20040928Comments.pdf

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SCOTT WOODBURY
DEPUTY ATTORNEY GENERAL
IDAHO PUBLIC UTILITIES COMMISSION
PO BOX 83720
BOISE, IDAHO 83720-0074
[phone]
IDAHO BAR NO. 1895
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UTtLiTIES COJif"ffSS1ON
Street Address for Express Mail:
472 W. WASHINGTON
BOISE, IDAHO 83702-5983
Attorney for the Commission Staff
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION OF
. )
UNITED WATER IDAHO INC. FOR AN
AMENDMENT TO ITS CERTIFICATE OF
PUBLIC CONVENIENCE AND NECESSITY NO. )
142 AND FOR AN ACCOUNTING ORDER.
CASE NO. UWI-O4-
COMMENTS OF THE
COMMISSION STAFF
COMES NOW the Staff of the Idaho Public Utilities Commission, by and through its
Attorney of record, Scott Woodbury, Deputy Attorney General, and in response to the Notice of
Application, Notice of Modified Procedure and Notice of Comment/Protest Deadline issued on
September 1 , 2004, submits the following comments.
BACKGROUND
On August 9, 2004, United Water Idaho Inc. (United Water; UWI) filed an Application with
the Idaho Public Utilities Commission (Commission) requesting authority to remove the Carriage
Hill Subdivision from UWI's certificated service area and for an accounting order regarding
distribution of proceeds from the sale of the Carriage Hill domestic water to the City of Nampa
(Nampa). On August 25 2004, UWI filed supporting testimony for its Application.
UWI proposes to sell the Carriage Hill well and water distribution system to the City of
Nampa through an agreement reached through arms length negotiations over the past year. Nampa
STAFF COMMENTS SEPTEMBER 27, 2004
proposes to purchase the well for $375 000. The City will finance the acquisition through a Local
Improvement District (LID).
The Carriage Hill system was established in 1999 through a non-contiguous system
agreement with UWI (Order No. 27976). The distribution system and water source was contributed
to UWI in December 1999 as part of that agreement. UWI booked the system valued at $532 345
for rate base treatment with two contra balances of $177,439 as contribution in aid of construction
for the distribution system and $354 906 as an advance in aid of construction for the source supply.
In accordance with the non-contiguous agreement, UWI reimburses the developers at a rate
of $800 per lot once a customer connects to the system and begins taking service. The
reimbursement rate was established in Case No. UWI-98-, Order No. 27718, as the average
embedded per customer cost of supply improvements. The total reimbursement amount is limited
to the lesser of the total number of connected lots at subdivision build-out or the total advance in
aide of construction. Reimbursements are also limited to a maximum of 15 years.
The UWI investment in the Carriage Hill system is equal to the reimbursement of
$800/connected lot and purchase of meters for each customer. Carriage Hill customers paying
standard UWI rates each contribute approximately $200 per year per customer. This annual
revenue amount is much less than the average UWI customer bill of over $300 due to availability of
irrigation water through a separate delivery system.
The Carriage Hill system is not included in UWI's current rate calculation. The test year of
the last UWI general rate case (Case No. UWI-OO-l) was the year ending September 30, 1999
and the Carriage Hill system was contributed to UWI in December 1999. A UWI general rate case
has not occurred since the approval of the Carriage Hill non-contiguous water system.
ORIGINAL FINANCING AND AFFILIATE RELATIONSHIPS
As noted in Section VI ofUWI's Application , in 1998 Carriage Hill, L.C. executed a
Design-Build Promissory Note with UWI's parent , United Waterworks, Inc. (UWW) in the original
principal amount of$350 000. The note provided funds to assist Carriage Hill in the construction of
the water system within the subdivision. In 1998 the principals of Carriage Hill also executed a
Joint and Several Individuals' Guaranty in favor ofUWW as guarantee for the Promissory Note.
However, in 2002 Carriage Hill L.C. failed to make the payments required under the Promissory
Note to UWW and the Promissory Note became delinquent (Wyatt, Di, page 2 , lines 8 and 9). UWI
personnel made numerous contacts with the developer requesting payment to UWW. In addition
STAFF COMMENTS SEPTEMBER 27, 2004
UWI personnel discussed loan refinancing with their corporate accounting and treasury departments
and subsequently made proposals to the developer regarding a potential refinancing of the loan
(Wyatt, Di, page 2, lines 11 through 14). Further evidence that UWI was operating on behalf of its
parent was the decision by UWI to stop its contractually obligated refunds to the developers of the
project water system source of supply investment. "When Carriage Hills became delinquent in its
loan repayment obligations (to United Waterworks), United Water Idaho suspended the refund
payments." (Wyatt, Di, page 7 , lines 9 through 21).
On page 3 of his direct testimony, Mr. Wyatt describes the Carriage Hills project as
precarious in early 2003. "The Carriage Hills developers informed me that they did not have funds
either to continue payments to United Waterworks or to drill a new well. Without a second source
of supply the project would not be able to expand and thereby generate funds to finance the new
well or to pay United Waterworks." (Wyatt, Di, page 3, lines 6 through 9). As a result, in 2003
UWI started discussions with the City of Nampa regarding the sale of the system. Section XII of
UWI's Application indicates that subject to final adjustment , approximately $339 000 of the
$375 000 purchase price for the sale shall be paid to UWW to discharge the accrued interest and
principal owing pursuant to the Design-Build Promissory Note. Greg Wyatt notes that this is a
unique set of circumstances that justifies such a disbursement of sale proceeds. On page 9, lines 16
through 17 of his direct testimony, he states "there are no other non-contiguous projects in which
United Waterworks operates as a financier, and I would not anticipate there would be any in the
future.
Staff strongly encourages United Waterworks and its wholly-owned regulated subsidiary
United Water Idaho to refrain from further financing transactions of this nature. Staff believes that
this transaction created a conflict of interest for UWI to maximize proceeds from the sale of
company assets and to recover a delinquent loan for the benefit of the parent company. Moreover
difficulties arise in reviewing, separating and allocating UWI costs between the two affiliates.
According to UWI, the Carriage Hill system is earning a 6.914% return on rate base. This is
below the 8.843% return authorized in UWI's last rate case, Case No. UWI-OO-, Order No.
28505, page 2. As described further in the Engineering Section below, the Carriage Hill water
system is currently limited to 35 customer connections due to its single well. Given that limitation
it is highly unlikely the system will substantially increase the return it is earning to become self-
supporting and avoid being subsidized by other customers.
STAFF COMMENTS SEPTEMBER 27, 2004
EN GINEERIN G
Staff believes both the City ofNampa and United Water have adequate water system
management and the financial capability to serve customers. Both the City ofNampa and United
Water Idaho employ full-time qualified experienced water system personnel. The City of Nampa
the second largest city in the state and UWI, the largest regulated water company, both have
adequate financial capabilities to serve its customers.
Staff further believes that interconnection with the City of Nampa will immediately improve
the supply capacity of the system. Currently the Carriage Hill water system is allowed to exceed
the maximum number of customers served by a single well through an agreement between UWI and
the Department of Environmental Quality (DEQ). DEQ requires a second source once the number
of full time customers exceeds 25. The agreement allows for up to 35 customers to be connected to
the Carriage Hill system until the issue of purchase by the City ofNampa is resolved. If the
sale/purchase is approved, the city will interconnect Carriage Hill with its existing citywide system
providing an adequate second source. If the purchase does not proceed, the Non-contiguous Water
System Agreement requires the developers to install a second water source. UWI has indicated that
the cost of the second source is expected to be approximately $90 000. If the developer cannot
fulfill its obligation then UWI would be required to make the necessary system improvements.
As of September 17, 2004, Staff is aware of one customer comment concerning water
quality. The customer indicates that the City of Nampa water sources are of lesser quality (harder
water) than the current Carriage Hill system. Staff assumes that it is the city s intention to keep the
Carriage Hill well in operation. While Staffhas not analyzed pressure differences between the
city s system and the Carriage Hill system it is logical to assume that even with the interconnection
customers should continue to receive the majority of their water from the existing Carriage Hill well
with backup supply from the city. In any case both systems must meet statewide water quality
standards as set by the Department of Environmental Quality.
One area where customers will benefit from the sale of the system is from the rate
differential between UWI and the City of Nampa. Currently Nampa s rates are significantly less
than those ofUWI (See Attachment A). Customers should also experience easier access to water
system administration with offices in Nampa as opposed to Boise.
Staffwas initially concerned that existing customers would end up paying twice for water
system improvements, once through the purchase price of lots and also through the local
STAFF COMMENTS SEPTEMBER 27, 2004
improvement district. Staff s investigation indicates that no existing customers will be included in
the assessment of the local improvement district.
ALLOCATION AND ACCOUNTING OF SALE PROCEEDS
UWI has proposed a distribution of sale proceeds as part of its Application. That proposed
distribution would initially allocate a portion of the sale proceeds to United Water Idaho to "make
the Company (UWI) whole These are the funds necessary to reverse all the entries on UWI's
books as a result of taking ownership of the Carriage Hill water system (water system). UWI then
proposes that the balance of the sales proceeds be distributed to United Waterworks, an affiliate of
UWI, to satisfy an obligation in the amount of $308 117.56 (principal note balance of $262 345.
and accrued interest through October 15 2004 in the amount of $45 771.96). This represents a
premium of approximately $30 000 being paid to UWW (a UWI affiliate) from the sale proceeds.
UWI does not address any legal basis for making any payment to United Waterworks nor
does it advance any rationale to justify a payment of any premium to United Waterworks. All the
documentation indicates that the entire legal obligation for any debt owed to United Waterworks for
the initial financing of the water project flows solely from Carriage Hill, L., hereafter
Developers. The Developers borrowed the money from United Waterworks and guaranteed
repayment with personal guaranties. The Developers then contributed all of the existing domestic
water system to UWI. A portion in the amount of$177, 438.79 was contributed as Contribution in
Aid of Construction (CIAC) (the distribution system) and a portion in the amount of$354 905.
was contributed as Advances in Aid of Construction (AIAC) (the source system). UWI's only
obligation in return for the Developers contributing this water system was to refund to the
Developers the amount of $800 for each connection to the system as an offset to AIAC. There is no
agreement by UWI to assume the Developers obligation to United Waterworks, nor was there any
provision in the agreement between UWI and the Developers to accelerate the payment of the
Advances in Aid of Construction upon the sale or transfer of the system, and finally, there is no
evidence of any legal claim that can be asserted by United Waterworks for any portion of the
proceeds from a sale of the water system. When the Developers transferred the water system
UWI, it was transferred free from all liens and other encumbrances.
Staff is in agreement with that portion of UWI' s Application that indicates a portion of the
proceeds should be paid to UWI to make it whole. UWI submitted Revised Exhibit E as its
STAFF COMMENTS SEPTEMBER 27, 2004
proposal to achieve that objective. Staffhas reviewed those entries and proposes that the following
adjustments be included to fairly reflect what would be necessary to make UWI whole:a. include chlorinating equipment at the well head- $1 722.
include paYroll overhead on MJ 2537- $72.
include materials overhead on MJ 2537- $752.
include paYroll overhead on MJ 2849- $711.
Attached, as Attachment B is UWI's proposed accounting entries with Staff s adjustments to make
UWI whole.
When the water system was transferred from the Developers to UWI (Commission Order
No. 27976), the only UWI obligation was to pay the AIAC in the amount of $800.00 per new
connection to the Developers. If the Commission approves the requested transfer, UWI's AIAC
obligation to the Developers ends, and all sales proceeds are UWI's.
UWI in its testimony (Wyatt, Di, page 5, lines 20 through 21) stated that its goal "was to
obtain a sale price that would produce sufficient funds to make United Water Idaho and United
Waterworks whole." It is Staff s position that UWI should be viewed independently from United
Waterworks, and the sales proceeds should be accounted for as if the total amount came only to
UWI. The original borrowing obligation of the Developers to United Waterworks is irrelevant to
the Application before the Commission. Therefore, Staff believes it is inappropriate to directly use
sale proceeds to retire the debt owed by Carriage Hills LLC as proposed by UWI. The issue before
the Commission should be how the sale proceeds are allocated between the parties with a vested
interest in the proceeds: that being the ratepayers and UWI. The Commission should narrow its
focus on the allocation of the sale proceeds to an allocation between only the ratepayers and UWI
and not be distracted by the interests of UWW or the Developers.
The proper allocation of the sale proceeds is subject to interpretation. This interpretation
leads Staff to three approaches: 1) Relative risks from contributions and advances are shared
equally by UWI and ratepayers so the sales proceeds should be shared equally. 2) Depreciable
assets in rate base provide the floor to allocate the sales proceeds. This ratio of depreciated assets to
total depreciable assets is the proper ratio to allocate the sales proceeds with the depreciated ratio
going to ratepayers and the undepreciated ratio going to UWI shareholders. 3) A combination of
the first two methods to recognize the actual investment and risk responsibilities in this situation for
ratepayers and UWI.
STAFF COMMENTS SEPTEMBER 27, 2004
With the first methodology in determining the allocation of the sale proceeds between the
ratepayers and UWI, the Commission should examine the relative risks of the respective parties.
The relative risks include the increase in rate base as advances are refunded, depreciation on the
investment, additional expense associated with operational and maintenance expenses, and whether
or not sufficient revenues are generated to cover costs. How these risks are borne by each party
should guide the allocation considerations of the Commission.
Neither UWI nor the ratepayers had any risk for the initial plant investment when the water
system was contributed to UWI. UWI did not have to use any of its capital to obtain the system
and the ratepayers were not exposed to any associated rate base costs. Once the system was
contributed, and UWI began to refund advances for customer connections and investment in meters
both parties began to be exposed to risk. UWI was investing by way of refunds creating an increase
in rate base, and the ratepayers were exposed to the upward pressure on rates caused by an increase
in rate base and associated costs.
Although there is no clear methodology to quantify each party s risk, Staff believes the
relative risks of the ratepayers and UWI are very similar and approximately equal. Thus, it is
reasonable that the allocation of the sale proceeds should reflect the similar and equal risks of each
party. To the extent risks are equal, then the net sale proceeds should be divided equally.
The second methodology develops ratios where the depreciated portion of the depreciable
asset is allocated to the ratepayers and the undepreciated portion of the asset is allocated to UWI
shareholders. The Supreme Court of Idaho in the case of Boise Water Corporation, v. Idaho Public
Utilities Commission, 99 Idaho Reports 158 , 578 P.2d 1089 (1978); has previously addressed the
issue of how the processes for the sale of a utility s depreciable assets are divided between the
utility s shareholders and ratepayers.
In the Boise Water Case, the Court held that as a general rule, the gain from the sale of an
asset is divided between the ratepayers and the shareholders according to that portion of the asset
that has been depreciated. The Supreme Court held as follows:
In the world of utility law there are two methods of treating revenue.
Some revenue benefits utility customers by decreasing the amount charged
for rates. Other revenue benefits the shareholders of the utility. Which
class of persons receives the benefit of such revenue depends on who has
borne the financial burdens and risks of that property. On property other
than real property, the utility receives a depreciation allowance which
effects its rate of return. The depreciation is an amortized amount allowed
to the utility for the consumptive utilization of its property. Theoretically,
STAFF COMMENTS SEPTEMBER 27, 2004
at the end of the depreciation period the property is useless or consumed
and the utility has been paid back its cost of acquiring that property for the
benefit of its customers. Again, theoretically, the utility can then turn
around with the money received as a depreciation allowance and buy a
new piece of equipment to perform the function of that property which has
been consumed or become useless. One way of looking at a depreciation
allowance on a utility s personal property is that the public buys that
property from the utility as it is used up. In one sense, therefore, the
public owns depreciable property, and when a utility sells depreciable
property, the ratepayers are entitled to have that sale treated as if it were
the sale of the ratepayers property. The revenue ought to be included in
the utility s revenue receipts which reduce the rate charges to customers.
With this guidance from the Supreme Court, it becomes clear that through depreciation, the general
ratepayers ofUWI should be treated in part as equitable owners of the water system being
transferred. The ratepayers' share of the sales proceeds , at a minimum, should be equal to the ratio
that accumulated depreciation is to the net book value of the system. That ratio is represented as
below:
Accumulated Depreciation
Net Book Value
$ 2.334.
$26 387.
Thus, as a minimum, the ratepayers should be entitled to 8.849% of the sales proceeds after UWI is
first made whole.
The Supreme Court decision is appropriate for the proceeds associated with rate base
investment that UWI has made and is being depreciated. The situation being discussed here is
different. The Carriage Hill water system was completely contributed and only became rate based
as advances were refunded. Since the assets were contributed as opposed to assets that were
completely rate based, a strict application of the Supreme Court holding in the Boise Water case is
inappropriate. The general rule of the Boise Water case should represent the minimum interest, not
the maximum interest, the ratepayers have in the sale proceeds when the assets are contributed.
The considerations associated with the first and second allocation methods gives rise to the
third method. This method develops a combination where the risk sharing approach allocates 50%
to ratepayers and 50% to UWI shareholders for the assets contributed or 95% of the plant value.
The remaining 5% of plant value is associated with depreciable assets and should be allocated
849% to ratepayers with the remaining 91.151 % to UWI shareholders
UWI proposed that United Waterworks should be entitled to the premium from the sale
proceeds (Wyatt, Di, page 8, lines 18 through 21) because it believes United Waterworks was the
STAFF COMMENTS SEPTEMBER 27, 2004
entity that faced the risk ofproject failure. This position is not supported by the original loan
documentation. UWW did not retain any legal or equitable interest in the water system at the time
of the financing. The only security for the repayment of the loan and the only security accepted by
UWW were the personal, joint and several guaranties of the principals in Carriage Hill L., the
development company. United Waterworks' legal right to be repaid by the Developer would not
change if the project fails, and its risk position does not change from the risk it assumed at the time
the loan was made to the Developer. Any premium that is realized from the sale of the water
system should be accounted for in the division of the sales proceeds between the ratepayers and
UWI.
The net sales price for the transfer of the water system is the difference between the gross
sells price from the City ofNampa, $375 000.00 and the reversing entries to make UWI whole
(Attachment B). The total of those entries is dependent upon the Commission accepting Staffs
adjustments, and the final sale transaction amounts that may cause the net figure to change in a
small amount. The net sales amount using the reversing entries, as put forth in Attachment B is
$336 256.02. If the Commission finds that the relative risks of the ratepayers and UWW are equal
then a reasonable allocation of the sale proceeds would be that ratepayers would be entitled to a
credit against future rates in the amount of$168 128.01. Alternatively, as a minimum, the
ratepayers would be entitled to the equitable ownership from depreciation or 8.849% of the net sales
proceeds, $29 755.30, which would also be a credit against future rates. The third methodology
would allocate $161 209 to ratepayers and $175 047 to UWI shareholders. Staff believes this is the
most reasonable allocation methodology. The UWI shareholders' portion could then be applied to
the UWW loan if desired.
SUMMARY
Staff believes that United Water Idaho s proposed sale of the Carriage Hill system is
primarily to avoid litigation between United Water Idaho s parent company United Waterworks and
the developers of the Carriage Hill development. UWI further states that its goal during
negotiations was to "obtain a sale price that would provide sufficient funds to make United Water
Idaho and United Waterworks whole." (Wyatt, Di, page 5, lines 20 and 21). UWI's request
appears to have little concern for either improved service to customers or to reduce customers
rates. Therefore, Staffs review focused on whether the sale was in the best interest of United Water
Idaho s customers both inside and outside the Carriage Hill development.
STAFF COMMENTS SEPTEMBER 27, 2004
Carriage Hill customers appear to benefit from the nearly immediate access to a second
source of domestic water and avoiding any delay in development of the second source due to
financing concerns. Carriage Hill customers will also benefit from the rate differential between the
City ofNampa and United Water. United Water Idaho s general body of ratepayers will be
unharmed because Staffs proposed accounting treatment will effectively eliminate all rate affects
of the Carriage Hill system. Furthermore, under Staffs proposal United Water s general body of
ratepayers should benefit from the gain on the system equal to their level of plant and operational
support. In spite of the significant gain to United Water Idaho due to the sale of contributed
property, Staff believes that customers are unharmed from the transaction and does not oppose the
sale of the Carriage Hill water system to the City ofNampa.
ST AFF RECOMMENDATION
Staff does not object to the sale of the Carriage Hill water system to the City ofNampa.
However, Staff recommends that the proceeds from that sale be accounted for as discussed in this
document.
Staff recommends that UWI be required to file (1) a copy of the Closing Documents and (2)
a copy of the accounting entries with this Commission within seven days from the completion of the
sale.
Staff recommends that UWI, in its next rate filing, ensure that all components associated
with this sale are excluded from that filing including but not limited to: rate base components
expenses such as legal expenses, costs associated with UWI management's time in negotiating and
processing the sale and attorney fees.
Staff recommends that the ratepayer s share of the sale proceeds be credited to ratepayers.
The Staff prefers the third methodology where $161 209 would be allocated to ratepayers and
$175 047 would be allocated to UWI shareholders.
STAFF COMMENTS SEPTEMBER 27, 2004
Respectfully submitted this
Technical Staff: Joe Leckie
Patricia Harms
Michael Fuss
SW :/umisc/comments/uwiwO4.3 swphjlmf
ST AFF COMMENTS
dl?day of September 2004.
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Deputy Attorney General
SEPTEMBER 27, 2004
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United Water Idaho
Proposed Journal Entry to Record Carriage Hill Sale
(Assumes Closing As of October 15,2004)
(Includes Staff's Adjustments)
UNITED WATER IDAHO:
Advanced Plant- Reverse original cost plant; reverse book amount of
advance liability; reverse accum depr. On refunds made; book cash
from City of Nampa
Plant in Service
Advances for Construction
Accumulated Depreciation
Cash
Contributed Plant- Reverse original cost plant; reverse CIAC;
reverse amort of CIAC
Plant in Service
Contributions in Aid of Construction
Accumulated Depreciation
Accumulated Amortization of CIAC
Miscellaneous Plant & Other:
PIS Meters
Accumulated Depreciation
Chlorination Equipment
MJ Cost # 2537
Payroll Overhead
Materials Overhead
MJ Cost # 2849
Payroll Overhead
Legal & IPUC Filing Expenses
Refunds Payable to Carriage Hill (g) closing
Cash
Adjustments
Account Number
101-000
252-000
108-010
131-000
101-000
271-000
108-010
272-000
101-000
108-010
101-000
186-025
186-025
186-025
186-025
186-025
143-000
232-000
131-000
Debit Credit
354 905.
341 305.
179.41
11,420.
354 905.354 905.
177 ,438. 79
177,438.
861.
861.
190,300.190,300.
000.
231.
038.
358.
500.
10,400.
323.
554.296.
257.
27,554.27,554.
572,760.572 760.
38,743.
Total UWlD Debits and Credits
Total Cash
Staffs
Adjustment
Debit(Credit)
722.00)
(72.33)
(752.29)
(711.16)
257.78)
Attachment B
Case No. UWI-04-
Staff Comments
9/27/04
CERTIFICATE OF SERVICE
HEREBY CERTIFY THAT I HAVE THIS 27TH DAY OF SEPTEMBER 2004
SERVED THE FOREGOING COMMENTS OF THE COMMISSION STAFF, IN
CASE NO. UWI-04-, BY MAILING A COpy THEREOF POSTAGE PREPAID
TO THE FOLLOWING:
GREGORYP WYATT
UNITED WATER IDAHO INC
PO BOX 190420
BOISE, ID 83719-0420
DEAN J MILLER ESQ
McD EVITT & MILLER LLP
PO BOX 2564
BOISE ID 83701
SECRETARY
CERTIFICATE OF SERVICE