VIII. Assignment of Proceeding and Procedural Matters

Geoffrey Brown and Michael Peevey are the Assigned Commissioners and Michael Galvin is the assigned Administrative Law Judge (ALJ) in this proceeding.

The utilities requested that their respective ROE application be classified as a ratesetting proceeding within the meaning of Rule 5(c). By Resolution ALJ 176-3088, dated May 16, 2002, the Commission preliminary determined that the applications of PG&E, SCE, and Sierra were ratesetting proceedings and that hearings were expected. ALJ Resolution 176-3089, dated June 6, 2002, made a similar finding on SDG&E's application. This ratesetting classification was subsequently affirmed in the Assigned Commissioners Brown and Peevey's July 20, 2002 Scoping Memo and Ruling.

That Scoping Memo and Ruling, among other matters, designated ALJ Galvin as the principal hearing officer, established an evidentiary hearing schedule and determined the issues of this proceeding. Those issues encompassed all estimates upon which the utilities proposed capital structure and rate of return for the test year 2003 were based on. However, issues, such as flotation cost, addressed and resolved in prior Commission proceedings are not to be re-litigated unless new information is asserted.35

An evidentiary hearing was held on August 12, 2002 and continued through August 16, 2002. Each of the utilities, Aglet, FEA, and ORA submitted testimony and evidence. The proceeding was submitted upon the receipt of September 6, 2002 reply briefs subject to receipt of a late-filed exhibit updating long-term debt and preferred stock costs. By a September 11, 2002 ALJ ruling the submission of this proceeding was set aside to receive additional information on the Commission's August 30, 2002 revised plan of reorganization for PG&E and to receive objections to an Aglet motion to strike certain information included in the reply brief of SCE. This matter was resubmitted on September 18, 2002.

The principal hearing officer's proposed decision on this matter was filed and served pursuant to § 311(d) and Rule 77.1 of the Commission's Rules of Practice and Procedure.

Findings of Fact

1. Applicants are public utilities subject to the jurisdiction of this Commission.

2. Each utility has unique factors and differences that need to be considered in arriving at a reasonable return.

3. Other than ORA recommending an optimum capital structure for each of the utilities, no party took issue with the utilities proposed capital structures.

4. ORA cannot affirm that its recommended optimum capital structure for he utilities actually produces an optimum capital structure.

5. The use of an optimum capital structure was considered and rejected by D.89-11-068.

6. 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.

7. 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.

8. Parties have the ability to investigate errors, study differences, and determine the reasonableness of a utility's long-term debt and preferred stock costs through audits, field investigations, data requests, meetings and examination of witnesses within the established ROE regulatory process.

9. We reject ORA's request to open a separate investigation into the reasonableness of a utility's long-term debt and preferred stock costs.

10. D.90-11-057 recognizes that actual interest rates do vary and that our task is to determine reasonable debt costs.

11. Prior decisions utilized AA utility bond interest rates as benchmarks for evaluating cost of common equity for electric utilities.

12. There is no objection to the long-term debt and preferred stock costs being proposed by the utilities in their application.

13. The legal standard for setting the fair ROE has been established by the United States Supreme Court in the Bluefield and Hope cases.

14. An ROE is set at a level of return commensurate with market returns on investments having corresponding risks, and adequate to enable a utility to attract investors to finance the replacement and expansion of a utility's facilities to fulfill its public utility obligation.

15. Quantitative financial models are commonly used as a starting point to estimate a fair ROE.

16. D.94-11-076 found that distinctions between diversifiable and non-diversifiable risks are not clear-cut.

17. Although the quantitative financial models are objective, the results are dependent on subjective inputs.

18. It is the application of informed judgment, not the precision of quantitative financial models, which is the key to selecting a specific ROE.

19. The individual parties' use of quantitative financial modes resulted in a broad ROE range from 9.05% to 15.80% for PG&E, 8.99% to 13.81% for SCE, 8.89% to 13.85% for Sierra, and 8.97% to 14.85% for SDG&E.

20. Two important components of the Hope and Bluefield decisions are that the utilities have the ability to attract capital to raise money for the proper discharge of their public utility duties and to maintain creditworthiness.

21. Our consistent practice has been to moderate changes in ROE relative to changes in interest rates in order to increase the stability of ROE over time.

22. The September 2002 AA utility bond interest rate forecast for test year 2003 is 7.16%, a 46 basis points drop in interest rate from the April 2002 forecast of 7.62%.

23. D.99-06-057 rejected the ECAPM financial model because it artificially raises the ROE requirement.

24. At this time, PG&E has a speculative grade D credit rating.

25. At this time, SCE and Sierra have a speculative grade Double-B credit rating.

26. SDG&E has an investment grade Single-A credit rating.

27. Alternative plans to bring PG&E out of bankruptcy are before the Bankruptcy Court.

28. PG&E expects to emerge from Chapter 11 at the beginning of its ROE test year.

29. SCE's Performance Based ratemaking mechanism governs its ROE until a final decision is issued in its pending GRC, A.02-05-004.

30. Procurement risk and lever/unlever betas addressed in this proceeding were also addressed in the 1999 cost of capital proceeding.

Conclusions of Law

1. Optimum capital structures should not be adopted for the utilities in this proceeding.

2. The utilities' test year capital structures are reasonable and should be adopted.

3. The long-term debt and preferred stock costs being proposed by the utilities are consistent with the law, in the public interest, and should be adopted.

4. This ROE proceeding should be used to flesh out errors, differences, and reasonableness of long-term debt and preferred stock costs.

5. Risks being experienced by the utilities warrant the ROEs being adopted in this proceeding at the upward end of an ROE range found just and reasonable.

6. The most recent trend of DRI interest rate forecasts between the date that testimony was prepared in April to the date this matter was submitted should be considered to moderate changes in ROE relative to changes in interest rates.

7. A downward trend in interest rates, except for SDG&E, warrants a downward adjustment in ROE.

8. A 20 basis points ROE differential between PG&E's electric and gas operations should exist because of differences in electric and gas financial model results, with its electric operations receiving the higher ROE.

9. A test year ROE range from 10.80% to 11.80% is just and reasonable for PG&E based on financial model results, increase business and regulatory risks, no change in capital structure, a downward trend in AA utility bond interest rate forecast, and a speculative grade credit rating.

10. A test year ROE range from 10.80% to 11.80% is just and reasonable for SCE, based on financial model results increased business and regulatory risks, no change in capital structure, a downward trend in AA utility bond interest rate forecast, embedded debt cost higher than the most recent AA utility bond interest rate forecast and a speculative grade credit rating.

11. A test year ROE range from 10.60% to 11.60% is just and reasonable for Sierra based on financial model results, increased business and regulatory risks, change in capital structure, downward trend in AA utility bond interest rate forecast, and a speculative grade credit rating.

12. A test year ROE range from 10.50% to 11.50% is just and reasonable for SDG&E based on financial model results, increased business and regulatory risks, no change in capital structure, downward trend in AA utility bond interest rate forecast, embedded debt cost lower than the most recent forecast AA utility bond interest rate forecast, and an investment grade credit rating.

13. A test year 11.70% electric ROE, which results in an overall 9.47% return on electric rate base and a test year 11.50% gas ROE, which results in an overall 9.37% return on gas rate base, should be adopted as just and reasonable for PG&E, based upon all of the evidence considered in this proceeding.

14. A test year 11.70% ROE, which results in an overall 9.80% return on rate base, should be adopted as just and reasonable for SCE, based upon all of the evidence considered in this proceeding.

15. A test year 11.20% ROE, which results in an overall 9.16% return on rate base, should be adopted as just and reasonable for Sierra, based upon all of the evidence considered in this proceeding.

16. A test year 11.00% electric and gas ROE, which results in an overall 8.82% return on electric and gas rate base, should be adopted as just and reasonable for SDG&E, based upon all of the evidence considered in this proceeding.

17. PG&E, Sierra, and SDG&E should file advice letters to implement changes in electric and gas revenue requirements being authorized by this order effective January 1, 2003.

18. SCE should file an advice letter to implement changes in its URG revenue requirements being authorized by this order effective January 1, 2003. Its revenue requirement being authorized by this order should be prorated and implemented as of the effective date of its GRC decision.

19. Appendices A and B to SCE's reply brief reflect positions taken in the 1999 cost of capital proceeding and do not necessarily reflect the current position on those issues. Aglet's motion to exclude these appendices should be denied.

20. This proceeding should remain open to address the impact of PG&E's ROE due to its implementation of the financing contemplated by the Chapter 11 plan approved by the Bankruptcy Court to enable PG&E emerge from Chapter 11.

21. Aglet motion to exclude from SCE's reply brief certain appendices and reference to those appendices should be denied.

22. The utilities ROE applications should be granted to the extent provided for in the following order.

INTERIM ORDER

IT IS ORDERED that:

23. Pacific Gas and Electric Company's (PG&E) cost of capital for its test year 2003 electric operations is as follows.

24. Pacific Gas and Electric Company's (PG&E) cost of capital for it s test year 2003 gas operations is as follows.

25. PG&E shall file an advice letter to change its electric rate components effective January 1, 2003 to incorporate the change in its electric revenue requirement as authorized by this decision. PG&E shall reflect the gas revenue requirement authorized by this decision in its January 2003 gas rates, in conjunction with the implementation of its annual true-up of Balancing Accounts rate changes. If the Energy Division Director suspends any tariffs, such tariffs shall become effective upon the date the Energy Division Director confirms that the tariffs are in compliance.

26. Southern California Edison Company's (SCE) cost of capital for its test year 2003 is as follows.

27. SCE shall record, effective January 1, 2003, the revenue requirement applicable to its utility retained generation operations (URG) operation in its "ISO Balancing Account" subject to refund or true up in A.02-05-004. The revenue requirement applicable to SCE's non-URG operations shall become effective and implemented on the same date as the final decision is issued in its general rate case (GRC) proceeding (Application 02-05-004). The test year revenue requirement applicable to non-URG operations shall be prorated as of the effective date of its GRC decision.

28. Sierra Pacific Power Company's (Sierra) cost of capital for its test year 2003 is as follows.

29. Sierra shall implement the revenue requirement change being authorized by this order through an advice letter filing to become effective January 1, 2003. If the Energy Division Director suspends any tariffs, such tariffs shall become effective upon the date the Energy Division Director confirms that the tariffs are in compliance.

30. San Diego Gas & Electric Company's (SDG&E) cost of capital for its test year 2003 electric and gas operations is as follows.

31. SDG&E shall file an advice letter to revise its respective tariffs to incorporate the tariff changes authorized herein effective January 1, 2003. SDG&E shall spread the revenue requirement changes being proposed by this decision on a uniform percentage basis to its electric and gas rates pursuant to the electric and gas rate design in effect, as explained in its application. If the Energy Division Director suspends any tariffs, such tariffs shall become effective upon the date the Energy Division Director confirms that the tariffs are in compliance.

32. Applications (A.) 02-05-025, 02-05-026, and 02-05-031 are closed.

33. PG&E's A.02-05-022 remains open to true up its test year 2003 ROE with changes in its capital structure, long-term debt and preferred stock costs, and risk that results from it implementing the financing contemplated by a Chapter 11 plan approved by the Bankruptcy Court that enables PG&E to emerge from Chapter 11. Within 30 days after completing any such financing, PG&E shall file a request in this proceeding for authority to true up its test year 2003 capital structure and ROE. That request shall include testimony on its revised capital structure, long-term debt and preferred stock cost, risks, and ROE.

34. SCE's Appendices A and B to its reply brief shall be included in the record only for the purpose of showing that Weil and ORA addressed procurement risk and lever/unlever betas in the proceeding that resulted in Decision 99-06-057.

This order is effective today.

Dated , at San Francisco, California.

Aglet 10.42% - 11.25% Aglet36 10.87%

FEA 9.35% - 13.88% FEA 9.35% - 13.88%

ORA 9.05% - 11.47% ORA 9.47% - 12.27%

SCE SIERRA

SCE 13.15% - 13.81% Sierra37 11.15% - 13.85%

Aglet 10.13% - 11.25% Aglet 10.13% - 11.25%

FEA 9.35% - 13.88% ORA 8.89% - 11.15%

ORA 8.99% - 11.51%

SDG&E38 11.15% - 14.85% SDG&E39 11.15% - 14.85%

Aglet 10.13% - 11.25% Aglet40 10.87%

ORA 8.97% - 11.42% ORA 9.47% - 12.27%

(END OF APPENDIX A)

APPENDIX B

APPEARANCES

35 Flotation cost consists of direct and indirect costs associated with the issuance of new stock. 36 Aglet used only the DCF model to quantify its gas operations recommendation. 37 The utility's quantitative financial model results, except for the allowed risk premium, were reduced by 25 basis points to exclude the impact of flotation cost not an issue in this proceeding. RT Vol. 4, pages 468 and 469. 38 Id. 39 Id. 40 Aglet used only the DCF model to quantify its gas operations recommendation.

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