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DECISION MEMORANDUM TO: COMMISSIONER KJELLANDER COMMISSIONER SMITH COMMISSIONER HANSEN JEAN JEWELL RON LAW LOU ANN WESTERFIELD RANDY LOBB DON HOWELL ALDEN HOLM MICHAEL FUSS DAVE SCHUNKE TERRI CARLOCK BOB SMITH GENE FADNESS BEV BARKER TONYA CLARK WORKING FILE FROM: LISA NORDSTROM DATE: MAY 6, 2002 RE: IN THE MATTER OF CAPITOL WATER CORPORATION'S APPLICATION FOR A TEMPORARY SURCHARGE, A DECLARATION OF PRUDENCY, AND AUTHORITY TO INCUR DEBT TO FUND SYSTEM IMPROVEMENTS. CASE NO. CAP-W-02-1 On February 26, 2002, Capitol Water Corporation (Capitol Water; Company) filed an Application requesting the Commission issue an Order that declares its proposed capital expenditures prudent, authorizes the Company to incur debt to fund the improvements, and institutes a temporary seven-year surcharge to recover the cost from customers. To improve water quality, the Commission authorized Capitol Water in 1997 to collect a surcharge of $3.27/month for unmetered residential customers and a 25.2% increase for metered commercial customers over a seven-year period ending August 1, 2004. Order No. 27022. To fund the proposed capital improvements, the Company now seeks to add a second surcharge of $3.56/month for unmetered residential customers and a 21.1% increase for metered commercial customers. In the Notice of Application and Modified Procedure issued on March 28, 2002, the Commission solicited comments regarding Avista's Application. Order No. 28957. No comments were received other than those submitted by Commission Staff, to which the Company responded on April 22, 2002. THE APPLICATION Capitol Water's Application directly or indirectly requests the Commission to issue an Order that declares the proposed capital expenditures prudent, authorizes the Company to incur debt to fund the improvements, and institutes a temporary surcharge to recover the cost from customers. Capitol Water serves approximately 2,800 customers in an area of approximately four square miles in the near southwest part of Boise. It is bounded roughly by Northview Street on the south, Ustick Road on the north, North Maple Grove on the west, and Curtis Road on the east. The system has seven wells, two of which have been abandoned. Capitol Water has no storage reservoirs. A. Declaration of Prudency Recognizing the need to ensure customer safety by correcting flow and pressure deficiencies, Capitol Water intends to focus its capital improvements on replacing Well No. 5 and upgrading its distribution system. Because the Company believes the expenses incurred to date and the proposed expenditures would be in the public interest, Capitol Water specifically requests a Commission Order "declaring that the incurrence of these expenses is a prudent capital investment." Application at 5. 1. Well 5 Replacement. The eastern portion of the Company's water system includes the approximately 420 customers located east of Fry Street. This area was historically supplied by Well Nos. 1, 2, and 5, which originally had a combined capacity of 1,700 gallons per minute (gpm). Based on Idaho Department of Environmental Quality (DEQ) criteria for estimating system demand for metered public water systems, the anticipated peak demand for this area is approximately 491 gpm. Id. at 2. Because DEQ recommends doubling the estimate for unmetered systems such as Capitol Water's, peak-hour demand could exceed 2,000 gpm. Id. In addition to normal peak demands, fire flow requirements for public safety are 1,500 gpm. Id. Thus under a worst-case scenario, peak hour demand could exceed 3,500 gpm. Id. Well No. 2 has failed due to casing collapse and Well No. 5 was abandoned in 2000 due to perchloroethylene (PERC) contamination. Well No. 1 is more than 40 years old, and has a capacity of just 350 gpm. It is typically only used during summer months due to high levels of iron and manganese. Company Well Nos. 3, 4, 6 and 7 located in the western portion of Capitol Water's service area currently supplements the water drawn from Well No. 1. In the winter months, water for the eastern portion of the Company's system is supplied entirely from the Company's Well Nos. 3 and 7. The combined capacity of Well No. 1 and the deliverable capacity of Well Nos. 3, 4, 6, and 7 leave a peak hour demand shortfall of 1,050 gpm, and a shortfall of approximately 2,050 gpm to meet recommended fire safety flows during peak summer hour demand. Id. at 3. Capitol Water plans to replace Well No. 5 as soon as possible to provide adequate water supply for fire protection and peak hour demands. The replacement well will be located on the same site and will seal off the contaminated shallow aquifer zones. Id. The replacement well will tap aquifer zones that are believed to have good water quality with respect to iron and manganese, and only residual levels of dissolved PERC. Id. The residual levels of PERC are anticipated to diminish over time as the well is pumped. Id. Based on the Company's current system capacity and customer demand, a well sized to produce approximately 1,000 gpm is needed to replace abandoned Well No. 5. Id. The Company proposes servicing this well with a 100-horsepower, variable speed, line-shaft turbine pump rated to produce 200 to 1,000 gpm. Id. Although the cost to replace Well No. 5 is projected to be $346,000, the Company also seeks to recover the $45,349.66 it has already expended to date for costs associated with the abandonment of old Well No. 5. Id. at 4. 2. Distribution System Upgrades. The eastern portion of the Company's service area is connected to the western portion by three 4-inch mains. These connections are located at the intersections of Pomona Road and Fry Street, Newman Street and Norman Drive, and Northview Street and Fry Drive. At five feet per second velocity, approximately one pound per square inch of pressure (psi) is lost for every 100 feet of four-inch pipe. Based on this calculation, a maximum supply of approximately 600 gpm can be delivered from the western portion of the system to the eastern portion. Id. at 3. At flow rates in excess of 600 gpm, delivery pressure in the current system may decline to unacceptable levels (i.e., below 35 psi). Id. The limited deliverable capacity of Well Nos. 3, 4, 6, and 7 from the western service area contributes to the peak hour demand shortfalls described above. To ensure adequate distribution capacity, the Company plans to complete a system-wide hydraulic map and model. Id. at 4. Based on current knowledge, it is estimated the distribution capacity upgrade will require installation of approximately 2,000 feet of eight-inch pipe. Id. Although the distribution upgrade is projected to cost $90,000, the Company also seeks to recover the $13,874.96 it has spent thus far on new distribution system connections in the Well No. 5 service area following abandonment of the well. Id. 3. Legal Expenses Because Capitol Water is a small company, the Company contends that the cost of preparing and processing this Application will represent a significant extraordinary expense. Id. The Company estimates that the legal and accounting costs associated with this Application will be approximately $12,500. Id. Capitol Water requests that it be allowed to recover its actual expenses for processing this rate case out of the proceeds of the temporary rate increase. B. Authority to Incur Debt Under Idaho Code, a regulated water utility like Capital Water must receive authorization from the Commission to incur long-term debt with respect to its property situated in Idaho. Idaho Code § 61?901. To make the capital investment necessary to provide adequate water supply and distribution, Capitol Water proposes to borrow $507,000 at 7.08 percent over seven years. Id. at 4 and Exhibit 104. Under this borrowing arrangement, the Company would be required to repay $92,061.96 each year. Id. C. Temporary Surcharge To recoup the costs of its capital investments, the Company requests that the Commission approve a seven-year temporary surcharge. This surcharge is in addition to the previously approved $3.27/month surcharge for unmetered residential customers and 25.2% surcharge for metered commercial customers that will expire on August 1, 2004. Capital Water proposes that a $3.56 per month charge added to the base monthly rate for residential customers under rate Schedule No. 1. Schedule No. 1 is applicable to all non-metered customers for domestic use and lawn sprinkling. When combined with the current 3% franchise tax, this proposed temporary surcharge would increase the flat monthly rate of non-metered residential customers by $3.56. Exhibit 106 at 1. Thus the monthly rates of customers served by ¾" lines would increase from $12.62 to $16.28. Id. Residential customers served by 1" lines would see their monthly rate increase from $14.47 to $18.14. Id. Customers served by 1¼" lines would likewise experience a rate increase from $15.72 to $19.38. Id. The Company also requests a 21.1% increase in the rates for metered commercial customers taking service under the Company's rate Schedule No. 2. If approved as requested, the first 1,000 cubic feet per month would increase from $1.06 to $1.24 per 100 cubic feet. The next 1,000 cubic feet per month would increase from $0.60 to $0.70 per 100 cubic feet. The rate for any additional consumption would increase from $0.45 to $0.53 per 100 cubic feet. When combined with the current 3% franchise tax, this proposed increase would also raise the monthly minimum charge as follows: SERVICE LINE SIZE CURRENT MONTHLY MINIMUM CHARGE PROPOSED MONTHLY MINIMUM CHARGE ¾" AND SMALLER $7.50 $8.76 1" $10.40 $12.10 1 ½" $15.00 $17.46 2" $25.65 $29.92 3" $45.75 $45.75 (no change) Exhibit 106 at 2. D. Procedural Matters The Company intends to maintain a separate balancing account on its books with all transactions related to the Application flowing through the account on a monthly basis as transactions occur. Id. at 5. Its Application states that none of the expenditures proposed in their Application will be recorded to the Company's plant accounts and the Company will not seek to add these costs to its rate base for ratemaking purposes. Id. Capitol Water also states that it will file written quarterly status reports to apprise the Commission of monies expended, construction progress and any testing results. Id. Citing the limited scope of the issues presented in their Application, Capitol Water requests that its Application be processed without a hearing under Commission Rule of Procedure 202. Id. The Company did not propose an effective date. STAFF COMMENTS 1. Source Replacement (Well 5) The Company's Application proposed construction of a new well and well house at the abandoned Well No. 5 site on the eastern portion of the system. According to Staff, this location would provide a source where the supply need is the greatest. The Company's consultants, Terry Scanlan of Scanlan Engineering and Ed Squires of Hydrologic, performed a preliminary system analysis and groundwater study. The consultants analyzed the groundwater contamination and believe that the upper aquifer contamination should not detrimentally affect a new properly constructed supply well in this location. According to Staff, the Company's consultants project a minimum additional supply requirement of 1,050 gpm and a worst-case requirement of 2,050 gpm for the system. They also estimate 1,000 gpm is reasonable to expect from a well drilled at the Well No. 5 location. Because the new well will not completely provide all of the calculated worst-case requirement for the eastern portion of the system, the consultants recommend pipeline improvements with this proposal and possible reconstruction of Well No. 2 in the future. It is apparent to Staff that the additional supply is needed because of the considerable shortage in the eastern portion of the Company's system. Staff agrees that the next logical improvement is to increase the transmission capacity associated with Well No. 5 as the Company proposes. Staff believes the system analysis submitted by the Company should address the potential for water conservation and system metering. While new capacity is primarily required to meet fire flow requirements, Staff also thinks the system analysis should also address the system savings to be gained in these other areas. 2. Other Requested Funding The Company has not made a specific proposal for the 2,000 feet of mainline improvements, nor will it be able to do so until a network study is performed. Staff agrees that some mainline improvement is probably necessary but cannot adequately assess the need or cost without further information. Staff recommends that the Company conduct its network analysis and submit improvement recommendations before proceeding with any further mainline improvements. Staff has reviewed the estimated costs for abandoning old Well No. 5, constructing a new Well No. 5, performing additional studies, and submitting Commission case filings. The costs appear to be reasonable given the preliminary nature of the estimates and the uncertainty of future improvements. Staff also believes it is reasonable to include the portion of mainline improvements proposed in this filing to minimize finance costs and facilitate the timely construction of the improvements. However, Staff believes that any monies for mainline improvements other than those directly associated with Well No. 5 should be held until the Commission has an opportunity to review the network study and approve recommended mainline upgrades. Staff recommends the Company file quarterly status reports that summarize the status of studies, proposed designs and construction schedules in addition to the Company's proposed quarterly financing status reports. Staff believes the Company's system improvement proposal is reasonably based on sound technical advice and recommends, with the previously stated conditions, that the Commission approve the plan and find the estimated costs to be reasonable. 3. Surcharge Calculation Staff reviewed the calculations made by the Company to develop an appropriate customer surcharge to fund the construction activities. The Company is proposing to borrow funds from the Bank of America to actually fund the construction and issue a note payable in the amount of $507,000. The proposed customer surcharge is intended to service the debt costs (principal and interest) over the seven-year life of the loan. According to Staff, the Company's calculations were intended to duplicate the approach proposed by Staff and approved by the Commission in Case No. CAP-W-96-2. That case was a similar request for a customer surcharge to pay for backbone system improvements. However, Staff found that Exhibit No. 105 attached to the Application does not recognize interest expense and depreciation expense deductions for income taxes as indicated. Staff also believes that the Company inappropriately allocated costs between flat rate residential customers and metered commercial customers. In making the allocation, the Company added all surcharge revenue collected pursuant to Case No. CAP-W-96-2 to the residential flat rate revenues. These surcharge revenues are not basic charges and thus Staff believes that they should not be included in calculating the customer class allocation percentages. According to Staff, the Company's proposed calculation allocates responsibility unfairly to the flat rate residential customers. Attached to this Memorandum is Staff Attachments A-1 through A-4, which show Staff recalculations of the required surcharge and determine the effect on the Company's customers. Staff has also updated the cost of borrowed funds in these calculations to reflect the 7.46% offered by the Bank of America on April 5, 2002. On Attachment A-3, Staff's calculations produce a surcharge of $3.07 per month for residential flat rate customers instead of the $3.56 surcharge calculated by the Company. Staff's calculations produce a surcharge of 23.6% for the Company's metered customers as compared with the 21.1% calculated by the Company. Also included on this attachment is a calculation showing the effect of the Boise City franchise tax of 3%. The franchise tax adds $0.10 to the residential flat rate customer surcharge, bringing the total effect of the surcharge to $3.17. The franchise tax increases the commercial metered surcharge by 0.71% bringing the total effect of the surcharge to 24.3%. Staff's Attachment A-4 shows the effect on customers' bills of both the 1996 surcharge and the proposed surcharge in this case. The majority of residential customers use ¾ inch service lines and would see an increase in their basic rates (without 1996 surcharge) of 13.33% in the six summer months and an increase of 25.72% during the six winter months. Staff notes that on an annual basis the increase for these customers would be 19.53%. Since commercial metered customers are not on seasonal rates, their uniform annual increase is 23.60% 4. Accounting Issues The Commission, by Order No. 27022 in Case No. CAP-W-96-2, directed Capitol Water to establish a balancing account on its books and flow all transactions related to the 1996 surcharge through the balancing account. Staff stated that this action was taken by the Commission to insure that no investment funded by the customer surcharge would find its way into the Company's general plant records used for normal ratemaking purposes. The Company in that case, as well as in the current case before the Commission, assured the Commission that it would not seek to include investments funded by the surcharge in its rate base. "The Company will maintain a separate balancing account on its books with all transactions related to this Application flowing through the account on a monthly basis as transactions occur. None of the expenditures proposed in this Application will be recorded to the Company's plant accounts and the Company will not seek to add these costs to its rate base for ratemaking purposes." (Case CAP-W-02-1 Application at page 5, item 21.) Staff stated that the Company did not follow the Commission's instructions in Order No. 27022 and instead opened a separate bank account. All surcharges collected and bank loan proceeds from the 1996 surcharge have been deposited to this account. When payments have been required to pay for improvements or make loan payments, the Company has transferred funds from the special bank account to its regular checking account from which checks have been written to make the payments. Payments made for system improvements have been recorded to the Company's regular plant accounts. Consequently, Staff has found it very difficult to identify the special project investments that are not to be included in the Company's rate base. Staff discussed this problem with the Company and the Company agreed that it must perform an analysis of its past activities to determine the amounts incorrectly recorded to each of its plant accounts. Staff is willing to work with the Company and its outside accountant to complete the analysis. The problem is compounded by the calculations for depreciation expense and accumulated depreciation that must also be corrected on the Company's books. Staff proposed that the Commission reiterate its instructions to the Company in this case to establish a balancing account on its books for all future surcharge activities. Moreover, Staff believes that the Company should be ordered not to record to its plant accounts any investments approved in this case. Staff also recommended that the Company be instructed to complete its analysis of its plant accounts and furnish to the Commission, for its approval, correcting entries to remove the investments recorded in error from the prior surcharge authorized in Case No. CAP-W-96-1. The Company's analysis and proposed correcting entries should be provided to the Commission no later than December 31, 2002. COMPANY REPLY COMMENTS In a response Fax to Staff's counsel on April 22, 2002, Capitol Water indicated that it is in agreement with all of Staff's recommendations. However, in regard to the odd amount of the increase, the Company asked that the amount of the $3.07 surcharge be changed to $3.10 for easier record keeping. COMMISSION DECISION 1. Does the Commission wish to approve Capitol Water's Application requesting: a declaration that its proposed capital expenditures are prudent, authorization to allow the Company to incur debt to fund the improvements, and institution of a temporary seven-year surcharge to recover the cost from customers? 2. Does the Commission wish to adopt Staff's recommendations requiring the Company to: Submit construction status reports together with the Company's proposed quarterly financing status reports. Submit the proposed network analysis and any further improvement recommendations prior to proceeding beyond the improvements directly associated with the proposed new Well No. 5 installation. Establish a balancing account on its books to track all financial activity associated with its surcharge. Correct its financial records as discussed above to remove from its plant accounts any investments associated with the Company's prior surcharge in Case No. CAP-W-96-1. Implement a residential flat rate surcharge in the amount of $3.07 and a metered commercial surcharge of 23.60%. 3. For ease of record keeping, does the Commission wish to approve the Company's proposed $3.10 residential flat rate surcharge instead of the $3.07 surcharge recommended by Staff? _________________________________ Lisa Nordstrom M:CAPW0201_ln2 (See Jean for attachments)