its accounting and ratemaking effort to ensure ratepayers were not unjustly charged for costs not properly allocable to them, and it would fall to general rate case intervenors and the Commission to audit the result.

After examining the evidence presented, we conclude that consolidation would generate additional regulatory costs and burdens for CalAm, ORA, the other parties intervening in CalAm's general rate cases, and the Commission.

Public Ownership

At the time the proposed decision in this proceeding was being drafted, efforts were underway at the local level to convert CalAm's Felton District system to public ownership. Santa Cruz County had begun the process to form a Mello-Roos Community Facilities District to finance the acquisition of Felton's water system,³⁷ and several significant steps toward public acquisition had been completed.³⁸ Santa Cruz Local Agency Formation Commission had approved an application by the adjoining San Lorenzo Valley Water District (SLVWD) to expand its sphere of influence to include Felton District. Santa Cruz County and SLVWD had entered into a Mutual Aid and Cooperation Agreement in relation to possible acquisition.³⁹ The Santa Cruz County Board of Supervisors had approved a FLOW petition and authorized funds to begin the process of forming a community facilities district, and had authorized a Joint Community Facilities Agreement with SLVWD. On July 26, 2005, Felton voters approved Measure W by a 74.8% to 25.2% margin, authorizing the formation of Community Facilities District No. 1 (Felton), issuance of up to $11 million in bonds to acquire CalAm's Felton water system, and a special tax based on water meter size to repay the bonds.⁴⁰ The new community facilities district will presumably either negotiate a purchase with CalAm or file suit in Superior Court to condemn and take over the Felton system.

The intervening parties all agree that public acquisition would be preferable to CalAm's consolidation proposal. ORA, Santa Cruz and FLOW fear that the Commission's approving consolidation with Monterey could hinder the public acquisition effort by obfuscating Felton District's cost and revenue accounting going forward. As they see it, any consolidation for ratemaking could obscure the cost and effect on rates of CalAm's continued ownership and operation of Felton District. They urge the Commission to either deny the application or hold off as long as public acquisition remains on the table.

CalAm disagrees, arguing that condemnation is an option a public agency can pursue at any time, irrespective of whether rates have been consolidated. We agree with CalAm. Public acquisition may well be the best option for the customers of privately owned water systems in some cases,⁴¹ but that depends on many factors including, e.g., the purchase price, the condition of the system, the acquiring district's ability to operate and maintain the system, and others, factors not developed in the record here. Although our approving or denying consolidation may have some influence one way or the other on the outcome, that possibility will not be a factor in our decision in this proceeding.

Customer Preferences

The major factor leading the Commission to consider consolidating Monterey and Felton's rates was its desire to relieve Felton District ratepayers of "rate shock," a large rate increase imposed over a short period of time. In D.04-05-023, the last Felton District general rate case, the Commission found that CalAm was due a 34.6% increase for test year 2003 and a further 7.1% for 2004, but deferred imposing the higher rates immediately out of concern for their possible rate shock effect on Felton customers. After the ALJ's proposed decision recommending the entire 34.6% increase be implemented in the first year was made public, members of the public and some parties expressed their disbelief that such a large one-time increase could possibly be justified, and urged the Commission to find a less-burdensome alternative. CalAm had proposed in that proceeding a Felton-Monterey consolidation to spread part of Felton's increased revenue requirement to the much larger Monterey District, but the proposed decision had rejected consolidation as unsupported by the evidentiary record. In its final decision, the Commission agreed, but also determined to examine district consolidation more closely as a possible solution to rate shock. CalAm was directed to continue charging its then-current Felton rates, to accumulate the shortfall in a balancing account, and to file a new application proposing district consolidation and a method to amortize the accumulated balancing account shortfall.

During the course of this proceeding, it has become abundantly clear, however, that public opinion is overwhelmingly against consolidation, even as a solution to rate shock. The Commission has received many letters and e-mails in opposition from concerned customers in both districts. At the public participation hearing in Monterey, speakers objected to what they saw as a one-sided proposal that they subsidize Felton with no prospect of benefiting in return. A public participation hearing in Felton the following evening was particularly well attended, with speakers strident in their opposition to being linked with a Monterey system they saw as distant and troubled. Felton speakers, many of them aligned with FLOW, were energized in their opposition by the ongoing campaign being waged by locals to form a public district to acquire the Felton system, and a CalAm-supported counter-effort. At the last day of evidentiary hearing in San Francisco, FLOW presented four Felton customers (three to testify under oath, and one to make an unsworn statement) to describe their displeasure with CalAm, its service, and its consolidation proposal.

ORA contrasts the public's view here with that in the only other successful rate consolidation CalAm cites as precedent. In D.00-06-075, customer support was a positive factor in our decision: "The Commission has received several hundred letters from ratepayers, most of them representing high-rate districts and most of them favoring the regional rate plan."

Our aim in requiring CalAm to file this consolidation proposal was to explore what at the time seemed to be a viable solution to relieve Felton customers from rate shock, a solution seen as having only a small effect on Monterey customers. Whatever public support there may have been for consolidation with Monterey as a solution has now evaporated completely. Monterey customers' reaction is understandable; they would be asked to subsidize Felton. It has become clear, however, that the public in Felton is even more vigorous in its opposition.

Alternatives

The parties have suggested several alternatives to consolidation: public acquisition by a local district, consolidation with CalAm's Sacramento District (possibly including Larkfield District as well), and phasing in Felton's suspended rate increase.

FLOW would prefer we reject consolidation and hold the issue of alternatives in abeyance until the community's public acquisition efforts are further along. We have already explained that the pending acquisition effort will not be a factor in this decision. In addition, when this proceeding was submitted no date for a public vote on acquisition had been set. Now that our order will issue after the public's vote, we can be confident it will have no effect on the outcome.

FLOW believes that consolidating the three former Citizens districts, Felton, Larkfield and Sacramento, would be a superior alternative to consolidating Felton with Monterey. CalAm has neither proposed nor developed that alternative and opposes it.⁴² Sacramento is a larger district than Monterey, has lower rates, and is not plagued by long-term problems as Monterey is. Thus, it may well be true, as parties have represented, that a Sacramento consolidation (with or without Larkfield) would generate a greater rate subsidy and fewer long term risks and uncertainties for Felton than would consolidation with Monterey. On the other hand, Sacramento is considerably more distant and appears to be less operationally coordinated with Felton than is Monterey. More importantly, stakeholders representing Sacramento ratepayers' interests could be expected to have strong views if they were asked to subsidize a CalAm district, and particularly one as distant as Felton, just as Felton and Monterey stakeholders do, yet they have not been provided notice and an opportunity to present those views. The record is insufficient to draw firm conclusions as to any of these factors. Consolidating Felton with Sacramento is not a viable solution to Felton rate shock in this proceeding.

ORA's preferred solution would be to deny the consolidation, order CalAm to phase the currently-suspended rates in over an 18-month period, continue to record the shortfall in the balancing account, and begin amortizing the balancing account over a five-year period after rates reach authorized levels.⁴³ To soften the effect on low-income customers, ORA would have CalAm establish a low-income program similar to that currently in effect in Monterey District. CalAm objects to the ORA proposal as delaying the implementation of rates the Commission has already approved, continuing to build up a shortfall in the balancing account for an additional 18 months, and not taking into effect CalAm's pending Felton general rate increase application.⁴⁴