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CPUC Sets Index for Profit-Level Setting

California regulators last Thursday adopted a new indexed process for setting major utilities' returns on equity (ROE) using shifts in the interest rates on some of Moody's Investors Service's bond ratings. The action does not change the authorized profit-levels for any of the state's major private-sector utilities. That was done late last year by the California Public Utilities Commission (CPUC).

The action sets up an automatic annual adjustment of the utilities' earnings levels without requiring them to file a formal cost-of-capital review each year. The CPUC can monitor the profit levels with less administrative time and resources expended, under the new process.

California's energy utilities get a new multi-year mechanism for setting their ROEs that Commissioner John Bohn said should provide more "regulatory certainty for the utilities as they face the capital markets" from year-to-year. Administrative Law Judge Michael Galvin outlined in an April 29 proposed decision a uniform multi-year cost of capital mechanism (CCM), and utilities have all voiced support for, or not opposed, the changes.

Future adjustments in the ROEs will be made when a change of 1% or more is experienced in the Moody's indexes ("AA" bond rating interest rate for A-rated utilities, and "Baa" bond rating interest rate for B-rated utilities). The index will be the average of 12 monthly Moody's rates, beginning with the rates in effect in September 2007 (5.87% for AA bonds and 6.26% for Baa).

When the 1% threshold is exceeded, the CPUC would adjust the ROE of a utility up or down by an amount that is half of the percentage change as what Bohn called "a fair sharing between the ratepayers and the shareholders." Aside from this automatic annual adjustment, each utility's earnings level would be fully reexamined in their respective general rate cases, he said.

The vote was unanimous (5-0) for the new process, but CPUC President Michael Peevey expressed some skepticism about putting the ROE-setting for utilities on what he called "auto pilot." He called the "formulaic approaches comforting to people, but not always satisfactory." He expressed surprise that none of the utilities resisted the change.

Except for Sempra Energy's San Diego Gas and Electric Co. (SDG&E), California energy utilities since the early 1990s have been filing annual capital cost applications. SDG&E in 1996 established a Market Indexed Capital Adjustment Mechanism, which has been modified several times.

ROEs for 2008 were set last December: Southern California Edison Co. is authorized a 11.50% return on equity (ROE), resulting in an 8.77% rate of return (ROR), after asking for an increase in its ROE to 11.80% from 11.60%. Pacific Gas and Electric Co. was given an 11.35% ROE, producing an 8.79% ROR, keeping the same profit level, after asking for an increase to 11.70% from 11.35%. SDG&E got a boost in its ROE to 11.10%, with 8.40% for its ROR, after seeking an 11.60% ROE from its current 10.70% level.

At that time last December, the CPUC concluded that market conditions over the year were sufficiently unchanged that the ROEs should remain basically unchanged.

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