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Clearing Up / Bearing Down

[June 2, 2017 / No. 1802]

Are Ratemaking Changes in Store in California?

SUMMARY: A fundamental piece of any rate-setting proceeding before regulators is the utility's authorized rates of return. A recent white paper from the California PUC staff calls for a hard look at the mechanism the commission uses to set these, after it found that the actual rates of return were often higher. The goals of the commission, the authors say, are to authorize a return high enough to attract investor capital on the one hand, and low enough to minimize ratepayer's costs on the other. The question they pose is, "What is a fair return that reasonably balances and optimizes these offsetting goals?"

A new paper from the California PUC's Policy and Planning Division looking at utility cost of capital calls for a reassessment of the mechanism the commission utilizes to set utility rates of return.

The April 18 paper, written by principal author Maryam Ghadessi and division Director Marzia Zafar, also highlights a disparity between the rates of return that are authorized by the commission and the rates of return utilities actually record.

Ghadessi and Zafar found that from 2000 to 2014, Pacific Gas & Electric and Southern California Gas had higher returns on equity than the national average, with the exception of 2002 and 2003 for Southern California Gas. Southern California Edison had a higher return on equity starting in 2001.

This divergence could be explained in part by CPUC actions to improve the credit ratings of PG&E and Edison during the energy crisis. But the divergence persisted well after the energy crisis.

The authors also found that recorded rates of return and return on equity for Edison, San Diego Gas & Electric and SoCal Gas were many basis points higher than authorized. In 2013, for example, Edison received about $302 million more in revenue requirement, according to the paper, because its actual return on equity was 180 basis points above its authorized ROE.

"Because of [the] possibility of gaming the system, it is important to investigate the reasons for the divergence when a utility records a rate of return that is higher than its authorized rate of return," the paper said. The paper did not name any specific utilities as gaming the system.

While it is not always easy to detect when or if a utility is trying to game the system, one indication that a utility could be trying to inflate shareholder returns at the expense of ratepayers could be when a utility holds a modified capital structure that is different from its authorized capital structure for an extended period of time, according to the paper.

As the authors note, when a utility's rate of return turns out to be higher than its authorized rate of return due to lower costs, it's hard to tell whether that came about because the forecasts were inflated or the utility operated more efficiently.

A utility's actual returns can also differ from authorized returns if the utility significantly overspends or underspends on capital expenditures, according to the paper. Such a situation would cause actual rate base to deviate from the authorized level.

Some utilities appear to have been permitted to earn above-authorized returns, with the rationale being that the higher rate of return acts as an incentive to operate as efficiently as possible, the paper notes.

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However, the authors said in conclusion, because of the "asymmetry" or difference in the information that a utility has about its operations compared to what the regulator has, the possibility of gaming does exist. While the policy division does not offer any recommendations, the paper calls for more attention to be paid to the issues raised.

The CPUC's current cost-of-capital mechanism includes an adjustment process based on utility bond rate changes in the years that the utilities are not required to file a cost-of-capital application. Utilities are required to file cost-of-capital applications every three years, but this requirement is often waived, especially when interest rates have not moved much.

In 2014 the commission extended the 2015 filing date one year, to 2016, and then gave utilities another one-year extension, to this year.

In February, all four IOUs, the Office of Ratepayer Advocates and The Utility Reform Network petitioned the commission to extend the cost-of-capital filing date to April 22, 2019; reduce the IOUs' authorized returns on equity; and reset authorized costs of long-term debt and preferred stock, beginning in 2018 [A12-04-015].

Ratepayers would benefit from the changes, according to the petition.

Policy and Planning Division work has informed the commission's regulatory proceedings; for example, a 2016 PPD paper on transportation electrification highlighted the outsized impact of goods and freight movement on disadvantaged communities.

When the commission directed utilities to file applications for new programs for transportation electrification, it had them look at diverse sectors, including ports and freight, that are crucial to reducing criteria pollutants and greenhouse-gas emissions.

CPUC spokeswoman Terrie Prosper said the cost-of-capital paper is not a precursor to any commissionaction.

If there is a possibility that utilities are gaming the system at the expense of ratepayers, then perhaps the commission should take a closer look. [Mavis Scanlon]

Bearing Down is excerpted from Energy NewsData's Clearing Up publication. If you aren't a current subscriber, see for yourself how NewsData reporters put events in an accurate and meaningful context -- request a sample of Clearing Up.

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