BILL ANALYSIS Ó SB 936 Page A Date of Hearing: June 23, 2014 ASSEMBLY COMMITTEE ON UTILITIES AND COMMERCE Steven Bradford, Chair SB 936 (Monning) - As Amended: June 11, 2014 SENATE VOTE : 32-0 SUBJECT : Monterey Peninsula Water Management District: financing orders and water rate relief bonds. SUMMARY : This bill would authorize the California Public Utilities Commission (PUC) to allow the Monterey Peninsula Water Management District (MPWMD) and other financing entities to issue water rate relief bonds to finance water supply infrastructure. Specifically, this bill : 1)Makes legislative findings concerning the obstacles faced by California American Water (Cal-Am) in obtaining adequate water supply from the Carmel River and groundwater sources. 2)Authorizes the PUC to issue financing orders, upon application of a qualifying water utility, to facilitate the recovery, financing, or refinancing of water supply costs, as specified. 3)Allows the qualifying water utility, beginning January 1, 2015, to apply to the PUC for a determination that no more than 50 percent of the water supply costs may be recovered through water supply charges. 4)Requires the PUC to authorize imposition and collection of the water supply charge if it determines the bond financing "would reduce the rates on a present value basis that customers within the qualifying water utility's service territory would pay as compared to the use of traditional utility financing mechanisms." 5)Requires the PUC to establish in a financing order an effective mechanism that ensures recovery of water supply costs and financing costs through nonbypassable water supply charges. 6)Requires customers to pay water supply charges until the water rate relief bonds and all financing costs are paid. SB 936 Page B 7)Requires the PUC to approve periodic true-up adjustments to the water supply charge. 8)Requires an annual customer notice to customers explaining the water supply charges and true-up adjustments to that charge. 9)Increases the length of time from 20 days to 210 days in which the PUC must issue a decision and order or rehearing regarding the implementation of certain provisions of law related to the Department of Water Resources. EXISTING LAW a)Establishes that access to an adequate supply of healthful water is a basic necessity of human life, and shall be made available to all residents of California at an affordable cost. (Public Utilities Code § 739.8) b)Authorizes the PUC to regulate water corporations and establish just and reasonable rates for recovering the costs of providing water service, including costs of water supply infrastructure. (Public Utilities Code § 2701 and 789) c)Establishes provisions related to the Monterey Peninsula Water Management District. (Public Contract Code § 21620) FISCAL EFFECT : Unknown. COMMENTS : 1)Author's statement: According to the author, "Working as a public-private partnership with Cal-Am, the Monterey Peninsula Water Management District is offering its access to the public financial markets in order to possibly reduce ratepayer impacts of a large capital outlay project. This project will address the Monterey Peninsula's mandatory water reductions they are facing by working with Cal-Am on a desalination plan, plus conveyance and storage facilities that are estimated to cost $277 to $320 million. By enabling an alternative financing mechanism, known as 'Water Rate Relief Bonds' to be issued, this could result in lower costs to Cal-Am customers when compared to traditional SB 936 Page C utility financing mechanisms." 2)The Monterey Peninsula Water Management District (MPWMD). MPWMD was created by a special act in 1977 (AB 1329, Mello, 1977) and formed with local voter approval in 1978. The District is comprised of six cities (Carmel-by-the-Sea, Del Rey Oaks, Monterey, Pacific Grove, Sand City, Seaside) plus unincorporated territory. The District is governed by a seven-member Board of Directors, with five directors elected from voter divisions, one a member of the Monterey County Board of Supervisors, and the final an elected official or chief executive officer. MPWMD is responsible for (1) augmenting water supply through integrated management of ground and surface water resources; (2) promoting water conservation, water reuse, and storm and wastewater reclamation; and (3) fostering scenic values, environmental quality, native vegetation, fish and wildlife, and recreation.<1> The Monterey Peninsula's retail water service is provided by the California-American Water Company (Cal-Am), an investor owned water utility regulated by the PUC. 3)Need for alternative water supply. The Monterey Peninsula has relied upon the Carmel River as its main source of water for over a century, and Cal-Am has traditionally supplied customers with water from wells located near the river in the Carmel Valley Aquifer.<2> Until recently, the water was considered groundwater, which is not under the jurisdiction of the State Water Resources Control Board (SWRCB). In 1995 SWRCB ruled that Cal-Am's wells were diverting from the underflow of the Carmel River, thus making diversion subject to SWRCB jurisdiction. Order 95-10 held that Cal-Am did not have valid permits for about 70 percent of the community's water supply. Supply restrictions increased in 2006, when cutbacks were ordered in the Seaside Groundwater Basin, the Peninsula's only other water source. A 2009 cease and desist order issued by SWRCB imposed a December 2016 deadline on Cal-Am to reduce its pumping from the Carmel River -------------------------- <1> http://www.mpwmd.dst.ca.us/ <2> http://www.amwater.com/caaw/customer-service/rates-information/mo nterey-coastal-water-project.html SB 936 Page D by 70%. Cal-Am customers have decreased their water usage by more than 20% through water conservation, but these efforts are not enough to meet the order for reduced pumping. To replace the water supply reductions ordered by SWRCB, Cal-Am applied to the PUC on April 23, 2012 with a proposal for the Monterey Peninsula Water Supply Project (MPWSP).<3> The three pronged approach consists of: (1) a desalination plant and infrastructure, (2) groundwater replenishment, and (3) aquifer storage and recovery. Cal-Am has has requested a $1 million grant from the state Department of Water Resources to part-fund a slant test well required for its proposed desalination project.<4> A July 31, 2013 settlement agreement among parties to a PUC proceeding provides for the development, construction, operation and financing of the MPWSP, as well as the recovery of costs in rates.<5> The agreement specifies that a tax-exempt securitization mechanism will be used to finance 27% of the proposed project. Securitization will require several steps, including: Cal-Am's establishment of a Special Purpose Entity (SPE); Sale to the SPE of the right to collect a non-bypassable charge from MPWMD customers; Authorization by the California Legislature (i.e., through this bill); and A financing order by the PUC. 1)Rate relief bonds (RRB, and a.k.a. rate reduction bonds). The deregulation of electricity markets in the 1990s resulted in decreased revenue for utilities, and many utility company assets became uneconomic to operate. These uneconomic assets are referred to as "stranded assets." RRBs were developed to --------------------------- <3> http://www.cpuc.ca.gov/Environment/info/esa/mpwsp/pdf/CAW_Applica tion_PDFA_.pdf <4> http://www.desalination.com/wdr/50/6/grant-sought-swro-intake-tes t <5> http://www.dra.ca.gov/WorkArea/linkit.aspx?LinkIdentifier=id&Item ID=2466&libID=2488 SB 936 Page E enable utilities to bridge the gap between the book value of stranded assets in the previously regulated environment and their market value in a deregulated one.<6> Essentially a RRB is the securitization of a cashflow stream generated by a fee charged to utility consumers. These asset-backed securities minimize borrowing costs by qualifying for AAA credit ratings, as AAA ratings allow a utility to borrow funds at an interest rate well below the rate typically applicable to the utility's long-term debt. The use of RRBs allows for an extended recovery period of those stranded assets at a AAA funding rate. To qualify for AAA ratings, RRB financing typically includes: Statutory authority to impose a dedicated charge on utility customers to repay the bonds; A requirement that the bonds must be issued, and the dedicated charge must be imposed, by a "bankruptcy remote special purpose entity (SPE)"; A "true-up" mechanism by which charges collected to pay debt service are regularly adjusted to ensure bonds are paid off at the final maturity date; and A pledge made by the state not to impair the right to collect charges until bonds are paid in full. Public officials from the Monterey region want the Legislature to authorize the District and Cal-Am to use RRBs to finance some of the costs of a new desalination plant and other elements of the proposed water supply project. 1)Shifting risk to ratepayers and cost controls. This bill uses a bankruptcy-remote special purpose entity (SPE) to issue RRBs and insulate bondholders from potential insolvency of Cal-Am. This allows for higher bond ratings and lower costs of debt issuance. However, by protecting rate reduction bondholders from becoming creditors if Cal-Am files for bankruptcy protection, the bill may increase the risks borne by vendors, employees, investors holding other forms of debt, and other potential creditors in a bankruptcy proceeding. It is unlikely that this bill's bankruptcy-remoteness provisions will be necessary to shield bondholders from a bankruptcy case. However, in the event that Cal-Am does become insolvent, it is unclear whether state law should shield some potential creditors, leaving a smaller pool of remaining creditors to --------------------------- <6> http://pages.stern.nyu.edu/~igiddy/cases/rrb.pdf SB 936 Page F bear the costs of restructuring. By requiring ratepayers to share costs of a desalination plant and other water supply facilities through a non-bypassable charge, this bill increases ratepayers' exposure to risks associated with the water supply infrastructure (e.g., construction and operation). The bill requires ratepayers to pay the water supply charge that secures the RRBs even if the financed infrastructure fails to function properly or is unusable because of design flaws, construction failures, or operational problems. It is unclear whether the potential - but not guaranteed - lower rates that securitization may generate justify shifting a greater share of project risks to ratepayers. Related to cost overruns, following an informational hearing this committee held in February 2014 on the affordability of water rates,<7> additional information was obtained regarding costs borne by ratepayers when the cost of a PUC-approved water treatment facility almost doubled. In 2006 the California Water Service Company, a PUC-regulated water utility, requested authority to borrow funds from the Safe Drinking Water State Revolving Fund (SDWSRF) for a new water treatment facility to serve the community of Lucerne, California. The requested loan amount was $4.5 million. On December 2, 2006, Cal Water amended A.06-02-003 to increase the loan amount to $5,676,277. On November 20, 2007, Cal Water filed A.07-11-020 increasing the requested loan amount to $7,442,700. The PUC approved the change in the loan amount without reviewing the reasonableness of the costs (a reasonableness review supposedly was conducted by the Department of Public Health, the agency administering SDWSRF). Although the sponsors believe this is unlikely, water ratepayers in Monterey could be exposed to similar cost overruns. To limit ratepayer risk and contain costs, the author may wish to consider an amendment specifying that financed infrastructure is limited to the desalination plant and necessary equipment solely for that facility, amending 849(l) of the proposed bill, as follows: "Water supply activity" means an activity or activities by or on behalf of a qualifying water ---------------------- <7> http://autl.assembly.ca.gov/2014hearings SB 936 Page G utility in connection with the acquisition and construction of infrastructure,plants, including, desalination facilities, pipelines, and other facilities, to develop new sources of supply,directly related to a desalination facility and necessary equipment solely for that facility, including the pipes necessary for conveyance and tanks necessary for water storage, as authorized by the commission in proceeding A.12-04-019. To further contain costs, the author also may wish to consider an amendment specifying that the amount authorized in the PUC financing order cannot increase by more than 5%, amending a to-be-determined section of the Public Utilities Code, as follows: The commission shall not approve in its financing order any increase of more than 5% for the special purpose entity created to finance the Monterey Peninsula Water Supply Project. 2)Ratepayer impacts. According to Cal-Am, the average ratepayer will be subject to a rate increase of 41% over a period of five years, with estimated bills increasing from $75.74 at the end of 2013 to $106.73 at the end of 2018 (94 cents/day).<8> The charge will be assessed volumetrically based on water usage, rather than a fixed charge. This bill does not currently provide qualifying low-income ratepayers (i.e., those who meet federal poverty guidelines) with an exemption from the non-bypassable water supply charges. Cal-Am reports about 9% of ratepayers (3,500 out of 38,000) in this district are in the low-income water rate assistance program (LIRA). A 41% rate increase on a low income ratepayer is likely to be extremely burdensome. To assist low-income ratepayers, the author may wish to consider an amendment specifying that ratepayers participating in commission-approved low-income water rate assistance program are exempt from nonbypassable MPWSP charges, as specified , amending a to-be-determined section of the Public -------------------------- <8> http://coastalwater.publishpath.com/Websites/coastalwater/files/C ontent/3984326/CA-Mtry_RateDesign-RateImpactFactSheet_FINAL2-rev. pdf SB 936 Page H Utilities Code, as follows: If the commission finds that the surcharge exclusion has no impact on the marketability of the financing, the commission shall order California American Water Company to exclude low income customers from payment of the surcharge. If the low income customers are excluded from payment of the surcharge and if computer programming upgrades are necessary to accommodate this exclusion, the Commission shall allow California American Water Company to recover just and reasonable costs from the Monterey ratepayers. 3)Related legislation. AB 850 (Nazarian), Chapter 636, Statutes of 2013, authorized joint powers authorities to issue rate reduction bonds to finance publicly owned water utility projects until December 31, 2020. The bonds will be secured by utility project property and repaid through a separate utility project charge imposed on customer bills. 4)Voters reject transfer of Cal-Am assets to the District. In the June 3, 2014 primary election, voters within the MPWMD rejected Measure O (55% to 45%), which would have directed MPWMD to "adopt a policy to move toward public ownership of all water systems within its boundaries [i.e., Cal-Am] by conducting a feasibility study, and if deemed feasible, move forward with acquisition of all such water systems' assets." 5)Support and opposition. Supporters state the need for an alternative water supply to the Monterey Peninsula, and contend that use of water rate relief bonds will result in lower costs to customers of Cal-Am as compared to traditional utility financing mechanisms. In opposition, WaterPlus questions why MPWMD would take on an obligation of $124.5 million to save $93 million, when for $276 million, it could own the project and save ratepayers $995 million. REGISTERED SUPPORT / OPPOSITION : Support CalDesal California Water Association (CWA) SB 936 Page I City Council of Monterey City Council of Sand City City Council of the City of Carmel by the Sea City Council of the City of Pacific Grove City Council of the City of Seaside Coalition of Peninsula Businesses Monterey County Board of Supervisors Monterey Peninsula Chamber of Commerce Board of Directors Monterey Peninsula Regional Water Authority Monterey Peninsula Water Management District Office of Ratepayer Advocates (ORA) Planning and Conservation League Opposition WaterPlus Analysis Prepared by : Brandon Gaytan / U. & C. / (916) 319-2083