Application No.: A.04-12-014Exhibit No.: SCE-21Witnesses: A. Fohrer
P. HuntL. Hedrick
(U 338-E)
2006 General Rate CaseRebuttal Testimony
SCE-21 - Post-Test Year Ratemaking
Before thePublic Utilities Commission of the State of California
Rosemead,
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SCE-21: Post-Test Year RatemakingTable Of Contents
Section Page Witness
I. POLICY..............................................................................1......................................................................A. Fohrer
A. The Commission Should Reject The Post Test Year Ratemaking Proposals Of ORA, Aglet, And TURN................................................................1
B. Large Reductions In Capital Expenditures Would Be Required Under The Proposals Of ORA, Aglet, And TURN......................................2
C. The Commission Should Not Reverse Its Commitment To SCE’s Infrastructure Replacement Program......................................3
D. SCE’s Post-Test Year Ratemaking Proposal Is The Optimal Method To Forecast Investment Needs Between GRC Test Years.......................6
E. The Commission Should Avoid A Compromise Solution............................................................6
II. POST-TEST YEAR RATEMAKING........................................8.........................................................................P. Hunt
A. Introduction......................................................8
B. Approval Of SCE’s Post-Test Year Ratemaking Methodology Is Necessary To Support SCE’s Creditworthiness...............................................9
C. SCE’s Current Post-Test Year Ratemaking Has Worked Well, Matching Revenues With Stepped-Up Capital Investment......................10
D. ORA’s And Aglet’s Proposals To Increase SCE’s Revenue Requirement By The Consumer Price Index Should Be Rejected...............................11
1. Simpler Is Not Better.............................11
2. The Consumer Price Index Does Not Adequately Track O&M Cost Increases. 13
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SCE-21: Post-Test Year RatemakingTable Of Contents (Continued)
Section Page Witness
3. The Consumer Price Index Does Not Adequately Track Capital-Related Cost Increases...............................................14
4. Aglet’s And ORA’s Citations Of PG&E And SDG&E/SoCalGas Settlements Are Not Compelling............................................15
a) Aglet And ORA Omit Key Points Of These Settlements.......................15
b) The Settlements Incorporate Ceilings And Floors That Limit The CPI Change..................................16
c) Global Insight Projections Made At The Time The PG&E And SDG&E/SoCalGas Settlements Were Adopted Indicate That Floors In The Mechanisms Compensated For The Inequities Embedded In The Use Of The CPI......................17
5. Aglet’s Arguments Regarding Comprehension, Verification, And Revision Are Not Compelling.................19
6. Aglet’s Comments About Price Index Stability And Bias Are Misleading And Irrelevant..............................................22
7. SCE’s Proposed Capital Expenditures Will Result In A Greater Overall Level Of Economic Activity Than ORA’s Proposed Expenditures.........................................23
E. ORA’s Alternate Post Test Year Ratemaking Proposal Will Not Provide Sufficient Revenues For SCE To Make Necessary Capital Investments In SCE’s Electric System............25
F. Aglet’s Comments About SCE’s Capital Costs Are Incorrect And Should Be Ignored..............27
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SCE-21: Post-Test Year RatemakingTable Of Contents (Continued)
Section Page Witness
G. Traditional Attrition Methodology Can No Longer Be Applied To SCE..............................29
H. Reasons Why Attrition Was Denied To PG&E In The Past Do Not Apply To SCE In This Application......................................................30
I. The New Regulatory Framework And Ratemaking Mechanisms For Class C And D Water Utilities Are Not Relevant To SCE’s Situation.........................................................31
1. Why The New Regulatory Framework Is Not Relevant.........................................31
2. Why Regulation Of Class C And D Water Utilities Is Not Relevant.........................33
J. Cost Recovery For Four Corners Variable Overhaul Outage Should Be Allowed..............34
K. SCE Opposes Extending ORA’s Proposed Attrition Mechanism Through 2009................35
Appendix A Discussion Of The Methodology Used To Develop The Contingent Forecast For Post Test Year Capital Expenditures.........................................................................................................................L. Hedrick
Appendix B Complete Copy Of Report On Industry-Specific Price Index Discussed In Aglet Testimony.............................................................................................P. Hunt
Appendix C Comparison Of Capital-Related Cost Escalation With The Consumer Price Index
Appendix D Cost Effectiveness Analyses of Forecast Capital Expenditures References to Testimony and Workpapers
Appendix E Global Insight Report
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SCE-21: Post-Test Year RatemakingList Of Tables
Table Page
Table II-1 CPI Expenditure Category, Relative Importance, December 2004................................................................................................12
Table II-2 Comparison Of SCE Overall O&M Escalation Rate And Consumer Price Index......................................................................14
Table II-3 Ceilings And Floors On CPI Changes In PG&E Attrition Mechanisms.....................................................................................16
Table II-4 Ceilings And Floors On CPI Changes In SDG&E And SoCalGas Attrition Mechanisms.......................................................................17
Table II-5 Global Insight CPI Growth Projections, June 2003 Through September 2003..............................................................................18
Table II-6 Global Insight CPI Growth Projections, June 2004 And July 2004................................................................................................19
Table II-7 Comparison Of Overall Economic Impacts From SCE’s And ORA’s Proposed Capital Expenditures.............................................24
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I.
POLICY
A. The Commission Should Reject The Post Test Year Ratemaking
Proposals Of ORA, Aglet, And TURN
In their testimonies, the Office of Ratepayer Advocates (ORA), Aglet Consumer Alliance (Aglet) and The Utility Reform Network (TURN) oppose SCE’s request to continue the Post-Test Year Ratemaking (PTYR) mechanism authorized in our 2003 GRC. Instead, ORA recommends a CPI-indexing methodology1 to establish SCE’s PTYR rates or in the alternative, an attrition hybrid mechanism that authorizes future capital investment based on a combination of previous capital additions and ORA cuts to SCE’s request, rather than on actual capital needs as forecast.2 Aglet proposes a similar CPI-indexing mechanism, which is endorsed by TURN.3 These proposals would result in deep reductions in needed capital spending, with consequences to be felt well into the future. Furthermore, as the attached analysis performed by Global Insight demonstrates, the economic benefit to our region is clearly greater than the cost of our GRC capital investment program.
The forecast capital needs cannot plausibly be reduced by further SCE efficiency initiatives as ORA suggests. To the contrary, the investment program represents a long-term cost minimizing strategy that takes account of replacement costs, uncertain failure rates, and system reliability. These proposals for the post-test year period would eliminate our Infrastructure Replacement program and
1 CPI refers to the Consumer Price Index, published by the U.S. Bureau of Labor Statistics.2 See The Office of Ratepayer Advocates Report on the Results of Operations for Southern
California Edison Company General Rate Case Test Year 2006 (ORA Report), Volume 2, p. 16-2, lines 2-9.
3 See TURN Report on Various Results of Operations Issues in Southern California Edison’s 2006 Test Year General Rate Case (TURN Report), p. 59, lines 2-4; and Aglet Consumer Alliance, Direct Testimony of James Weil (Aglet Report), pp. 25-33.
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other system-related capital investments that are essential to preserving the long-term safety and reliability of our electric system. Because enactment of these proposals would so drastically reduce SCE’s ability to provide safe and reliable service to our customers, the Commission must reject them.B. Large Reductions In Capital Expenditures Would Be Required Under
The Proposals Of ORA, Aglet, And TURN
When we received the ORA’s testimony in mid-April, I directed each company department to analyze the impact of ORA’s proposals on their capital expenditures forecast. My intent was to develop a plan to prioritize capital spending and to immediately implement it should the Commission choose to adopt either of the ORA’s proposals. As the recommendations of Aglet and TURN endorse the CPI-indexing methodology proposed by ORA, the analyses of ORA’s proposal are equally applicable to the Aglet and TURN recommendations. As I have stated in my direct testimony, SCE will conform its spending to be aligned with the overall revenue requirement authorized in this GRC. For its Hybrid-Attrition plan, the ORA simply made equal percentage cuts in each and every capital expenditure through their Results of Operations model4, our contingency plan has prioritized capital spending to direct what capital remains to the areas absolutely essential to preserve the safety of our employees and customers, connect new customers moving to our service territory, and do our best to comply with the laws and regulations that govern our business. We also plan to direct more capital to the budget items designated for in-service failures and emergency work, because these ORA proposals would not permit continued investment in preventive capital replacement such as our Infrastructure Replacement program.
The analysis of the ORA, Aglet and TURN proposals and their effect on our capital spending plans reveals, quite strikingly, that many deep and severe cuts in 4 See Results of Operations Model supporting the ORA’s testimony dated April 14, 2005.
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capital expenditures would be required to conform to these proposals. ORA’s Hybrid Attrition proposal would make across the board cuts to capital expenditures of 41 percent in 2007 and 36 percent in 2008.5 Subjecting SCE’s capital forecast to the ORA, Aglet and TURN CPI-indexing proposals would require cuts of $706 million in 2006, $611 million in 2007, and $551 million in 2008.6 Appendix A and its workpapers provide a comprehensive list of projects that would be postponed or cancelled to align our capital expenditures with the ORA, Aglet and TURN forecasts.
Although rates would be reduced in the short-term under these proposals, the reductions in our capital expenditures will ensure that our costs to serve customers will increase significantly in the future and that long-term system reliability will be compromised in the years to come. ORA, Aglet and TURN have not demonstrated that either of these proposals justify the unsparing cuts SCE would be required to make.C. The Commission Should Not Reverse Its Commitment To SCE’s
Infrastructure Replacement Program
As we testified before the Commission in SCE’s 2003 General Rate Case, much of our electric system is experiencing an “age bubble” and is nearing the end if its useful life. We cannot replace system components at the same pace we have replaced them in the past, without creating a large backlog of work. Furthermore, if we wait until system components fail while in service, as these proposals would require, the cost of such replacements will be much greater than those which are the product of our planned systematic inspection, repair or replacement. The capital investment required to replace this equipment has
5 Ibid.6 These are CPUC-jurisdictional and exclude non-GRC capital expenditures. Reductions in
2006 are necessary because of large Construction Work In Progress balances projected for 2006 in both the ORA and SCE forecasts.
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created great demands on company resources. In the 2003 GRC testimony we described the need to commence a detailed, systematic program of capital investment to replace components nearing the end of their useful lives. The need to continue the increased volume of equipment repair and replacement remains, otherwise there is a genuine threat of significant degradation of service and higher replacement costs in future years. I cannot tell you precisely when the degradation of system reliability would occur, but only that it will occur, and the cost to return our system to historic reliability levels would be more expensive.
The analysis of SCE’s infrastructure replacement needs began in 1998 and increased spending commenced in 1999. In the 2003 GRC testimony I stated that “This program is essentially permanent, extending over several rate case cycles, and is designed to minimize costs over the long term with a goal of preserving the current level of system reliability.”7 In the 2003 GRC Decision, D.04-07-022, the Commission recognized the importance of these programs and made a policy decision to authorize increased capital expenditures to support SCE’s investments to meet customer growth, load growth, and to increase our level of investment in the infrastructure replacement program. When approving nearly all of our capital forecast and adopting SCE’s mechanism, the Commission noted, “When older facilities are replaced with new ones, the associated costs are typically much higher than what is included in rates for the original facilities. Moreover, the effect of this phenomenon is enhanced by the accelerated pace of planned capital spending associated with SCE’s infrastructure replacement program.”8 In other words, just one year ago the Commission recognized the need for SCE’s program of stepped-up capital investment. I believe the Commission likewise understood
7 See Exhibit 1, A. 02-05-004.8 See D.04-07-022, (mimeo), p. 276.
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the long-term benefit of planned replacements rather than waiting for inevitable in-service failures and emergency replacements.
Based on the Commission’s approval of our capital spending for 2004 and 2005, we have been methodically working on this program despite significant interruptions such as the destructive fires of October 2003 which burned over 750,000 acres of land in southern California (366,000 acres in our service territory alone). These and other unanticipated conditions, including the record rainfall that began in late 2004, required us to reallocate resources originally intended for the Infrastructure Replacement program. Despite these setbacks, our 2004 recorded capital investment is close to levels authorized in SCE’s 2003 general rate case and to the level forecast in this 2006 GRC. Our 2004 recorded capital additions were 94 percent9 of our authorized level, despite the interruptions described above. We expect capital investment to exceed authorized levels in 2005 because customer and load growth demands have outpaced the levels authorized in the 2003 general rate case. At year-end 2005, we will have invested in our electric utility system as the Commission intended when it approved our plan. We are committed to this capital investment initiative because it is the right thing to do to preserve system reliability.
The ORA, Aglet and TURN have requested the Commission to reverse its policy decision of last year, authorizing the first part of SCE’s long-term capital plan. I believe the Commission accepted the proposition that aged infrastructure and the possibility of increasing failure rates makes it necessary to accelerate our Infrastructure Replacement program. These proposals by ORA, Aglet and TURN would impede our efforts to mitigate the inevitable deterioration in reliability and safety that would ensue if our system replacements were not stepped up at the same time we work to keep pace with strong customer and load growth. Either of 9 CPUC Jurisdiction, Gross Capital Additions.
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these proposals would limit SCE’s system asset replacement to inadequate historic levels, creating an ever-larger backlog of work every year.D. SCE’s Post-Test Year Ratemaking Proposal Is The Optimal Method To
Forecast Investment Needs Between GRC Test Years
In support of its proposal, ORA speculates that SCE’s reliance on budgeted capital expenditures is less reliable than historical spending data and provides SCE with strong incentives for “excessive capitalization.”10 ORA’s speculation is unwarranted and fails to recognize significant features of SCE’s Post-Test Year ratemaking adopted by the Commission last year. SCE’s PTYR mechanism includes a one-way balancing account for capital additions during the period between rate case test years. If SCE does not make investments equal to or greater than authorized levels, we will return the excess revenue requirement. Further, the reasonableness of SCE’s capital investments between GRC test years is reviewed in the following general rate case. We do not shrink from such accountability, as these capital investments are essential to continued reliable service for our customers. These regulatory protections are fair to both our customers and to SCE, yet permit us to retain discretion to direct resources where they are most needed. To the extent SCE fully implements its capital spending budget in 2007-2008, we will be able to recover the associated costs through the PTYR mechanism, subject to review for reasonableness in our 2009 General Rate Case.E. The Commission Should Avoid A Compromise Solution
We also ask the Commission to resist the temptation to just choose a compromise option that would set a 2007 – 2008 revenue requirement somewhere between the ORA’s, Aglet’s and TURN’s unreasonable forecast and SCE’s Post-Test Year Ratemaking request. If the Commission chooses this option, it will reverse a decision it made just a year ago, to recognize the inevitable degradation of electric 10 See ORA Report, pp. 16-13 and 16-14.
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system reliability if the need for replacement capital is left unattended. Authorizing a revenue requirement that chooses an unreasonable level as a starting point and then indexes it without regard to capital investments required to maintain a safe and reliable system would be a genuine disservice to our customers. As I indicated above, investing in a systematic and methodical plan of capital replacement, over a number of years, is the optimal way to maintain SCE’s system. Further, choosing a compromise outcome would reward the ORA, Aglet and TURN for making an unreasonable proposal that is completely detached from the requirements of managing a modern electric power system. I ask that you reject the ORA, Aglet and TURN proposals and adopt SCE’s Post-Test Year Ratemaking mechanism.
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II.
POST-TEST YEAR RATEMAKING
A. Introduction
In this chapter, we rebut the proposals of the Office of Ratepayer Advocates (ORA), Aglet Consumer Alliance (Aglet), and The Utility Reform Network (TURN) regarding our Post Test Year Ratemaking (PTYR) mechanism. Due to major flaws in their analyses and the draconian outcomes that these proposals would create, the Commission should reject intervenors’ recommendations and adopt SCE’s proposal to continue its PTYR mechanism.
In this application, the Commission has an obligation to authorize a revenue requirement that will yield a reasonable rate of return on prudent investments. As explained in the previous chapter, if the Commission adopts any of the ORA, Aglet or TURN proposals on post test year ratemaking, SCE will not be able to earn a reasonable return on its invested capital unless it cuts or defers essential capital investments, including the infrastructure replacement program.
Aglet’s proposal on post test year ratemaking largely duplicates ORA’s. Aglet proposes a “CPI-based mechanism for SCE,”11 but does not present detailed numerical estimates of SCE’s revenue requirement for 2007 and 2008. This is effectively an endorsement of ORA’s CPI-indexing mechanism. Any mechanism that ignores SCE’s actual future capital investment needs to provide safe and reliable service and simply assumes arbitrarily that the future will be a mirror image of the past is inherently flawed and must be rejected.
TURN’s recommendation is less specific. TURN supports “Aglet’s testimony recommending that the Commission reject budget-based approaches to attrition year capital.”12
11 Aglet Consumer Alliance Testimony (Aglet Testimony), Weil, p. 27, lines l0-11.
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B. Approval Of SCE’s Post-Test Year Ratemaking Methodology Is
Necessary To Support SCE’s Creditworthiness
We need the continuous support of the Commission to maintain our financial credit rating. In a recent report, Standard & Poor’s wrote, “A failure by the CPUC to provide timely recovery of amounts recorded in balancing accounts and to maintain an alignment of revenues and expenses could impair SCE’s financial performance in the face of material changes in operating expenses, fuel prices, electric procurement costs, electric demand, or capital expenditures.”13 One of the strengths identified by Moody’s Investor Service was a favorable 2003 GRC Decision that approved post test year ratemaking for SCE: “Of particular importance in the GRC decision is the CPUC’s award of attrition revenues of $144 million and $163 million for test years 2004 and 2005, respectively, which signals a constructive approach towards supporting SCE’s credit quality as the company’s capital expenditure program increases over the next few years.”14 SCE’s stable outlook is based on the expectation that the current trend of constructive regulatory support from the CPUC will continue. Without the Commission’s continuous support, we risk jeopardizing the financial recovery we’ve achieved thus far.
While the comments of Standard & Poor’s and Moody’s are primarily focused on SCE’s credit rating, the issues that they highlight are equally applicable to the interests of SCE’s sharedholders. Unless the Commission authorizes proper cost recovery, we will be required to either defer or discontinue necessary expenditures. The recommendations of ORA, Aglet, and TURN present an 12 TURN Reports on Various Results of Operations Issues in SCE’s 2006 Test Year General Rate
Case (TURN Report), Marcus, p. 59, lines 19-20.13 Standard & Poor’s Ratings Direct, Southern California Edison Co., Corporate Credit Rating,
February 16, 2005.14 Moody’s Investor Service, Credit Opinion: Southern California Edison Company, December 15,
2004.
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untenable dilemma for SCE: earn an inadequate return on equity or drastically scale back our operations and our capital program to try to earn an adequate return. Neither alternative is acceptable. In the first, our shareholders earn an inadequate return, while in the second, the reliability of our system is sacrificed.
ORA’s testimony is particularly disingenuous on this point, as ORA claims it “does not oppose a mechanism that provides SCE the opportunity to earn its authorized rate of return for its GRC related operations during the years 2007-2009.”15 ORA also posits that “[p]roviding reliable electric service is of utmost importance to the health and welfare of the state’s citizens and the state’s economy. (Footnote omitted.)”16 Under both of ORA’s proposals, SCE could only achieve one of these objectives.
Trying to support SCE’s planned capital investments with the revenue requirement recommended by ORA, Aglet and TURN would create problems for SCE that cannot be fixed in SCE’s next GRC or succeeding GRCs. Capital investments that are made during 2006 through 2008 must begin depreciation when they close to plant. If there are inadequate revenues to produce an earned return on these investments during the 2006-2008 period, the lost earned return can never be recovered for shareholders. If SCE is forced to forgo capital investments, then we and our customers will only find ourselves with a system that is older than it is today.C. SCE’s Current Post-Test Year Ratemaking Has Worked Well,
Matching Revenues With Stepped-Up Capital Investment
SCE is on track to make capital investments consistent with currently-authorized levels and 2006 GRC forecasts. For the 2004 post test year period, our recorded capital additions (including cost of removal, which ORA failed to include
15 ORA Report, Volume 2, p. 16-1, lines 14-16.16 Id. at lines 10-12.
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in its calculations17) came in slightly below what we projected for 2004, but ratepayers were not harmed due to the one-way capital additions balancing account that was authorized in D.04-07-022. The 2004-2005 Capital Additions Adjustment Mechanism (CAAM) protects SCE customers by ensuring that authorized revenue requirements are adjusted to recover only the costs of capital investments that are actually made. Any scope changes or capital project substitutions are reviewed by the Commission in subsequent general rate cases. SCE’s proposal to continue its current PTYR mechanism allows the company to make essential capital investments, as discussed above, and to recover those costs, all while protecting ratepayers. It is a win-win situation. Continuation of SCE’s PTYR mechanism along with the capital additions balancing account aligns both shareholder and ratepayer interests and should be adopted.D. ORA’s And Aglet ’ s Proposals To Increase SCE’s Revenue
Requirement By The Consumer Price Index Should Be Rejected
1. Simpler Is Not Better
In support of its position, ORA states that its CPI-indexing method is a simpler approach than SCE’s PTYR proposal. Aglet makes a similar claim. However, in SCE’s 2003 GRC Decision 04-07-022, the Commission found “This [CPI] approach may be simple, but it has no other known benefit. Simplicity alone does not prompt us to prefer it over SCE’s approach, which provides for separate and therefore, we believe, more accurate treatment of O&M expenses and capital related costs.”18
In addition, general measures of inflation such as the CPI do not adequately track utility cost increases because they do not reflect the same basket of labor, materials, and capital inputs used to provide electricity service and their
17 See SCE-ORA-21, Question 9.18 D.04-07-022, (mimeo), p. 272-273.
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respective changes in input prices, do not reflect the increases in capital expenditures projected by SCE, and are not consistent with traditional regulated utility capital cost accounting procedures. The CPI should not be used in a post test year ratemaking mechanism when utility-specific indexes are available and provide better estimates of utility cost changes. The CPI represents changes in the price paid for goods and services that an average consumer purchases. Excluded from CPI are purchases by business and government and purchases made on behalf of consumers but not directly by them. Thus, the CPI does not include large cost categories, such as those typically incurred by SCE. While electricity purchased by consumers is included in the CPI market basket, utility inputs are not because they are not directly purchased by consumers.
The weights of major categories that comprise the CPI are shown in Table II-1. What becomes immediately apparent is that the “basket” of goods and services purchased by a typical consumer is very different from that of a utility. For instance, utilities do not purchase food and beverages to the extent an average consumer does (i.e., 15 percent of total purchases). And, while housing could be considered a distant proxy for cost of offices for SCE employees, the cost of operating and maintaing office buildings is nothing near 42 percent of SCE’s total operating and maintenance costs.
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Table II-1CPI Expenditure Category, Relative Importance, December 2004
Line No.
Expenditure Category Relative Importance
1 Food and beverages 15.291% 2 Housing 41.993% 3 Apparel 3.841% 4 Transportation 17.414% 5 Medical care 6.132% 6 Recreation 5.733% 7 Education and communication 5.846% 8 Other goods and services (tobacco and
smoking products; personal care) 3.750%
In D.04-07-022, the Commission affirmed these facts:The CPI may be a simple, accessible measure of general inflation faced by urban U.S. consumers, but that alone does not make it appropriate as a measure of price changes faced by an electric utility. It does not specifically cover the prices of the typical goods SCE purchases. Conversely, SCE’s proposed escalation rates were not designed to track the general level of inflation, and there is no reason why they should do so. Moreover, even if the CPI includes health care price inflation faced by consumers, it excludes the prices of health care paid for by employers.Apart from simplicity (and the fact that it yields a lower revenue requirement), Aglet has not demonstrated why it is appropriate to forecast SCE’s cost changes using a measure of price changes faced by consumers instead of measures of price changes faced by utilities. SCE’s escalation approach more accurately reflects utility purchases and will therefore be approved.20
2. The Consumer Price Index Does Not Adequately Track O&M
Cost Increases
SCE has constructed an overall O&M escalation rate from the separate O&M escalation indexes used in the Company’s escalation showing in Exhibit SCE-8, Volume 1, Chapter VII, plus projected benefit escalation rates for 2007-2009. 19 U.S. Department of Labor, Bureau of Labor Statistics, Consumer Price Index Detailed Report
Tables 1-29, April 2005, Table 1. (Available on the Internet at http://www.bls.gov/cpi/cpid0504.pdf.)
20 D.04-07-022, (mimeo), pp. 278.
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These separate O&M escalation indexes were updated to the latest available Global Insight projection (first quarter of 2005) to facilitate comparison with ORA’s projection of the Consumer Price Index presented in ORA’s report (taken from the March 2005 Global Insight projection).21 The results of this comparison are shown in Table II-2, and show that the CPI is projected to rise less rapidly than SCE’s O&M escalation indexes over the post test year ratemaking period. Thus, the CPI is an inadequate escalator for SCE’s O&M expenses.
Table II-2Comparison Of SCE Overall O&M Escalation Rate And
Consumer Price Index
YearSCE Overall O&M Escalation Rate
Consumer Price Index
Difference (SCE Rate – CPI)
2007 2.65% 1.94% 0.71%2008 2.24% 2.12% 0.12%2009 2.93% 2.32% 0.61%
Average 2.61% 2.13% 0.48%
3. The Consumer Price Index Does Not Adequately Track Capital-
Related Cost Increases
For capital-related costs (depreciation, return, and taxes), the proof is more complicated, but the end result is the same: the CPI does not adequately track increases in SCE’s capital-related costs. As shown in Appendix C, increases in SCE’s capital-related costs depend not only on current growth in capital additions and capital equipment prices, but the past history of growth in capital additions and capital equipment prices and the regulatory mechanisms used to transform capital expenditures (a stock) into a stream of revenues to recover a return of and on these expenditures (a flow). During the lifetime of SCE’s current capital stock, escalation in capital equipment prices was much higher than it is
21 ORA Report, Volume 2, p. 16-11, fn. 137.
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currently. SCE’s transmission and distribution assets, for example, have very long lives. Much of SCE’s T&D system was built and placed in rate base during or prior to the 1970s and 1980s, when prices for all products were rising much faster than today. Because capital-related costs are based on the original cost of SCE’s capital assets and these assets have long lives, past escalation affects current escalation in capital costs. Thus, an escalation rate for capital-related costs must capture more than contemporaneous changes in prices. The CPI, which is based only on current information about prices, cannot do this.
In addition, as noted above, increases in capital-related costs depend not only on the escalation of capital equipment prices, but also on the growth in capital additions. The CPI, because it is only an index of prices, cannot properly capture SCE’s growth in capital additions now, or the effect of past capital additions on current and future capital-related costs.
It is clear from the discussion in section B and the data presented in Appendix A that a CPI-indexing methodology grossly underfunds SCE’s capital-related revenue requirement for 2007 and 2008. But the underfunding problem arises even if SCE had no growth in real capital. Appendix C estimates how capital-related costs would change even if SCE had no growth in real capital during the average service life of its capital assets. The results of this appendix demonstrate the deficiencies of the CPI for estimating capital-related cost increases at this time. The Commission should reject the use of the CPI for this purpose.
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4. Aglet ’ s And ORA ’ s Citations Of PG&E And SDG&E/SoCalGas
Settlements Are Not Compelling
a) Aglet And ORA Omit Key Points Of These Settlements Aglet cites settlements in PG&E and SDG&E/SoCalGas cases as
support for use of the CPI.22 ORA does the same.23 The PG&E settlement agreements were accepted by the Commission in D.04-05-055, while the SDG&E/SoCalGas settlement agreement was accepted in D.05-03-023. Aglet and ORA omit key points regarding these agreements. First, each agreement is intended to be adopted as a unified agreement.24 Concessions in one area of an agreement may offset concessions in another area. Because the use of the CPI is only one factor in a larger agreement, it is not possible to determine how the Commission might have ruled in the absence of other provisions that it had to consider as a unified whole in approving these settlements. The settlements are compromises and the terms are not precedential in any way.25
b) The Settlements Incorporate Ceilings And Floors That Limit The CPI ChangeThe settlements incorporate ceilings and floors so that if the CPI
change is too high or too low, it is overridden.26 These ceilings and floors are displayed in the following two tables:22 Aglet Testimony, Weil, pp. 26-28.23 ORA Report, Volume 2, pp. 16-9 through 16-10.24 PG&E Distribution Settlement, Reservation 8; PG&E Generation Settlement, Reservation 21;
SDG&E/SoCalGas Settlement, Section IV.C.25 PG&E Distribution Settlement, Reservations 1, 3, and 9; PG&E Generation Settlement,
Reservations 17 and 22; SDG&E/SoCalGas Settlement, Sections IV.B and IV.C. All of the settlements were presented for adoption under the Commission’s rules regarding settlements. Rule 51.8 provides: “Commission adoption of a stipulation or settlement is binding on all parties to the proceeding in which the stipulation or settlement is proposed. Unless the Commission expressly provides otherwise, such adoption does not constitute approval of, or precedent regarding, any principle or issue in the proceeding or in any future proceeding.” As far as SCE can determine, the Commission has not stated that the relevant terms in these settlements are precedential for any other proceeding.
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Table II-3Ceilings And Floors On CPI Changes In PG&E
Attrition Mechanisms
YearPG&E
DistributionMinimum Change
PG&E DistributionMaximum Change
PG&E Generation Minimum Change
PG&E Generation Maximum Change
2004 2.0% 3.0% 1.5% 3.0%2005 2.25% 3.25% 1.5% 3.0%2006 3.0% 4.0% 2.5% 4.0%
In the PG&E settlement, for 2006, the authorized revenue requirement increase is equal to CPI plus one percent, for both the distribution and generation mechanisms.
Table II-4Ceilings And Floors On CPI Changes In SDG&E And
SoCalGas Attrition Mechanisms
YearSDG&E Minimum
Change SDG&E
Maximum Change
SoCalGas Minimum Change
SoCalGas Maximum Change
2005 3.2% 4.2% 2.0% 3.0%2006 3.5% 4.5% 2.5% 3.5%2007 3.8% 4.8% 3.3% 4.3%
The minimum changes for SDG&E are particularly large, especially when compared with CPI projections that were available when the SDG&E/SoCalGas Settlement was negotiated (as discussed more fully in the next section) and when compared with the CPI projection included in ORA’s Report. The CPI forecast, based on ORA’s Report, is 1.9 percent for 2007.27 Assuming that this forecast doesn’t change much for 2007, SCE would be allowed a base revenue increase of 1.9 percent under ORA’s proposal, whereas SDG&E would be allowed 26 PG&E Distribution Settlement, Settlement Agreement Section 5.3; PG&E Generation Settlement,
Settlement Agreement Sections 9 and 10; SDG&E/SoCalGas Settlement, Section III.2.27 ORA bases its forecast for CPI on Global Insight’s U.S. Economic Outlook, March 2005.
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an increase of 3.8 percent under its settlement. Obviously, ORA’s CPI mechanism proposed for SCE is different from that proposed for either SoCalGas and SDG&E. For ORA to recommend half the amount of increase for SCE is inequitable and unjust, and should not be adopted.
c) Global Insight Projections Made At The Time The PG&E And SDG&E/SoCalGas Settlements Were Adopted Indicate That Floors In The Mechanisms Compensated For The Inequities Embedded In The Use Of The CPIThe PG&E Settlements were negotiated and concluded during
the months of June, July, August, and September 2003.28 Global Insight macroeconomic projections for these months show that the projected growth rates for the CPI during the relevant years were below the floors embedded in the Distribution Settlement. As noted above, for 2006, one percent was added to the CPI change before the application of the ceilings and floors.
Table II-5Global Insight CPI Growth Projections,June 2003 Through September 2003
Year June 2003 July 2003 August 2003 September 20032004 1.53% 1.46% 1.22% 1.22%2005 2.16% 2.21% 1.87% 1.76%2006 2.43% 2.44% 1.95% 1.81%
A comparison of the projected CPI growth rates shown in Table II-5 with the PG&E Distribution Settlement ceilings and floors shown in Table II-3 demonstrates that if the projections were accurate, the CPI growth rates would have been irrelevant to the operation of the distribution attrition mechanism because CPI growth would have been inadequate. For the PG&E Generation
28 PG&E Distribution Settlement, Recitals 7, 8, and 10; PG&E Generation Settlement, Recitals 6 and 7.
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Settlement, projected CPI growth exceeded the floor for 2004 only in the June 2003 projection, falling short in all the other months.
Similar differences are observed when one compares CPI projections with the ceilings and floors for the SDG&E/SoCalGas Settlement. The SDG&E/SoCalGas settlement was negotiated and concluded during June and July of 2004.29 As in the case of the PG&E Distribution Settlement, Global Insight macroeconomic projections for these months show that the projected growth rates for the CPI during the relevant years were below the floors embedded in the SDG&E/SoCalGas Settlement.
Table II-6Global Insight CPI Growth Projections,
June 2004 And July 2004Year June 2004 July 2004
2005 1.59% 1.82%
2006 1.30% 1.26%
2007 1.94% 1.97%
In this instance, the differences are striking, especially in the case of SDG&E’s ceilings and floors. Comparing Table II-6 with Table II-4, we find that the SDG&E floors are nearly twice the CPI projections and the ceilings are nearly two and one-half times the CPI projections.
One can only conclude from this analysis that the parties to the PG&E and SDG&E/SoCalGas settlements recognized that the utilities needed revenue increases that exceeded specific minimum levels. Based on the Global Insight CPI projections from the time that the settlements were negotiated, there was little likelihood, except for the PG&E Generation Settlement, that a CPI-
29 SDG&E/SoCalGas Settlement, Section I.
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indexing mechanism would produce sufficient revenues for the utilities. The PG&E Distribution Settlement and the SDG&E/SoCalGas Settlement are not CPI-indexing mechanisms and it is misleading to suggest that they are. Rather than supporting the use of a CPI-indexing mechanism, these settlements only highlight the fact that such a mechanism will yield inadequate revenue increases for SCE at this time, as discussed elsewhere in this exhibit.
5. Aglet ’ s Arguments Regarding Comprehension, Verification, And
Revision Are Not Compelling
Aglet claims that comprehension by consumers, verification, and revision are reasons to favor its CPI indexing proposal. Aglet is mistaken. Aglet claims that “[t]he CPI is a measure of inflation that is widely recognized by consumers,” but offers little proof of this assertion beyond conclusory statements that small customers identify the CPI and large customers use it in contracts.30 It is just as easy to find counter-examples where specific indexes are used to describe price increases. For example, with the increase in the world price of oil, media stories on this subject identify price changes for crude oil futures and changes in the price of gasoline. When price increases for utility operations and maintenance expense are at issue and specific indexes are available, it makes sense to use them.
Aglet comments that the CPI is objective and easily verified. Aglet’s basis for this statement is that “utilities and commission staff subscribe to Global Insight publications, which include CPI forecasts.”31 This applies equally to SCE’s O&M escalation indexes, which are published by Global Insight,32 except for known union and non-union wage increases. SCE’s known wage increases are obviously
30 Aglet Testimony, p. 28, lines 17-18.31 Id. at lines 23-25.32 SCE-8, Volume 1, pp. 69-71.
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verifiable. SCE’s proposed capital additions are presented in this application, and the only additional verification that is required is whether actual capital additions are higher or lower than SCE’s proposed capital additions.
Aglet’s comments about revision are partially incorrect. Aglet claims that the CPI is not subject to revision, but that is not true. The CPI is revised from time to time, as errors are recognized by the Bureau of Labor Statistics.33 Aglet’s real concern appears to be that there be no true-up of price index forecasts. Aglet claims that SCE’s current post test year ratemaking mechanism contains no true-up.34 It is unclear what Aglet means by “true-up.” SCE’s current post test year ratemaking mechanism trues up price index data on a going-forward basis, meaning that actual inflation will become incorporated as it becomes known.35 SCE’s current mechanism does not refund or recover funds based on forecast price index error when observed price index data become known.
Aglet comments that “[r]eliance on an October forecast of the next year’s CPI introduces a modest amount of uncertainty, but that risk is no different from the uncertainty the Commission accepts in forecasting test year revenue requirements for utilities generally.”36 This comment is false with respect to a 2008 or 2009 revenue requirement change. The Rate Case Plan provides for a September or October update to escalation projections, which become embedded in rates effective on the following January 1st.37 Aglet, however, states that “[n]o
33 For example, on September 28, 2000, the BLS released revised Consumer Price Index data for January through August 2000. See the BLS press release at http://www.bls.gov/cpi/cpirev01.htm.
34 Aglet Testimony, p. 29, lines 8-9.35 A.02-05-004, Exhibit 65, p. 11. “In any event, SCE proposes to update its revenue requirement
projections based on updated price inflation forecasts that will be made in annual advice letter filings.” (D.04-07-022, (mimeo), pp. 269-270.)
36 Aglet Testimony, p. 29, lines 3-6.37 D.89-01-040, 30 CPUC 2d 576, 598, 604, 609; D.93-07-030, 50 CPUC 2d 354, 359, 366. This
update is filed on Day 280. Normally this date will fall in September or October of the year
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true-up of forecast to recorded CPI is necessary, either retroactively or prospectively, for 2007 and 2008.”38 Under Aglet’s proposal, rates effective on January 1, 2008, will incorporate not only forecast error from the October 2006 projection, but also forecast error from the October 2007 projection. The cumulative error from projections for two consecutive years will generally exceed the error from one projection that is incorporated in test year projections. If Aglet’s proposal were combined with ORA’s proposal to extend attrition through 2009, rates effective on January 1, 2009, would incorporate cumulative error from three years of projections.
6. Aglet ’ s Comments About Price Index Stability And Bias Are
Misleading And Irrelevant
Aglet claims that the CPI is generally less volatile than utility price indexes and that the CPI shows no long-term bias compared to utility price indexes.39 As support, Aglet cites an SCE report from a 1999 performance based ratemaking proceeding.40 These claims are irrelevant and misleading because the industry price index in the report is not being proposed for use in this proceeding. Aglet provides only one page out of the 29-page report with its testimony, hampering any reader interested in learning the context or full implications of the report.
SCE has included the entire report in Appendix B to this exhibit. It is clear from the discussion on page B-2 (page D-1 in the original report) that SCE developed the industry price index (IPI) in the context of a performance based
before rates become effective. In this application, the date for serving update materials is September 26, 2005. (Assigned Commissioner’s Ruling and Scoping Memo Establishing Scope, Schedule, and Procedures for Proceeding, dated March 15, 2005, Appendix A.)
38 Aglet Testimony, p. 28, lines 15-16.39 Aglet Testimony, p. 29, lines 14, 24.40 A.99-03-020, “Report on Industry-Specific Price Index.” This report is included as Appendix B to
this exhibit.
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ratemaking (PBR) mechanism. SCE’s proposed mechanism in this application is not a PBR mechanism of the type that was adopted in D.96-09-092 and which prompted the Commission to order SCE to prepare a report on an industry price index. SCE’s proposed mechanism in this application uses price indexes only to adjust authorized O&M expense levels. SCE’s IPI includes a capital price component which appears nowhere in SCE’s current or proposed post test year ratemaking proposal.41 The one page included in Aglet’s workpapers clearly indicates that it is the capital component that causes volatility. Aglet has checked and marked the relevant bullet point.
SCE’s report measured bias between the CPI and utility price indexes over a 23-year period.42 Immediately following the finding that over long periods, mean growth in an IPI does not differ appreciably from mean growth in the CPI, SCE reported: “Over shorter periods, however, greater differentials are found—and these differentials will be both positive and negative.”43 SCE’s proposed post test year ratemaking mechanism will span two years, a much shorter period than a 23-year period. In addition, SCE’s capital spending is projected to increase in real terms during this rate case cycle, a factor which cannot be captured with a price index. Aglet’s comments about bias are patently misleading and irrelevant to SCE’s proposal in this application.
7. SCE’s Proposed Capital Expenditures Will Result In A Greater
Overall Level Of Economic Activity Than ORA’s Proposed
Expenditures
The primary reason for adopting SCE’s proposed test year ratemaking mechanism is that it will support the capital expenditures that SCE needs to make
41 See the discussion in Appendix B, pp. B-5 – B-11 (pp. D-6 through D-12 in the original report).42 Appendix B, p. B-12 (p. D-13 in the original report), footnote 24.43 Appendix B, pp. B-12 – B-13 (pp. D-13 and D-14 in the original report).
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to maintain its system to properly serve its customers. SCE’s plan will also result in lower cost in the long run because infrastructure will be replaced on a planned basis, as opposed to only replacing equipment on an emergency basis when it fails. As discussed elsewhere in this exhibit, the ORA and Aglet CPI-indexing approach will require SCE to cut capital expenditures drastically, harming our system and resulting in higher long-run costs for our customers.
However, there is a secondary benefit to SCE’s proposed capital expenditures when compared with the capital expenditures implied by ORA’s proposal: SCE’s expenditures will result in greater overall economic activity in Southern California than ORA’s, benefiting SCE’s customer base with higher incomes and stronger employment. The difference is significant. To estimate this benefit, SCE engaged the services of Global Insight’s US Regional Service44 to estimate the overall economic effects in Southern California of SCE’s proposed capital expenditures when compared with ORA’s proposed capital expenditures. Global Insight’s study is found in Appendix E of this exhibit. Global Insight used an economic input/output model to estimate the total economic effects of the different capital spending programs. Global Insight’s findings are summarized in the following table:
Table II-7Comparison Of Overall Economic Impacts From SCE’s And
ORA’s Proposed Capital ExpendituresImpact From
SCE’s Proposal Impact From
ORA’s ProposalDifference
(SCE – ORA)Increase in
Average Employment (Full-
Time Jobs)9,603 6,704 2,899
44 Both the Commission and SCE have used Global Insight macroeconomic projections since at least the early 1980s.
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Increase in Total Economic Output
($ Millions) 10,519 7,137 3,382Increase in
Economic Value Added ($ Millions) 7,009 4,757 2,252Increase in Labor
Income ($ Millions) 2,996 2,031 965Increase in State and Local Taxes
($ Millions) 496 336 160
In calculating these impacts, Global Insight took into account the possibility that our spending might divert currently-employed resources from other projects. For this reason, these are conservative estimates. Because of multiplier effects, the increase in total economic output that results from SCE’s proposal is actually larger than the net present value of the future revenue requirement associated with the higher capital spending that will occur under SCE’s proposal but not under ORA’s proposal. Over the 2006-2008 period, the present value of the increase in total economic output is about $2.15 billion, while the present value of the future revenue requirement is about $2.0 billion.45 The multiplier effect results when those individuals and firms employed in building SCE’s capital projects in turn spend their income on other goods and services. The sellers of those goods and services then have added income which they spend, and so on, resulting in an economic impact that is a multiple of the original expenditure.
One might think that the same economic impact would result over the 2006-2009 period if SCE did not make the capital expenditures and customers had more money to spend for themselves. But that is not likely to be the case. The capital expenditures will be financed with equity and debt raised from inside and
45 SCE’s revenue requirement estimates are based on the results of Appendix A, which projects capital spending scenarios through 2008. SCE does not have corresponding data at the same level of detail for 2009. SCE believes that extending the analysis through 2009 would not change the conclusion.
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outside SCE’s service territory. Customers will only pay the revenue requirement associated with the capital expenditures in rates, which will be only a fraction of the total expenditures.
Thus, as the Global Insight report shows, in addition to the greater direct benefits to our customers that result from our capital expenditure program compared to the one implied by ORA’s CPI-indexing proposal, our capital expenditure program provides greater broad economic benefits for our service territory.E. ORA’s Alternate Post Test Year Ratemaking Proposal Will Not
Provide Sufficient Revenues For SCE To Make Necessary Capital
Investments In SCE’s Electric System
ORA claims that its proposed alternative to the CPI-indexing methodology is based on a more traditional attrition mechanism. However, ORA has significantly modified the traditional attrition formula. Rather than calculating an average of historical capital additions, ORA incorrectly relies upon a five-year average consisting of a hybrid of historical and forecast capital additions. For example, ORA takes the average of three years of historical capital additions (2002-2004) and two years of ORA’s forecast for capital additions (2005 and 2006) to derive its forecast for 2007. This, in essence, is a projection based upon a projection. Even if ORA applied the traditional attrition formula correctly, the result of this averaging forecast bears no resemblance to SCE’s future capital investment needs.
ORA’s proposed attrition methodology may be appropriate if forecast capital spending per customer is similar to historic capital spending per customer, but this is not the case due to our need for infrastructure replacement, concurrent with investments related to load growth as well as customer growth. When the Commission adopted SCE’s budget-based forecast in the 2003 GRC, it clearly understood the higher costs associated with capital replacement:
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When older facilities are replaced with new ones, the associated costs are typically much higher than what is included in rates for the original facilities. Moreover, the effect of this phenomenon is enhanced by the accelerated pace of planned capital spending associated with the SCE’s infrastructure replacement program. The use of historical capital spending incorporates the lower capital additions from SCE’s financial crisis years, and it may not adequately reflect the increased pace of capital investments associated with the infrastructure replacement program.46
Removing 2001 data that reflect SCE’s financial crisis year is an improvement, but the resulting average is still insufficient in providing the revenues needed to make the necessary capital investments in SCE’s electric system. Should ORA’s proposal be adopted, SCE will be forced to halt the progress it has made thus far, resulting in consequences discussed nowhere in ORA’s testimony. Appendix A shows the consequences of ORA’s proposal. If costs are relatively stable over time, using a historical average to forecast future costs may be appropriate; however, when costs are expected to rise significantly in the future due to some known, underlying cause (e.g., infrastructure replacement), a budget-based or “bottoms-up” estimate is a better predictor of future costs. Thus, ORA’s proposal to use its “hybrid” five-year average for capital additions should be rejected and SCE’s budget-based forecast should be adopted.
ORA claims that its alternative proposal “would limit SCE’s capital additions to its historic spending level and compel SCE to prioritize its additions to those necessary for the safe and reliable operation of its system.”47 Instead, ORA’s radical alternative proposal would cut SCE’s current operations down to its “bare bones,” and safety and reliability would be jeopardized, as a result. The Commission must not let this happen.
46 D.04-07-022, (mimeo), p. 276.47 ORA Report, Volume 2, p. 16-13, ll. 3-5.
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F. Aglet’s Comments About SCE’s Capital Costs Are Incorrect And
Should Be Ignored
Aglet complains that it could not find cost-effectiveness analyses associated with SCE’s proposed capital projects for 2007 and 2008.48 Aglet references a response SCE provided to an Aglet data request question.49 Aglet’s question was: “In A.04-12-014, p. 9, SCE discusses a ‘one-way balancing account for capital additions in 2007 and 2008.’ Please identify the SCE testimony and workpapers in which SCE specifies the relevant 2007 and 2008 capital additions.” There is nothing in this question about cost-effectiveness, and it is unreasonable for Aglet to complain that it could not find cost-effectiveness analyses, based on the response to this question.
SCE has provided testimony in this application supporting the need for every proposed capital project during the 2004-2008 time period that exceeds $1 million. This testimony is found in the locations specified in the table contained in Appendix D. Aglet’s complaint has no foundation.
Aglet claims that SCE’s proposal is not budget-based. As Aglet itself recognizes, D.04-07-022, in adopting an identical mechanism in SCE’s 2003 GRC, described it as “budget-based.”50 D.04-07-022 comments: “SCE’s proposed PTYR mechanism uses detailed, budget-based estimates of capital additions in 2004 and 2005.”51 That is as true in this GRC as it was in SCE’s last GRC. In workpapers for Exhibit SCE-8, SCE provided a copy of its 2004 Approved Five-Year Plant and Work
Element Budget and Forecast52 (“Capital Budget”), an updated version of the same document that was provided in SCE’s last GRC. This document spans over 600 48 Aglet Testimony, p. 30, lines 13-15.49 Aglet Testimony, p. 30, lines 10-15. The response is included at page 9 of Aglet’s workpapers.
It is the response to Data Request Set DR-AGLET-01, Question 4.50 Aglet Testimony, p. 30, lines 18-20.51 D.04-07-022, (mimeo), p. 275.
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pages. Based on a single chart from one of the 600 pages, Aglet claims that SCE’s proposal is not “budget-based.”53 In addition, Aglet comments that “[m]ore than 88% of SCE’s post-test year plant additions are forecast but unbudgeted projects.”54
Aglet does not understand how SCE’s budgeting process works. The Capital Budget is a budget, in the general sense of the word.55 At SCE, a budget is used as an internal control mechanism and conveys an authority to spend. Because of this authority to spend, SCE reviews both O&M and capital budgets annually and approves organizational budgets generally for only the next year. In Aglet’s workpaper, it is projects that are included in organizational budgets that are labeled as “budgeted.” However, because certain capital projects are multiple year projects, this authority to spend extends beyond the budget year for certain projects. In addition, because capital spending is more long term in nature, the company reviews these spending plans beyond the budget year and provides an additional four years of forecasted data. This five-year capital budget and forecast receives rigorous internal review and is eventually approved by the Finance Committee of SCE's Board of Directors. It represents SCE's best estimate of total capital spending over the five year period and is the basis for SCE’s budget-based capital spending proposal.
Regarding review of SCE’s Capital Budget, Aglet comments: “ORA, TURN and Aglet do not have the resources to evaluate SCE’s capital budgets for 2007
52 SCE-8, Volume 2, p. 6, footnote 7. The workpapers are for Exhibit SCE-8, Volume 2, Chapter I, Part 3.
53 Aglet Testimony, p. 30, lines 16-27.54 Aglet Testimony, p. 30, lines 25-26.55 “An itemized summary of probable expenditures and income for a given period, usually
embodying a systematic plan for meeting expenses.” American Heritage Dictionary of the English Language, (Boston: Houghton Mifflin Company, 1981), p. 173. In this context, “an itemized summary of probable expenditures” is relevant.
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and 2008. We have our hands full reviewing test year 2006 costs.”56 It is not clear why Aglet and TURN are resource-constrained. SCE tendered its Notice of Intent to file its 2006 GRC on August 20, 2004. Aglet and TURN have had nearly nine months to evaluate SCE’s showing on post test year ratemaking. TURN has retained four consultants to provide testimony on its behalf in this application, and Aglet has retained consultants in other SCE applications, most notably in SCE’s 2003 and 2005 cost of capital applications.57 Both Aglet and TURN have been found eligible for intervenor compensation in this application.58 Both organizations have received intervenor compensation in numerous other applications.G. Traditional Attrition Methodology Can No Longer Be Applied To SCE
The traditional attrition methodology found in D.91-12-076 can no longer be applied to SCE. This is because the traditional attrition methodology projects capital additions (except for large projects) only as a function of new customers. Infrastructure replacement means that not only is SCE installing new capital to serve new customers, but also that SCE is replacing old capital that has worn out, in order to maintain reliable service to existing customers.
A crude estimate of the age of SCE’s system can be obtained by estimating the average vintage of SCE’s customers.59 SCE has data on the number of customers served back to 1919. If one makes the simplifying assumption that all of the existing customers in 1919 came on the system in that year and then weight all customer additions since that time by their age, the average vintage of our
56 Aglet Testimony, p. 31, lines 2-4.57 A.02-05-022, et al. and A.04-05-021, et al.58 Administrative Law Judge’s Ruling on Notices of Intent to Claim Compensation, dated April 8,
2005.59 Assuming, of course, that the average life of the system exceeds the average vintage of
customers. Otherwise, substantial parts of the system will have already been replaced.
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customers is slightly less than 38 years.60 This average vintage has been steadily increasing at slightly less than one-half year per year since 1955, when it was between 16 and 17 years. As Mr. Roger Lee explains in his rebuttal testimony, our system is not “stable” and we must inevitably replace enormous amounts of infrastructure. He also makes the point that even if we do all the preemptive infrastructure replacements that we have proposed, the average age of our infrastructure will continue to increase.61 A methodology that bases projected capital requirements only on the number of new customers will not provide adequate revenues.H. Reasons Why Attrition Was Denied To PG&E In The Past Do Not
Apply To SCE In This Application
ORA cites two instances where PG&E was denied attrition, for 2000 and 2002. In PG&E’s 1999 GRC decision,62 attrition was denied for 2000 but granted for 2001. The Commission approved this decision while the electric industry was in the midst of restructuring and Performance-Based Ratemaking (PBR) was replacing cost of service ratemaking for many utilities. SCE was operating under a PBR mechanism at the time.
PG&E ‘s request for 2002 attrition was denied based on facts unique to PG&E. Specifically, PG&E’s recorded numbers were too stale and escalation rates too uncertain to support their request for additional funding;63 their costs had not been reviewed since their 1999 GRC which used recorded 1996 and 1997 cost
60 In this context, a “customer” is really a location where a customer is served.61 See Exhibit SCE-23, Chapter I, Section G.1.62 D.00-02-046.63 D.03-03-034, (mimeo), p. 10.
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data;64 and PG&E’s 2001 recorded rate of return was considerably above its authorized rate of return.65
SCE’s current situation is factually different from PG&E’s situation in 2002. The Commission’s decision on SCE’s proposed mechanism for 2007 and 2008 should not be determined by facts from a PG&E application for 2002 attrition. SCE will have a full review of its costs for 2006 in this case. The gap between the recorded cost year of 2003 and the post test ratemaking years of 2007 and 2008 is less than the gap in PG&E’s situation from 1996 to 2002. Unlike what the decision on PG&E’s 2002 attrition application found, SCE has proposed to use the latest escalation rates available in its annual advice letters.66 Finally, no one knows what rate of return SCE will earn in 2006. Even if SCE earned a rate of return above the authorized level for 2006, the issue at hand is ensuring sufficient revenues for SCE so that SCE has a reasonable opportunity to earn its authorized rate of return in 2007 and 2008.I. The New Regulatory Framework And Ratemaking Mechanisms For
Class C And D Water Utilities Are Not Relevant To SCE’s Situation
1. Why The New Regulatory Framework Is Not Relevant
ORA discusses the New Regulatory Framework (NRF) and ratemaking mechanisms for Class C and D water utilities as if they were somehow relevant to SCE’s situation.67 They are not.
The NRF was designed for Pacific Bell (now SBC) and GTE California (now Verizon) in D.89-10-031. That decision explained why the Commission adopted the NRF:
64 Id. at p. 8.65 Id. at p. 10, footnote 1.66 SCE-8, Volume 1, p. 28.67 ORA Report, Volume 2, pp. 16-8 - 16-9.
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The basic regulatory framework now in place for local exchange carriers in California has changed very little since this Commission began regulating telecommunications. We still rely on traditional cost-of-service regulation, sometimes known as rate base, rate-of-return regulation, to set rates for these carriers.This Commission has recognized, however, that the telecommunications industry and the California marketplace have changed tremendously, especially in recent years, as a result of technological innovations as well as major legal and federal regulatory developments, and that regulatory changes in California are needed to respond to these changing industry conditions.68
The NRF was a sweeping change in telecommunications regulation. The Commission established three categories for telecommunications services, depending on the market power of the Local Exchange Carriers (LECs; Pacific Bell/SBC and GTE California/Verizon). The Commission granted no pricing flexibility for Category I services, downward pricing flexibility for Category II services, and complete pricing flexibility for Category III services.69
SCE’s current ratemaking mechanisms do not contain pricing flexibility of the scope granted to the LECs. In addition, unlike the LECs, SCE currently operates under ratemaking that incorporates a revenue balancing account mechanism known as the Base Revenue Requirement Balancing Account (BRRBA).70 Under a revenue balancing account mechanism, any variation between authorized revenues and actual revenues is ultimately trued-up. As a result, SCE cannot gain additional revenues from sales growth. For these reasons, the NRF is not a useful guide for developing a ratemaking mechanism for SCE.
68 D.89-10-031, (mimeo), pp. 6-7, 33 CPUC 2d 43, p. 61, 1989 Cal. PUC LEXIS 576, *8-9.69 D.89-10-031, (mimeo), pp. 6-7, 33 CPUC 2d 43, p. 126-127, 1989 Cal. PUC LEXIS 576, *246-253.70 See SCE-8, Volume 1, Chapter IV.
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2. Why Regulation Of Class C And D Water Utilities Is Not
Relevant
Class C water utilities serve 500 to 2,000 connections, while class D water utilities serve fewer than 500 connections.71 In D.92-03-093, the Commission summarized its ratemaking changes for these water utilities as follows:
First, in order to provide at least minimal additional revenue to small utilities, the Commission offers a simplified rate filing based on the Consumer Price Index, along with a new method for small companies to recover unanticipated repair costs deemed critical to continued service. Second, in order to encourage small utilities to seek Commission review of their operations as part of more substantial adjustments in rates, the Commission increases the range of rate of return for small utilities and offers a number of streamlined procedures (including a so-called "small claims court" appeal process) to simplify and speed regulatory review.72
The details of the repair cost mechanism and the ranges of rates of return specified in D.92-03-093 are as follows:
A memorandum account is authorized to track “unanticipated costs of repairs necessary for a utility's service to its customers.” Costs in the memorandum account can be recovered when they exceed 2 percent “of the utility's last adopted gross revenues.”73
Rate of return ranges were authorized as follows: between 11.6 percent and 12.1 percent for Class C water utilities and between 13.9 percent and 14.4 percent for Class D water utilities.74
If this ratemaking structure were applied to SCE, large increases in authorized revenues would result. SCE’s application assumes a 9.75 percent rate of return, based on the cost of capital authorized in D.02-11-027 and extended in
71 D.92-03-093, (mimeo), p. 2, 43 CPUC 2d, 568, 571, 1992 Cal. PUC LEXIS 237, *1.72 D.92-03-093, (mimeo), pp. 2-3, 43 CPUC 2d, 568, 571,1992 Cal. PUC LEXIS 237, *2-3.73 D.92-03-093, (mimeo), p. 52, Ordering Paragraph 2, 43 CPUC 2d, 568, 592, 1992 Cal. PUC LEXIS
237, *80-81.74 D.92-03-093, (mimeo), p. 52, Ordering Paragraphs 3 and 4, 43 CPUC 2d, 568, 592, 1992 Cal.
PUC LEXIS 237, *81-82.
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D.03-08-063.75 The rates of return for class C and D water utilities assume a capital structure that is 100 percent equity.76 The current midpoint of the class C range is 12.40 percent, while the midpoint of the class D range is 13.15 percent. If SCE were authorized a rate of return equal to the class C midpoint, its 2006 revenue requirement would increase by approximately $675 million, while if SCE were authorized a rate of return equal to the class D midpoint, its 2006 revenue requirement would increase by approximately $795 million.
If the Commission chooses to use the ratemaking methods specified in D.92-03-093 as a model for SCE’s post test year ratemaking mechanism in this application, it needs to incorporate these increases, as well as the CPI-indexing mechanism proposed by ORA.J. Cost Recovery For Four Corners Variable Overhaul Outage Should Be
Allowed
Aglet specifically opposes SCE’s $4.58 million request for a major overhaul outage at Four Corners Generating Station77 and ORA fails to mention it at all. These lengthy and costly overhaul outages at Four Corners, which occur every six years for each unit, results in substantial variations in year-to-year costs with notable cost “peaks” occurring in the years that a major overhaul takes place.78 Historically, when SCE owned a fleet of generating stations, these year-to-year variations tended to smooth itself out, on whole. However, since electric utilities were required to divest many of its plants during industry restructuring, we no longer have this cost smoothing effect. Aglet’s assertion that “[t]here is no
75 D.02-11-027, (mimeo), Ordering Paragraph 3, p. 38; D.03-08-063, (mimeo), Ordering Paragraph 1, p. 5.
76 D.92-03-093, (mimeo), p. 52, 43 CPUC 2d, 568, 582, 1992 Cal. PUC LEXIS 237, *41-44.77 Aglet Testimony, p. 33, lines 12-13.78 For more details on the Four Corners overhaul and the actual work involved, see Exhibit SCE-2,
Volume 6, Part 1, pp. 75-78.
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Commission precedent for such adjustments at fossil plants”79 is backward-looking and fails to consider the dynamic changes that have impacted our business.
There is no major overhaul planned for Four Corners during the 2006 test year, but there is one scheduled for 2008. SCE could have simply included the recorded costs of prior overhauls to develop the 2006 forecast, as we did in the 2003 General Rate Case, but we determined that a more transparent means of funding major overhauls, especially if it falls outside the test year, is through the advice letter process. Similar to the mechanism currently in place for nuclear refueling outages, this process provides SCE with the flexibility to recover costs in the year the overhaul actually occurs. It also ensures that ratepayers do not unfairly pay for an activity that may get postponed into the next rate case cycle.
Adopting Aglet’s recommendation to deny recovery of a major overhaul outage at the aging Four Corners Generating Station would compromise the plant’s ability to provide reliable and fuel-efficient operations well beyond 2006. A mechanism that allows for the recovery of the incremental cost of a major overhaul, only when it is actually undertaken, is reasonable and should be adopted. K. SCE Opposes Extending ORA’s Proposed Attrition Mechanism
Through 2009
Extending ORA’s proposed attrition mechanism another year in 2009 simply makes a bad situation worse. A general rate case allows the Commission to conduct a full reasonableness review with more current data. Determining 2009 revenues based on 2003 recorded data means that rates would be set based on recorded data that is over five years old. As mentioned above, in denying attrition for PG&E in 2002, the Commission specifically expressed concerns about the long
79 Aglet Testimony, p. 33, lines 14-15.
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duration since the prior full review of PG&E’s costs.80 Deferring SCE’s next general rate case to 2010 would create the same situation, increasing the risk to our ratepayers and our shareholders of a significant disparity between costs and revenues.
ORA provides examples of past settlements with other major utilties which incorporated an additional attrition year.81 None of these settlements explains why the settlement incorporated a fourth year of attrition, and the Commission decision does not explain why the provision is reasonable. Since the settlements are not precedential and are designed to be approved or denied as an indivisible proposal, they do not tell us anything about whether the Commission would have approved the duration of an attrition mechanism if the Commission were considering that issue as a separate item. These settlements do not support the proposition that the Commission now views a four-year period as the standard rate case cycle.
D.04-03-034 (Southwest Gas) was a decision resolving a litigated case. The Commission’s decision notes that Southwest Gas proposed a five-year rate case cycle, including a rate phase-in plan.82 The adopted rate phase-in plan spans four years,83 which appears to be the reason why a four-year rate case cycle was selected.84 There is no discussion suggesting that the four-year rate case cycle was chosen for any of the reasons that ORA claims support the concept.85
The settlement agreement approved in D.05-03-010 (Southwest Gas) is not on point. As noted in ORA’s report, Southwest Gas was obligated under the settlement to file an application requesting that its rate case cycle be extended for 80 D.03-03-034, (mimeo), p. 8.81 D.04-05-055 (PG&E) and D.04-12-015 (SDG&E/SoCalGas).82 D.04-03-034, (mimeo), p. 4.83 Id. at p. 2.84 Id. at pp. 79-80.85 ORA Report, Volume 2, pp. 16-17 – 16-18.
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another two years,86 but the Commission has not ruled on the merits of that proposal.
86 Id. at p. 16-18, lines 24-26.
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Appendix ADiscussion
Of The Methodology Used To
Develop The
Contingent Forecast For Post Test Year Capital
Expenditures
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IntroductionAs described in the previous chapters of this volume, SCE Chief Executive
Officer Al Fohrer directed that a contingent capital expenditure forecast for 2007 and 2008 be prepared that would conform SCE’s spending to either of the ORA’s proposals for the post-test years. If the Commission were to adopt ORA’s proposal, which has been endorsed by Aglet and TURN, SCE would then be prepared to immediately implement the required capital expenditure cost-cutting to bring spending in line with revenue requirement levels authorized by the Commission.
This appendix will discuss the process used to develop this contingent forecast, the priorities and guidelines established for the development of new capital spending plans, and show how benchmarks were used to insure that our contingent forecasts were consistent with the ORA’s proposals. In the workpapers to this Appendix, there is a list of the reductions in capital expenditures that would be made, on a project by project basis, to achieve these contingent forecasts. We believe that it’s important for the Commission to recognize the depth of cuts in capital spending that would ensue if it chooses to adopt either of the ORA’s proposals.
Process Used to Develop These forecastsWe could not apply our normal process to prepare the forecast that was needed
for this testimony. Normally our capital expenditure forecasting process takes months to complete. We thoroughly evaluate the forecasts of all the departments to insure that our capital is allocated in an effective manner. The forecast presented here was developed on an accelerated pace. Despite the shortened timetable, this forecast reflects a systematic matching of expenditures to priorities, within the constraints of the ORA proposals. This forecast accurately reflects the direction and magnitude of the reductions that would be necessary to conform SCE capital expenditures with either of the ORA proposals.
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The steps that we followed in preparing this contingent forecast were as follows:1. Reviewed the ORA Results of Operations Model . In reviewing the
ORA proposal we discovered that ORA had prepared a revised set of detailed capital expenditures forecasts comparable to SCE’s capital expenditure forecast to develop the revenue requirements for their Hybrid-Attrition proposal.
2. Analyzed ORA capital expenditure forecast . The table below shows the differences between ORA’s proposed capital expenditures and SCE’s proposed capital expenditures for the years 2007 and 2008.
Total Capital Expenditures$M
Year SCE Proposal
ORA Proposal Variance
2007 2,025 1,207 818
2008 2,068 1,323 745
Our review revealed that ORA had adjusted all of SCE’s forecast capital expenditures through the use of simple across-the-board cuts.87
3. Identified flaws in the ORA forecast . ORA’s use of simple, across-the-board reductions is badly flawed from both a methodological perspective and a perspective of prioritizing and managing a capital budget. Some ORA reductions in capital
87 There was one exception to the across-the-board proportional cuts made by ORA. That exception was that the capital expenditures had been adjusted to reflect ORA’s proposal to delay by one year the starting date for a number of load growth projects.
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expenditures involved 100 percent FERC jurisdictional projects, customer reimbursable expenditures, multi-year projects that close in 2007 or projects that close after 2008. Reductions in these categories are problematic.
4. SCE Corrected ORA’s Forecast . After reviewing the ORA capital expenditure forecast for 2007 and 2008, we determined that to demonstrate the impact of the ORA post-test year proposals, we should develop realistic forecasts that were consistent with ORA’s proposed revenue requirements. First, we restored the spending in areas such as FERC jurisdictional projects, reimbursables, multi-year projects closing in 2007 and projects closing after 2008. We also restored spending for other projects that are outside of the GRC scope.88 However, in the interest of time and simplification, we concluded that the inclusion of the higher level of spending on these projects has only a small impact on the 2007-08 revenue requirements. If the ORA proposals were adopted by the Commission, the impacts of these projects would necessitate additional spending reductions by SCE, if we were to manage to the ORA revenue requirement proposals. The decision to restore spending in these areas in our contingent capital expenditure forecast allowed us to focus on the projects that are most germane to the GRC. These other areas of the capital expenditure forecast, the projects that did not have spending restored, were considered within the scope of
88 The most notable example is the Steam Generator Replacement (SGR) at SONGS, which is included in our Yellow Book. The SGR is the subject of a separate application.
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this analysis to develop a contingent capital expenditure forecast.
5. Developed Capital Expenditure Targets. For ORA’s Hybrid-Attrition89 proposal, we developed total company capital expenditure targets for 2007 and 2008 which matched the total capital expenditure levels (for projects within the scope of our analysis) contained in the ORA’s Results of Operations Model. For the ORA’s CPI proposal we developed total company capital expenditure targets for 2006, 2007 and 2008. It was necessary to cut forecast capital expenditures in 2006 below the ORA’s test year forecast, in order to realize the effect of ORA’s CPI proposal.90 This is largely due to the fact that the plant expenditures made in the test year are not fully reflected in the revenue requirement until the next year. This required plant reductions in test year 2006 in order to live within the revenue requirement under the ORA’s CPI proposal.
6. Established Priority Guidelines . After the total capital expenditure reductions were determined to conform to the ORA proposals, we met with the budget directors from the various departments and business units to establish priorities and
89 The two ORA proposals for post-test year ratemaking are discussed in the main body of this testimony.
90 The ORA did not use the Results of Operations Model to forecast the CPI-adjusted revenue requirement for 2007 and 2008. Because of the lags in closing expenditures to ratebase, capital expenditures have a lagged effect on the revenue requirement. This can be seen particularly well in the CWIP balance, which effectively captures the momentum carried over from one year to the next in capital additions. ORA’s Results of Operations model shows a 2006 year end CWIP balance of $741.6 million. Thus, the 2007 rate base that results solely from ORA’s 2004-2006 adjustments to SCE’s forecast is too large to achieve their proposed 2007 revenue requirement under the CPI proposal. In other words, ORA’s 2007 proposed revenue requirement is not consistent with their proposed capital spending for 2005 and 2006.
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timetables to be used in developing the contingent capital expenditure plans. The highest priorities used in developing this contingent forecast were consistent with the guidelines outlined by SCE CEO Al Fohrer, which are: a. Safety, both public and employee.b. Continuing Operations.c. Reliability and Service Quality.We also concluded that we would have to increase, not decrease, capital expenditures for emergency repair categories, as we would be operating in an environment that eliminates planned replacements and only permits repair or the replacement of assets after they would fail in-service. We would also make best and reasonable efforts to comply with regulations on our business.
SCE’s Transmission and Distribution Business Unit (TBBU) developed additional, more detailed guidelines for their spending. These more detailed guidelines were as follows:
Safety. Connecting new customers. Breakdown replacements. Criteria driven infrastructure additions for load growth.91
Inspection driven replacements (e.g., poles, overhead and underground equipment and apparatus)
Overhead to underground conversions.
91 These investments are included in our Distribution System Plan and Transmission System Plan (DSP and TSP) discussed in SCE-3, Volume 3, Part 2 of our direct testimony.
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Cost effective facilities to lower costs or access new generation sources.
Cost effective discretionary replacements.92
7. Business Units Develop Revised Forecasts . The budget directors were assigned to develop, under this vastly accelerated timeframe, how they would reduce the capital expenditures they had proposed in the GRC consistent with these guidelines. Given the severity of the reductions that were necessary to meet the ORA proposals, they were directed to identify only the highest priority projects. For example, discretionary spending on areas such as Furniture and Equipment was to be reduced to an absolute minimum. Spending on tools, equipment and spare parts was reduced, with the assumption that inventories would be run down. Expenditures on computers and telecom equipment was to be drastically reduced, although we would fund telecom expenditures that supported circuit build outs and replaced essential monitoring and control equipment on our network. After the budget directors provided revised capital expenditure plans, we reviewed the results to insure that our priorities had been reflected in a manner consistent across the departments.
8. Consistency with the ORA results . We benchmarked our results against the ORA proposals. As the tables below show, we are within .27 percent of the ORA revenue requirements in all of the
92 The category of cost effective replacements generally refers to our proactive infrastructure and substation replacement programs, as discussed in SCE-3, Volume 3, parts 3 and 4 of our direct testimony.
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cases. In the CPI proposal, our 2006 capital expenditures are substantially below ORA’s. As explained above, if the Commission were to adopt the CPI proposal, it would be necessary for us to reduce expenditures in 2006 in order to conform our spending to the ORA proposed revenue requirements.
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Benchmarks for Hybrid-Attrition Post Test Year Ratemaking($M)
2007 2008ORA SCE ORA SCE
Revenue Requirement 3,698 3,697 3,796 3,806Total Company Capital Expenditures
1,207 1,589 1,323 1,678
In-Scope Capital Expenditures 648 648 677 677
The In-Scope Capital Expenditure figures cited in both of these tables refer to expenditures for projects that were not FERC jurisdictional, were not reimbursable, did not close after 2008 or were not multi-year projects that closed in 2007. In other words, these expenditures are for the projects that were in the scope of the analysis for the development of this contingent capital expenditure forecast.
Benchmarks for CPI Version of Post Test Year Ratemaking($M)
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9. Results. As shown in the attached Tables 1 and 2, significant reductions in capital
expenditures are needed to conform our spending with the ORA post-test year ratemaking proposals. For the Hybrid-Attrition case, we would reduce almost $47 million93 from capital spending at SONGs and our other generation (hydro and coal) facilities. Some of these reductions take the form of reduced spending on tools, lab and test equipment, general equipment, facility replacements, site maintenance and upgrades (e.g., repaving access roads at SONGS and at Hydro facilities), and delay communication system upgrades. As documented by the budget directors, these reductions could result in reduced productivity, increased O&M costs, higher future costs for delayed repairs, and reduced effectiveness of training. Spending in our Shared Services (principally real estate and buildings) would be reduced from over $90 million to $7 million. Facility consolidations to consolidate employees in fast growing parts of the service territory, facility upgrades to accommodate increased electrical loads, and upgrades to our obsolete Data Center would be delayed. The only spending in the Shared Services area would be for essential security and safety. Spending on Information Technology (IT) would be reduced by $267 million, with $164
93 The totals shown in this paragraph are two year, 2007-08, totals.
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million of that reduction in the area of software. Replacement of the copper wire would be delayed. Upgrades and the systematic and orderly replacement of our software systems would be delayed indefinitely. Ironically, ORA has opposed none of these projects. In the Transmission and Distribution area, we would reduce spending on Infrastructure Replacement and Overhead to Underground conversions by $423 million over the two years.
Conforming our spending to the ORA’s CPI proposal would be even more extreme. In addition to all of the reductions taken in the Hybrid-Attrition case, we would have to impose similar reductions in 2006 as was done for 2007-08 on IT, Shared Services, SONGS and Other Generation, and CSBU. For this case, we would reduce spending on Infrastructure Replacement by almost $618 million over the three years 2006-2008. This translates into replacing fewer than 3,000 wood poles instead of replacing more than 37,000 wood poles, replacing 0 miles of underground cable and 0 oil-filled underground switches instead of replacing some 800 miles of underground cable and 2,000 oil-filled underground switches. The numbers are similarly bleak for other categories of Infrastructure Replacement.
Spending on other Preventive Maintenance would be reduced by $93 million. Spending on Pole and System repairs would be reduced by over $90 million. Instead of steel stubbing or fiber glass wrapping 15,000 deteriorated poles, we would do zero. . Instead of replacing 8,000 streetlights and 20,000 luminaires, we would replace only a nominal quantity. There would be significant reductions in spending in the Load Growth area. Many new circuits, or upgrades to existing circuits would not be made, resulting in the risk of not being able to serve areas under peak day design conditions. New substations in areas such as Beaumont, Chino and Lakeview would not be built to meet forecasted load.
Conclusions
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As evidenced by the tables above, the capital expenditure forecasts we have prepared are consistent with the ORA’s proposals on post-test year ratemaking. The forecasts developed here are consistent with Mr. Fohrer’s direction, and accurately reflect the amount and types of capital expenditures that will be made should the Commission adopt either of ORA’s proposals for post-test year ratemaking.
These cuts would result in cumulative reductions from SCE’s request of $826 million or 20 percent for 2007 and 2008 in the instance of the ORA’s Hybrid-Attrition, and $1,868 million or 32 percent for 2006, 2007 and 2008 under the ORA’s CPI proposal. Implementing these adjustments will have deeply-felt impacts on SCE’s customers in the years to come, forcing SCE to discard a significant amount of planned investments in system Infrastructure Replacement and severely rationing any load-growth capital spending.
A detailed listing of the reductions prepared by the individual departments, on a project by project basis, is provided in the workpapers.
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Appendix BComplete Copy Of
Report On Industry-Specific
Price Index Discussed In Aglet
Testimony
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Appendix CCompariso
n Of Capital-Related
Cost Escalation With The Consumer Price Index
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L. Introduction
This appendix compares capital cost escalation with inflation as measured by the Consumer Price Index (CPI) under the restrictive assumption that real capital (capital in real dollars) is unchanged for the average service lives of transmission, distribution, and general plant. Even under this restrictive assumption, the CPI underestimates the increase in capital-related costs over the 2006-2008 period. With real capital growing because of a growing customer population and infrastructure replacement, this is a conservative estimate of the shortfall that would result if CPI were used to index SCE’s capital-related costs. This analysis is still valuable because it shows that the CPI will generally fail to track SCE’s capital-related costs. A. Indexing Capital Costs
Indexing capital-related costs is more complicated than simply using a single index (as in the case of labor price) or constructing a weighted average of several price indexes (as in the case of nonlabor price). To index capital related costs, we use an equation with lagged terms to take into account the fact that our capital costs are recovered over the service lives of our capital assets and our capital is a mix of old and new equipment. Our capital-related costs include depreciation, return on investment (interest paid to bond holders and equity returns earned by shareholders), and taxes. These costs are all based on the original cost of the capital equipment.
Capital-related costs are expressed by the following equation:94
(1)
94 Variables in equation (2) are defined as follows: Ct is capital-related costs in period t, rt is the rate of return on rate base in period t, grossed-up for taxes, L is the depreciation life or service life, pt is the price of capital goods in period t, It is capital additions in period t, s is a factor capturing the salvage value and the cost of removal at asset retirement, and x is the income tax rate.
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where the first part of the right-hand side of equation (1) is the ratemaking return, including taxes, and the second part is the ratemaking depreciation (calculated on a straight-line basis) after taxes. Simply stated, this equation calculates the utility’s annual capital costs as a function of its return on its remaining undepreciated rate base and its annual depreciation charges.
The significance of equation (1) is that it demonstrates how SCE’s capital costs depend not only on current growth in capital additions and capital equipment prices, but the past history of growth in capital additions and capital equipment prices. Thus, an escalation rate for capital-related costs must capture more than contemporaneous changes in prices—it must capture historical growth factors as well.
Equation (1) captures the different vintages of capital that are included in a utility’s rate base and reflects their original costs. The return on rate base (rt) is SCE’s authorized return on rate base, including taxes.95 pt is the price of capital equipment in period t. It is measured by the Handy-Whitman price index for the category of capital goods being indexed.96
s is a factor reflecting future net salvage costs. When we retire a capital asset, we sell the asset for its salvage value and deduct the cost of removal. The amount remaining is the net salvage value of the asset. We adjust our depreciation accrual rates for different classes of assets based on our recent salvage experience. We calculate a net salvage percentage of the original cost of the asset for each class. The negative of this net salvage percentage is s. For example, if the net salvage
95 SCE’s authorized return on rate base is determined in annual cost of capital applications, which are separate from this General Rate Case. Full revenue requirement adjustments for changes in SCE’s authorized cost of capital are made in the annual cost of capital applications, so they need not be considered here. To simplify our spreadsheet calculations, we fix rt, the rate of return on rate base in period t at a constant value.
96 For transmission and distribution plant, SCE used the Handy-Whitman price index. For general plant, SCE used a price index that it calculated in response to an ORA data request in this application. That price index included a Handy-Whitman price index for reinforced concrete structures with some additional indexes.
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percentage is –30%, the projected salvage value less the cost of removal is –30% of the original cost of the asset, and the depreciation accrual must be 30% higher than what it would be based on the purchase cost of the asset alone. In this example, s would equal 0.3.
The significance of equation (1) is that it demonstrates how SCE’s capital costs depend not only on current growth in capital additions and capital equipment prices, but the past history of growth in capital additions and capital equipment prices. Thus, an escalation rate for capital-related costs must capture more than contemporaneous changes in prices.
We have estimated the annual increase in SCE’s capital-related costs, assuming no growth in real capital additions. The following table lists the assumed values that we used for different categories of plant. (Other generation plant was excluded from the analysis because it comprises only about 0.1 percent of SCE’s net plant.)
[Need to fix table number.]
Table II-8Modeling Assumptions For Different Classes Of Plant
VariableCoal (Steam)
Plant Nuclear Plant Hydro PlantService Life (L) 45 years 38 years 52 yearsRate of Return,
Including Taxes (r)13.19% 13.19% 13.19%
Salvage Factor (s)* 12% 0% 0%Income Tax Rate
(x)40% 40% 40%
VariableTransmission
Plant Distribution Plant
General Plant
Service Life (L) 46 years 37 years 20 yearsRate of Return,
Including Taxes (r)13.19% 13.19% 13.19%
Salvage Factor (s)* 36% 64% 1%
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Income Tax Rate (x)
40% 40% 40%
* - Salvage factor s greater than zero implies negative net salvage equal to -s.
If we calculate equation (1) for 2006 through 2009 for these different plant categories, and then compute a weighted (by net investment) average index across these plant categories, then we can estimate the rate of increase in SCE’s capital-related costs under the assumptions of this appendix. The estimated rates of increase can then be compared with the Consumer Price Index. This comparison is shown in the following table.
Table II-9Comparison Of SCE Overall Capital-Related
Cost Escalation Rate (No Real Growth In Capital Additions) And Consumer Price Index
Year
SCE Overall Capital-Related Cost Escalation Rate, No Real
Growth In Capital Additions
Consumer Price Index
Difference (SCE Rate – CPI)
2007 2.93% 1.94% 0.99%2008 2.83% 2.12% 0.71%2009 2.75% 2.32% 0.43%
Average 2.83% 2.13% 0.70%
We observe that the projected growth rate in the CPI is lower than the projected escalation in SCE’s capital-related costs under the assumption of no real growth in capital additions. Any growth in real capital additions during the historical period or the post test year ratemaking period will increase the escalation rate for SCE’s capital-related costs and increase this disparity.
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Appendix DCost
Effectiveness
Analyses of Forecast
Capital Expenditur
esReferences
to Testimony
and Workpaper
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Cost Effectiveness Analyses of Forecast Capital ExpendituresReferences to Testimony and Workpapers
Subject Exhibit Workpapers
SONGS 2&3 Capital SCE-2, Volume 3: p. 95 SCE-2, Volume 3, Part 2: pp.437-447
Coal Capital SCE-2, Volume 6: pp. 21, 34, 41, 50, 52, 54, 55, 57, 59, 60, 61, 63, 65, 70, 72, 73, 75, 77, 82, 84, 85, 87, 91, 92, 95, 96, 97
SCE-2, Volume 6: All
Hydro Capital SCE-2, Volume 8: pp. 38, 40, 42, 47 SCE-2, Volume 8, Part 1: pp. 274, 276, 278, 280 SCE-2, Volume 8, Part 2: All
Transmission & Distribution Capital SCE-3, Volume 3, Part II: pp. 75-76 SCE-3, Volume 3, Part II, Ch.I-IV, Part 12: pp. 1-88, 89-91, 92-94
Transmission & Distribution Capital - Infrastructure Replacement
SCE-3, Volume 3, Part III: pp. 82-85 SCE-3, Volume 3, Part III, Ch.I-III: pp. 188-205
Information Technologies & Shared Services - Capitalized Software
SCE-5, Volume 3, Chapter 2, pp. 4-11 SCE-5, Volume 3, Chapter IV, pp. 51-55
SCE-5, Volume 3, Ch.II: All SCE-5, Volume 3, Ch.III-IV, p. 251
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Appendix EGlobal Insight Report
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