IV. Partial Settlement Agreement Between Cal-Am and DRA

On June 23, 2006, Cal-Am and DRA filed a partial settlement agreement for the revenue requirement phase. The comparison exhibits attached to the settlement were corrected by an August 16, 2006 filing and on February 15, 2007, Cal-Am filed a motion to reopen the record to amend the settlement agreement to correct further errors and to include an update to the cost of capital to reflect Cal-Am's most recent debt financing.10

We review this settlement under Article 12. Settlements of the Commission's Rules of Practice and Procedure. Rule 12.1(d) provides that, prior to approval, the Commission must find a settlement, whether contested or uncontested, "reasonable in light of the whole record, consistent with law, and in the public interest." Cal-Am and DRA state that they have entered into the settlement agreement on the basis that the Commission's adoption should not be construed as a precedent or policy of any kind in this or future proceedings. Further, the settlement is an integrated agreement, so that if the Commission rejects any portion of the settlement, each party has the right to withdraw.

While all parties in the proceeding received notice of the settlement conference, and Duarte, Inglewood, and San Marino participated in the May 23, 2006 settlement conference, only Cal-Am and DRA are signatories to the settlement.11 In their motion for adoption of the settlement, Cal-Am and DRA state that the settlement addresses disputed issues between DRA and Cal-Am and Cal-Am and DRA are fairly representative of affected interests.12

On July 7, 2006, Duarte objected to the settlement, insofar as residents of Duarte would be charged any costs related to three projects in Section 4.8 of the settlement. Duarte stated it does not dispute the need for these projects but claims that they solely and exclusively benefit the San Marino service area. Further, Duarte stated that in light of the magnitude of these projects, and without any commitment by Cal-Am as to reciprocity in either this GRC or any future GRC, it may be time for the Commission to reevaluate the concept of district consolidation, at least as to capital improvements. On August 8, 2006, Bradbury joined in this objection.

Duarte notes Cal-Am initially proposed that purchased water costs be consolidated between the subsystems and then withdrew this request. Duarte concludes that Cal-Am's own actions in first proposing full rate consolidation and then withdrawing its proposal demonstrate the need to constantly reevaluate prior rate consolidation decisions because unforeseen circumstances may operate to the detriment of certain ratepayers and the public interest. Further, Duarte states it is waiting for information from Cal-Am regarding the allocation of capital improvements among the service areas since district consolidation.

On July 24, 2006, in reply to Duarte, Cal-Am stated that Duarte's objection as to how costs are allocated between subsystems is a rate design issue, and therefore not before the Commission until Phase 2. Further, Cal-Am states that Duarte's request to reconsider rate consolidation between the subsystems is short-sighted and contrary to the long-range planning objectives the Commission has adopted in our Water Action Plan. To place the issue in an historical context, and show that Duarte has received capital investment benefits from consolidation, Cal-Am provides a table showing the total plant additions for each service area since the Commission's 1994 decision consolidating rate bases and revenue requirements, minus the purchased power and purchased water costs, of the Baldwin Hills, Duarte, and San Marino service areas.13 In its August 14 reply brief, San Marino supports Cal-Am's position.

We find Duarte's objection goes to cost allocation issues that are before us in the rate design phase, not this phase. Duarte will have the opportunity to receive and analyze the information it has requested from Cal-Am, and to conduct discovery on the table provided in Cal-Am's reply. Duarte has not been an active party in Phase 2 hearings that have occurred to date, but it will have an opportunity to file comments on the proposed Phase 2 settlement reached by Cal-Am and DRA, which is scheduled to be filed with final and comprehensive rate design tables, within 30 days of this decision. We find Duarte's objections are premature, and not applicable to the Phase 1 settlement.

In the settlement, Cal-Am and DRA agree on the capital structure and cost of debt. Specifically, the settlement uses Cal-Am's projected 2007 capital structure for all three years, as recommended by DRA, and the parties compromised on the cost of debt. The cost of equity remains a contested issue, and therefore the overall rate of return is also not a part of the settlement.

For the capital structure, the parties propose to impute 58.97% debt and 41.03% equity for 2007, 2008, and 2009. Cal-Am imputes a separate capital structure for the Los Angeles District based on its methodology of calculating synergy savings and amortizing the acquisition premium it paid to acquire the former Citizens' districts in 2002.

Cal-Am's application does not provide Cal-Am's actual consolidated capital structure. Rather, it states that the capital structure proposed here is calculated as the residual of calculating a ratemaking capital structure for the former Citizens districts of 63% debt and 37% equity.14

We would prefer to use Cal-Am's consolidated capital structure. There is evidence to support using the actual year end December 31, 2006 consolidated capital structure of 62.6% debt/37.4% equity, or the target 60%/40% consolidated capital structure contained in Cal-Am's testimony,15 and the use of a consolidated capital structure would be beneficial to the customers of the Los Angeles District.

In D.06-11-050, which resolved Cal-Am's Monterey/Felton GRCs, we found that there is good cause to return to the use of a consolidated capital structure and directed Cal-Am to present a comprehensive showing in support of a consolidated capital structure in its next district GRC filing.16 The Los Angeles District evidentiary record had closed prior to the issuance of D.06-11-050; Cal-Am's next scheduled GRC filings occurred in January 2007 for the Sacramento, Larkfield, Coronado, and Village districts.

The evidentiary record here does explore the use of a 62.6% debt/37.4% equity capital structure that Cal-Am represents as its actual December 31, 2006 consolidated capital structure in its financing application, A.06-05-005. However, Cal-Am testified it was not willing to modify the settlement on this issue. DRA indicated more flexibility, but supported Cal-Am's testimony that $20,000,000 in projected, not actual, Coastal Water Project (CWP) funding should be removed first, and that a separate imputed capital structure for the historic districts should still be made. We do not agree with these adjustments.17

While we prefer the use of the actual year end 2006 62.6% debt/37.4% equity capital structure, we will adopt the settlement's proposed 58.97% debt/41.03% equity. We have weighed the benefits of the overall settlement in making this decision.

We recognize that the capital structure we adopt here will have an impact on other pending Cal-Am district GRCs. Monterey and Los Angeles are the two largest historical Cal-Am districts and, as such, have been providing a capital structure subsidy to the former Citizens' districts. Sacramento is the largest former Citizens' district and has a pending GRC filing. We should carefully watch the test year period overlap of our GRC decisions to ensure Cal-Am's shareholders do not receive a windfall as we shift to a consolidated capital structure for all districts.

For the cost of debt, the settlement uses 6.89% for all three years, based on the projected cost of debt in the test year 2007. In arriving at the 2007 projection, parties agreed that the estimated cost of new debt issuances for 2006 and 2007 should be 6.42% for 2006 and 6.26% for 2007, based on the latest Data Resources, Inc. (DRI) forecast for the period in which the issuances will be made. These estimates represent an increase in DRA's original estimates, and are due to the Federal Reserve Board raising interest rates .6% between March 2006 and the settlement agreement date. The cost of debt represents a compromise between Cal-Am's original position of 6.9% for 2007, 6.91% for 2008, and 6.94% for 2009 and DRA's original position of 6.41% for all three years.

At the January 9, 2007 evidentiary hearing in Phase 2, Cal-Am asked to update the cost of debt for the Los Angeles District based on its actual December 21, 2006 debt issuance. On February 15, 2007, it filed an amended settlement which describes this issue and results in a weighted average cost of debt for 2006 of 5.77%, less than the 6.26% agreed to in the settlement. The amended settlement tables incorporate this revised cost of debt of 6.36% for 2007, 2008, and 2009; this is a reduction of .63% each year.18

In Section 4.3 of the settlement, Cal-Am and DRA set forth customer counts and average water use per customer, including an allowance for unaccounted-for water. There were no initial differences between the two parties on these issues, and therefore we find this section reasonable.

In Section 4.4, the parties agree that the lower inflation rates initially used by Cal-Am will be adopted. This change can be seen in the table at Exhibit 36, page 3-2. It appears that errors made by DRA in its workpapers are corrected, as referenced in Cal-Am's rebuttal, Exhibit 11, pages 2-3.

Parties agree that purchased water and chemical costs should be based on the latest rates from the suppliers. Cal-Am's application uses January 2006 unit prices for purchased water. As discussed at hearing, Cal-Am has authority to update its water balancing account by advice letter to reflect actual unit costs for water, chemicals, and power, but not supply mix. Cal-Am and DRA provide rate tables to the settlement that contain updated July 2006 water costs. We find beneficial the use of updated water costs.

On February 15, 2007, Cal-Am filed a motion to reopen the record to correct errors it made in the supply mix. In its supplemental February 27 filing, Cal-Am shows its correction results in an increase in purchased water costs over the three-year GRC of $1,683,741 to San Marino, a decrease of $1,106,855 to Duarte, and a decrease of $29,472 to Baldwin Hills. The net change overall is an increase in operating and maintenance expenses of $547,414. The rate comparison included in Cal-Am's filing shows 2007 rates for San Marino residential customers rising 7%-10% from this correction.19

In its filing, Cal-Am also addresses how its correction of supply mix would be handled after a final decision is issued under existing ratemaking and under its proposed Phase 2 proposal. It emphasizes that it has changed its Phase 2 proposal from a Full Cost Balancing Account (FCBA) mechanism to an MCBA.

DRA responded to Cal-Am's supplemental filing on March 7. DRA disagrees with Cal-Am's statement that the utility could correct its supply mix error after a final decision under present ratemaking. DRA does agree with Cal-Am's statement that the utility no longer proposes an FCBA in Phase 2.

Based on its review, DRA states Cal-Am's amended tables have an error in plant-in-service and are missing two pages; it recommends that these omissions be promptly corrected. DRA also disagrees with Cal-Am's rate impact analysis as the utility appears to allocate all of the additional cost resulting from the change in water supply mix to only the metered customers, rather than all customer classes. DRA recommends Cal-Am file amended tables to correct these errors. In response to an ALJ ruling, Cal-Am submitted the amended tables.

Based on the filings of Cal-Am and DRA, we find that correcting the supply mix is reasonable.

The parties agree that customer accounting should reflect the settlement for General Office filed in A.05-02-012, and that cost for postage and bill forms should be reflected at the district level. This is consistent with D.06-11-050.

We find this section of the settlement reasonable. It is also consistent with the requirements of D.01-09-057 that Cal-Am carry the burden of proof for any new or increased GRC expenses, excluding those due to inflation and customer growth.

Administration and General (A&G) expenses are addressed in Section 4.5 of the settlement. The largest dollar category here is payroll expense. There were fairly large percentage differences between Cal-Am and DRA originally. Cal-Am explained that an error existed in its presentation of 2003 and 2004 numbers in that capitalized labor was removed twice from O&M expense. With this correction, DRA's trend analysis produced results close to Cal-Am's original request, and DRA agreed to accept this number.

The next largest A&G expense item is employee pension and benefits. DRA agrees with Cal-Am that pursuant to D.88-03-072, pension cost must be based on Employee Retirement Income Security Act minimum funding requirements. The settlement notes that Cal-Am's funding requirement has increased significantly since its pension fund is no longer in an over-funded position as it had been for a number of years.

The parties compromise on rent expense for the San Marino office space and regulatory commission expense. DRA agrees that maintenance of general plant should include the net salvage portion of depreciation expense. As a result of the adjustments to A&G and correction by Cal-Am of a formula error in the calculation of payroll taxes, the company and DRA agree on "taxes other than income."

For the category of income taxes, a difference of $224,000 remains due to the contested issues of estimated rate base and ROE.

Based on the foregoing, we find this section of the settlement reasonable.

Following extensive exchanges of information and negotiations on the rationale for each requested plant item, Cal-Am and DRA agree as follows:

TABLE 1: ADJUSTMENTS TO UTILITY PLANT

Project

Cal-Am

DRA

Settlement

2005 Lamanda Park

    $ 1,200.0

      $ 871.5

    $ 1,200.0

Beginning Plant Balance for 2007

72,573.3

72,317.3

72,689.8

2006-2008 Small Main Replacement

149.0

72.7

110.8*

2006-2008 Pump Replacements

155.0

138.6

146.8*

BH Fire Flow Imp.

839.0

688.5

713.6

Circle Drive Main

292.0

244.0

252.0*

Garth Reservoir

763.0

596.7

648.9*

Shenandoah Main

360.0

297.8

308.2*

Lamanda Park Main

431.0

390.2

397.0

Lemon Reservoir

604.0

501.6

518.7*

Baldwin Ave. Main

179.0

160.0

163.2*

Danford Reservoir Main Project

      

2007 CWIP

100.0

0.0

0.0

2008 Plant in Service

1,220.0

496.6

0.0

2009 Plant in Service

0.0

496.5

0.0

2008 Advice Letter

0.0

0.0

1,027.6*

Patton Well and Treatment Project

      

CWIP BOY 2007

597.0

0.0

0.0

CWIP EOY 2007

3,097.0

0.0

0.0

Plant Adds in 2008

4,124.0

0.0

  

Memo Accounts

0.0

4,124.0

1,989.0

2008 Advice Letter

0.0

0.0

1,027.6

All figures ($000)

* Projects are proposed Infrastructure Surcharge projects

Based on the explanations provided for each project, we find this section of the settlement reasonable.

The adjustments in this section are minor and generally reflect the settlement of plant additions. We find this section of the settlement reasonable.

In this section, Cal-Am agrees to accept DRA's calculation of cash working capital and operational working cash based on the latest information on lead/lag days. The net effect is a substantial increase in working capital from Cal-Am's original request.

We find that it would be helpful to have more information in the record on this section of the settlement, particularly the lead/lag studies relied on by the parties. However, our concern is not sufficient to modify or reject the settlement. We will examine this issue further in the next GRC.

Cal-Am and DRA do not dispute these issues.

This issue is removed to Phase 2 of the proceeding.

This is a request for implementation of an ISRS. There is no settlement on this issue.

Special Request 2 is for a conservation rate design, an issue before us in Phase 2. Special Request 3 is for consistent rates across the Los Angeles District, a request withdrawn by Cal-Am following the PPHs.

This request is for adoption of a temporary low income program for qualifying residential customers in the Los Angeles District. Cal-Am's proposed program would provide a fixed sur-credit of $6.50/month for participating customers, which equates to an approximately 15% discount at average usage under present rates. In its application, Cal-Am links its request to approval of Special Requests 2 and 3. Cal-Am would track the sur-credit revenue losses along with program implementation costs in a WRAM account. The Los Angeles District low-income program would end either when the Commission adopts a generic state-wide low-income program or at the end of this GRC cycle, whichever occurs first.

DRA recommends that the low-income program continue until the next GRC when it will be reviewed. The program would also be adjusted to meet the criteria when, and if, the Commission adopts a state-wide program. DRA agrees with the general program features but recommends some modifications: (a) consistency with energy program low-income eligibility guidelines; and (b) a concerted effort by Cal-Am to target low-income customers for conservation programs in order to assist these customers to conserve water, thereby further lowering their monthly water bills.

In the settlement, Cal-Am accepts DRA's recommendation to remove the temporary feature of its low-income proposal.

Special Request 5 is for a MCBA for purchased water and purchased power and Special Request 6 is for a conservation memorandum account. Both requests are before us in Phase 2.

This request is to establish a memorandum account to track the actual tax effects of the American Job Creation Act. This request is not disputed.

The parties agree in this section that the language previously adopted for historical Cal-Am properties, including the Los Angeles District, and the language adopted for the former Citizens properties should be used in this decision to distinguish the capital structures of the different properties.

As we discuss with reference to Section 2.1 of the settlement, the Commission is concerned with Cal-Am's imputed separate capital structures and has directed that the company present a consolidated capital structure for our review in its more recent GRC filings. For this proceeding, we find this section acceptable.

Based on our review of the proposed settlement, we are concerned with the imputed capital structure and the rate base sections. We will examine these issues further in the next GRC. We are also concerned with Cal-Am's submission of two substantial corrections to the settlement, on August 16, 2006 and February 15, 2007. In future proceedings, Cal-Am should address the additional procedures it has adopted to better review the accuracy of its filings.

Weighing the settlement as an integrated agreement, we find it is reasonable in light of the whole record, consistent with the law, and in the public interest. Therefore, we adopt the settlement.

10 The August 16, 2006 corrections are to O&M expenses in Attachments C, E, K, and M; these expenses were incorrectly calculated when the purchased water costs were updated to reflect July 2006 purchased water rates. The corrections result in an increase in O&M expenses of $1,096,000 in 2008 and $1,113,900 in 2009, at proposed rates. With these corrections, Cal-Am states the total operating expense (and total operating revenue) is still lower than that originally proposed in the application in this proceeding. The February 15, 2007 revision reflects Cal-Am's December 2006 debt filing and corrects water supply mix. The water supply mix correction is discussed in Section IV.B.3 of this decision.

11 See June 23, 2006 Motion of Cal-Am and DRA for Adoption of Settlement Agreement as to Certain Issues on the Revenue Requirements, page 1, footnote 2.

12 Id., page 1.

13 See D.94-11-004, 57 CPUC2d 127.

14 Cal-Am cites as authority for this calculation the settlement adopted in A.04-04-040. As discussed in D.06-11-050, the settlement does not specifically provide for this proposition. That settlement, as well as all settlements we adopt, is not precedential.

15 Exhibit 7, Reiker, page 6.

16 See Finding of Fact 6 and Ordering Paragraph 7. The discussion of this issue is found in Section IV.A.1., mimeo. at pages 9-13, and the related issue of amortization of the acquisition premium is discussed in Section VI.C., mimeo. at pages 94-96 and Finding of Fact 48.

17 We are concerned with the appropriateness of the CWP adjustment and especially with the level proposed. In D.06-12-040, only $3,000,000 in CWP costs was authorized for recovery by surcharge.

18 At the January 9, 2007 hearing, the ALJ asked Cal-Am to consider whether it should update its cost of new debt for 2007. In its motion to amend, Cal-Am states it examined the issue and believes that it is not appropriate to update the forecasted cost of new debt for 2007 included in the settlement. It states it does not believe that there is any reason to vary from our established methodology for forecasting future issuances.

19 2007 detailed bill comparison under standard rate design, revised settlement, if Infrastructure System Replacement Surcharge (ISRS) proposal not adopted.

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