BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 2958
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          ASSEMBLY THIRD READING
          AB 2958 (Wright)
          As Amended May 6, 2002
          Majority vote 

           UTILITIES AND COMMERCE     15-0 APPROPRIATIONS      21-0        
           
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          |Ayes:|Wright, Pescetti,         |Ayes:|Steinberg, Bates,         |
          |     |Calderon,                 |     |Alquist, Ashburn, Cohn,   |
          |     |John Campbell,            |     |Corbett, Correa, Daucher, |
          |     |Canciamilla, Cardenas,    |     |Diaz, Firebaugh,          |
          |     |Diaz, Horton, Kelley, La  |     |Goldberg, Maldonado,      |
          |     |Suer, Leonard, Maddox,    |     |Negrete McLeod, Robert    |
          |     |Liu, Papan, Reyes         |     |Pacheco, Papan, Chu,      |
          |     |                          |     |Runner, Washington,       |
          |     |                          |     |Wiggins, Wright, Zettel   |
           ----------------------------------------------------------------- 

           SUMMARY  :  Codifies in statute portions of a 1998 decision by the  
          California Public Utilities Commission (PUC) adopting a new  
          regulatory framework program and price adjustment formula for  
          two major incumbent local exchange telephone carriers (ILECs).   
          Specifically,  this bill  :  

          1)Affects SBC-Pacific Bell and Verizon, companies that were  
            subject to the modifications made by PUC to the new regulatory  
            framework (NRF) in Decision 98-10-026.

          2)Specifies that any price cap, index productivity factor,  
            sharing mechanism, and related elements of NRF shall continue  
            to be suspended, consistent with PUC's decision.

          3)Provides that PUC shall maintain authority to regulate prices  
            for all services subject to its jurisdiction, and shall  
            continue to have authority to move service between all pricing  
            categories.

          4)Clarifies that PUC's existing authority to regulate the  
            quality of service provided by telephone corporations shall be  
            preserved.

          5)Sunsets on January 1, 2007.

          6)Makes various legislative findings: 








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             a)   Making reference to NRF;

             b)   That, in exchange for certainty provided by the  
               Legislature, telephone corporations should reinvest in the  
               state's communications network and employment base; and,

             c)   To the fact that circumstances exist making this special  
               statute valid because a general law cannot be made  
               applicable.

           EXISTING LAW  :

          1)Grants PUC regulatory authority over local telephone  
            corporations.

          2)Requires PUC to inspect and audit the books and records of  
            telephone corporations for regulatory and tax purposes at  
            least once every three years.

           FISCAL EFFECT  :  According to the Assembly Appropriations  
          Committee, potential savings to PUC from avoided proceedings  
          that might otherwise be undertaken regarding the regulatory  
          elements suspended in its 1998 decision.

          [The PUC estimates costs of about $1.4 million for 14 new  
          positions to develop an alternative regulatory tools-in lieu of  
          those being suspended in the bill- to ensure just and reasonable  
          telephone rates.  However, by freezing the existing regulatory  
          scheme with respect to certain elements of NRF, AB 2958, in and  
          of itself, does not impose additional workload on the PUC.  The  
          commission's cost estimate is based on how the commission might  
          choose to respond based on the results of a future audit of the  
          company or companies.  Moreover, should the commission choose to  
          modify NRF regulation, it would have to justify any request for  
          additional staff for this purpose through the budget process  
          given the commission's existing regulatory staff and workload.]

           COMMENTS  :  

          1)Before 1989, ILECs were regulated under a rate-of-return  
            framework, which in general sets rates based on expenses  
            incurred in providing service, allowing a reasonable profit on  
            the utility's assets that are used to provide the service.  









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          In 1989, PUC adopted NRF, an incentive-based regulatory system  
            designed to promote PUC goals of universal service, economic  
            efficiency, technological advancement, rate stability, full  
            utilization of the local exchange network, and avoidance of  
            cross-subsidies and anti-competitive behavior.

          Under NRF, rates are adjusted annually based on a formula that  
            offsets inflation costs against cost decreases due to  
            increased productivity, additionally allowing cost recovery on  
            matters outside the control of the utility.

          2)Category I, II and III services:  NRF classifies basic  
            monopoly services like dial tone as Category I services.  PUC  
            sets prices for all Category I monopoly services.  Category II  
            includes partially competitive and discretionary services.   
            These services have price ceilings and floors approved by PUC,  
            and the regulated entity is free to adjust price in between.   
            Utilities are allowed maximum pricing flexibility for Category  
            III, or fully competitive, services.

          3)Price cap index & productivity factor:  NRF contains a price  
            cap index formula, equal to inflation minus a productivity  
            factor, and applicable to Category I and II services.  The  
            productivity factor was designed as a substitute for market  
            forces, passing through gains in productivity to customers.   
            In 1995, PUC suspended the price cap index and productivity  
            factor on the belief that the market was evolving and that  
            market conditions did not warrant continued application of the  
            formula. 

          4)Sharing:  NRF contains an earnings-sharing mechanism, which  
            includes a benchmark, ceiling and floor rate of return.  ILECs  
            retain 100% of earnings up to the benchmark, but return  
            earnings at varying percentages to ratepayers for earnings  
            above the ceiling rate of return.    

          5)The PUC decision regarding SBC-Pacific Bell and Verizon:  In  
            the 1998 decision established as the NRF benchmark in this  
            bill, PUC ordered continuing suspension of the price cap index  
            and productivity factor previously suspended in 1995, and  
            suspended sharing for Pacific Bell and Verizon.  

          PUC found that continuing the suspension of price caps and the  
            productivity factor would advance the goals (outlined above)  
            of NRF and would produce rates that are just and reasonable.   








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            PUC noted that suspension does not eliminate PUC authority  
            over, or remove, rate caps, floors or ceilings on Category I  
            and II services.

          In the decision, PUC suspended sharing for Pacific Bell and  
            Verizon on the belief that sharing distorts operating and  
            investment decisions because it changes the forecast of  
            present and future cash flows, and introduces uncertainty into  
            the stream of returns.  PUC also voiced concern about  
            asymmetric application of sharing; giving potential  
            competitors an ability to make investment decisions without  
            similarly imposed profit constraints.

          6)Audit:  PUC recently announced completion of a Section 314.5  
            triennial audit of Pacific Bell, covering the years 1997  
            through 1999.  The audit recommends customer refunds of almost  
            $350 million for the years 1997 and 1998, consistent with the  
            sharing mechanism in place during the relevant time.  PUC  
            intends to review the audit report in a formal proceeding,  
            during which Pacific Bell and interested parties will have an  
            opportunity to be heard on the audit findings.  

          This bill does not affect the audit review process, including  
            the adjudication of whether or not refunds in the form of  
            sharing are due to consumers.


           Analysis Prepared by  :    Paul Donahue / U. & C. / (916) 319-2083


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