Water activity in California, New Jersey and Pennsylvania of greatest interest

Introduction

There are 11 major rate cases pending across nine U.S. states for the investor-owned water utility operating companies followed by Regulatory Research Associates, a group within S&P Global Market Intelligence. In those proceedings, the companies are seeking ROEs ranging from 9.5% to 10.75%. The most notable cases are being conducted in California, New Jersey and Pennsylvania.

RRA evaluates water utility regulation in 25 state jurisdictions and is currently monitoring 11 base rate proceedings involving rate change requests of $1.0 million or greater.

* Regulatory activity in California is likely to be of greatest interest to investors during 2022. In addition to base rate proceedings for three of the state's largest water utilities, a cost-of-capital proceeding, which is quite delayed, will determine the authorized returns for the four largest water utilities.

* In Essential Utilities Inc.'s pending base rate case in Pennsylvania, the date for a settlement to be filed recently passed. With no agreement forthcoming, the case is proceeding on a litigated track. It has been decades since an investor-owned water utility has completed a fully litigated rate case.

* A sizable base rate case in New Jersey, American Water Works Co. Inc.'s largest regulated operating jurisdiction, has just gotten underway.

California — There are three meaningful general rate cases, or GRCs, pending before the California Public Utilities Commission, or CPUC. Rate of return is not an issue in any of these GRCs, as California utilizes a separate cost of capital proceeding to set returns for Class A water utilities — those that serve 10,000 customers or more.

* California Water Service Co., or Cal Water — Cal Water, filed its multiyear GRC on July 1, 2021. The company requested rate increases of $80.5 million, or 11.1%, in 2023; $43.6 million, or 5.4%, in 2024; and $43.2 million, or 5.1%, in 2025, which incorporate a $2.124 billion rate base for a calendar 2023 test year. While a new ROE will ultimately be set in the ongoing cost-of-capital proceeding, the proposed revenue requirements in this proceeding reflect the 9.2% ROE (53.4% of capital) and 7.48% rate of return authorized in 2018.

Testimony from the Public Advocates Office is expected to be filed Feb. 4, with evidentiary hearings to begin May 3.

Cal Water is a subsidiary of California Water Service Group.

* Golden State Water Co., or GSWC — On Nov. 23, 2021, a settlement between GSWC and the Public Advocates Office was filed that, if adopted by the CPUC, would allow the company to increase rates by $27.8 million, or 8.1%, in 2022. Additionally, escalation increases of $12.9 million, or 3.47%, and $13.2 million, or 3.41% would take effect in 2023 and 2024, respectively. The settlement includes a capital spending program of $126.1 million, $136.7 million and $142 million, for 2021, 2022 and 2023, respectively.

The settlement calls for approval of most of the company's requested balancing accounts and the continuation of the GSWC's sales adjustment mechanism as a pilot program with the existing terms and conditions.

GSWC's requests to establish a medical cost balancing account and liability insurance balancing account, and its proposal to consolidate the Los Osos and Santa Maria districts into a single ratemaking area, will be litigated.

Golden States Water is the largest subsidiary of American States Water Co.

* San Jose Water Co., or SJWC — On Jan. 14, SJWC and the Public Advocates Office filed a settlement that, if adopted, would allow increase rates by $25.1 million, or 6.03%, in 2022 and escalation increases of $13.0 million, or 2.94%, and $16.1 million, or 3.56%, in 2023 and 2024, respectively. The settlement includes capital spending budgets of $115 million in each of 2021 and 2022, $120 million in 2023 and specifies a 2022 rate base of $1.027 billion.

SJWC filed the GRC on Jan. 4, 2021, seeking a $51.9 million, or 13.4%, base rate increase in 2022; a $16.9 million increase in 2023; and a $19.2 million increase in 2024, which incorporated a $1.04 billion rate base for a calendar-2022 test year. While the authorized ROE will ultimately be decided in the pending cost-of-capital proceeding, the requested revenue requirements reflected an ROE of 8.9% and rate of return of 7.64%, which was established in 2018.

San Jose Water is the largest subsidiary of SJW Group.

* Cost of capital proceeding — On May 3, 2021, the four largest water utilities in the state — California American Water Co., or Cal-Am, Cal Water, GSWC and SJWC — filed separate cost of capital applications, requesting ROEs ranging from 10.30% to 10.75%, which were consolidated into a single docket. New costs of capital parameters are expected to be effective for the period Jan. 1, 2022, through Dec. 31, 2024.

In an unusual decision in the prior cost of capital proceeding, the PUC approved a revised proposed decision, which included ROEs that ranged from 8.9% to 9.2%. This was higher than the ROEs in the initial proposed decision, which would have adopted the capital structures and rates of return proposed by the Office of Ratepayer Advocates, which is now known as the Public Advocates office, including ROEs ranging from 8.22% to 8.30%.

In the pending case, the water utilities are expected to file direct testimony during the first week in February 2022 and public participation hearings will be held in March. Evidentiary hearings are scheduled for April 5-8 and a proposed decision is anticipated in the summer of 2022.

The California regulatory climate is relatively balanced from an investor viewpoint, according to RRA, though a level of uncertainty exists with the pending cost-of-capital proceeding. RRA accords the California regulatory climate an Average/1 rating for water utilities. Use of a forward-looking test year and multiple balancing accounts reflecting operating expenses, including pension expenses and healthcare costs, provide the water utilities a reasonable opportunity to earn their allowed returns. Water utility rate proceedings have been frequently delayed past the date new rates were expected to take effect, increasing regulatory risk. The use of retroactive effective dates for approved rate changes has minimized the financial impact of these delays.

The creation of the 2005 Water Action Plan and subsequent implementation of key action items made water utility regulation more stable and consistent. However, in a 2020 order within a proceeding associated with low-income affordability, the CPUC ruled that the full decoupling mechanism used by the largest water utilities should be transitioned to one that only recognizes changes in water prices from wholesale water providers and not volumetric fluctuations. The current cost-of-capital proceeding will be instructive in gauging whether or not that increased operating risk is reflected in authorized returns.

Cal-Am is a subsidiary of American Water.

Pennsylvania — Evidentiary hearings convened for Aqua Pennsylvania Inc. and Aqua Pennsylvania Wastewater Inc.'s combined base rate case on Dec. 20, 2021. In testimony filed by the Bureau of Investigation and Enforcement, or I&E, on Jan. 11, it was disclosed, that "during the course of this proceeding the parties held a series of settlement conferences but were unable to amicably resolve the issues presented in this Aqua base rate proceeding."

I&E supports a $33.9 million rate increase, based on an 8.9% return on equity (53.95% equity) and a 6.64% return on year-end rate base valued at $4.014 billion for a test year ending March 31, 2023.

In a brief filed the same day, the Office of Consumer Advocate, or OCA, recommended a $12.1 million, or 2.2%, revenue decrease, referencing "the continued impact of the COVID-19 pandemic on Aqua's service territory" to support its recommendation. The proposed OCA rate decrease was based on an 8.0% return on equity (50% equity) and a 6.0% return on a rate base of $4.007 billion.

In August 2021, the companies had filed for a combined water and wastewater base rate increase of $97.7 million based upon a 10.75% return on equity (53.92% of capital) and a 7.64% return on year-end rate base valued at $4.016 billion for a test period ending March 31, 2023.

RRA anticipates a hearing examiner report in the proceeding in late March, with a final commission vote ahead of the expiration of the May 19 suspension date.

Aqua Pennsylvania and Aqua Pennsylvania Wastewater are subsidiaries of Essential Utilities.

RRA considers the regulatory climate for water utilities in Pennsylvania to be constructive from an investor perspective. Legislative changes over the past decade have allowed the Pennsylvania Public Utility Commission to rely on fully forecast test years in general rate cases, expanded the use of infrastructure surcharge mechanisms and facilitated the consolidation of municipal systems. Rate settlements, which are frequently utilized, are typically black box and do not specify traditional regulatory parameters underlying the approved revenue requirements. The ROE water utilities can apply to infrastructure surcharge mechanisms is adjusted quarterly and is currently above the average ROE authorized in recently decided rate cases for water utilities nationwide. RRA accords Pennsylvania regulation an Above Average/2 rating as it pertains to water utilities.

New Jersey — Most recently, New Jersey-American Water Co. Inc., or NJAW, filed with the New Jersey Board of Public Utilities, or BPU, on Jan. 14, 2022, seeking a $94.7 million, or 11.22%, base rate increase. The requested increase is premised upon a 10.5% return on equity (54.56% of capital) and a 7.48% return on a year-end rate base valued at $4.267 billion for a test period ended June 30, 2022.

NJAW represents over 20% of American Water's regulated customer base and 25% of its rate base. In its filing, the company stated that approximately 68% of the proposed revenue increase was driven by infrastructure investments.

The BPU may initially suspend proposed rates for up to eight months, but the schedule may be further extended with the consent of the petitioner. Many cases in recent years have been settled and were completed within this time frame. Fully litigated cases, however, have generally taken substantially longer to complete.

RRA accords New Jersey regulation an Average/3 ranking and considers the regulatory climate in New Jersey to be somewhat more restrictive than average from an investor viewpoint as it pertains to water utilities. While equity return authorizations by the BPU have generally been at or above the prevailing industry averages, the use of a historical test year can make it challenging for utilities to earn the authorized returns.

^{Regulatory Research Associates is a group within S&P Global Market Intelligence.}

^{This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.}