PUBLIC DOCUMENT - TRADE SECRET DATA REDACTED

MPUC Docket No. P-421/CP-00-686 OAH Docket No. 7-2500-15723-2

 

 

STATE OF MINNESOTA

OFFICE OF ADMINISTRATIVE HEARINGS

 

FOR THE MINNESOTA PUBLIC UTILITIES COMMISSION

 

In the Matter of the Request for Service in Qwest’s Tofte Exchange

FINDINGS OF FACT, CONCLUSIONS OF LAW, AND RECOMMENDATION

 

          The above-entitled matter came before Administrative Law Judge (ALJ) Richard C. Luis for an evidentiary hearing on January 10-12, 2005 in the Large Hearing Room of the Minnesota Public Utilities Commission, Suite 350, Metro Square, 121 Seventh Place East, St. Paul, Minnesota.  The hearing record closed on March 22, 2005, upon receipt of final post-hearing submissions.

 

          Joan Peterson, Attorney at Law, Qwest Corporation, 200 South Fifth Street, Room 395, Minneapolis, Minnesota 55402 and Larry Espel, Attorney at Law, Greene, Espel, Suite 1200, 200 South Sixth Street, Minneapolis, Minnesota 55402, appeared for Qwest Corporation (“Qwest” or “the Company” or “the Utility”).

 

          Julia Anderson and Priti Patel, Assistant Attorneys General, 1400 NCL Tower, 445 Minnesota Street, St. Paul, Minnesota 55101-2131, appeared for and on behalf of the Minnesota Department of Commerce (“Department”).

 

          Robert Tyson, Intervenor, 70 Pine Tree Drive, PO Box 232, Lutsen, Minnesota 55612-0232, appeared on his own behalf.  Intervenor Paul Nelson, 2339 Caribou Trail, PO Box 264, Lutsen, Minnesota 55612-0264, did not appear.

 

          John Lindell, Suite 350, Metro Square, 121 Seventh Place East, St. Paul, Minnesota 55101, represented the Staff of the Minnesota Public Utilities Commission (“PUC” or “MPUC” or “the Commission”).

 

NOTICE

 

          Notice is hereby given that pursuant to Minnesota Statute § 14.61, and the Rules of Practice of the Public Utilities Commission and the Office of Administrative Hearings, exceptions to this report, if any, by any party adversely affected must be filed within twenty (20) days of the mailing date hereof or such other date as established by the Commission’s Executive Secretary or as agreed to by the Parties with the Commission’s Executive Secretary.

 

          Questions regarding filing of exceptions should be directed to Dr. Burl Haar, Executive Secretary, Minnesota Public Utilities Commission, Suite 350 Metro Square, 121 Seventh Place East, St. Paul, Minnesota 55101.  Exceptions must be specific and stated and numbered separately.  Oral argument before a majority of the Commission will be permitted to all parties adversely affected by the ALJ’s recommendation who request such argument.  Such request must accompany the filed exceptions or reply, and an original and 14 copies of each document should be filed with the Commission.

 

          The Commission will make the final determination of the matter after the expiration of the period for filing exceptions as set forth above, or after oral argument, if such is requested and had in the matter.

 

          Further notice is hereby given that the Commission may, at its own discretion, accept or reject the ALJ’s recommendation and that said recommendation has no legal effect unless expressly adopted by the Commission as its final order.

 

 

FINDINGS OF FACT

 

I.        Procedural Background

 

          1.       On May 31, 2000, approximately 70 property owners (“Petitioners”) residing in a rural area of Cook County, near Tofte, Minnesota, filed a complaint with the Minnesota Public Utilities Commission requesting the Commission to investigate Qwest’s failure to provide telephone service to their residences.[1] 

 

          2.       Qwest responded to the complaint and estimated the cost to provide basic telephone service to 68 residences in the Tofte exchange to be $2.2 million, using a buried cable design.[2] 

 

          3.       Qwest argued that its Exchange and Network Tariff specifies line extension charges for customers requesting service beyond Qwest’s existing facilities: 

 

·       Sections 4.1.B.16 and .17 of the tariff address line extension charges and provide that Qwest will extend its line beyond current network facilities for 700 feet at no charge.[3]  After that Qwest will charge a non-recurring charge starting at the nearest network facility of $55 per line and a per foot charge of $0.51 for the first customer line, and a $0.04 per foot charge for a second line to the same location.[4] 

 

·       Section 4.1.B.1 of the tariff addresses excess construction charges and authorizes Qwest to apply excess construction charges when the provision of required equipment or facilities at the Company’s expense would not constitute a “prudent investment” if the services were furnished at the tariffed rates.[5] 

         

          4.       By Order dated June 21, 2003, the Commission directed Qwest to provide service to the Tofte petitioners and others in the unserved area of the Tofte exchange.[6]  The Commission decided that Qwest has an obligation to provide local service to all requesting customers within the carrier’s service area on a nondiscriminatory basis, regardless of a customer’s proximity to the carrier’s facilities, and the only issue in dispute was who should bear the costs of bringing the service to the petitioners.[7]  The Commission disagreed with Qwest that excess construction charges and line extension charges should be charged to the petitioners and others similarly situated in the Tofte exchange.[8] The Commission found that petitioners should share in the cost of extending service to the unserved area by paying a one time $55.00 per line charge and a $0.51 per foot non-recurring charge from the residence to the point where Qwest’s service line passes the property of a customer wanting service (assumed to be the local access road).[9]

         

          5.       On July 1, 2002, Qwest moved for reconsideration, request for stay and request for clarification, requesting that it be given two weeks to submit a proposal that would take into account its obligation to make a reasonable investment to extend its network. 

 

          6.       On reconsideration, the Commission found that Qwest had not provided specific information as to the cost to individual property owners, how total costs would be divided between new customers, nor as to Qwest’s participation in the cost of providing such service.[10] The Commission granted Qwest’s request and issued an Order[11] instructing Qwest to submit a proposal setting forth proposed prices for extending service to residents in the unserved areas of the Tofte exchange and the number of people in that area that are willing to sign up for service at those prices. 

         

          7.       On September 6, 2002, Qwest filed its conditional proposal to provide service to the Tofte petitioners.  Qwest proposed to construct the facilities necessary to extend service to the petitioners and their neighbors at a charge of $3,600 per lot for initial service, but only if 75% of the currently eligible households accepted the rate.[12]  Qwest offered this proposal as a settlement to address the cost recovery aspects of extending service to the petitioners.[13]     

         

          8.       By Order dated October 31, 2002, the Commission rejected Qwest’s proposal because it

 

did not demonstrate with appropriate cost support that the pricing proposed was fair and reasonable [footnote omitted].  Therefore, the Commission could not conclude that excess construction charges were appropriate in this case.[14]

          9.       The Commission reaffirmed its June 21, 2002 Order, clarifying that:

 

·                 Qwest shall provide order forms to each of the petitioners and other residents in the Tofte exchange within 90 days;

·                 Qwest shall extend its facilities along all public, private and forest service roads serving the customers; and

·                 customers shall be charged a $55 installation fee and a $0.51 per foot charge from the newly-installed facilities to their homes.[15]

          10.     Qwest appealed the Commission Orders, asserting that the Commission unlawfully required Qwest to bear most of the cost of providing services to the residents living within the Tofte exchange and that the Commission disregarded existing tariff provisions.

         

          11.     The Minnesota Court of Appeals agreed with Qwest and in a decision filed on July 22, 2003, the Court reversed and remanded the Commission’s Orders.[16]  The Court found the Commission’s decision to require Qwest to bear most of the costs of providing service to the Tofte petitioners was unsupported by substantial evidence in the record and failed to consider adequately the tariff provisions (line extension and excess construction charges) that allow Qwest to recover a sufficient amount of its construction charges to constitute a prudent investment.  In particular, on remand, the Court directed Qwest to

 

submit a proposal and provide data from which a determination can be made about how much of the costs need to be recovered to make the investment prudent while remaining reasonable to the petitioners.[17]

Additionally, the Court directed the Commission to

 

determine an allocation of costs that is fair and reasonable and that follows the tariff provisions, which allows Qwest to charge line extension and excess construction charges so as to make its provision of these services a prudent investment.[18]

12.           In the Notice and Order for Hearing in this matter, dated January 28, 2004[19], the Commission sought a Report from the Office of Administrative Hearings (“OAH”) making proposed findings and recommendations on issues relevant to this matter and to the Court of Appeals decision of July 22, 2003.

 

II.       General Information About the Tofte Exchange and the Joint Build

 

13.           The Tofte Exchange in Cook County is isolated territory.  The terrain is rugged and the properties are remote, diverse, and scattered.[20]  Much of the area is surrounded by U.S. Forest Service Land, which limits development.  The limited residential development that has occurred does not contain telephone facilities.  The income levels of the residents and the types of residential structures vary widely from log cabins to large homes.  Some residents live in the area year round, while others visit their properties seasonally.[21]

14.           Two distinct areas within the Tofte Exchange have requested service.  The first area surrounds Pike Lake (“Pike Lake” area) and encompasses approximately six square miles.  The second area encompasses approximately seventeen square miles around Christine Lake, White Pine Lake, Lake Clara, Holly/Mistletoe Lake, and Tait Lake (“Five Lakes” area).[22]  The total number of residential lots at issue is 249; 27 in the Pike Lake area and 222 in the Five Lakes area.[23]

15.           Qwest’s existing Tofte Exchange facility is east of Lake Christine, the southernmost lake at issue in this matter.  Initially, Qwest planned to service the Pike Lake area from that last existing Tofte Exchange facility.  Subsequently, as a way to reduce the cost of the project, Qwest decided to shift Pike Lake into the Grand Marais Exchange, and the final cost estimates reflect that Pike Lake residents would be serviced by Qwest’s existing Grand Marais Exchange facility, located at the upper northeast corner of the lake.[24] 

16.           Qwest investigated ways to provide service to the lake areas at costs that were reasonable to residents in a manner consistent with prudent investment by Qwest.  During this process, Qwest maintained a continuous dialogue with the Department and the Petitioners and updated the project as new information became available.  Qwest and the Department have reached agreement over the technology to be used in the project.[25]

17.           In the spring of 2004, Qwest learned that the electric company serving the Tofte area, Arrowhead Electric, needed to bury cable in the Tofte Exchange area.  Qwest and Arrowhead Electric reached an agreement to participate jointly in the project (“joint build”).  As a result, in the summer of 2004, Qwest completed a major portion of the construction required to provide service to the area.  The costs it experienced in this “joint build” construction project caused Qwest to reduce significantly its projected costs of completing the project.  The costs for the entire project, originally estimated at $2.2 million, were reduced first to $1.7[26] million and then to $1.16[27] million.  Of the total reduction of some $1,000,000, approximately $100,000[28] can be attributed to cost sharing with the local electric utility.

III.       Qwest Contributions to the Tofte Project

18.           Qwest is prepared to guarantee its projection against cost overruns and to charge only the actual costs (or to refund the difference) if actual costs turn out to be lower than Qwest’s estimated total.[29]

19.           Qwest believes it has more than accounted for its prudent investment in the Tofte project by accepting 10% of the costs of the project as a proxy for prudent investment.  Qwest projects that this 10% investment is likely higher than the amount that Qwest will recover in monthly revenues from customers.[30]  Qwest proposed the 10% proxy for prudent investment in an effort to be as generous as possible to the Tofte Petitioners without unduly creating subsidies from other customers.[31]  As was pointed out by Commission staff in the Access Reform Docket, subsidies are antithetical to competitive markets.[32]  Under monopoly rate-of-return regulation, the Commission has generally tried to avoid creating subsidies from one group of customers to another.[33]  Qwest argues, given the ever-increasing competitive nature of the telecommunications market, existing subsidies cannot be tolerated and new subsidies cannot be created. 

20.           Qwest has made other investments in addition to the 10% proxy for prudent investment that the company has not included in its project cost estimates and thus would not be paid by Petitioners or other customers.[34]  According to Qwest, these additional costs represent a significant contribution to the investment in the Tofte project.  In particular, in order to support the extension of service to the Five Lakes area, Qwest would incur costs for the electronics and the feeder portion of the proposed project.  These upgraded facilities would be necessary to serve the new customers in the Five Lakes areas who would be added to the system through the Tofte project.  The feeder reinforcement would be necessary to provide additional support electronics in the central office, additional cross-connecting mechanisms within the central office and reinforcement from the central office to the last-served facility.  The reinforcement would be to the “feeder” cable that serves the distribution area.  In the Tofte lakes area, this distribution portion of the network is widely dispersed.[35]  There may also be reinforcement of the cabling, repeaters and other supporting infrastructure to get service to the most remote facility.[36]

21.           Qwest excluded the costs of the electronics needed to provide the feeder component of the proposed project from the cost estimate because Qwest is not asking Tofte customers in the Five Lakes area to pay for these costs.  Nevertheless, Qwest argues that the electronics represent a substantial investment by Qwest in the project.[37]  The cost of the electronics needed to serve the area surrounding Tait Lake is [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS].  Qwest would also assume the additional costs for the electronics needed at the intersection of Caribou Trail and Honeymoon Trail.[38]

IV.      The Costs That Need To Be Recovered To Make The Investment Prudent.

22.           The parties agree that there are substantial costs related to the project that cannot be avoided and that a significant portion of the costs must be recovered immediately in order for the project to be a prudent investment for Qwest. 

23.           The analysis set forth in this report may never be implemented based upon the possibility that an insufficient number of Tofte exchange residents will take Qwest service.

24.           Qwest and the Department’s direct cost estimates are within 5% of each other for the Pike Lake area and within 25% for the Five Lakes area.  The evidence provided in prefiled testimony and at the hearing provides a well-developed record concerning the costs for this project.  Thus, both Qwest and the Department agree on the basic design methodology and agree that the costs for this project are significant.

25.           The differences in the Qwest and Department cost estimates reflect very little technical disagreement and differ primarily because of philosophical approaches.  For example, while Qwest attempts to estimate a reasonable projection, the Department’s analysis provides evidence of what is most likely to be the lowest excess charge required for Qwest to recover its investment.[39]  In contrast, Qwest has aimed for a probable case.[40]  The differences between the Qwest cost estimate and the Department cost estimate relate primarily to the Department’s use of cost assumptions that potentially erred on the lowest end of the range of costs.

26.           The Department calculates a total construction cost of [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS] while Qwest calculates a total construction cost of [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS].

27.          

 The significant cost differences between Qwest and the Department estimations involve:  use of actual costs incurred by Qwest instead of projections (particularly, labor costs), costs varying due to cable placement depth, reconciling anticipated rock projection with the actual experience of the joint build, and use of an overhead cost factor.

Labor Costs.

28.           The Department uses labor costs experienced during the joint build  construction that occurred in the summer of 2004.

29.           In contrast, Qwest uses its current average statewide labor costs for facilities construction and installation. 

30.           The Department notes that the cost models that have used Qwest’s average labor costs have consistently over-estimated costs at Tofte. The Department believes that a more accurate prediction of future labor costs is achieved through actual labor costs from a recent period at the actual location.

31.           In his analysis, Department witness Anthony Capaci assumed that the material costs would be the same as Qwest projected in its revised cost study minus the 10.58% overhead factor included by Qwest.[41] 

32.           Mr. Capaci testified that his projection total, which is 9 percent less than the costs that Qwest projected in response to Department Information Request No. 70, is reasonable, even though construction variables will result in the actual costs being either higher or lower than his estimate.[42]

33.           Qwest does not endorse the costs calculated and provided in response to Department Information Request No. 70.  Rather, Qwest endorsed the costs reflected in Exhibit RT-7, as adjusted and attached to the Rebuttal Testimony of Qwest witness Rachel Torrence.

34.           Mr. Capaci has testified, however, that the distances that will be invoiced by contractors will be close to the distances contained in the engineering prints he used to make his calculations.  Also, Mr. Capaci’s conversion of feet to cost estimates are reflective of the relationship between feet and cost that actually occurred this past summer in the joint build between Qwest and Arrowhead Electric.[43]

35.           The primary assumption used by Mr. Capaci is that the remaining construction will encounter the same proportion of rock and the same construction pricing as the jointly developed project.[44]  His cost projections also assume that all Qwest labor and material would remain the same as specified in revised projections provided by Qwest in response to Department Information Request No. 70.[45]  He did not include Qwest's overhead factor of 10.58% in his projections or in the comparison with Qwest’s revised projections.[46]

36.           In an explanation for why the Qwest cost model overestimated the costs for construction experienced in the summer of 2004, Ms. Torrence states that, “There were primarily two factors that contributed to substantial savings realized by the joint build: (1) the extraordinarily low labor costs that were negotiated and (2) the lower than expected percentage of rock that was encountered during placing.”[47]

37.           Although Qwest has used Minnesota standard construction costs in its final cost estimate shown in Exhibit RT-7[48] rather than the Qwest standard costs based on its experience across its 14 states, it has not provided sufficient evidence to show that its estimated cost factors are more accurate than the cost factors based upon actual costs experienced during the 2004 joint build.

Rock Placement.

38.           The Department’s projection for rock placement for the balance of the project is 17.5%, the same as what was experienced during Qwest’s 2004 construction project.  Because the 2004 construction project covered almost one-third of the entire project area, it is reasonable to believe that rock placement factors for the balance of the project will be similar.

39.           Although Qwest has adjusted the percentage of rock placement downward from its initial estimates, it does not list its projections in its testimony.  Based on a response to a Department information request, the Department believes that Qwest is projecting higher percentages of rock placement to complete the project than what Qwest actually encountered during the 2004 construction project.

40.           The Department has demonstrated that there is no basis in the record to project rock placement percentages higher than 17.5%.

41.           Mr. Capaci based his initial cost projections on a 2.5 percent discount for plowing and 14.3 percent discount for trenching and rock trenching.[49]  These discounts averaged over the entire project equal 8 percent, which he found reasonable when accounting for the additional rock anticipated in the Tofte project.[50]  However, in his surrebuttal, Mr. Capaci adjusted his estimate slightly to reflect, an across-the-board average depth placement discount of [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS] on plowing, trenching, rock trenching and associated costs.[51]

42.           Mr. Capaci notes that Qwest did not use the Joint Development Construction Unit Pricing developed by the joint build contractor Lonnie Gulbranson as a factor in their calculations.[52]  The actual Gulbranson Joint Development Construction Unit Pricing is a more accurate indicator of future costs since it takes into account recent actual local area experience, not overall statewide averages.[53]

43.           Mr. Capaci disagrees with Qwest regarding the percent of rock anticipated in the remaining development.[54]  According to Mr. Capaci, while the 40 percent rock projection near Tait Lake is reasonable, Qwest has provided no evidence to support the [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS] plus projection of rock placements for the roads leading to the other lakes nor does Qwest provide evidence to support a 40 percent rock factor on the roads that surround Lakes Clara, White Pine and Christine.[55]

44.           Additional information provided by Qwest regarding the percentage of rock in the Tait Lake area versus the other areas under construction in 2004, provided in response to Department Information Request No. 81, confirmed the reasonableness of Mr. Capaci’s estimation of the percentage of rock in the Tofte exchange area.  After doing a sensitivity analysis using the new information, he adhered to his original estimate of 17.5 percent of rock placement because the new number calculated according to the information in Qwest's response to the Department’s Information Request was very similar to the factor originally used by Mr. Capaci.[56]

45.           In contrast to Mr. Capaci’s documentation on the percentage of rock placement projected in the balance of the project, there is no support in the record for Ms. Torrence’s assumptions regarding the percentage of difficult placement conditions for completion of the project.  In her testimony, Ms. Torrence states that, “For Exhibit RT-7, Qwest analyzed each section and employed varying percentages on a section-by-section basis.”[57]  However, no party took core samples in the areas slated for future construction.  Therefore, apart from the construction project from the summer of 2004, there is no basis for projecting percentages of rock placement.  Ms. Torrence failed to show exactly what percentages of rock were used for each section or to provide a reasonable basis to calculate such percentages.

Reduced Depth.

46.           The Department reduces the cost of placement because it assumes that future cable is placed for Qwest’s use only, as opposed to a joint placement project.  The Department’s calculations recognize that the depth at which the cable is placed will be more shallow than the joint build because only telephone cable will be placed, not telephone and electrical cable.

47.           Mr. Capaci determined not only the per foot cost, but the percentage of rock placement.[58]  He found that the actual costs from the construction project in the summer of 2004 included placement of electric cable at a depth of 42 inches in order to meet the National Electric Code.  Because telephone cable is normally placed at 36 inches, he reduced expected placement costs by 14.3 percent, which is the percentage difference in placement depth for the remainder of the project compared to the 42 inch depth used in the joint build.[59]  His projections for costs do not include the overhead factor of 10.58%.[60]

48.           In response to Ms. Torrence’s testimony that the cable placement depth does not directly correlate to placement costs and the 14.3 percent discount factor should not be applied in projecting the costs of the remaining sections of the proposed build, Mr. Capaci testified that a reduction is still appropriate.  He agreed that the majority of placing costs are associated with labor, equipment, set-up and trenching, as provided for in Qwest testimony, but notes there is also less cost associated with shallower placement.

49.           Mr. Capaci argues that placement depth directly affects labor, equipment and trenching costs. 

Based upon his experience, contractors bid higher costs for deeper placement and lower costs for less deep placement.  He testified that the cable placement depth can vary placement costs from 0 percent to 50 percent plus, depending on placement depth variance, obstacles, and terrain.[61]  He cites an example that illustrates the cost difference for placement conditions depending on depth.[62]

50.           Qwest’s arguments do not negate the fact that there are lower costs due to the reduced placement depth.

Overhead Costs.

51.           Qwest used an overhead factor of 10.58% (or 11%) applied to investment in estimating its costs in this proceeding.  The Department does not accept Qwest’s calculation or application of this factor.

52.           “Overhead” is a term often used to refer to common costs, which can be defined as those costs that do not vary with the change in output of either a single service or a family of services.[63]  Common costs differ from attributed costs, which are those costs that can be associated with a specific group of two or more services.[64]  Attributed costs vary with the level of output of the group of services.[65]  Any cost that can be associated with a single service and varies directly with the production of that service is called a direct cost.[66]

53.           Qwest argues that the tariff provisions, specifically the “General Terms and Conditions” (item 4.1 B.2) and the “Unusual Installations – Extensions for New Real Estate Additions” (item 4.4.1 A.3), provide for the inclusion of overhead in Qwest’s costs. 

54.           Pursuant to these tariff provisions, Qwest argues that it has the right to include such overhead costs in its cost estimates when constructing projects such as Tofte.  Qwest chose not to avail itself fully of that right for this project.  Qwest witness D.M. Gude testified that the overhead loading factors that Qwest used are extremely conservative and are fully allowable under the tariff.[67]  Specifically, Qwest chose not to use a retail overhead factor in the Tofte cost estimates as is usually its practice in projects like this.  Ms. Gude explained that retail overhead is always higher than wholesale overhead because it includes additional costs that apply only when products and services are provided at retail.  In estimating overhead for Tofte, Qwest decided to use the wholesale loading components developed from the wholesale cost model and rates recently approved by the Minnesota Public Utilities Commission in the UNE Cost Docket, which approved a full wholesale loading factor of 33%.[68]  Qwest points out that the 11% loading factor used in the Tofte cost estimate is “ultra conservative” by contrast.[69]

55.           Qwest included network-related attributable costs reflecting the network overhead operations and the network support assets and computers in its Tofte estimate.[70]

56.           With respect to the application of an overhead factor, Department witness Gregory Doyle identified some errors in Qwest’s development of its cost study.  He found that Qwest applied the factor as a percentage of the investment, including both materials and labor costs.  He testified that the application of an overhead factor based on investment is concerning because such costs are not a function of the level of investment.[71]  For example, if overhead costs are assigned to loops based on investment, rural loops with greater levels of investment would be allocated a greater dollar amount of such costs than would urban loops.[72]  And, since the costs included in the overhead factor are no more attributable to a rural loop than an urban loop, it is inappropriate to have the rural consumer pay more than urban consumers in actual dollar terms.

57.           The Department maintains that Qwest has not demonstrated that its costs will vary with the level of investment to provision service in the petitioned area or that a factor used to price UNEs throughout the State is appropriate and reasonable to use in this application.[73]

58.           While additional costs resulting from the Tofte project should be considered if incurred, Mr. Doyle found that Qwest made no showing that additional “overhead” costs related to the Tofte project actually exist.  Specifically, the Department argues that Qwest failed to provide an analysis of additional costs with respect to those functions included in its “overhead” category.[74]  The accounts that Qwest included as “overhead” are not a direct function of investment.  Therefore, the Department argues that Qwest's underlying basis to apply an overhead factor--investment--is unsupported in the record.[75]

59.           Tofte customers still would be charged overhead as part of the Department’s proposed charges even if the proposed “overhead factor” by Qwest is not applied.[76]  To the extent that there are common costs or overhead costs to be recovered, Qwest will recover such costs from Tofte customers in recurring monthly charges to the same extent as it recovers those costs from the rest of Qwest's customer base.[77]  Qwest provided no basis to show that Tofte customers should be responsible for a greater portion of Qwest's overhead costs than other Qwest customers.[78]

60.           It is found that Qwest is entitled to receive overhead costs for the project.  The 11 percent overhead that Qwest seeks is well below the approved UNE docket percentage of 33 percent, and Qwest has opted to calculate the overhead factor under a wholesale rather than a retail method, resulting in a further discount to the overhead costs.  Qwest’s request to use an 11% loading factor is reasonable under these circumstances. 

V.       Reasonable Construction Charge To Be Paid By Petitioners And Future Customers.

61.           Qwest has not proposed a firm construction charge to customers in the Tofte and Grand Marais exchanges.  Qwest, however, asserts that it is entitled to recover all of its construction costs up front from initial customers desiring service.

62.           By placing all of the risk onto the initial customers, as opposed to spreading the costs and accompanying risks onto current and future customers, the construction charge will be as high as [TRADE SECRET DATA BEGINS]  trade secret data deleted[79]  [TRADE SECRET DATA ENDS] for some customers in the Pike Lake area.  A construction charge that high likely will fail to attract enough customers to make wire line service viable at Pike Lake.

63.           The Department has proposed a firm construction charge: subscribers in all project locations must each agree to a non-recurring construction charge of $4,875.[80] 

64.           Department witness John Grinager calculated the construction charge by subtracting the value of the investment from Qwest's construction costs.  Department witness Anthony Capaci estimated construction costs at [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS].  The remaining cost after the value of the investment is subtracted out, [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS], is the sum recommended by the Department to be recovered by Qwest from the initial and future customers in the form of a construction charge.

65.           Mr. Grinager testified that the construction cost should be collected from not only the initial 50 customers that sign up for service, but also from future Tofte customers who are willing to take service in subsequent years.

66.           In order to collect the shortfall between the up-front construction costs and the investment value accruing to Qwest from obtaining customers in Tofte, he calculated that Qwest would need a construction charge of $4,875 from each of the initial 50 customers and subsequently, from each future customer until a total of 162 customers subscribe.

67.           Mr. Grinager’s analysis used to calculate Qwest's per customer investment value per line of [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS], depends on the assumption that all property owners who subscribe to service will subscribe to Qwest as opposed to a competitive carrier.[81]  While Qwest does face competition from other providers in the Tofte exchange, competition has had a low impact on Qwest's residential customers in the exchange.  Accordingly, Mr. Grinager provided an analysis in which he assumed a rate of [TRADE SECRET DATA BEGINS]  trade secret data deleted  [TRADE SECRET DATA ENDS] of residential customers lost to competition.[82]  His analysis shows that with this rate of customer loss to competitors, there is a minimal financial impact to Qwest.  His analysis assumes that no matter what company provides service to the customer, Qwest receives a construction charge prior to initiation of service.

68.           Mr. Grinager recommended that the Commission condition Qwest's obligation to provide service on at least 50 customers agreeing to purchase service and providing a payment up front to assure that they will subscribe when the service becomes available.[83] 

69.           In his analysis, Mr. Grinager assumed a “take rate” of 65 percent.  He expected that roughly 45 percent of the current available customers would have to subscribe in order to get the project off of the ground.[84]  A 45 percent subscription rate (50 subscribers out of 114 properties currently with structures equals 45 percent) would be a reasonable showing of demand.  Specifically, Mr. Grinager testified that if 50 customers sign up and pay up, they demonstrate that there is a reasonable level of demand for residential service in the Tofte area.  Furthermore, as new construction takes place and property owners are able to include the cost of wire line phone service into their home construction plans and budgets, he expects the subscriber percentage to increase.[85]

70.           In response to his revised estimates of the cost of construction made by Mr. Capaci, Mr. Grinager calculated new, slightly lower rates.  Mr. Grinager’s revised proposed rates are $4,875 if the whole project is completed and $3,075 if construction is limited to just the Five Lakes area.[86] 

71.           The Department’s proposal poses a reasonable risk to Qwest that is mitigated by its proposal that the Tofte project not proceed without 50 customers initially subscribing to the service.  If 50 customers subscribe, the Department’s proposal demonstrates that demand exists at the rate proposed by the Department.  That is, once 50 customers subscribe, along with the Department’s estimated future subscribers for service in the Tofte exchange, Qwest will not be placed at undue risk of not recovering its investment.  The Department’s proposal protects the company from imprudent investment while providing a reasonable opportunity for customers to subscribe to telephone service.

72.           Under the Department’s plan, the financial risks of the project will be shared by customers and Qwest.  Of the initial [TRADE SECRET DATA BEGINS]  trade secret data deleted[87]  [TRADE SECRET DATA ENDS] in construction costs, the initial group of 50 customers will provide a total of $243,750. Customers who come on line at later dates will provide the additional revenues to cover Qwest’s investment.  The anticipated revenue stream from these future customers has been discounted in Mr. Grinager’s analysis to recognize the time value of money.[88]  If an insufficient number of customers sign up in the future, Qwest has a number of options for recovery, including negotiating terms in an Alternative Form of Regulation (AFOR) proceeding or even initiating a rate case.

73.           Qwest acknowledges that the Department’s cost allocation approach is responsive to a suggestion from some Petitioners that costs might be allocated in a uniform fashion among all owners rather than on a per location basis.  But Qwest argues that the tariff does not explicitly provide for the type of uniform allocation suggested by the Department.  Nevertheless, Qwest has no position on whether the costs of the project should be allocated equally across the entire project or whether the costs should be allocated to each lake individually.

74.           Qwest argues that the assumptions made by Mr. Grinager in his take rate analysis are not necessarily applicable to this particular project and may be highly optimistic.  For example, Mr. Grinager uses as a basis for his analysis take rates from other lake areas in northern Minnesota.  Qwest has two objections to this analysis.  First, while his analysis yields a range of take rates in the comparison areas, he chooses to rely on the highest take rate in that range.  The second objection is that his take rate analysis does not include any information about whether any of the customers in the comparison areas paid up-front excess construction charges prior to obtaining telephone service.

75.           Qwest is also concerned about the assumptions made by Mr. Grinager regarding growth of demand over the next 10 years.  Qwest asserts that while these assumptions are not per se unreasonable in terms of growth in the area, they are not a valid basis to decide to change the tariff and impose risks upon Qwest in addition to the up-front prudent investment offered by Qwest.  Additionally, Qwest is concerned by Mr. Grinager’s assumptions that the Tofte Exchange customer base will always be growing and never shrinking, especially since the Department’s proposal would require a substantial up-front construction charge before service could begin.

76.           Qwest notes that a new Verizon cell phone tower located near the Tofte Exchange has increased the quality and range of cellular options in the area.  As a result, some Tofte residents may prefer cellular phones over landline service, decreasing the possibility of meeting Mr. Grinager’s take rate analysis.  In that connection, Mr. Tyson testified that the general sentiment of a number of the original Petitioners is that cell service is the preferred method of service given the new tower, which has increased the availability and reliability of wireless service.[89]

77.           Qwest’s proposal in this case is that the tariff provisions be applied to the assessment and collection of special construction charges.[90]  According to Qwest, a direct application of the excess construction portion of the tariff would result in the entire cost of the project being recovered immediately by customers who wish to take service.  The Petitioners and other potential customers would be given the information about the costs of the project and the potential allocation and make their decisions about landline service based upon that information.

78.           The Department and Qwest agree that under a literal application of the line extension tariff, the charges to each of the customers would actually be higher than the amount proposed by the Department for all of the locations except for the customers along Lake Christine, and for those customers the line extension charges would be in the same range as the charges proposed by the Department.[91]

79.           Qwest has not proposed a firm construction charge to customers in the Tofte and Grand Marais exchanges.  To the extent that it developed per customer cost allocations, it failed to update those allocations to match its proposed cost of construction.  Further, it has not shown that its cost allocations are reasonable.  Nor has Qwest provided sufficient criteria under which further construction beyond the joint build but within the scope of the project will take place.

80.           The Department’s proposed firm construction charge of $4,875, plus an overhead factor of 11%, is fair and reasonable in amount and methodology and supported by the record.

CONCLUSIONS OF LAW

 

1.               The Commission has jurisdiction over the request for service by residents in the unserved areas of the Tofte exchange under Minn. Stat. §§ 237.06 and 237.081, subd. 4.

2.               The Commission is reviewing this matter pursuant to the July 22, 2003 Minnesota Court of Appeals decision discussed above.[92]  The Commission has found that the record necessary for the Commission to make a decision regarding this matter is best developed through formal evidentiary hearings and therefore, the Commission referred this matter to the OAH for contested case proceedings.[93]

3.               The OAH conducted hearings in this matter in accordance with the Administrative Procedure Act, Minn. Stat. §§14.57-14.62; the rules of the OAH, Minn. Rules, parts 1400.5100 to 1400.8400; and, to the extent that they are not superseded by those rules, the Commission’s Rules of Practice and Procedure, Minn. Rules, parts 7829.0100 to 7829.3200.

4.               According to the Court of Appeals in Tofte, the burden of proving that its proposed rates or charges (including allocation of costs) are reasonable is properly placed on Qwest.[94]

5.               Minn. Stat. §237.28, provides that:

In any investigation, action or proceeding arising under, or growing out of, an action initiated by the commission upon its own motion, the burden of proof shall be upon the telephone company to establish the reasonableness of the existing rates.

6.               A party asserting an affirmative defense shall have the burden of proving the existence of the defense by a preponderance of the evidence.[95]

7.               Both Qwest and the Department have provided data from which a determination can be made about the costs of the construction that would be needed to serve Petitioners.

8.               Both Qwest and the Department have provided data from which a determination can be made about how much of the costs need to be recovered to make the investment prudent while remaining reasonable to Petitioners.

9.               Both Qwest and the Department have presented proposals for addressing the cost recovery.

10.           Qwest is entitled to recover overhead under the tariff, and Qwest’s proposal to limit its overhead to 11% is reasonable and appropriate for this particular project. 

11.           Qwest’s proposal to absorb 10% of the construction costs for the project, coupled with Qwest’s commitment to provide other “upstream” improvements and enhancements necessary to serve the project does not represent a reasonable approach to keep the costs at a level that is reasonable for Petitioners and, therefore, does not comply with the Court of Appeals determination. 

12.           Qwest’s proposal to allocate the remaining costs (total construction costs specific to the project, plus a reduced overhead of 11%, excluding “upstream” costs, and then reducing the total by 10%) among the particular customers who order service is not reasonable.

13.           Qwest has determined that any proposal that allocates construction costs to future customers who are not placing orders at the time of the original project increases the risks to Qwest in such a fashion as to make the construction investment imprudent.  The determination that shifting cost recovery to future customers would make the investment imprudent is not reasonable.

14.           The Department’s proposal to allocate construction costs not only among the current subscribers but among projected future customers is not inconsistent with the existing tariff.

15.           Overall, the costs provided by Qwest do not accurately reflect the most recent costs for the Tofte exchange area at issue.  The Department’s cost projections, on the other hand, closely track the actual costs experienced by Qwest in the Tofte area and, therefore, are a more accurate reflection of the actual cost of construction.

RECOMMENDATIONs

 

          1.       A determination that the estimated construction costs for the Tofte project will amount to [TRADE SECRET DATA BEGINS]  trade secret data deleted[96] 

[TRADE SECRET DATA ENDS];

 

          2.       A determination that before Qwest is required to provide telephone service in the Tofte and Grand Marais exchanges, at least 50 customers must request service by paying a one-time up front construction charge in the amount of $5,441[97] per customer at a single location;

 

          3.       A determination that the remaining costs be recovered by Qwest from both end users and CLECs in the Five Lakes and Pike Lake areas of the Tofte and Grand Marais exchanges in the form of a construction charge in the amount of $5,441[98] per customer at a single location;

 

4.               A determination to have the remaining costs paid by Qwest as a prudent investment; and

 

 

 

 

 

 

 

          5.       A determination that the above allocation of costs is fair and reasonable.

 

 

 

 

 

Dated: April 21st, 2005                          /s/ Richard C. Luis

______________________________________

RICHARD C. LUIS

Administrative Law Judge

 

Reported: Shaddix & Associates.

                Transcripts prepared (3 volumes).