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The San Diego County Water Authority on July 31 petitioned California’s highest court to review an issue of statewide significance – whether the Metropolitan Water District of Southern California may charge its transportation-only customers costs associated with a service those customers do not purchase.
Specifically, the petition asks the Supreme Court to review whether MWD may include in the transportation rates it charges the Water Authority to wheel its conserved Colorado River water, MWD's unrelated State Water Project costs.
Central to the case are two pillars of public policy in California: the efficient allocation and conservation of the state’s water supplies, and the state’s broad commitment to ensure that the price of government services reflects no more than the costs the government incurs in providing them.
The petition also urges Supreme Court review because the Court of Appeal decision breaks with a line of prior state appellate court opinions that have appropriately recognized that--particularly when it comes to water service--charges must be based on the reasonable cost of the services provided to ensure basic fairness in the prices Californians pay for this basic necessity of life.
The state Supreme Court has until Sept. 29 to determine if it will hear the case, though it can grant itself a 30-day extension. If the court decides to hear the case, it would likely take 18 to 24 months to issue a final decision.
Review of the petition by the California Supreme Court is of vital importance to the Water Authority, serving San Diego County's 3.3 million residents, its thriving $222 billion economy and one of the largest concentrations of military facilities in the United States, including the First Marine Division at Camp Pendleton and much of the Navy's Pacific Fleet.
The Water Authority is represented by Neal Katyal, Hogan Lovells US, Washington, D.C., Keker, Van Nest & Peters, San Francisco, and Brownstein Hyatt Farber Schreck, a national firm with offices in San Diego.
Correspondence and Consultant Reports
Water Authority Wins Key Rulings at Court of Appeal
On June 21, 2017, the 1st District Court of Appeal ruled in favor of the Water Authority on nine out of 10 significant issues, including that MWD: breached its contract with the Water Authority, which required MWD to set legal rates; undercounted the Water Authority’s right to MWD water by nearly 100,000 acre-feet a year; and collected tens of millions of dollars in illegal "water stewardship" charges from San Diego ratepayers.
But the Court of Appeal ruled against the Water Authority on one important issue that has broad implications for California ratepayers and taxpayers, finding that certain state "project water supply charges," itemized by the Department of Water Resources as transportation-related for purposes of billing its own customers and comprising about 75 percent of total State Water Project costs, could be treated by MWD as though they were its transportation costs and charged to its transportation-only customers. This single issue, involving the court’s analysis of State Water Project costs, is the basis of the Water Authority’s petition to the state Supreme Court.
Superior Court Rulings Favor Water Authority
Superior Court Judge Curtis E.A. Karnow ruled in November 2015 that MWD’s rates for 2011-2014 were illegal. The judge directed MWD to pay the Water Authority more than $243 million in damages, costs, pre-judgment interest and attorneys’ fees – the largest plaintiff’s award in the state for 2015. Judge Karnow also ordered MWD to only set legal rates in future years.
The Water Authority’s Board of Directors has already determined that any money returned to the Water Authority will be refunded to its 24 member agencies in proportion to their payment of MWD’s illegal overcharges over the years in dispute, after deducting any litigation expenses that are not recovered.
Judge Karnow issued a peremptory writ of mandate that, going forward, commands MWD to:
- “Enact only legal transportation and wheeling rates in the future, and specifically, not to do the things this Court held were illegal and/or unconstitutional in the Court’s April 24, 2014 Statement of Decision….”
- “…henceforth set its rates based upon cost causation – that is, Met must charge for its services based only on what it costs to provide them.”
- “…not… include in its future transportation or wheeling rates costs that are not attributable to Met’s own conveyance system or to its actual costs in conveying water.”
- “…allocate its costs associated with local water supply development, water reclamation, desalination and conservation programs to Met’s rates and charges based on cost causation. The costs of such programs may be included in Met’s wheeling rate only to the extent that the costs of transporting wheeled (i.e. non-Met) water are a function of the costs of such programs.”
On his order barring MWD from including in its future transportation or wheeling rates costs that are not attributable to MWD’s own conveyance system, Judge Karnow explicitly ruled that:
“Met does not own or operate the State Water Project (SWP) or the SWP transportation facilities, nor does Met transport SWP water from Northern California to the terminal reservoirs at Castaic Lake and Lake Perris. The SWP is not part of Met’s conveyance system, and the SWP conveyance facilities are not a part of Met’s conveyance facilities.”
This is a very significant aspect of the ruling because MWD claimed throughout the trial that the separately owned and operated California Department of Water Resources’ State Water Project facilities were actually part of MWD’s own conveyance system and thus could be treated as an MWD “transportation” cost. MWD’s State Water Project costs constitute the largest share of costs that the Court held were improperly charged by MWD to the Water Authority for transporting the Water Authority’s independent Colorado River supplies.
In addition, as part of the judgment, Judge Karnow ruled that he will retain continuing jurisdiction to enforce his judgment and the peremptory writ of mandate.
The final ruling by Judge Karnow included a determination that MWD’s interpretation of a statutory water rights formula has improperly excluded payments by the Water Authority for transporting the Water Authority’s independent Colorado River water supplies. By law, each MWD member agency is entitled to a percentage of MWD’s available water supplies at any time based on all payments made to MWD throughout history – “excepting the purchase of water.”
The court found that the Water Authority has been purchasing transportation service from MWD to convey water supplies the Water Authority buys from the Imperial Irrigation District and from lining the All American and Coachella canals in the Imperial Valley, rejecting MWD’s argument that the Water Authority’s transfer supplies were purchases of MWD water that should therefore be excluded from the calculation of preferential rights. Correct assessment of the Water Authority’s preferential rights will mean access to tens of thousands of acre-feet of water per year for the San Diego region, a significant increase in supplies.
Fourth rate case lawsuit filed
Ignoring the judge’s ruling and order to set only lawful rates, MWD's board of directors on April 12, 2016, approved rates and charges for 2017 and 2018 using the same illegal methodology that it used in 2011-2014. MWD charges an illegally high rate to transport the Water Authority’s independent Colorado River supplies.
MWD’s overcharges of the Water Authority for 2017 and 2018 are expected to be more than $134 million, and overcharges for the eight years contested by the Water Authority are approximately $524 million (not counting the interest, court costs and attorney’s fees from 2015-2018).
The Water Authority in April 2016 filed its fourth lawsuit against MWD, alleging that MWD’s rates for 2017 and 2018 violate California law, the state Constitution and common law that all require rates to be set based upon cost of service.
Phase 1 ruling finds MWD violations
In April 2014, Judge Karnow issued his final statement of decision in Phase 1 of the Water Authority's legal challenge to rates set by the Metropolitan Water District of Southern California. Judge Karnow upheld and strengthened his tentative ruling issued Feb. 25. Judge Karnow ruled that MWD's rates for 2011, 2012, 2013 and 2014 violate cost of service requirements of California’s Constitution, statutes and common law. Specifically, Judge Karnow’s final statement of decision is that MWD’s rates violate:
- Proposition 26
- the Wheeling Statute
- Government Code Section 549997(a)
- Common law rules that apply to ratemaking
The final Phase 1 ruling came in lawsuits filed in 2010 and 2012 by the San Diego County Water Authority challenging rates imposed by MWD for 2011-2014.
Over the five-day trial held Dec. 17-23, 2013, in San Francisco Superior Court, the Water Authority’s attorneys presented reams of evidence and witness testimony that proved MWD’s rates artificially inflate the cost of its water transportation services by improperly including unrelated expenses. Numerous California statutes, the California Constitution and common law all require that public agencies such as MWD base their rates on the actual costs of the services provided.
MWD’s flawed rates create overcharges for San Diego County for the transportation of water and corresponding undercharges for the water MWD sells to its member agencies.
The Water Authority first sued MWD in June 2010 for adopting illegal rates that are not based on the costs of providing the services for which they are collected. The Water Authority filed another lawsuit in June 2012 because the 2010 case had not been resolved and MWD had adopted rates for 2013 and 2014 based on its same flawed allocation.
On May 30, 2014, the Water Authority filed a third legal challenge against MWD’s rates following a decision by the MWD Board to adopt rates for 2015 and 2016 using the same illegal methodology it used the prior four years.
Two decades ago, almost all of San Diego County’s water needs were met by a single supplier – the Los Angeles-based Metropolitan Water District of Southern California. In 1991, after a multi-year drought severely limited water supplies, MWD cut water deliveries 30 percent to the San Diego region, severely impacted the local economy and quality of life. Delivery cuts of 50 percent were only averted by “Miracle March” rains. The Water Authority Board then set forth a course to develop a supply diversification strategy to ensure that the region was never again dependent on a single supplier for nearly all of its water.
The cornerstone of this diversification strategy is a set of historic agreements the Water Authority signed in 2003 to secure its own sources of water from the Colorado River. Under long-term agreements, ranging from 45 to 110 years, the Water Authority purchases water from the Imperial Irrigation District and receives other independent water supplies from relining the All-American and Coachella canals. In order to get this water to San Diego County, the Water Authority uses pipelines that are controlled by MWD.
The Water Authority is the only MWD member agency that uses the pipelines MWD controls to transport a large volume of third party water supplies each year.
MWD’s Misallocation of Costs
The Water Authority believes that MWD is overcharging to transport this water and is using that money to subsidize the cost of water MWD sells to its member agencies. This practice violates the California Constitution, other state law and standard water utility practice.
About half of MWD's supplies come from its purchases from the State Water Project under a supply contract with the Department of Water Resources. Instead of treating these purchases as a cost of water, MWD allocates nearly 80 percent of the cost to charges it imposes for the transportation of the Water Authority's water through MWD facilities - even though MWD does not own the state system, and not a drop of Water Authority's own Colorado River water supplies touches that system. This discriminates against the Water Authority, which is the single largest user of MWD transportation services. The Water Authority uses MWD facilities to transport Colorado River water it purchases under a water conservation agreement with the Imperial Irrigation District, and also from lining sections of the All-American and Coachella Canals.
Financial Impacts to San Diego County Ratepayers
MWD’s illegal rates cause significant financial harm to the San Diego region. The overcharges may grow to as much as $217 million annually as the Water Authority’s independent Colorado River supplies reach their peak in 2021. Collectively, these overcharges could amount to $2.1 billion over the life of the agreements.
In 2010, after years of trying to work with MWD to resolve concerns with MWD’s-rate setting practices, the Water Authority filed a lawsuit against MWD for its 2011 and 2012 rates. The Water Authority filed a second suit in June 2012, after MWD set rates for 2013 and 2014 that were based on the same flawed cost-of-service methodology as the first action. The second lawsuit was necessary because MWD’s delays in the first lawsuit slowed its resolution.
The Water Authority’s two lawsuits against MWD present common factual and legal elements. Each lawsuit asserts that MWD’s rates assign water supply costs to transportation rates in violation of state law and the state Constitution. Both cases also allege that the water rates set by MWD discriminate against the Water Authority by artificially inflating the price charged for “wheeling” (or transporting) water through MWD’s pipes if it is purchased from a water supplier other than MWD.
Why are MWD’s Rates Illegal?
MWD is legally required to charge rates that are reasonably related to the costs of services provided and reasonably allocated among its member agencies according to the benefit they receive from particular services. The Water Authority’s lawsuit claims MWD is improperly charging hundreds of millions of dollars in water supply costs to its System Access Rate, System Power Rate and Water Stewardship Rate. These three rate components comprise MWD’s transportation Rate.
The lawsuits allege:
- MWD’s rates misallocate MWD’s “supply” costs by characterizing the water MWD purchases under its contract with the State Water Project as “transportation” when in fact MWD does not own or operate any of the facilities that deliver State Water Project water to Metropolitan. The State of California owns and operates those facilities.
- MWD’s rates misallocate MWD’s “supply” costs by characterizing its subsidy investments in water conservation and local water supply projects, such as recycled water and seawater desalination, as “transportation” costs.
- At the urging of self-interested member agencies, MWD’s board has set invalid rates without taking into account where the costs should be properly allocated. MWD is not following clear industry standards or California law.
- MWD’s illegal rates breach a 2003 contract with the Water Authority in which MWD promised to charge the Water Authority for water transportation services in accordance with state law.
- The 2012 lawsuit additionally alleges that MWD violated Proposition 26, a voter-approved measure passed in November 2011. Prop. 26 aims to prevent public agencies from passing hidden taxes by ensuring that rate increases are tied to cost of service.
- In its 2012 lawsuit, the Water Authority is also seeking to address another major flaw in MWD’s rates: MWD has failed to properly recover tens of millions of dollars annually in operational and other costs it incurs as a “standby” supplier for member agencies whose water demands vary greatly from year to year. MWD has not performed adequate studies or calculated the costs of purchasing, storing and delivering water supplies to meet the varying annual needs of its member agencies. Instead, MWD misallocates many of these costs to its other rates. MWD's current rate structure is akin to allowing member agencies getting the insurance benefits, without ever paying for the service. This practice forces steady MWD customers, such as the Water Authority, to pay a disproportionate share of the costs of providing this stand-by service. The annual benefit is estimated at $40 million, just for the city of Los Angeles, which has historically altered its purchases of MWD water by more than 200,000 acre-feet from one year to the next.