BILL ANALYSIS 1 1 SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE DEBRA BOWEN, CHAIRWOMAN AB 2898 - Pescetti Hearing Date: June 25, 2002 A As Proposed to be Amended FISCAL B 2 8 9 8 DESCRIPTION NOTE: The analysis reflects amendments the author will propose in committee to limit the application of this bill to Roseville Telephone Company and Citizens Communications. Current law requires that telephone rates be just and reasonable. Current law provides that it's the policy of the state to promote lower prices, broader consumer choice, and avoidance of anti-competitive conduct. This bill states legislative intent to maintain the progress created by the California Public Utilities Commission's (CPUC) new regulatory framework (NRF) for telecommunications companies. This bill finds that telecommunications companies regulated under NRF require certainty with respect to its provisions. This bill requires the CPUC to suspend any price cap index, productivity factor, and sharing mechanism until January 1, 2007 for Roseville Telephone Company and Citizens Communications. BACKGROUND This bill is identical to AB 2958 (Wright), which is scheduled to be before the committee today, except that it - as proposed to be amended by the author -applies only to Roseville Telephone Company and Citizens Communications. Federal and state laws and policies have consistently tried to transform telecommunications monopolies into competitive markets. This started with the market for telephone sets in the early 1980's, moved to long distance telephone service in the mid-80's, then to short distance telephone service in the late 80's, and finally to local telephone service in the mid-90's. As the markets became competitive, regulation changed. Telephone sets, once only obtainable through the AT&T monopoly at regulated prices, can be purchased virtually anywhere. Long and short distance service can be purchased from hundreds of companies. Local telephone service is now starting to become competitive, based upon very recent decisions at the state and federal level. NRF, or New Regulatory Framework, is the now outdated name for the regulatory structure for the larger local telephone companies. It was created by the CPUC in 1989 to replace the long-standing process of setting telephone rates equal to the cost of serving those customers, plus a fair profit for the telephone company. Under NRF, rates charged were indexed annually - increased by the rate of inflation and decreased by a "productivity factor" aimed at reflecting gains from technological innovation occurring in telecommunications markets. Initially, NRF applied to only the two largest local telephone companies, SBC and Verizon (then Pacific Bell and GTE California). Subsequently, NRF was applied to the next two largest local telephone companies, Citizens Communications and Roseville Telephone Company (RTC). Citizens Communications offers services in 24 states, serving primarily rural areas. It's the 3rd largest local telephone company in California, serving about 145,000 lines with the biggest concentration in Elk Grove. Citizens has been regulated under a form of NRF since 1996. At that time, NRF consisted of a sharing mechanism with prices indexed to inflation less a productivity adjustment. In 2000, the CPUC altered Citizens' NRF to suspend the price indexing, but to retain the profit sharing. Citizens' NRF is currently under review at the CPUC and the company has asked the CPUC to eliminate the profit sharing mechanism. RTC is a division of SureWest Communications, headquartered in Roseville. RTC is the 4th largest local telephone company in California, serving about 135,000 lines exclusively in the Roseville/Sacramento area. RTC has been regulated under a form of NRF since 1996. The beginning NRF consisted of a price index, which effectively capped prices and a profit sharing mechanism. In 2001, the CPUC tinkered with the NRF structure and continued the profit sharing mechanism. RTC has petitioned the CPUC to change the 2001 decision. COMMENTS 1)CPUC Proceedings . Citizens is in the midst of a NRF review at the CPUC. RTC's NRF was just reviewed by the CPUC and RTC is in the process of challenging the CPUC's decision. Therefore, this bill in one case reverses a CPUC decision (for RTC) and prejudges a CPUC decision in another case (Citizens). The Legislature long ago gave the CPUC clear policy direction that telecommunications rates must be "just and reasonable," and left with the CPUC the job of creating the mechanism for meeting that policy. For decades, the CPUC met the Legislature's policy goals through traditional rate of return regulation. In response to the changing telecommunications market place, the CPUC replaced that old regulatory scheme with the NRF. NRF is wholly a creature of the CPUC and the Legislature appropriately never codified the NRF or changed its structure, because doing so would have moved the Legislature into the business of rate-making and would have limited the discretion of future CPUCs. 2)Is Freezing the Current Version of the NRF Good For Ratepayers? Apart from the philosophical question of whether the Legislature should effectively override the decisions of the CPUC when it comes to NRF is the practical question of whether freezing the current terms of NRF in place is good for ratepayers. Theoretically, in a fully competitive market regulators wouldn't need to review or constrain prices or profits, because competitors would provides such a check on one another, allowing ratepayers to benefit. As this committee heard during an informational hearing on June 10, there is little evidence to suggest that competition is anywhere close to approaching "robust." According to the CPUC's recently released competition report, The Status of Telecommunications Competition in California (June 5, 2002), 95% of the telephone lines in the state are controlled by SBC, Verizon, and the other incumbent telephone companies as of June 2001. (The number is slightly higher for residential lines and lower for business lines.) This finding is corroborated by data from the Federal Communications Commission, which found that competitors provide about 7% of the lines. 3)Bill Implications . The NRF is intended to represent a balanced application of regulatory tools which leads to just and reasonable rates. This bill takes away the CPUC's flexibility to utilize the profit sharing and price indexing tools to meets its statutory obligation of assuring that prices are just and reasonable. Since the NRF was established in 1989, the CPUC has continued to tinker with the balance in the NRF by adjusting profit sharing levels, price indexes, and permanent rate adjustments, all in response to changing market conditions. This bill has one of two implications. The first is that it is intended to substitute for the CPUC's judgement on whether existing rates are fair and reasonable. This could be inferred from the intent language in the bill which speaks to "maintaining the progress created by the commission's NRF" and the findings about the need for certainty about the provisions of the NRF. By locking the 1998 version of NRF in place through 2006, this bill appears to make adherence to a particular regulatory structure (NRF, which has been altered three times to reflect changing market conditions since 1989) more important than adherence to the CPUC's overall statutory charge of protecting ratepayers (which is to ensure ratepayers are charged no more than just and reasonable rates). The second, alternative implication is that the bill is solely intended to restrict the CPUC's use of the profit sharing and price indexing tools but not its ability to ensure prices are just and reasonable. If that's the case, then the CPUC will have to find some other mechanism to meet that larger statutory mandate. In that sense, the bill paradoxically moves the CPUC back to traditional rate of return regulation, as that's the one known mechanism that can produce fair and reasonable rates. Perhaps some alternative mechanism can be found, but that of course is what the NRF represented. 4)Picking Winners . Supporters of this bill assert that freezing the current NRF in place creates strong incentives to invest. Objective data supporting this analysis is hard to come by, though several highly touted infrastructure initiatives designed to deploy advanced technologies throughout California have been shelved or curtailed. In a tightly regulated, non-competitive world, regulators may choose to increase the allowed return of the regulated companies to encourage those companies to invest in necessary infrastructure. However, providing incumbent telephone companies with strong incentives to invest in a world where competitors are also trying to enter only skews the competitive marketplace. While the possibility of high returns for the incumbent regulated company will of course create an incentive to invest, it will also tip the playing field against competitors. The extra incentive for incumbents to invest will drive out competitors that won't want to compete in a biased game. Striking the right balance which encourages healthy competition is a tricky task, and one which is extremely difficult to find in an instrument as blunt as this bill. Clearly investment will go where returns are best, but remember that the revenues that make returns high come from telephone customers. To the extent that investment is attracted by the highest returns, customers may be paying too much. Consider the recent short-lived boom in electric powerplant investments, which resulted from the high prices customers paid for electricity. 5)Can You Hear Me Now? Since the mid 1990's, Citizens has had problems with the quality of its telecommunications service in the Elk Grove area. Citizens has admitted to service quality problems and in 1995, the CPUC reduced Citizens' telephone rates as a penalty. Service quality subsequently improved and in 2000, Citizens and the CPUC's Office of Ratepayer Advocates agreed that the required service quality improvements had been made. 6)Mitigating Circumstances for RTC . Some circumstances make RTC unique among California's larger and more well-known incumbent local telephone companies. First, all of its operations are in California, so all of its investments stay in California. Second, through its affiliates RTC is investing not just in its own service territory but also in the service territory of its much bigger rival, SBC. No other sizeable incumbent local telephone company has attempted to compete by investing in their own facilities as vigorously as RTC and its affiliates. While this may not justify the Legislature overriding a CPUC decision, it is a distinction worth noting. ASSEMBLY VOTES Assembly Floor (64-2) Assembly Appropriations Committee (19-0) Assembly Utilities and Commerce Committee (13-0) POSITIONS Sponsor: Roseville Telephone (Surewest Communications) Support: California Chamber of Commerce California Telephone Association Citizens Telecommunications Company of California Inc. City of Roseville Construction and General Laborer's Local 185 County of Placer Board of Supervisors Hewlett-Packard Company Intel Corporation Kerman Telephone Company McClellan Park Placer Electric Inc. PRIDE Industries Rocklin Area Chamber of Commerce Roseville Chamber of Commerce Sacramento Metropolitan Chamber of Commerce SBC Pac Bell Verizon Oppose: AARP California California Association of Competitive Telecommunications Companies California Public Utilities Commission Office of Ratepayer Advocates Pac West Telecomm, Inc. The Utility Reform Network XO Communications, Inc. Randy Chinn AB 2898 Analysis Hearing Date: June 25, 2002