EXHIBIT L

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BEFORE THE PUBLIC UTILITIES COMMISSION OF THE

STATE OF CALIFORNIA 

Application of Southern California Edison 

Company (U338E) for Authority to Establish Its 

Authorized Cost of Capital for Utility Operations 

for 2020 and to Partially Reset the Annual Cost of 

Capital Adjustment Mechanism 

)

) 

) 

) 

) 

) 

Application 19-04-014 

And Related Matters. 

) 

) 

) 

Application 19-04-015 

Application 19-04-017 

Application 19-04-018 

OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

CLAIRE E. TORCHIA 

Attorney for 

SOUTHERN CALIFORNIA EDISON COMPANY 

2244 Walnut Grove Avenue 

Post Office Box 800 

Rosemead, California 91770 

Telephone: (626) 302-6945 

Facsimile: (626) 302-1935 

E-mail:Claire.Torchia@sce.com 

Dated: September 30, 2019 

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OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

TABLE OF CONTENTS 

Section Page 

-iI. INTRODUCTION AND SUMMARY OF RECOMMENDATIONS .........................................1

A. SCE Recommends an Overall Rate of Return of 8.28 Percent and a Return 

on Common Equity of 11.45 Percent .......................................................................1

B. Key Considerations for the Commission in Setting a Fair and Reasonable 

ROE for SCE............................................................................................................3

C. Summary of SCE’s Recommendations ....................................................................4

II. LEGAL STANDARDS AND POLICY CONSIDERATIONS ..................................................7

A. Supreme Court and Commission Precedent Require a ROE that Accounts 

for the Increased Risks SCE Faces ..........................................................................7

1. Hope and Bluefield Require that a ROE Be Set Commensurate 

with Risks.....................................................................................................7

2. Financial Models are a Starting Point, But Informed Judgment 

Also is Needed in Setting the Appropriate ROE .........................................8

3. Wildfire Risk Must be Taken Into Account .................................................9

4. Credit Rating Agency Views are Important for Assessing Equity 

Risk ............................................................................................................10

5. A Fair and Reasonable ROE is Necessary to Enable SCE to Meet 

the State’s Policy Goals .............................................................................10

B. A Higher ROE is Needed to Compensate for a Higher Debt Ratio .......................11

III. SCE’S RETURN ON EQUITY ...............................................................................................12

A. SCE’s Financial Models Support SCE’s ROE Request and Should be Used 

as a Starting Point ..................................................................................................12

1. SCE’s Proxy Group is Reasonable and Consistent with 

Commission Precedent ...............................................................................12

2. SCE’s Financial Models All Produce Consistent Results..........................12

3. SCE and Intervenors Place SCE at the Top of the Financial Model

Ranges ........................................................................................................14

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OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

TABLE OF CONTENTS (CONTINUED) 

Section Page 

-iiB. The Intervenors’ Financial Models are Based on Incorrect Assumptions 

and Inputs and the Commission Should Reject Their Recommendations .............15

1. Intervenors’ ROE Recommendations are Below the National ROE 

Average and Reflect a Clear Downward Bias ...........................................15

2. Intervenors Fail to Account for Financial Leverage in 

Recommending a ROE ..............................................................................16

3. Intervenors’ CAPM and ECAPM Estimates are Flawed ...........................17

a) SCE’s Forecasted Risk-Free Rate Remains Reasonable ...............17

b) SCE’s Beta Must be Adjusted for Financial Leverage ..................19

c) Intervenors’ Market Risk Premiums Are Flawed ..........................20

d) Empirical Data Supports SCE’s ECAPM Adjustment ..................22

4. The Intervenors’ DCF Models and Assumptions are Flawed ....................23

a) SCE’s Use of Financial Analysts’ Forecasts is the Most 

Reliable Method for Estimating Dividend Growth Rates ..............23

b) SCE Uses the Most Reasonable Time Period for 

Determining the Current Stock Price .............................................25

c) SCE’s Time Period for Forecasting the Dividend Price is 

Superior Because it Avoids the Need for Approximation 

and is Transparent ..........................................................................26

5. SCE’s Risk Premium Model is Statistically Sound and Supports 

the DCF and CAPM Results ......................................................................26

6. Market-to-Book Ratios are Irrelevant ........................................................28

C. Additional Risks Warrant Placing SCE at the High End of the Financial 

ROE Model Range .................................................................................................29

1. SCE’s Business Risk Has Increased Since the Last Cost of Capital 

Proceeding Due to an Increased RPS and Industry Transformation ..........30

a) The Scale of California’s Recent RPS Changes Creates 

Unique Risks for California Utilities .............................................31

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OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

TABLE OF CONTENTS (CONTINUED) 

Section Page 

-iiib) Recent Mass Adoption of Customer-Choice Programs in 

SCE’s Territory Have Revealed New Implementation Risks ........33

c) Risks Related to SCE’s Ambitious Electrification Efforts, 

Although Necessary, Require Compensation ................................35

d) SCE’s Large Distribution Capital Investment Program is 

Unique in Scale and Regulatory Lag Creates Disallowance 

Exposure ........................................................................................35

2. Mitigating Factors Have Been Taken Into Account ..................................36

3. SCE’s Credit Metrics Show that SCE’s Business, Financial, and 

Regulatory Risk All Have Increased Since the Last Cost of Capital 

Case ............................................................................................................37

4. SCE’s Current Authorized ROE of 10.30 Percent is No Longer 

Sufficient ....................................................................................................38

D. Asymmetric Wildfire Risk Requires Adjusting Upward the Base ROE

Range by 85 Basis Points .......................................................................................39

1. Wildfire Risk is Unique to California ........................................................39

2. Credit Rating Agencies Perceive California Utilities to be a Riskier 

Investment Due to Wildfires ......................................................................41

3. AB 1054 Mitigates SCE’s Wildfire Risk, But Does Not Eliminate 

It .................................................................................................................43

4. Joint Intervenors’ and FEA’s Quantification of Wildfire Risk is

Close to SCE’s ...........................................................................................46

5. The Denial-of-the-Obvious Stance Assumed by EDF and Cal 

Advocates Should be Ignored ....................................................................47

IV. CAPITAL STRUCTURE ........................................................................................................48

A. Record Evidence Shows SCE’s Current Preferred Equity Level Should Be 

Reduced..................................................................................................................49

B. SCE’s Debt Leverage Must be Reduced ................................................................50

C. SCE’s Recommended Capital Structure is the Only Proposal that Will 

Reduce SCE’s Leverage ........................................................................................51

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OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

TABLE OF CONTENTS (CONTINUED) 

Section Page 

-ivD. EIX’s Capital Structure is Irrelevant ......................................................................52

V. EMBEDDED COST OF DEBT AND PREFERRED EQUITY ..............................................53

VI. COST OF CAPITAL ADJUSTMENT MECHANISM ..........................................................53

VII. REQUEST FOR ORAL ARGUMENT ..................................................................................54

VIII. CONCLUSION .....................................................................................................................54

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OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

LIST OF FIGURES 

Figure Page 

-vFigure I-1 2020 Recommended Cost of Capital for SCE ........................................................................... 2

Figure III-2 Comparison of Parties’ Model Results ................................................................................. 14

Figure IV-3 SCE and Intervenor Capital Structure Proposals .................................................................. 49

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Case Law

Bluefield Water Works & Improvement Co. v. Public Service Comm’n of the State of Virginia, 

262 U.S. 679 (1923) ................................................................................................................................ 4, 7 

Federal Power Comm’n v. Hope Natural Gas Co., 

320 U.S. 591 (1944) ........................................................................................................................ 4, 7, 8, 9 

Leslie G. v. Perry & Associates, 

43 Cal. App. 4th 472, 483 (1996) ............................................................................................................... 40 

Missouri Public Service Com'n v. F.E.R.C., 

215 F.3d 1 (2000) ...................................................................................................................................... 53 

Federal Energy Regulatory Commission (FERC) Decisions

80 FERC ¶ 61158 .......................................................................................................................................... 53 

143 FERC ¶ 61257, 62879 ............................................................................................................................ 53 

146 FERC ¶ 63 .............................................................................................................................................. 40 

154 FERC ¶ 61004 ........................................................................................................................................ 53 

CPUC Decisions

D.88-01-063 .................................................................................................................................................. 53 

D.04-03-039 .................................................................................................................................................. 29 

D.05-12-043 .......................................................................................................................................... 8, 9, 45 

D.06-12-029 .................................................................................................................................................. 53 

D.07-12-049 ........................................................................................................................................... passim 

D.08-05-035 .................................................................................................................................................. 53 

D.12-12-034 ........................................................................................................................................... passim 

D.13-03-015 .................................................................................................................................................. 53 

D.17-07-005 .............................................................................................................................................. 3, 10 

D.17-11-033 .................................................................................................................................................. 40 

D.18-07-025 .................................................................................................................................................. 40 

CPUC Rules of Practice and Procedure

Rule 13.11 ....................................................................................................................................................... 1 

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BEFORE THE PUBLIC UTILITIES COMMISSION OF THE 

STATE OF CALIFORNIA 

Application of Southern California Edison 

Company (U338E) for Authority to Establish Its 

Authorized Cost of Capital for Utility Operations 

for 2020 and to Partially Reset the Annual Cost of 

Capital Adjustment Mechanism 

)

) 

) 

) 

) 

) 

Application 19-04-014 

And Related Matters. 

) 

) 

) 

Application 19-04-015 

Application 19-04-017 

Application 19-04-018 

OPENING BRIEF OF SOUTHERN CALIFORNIA EDISON COMPANY (U 338-E) 

Pursuant to Rule 13.11 of the Rules of Practice and Procedure of the California Public 

Utilities Commission (“CPUC” or “Commission”) and the Assigned Commissioner’s Scoping 

Memo and Ruling, issued June 2, 2019, Southern California Edison Company (“SCE”) submits 

its Opening Brief in support of its request to set a 2020 cost of capital as set forth in Application 

(A.) 19-04-014 and as modified by its Supplemental Testimony.1 

I. 

INTRODUCTION AND SUMMARY OF RECOMMENDATIONS 

A. SCE Recommends an Overall Rate of Return of 8.28 Percent and a Return on 

Common Equity of 11.45 Percent 

SCE’s most recent comprehensive cost of capital proceeding was in 2012. Since that 

proceeding, the risks SCE faces compared to its peer companies have increased substantially. 

 

1 Exhibit SCE-01-A. 

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Most significantly, SCE has seen dramatic risk increases related to severe wildfires in California 

and associated utility liability due to the legal doctrine of inverse condemnation, a risk unique to 

California. Although wildfire risk has dominated the recent discussion of California electric 

utility company risks, California’s energy industry transformation also creates significant risks for 

SCE’s investors. 

To compensate investors for these increased risks, SCE recommends an overall rate of 

return (“ROR”) of 8.28 percent for test year 2020. This ROR reflects a proposed return on 

common equity (“ROE”) of 11.45 percent, a proposed cost of long-term debt of 4.74%, and a 

proposed cost of preferred equity of 5.70 percent. The requested ROR assumes changes to SCE’s 

capital structure to reduce SCE’s levels of preferred equity from 9 percent to 5 percent, increasing 

SCE’s common equity from 48 to 52 percent and leaving SCE’s long-term debt at 43 percent. 

SCE’s recommended Cost of Capital by component, percentage, cost, weighted cost, and overall 

cost for 2020 is shown in Figure I-1. 

Figure I-1 

2020 Recommended Cost of Capital for SCE 

Component Percentage Cost Weighted Cost

Long-Term Debt 43.0% 4.74% 2.04% 

Preferred Equity 5.0% 5.70% 0.29% 

Common Equity 52.0% 11.45% 5.95% 

Total 100.0% 8.28% 

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B. Key Considerations for the Commission in Setting a Fair and Reasonable ROE for 

SCE 

 Since the last Cost of Capital proceeding in 2012, when the Commission authorized a 

ROE of 10.45 percent for SCE,2 the risks SCE faces compared to its peer companies 

have increased significantly. 

 SCE has experienced multiple credit rating downgrades and an increased cost of 

capital because of severe wildfires in California and the uncertainty of cost recovery. 

These credit ratings indicate that investors view SCE to be more risky than utilities 

outside of California and more risky than during the last Cost of Capital case. A ROE 

that fairly compensates investors for these risks is necessary to help SCE improve its 

credit ratings, attract capital at reasonable costs, and ensure that SCE has the ability to 

provide reliable electric service at just and reasonable rates.

 AB 1054 has mitigated but not eliminated the risks associated with wildfires. Residual 

risk for investors remains, particularly surrounding the implementation of AB 1054’s 

new reasonableness standard for cost recovery. Significantly, although SCE’s credit 

rating metrics have stabilized since the passage of AB 1054, SCE’s credit ratings have 

not been upgraded. 

 California’s ambitious clean energy and electric transformation goals also create 

increased risks for SCE, particularly operational and cost-shifting risks given the 

changes in the competitive environment and generation technology. Credit rating 

agencies have taken note of these risks, as has the Commission. SCE and its 

shareholders support California’s ambitious public policy initiatives. A fair and 

reasonable rate of return, however, is necessary for SCE to be able to attract capital for 

projects that will benefit the public. 

 SCE’s financial ROE models, its evaluation of the asymmetric risk that wildfires pose, 

and the qualitative factors concerning SCE’s risks firmly support an overall ROE of 

11.45 percent. Intervenors’ financial models, on the other hand, are flawed and 

 

2 See D.12-12-034, p. 3. In D.17-07-005, the Commission granted a joint petition for modification and 

modified SCE’s ROE to 10.30 percent. 

 

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produce unreliable results. Intervenors’ ROE recommendations are below the national 

average, which exposes their downward bias. The objective evidence demonstrates 

SCE is more, not less, risky than peer utilities nationwide. 

 SCE’s request to increase its common equity percentage from 48 percent to 52 percent 

is a critical part of SCE’s goal to improve its credit ratings and reduce its overall risk. 

SCE’s requested common equity level of 52 percent will bring it to the same level as 

the other California utilities and within the nationwide average. Authorizing this 

change will send a signal to equity and debt investors that the State supports SCE’s 

financial health and a financially sound electric utility supports the State’s policy 

objectives. 

C. Summary of SCE’s Recommendations 

The United States Supreme Court’s decisions in Hope and Bluefield3 establish that a 

public utility is entitled to earn a return on invested capital that maintains and ensures confidence 

in its financial soundness and integrity, attracts necessary capital, and fairly compensates 

investors for their risks. SCE has shown its recommended overall ROE of 11.45 percent and its 

requested capital structure changes are necessary to satisfy the Hope and Bluefield standards and 

enable SCE to improve its financial condition and credit rating metrics. As the Commission has 

long recognized, a strong investment grade credit rating benefits SCE and its customers because it 

allows the utility to attract capital at reasonable costs ensuring the ability to provide reliable 

electric service at just and reasonable rates.4

In support of its Application, SCE has submitted the results of three standard financial 

models that the Commission has accepted and used in prior Cost of Capital proceedings to 

establish a fair and reasonable ROE: the Capital Asset Pricing Model (“CAPM”); the Discounted 

Cash Flow model (“DCF”); and the Risk Premium Model (“RPM”). SCE’s assumptions, inputs, 

 

3 Federal Power Comm’n v. Hope Natural Gas Co., 320 U.S. 591 (1944) (“Hope”) and Bluefield Water 

Works & Improvement Co. v. Public Service Comm’n of the State of Virginia, 262 U.S. 679 (1923) 

(“Bluefield”). 

4 D.12-12-034, p. 29. 

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and adjustments to the models are based on unbiased third-party economic forecasts, accepted 

financial principles, and expert judgment. The results, which firmly support a base ROE of 10.60, 

provide the Commission with an accurate and credible starting point for setting a ROE 

commensurate with SCE’s risks. 

SCE’s recommended ROE also accounts for the fact that although standard financial 

models capture certain business, financial, and regulatory risks that investors consider when 

deciding whether to invest in SCE, SCE’s risks are higher than the average utility nationwide. 

SCE’s recommendation that the Commission authorize a ROE at the high end of the financial 

model range reflects that California utilities are subject to ongoing risks from transformative 

public policies requiring unprecedented infrastructure investment.5 

As the Commission has recognized repeatedly, however, the financial models are just a 

starting point in setting a fair and reasonable ROE. SCE also faces increased and asymmetric 

risks due to the frequency and increasing severity of California wildfires coupled with 

California’s unique application of inverse condemnation to privately-owned utilities regardless of 

fault. The financial models do not capture these unique California risks; therefore, the 

Commission must incorporate these risks when it authorizes SCE’s ROE. Even with the passage 

of AB 1054, credit rating agencies perceive California utilities to be a riskier investment than 

utilities outside of California for several reasons, including the continued existence of inverse 

condemnation and the uncertainty surrounding the implementation of AB 1054.6 

Four intervenors, the Commission’s Public Advocates Office (“Cal Advocates”), Energy 

Producers & Users Coalition/Indicated Shippers/The Utility Reform Network (together, “Joint 

Intervenors”), Environmental Defense Fund (“EDF”), and Federal Executive Agencies (“FEA”) 

 

5 Exhibit SCE-01 (Stern), pp. 9-16, 18-32; Exhibit SCE-04 (Stern Rebuttal), pp. 5-8; SCE, Stern, Tr. 

Vol. 1/127-131; SCE, Stern, Tr. Vol. 2/167-74. 

6 See Exhibits SCE-15, SCE-16, and SCE-17. 

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submitted testimony addressing SCE’s Application (collectively, “Intervenors”).7 Although 

several of the Intervenors recognize the increased risks wildfires present and the negative impact 

on SCE’s credit rating,8 in general, the Intervenors propose to set SCE’s ROE below the national 

allowed ROE average of 9.7 percent for integrated electric utilities in 2018-20199 and to lower 

SCE’s ROE further based on perceived benefits of the electric transformation. Even if the unique 

risk that wildfires present were set aside, there is no reason SCE’s authorized ROE should be 

below the national average. Substantial evidence in the record shows investors view investing in 

California utilities to be riskier than investing in utilities outside of California. Intervenors’ 

recommendations are unreasonable and fall short of meeting the standards established in Hope

and Bluefield. 

SCE’s proposed changes to its capital structure also are a critical and inseparable part of 

its goal to improve its financial condition. SCE seeks to reduce its preferred equity percentage 

from 9 percent to 5 percent and increase its common equity percentage from 48 percent to 52 

percent. SCE’s proposed changes would reduce SCE’s ratio of debt to equity (making it less 

levered), thereby reducing its overall financial risk. No intervenor objects to SCE’s request to 

reduce its preferred equity. However, Intervenors’ alternative proposals to reduce preferred 

equity would increase SCE’s debt level and would not improve its leverage. 

 SCE’s recommended overall ROE of 11.45 percent and capital structure adjustments 

align fully with the Hope and Bluefield standards. They will improve SCE’s financial health and 

also send the investment community the message that investors will be compensated fairly for 

 

7 Several other parties submitted testimony regarding the cost of capital of other investor-owned utilities 

(“IOUs”) in this consolidated proceeding. Such testimony does not include a recommendation 

regarding SCE’s cost of capital, so we do not address it directly. 

8 See, e.g., Exhibit FEA-01 (O’Donnell), p. 41 (noting that AB 1054 did not address inverse 

condemnation and adding that this “legal issue does make an investment in a IOU more risky, as a 

whole, than an investment in a utility that operates in a state without such liability risk”); Exhibit 

EPUC-IS-TURN-01 (Gorman), p. V-10 (observing that the credit ratings of California utilities have 

been decreased “one to three notches between 2017 and 2019”). 

9 Exhibit SCE-05 (Villadsen), p. 6 (citing Regulatory Research Associates, RRA Regulatory Focus 

Major Rate Cases – January -June 2019, July 22, 2019 and underlying data); see also Exhibit EPUC 

IS-03-C. 

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their risks, including risks that are needed to achieve the state’s important policy objectives 

enable SCE to continue to provide quality electric service to its customers. 

II. 

LEGAL STANDARDS AND POLICY CONSIDERATIONS 

A. Supreme Court and Commission Precedent Require a ROE that Accounts for the 

Increased Risks SCE Faces 

1. Hope and Bluefield Require that a ROE Be Set Commensurate with Risks 

SCE’s opening testimony discusses the well-established legal principles that govern the 

Commission’s determination of SCE’s 2020 authorized capital structure and rate of return on 

invested capital. The Supreme Court and the Commission have long recognized that for a rate of 

return to meet constitutional standards: 

 The return must be comparable to returns on investments of similar risk; 

 The return should support the utility’s credit rating; 

 The return should allow the utility to attract the capital necessary to provide proper 

service to customers; and 

 The return must be sufficient to ensure confidence in the financial soundness of the 

utility.10

No party has disputed the applicability of these four principles to the Commission’s 

determination of a rate of return that will maintain SCE’s financial integrity, attract capital, and 

compensate investors fairly for their risks. Indeed, the parties recognize that for a Cost of Capital 

decision to be lawful, it must meet the mandates set forth in the “seminal” Supreme Court cases 

that established these principles.11

 

10 Hope, 320 U.S. 591, 603 (1944) and Bluefield, 262 U.S. 679, 690-93 (1923); D.12-12-034, pp. 17-18; 

D.07-12-049, pp. 9-10. 

11 Exhibit FEA-01 (O’Donnell), pp. 8-9; Exhibit EPUC-IS-TURN-01 (Gorman), p. III-1; Exhibit Cal 

Advocates-01 (Rothschild), p. 56 n.27. 

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2. Financial Models are a Starting Point, But Informed Judgment Also is 

Needed in Setting the Appropriate ROE 

The Commission has recognized that to set “the ROE at a level of return commensurate 

with market returns on investments having corresponding risks, and adequate to enable a utility to 

attract investors to finance the replacement and expansion of a utility’s facilities to fulfill its 

public utility service obligation,” the evaluation of analytical financial models is a “starting 

point.”12 The Commission has explained that in “the final analysis, it is the application of 

informed judgment, not the precision of financial models, which is the key to selecting a specific 

ROE estimate.”13 For this reason, after the Commission evaluates the results of the financial 

models, it considers “additional risk factors not specifically included in the financial models,” 

such as financial, business, and regulatory risks, and applies “informed judgment” to select a 

specific ROE estimate.14 The Commission also “must assess” whether the authorized ROE is 

“sufficient to maintain and support [the utility’s] credit ratings.”15 In fact, Hope holds that it is 

the reasonableness of the end result, not the formula used to arrive at that result, that is relevant.16

In past Cost of Capital decisions, the Commission has applied its informed judgment to 

account for additional risk factors in setting the ROE in two ways. In Decision 05-12-043 and 

Decision 07-12-049, the Commission calculated a ROE base range based on the financial models. 

It then increased the ROE base range, making an upward adjustment to include a “risk premium” 

representing business, financial, and regulatory risks not specifically captured by the models, to 

arrive at an overall ROE range.17 For example, in D.07-12-049, the Commission adjusted the 

base ROE upward to account for investors’ perceptions of California regulatory risks and Value 

 

12 D.12-12-034, p. 18. 

13 D.12-12-034, p. 28; D.07-12-049, p. 28. 

14 D.12-12-034, p. 28; D.07-12-049, p. 28. 

15 D.05-12-043, p. 26. 

16 Hope, 320 U.S. 591, 602 (1944). 

17 D.05-12-043, pp. 23-24, 32-33; D.07-12-049, pp. 30-35. 

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Line’s rating of California regulatory environment as below average.18 The Commission 

completed its analysis by determining a ROE within the overall ROE range.19

In Decision 12-12-034, where SCE and PG&E were seeking to reduce their ROE, the 

Commission noted that although the Sempra utilities were seeking an upward adjustment to their 

ROE base ranges to compensate for increased risks, SCE and PG&E reflected the effect of “any 

perceived increased financial, business and regulatory risk in their selection of specific ROEs 

within the range of their financial modeling results.”20 The Commission then considered these 

risk factors in deciding to place SCE at the upper end of its ROE range.21 

3. Wildfire Risk Must be Taken Into Account 

SCE’s Application and initial testimony submitted on April 22, 2019 referenced a Base 

ROE and a Wildfire Risk ROE. In the July 2, 2019 Scoping Memo and Ruling, Commission 

President Picker explained: “The Commission will not consider a separate wildfire adder in the 

scope of this proceeding. Risk of all kinds are addressed in this proceeding; thus a separate adder 

is not appropriate for one risk.” 22 SCE clarified with ALJ Stevens that although the Commission 

will not consider a separate, stand-alone ROE adder for wildfire risk, it will consider wildfire risk 

among many other risks when determining an authorized ROE. Consideration of wildfire risk is 

consistent with the Commission’s longstanding approach for considering risk factors in prior Cost 

of Capital cases.25 The Commission’s approach also is consistent with the Supreme Court’s focus 

on determining an overall rate of return.23 

 

18 D.07-12-049, p. 33. 

19 D.05-12-043, p. 25, 33; D.07-12-049, pp. 35-36. 

20 D.12-12-034, pp. 28-29. 

21 D.12-12-034, p. 39. 

22 A.19-04-014, Scoping Memo and Ruling of President Picker, p. 3 (July 2, 2019). 

23 See Hope, 320 U.S. at 602-03. 

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SCE has recommended an overall authorized ROE of 11.45 percent that reflects that 

increased financial, business, and regulatory risks SCE faces as a result of the state’s ambitious 

electric transformation and clean energy goals and unique and extreme wildfire risks. 

4. Credit Rating Agency Views are Important for Assessing Equity Risk 

At least one Intervenor has suggested that credit rating agencies do not represent the 

interest of investors, the implication being that their opinions should not be given any weight.24

Not all intervenors are aligned on this point. Mr. Gorman testified that “one of the most direct 

pieces of information available to the equity market are the credit analysts’ assessment or the 

credit standing of the utilities.” 25 He adds that the utility’s credit rating is “relevant in assessing 

the investment risk from an equity investor standpoint.”26 This Commission has relied upon 

credit rating agency reports and ratings in many Cost of Capital cases and also has inferred credit 

rating agency silence as reflecting an absence of investor risk.

27 In fact, the California utilities 

would not be able to answer the eight questions the Commission posed in the 2017 Cost of 

Capital Decision without relying on the credit rating agency metrics.28 Accordingly, credit rating 

agency information should continue to factor into the Commission’s assessment of risk. 

5. A Fair and Reasonable ROE is Necessary to Enable SCE to Meet the State’s 

Policy Goals 

To provide reliable, safe, and affordable electric service to its customers and meet 

California’s ambitious electric grid transformation and clean energy goals, SCE needs to 

prudently invest in its infrastructure. To do so, SCE must be able to attract private investors to 

fund its substantial infrastructure projects that benefit the public and SCE’s customers. 

 

24 EDF, McCann, Tr. Vol. 6/1028-29. 

25 Gorman, Tr. Vol. 3/458. 

26 Id.

27 D.12-12-034, p. 30-31. 

28 D.17-07-005, pp. 12-13. 

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The Commission long has recognized its adopted ROE must “provide utilities the ability 

to raise money necessary for the proper discharge of their public duty.”29 For SCE to be able to 

finance its investments in clean energy and transforming the electric grid, investors need to 

perceive SCE as an investment that will provide a return competitive with similar investment 

options. A fair and reasonable rate of return will encourage investors to provide capital for 

projects that will benefit the public. If investors view the rate of return as inadequate, it will be 

more difficult for SCE to raise the funds necessary for its infrastructure projects, jeopardizing the 

state’s environmental policy objectives. 

B. A Higher ROE is Needed to Compensate for a Higher Debt Ratio 

The Commission has recognized that financial risk is tied to a utility’s capital structure 

and as a “utility’s debt ratio increases, a higher return on equity may be needed to compensate for 

that increased risk.”30 SCE has recommended an overall ROE of 11.45 percent based on its 

proposed common equity ratio of 52 percent. If the Commission were to decline SCE’s 

recommended common equity increase to 52 percent, SCE’s overall ROE request would increase 

to 11.75 percent, consisting of a base ROE of 10.9 percent and an 85 basis point upward 

adjustment for wildfire risk.31 

As SCE demonstrates below, its recommended ROE of 11.45 percent and proposed capital 

structure of 52 percent common equity fulfill the legal requirements of Hope and Bluefield. 

SCE’s proposals will allow SCE to offer investors a return that will compensate them fairly for 

the risks of investing in SCE, while increasing confidence in the credit quality and financial 

soundness of the utility. No party has presented credible evidence that a different capital structure 

or ROE level will satisfy the four principles of Hope and Bluefield for a company with SCE’s 

specific risk profile. 

 

29 D.12-12-034, p. 29. 

30 D.12-12-034, p. 29. 

31 See Exhibit SCE-01 (Wood), p. 3 n.2 and Exhibit SCE-02 (Villadsen), pp. 5, 66. 

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III. 

SCE’S RETURN ON EQUITY 

A. SCE’s Financial Models Support SCE’s ROE Request and Should be Used as a 

Starting Point 

 SCE’s financial models are based on unbiased third-party economic forecasts, accepted 

financial principles, and expert judgment. They provide the Commission with a reliable and 

accurate starting point in setting a fair and reasonable ROE. 

1. SCE’s Proxy Group is Reasonable and Consistent with Commission 

Precedent 

To begin its base ROE analyses, SCE selected a proxy group that meets the Commission’s 

standards of having “basic characteristics similar to the utility that the companies are selected to 

proxy.”32 SCE used a proxy group that includes electric, as well as water and natural gas utilities, 

because gas and water utilities are highly regulated and provide insights into the cost of equity for 

state-regulated utilities.33 The Commission has accepted the use of such utility proxy groups in 

the past.34 Using the proxy group, SCE calculated a base ROE range for each financial model, 

which provides the basis for SCE’s recommended ROE. 

2. SCE’s Financial Models All Produce Consistent Results 

In support of its Application and its recommended ROE, SCE submitted for the 

Commission’s consideration, the properly calculated results of three standard financial models 

 

32 D.07-12-049, Conclusion of Law, No. 4, p. 53. SCE’s proxy group also is consistent with the selection 

criteria outlined elsewhere in D.07-12-049. 

33 Exhibit SCE-02 (Villadsen), p. 37, Exhibit SCE-05 (Villadsen Rebuttal), p. 21. 

34 D.12-12-034, pp. 19-20. Cal Advocates and FEA exclude gas and water utilities but do not provide a 

rationale for doing so. Joint Intervenors take no issue with inclusion of gas and water utilities in the 

proxy group and their models include them. 

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commonly used in ROE proceedings – namely the CAPM, DCF, and RPM.35 The results of 

SCE’s financial models all support SCE’s recommended base ROE of 10.6 percent. 

The CAPM calculates the ROE as the return on a risk-free asset and the company-specific 

business risk measure (beta), multiplied by an expected market risk premium (“Market Risk 

Premium”). SCE implements a Commission-accepted adjustment to the CAPM through the 

empirical CAPM (“ECAPM”).36 SCE’s CAPM-based models support a ROE range of 9.5 percent 

to 10.6 percent at 52 percent common equity.37 

The DCF model encompasses a wider range of approaches and results. Previously, one 

DCF approach – the multi-stage DCF – was the sole model the FERC used to estimate ROE. But 

the multi-stage DCF approach has been disfavored recently,38 as investor behavior has diverged 

from the model’s predictions. SCE’s ROE expert Dr. Villadsen calculates a ROE range using 

both single-stage and multi-stage DCF models for electric and water and gas proxy groups, but 

she relies more heavily on the single-stage approach in concluding that a ROE range of 9.5 

percent to 10.75 percent at 52 percent common equity is fair and reasonable.39 

The RPM estimates the cost of equity capital for utilities based on the historical 

relationship between allowed ROEs in utility rate cases and the risk-free interest rate at the time 

the ROEs were authorized.40 The RPM provides a useful benchmark for the cost of equity in any 

interest rate environment.41 SCE’s RPM supports a ROE range of 10.5 percent to 10.6 percent at 

52 percent common equity, and Dr. Villadsen shows that these results are statistically sound.42 

 

35 D.12-12-034, p. 22. SCE included ROE results from a sample of Capital-Intensive Network Industries 

to illustrate the range of ROEs that result for entities of higher risk than regulated utilities but does not 

include these results in its model range (Exhibit SCE-02 (Villadsen), pp. 10-11). 

36 Exhibit SCE-02 (Villadsen), pp. 45-46 and Appendix BV-B-11, Figure A-2; see also Exhibit SCE-05 

(Villadsen Rebuttal), p. 35. 

37 Exhibit SCE-02 (Villadsen), pp. 48-49, Figure 16; p. 57, Figure 20. 

38 Exhibit SCE-02 (Villadsen), p.15. 

39 Exhibit SCE-02 (Villadsen), pp. 53, 57, Figure 20. 

40 Exhibit SCE-02 (Villadsen), p. 53. 

41 Exhibit SCE-02 (Villadsen), pp. 55-56. 

42 Exhibit SCE-02 (Villadsen), pp. 55-56, Figure 19; p. 57, Figure 20. 

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When appropriate risk factors are considered, all of SCE’s financial model results support 

SCE’s recommended 10.6 percent base ROE. As Dr. Villadsen explains, California and SCEspecific business and regulatory risk factors support placement of SCE near the top of the base 

ROE range (at 10.6 percent). Dr. Villadsen’s financial models, however, do not reflect the unique 

risks related to California wildfires, which warrant separate analysis, as discussed in Section 

III.D. 

3. SCE and Intervenors Place SCE at the Top of the Financial Model Ranges 

Figure III-2 shows SCE’s financial model results and recommended ROE and also 

compares them to the model results and ROE recommendations of the Intervenors. 

Figure III-2 

Comparison of Parties’ Model Results 

         Recommendations 

Party 

Model Result 

ROE Ranges      Base ROE1

Wildfire  

Adjustment 2 Overall ROE 

SCE   9.50 ‐ 10.75%3 10.60%  0.85%  11.45% 

FEA  5.00 ‐ 10.50%4 9.00%  0.75%5  9.75% 

Joint Intervenors  7.00 ‐ 9.62%  9.00%  0.65%  9.65% 

Cal Advocates   6.77 ‐ 9.41%  8.65%  0.00%  8.65% 

EDF6  N/A  N/A  N/A  N/A 

           

SCE Currently Authorized     10.30%  0.00%  10.30% 

     

1  Base ROE refers to the portion of the recommended ROE that can be quantified using standard 

financial ROE models such as CAPM, DCF, , and RPM. 

2  Wildfire adjustment refers to the portion of the recommended ROE that has been quantified using 

alternative methodologies, e.g., Brattle’s insurance premium methodology. 

3  SCE’s model results and recommendations assume a 52 percent authorized level of common equity. 

4  FEA witness O'Donnell does not use the RPM.  He includes results from a comparable earnings 

analysis. 

5  FEA witness O'Donnell refers to his recommended 0.75% ROE premium as related to inverse 

condemnation. 

6  EDF did not use any financial models and does not make any specific ROE recommendation.  

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As discussed, SCE’s expert Dr. Villadsen recommends placing SCE at the high end of the 

model range because of unique California risks. Figure III-2 shows that Intervenors also place 

SCE at the high end of their model ranges. Intervenors’ model ranges, however, have a clear 

downward bias and other shortcomings, which SCE discusses below. 

B. The Intervenors’ Financial Models are Based on Incorrect Assumptions and Inputs 

and the Commission Should Reject Their Recommendations 

The Intervenors present their financial model results as supporting accurate estimates of a 

fair and reasonable ROE for SCE. However, as discussed below, the Intervenors’ models rely on 

inaccurate assumptions and inputs that cause a severe downward bias in their results. A 

comparison of Intervenors’ ROE recommendations to authorized ROEs for comparable utilities 

across the country clearly shows Intervenors’ downward bias. In addition, Intervenors fail to 

account for accepted principles of financial leverage, and they selectively use models that produce 

lower ROEs. 

1. Intervenors’ ROE Recommendations are Below the National ROE Average 

and Reflect a Clear Downward Bias 

A clear indication of Intervenors’ downward bias is the fact that their models result in a 

ROE for SCE that is below the national ROE average. In determining a fair and reasonable ROE, 

this Commission consistently has considered the average national ROE authorized by regulatory 

commissions throughout the country.43 Dr. Villadsen has pointed out that the average ROE 

authorized for electric utilities in 2018-2019 was 9.7 percent.44 The Intervenors’ experts likewise 

have acknowledged an average ROE of 9.6 to 9.7 percent in 2018-2019.45 In fact, only one of 45 

integrated electric utilities nationwide had an authorized ROE at or below 9.0 percent.46 Yet each 

 

43 D.12-12-034, p. 39. 

44 Exhibit SCE-05 (Villadsen Rebuttal), p. 6. 

45 Exhibit EPUC-IS-TURN-01 (Gorman), p. II-3; FEA, O’Donnell, Tr. Vol. 3/361. 

46 Exhibit SCE-05 (Villadsen Rebuttal), p. 4, n.3. 

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Intervenor recommends a base ROE for SCE at or below 9.0 percent, which would suggest 

California is less risky than other states.47 Even if the unique California risk factors that warrant a 

higher ROE for California utilities were set aside, there is no reason SCE’s authorized ROE 

should be below the national average. In light of this, Intervenors’ below average ROE 

recommendations must be seriously questioned. 

In fact, recent credit rating downgrades and credit rating agency reports provide 

substantial evidence that investors view investment in California utilities to be much riskier than 

investment in other utilities and strongly support a ROE well-above the national average. 

2. Intervenors Fail to Account for Financial Leverage in Recommending a ROE 

As discussed in Section II.B above, if the Commission were to decline to adopt SCE’s 

request to increase its common equity percentage to 52 percent, a higher ROE of 10.9 percent 

would be necessary to satisfy the Hope and Bluefield principles.48 This increase in ROE is 

necessary to account for the basic financial concept that financial leverage affects ROE. 

EDF agrees with this basic financial principle. In fact, EDF’s witness Dr. McCann 

criticized the utilities that are seeking to increase their equity layer (including SCE) for failing to 

take financial leverage into account in their ROE recommendations. However, at hearings, he 

acknowledged that SCE had taken financial leverage into account in determining its ROE.49 

Mr. Gorman, the Joint Intervenors’ ROE witness, takes the unreasonable position that 

ROE should be calculated without regard to the level of debt in the capital structure,50 a position 

contrary to the Commission’s own practice, as well as well-accepted financial principles. 

Similarly, Cal Advocates witness Mr. Rothschild and FEA’s witness Mr. O’Donnell recommend 

 

47 Id.

48 Exhibit SCE-02 (Villadsen), pp. 4-5, 11-13, and Appendix B. 

49 McCann, Tr. Vol. 6/1013-14. 

50 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-41. 

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alternatives that would increase SCE’s current debt levels and leverage, without making 

corresponding adjustments to SCE’s ROE. 

3. Intervenors’ CAPM and ECAPM Estimates are Flawed 

To calculate the CAPM and ECAPM adjustment, assumptions must be made about the 

risk-free rate, the company-specific risk measure (beta), and the expected market risk premium.51

Intervenors’ CAPM and ECAPM results are inaccurate and unreliable for the following key 

reasons discussed in more detail below: 

 Intervenors rely on historical values for the risk-free rate, which is inappropriate 

when establishing a ROE for 2020-2022, and they fail to take into account 

downward pressure on interest rates since the 2008 financial crisis, which 

suppresses their risk-free rate. 

 Intervenors fail to apply the CPUC-accepted financial leverage adjustment that 

ensures an accurate comparison between SCE and the proxy companies. 

 Intervenors base their Market Risk Premium calculations on total market returns 

rather than income returns and use geometric means for a forecast, which is 

incorrect. 

 Intervenors fail to apply the CPUC-accepted ECAPM. 

a) SCE’s Forecasted Risk-Free Rate Remains Reasonable 

A key element driving the difference in results of SCE’s CAPM and Intervenors’ CAPM 

is the risk-free rate. Because this proceeding is establishing a ROE for 2020-2022, Dr. Villadsen 

relies on a forecast of 20-year Treasury bond yields for 2020, adjusted for any unusual downward 

 

51 Exhibit SCE-02 (Villadsen), p. 39. 

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pressure.52 Third-party economic indicators predict a sustained increase in the risk-free rate going 

forward.53 

FEA’s witness Mr. O’Donnell and Cal Advocates’ witness Mr. Rothschild, in contrast, 

rely on historical values for the risk-free rate.54 The use of a historical value, rather than a 

forecast, for the risk-free rate produces an inaccurate and unreliable result given that the 

proceeding is establishing a ROE for 2020-2022, not 2019 or earlier. Although Mr. Gorman, the 

Joint Intervenors’ witness, uses a forecast, he fails to take into account downward pressure on 

interest rates since the 2008 financial crisis.55 This failure underestimates the CAPM ROE by 20 

basis points.56

Although the IOUs’ ROE requests do not reflect post-filing reductions in interest rates, 

including the risk-free rate, at hearings, it emerged that recent reductions in the interest rates 

would have a marginal impact on the ROE requests, if any. For example, the risk-free rate does 

not impact the DCF model and has only a minimal impact on the RPM. PG&E witness Dr. 

Vilbert and SDG&E witness Dr. Morin also explained that, with respect to the CAPM-based 

models, a drop in the risk-free rate will cause the Market Risk Premium used in the CAPM to 

increase, not decrease.57 Moreover, the reduction in the recent Federal Funds Rate is a momentin-time reduction but does not change the fact that third-party economic forecasts continue to 

show rates increasing over time.58 At hearings, Dr. Morin was willing to estimate that the recent 

 

52 Exhibit SCE-02 (Villadsen), pp. 40-41. Dr. Villadsen uses a forecast for 2020 because the 

Commission has provided for an adjustment mechanism to allow for movements above a certain level 

in interest rates – the Cost of Capital Adjustment Mechanism (“CCM”). See D.08-05-035 and D.13-

03-015. 

53 Exhibit SCE-02 (Villadsen), p. 21; Exhibit SDG&E-09 (Morin Rebuttal), pp. 22-23; PG&E, Vilbert, 

Tr. 3/541-542. 

54 Exhibit Cal Advocates-01 (Rothschild), p. 25; FEA-01 (O’Donnell), p. 35; Exhibit SCE-05 (Villadsen 

Rebuttal), p. 24. 

55 As Dr. Villadsen explains at Exhibit SCE-02, p. 17, one implication of the recent elevation in the 

spread between utility bond yields and Treasury bond yields is that monetary policy has put downward 

pressure on risk-free rates. Mr. Gorman’s analysis does not account for this downward pressure. 

56 Id. See also Exhibit SCE-02 (Villadsen), p. 17. 

57 PG&E, Vilbert, Tr. Vol. 4/579. 

58 Exhibit SCE-02 (Villadsen), p. 21; PG&E, Vilbert, Tr. Vol. 3/541-42. 

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drop in interest rates could impact SDG&E’s base ROE by reducing it 0.2 percent,59 whereas Dr. 

Vilbert was unwilling to estimate the impact on his prior forecast.60

b) SCE’s Beta Must be Adjusted for Financial Leverage 

The only disputed issue among the parties regarding the beta (or measure of business risk) 

in the CAPM is the adjustment SCE uses to control for financial risk or leverage. Financial 

leverage – the relative share of debt and equity in the company’s capital structure – is a key 

element of equity risk. Financial leverage matters in determining a fair and reasonable ROE 

because higher financial leverage amplifies the volatility of earned equity returns, all other factors 

equal. As such, it is a critical factor in determining the required ROE that investors demand. An 

adjustment therefore is needed to enable SCE to use companies with different financial risk to 

determine the appropriate ROE for SCE on an “apples to apples” basis.61 Because SCE’s leverage 

is higher than its proxy group, failure to make this adjustment undervalues the ROE.62 

SCE used what is known as a Hamada adjustment to control for financial leverage in its 

CAPM model.63 As SCE witness Dr. Villadsen explains, the Hamada adjustment is a standard 

textbook technique used to control for financial leverage and isolate business risk.64 SCE has 

used the Hamada adjustment for many years in prior Cost of Capital applications.65 In setting an 

ROE, the Commission has adopted SCE’s model results that incorporate this adjustment.66 

 

59 SDG&E, Morin, Tr. Vol. 2/263. 

60 PG&E, Vilbert, Tr. Vol. 4/579. 

61 Exhibit SCE-02 (Villadsen), pp. 12, 44 and Appendix BV-B-18. The observed betas of the firms in the 

proxy group are levered betas, incorporating the combined effect of business risk and financial risk 

(leverage). 

62 Exhibit SCE-02 (Villadsen), p. 44 and n.69. 

63 Exhibit SCE-02 (Villadsen), p. 12, 44 and Appendix BV-B-18. The Hamada adjustment “unlevers” 

the beta of the proxy group companies to calculate an unlevered beta that captures only business risk – 

that is, the financial risk effect measured by the firm’s debt/equity ratio is removed to isolate the beta 

corresponding to each firm’s business risk. This business risk beta is then re-levered at SCE’s 

debt/equity ratio to properly calculate the beta that should be used to estimate SCE’s cost of equity. 

64 Exhibit SCE-02 (Villadsen), p. 44 and n.69, Appendix BV-B, pp. 16-18. 

65 Exhibit SCE-13, p. 63 (describing the unlevering and re-levering of the company betas). 

66 Exhibit SCE-13, pp. 63, 67 (SCE’s CAPM results using the Hamada adjustment produced a ROE 

range of 9.73 percent to 11.71 percent) and D.12-12-034, p. 38 (pointing to SCE’s CAPM results and 

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Joint Intervenors oppose the use of the Hamada adjustment but not because they disagree 

it is standard finance practice. They argue that because the Value Line betas of the proxy 

companies that Dr. Villadsen uses for her CAPM-based models are already adjusted for leverage, 

it is inappropriate to apply a Hamada adjustment to them.67 But the Joint Intervenors offer no 

reason why the Hamada adjustment should not be used to control for leverage in this 

context. The Joint Intervenors also claim that Dr. Villadsen’s Hamada adjustment “mismatches 

the measurement of leverage risk for the proxy group, and that for SCE.”68 The Joint Intervenors 

are incorrect. Dr. Villadsen appropriately applies the Hamada adjustment to unlever the equity 

betas of the companies in her proxy group, which are based on their market value capital 

structures, and then relever them at the SCE’s regulatory capital structure, because that is the 

capital structure that is used to set the ROE.69 

c) Intervenors’ Market Risk Premiums Are Flawed 

The Market Risk Premium is the premium above the risk-free interest rate that investors 

can expect to earn by investing in the market as a whole and is an indication of the level of risk 

compensation capital market participants demand.70 The Market Risk Premium is not directly 

observable but must be forecasted based on market information.71 SCE uses two estimates of the 

Market Risk Premium: 

 

ROE range of 9.73 percent to 11.71 percent using the Hamada adjustment). Dr. Villadsen also 

calculated after-tax weighted average cost of capital (“ATWACC”) adjustments, just as SCE did in the 

2013 Cost of Capital proceeding. See Exhibit SCE-02 (Villadsen), p. 47, Figure 15; p. 57, Figure 20. 

But as in the 2013 Cost of Capital Proceeding (D.12-12-034, p. 25, n.58), SCE does not propose that 

its ATWACC adjustments be used as an adjustment to the CAPM to determine its cost of capital. 

67 Exhibit EPUC-IS-TURN-01 (Gorman), p. VI-52. 

68 Exhibit EPUC-IS-TURN-01 (Gorman), p. VI-52. 

69 Exhibit SCE-02 (Villadsen), p. 44 and n.69, Appendix BV-B, pp. 16-18. 

70 Exhibit SCE-02 (Villadsen), p. 21. 

71 Exhibit SCE-02 (Villadsen), p. 41. 

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1) a historical average premium calculated from the difference of market 

returns over the income returns on government bonds from 1926 to 2017, 

which is 7.07 percent; 

2) a forecast based on empirical evidence that the Market Risk Premium has 

increased relative to historical levels by approximately 1 percent, for a 

Market Risk Premium of 8.07 percent.72 

Intervenors’ estimates of the Market Risk Premium have serious flaws. First, Mr. Gorman 

and Mr. O’Donnell calculate the historical Market Risk Premium using total market returns rather 

than income returns. Because the income return is the only part of the return that is truly risk free, 

using total market returns is not correct.73 Second, Mr. O’Donnell relies on a geometric mean, 

rather than arithmetic mean, to forecast the Market Risk Premium.74 Although geometric means 

are a useful way to measure historical performance, they are not accurate in forecasting expected 

future returns needed for the CAPM and they result in underestimating future returns.75 Empirical 

evidence and academic opinion support the superiority of arithmetic averages in forecasting 

expected returns.76

Finally, Mr. O’Donnell uses survey data to support his Market Risk Premium,77 but 

several witnesses testified that the use of survey data to estimate the Market Risk Premium is 

seriously flawed.78

 

72 Exhibit SCE-02 (Villadsen), p. 42. 

73 Exhibit SCE-05 (Villadsen Rebuttal), p. 30. 

74 Exhibit FEA-01 (O’Donnell), p. 37. 

75 Exhibit SCE-05 (Villadsen Rebuttal), pp. 30-31. Exhibit SDG&E-09 (Morin Rebuttal), pp. RAM-28 

through RAM-30. 

76 Exhibit SCE-05 (Villadsen Rebuttal), p. 31 

77 Exhibit FEA-01 (O’Donnell), p. 38. 

78 Exhibit SCE-05 (Villadsen Rebuttal), p. 32. Exhibit SDG&E-09 (Morin Rebuttal), pp. RAM-60 

through RAM-61; PG&E, Vilbert, Tr. Vol. 3/543 and SDG&E, Morin, Tr. Vol. 2/256-257 (regarding 

unreliability of surveys). 

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d) Empirical Data Supports SCE’s ECAPM Adjustment 

The ECAPM is an adjustment to the CAPM to account for the fact that the CAPM tends to 

underestimate the ROE for stocks with betas below one and overestimates the ROE for stocks 

with betas above one. The adjustment makes the stock’s risk/expected return relationship match 

more closely the risk/expected return relationship observed in empirical tests. The ECAPM thus 

is a more accurate prediction of eventual realized risk premiums than the CAPM. Because betas 

for all utilities in the proxy group are below one, failing to consider the ECAPM artificially 

reduces the ROE. Dr. Villadsen estimates that by failing to consider the ECAPM, Intervenors’ 

ROE estimates are underestimated by between 0.4 to 0.6 percent.79

Dr. Villadsen provides academic evidence in support of adjusting CAPM results through 

the use of the ECAPM.80 SCE used the ECAPM in its 2013 Cost of Capital proceeding, and the 

CAPM-based ROE range upon which the Commission relied in its decision in that proceeding 

indicates acceptance of this adjustment.81

Mr. Gorman argues that because Value Line already adjusts betas, application of ECAPM 

would be a form of double-counting. But Dr. Villadsen shows that Value Line’s adjustment to 

betas is fundamentally different from and complementary to ECAPM. Value Line’s adjustment to 

betas corrects the estimate of the relative risk of the company, whereas ECAPM adjusts the riskreturn tradeoff, meaning that the expected return for a given level of risk is different from 

predictions of the CAPM.82 Accordingly, there is no double-counting. 

 

79 Exhibit SCE-05 (Villadsen Rebuttal), pp. 35-36 and Figure 12.

80 Exhibit SCE-02 (Villadsen), Appendix BV-B-12. 

81 Exhibit SCE-13, pp. 63, 67, Table IV-8 (SCE’s CAPM-based model results included the ECAPM and 

produced a ROE range of 9.73 percent to 11.71 percent) and D.12-12-034, p. 38 (pointing to SCE’s 

CAPM-based model results, including ECAPM, and ROE range of 9.73 percent to 11.71 percent). 

82 Exhibit SCE-05 (Villadsen Rebuttal), pp. 36-39. 

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4. The Intervenors’ DCF Models and Assumptions are Flawed 

The DCF model is based on the relatively simple intuition that the expected return on an 

investment is equal to the expected current income (i.e., the next dividend payment) plus the 

expected amount of capital gain (i.e., the growth in the share price based on the growing value of 

future dividend payments). 

The dividend growth rate is the most controversial input into the DCF.83 SCE’s reliance 

on unbiased, third-party financial inputs is superior to Intervenors’ reliance on historical data for 

establishing a forecast or, worse, reliance on the circular and illogical sustainable growth 

methodology. SCE discusses below the DCF components and Intervenors’ flawed assumptions 

related to each. 

a) SCE’s Use of Financial Analysts’ Forecasts is the Most Reliable Method 

for Estimating Dividend Growth Rates 

There are three ways to estimate growth rates: 1) use average historical growth rates; 2) 

rely on financial analysts’ forecasts of earnings per share (“EPS”) growth rates (through a single 

or multi-stage analysis); and 3) calculate the sustainable growth rate. SCE’s witness Dr. 

Villadsen used the second approach, relying on consensus 3-5 year growth rate data from 

I/B/E/S,84 supplemented with consensus value growth rates based on EPS estimates from Value 

Line.85 Dr. Villadsen explains that reliance on the forecasts of financial analysts (second 

approach) is the best source of growth rates because those forecasts attempt to capture the market 

sentiment of investors.86 Although Dr. Villadsen used single- and multi-stage DCFs, concerns 

 

83 Exhibit SCE-05 (Villadsen Rebuttal), p. 43. 

84 I/B/E/S stands for “Institutional Brokers' Estimate System” and is a database of earnings estimates, 

which is currently owned by Thomson Reuters.

85 Exhibit SCE-02 (Villadsen), Appendix BV-B-4. 

86 Exhibit SCE-05 (Villadsen Rebuttal), p. 45; Appendix BV-B-4 through BV-B-5. 

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over how the multi-stage model has performed caused her to give it somewhat less weight than 

the single-stage approach.87 

FEA witness Mr. O’Donnell, in contrast, relies on historical growth rates,88 which is 

problematic because it requires an assumption that the future will be exactly like the past.89 For 

example, reliance on historical rates fails to reflect the higher cost of equity due to tax reform.90 

Historical rates of growth also provide less information than analyst projections because financial 

analysts already take into account historical rates in their forecasts.91 

Reliance on the third approach – a sustainable growth rate92 – has a number of 

weaknesses.93 SDG&E witness Dr. Morin explained that this method is circular when applied to 

regulated utilities because it requires establishing the authorized ROE that is being calculated.94 

Notably, while Mr. O’Donnell ran a model using this approach for Sempra, he did not rely on the 

results.95 He did however rely on the results for SCE.96 Selective application of the sustainable 

growth methodology97 calls into question its reliability. 

 

87 Exhibit SCE-02 (Villadsen), p. 16 (noting that the FERC recently expressed concern about and 

reconsidered its primary reliance on the multi-stage DCF model to calculate ROE because investor 

behavior has diverged from that model’s predictions.). 

88 Exhibit FEA-01 (O’Donnell), pp. 48-50. 

89 Exhibit SCE-05 (Villadsen Rebuttal), p. 43. 

90 Exhibit SCE-05 (Villadsen Rebuttal), p. 5. 

91 Exhibit SCE-05 (Villadsen Rebuttal), p. 43. 

92 Exhibit Cal Advocates-01 (Rothschild), p. 19. This is also referred to as the “plowback” method. 

93 Exhibit SCE-05 (Villadsen Rebuttal), p. 46. 

94 SDG&E, Morin, Tr. Vol. 2/202-203. 

95 Exhibit FEA-01 (O’Donnell), p. 60. Mr. O’Donnell selects a dividend growth rate range of 5.5% to 

7.5%, despite having calculated a plowback growth rate of 4.0% for Sempra, which is below the 

bottom of the range. 

96 Exhibit FEA-01 (O’Donnell), p. 50, lines 2-4 and Exhibit KWO 5, relying on an average of the 

plowback growth rates for Edison International and with two other forecasted growth rates. 

97 See also Exhibit EPUC-IS-TURN-01, p. IX-18 (reducing the weight given to the sustainable growth 

methodology for SoCalGas); SDG&E, Morin, Tr. Vol. 2/204-205 (indicating that although Mr. 

O’Donnell and Mr. Gorman used the sustainable growth method in their DCF analysis for SDG&E, 

they rejected the results in the final recommendation and placed “no weight on it”). 

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Mr. Rothschild puts “all his eggs in one basket, the DCF basket using sustainable growth,” 

while refusing to perform a RPM and giving his CAPM results zero weight.98 Relying on Value 

Line forecasts of expected returns on book value per share for 2022-2024, Mr. Rothschild sets the 

return on book value of equity equal to 10.50 percent in perpetuity.99 Yet, Mr. Rothschild 

recommends a ROE of only 8.65 percent, showing the illogic and inherent bias in his sustainable 

growth methodology.100 Given the problems with the sustainable growth methodology and the 

trend away from primary reliance on the DCF approach, Mr. Rothschild’s ROE recommendation 

should be considered with skepticism.101 

Although Mr. Rothschild’s Value Line data is not particularly useful for its intended 

purpose, it does support the notion that SCE is riskier than its peers. The data shows that SCE’s 

parent, Edison International (“EIX”), has the second lowest financial “Safety” ranking of all the 

utilities in its proxy group and is tied for last place out of 29 utilities in the peer group.102 Value 

Line indicates that stocks with “Safety” ranks of 1 or 2 are most suitable for conservative 

investors, whereas EIX and two other utilities received financial “Safety” rankings of 3, 

indicating that these are higher risk investments.103

b) SCE Uses the Most Reasonable Time Period for Determining the Current 

Stock Price 

Intervenors also select inappropriate periods over which to determine the current stock 

price for their DCF models.104 Whereas SCE’s witness Dr. Villadsen uses a reasonable 15 trading 

days,105 Mr. Gorman uses the average stock price over a 13-week period, which is too long. Mr. 

 

98 SDG&E, Morin, Tr. Vol. 2/215-216. 

99 Exhibit Cal Advoctes-01 (Rothschild), p. 18; Exhibit SCE-05 (Villadsen Rebuttal), p. 46. 

100 Exhibit SCE-05 (Villadsen Rebuttal), pp. 44-45. 

101 Exhibit Cal Advoctes-01 (Rothschild), p. 30, lines 9-12. 

102 Exhibit SCE-11 (showing a Safety rank of 3 for EIX, Entergy Corp. and PNB Resources only and 2 or 

1 for all others in the proxy group). 

103 Exhibit SCE-10, How to Read a Value Line Report, p. 4. 

104 Exhibit SCE-05 (Villadsen Rebuttal), p. 41. 

105 Exhibit SCE-02 (Villadsen), Appendix BV-B-4, Section C.1. 

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Rothschild uses a single day, June 30, 2019, which is far too short.106 Too long an estimation 

period weakens the forward-looking nature of the DCF model, while too short a period fails to 

eliminate the impact of a single unusual day. 

c) SCE’s Time Period for Forecasting the Dividend Price is Superior Because 

it Avoids the Need for Approximation and is Transparent 

Mr. Gorman, Mr. Rothschild, and Mr. O’Donnell all rely on an annual estimation period 

for the dividend price in their DCF models. SCE’s use of a quarterly period, however, is 

preferable because it reflects the actual period when dividends are paid and removes the need for 

approximation required by an annual estimation period.107 Mr. O’Donnell’s objection to SCE’s 

calculation of the dividend yield formula should be dismissed because he assumes SCE is using a 

longer period of time, which would require approximation.108 Mr. O’Donnell, however, is 

incorrect as SCE is using the preferred quarterly period which requires no approximation. 

Mr. O’Donnell states that he uses 12-month ahead dividend price forecasts from Value 

Line. However, his cited dividend yields do not match the yields Value Line provides.109 

Moreover, it is not clear how Value Line calculates the dividend yield forecast. Mr. O’Donnell’s 

method therefore is not transparent and cannot be relied upon. 

5. SCE’s Risk Premium Model is Statistically Sound and Supports the DCF and 

CAPM Results 

The Risk Premium Model (“RPM”) estimates the cost of equity capital for utilities based 

on the historical relationship between authorized ROEs in utility rate cases and the risk-free rate 

of interest at the time the ROEs were granted.110 The RPM is a standard model that both the 

 

106 Exhibit Cal Advocates-01 (Rothschild), p. 16. Mr. Rothschild’s market data is as of Friday June 28, 

2019. 

107 Exhibit SCE-05 (Villadsen Rebuttal), p. 41. 

108 Exhibit FEA-01 (O’Donnell), p. 82. FEA argues incorrectly that SCE should use 1 + 0.5g as opposed 

to 1+ g. FEA would be correct only if SCE had used a 6-month period, rather than a quarterly period. 

109 Exhibit FEA-01 (O’Donnell), p. 26. 

110 Exhibit SCE-02 (Villadsen), p. 53. 

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Commission and FERC use. It serves as a valuable benchmark for analyzing the appropriateness 

of the results of other empirical models. 

To estimate the risk premiums as part of the RPM, Dr. Villadsen performed a regression 

analysis using rate case data from 1990-2018 and average 20-year Treasury bond yields. Dr. 

Villadsen demonstrates that her RPM results confirm the accuracy and reasonableness of her 10.6 

ROE recommendation.111 

Neither Mr. Rothschild for Cal Advocates nor Mr. O’Donnell for FEA nor Dr. McCann 

for EDF performs a RPM analysis to estimate a ROE. (In fact, Dr. McCann did not use any of the 

standard financial models to calculate a ROE.) 112 Indeed, despite the Commission’s reliance on 

the RPM in prior decisions to help determine a fair and reasonable ROE, Mr. Rothschild 

inexplicably declares the RPM “flawed”113 because it relies on a “compilation of the average 

returns on equity allowed by utility commissions throughout the United States for each of the last 

several years.”114 But this approach is a strength, not a flaw. As Dr. Villadsen explains, the RPM 

“is the only model that directly compares the allowed return for regulated utilities to that 

calculated for SCE.”115 

Rather than running a standard RPM, Mr. O’Donnell compares earnings for EIX, SCE’s 

parent company, to those of a proxy group. This comparative earnings analysis relies upon two 

years of historical and five years of forecast earnings based on the book value for a proxy group 

of regulated utilities outside of California. Using this approach, he calculates a ROE range of 9.5 

percent to 10.5 percent.116 Notably, the high end of his range is consistent with Dr. Villadsen’s 

RPM range.117 This result is an important data point for the Commission because it demonstrates 

 

111 Exhibit SCE-02 (Villadsen), pp. 54-55. 

112 See EDF, McCann, Tr. Vol. 6/1012-13. 

113 Exhibit Cal-Advocates-01 (Rothschild), p. 91. 

114 Exhibit Cal-Advocates-01 (Rothschild), p. 88. 

115 Exhibit SCE-05 (Villadsen Rebuttal), p. 39. 

116 Exhibit FEA-01 (O’Donnell). p. 52. 

117 Exhibit SCE-02 (Villadsen), p. 55, Figure 19. 

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that regulatory commissions nationwide are granting authorized ROE to SCE’s peers outside of 

California that are much higher than the ROEs Intervenors have proposed for SCE, even without 

consideration of any unique California risks. 

Mr. Gorman does perform an RPM analysis for the Joint Intervenors, but his analysis 

contains serious flaws. It is based on a risk-free rate that is too low.118 Mr. Gorman has two 

versions of the RPM, one that compares authorized utility equity returns to the yield of a 30-year 

Treasury Bond and one that compares authorized utility equity returns to the yield of an “A” rated 

utility bond. Mr. Gorman then calculates the five and ten-year rolling averages of the equity risk 

premium for both versions. However, instead of simply using the current five or ten-year rolling 

average, Mr. Gorman takes a weighted average of the highest rolling averages (which is close to 

the current rolling average) and the lowest rolling averages experienced over the last 34 years. In 

essence, Mr. Gorman has lowered his ROE range by mixing today’s observed equity risk 

premiums with those from more than 25 years ago.119 Finally, and most importantly, he does not 

recognize the inverse relationship between the risk premium and interest rates.120

6. Market-to-Book Ratios are Irrelevant 

The market-to-book ratio is the ratio of the market price of a share of stock to its book 

value. Several Intervenors claim or imply that a market-to-book ratio greater than 1.0 is prima 

facie evidence that regulators have allowed ROEs greater than the cost of capital. 

It is a fallacy to consider a market-to-book ratio above one as indicative of an allowed 

ROE that is too high. Just as financial economics cannot explain absolute stock prices, neither can 

it explain market-to-book ratios.121 Dr. Villadsen also explains that using the market-to-book 

ratio to determine the ROE is circular: 

 

118 Exhibit SCE-05 (Villadsen), p. 40. 

119 Exhibit SDG&E-09 (Morin), p. RAM-81; Exhibit EPUC-IS-TURN-01 (Gorman). p. VII-34; Exhibit 

EPUC-IS-TURN-01 (Gorman). p. VII-Exhibit MPG 10-11. 

120 Exhibit SCE-05 (Villadsen), p. 40. Exhibit SDG&E-09 (Morin), pp. RAM-81 through RAM-82. 

121 Exhibit SCE-05 (Villadsen Rebuttal), p. 48. 

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If investors believed that the Commission was attempting to target a 

MB ratio of 1.0, the ratio would not deviate from 1.0 because 

investors would know that the Commission would alter the allowed 

ROE if it did deviate. Under that policy, the MB would provide no 

information about the relationship between the allowed ROE and 

the cost of capital.

122

Dr. Morin likewise explains that because utilities across the country have been trading at a 

market-to-book ratio of about two for 30 years,123 a Commission decision trying to affect a 

market-to-book ratio closer to one would result only in undercompensating California investors 

and constraining utilities’ ability to attract capital.124 

Dr. McCann’s fruitless attempts to use market-to-book ratios to estimate a ROE leads to 

absurd results. Dr. McCann calculates PG&E’s implied market return – the return earned by its 

investors – as exceeding 14 percent upon bankruptcy.125

In the past, the Commission has examined market-to-book values and chose not to rely 

upon them in setting a ROE.126 Instead, the Commission, like other regulators, seeks to set the 

allowed ROE equal to the cost of capital to meet the standards the Supreme Court has specified, 

rather than trying to achieve an arbitrary and circular market-to-book outcome.127 

C. Additional Risks Warrant Placing SCE at the High End of the Financial ROE Model 

Range 

After determining the base financial ROE model range, the Commission applies informed 

judgment to include additional risks not adequately reflected in the financial models, including 

business, financial and regulatory risk.128 The following business, financial, and regulatory risks 

 

122 Id.

123 SDG&E, Morin, Tr. Vol. 2/211. 

124 SDG&E, Morin, Tr. Vol. 2/299, lines 16-20 (“If utility stocks have market-to-book ratios of one and 

everybody else has a two or three on the overall stock market you are going to be at a disadvantage in 

terms of attracting capital for one thing.”). 

125 Exhibit SCE-05 (Villadsen Rebuttal), p. 49. 

126 D.04-03-039, pp. 65-66 (declining to rely upon a market to book conversion in determining a 

reasonable equity return); see also D.07-12-049, p. 44. 

127 Id., 48. 

128 D.07-12-049; D.12-12-034. 

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that SCE faces, which are described more fully below, strongly support the placement of SCE at 

the high end of the financial model ROE range: 

 California’s ambitious and recent increased Renewables Portfolio Standard (“RPS”), 

which will require procurement from new technologies at an unprecedented scale, 

creates substantial operational risks for SCE that are greater than those utilities face 

outside of California given the lower RPS standards in other states and diminishing 

implementation of RPS policies throughout the country. 

 The operational risks associated with California’s trajectory towards a 100 percent 

clean energy standard are exacerbated because California’s new standards are being 

implemented in a changing competitive environment as a result of Direct Access, 

Community Choice Aggregation (“CCA”), distributed energy resources, and the shift 

to greater electrification. The Commission itself has recognized and highlighted the 

challenges and dangers this changing environment presents. 

 California’s electric grid transformation and clean energy goals create the need for 

new capital investments. Although these increased expenditures are not unique to 

SCE or California, the scale of investments is significantly greater. In addition, given 

the trend of increased regulatory lag in California in comparison to other states, SCE 

faces greater disallowance exposure, as credit rating agencies have observed. 

1. SCE’s Business Risk Has Increased Since the Last Cost of Capital Proceeding 

Due to an Increased RPS and Industry Transformation 

Business risk pertains to new uncertainties resulting from competition and the economy. 

An increase in business risk can be caused by a variety of events that include capital investments, 

electric procurement, and catastrophic events.129 Since the last Cost of Capital proceeding, SCE 

faces increased operational and cost-shifting risks in all three categories, creating increased 

shareholder exposure. Credit rating agencies have taken note, expressing concerns about the 

operational demands being placed on California utilities as a result of the state’s ambitious energy 

 

129 D.12-12-034, p. 30. 

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policy goals.130 The Commission also has warned about the challenges and risks the evolving 

California electricity market and customer choice present.131 SCE and its shareholders support 

California’s clean energy goals and electric grid transformation. However, because these 

programs come with risks, shareholders need to be compensated fairly so that SCE can the access 

capital necessary to ensure their success. 

a) The Scale of California’s Recent RPS Changes Creates Unique Risks 

for California Utilities 

Significant changes in SCE’s electric procurement have occurred since the last Cost of 

Capital case. In particular, in 2018, SB 100 dramatically increased the RPS to 60 percent by 2030 

and 100 percent carbon-free electricity by 2045.132 Although the RPS is neither new nor unique 

to California, the mere fact that other states have RPS programs does not mean that they pose 

equal or even comparable risks. California’s RPS is, by any measure, one of the highest in the 

nation and double or triple most other states.133 Moreover, RPS programs in other states do not 

include the same restrictive definitions of what qualifies as a renewable resource; therefore, they 

are not as high as they appear.134 Credit rating agencies have called out specifically the new 

California RPS as an area of concern given the operational demands being placed on California 

utilities.135 

Historically, California has been a leader in procuring renewable and alternative power. 

This leading position has required California utilities to enter into long-term renewable energy 

and capacity contracts at high prices – the only prices available in nascent markets.136 SCE faces 

 

130 Exhibit SDG&E-23-C, Moody’s Report August 2, 2019, pp. 6-7. 

131 Exhibit SCE-04, Appendix A, California Customer Choice, An Evaluation of Regulatory Framework 

Options for an Evolving Electricity Market (August 2018) (excerpts). 

132 Exhibit SCE-01 (Stern), p. 10. 

133 Exhibit SCE-01 (Stern), p. 10; Exhibit EPUC IS-06. 

134 SCE, Stern, Tr. Vol. 1/128. 

135 Exhibit SDG&E-23-C, Moody’s Report August 2, 2019, pp. 6-7. 

136 Exhibit SCE-01 (Stern), p. 31 & Appendix B, EPUC-SCE-005 Q.09, regarding collateral 

requirements. 

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additional risk with respect to the new RPS standards, which will require procurement from new 

technologies at an unprecedented scale. California’s trajectory towards a 100 percent clean energy 

standard may create a further chasm between California and the rest of the nation, given that the 

role of RPS policies across the country has diminished in recent years.137 Some states are 

considering whether RPS policies are still needed and whether the costs outweigh the benefits.138 

Dr. Stern describes the operational risks associated with a 100 percent clean energy 

standard. This standard is different in kind than the lower standards in other states, because of 

issues related to intermittency and the duck curve, which refers to the midday challenge of having 

low net load and the ramp that occurs once the sun begins to set in the evening.139 At hearings, 

Dr. Stern explained: 

When we're talking about a substantial increase, we're talking about a doubling of 

the target for 2030 and going to basically a previously unforeseen 100 percent 

clean energy by 2045. That creates a variety of new risks. Operating a system with 

that kind of an energy mix is something we've never seen or done before.140

Dr. Stern added that it is yet unknown how much reduction in flexible fossil fuel resources the 

system can withstand.141

These risks are exacerbated because the new standards are being implemented in a 

departing load environment as a result of direct access and CCA, as discussed below. This 

combination of factors will require the restructuring of procurement contracts and cause current 

procurement levels to be heavily scrutinized and called into question. The risks and uncertainty 

related to these contracts are asymmetric because they are not offset by direct shareholder return 

 

137 EPUC IS-06, p 2. 

138 EPUC IS-06, p 2. 

139 SCE, Stern, Tr. Vol. 1/113-114. 

140 SCE, Stern, Tr. Vol. 1/108, 112-116. 

141 SCE, Stern, Tr. Vol. 1/115. 

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potential due to decoupling.142 Increased competition, policy changes, and/or changes in 

generation technology could leave SCE with contracts for unneeded and high cost power.143 

For these reasons, EIX and SCE have identified specifically for investors the “increasing 

procurement of renewable power and energy storage” among the “risks related to Southern 

California Edison Company” that could materially affect its financial condition and results of 

operation.144 Credit rating agencies, likewise, have pointed out the risks. 145 Notably, Moody’s 

has expressed concerns regarding “significant demands that are placed on the California utilities, 

including many ambitious public policy initiatives that are implemented through utility 

operations,” and pointed to the new RPS standards specifically.146 

b) Recent Mass Adoption of Customer-Choice Programs in SCE’s 

Territory Have Revealed New Implementation Risks 

Although CCAs are not new, they have morphed from a potential risk to an actual risk 

since the last Cost of Capital case, with mass CCA departures occurring in 2019.147 CCAs are 

under consideration in every major city and/or county in California.148 Likewise, while many 

states are experiencing rooftop solar growth, distributed energy resource (“DER”) penetration 

levels in California are among the highest in the nation. This trend will not abate given the 2018 

ruling by the State’s energy commission requiring solar on almost all new homes built beginning 

 

142 SDG&E, Folkmann, Tr. Vol. 5/827-29. 

143 Exhibit SCE-04 (Stern Rebuttal), p. 8; Exhibit EDF-06, Edison International and Southern California 

Edison 2018 Annual Report and 10-K (Excerpts), p. 37. 

144 Exhibit EDF-06, p. 37. 

145 Regulatory Research Associates, a group within S&P Global Market Intelligence, noted these 

legislative changes in its August 15, 2019 evaluation, which reflects its “assessment of the probable 

level and quality of the earnings to be realized by the state’s utilities as a result of regulatory, 

legislative, and court actions.” EPUC IS-11-C, RRA Regulatory Focus – State Regulatory Evaluations

(August 15, 2019), p. 3. See also SDG&E, Folkmann, Tr. Vol. 5/854-55; see also Exhibit SCE-01 

(Deana), p. 53. 

146 Exhibit SDG&E-23-C, Moody’s Report August 2, 2019, pp. 6-7. 

147 Exhibit SCE-01 (Stern), pp. 21-22; Exhibit SCE-04 (Stern Rebuttal), pp. 5-7 and Appendix A. 

148 Exhibit SCE-04 (Stern Rebuttal), Appendix A, California Customer Choice, An Evaluation of 

Regulatory Framework Options for an Evolving Electricity Market (August 2018) (excerpts), A-3. 

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in 2020.149 SCE has explained why self-generation, including net energy metering (“NEM”), 

creates risks related to cost-shifting150 and operational issues.151 Although these risks may be 

surmountable, they are risks utilities in other states do not face or face to a lesser degree, and they 

create exposure for shareholders.152 Even Intervenors acknowledge the risks associated with 

CCA153 and DERs.154

The major CCA departure and other technological developments that allow users to have 

more individual control over their energy supply have caused members of this Commission and 

credit agencies to sound the alarm. S&P Global referred to these events as nothing short of a 

“customer-driven revolution” that “will radically change the structure of the investor-owned 

utility industry.”155 This Commission has warned that “[w]ithout a coherent and comprehensive 

plan, the current policies in place may drift California to an unintended outcome and breakdown 

in services like the Energy Crisis.”156 SCE also has warned investors of the risks related to costshifting issues, explaining that “if SCE is no longer effectively able to recover such charges from 

its customers, SCE’s business, financial condition and results of operations will be materially 

impacted.”157 

Although the Power Charge Indifference Adjustment (“PCIA”) has done much to mitigate 

CCA risk, SCE still faces implementation risk.158 Important implementation issues such as the 

mechanics of the annual benchmark true-up, the development of a framework for IOU portfolio 

optimization, and the development of a prepayment option, are pending resolution in Phase 2 of 

 

149 Exhibit SCE-01 (Stern), p. 24, n.34. 

150 Exhibit SCE-01 (Stern), pp. 24-25. 

151 Exhibit SCE-01 (Stern), pp. 12-14 

152 SDG&E, Folkmann, Tr. Vol. 5/843, lines 7-23. 

153 Exhibit EPUC-IS-TURN-01 (Gorman), p. IV-20. 

154 Exhibit FEA-01 (O’Donnell), p. 93. 

155 Exhibit SCE-04 (Stern Rebuttal), p. 6. 

156 Exhibit SCE-04 (Stern Rebuttal), pp. 5-7 and Appendix A, California Customer Choice, An 

Evaluation of Regulatory Framework Options for an Evolving Electricity Market (August 2018) 

(Excerpts). 

157 Exhibit EDF-06, p. 40. 

158 Id.

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the PCIA proceeding. SCE has raised the specter of failed CCA departures and involuntary 

customer returns that create cost exposure and operational risks for SCE.159 Until cost-shifting 

issues are resolved in a manner that ensures bundled service customers are indifferent to departing 

load, risk of generation-related cost shifts to bundled customers remain. If bundled service 

customers are put at a systemic cost disadvantage to departing load, customer affordability, and 

the stability of the customer choice structure all are at some risk.160 

c) Risks Related to SCE’s Ambitious Electrification Efforts, Although 

Necessary, Require Compensation 

SCE also has been actively engaged in the shift to greater electrification – promoting 

electric vehicle adoption and developing needed electric vehicle charging station infrastructure 

throughout its service territory.161 Almost half the electric vehicles in the country are in 

California,162 with nearly all of that growth occurring since the last Cost of Capital case.163 There 

is no question that this transformation towards greater transportation electrification is needed to 

achieve important State policy goals. There also is no question that this transformation creates 

greater risks for California utilities than they faced historically or than other states face today, 

particularly in light of conflicting policies at the federal level.164 

d) SCE’s Large Distribution Capital Investment Program is Unique in 

Scale and Regulatory Lag Creates Disallowance Exposure 

One hundred percent clean energy, the customer choice transformation, and electrification 

create the need for new capital investments, especially on SCE’s distribution system. And 

 

159 Exhibit SCE-01 (Stern), pp. 22-23. 

160 Exhibit SCE-04 (Stern Rebuttal), p. 7. 

161 Exhibit SCE-01 (Stern), p. 14. 

162 SCE, Stern, Tr. Vol. 2/167. 

163 SCE, Stern, Tr. Vol. 1/105. 

164 Exhibit SCE-01 (Stern), p. 15. 

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although increased expenditures for grid modernization and grid resiliency are not unique to SCE 

or California, the scale of investments is significantly greater.165 

Given trends of increased GRC regulatory lag over time and as compared to other 

states,166 disallowance exposure related to such increased capital investment on the distribution 

system is a real risk. Regulatory Research Associates (“RRA”), a group within S&P Global 

Market Intelligence, has acknowledged this unique California risk, explaining that there is no 

penalty or mechanism to enforce the statutory time limits for GRC decisions and noting that 

“[c]ertain recent GRCs have taken two years or more to complete.”167 SCE provided several 

examples of millions of dollars of distribution and grid modernization investment disallowances 

from its 2018 GRC that could have been mitigated by a timely GRC decision.168 

2. Mitigating Factors Have Been Taken Into Account 

Intervenors argue that balancing accounts and decoupling reduce SCE’s risk and warrant a 

lower ROE. But this Commission previously has determined that mitigation from memorandum 

accounts at SCE’s level already is taken into account.169 In the 2013 Cost of Capital case, this 

Commission stated that “[c]learly, the impact of balancing and memorandum accounts is captured 

in the various financial modeling results. Any adjustment to the financial modeling results being 

adopted due to cost recovery mechanisms would be redundant or uncertain.”170 The benefits of 

revenue decoupling also are not new and are captured by the financial models.171 Lowering SCE’s 

ROE for these benefits would result in double-counting.172 

 

165 Exhibit SCE-01, p. 18, Figure III-4. 

166 Exhibit SCE-01, pp. 34-36. 

167 EPUC IS-11-C, p. 3. 

168 Exhibit SCE-04 (Stern Rebuttal), pp. 16-17. 

169 Exhibit SCE-04 (Stern Rebuttal), pp. 14-15. 

170 D.12-12-034, p. 34. 

171 Exhibit SCE-04 (Stern Rebuttal), pp. 15-16; D.12-12-034, p. 35 (w]hile the risk associated with 

revenue decoupling varies between utilities, the financial modeling results already reflect degrees of 

revenue decoupling risks.”). 

172 Morin, Tr. Vol. 2/238-39. 

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SCE acknowledges the many benefits that come from electrification and a clean energy 

transformation. But as Dr. Stern explains, SCE’s position in front comes with risks.173 SCE and 

its shareholders clearly support movement in this direction; it is the correct policy approach.174

Nevertheless, shareholders need to be compensated for increased risks. EDF acknowledges that 

shareholder incentives should be aligned with the State’s policy.175 To discount SCE’s 

shareholder returns because of their commitment to increased electrification and a clean energy 

transformation, despite the risks associated with these programs and the need to access capital to 

ensure their success, contravenes EDF’s premise and sends the wrong signal to SCE’s 

shareholders. 

3. SCE’s Credit Metrics Show that SCE’s Business, Financial, and Regulatory 

Risk All Have Increased Since the Last Cost of Capital Case 

One way to determine SCE’s business, financial and regulatory risks is to look at SCE’s 

credit metrics over time and compare them to other utilities nationally. SCE’s business, financial 

and regulatory risks all have increased since SCE’s 2013 Cost of Capital case, resulting in lower 

ratings. SCE’s business risk profile measures worse than 74 percent of electric utilities sampled 

and worse than the non-utility benchmark and has deteriorated since 2012.176 SCE’s financial risk 

rating also has deteriorated relative to its peers;177 SCE ranked third lowest out of 62 nonCalifornia electric utility companies for financial risk and had the worst financial rating compared 

to the non-utility benchmark in 2018.178 Unsurprisingly, California IOUs, including SCE, have 

seen deteriorating regulatory risk ratings (which are now worse than most other states) due to the 

confluence of factors related to recent wildfires.179 None of these ratings has been modified since 

 

173 Stern, Tr. Vol. 1/118-24. 

174 Stern, Tr. Vol. 1/119. 

175 EDF-01, p. 32. 

176 Exhibit SCE-01 (Woodward), p. 73. 

177 Exhibit SCE-01 (Woodward), p. 77. 

178 Exhibit SCE-01 (Woodward), pp. 77. 

179 Exhibit SCE-01 (Woodward), pp. 80-85. 

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the passage of AB 1054.180 In fact, RRA’s rating of California’s regulatory environment was 

downgraded after the passage of AB 1054.181 

4. SCE’s Current Authorized ROE of 10.30 Percent is No Longer Sufficient 

Another rate of return factor to consider is SCE’s current authorized ROE of 10.30 

percent. This ROE, which was reduced from 10.45 as of 2018, allowed SCE to attract capital and 

continue to receive fairly favorable rating treatment from the rating agencies until the 2017/2018 

wildfires and mudslides, which coincided with SB 100 and large-scale customer departures from 

SCE’s service territory. Since then, the credit rating agencies have downgraded SCE’s credit 

ratings to just above investment grade, leaving SCE very little cushion to withstand another 

adverse financial event. These downgrades are significant because maintaining creditworthiness, 

at least at investment grade levels, is an important component of Hope and Bluefield.

182 Although 

SCE’s credit ratings stabilized, they were neither upgraded nor restored as a result of the passage 

of AB 1054 or any of the other recent regulatory or legislative features Intervenors claim lower 

SCE’s risk. 

SCE’s credit ratings are below what they were in the 2013 Cost of Capital case,183 when a 

10.45 ROE was determined to be adequate. They also are below what they were in 2018, when a 

10.30 ROE was determined to be reasonable.184 They also are below the average for nonCalifornia utility peers.185 

These facts lead to only one conclusion: the cost of equity for SCE has increased. 

Although SCE’s previous ROEs were fair and reasonable when authorized, a higher ROE is 

needed for 2020. Without an increase, SCE’s credit ratings are likely to remain at pre-downgrade 

levels and SCE will not be able to compete with its higher-rated utility peers. 

 

180 Exhibit-01 (Woodward) p. 68. 

181 Exhibit EPUC IS- 11-C, p. 3. 

182 D.12-12-034, p. 37. 

183 Exhibit EPUC-IS-26. 

184 Exhibit EPUC-IS-26. 

185 Exhibit SCE-04 (Stern), p. 12, n.39. 

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D. Asymmetric Wildfire Risk Requires Adjusting Upward the Base ROE Range by 85 

Basis Points 

The single most significant change affecting SCE’s cost of capital since the last Cost of 

Capital proceeding has been the devastating impact of wildfires in SCE’s service territory and 

throughout California. The 2017/2018 wildfires and mudslides were bigger and more damaging 

than ever before in the state and far beyond what any other region of the country has experienced. 

They have resulted in multiple downgrades to SCE’s credit rating and increased SCE’s cost of 

capital. Because wildfire risk is asymmetric and not captured by the financial models, SCE 

requests that the base ROE range be adjusted upward by 85 basis points. The following reasons, 

discussed below, strongly support this upward adjustment: 

 California’s application of inverse condemnation with a strict liability standard to 

public utilities coupled with the uncertainty of cost recovery is unique and creates 

greater risks for investors. 

 Credit rating agencies, upon which investors and this Commission have relied to 

assess risk, perceive California utilities to be a riskier investment because of wildfires. 

 AB 1054 mitigates wildfire risk but does not eliminate it. Inverse condemnation 

continues to exist and uncertainty surrounds the implementation of AB 1054, 

particularly its new reasonableness standard for cost recovery.

 Because wildfire risk is asymmetric, it is not captured by standard cost of capital 

financial models and must be modeled separately. An implied insurance premium 

methodology supports a 85 basis point upward adjustment to the base financial model 

ROE to compensate investors for the unique risks that wildfires present. 85 basis 

points is comparable to the 70-80 basis point range calculated by other Intervenors in 

this proceeding. 

1. Wildfire Risk is Unique to California 

Several Intervenors acknowledge California’s unique application of the legal doctrine of 

inverse condemnation to public utilities and imposition of a strict liability standard that requires 

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utilities to pay claims for property damage when their facilities are a substantial cause of a 

wildfire, regardless of fault.186 The strict liability standard means utilities do not receive the 

benefit of the shifted burden of proof, which rests squarely on the plaintiff in a typical common 

law negligence case.187 SCE and the other California utilities thus face tremendous liquidity 

exposure when their facilities are the cause of wildfires. 

The significant cost recovery risk associated with the inverse condemnation doctrine came 

into sharp focus in 2017 when the Commission denied SDG&E cost recovery of its 2007 wildfire 

costs.188 This Commission’s decision came after FERC had concluded that SDG&E’s conduct 

was prudent and awarded full recovery for unrecovered costs related to the same wildfire.189 

SDG&E’s witness Mr. Folkmann testified that the Commission’s decision was unexpected given 

FERC’s order and prior precedent. Indeed, SDG&E’s accounting treatment of these costs 

indicated SDG&E believed it was likely to recover them.190 

The difference in outcomes was attributable in part to the disparate cost recovery 

standards FERC and the Commission applied. FERC applies a strong presumption that the utility 

acted prudently, “unless a challenging participant casts serious doubt on the prudence of that 

expense.”191 The FERC decision makes clear that this presumption is “not easily refuted” and 

that a mere rule violation is not enough.192 FERC’s standard “permits considerable latitude” and 

“does not look for a single correct result or require that every possible alternative be 

 

186 FEA, O’Donnell, Tr. Vol. 3/359-60; EPUC-IS-TURN, Gorman, Tr. Vol. 3/393; EDF, McCann, Tr. 

Vol. 6/1031. 

187 See, e.g., Leslie G. v. Perry & Associates, 43 Cal. App. 4th 472, 473 (1996) (“To prevail in a 

negligence action, the plaintiff must establish every essential element of her case by a preponderance 

of the evidence.”). 

188 A.15-09-010, Decision (D.)17-11-033, Decision Denying Application (issued December 6, 2017); 

reh’g denied, D.18-07-025 Order Denying Rehearing of D.17-11-033 (July 12, 2018) (“SDG&E 

WEMA Decision”). 

189 San Diego Gas & Electric Company, 146 FERC P63, 017, ¶¶ 56, 61-62 (2014). 

190 SDG&E, Folkmann, Tr. Vol. 5/810. 

191 Docket No. ER12-2454-003, Initial Decision and Order Granting SDG&E Motion for Summary 

Disposition, But Denying SDG&E Motion to Terminate, ¶ 47 (February 24, 2014). 

192 Id., ¶ 57 (“even if SDG&E had been found to have violated GO-95, such a violation standing alone 

would be insufficient to shift the presumption against SDG&E.”). 

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evaluated.”193 In contrast, under the CPUC’s prudent manager standard, the Commission placed 

the burden of proof squarely on SDG&E, as the party seeking cost recovery, to demonstrate 

prudent conduct. The Commissions defined as this standard as including “best practices of the 

era,”194 and acknowledged that it imposed a “high burden of proof.”195 

Regardless of the precise contours of the FERC and CPUC cases, the upshot is: “the 

fundamental question of San Diego’s prudence was evaluated in both cases. And different results 

were found. The standard at FERC did not result in a disallowance. The standard the CPUC 

applied did.”196 What investors came to understand is that California imposes a higher costrecovery burden on its utilities.197 A higher standard creates greater risk for investors. California’s 

extreme wildfire risk and inverse condemnation, when combined with the Commission’s 

heightened prudency and cost recovery standard, created a new and unacceptable level of risk for 

California utility investors. 

2. Credit Rating Agencies Perceive California Utilities to be a Riskier 

Investment Due to Wildfires 

The credit rating agencies downgraded the credit ratings of SCE and the other California 

utilities multiple times.198 SCE’s credit ratings came precipitously close to falling below 

investment grade levels.199 The credit reports pointed to the SDG&E WEMA Decision200 and 

 

193 Id., ¶ 59 (internal citation omitted). 

194 SDG&E WEMA Decision, p. 6. 

195 SCE Reply to Protest, p. 6, n.20. 

196 SCE, Stern, Tr. Vol. 1/96-97. 

197 Exhibit SCE-01, pp. 33-34; SDG&E-23-C, Moody’s Report August 2, 2019, p.5 (“The most important 

change is that the burden of proof has shifted from the utility to the intervenors, who are required to 

raise serious doubt as to the reasonableness of the utility’s conduct. We understand that this revised 

prudency standard is in line with the recovery standards applied by FERC. This is an important change 

because, in the case of SDG&E's 2007 wildfires, while the CPUC denied recovery, the FERC ruled 

that SDG&E acted prudently and allowed the recovery of the wildfire costs.”). 

198 Exhibit SCE-01, p. 43, 49, 52. 

199 Exhibit SCE-01 (Deana/Stern), p. 48, 64 and Appendix A. 

200 Exhibit SCE-15, 2019-03-05 Rating Action – Moody’s Downgrades Edison International to Baa3 and 

Southern California Edison to Baa2, p. 1. 

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also noted the differing standards between FERC and the CPUC.201 PG&E filed for bankruptcy 

as a result of the wildfire liabilities it was facing. Ultimately, this flawed regulatory environment 

required a legislative fix in the form of AB 1054. 

The credit rating reports also noted the unique nature of wildfires to California utilities. 

Moody’s noted that “California is in a unique situation because its wildfires are on average much 

more destructive because of its higher population density compared to other western states” and 

adding that resulting property damages have “an outsized effect on investor-owned utilities 

because of California courts’ application of the inverse condemnation legal doctrine.”202 S&P 

Global analyzed California risks for natural disasters compared to Florida, which also has 

exposure to such risks, but concluded that there were two key distinguishing factors making 

California riskier: inverse condemnation and cost recovery.203 S&P Global referred to Florida’s 

cost recovery process as “predictable and reliable” and California’s as “untested and 

uncertain.”204 

Notably, credit rating agencies have not found solace in the fact EDF focused on – 

namely, that the estimated number of properties per capita at risk is higher for Montana.205 One 

would think that the Environmental Defense Fund would be more concerned with total acres 

burned (California: 1,823,153 vs. Montana: 97,814), rather than properties per capita at risk.206 

Nonetheless, what investors care about is cost, and the top ten costliest wildfires in history have 

occurred in California.207 

 

201 Exhibit SCE-17, 2019-07-18 Fitch Affirms Edison Int’l & SoCal Edisons IDRs at ‘BBB-’, p. 3. 

202 Exhibit SCE-15, p. 1. 

203 Exhibit SCE-16, p. 6. 

204 Id. p. 6-7. 

205 EDF, McCann, Tr. Vol. 6/1020-24. 

206 Exhibit SCE-14, Insurance Information Institute Facts and Statistics, Wildfires, p. 6 (Table entitled 

Wildfires by State, 2018). 

207 Exhibit SCE-14, pp. 8-9 (table shows the top 10 costliest wildland fires in the United States all have 

occurred in California). See also id., pp. 5-6, 7-9 (California ranks number 1, by an extremely wide

margin, in the estimated number of properties at high to extreme wildfire risk, California ranks number 

1 in the number of acres burned in 2018). 

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Credit rating agencies perceive California wildfire risk to be much greater than it was in 

the past. Fitch notes: “The sharp increase in the magnitude and frequency of catastrophic 

wildfires in California in 2017 and 2018 underscores risk that this phenomenon may continue into 

the future and with it mounting liabilities and financial stress on IOUs in the state.”208 Moody’s 

states: “wildfires have become a significant risk to SCE and other California utilities over the 

past few years.” Noting that “seven out of the ten most damaging fires have occurred in the past 

five years,” Moody’s expresses concern that “the size of the wildfires has been growing larger and 

could continue to grow.”209

3. AB 1054 Mitigates SCE’s Wildfire Risk, But Does Not Eliminate It 

SCE anticipates AB 1054 will reduce SCE’s wildfire liability and cost recovery risks 

materially, but some residual risk for SCE’s investors remains. SCE has reduced substantially its 

overall ROE request related to wildfire risk and has not attempted to quantify or include all risks 

related to AB 1054, instead opting to give AB 1054 a chance. However, although SCE’s credit 

ratings have stabilized, credit rating agencies have not upgraded them and they continue to 

express concern regarding the continued existence and application of inverse condemnation in 

California to investor-owned utilities and uncertainty around the implementation of AB 1054.210 

Therefore, SCE is unable to conclude that AB 1054 has eliminated entirely its risk related to 

wildfires and wildfire cost recovery.

 

208 Exhibit SCE-17, p. 2. 

209 Exhibit SCE-15, p. 1. 

210 Exhibit SCE-04 (Stern Rebuttal), p. 12-13 (quoting Moody’s post-AB 1054 concerns regarding 

implementation of wildfire legislation and Fitch’s concerns regarding the failure of AB 1054 to 

address inverse condemnation); SDG&E-22-C (“Another longer-term risk deals with the uncertainty as 

to how the CPUC, which is responsible for implementing much of the new law, will interpret AB 

1054. If the Commission does not implement AB 1054 in a credit supported manner, then much of the 

new law's credit supportive elements related to the revised standards of the utilities' reasonable conduct 

could potentially be negligible.”); SDG&E-23-C (Moody’s Report August 2, 2019), p. 5 (“The 

application of this revised prudency standard by the CPUC in a credit supportive manner would likely 

strengthen our view of the credit supportiveness of the regulatory environment in California. However, 

this is likely to take some time as it remains to be seen how challenging it will be for the intervenors to 

create serious doubt, an undefined term and subject to the CPUC’s interpretation.”). 

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SCE’s experts Frank Graves and Robert Mudge (“Brattle”) have explained that wildfire 

risk is an asymmetric risk – meaning it involves only downside potential for uncompensated 

losses – and explained in detail why wildfire risk is not reflected in traditional cost of capital 

modeling approaches.211 Although Dr. Morin indicated some level of wildfire risk was taken into 

account in his base ROE analysis for SDG&E,212 he included Sempra in his proxy group, which 

would cause some of SDG&E’s wildfire risk to be reflected in the base ROE. SCE, in contrast, 

did not include EIX or any California utility in its base ROE proxy group. Dr. Villadsen 

explained that wildfire risk was not reflected in the base ROE she recommended for SCE.213

Therefore, to capture and quantify the asymmetric and unique risk that wildfires present in 

California, Brattle used an implied insurance premium methodology. Following the passage of 

AB 1054, at SCE’s request, Brattle relied upon assumptions in an analysis that Filsinger Energy 

Partners, a consultant to Governor Newsom’s office, performed and that Moody’s referenced in 

its reports to model the residual risks to investors of wildfires. Brattle relied on Filsinger’s 

assumption that 75 percent of wildfire costs will be disallowed in 2020 with the disallowance 

percentage “falling steadily” to 25 percent by 2030 to calculate the risks remaining for investors 

after AB 1054.214 

 

211 Exhibit SCE-03 (Graves), Appendix B, pp. B-26 – B-27 (“when a utility stock faces an asymmetric 

risk such as the increasing exposure to wildfire liability in California, its stock price will fall (as 

happened to both PG&E and SCE). However, that stock will not be expected thereafter to appreciate 

more than similar utilities that do not have that problem, and so shareholders will not have the 

opportunity to cover the unexpected loss. Correspondingly, the market-required return estimated by 

applying quantitative models (such as the Capital Asset Pricing Model (“CAPM”) and the Discounted 

Cash Flow (“DCF”) model) to a proxy group of other utilities does not capture a premium for all 

asymmetric risk. So when that measured rate of return is allowed against the equity in rate base, 

shareholders are not compensated for such exposures.”); id. B-61 (“Importantly, asymmetric risk 

cannot be ignored by regulators simply because it is not priced by traditional models, such as the 

CAPM or DCF models used to estimate the cost of capital. Under long-received and uncontroversial 

legal decisions and regulatory conventions, utilities must be entitled to a fair (i.e., unbiased) 

opportunity to earn their cost of capital against their prudently invested capital.”). See also PG&E, 

Vilbert, Tr. Vol. 4/578-79; IEI, Hern, Tr. Vol. 4/594. 

212 SDG&E, Morin Tr. Vol. 2/302. 

213 Exhibit SCE-02 (Villadsen), pp. 3, 9-10, 38, n.55, 59. 

214 Exhibit SCE-01-A, (Wood), p. 8; Exhibit SCE-03A, Appendix A: Brattle Supplemental Report on 

Wildfire Risk and AB 1054, p. 12, Exhibit SCE-06, p. 15.

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Based on Brattle’s analysis, SCE concluded that an upward adjustment of 85 basis points 

to the base financial ROE model range is needed to account for residual wildfire risk (taking into 

account the mitigating impacts of AB 1054).215 The Commission previously has used factors to 

adjust upward the base ROE model range to account for risks not specifically captured in the 

financial models.216 Here too, it is appropriate to adjust upward the base ROE model range by 85 

basis points to account for the asymmetric risk that wildfires present in California. 

Contrary to Intervenors’ misconceptions, this implied insurance premium approach is not 

intended to serve as a form of self-insurance.217 Nor is it an attempt to compensate investors for 

past or future wildfire costs.218 Instead, it is a method to quantify the return that investors require 

to continue to invest with SCE following the passage of AB 1054 given the risks that the remain. 

For this reason, Cal Advocate’s proposal to create a wildfire reserve using “excess profits” 

collected through previously-authorized ROEs219 is inappropriate for a Cost of Capital proceeding 

and fundamentally misses the point.220

Another misconception several Intervenors have perpetuated is that SCE’s request is a 

“backdoor method of collecting disallowances from ratepayers.”221 This is incorrect. AB 1054’s 

changes to the review standard for cost recovery, in particular, the shifting of the burden of proof, 

are intended to create a standard akin to the standard FERC applies in reviewing cost recovery 

applications. AB 1054’s new reasonableness standard of review replaces the Commission’s prior 

“prudent manager” standard, which this Commission has acknowledged is very high.222 However, 

there is no track record to determine how this new standard will be applied in practice. In fact, 

 

215 In its Application and initial testimony submitted on April 22, 2019 prior to AB 1054, SCE had 

requested an upward adjustment of 600 basis points. See Exhibit SCE-01, p. 47 and SCE-03 (Graves), 

p. 3. 

216 D.05-12-043, pp. 23-24. 

217 See Exhibit FEA-01 (O’Donnell), p. 29. 

218 See Exhibit EDF-02 (McCann Rebuttal), p. 3. 

219 Exhibit Cal Advocates-01(Rothschild), p. 100. See also Exhibit EPUC-IS-TURN-01, p. V-6 

(suggesting cash associated with an increased ROE should be sequestered in a wildfire fund). 

220 Exhibit SCE-06 (Graves/Mudge Rebuttal), pp. 5-7. 

221 Exhibit EDF-02 (McCann Rebuttal), p. 1. 

222 See SCE Reply to Protests, p. 6. 

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the only precedent – SDG&E’s WEMA Decision – suggests that the Commission may be willing 

to impose a higher standard on California utilities than other jurisdictions. 

Until there is a track record, investors remain concerned that under inverse condemnation, 

California utilities face a significant threat of being held responsible for substantial costs, 

particularly in light of the increased frequency and severity of California wildfires. Investors 

express concerns that the utilities will not be able to recover those costs because AB 1054’s new 

wildfire cost recovery standard still will be higher than the standard at FERC or in other states. 

That differential would create more exposure for California utilities and higher costs for 

shareholders; investors must be compensated for this uncertainty or they will select a less-risky 

alternative.223 

There are several risks associated with AB 1054 that SCE has not quantified as part of its 

85 basis point estimate of wildfire risk, indicating that this number is conservative.224 In 

particular, the 85 basis points does not include the risk of fund depletion.225 Were SCE to have 

used a disallowance level lower than the 75 percent relied upon by Moody’s, the fund depletion 

risk would increase.226 Although Mr. O’Donnell believes the fund would be reconstituted upon 

depletion, he bases his conclusion on “common sense” and “hope,” rather than statute.227 

4. Joint Intervenors’ and FEA’s Quantification of Wildfire Risk is Close to 

SCE’s 

The Joint Intervenors and FEA acknowledge that even after the passage of AB 1054, 

wildfire risks continue to affect the IOUs’ returns on equity.228 At hearings, FEA witness Mr. 

 

223 Exhibit SDG&E-11 (Folkmann Rebuttal), p. BAF-3; SDG&E, Reed, Tr. Vol. 4/718-19, 724-25. 

224 Exhibit SCE-03-A (Graves/Mudge Supplemental), p. 3. 

225 SCE, Wood, Tr. Vol. 1/82. 

226 SCE, Wood, Tr. Vol. 1/82; SCE, Graves/Mudge, Tr. Vol. 3/496. 

227 FEA, O’Donnell, Tr. Vol. 3/373. 

228 Exhibit EPUC-IS-TURN-01 (Gorman), pp. V-10 to 11, VII-1 and EPUC IS TURN, Gorman, Tr. Vol. 

3/399 (acknowledging that AB 1054 did not fully mitigate wildfire risk); Exhibit FEA-01 (O’Donnell), 

p. 41. 

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O’Donnell was unambiguous in his view that inverse condemnation is a unique California risk 

warranting an ROE premium, stating “I do believe that California utilities are at a higher risk and 

deserve a higher return.”229 These Intervenors provide alternative approaches to SCE’s implied 

insurance premium methodology approach to quantify that risk.230 Their results, capped at 70 

basis points for the Joint Intervenors231 and a 70 to 80 basis point range for FEA,232 are very close 

to SCE’s 85 basis point estimate. Notably, the 70 basis points Joint Intervenors calculate is based 

on debt yields, and they acknowledge that equity is more expensive than debt.233 Although FEA 

has based its premium on the continued application of inverse condemnation to utilities in 

California, SCE has explained why this risk and implementation risk are intertwined.234 

5. The Denial-of-the-Obvious Stance Assumed by EDF and Cal Advocates 

Should be Ignored 

EDF and Cal Advocates take untenable positions regarding wildfire risks. EDF argues 

SCE has failed to show that wildfires are either a new or a unique risk to California.235 In fact, 

the record includes ample evidence of California’s unique laws around application of inverse 

condemnation to investor-owned utilities,236 uncertainty around cost recovery implementation, 

and higher costs due to relatively high population and density of human structures compared to 

 

229 FEA, O’Donnell, Tr. Vol, 3/364, lines 7-9. See also FEA-01 (O’Donnell), p. 41 (stating that inverse 

condemnation makes “an investment in a California utility more risky as a whole than an investment in 

a utility that operates in a state without such liability risk.”). 

230 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-1. 

231 Exhibit EPUC-IS-TURN-02 (Gorman Rebuttal), p. 10. 

232 Exhibit FEA-01 (O’Donnell), p. 54 (“The issue of inverse condemnation is still outstanding to the 

California utilities, which is the primary reason I believe there is a 70-80 basis-point difference in the 

dividend yields of the comparable group and Edison.”). 

233 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-9. Mr. Gorman states, “utility common equity capital 

is more than twice (11.4% vs. 4.5%) as expensive as common equity capital.” As Brattle noted, the 

second reference to “common equity capital” likely is meant to refer debt given that it is a basic 

premise of financial economics that equity is more expensive than debt. See Exhibit SCE-06 

(Graves/Mudge Rebuttal), p. 18. 

234 Exhibit SCE-07 (Stern Sur-rebuttal), pp. 1-2. 

235 Exhibit EDF-01 (McCann), pp. 24-25. 

236 SDG&E-03, Widjaja, p. DW-9; FEA, O’Donnell, Tr. Vol. 3/359-60; EPUC-IS-TURN, Gorman, Tr. 

Vol. 3/393; EDF, McCann, Tr. Vol. 6/1031. 

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the rest of the West, all of which expose the utility to increased wildfire risk.237 Brattle shows 

that the trend is clearly towards increasing wildfire costs and damage, with the most costly fires 

occurring in the 2017 – 2018 time period.238 The two most serious wildfires in recent history, by 

a wide margin, have occurred since the last adjustment to SCE’s ROE in 2017. And the top five 

costliest wildfires in the United States all have occurred in California in the last two years.239 In 

addition, credit rating downgrades of California utilities – with commentary specifically 

addressing increased wildfire and cost recovery risks – show that investors perceive wildfires in 

California as a significant risk.240 

Cal Advocates also must ignore reams of evidence of the negative impact of wildfires on 

the IOUs’ credit ratings to reach its conclusion that wildfire risk does not impact the cost of equity 

of regulated utilities.241 And Cal Advocates ignores this evidence selectively and only when it 

suits their interest. In a separate proceeding on funding the customer portion of the Wildfire Fund, 

Cal Advocates notes that even after the passage of AB 1054, credit rating agencies may still 

downgrade the utilities in the next 18 months and that “for SCE, S&P specifically warned that an 

upgrade within the next year is ‘unlikely.’”242 Accordingly, the CPUC should dismiss these 

selective denial-of-the-obvious positions. 

IV. 

CAPITAL STRUCTURE 

SCE requests increasing its common equity percentage from 48 percent to 52 percent, 

while reducing preferred equity from 9 percent to 5 percent and leaving its debt level unchanged 

at 43 percent.243 SCE’s proposal to reduce preferred equity is not controversial. SCE’s proposal is 

the only one that achieves this reduction while also reducing its leverage at a time when credit 

 

237 Exhibit SCE-03 (Graves), Appendix B, pp. B-13 – B-14; Exhibit SCE-14, pp. 5-6, 7-9. 

238 Exhibit SCE-03 (Graves), Appendix B, Figure 3, p. B-15. 

239 Exhibit SCE-14, pp. 8-9. 

240 Exhibit SCE-04 (Stern Rebuttal), pp.12-13; see also Exhibits SCE-15, SCE-16, and SCE-17. 

241 Exhibit Cal Advocates-01 (Rothschild), p. 49. 

242 Exhibit SDG&E-27. 

243 Exhibit SCE-01 (Deana), p. 48. 

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supportive action is needed. Moreover, while SCE proposes increasing its common equity level, 

it remains on par with utilities nationally and in California. SCE’s currently authorized levels, 

recommended capital structure and Intervenors’ recommendations are summarized in 

Figure IV-3 below. 

 Figure IV-3 

SCE and Intervenor Capital Structure Proposals 

A. Record Evidence Shows SCE’s Current Preferred Equity Level Should Be Reduced 

The record evidence clearly shows that SCE’s 9 percent level of preferred equity makes it 

an extreme outlier. It is substantially higher than the 1.0 to 2.75 percent levels currently 

authorized for the other California electric utilities.244 In addition, most other U.S. utilities in the 

national utility sample group have preferred equity ratios of less than 1%.245 The Joint Intervenors 

agree SCE’s preferred equity is “unusually high.” 246 SCE’s preferred equity is currently trading 

below investment grade. The preferred equity market accessible to SCE thus is relatively small.247 

No party contests a reduced authorized preferred equity level for SCE. 

 

244 Exhibit SCE-01 (Deana), p. 61, Exhibit SCE-01 (Woodward), p. 87-88. 

245 Exhibit SCE-01 (Deana), pp. 60-61; Exhibit SCE-01 (Woodward), p. 89 

246 EPUC-IS-TURN, Gorman, Tr. Vol. 3/448.

247 Exhibit SCE-01 (Woodward), p. 86. 

 Common Equity Preferred Equity Debt

Currently Authorized 48 9 43 

SCE Recommendation 52 5 43 

FEA Recommendation 52 0 48 

Joint Intervenor 

Recommendation 50 5 45 

Cal Advocates 

Recommendation 48 5 47 

EDF Recommendation None None None 

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B. SCE’s Debt Leverage Must be Reduced 

SCE’s credit ratings have been downgraded significantly as a result of the 2017/2018 

wildfire events. Its credit rating hovers just at investment grade.248 Credit metrics for business, 

financial and regulatory risk have all been reduced.249 Even Value Line data shows that SCE is 

riskier than its peers and no longer ranked as a safe investment.250 SCE has explained how such a 

low ratings and weak credit metrics create additional costs for customers.251 A sufficient cushion 

is needed to withstand a market downturn, increased PPA obligations, or issuances of more 

debt.252 Although the outlook for SCE’s credit ratings has stabilized after the passage of AB 

1054, credit ratings have not improved. In fact, after the passage of AB 1054, Regulatory 

Research Associates downgraded its rating for California’s regulatory environment.253 

Authorizing SCE’s proposed 52 percent equity ratio is a needed supportive step to restore SCE’s 

credit ratings to levels more typical of U.S. utilities. 

Another reason to avoid increasing SCE’s debt level is imputed debt equivalence. SCE 

has explained that in 2005, it increased its preferred equity to mitigate the impact of debt 

equivalence related to its ongoing PPA obligations.254 To continue to address its unabated debt 

equivalence risk,255 SCE must reduce its preferred equity in a way that reduces, not increases, its 

overall debt levels. 

Authorizing this change will also send a signal to equity and debt investors that the State 

supports SCE’s financial health. A financially sound electric utility will be able to access the 

credit markets to support the State’s policy objectives. 

 

248 Exhibit EPUC-IS-TURN-01 (Gorman), p. IV-1. 

249 Exhibit SCE-01 (Woodward), p. 68. 

250 See Section III.B.5, above. 

251 Exhibit SCE-01 (Deana), pp. 55-57; Exhibit SCE-01 (Woodward), p. 95. 

252 Exhibit SCE-01 (Deana), pp. 64-65. 

253 Exhibit SCE-07 (Villadsen Rebuttal), p. 3; EPUC IS-11-C, p. 3 254 Exhibit SCE-01 (Deana), p. 60. 

255 Exhibit SCE-01 (Deana), pp. 57-59. 

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C. SCE’s Recommended Capital Structure is the Only Proposal that Will Reduce SCE’s 

Leverage 

SCE’s proposed capital structure changes have the impact of reducing SCE’s preferred 

equity while making SCE less levered, by increasing its common equity percentage. Intervenors 

do not oppose a reduction in SCE’s preferred equity levels for the reasons stated above. 

Intervenors’ alternative proposals, however, fail to reduce SCE’s overall leverage at a time when 

SCE’s credit metrics require such credit supportive action. 

Cal Advocates does not oppose reducing SCE’s preferred equity by 4 percent. However, 

Cal Advocates opposes increasing SCE’s common equity percentage on grounds that EIX, 

maintains a lower common equity level than SCE’s current level.256 SCE explains, in Section 

IV.D below, why EIX’s common equity level should not factor in to this determination. But by 

reducing SCE’s preferred equity without increasing SCE’s common equity, SCE’s debt would be 

increased from 43 percent to 47 percent. 

The Joint Intervenors, like Cal Advocates, do not oppose SCE’s request to reduce its 

preferred equity to 5 percent. However, the Joint Intervenors believe SCE’s common equity 

should be increased by only 2 percent to 50 percent. The Joint Intervenors’ main rationale for 50 

percent common equity, as opposed to the 52 percent that SCE has requested, is that debt is less 

expensive than equity, especially in this low-cost interest rate environment.257 But the Joint 

Intervenors’ alternative proposal results in an increase of SCE’s debt by 2 percent, to 45 percent. 

Moreover, the Joint Intervenors’ own evidence supports the reasonableness of SCE’s 

request to increase its common equity to 52 percent.258 It shows that since 2016, average utility 

equity ratios have been increasing year-over-year. In 2019, the average was 51.75 percent.259 

 

256 Exhibit Cal Advocates-01 (Rothschild), pp. 36-37. 

257 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-9. 

258 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-12, Table 24. 

259 Exhibit EPUC-IS-TURN-01 (Gorman), p. VII-12, Table 24; EPUC-IS-TURN, Gorman, Tr. Vol. 

3/450-51. 

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The Joint Intervenors also acknowledge that SCE’s 52 percent request would bring it to the same 

level as the other California utilities.260 And while the Joint Intervenors insist that SCE should 

take advantage of this low-cost debt environment, they have not proposed reducing the common 

equity levels of the other California utilities so that they can do the same. Given that SCE’s 

requested common equity percentage is consistent with other utilities nationally and in California, 

SCE’s request to increase its common equity to 52 percent should be adopted. 

FEA adopts SCE’s request to increase its common equity to 52 percent but proposes to 

eliminate SCE’s preferred equity altogether.261 By reducing SCE’s preferred equity from 9 

percent to zero while increasing SCE’s common equity by only 4 percent, FEA’s 

recommendation increases SCE’s debt leverage by 5 percent. SCE explains in Section IV.B why 

it should not increase its leverage at this time. In addition, as Mr. Deana has explained, “the 

redemption or buy back of all 9 percent, over $2 billion, of its preferred equity in 2020 hampers 

SCE’s ability to seek cost efficient opportunities for reducing its preferred equity holdings.”262 

The Commission should adopt SCE’s more measured approach to replacing preferred equity with 

common equity, which would reduce its debt leverage but not eliminate SCE’s preferred equity 

entirely within this Cost of Capital period. 

D. EIX’s Capital Structure is Irrelevant 

Cal Advocates argues that because EIX’s common equity ratio is substantially lower than 

SCE’s, SCE’s equity ratio should remain at the current 48 percent level.263 The holding company 

decision establishing EIX as SCE’s parent company and the related decision revising the affiliate 

transaction rules establish holding company conditions and ring-fencing provisions that insulate 

SCE. These decisions make clear that EIX’s capital structure is irrelevant to the question of the 

 

260 EPUC-IS-TURN, Gorman, Tr. Vol. 3/449. 

261 Exhibit FEA-01 (O’Donnell), p. 47. 

262 Exhibit SCE-04 (Deana Rebuttal), p. 22. 

263 Exhibit Cal Advocates-01 (Rothschild), pp. 36-37. 

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appropriate regulatory capital structure for SCE, which should be regarded as a standalone utility 

for ratemaking purposes.264 FERC precedent is consistent, generally viewing a parent company’s 

capital structure as irrelevant, except in circumstances not applicable here.265

V. 

EMBEDDED COST OF DEBT AND PREFERRED EQUITY 

No party contests SCE’s recommendations regarding its 2020 cost of long-term debt and 

preferred equity. In fact, all parties were able to stipulate to these amounts.266 Because no party to 

this proceeding has contested these issues, the CPUC should adopt them as set forth at Figure I-1 

above. 

VI. 

COST OF CAPITAL ADJUSTMENT MECHANISM 

In its Application, SCE proposed that the Cost of Capital Adjustment Mechanism 

(“CCM”), established in D.08-05-035 and continued in D.13-03-015, be retained for its original 

base ROE request but that it not apply to the wildfire ROE SCE was seeking because wildfire cost 

recovery risk is not tied to capital market conditions or macroeconomic changes. SCE proposed 

 

264 Exhibit SCE-04 (Deana Rebuttal), pp. 20-21; Southern Calif. Edison Co., D.88-01-063, 22 CPUC 2d 

347, 356 (1988) (“Edison Holding Company Decision”); D.06-12-029, Affiliate Transaction Rule IXC. 

265 Midcontinent Indep. Sys. Operator, Inc., 154 FERC ¶ 61004 (Jan. 6, 2016); ITC Holdings Corp., 143 

FERC ¶ 61257, 62879 (June 20, 2013) (opting to use the actual capital structure of the utility where 

“(1) issues its own debt without guarantees; (2) has its own bond rating; and (3) has a capital structure 

within the range of capital structures approved by the Commission.”); Order on Rehearing, Williams 

Natural Gas Company, 80 FERC P61158, (August 1, 1997), pp. 5-7 (holding that it was not required 

to impute to natural gas pipeline company the capital structure of its corporate parent, in setting rate 

for company, despite claim that failure to impute that structure would result in “double leveraging,” as 

company issued its own non-guaranteed debt and had its own bond rating”); Missouri Public Service 

Com'n v. F.E.R.C., 215 F.3d 1 (2000) reversed and remanded on other grounds (“we have no basis to 

disturb FERC's refusal to apply the double leveraging theory.”). 266 A.19-04-014, Joint Filing To Report Results Of Meet-And-Confer To Identify Stipulated Facts, p. 3

(August 29, 2019). 

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that the wildfire ROE be subject to change upon SCE filing a new application if “SCE’s wildfire 

cost recovery and liquidity risk materially change due to legislative or regulatory actions.”267 

In the Scoping Memo, President Picker explained: “The Commission will not consider a 

separate wildfire adder in the scope of this proceeding. Risk of all kind are addressed in this 

proceeding; thus a separate adder is not appropriate for one risk.” 268 Based on the Commission’s 

direction for an overall ROE and the effect of AB 1054 on SCE’s ROE request, SCE has 

determined this separate adjustment mechanism is no longer necessary.269 

No party has contested SCE’s proposal to continue the CCM. Accordingly, SCE’s overall 

ROE request should be subject to the CCM. 

VII. 

REQUEST FOR ORAL ARGUMENT 

SCE hereby requests the opportunity for oral argument in this proceeding. 

VIII. 

CONCLUSION 

For all of the foregoing reasons, as well as the reasons set forth in SCE’s testimony in this 

proceeding, the Commission should grant SCE’s 2020 test year Cost of Capital recommendation, 

as set forth and justified in this Opening Brief. 

 

267 Exhibit SCE-01 (Rumble), p. 67. 

268 A.19-04-014, Scoping Memo and Ruling of President Picker, p. 3 (July 2, 2019). 

269 Exhibit SCE-01-A (Rumble Supplemental), pp. 10-11. 

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Respectfully submitted, 

CLAIRE TORCHIA 

/s/ Claire Torchia 

By: Claire Torchia

Attorney for 

SOUTHERN CALIFORNIA EDISON COMPANY 

2244 Walnut Grove Avenue 

Post Office Box 800 

Rosemead, California 91770 

Telephone: (626) 302-6945 

E-mail:Claire.Torchia@sce.com 

September 30, 2019 

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