IV. Long-Term Debt and Preferred Stock Costs

Long-term debt and preferred stock costs are based on actual, or embedded, costs. Future interest rates must be anticipated to reflect projected changes in a utility's cost caused by the issuance and retirement of long-term debt and preferred stock during the year. This is because the ROE is established on a forecast basis each year.

In D.90-11-057, we recognized that actual interest rates do vary and that our task is to determine "reasonable" debt cost rather than actual cost based on an arbitrary selection of a past figure.¹⁰ In that regard, we concluded that the latest available Data Resources, Inc. (DRI) forecast should be used to determine embedded debt cost in ROE proceedings. Consistent with this conclusion, the assigned Commissioners' Scoping Memo and Ruling allowed the utilities to update their long-term debt and preferred stock costs to reflect September 2002 interest rate forecasts. That update was submitted on September 18, 2002.

A. Investigation

Although ORA recommends that the utilities proposed costs be adopted for this proceeding, it "questions the range of debt and preferred costs filed by the utilities and recommends that the Commission order that these costs be audited in a separate proceeding."¹¹ ORA wants the Commission to open an investigation into the reasonableness of these costs. The purpose of that investigation is to require the utilities to file updated long-term debt and preferred stock costs so that ORA and interested parties could review such costs for reasonableness through discovery on exactly how the estimates were made, verification that there are no arithmetic errors, and confirmation that the estimates are consistent with past agreements.¹²

Prior to the establishment of the utility rate case plan in 1989, ROE and rate design issues were addressed as part of GRC proceedings taking up to two years, and in some instances longer, for a decision. Recognizing the need to streamline GRCs and to ease the burden of issuing end of year decisions, a rate case plan was established. That plan bifurcated the ROE and rate design components of a GRC into distinctly separate proceedings.

ROE applications then became a generic ROE proceeding for addressing issues strictly related to ROE. Those issues involve the reasonableness of capital structure, long-term debt and preferred stock costs, and ROE. Long-term debt and preferred stock costs are an integral component of the ROE proceeding and, as such, are properly reviewed in an ROE proceeding. To the extent that ORA or an interested party question the reasonableness of any of these costs, that party has the ability to flesh out errors, differences, and reasonableness through audits, field investigations, data requests, meetings, and examination of witnesses within the established ROE regulatory process. We reject ORA's request to open a separate investigation into the reasonableness of such costs.

B. PG&E

PG&E estimates its long-term debt cost by starting with its March 31, 2002 recorded cost, which reflects the contractual interest rates that PG&E is obligated to pay once the Bankruptcy Court authorizes payment of the accrued interest. Added to this base are anticipated changes in interest rates for variable rate bonds, factors in bond maturities, and changes due to amortization of redemption premiums, to arrive at a 2002 and 2003 year-end estimated cost of long-term debt. With no new issuances of debt forecasted in 2002 or 2003, PG&E derives a 7.63% average long-term debt cost for its test year. It uses the same method to calculate its 6.05% preferred stock cost.

PG&E updated its long-term debt and preferred stock costs to reflect the September 2002 DRI interest forecast for test year 2003. That update resulted in its long-term debt cost being reduced to 7.57% from 7.63%. The result of this update did not change PG&E's preferred stock cost.

C. SCE

SCE projects its long-term debt cost to be 8.19% based on a simple average of its year end 2002 long-term debt and year end test year 2003 long-term debt. It uses the same method to calculate its 6.51% preferred stock cost. Its updated costs exhibit using the most recent DRI forecast shows no change in its test year long-term debt and preferred stock costs.

D. Sierra

Sierra estimates its long-term debt cost by weighting its average long-term debt cost assigned to its electric department. That long-term debt cost is 7.67%. Sierra does not expect to issue any new electric department debt in the test year. As with long-term debt, its preferred stock cost is determined by calculating its embedded cost. With no plan on issuing preferred stock in the test year, Sierra's 7.91% preferred stock cost reflects embedded cost.

E. SDG&E

SDG&E estimates its long-term debt cost by starting with its December 31, 2001 embedded cost. Adjusted from that cost are 2002 and 2003 amortizations of issue discounts and premiums, issuance expenses, debt reacquisition costs and the retirement of its first mortgage bond series MM. In keeping with its 1998 ROE testimony, SDG&E excludes rate reduction bonds from its cost calculation because such bonds don't support utility ratebase.¹³

With no new issuances of debt during the test year, its average long-term debt cost for the test year 2003 is 6.67%. SDG&E is not planning on issuing any preferred stock in the test year, and uses the same method to calculate its 7.51% preferred stock cost.

Subsequent to the filing of its testimony, SDG&E called its Bond Series LL on July 1, 2002, thereby impacting its long-term debt cost. That change reduced its average long-term debt cost to 6.64% from 6.67%, as reflected in its update cost exhibit. That update exhibit did not change SDG&E's preferred stock cost.

F. Conclusion

No party disputes the long-term debt or preferred stock costs being proposed by the utilities. We have reviewed the costs, which are consistent with the September 2002 DRI interest forecast. The following long-term debt and preferred stock costs for the utilities are consistent with the law, in the public interest and should be adopted.

PG&E SCE SIERRA SDG&E

Long-Term Debt 7.57% 8.19% 7.67% 6.64%

Preferred Stock Cost 6.05% 6.51% 7.91% 7.51%

Having determined the appropriate long-term debt and preferred stock costs we now address the appropriate ROE.