of

Terry L. Murray

on behalf of the Utility Consumers Action Network

April 14, 2006

I.                   Introduction and Qualifications

Q.            Please state your name, title and business address.

A.        My name is Terry L. Murray.  I am President of the consulting firm Murray & Cratty, LLC.  My business address is 8627 Thors Bay Road, El Cerrito, CA  94530.

Q.            Please describe your qualifications and experience as they pertain to this proceed­ing.

A.        I am an economist specializing in analysis of regulated industries.  I received an M.A. and an M.Phil. in Economics from Yale University and an A.B. in Economics from Oberlin College.  At Yale, I was admitted to doctoral candidacy and completed all requirements for the Ph.D. except the dissertation.  My fields of concentration at Yale were industrial organization (including an emphasis on regulatory and antitrust economics) and energy and environmental economics.

My professional background includes employment and consulting experience in the fields of telecommunications, energy and insurance regulation.  As a consultant, I have testified or served as an expert on telecommunications issues in proceedings before state regulatory commissions in Alaska, California, Connecticut, Delaware, the District of Columbia, Florida, Georgia, Hawaii, Illinois, Indiana, Kansas, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington and Wisconsin, and before the Federal Communications Commission (“FCC”).

Before I became a consultant in 1990, I was employed in a variety of positions (including Director of the Division of Ratepayer Advocates (“DRA”)) at the California Public Utilities Commission (“CPUC” or “Commission”) for approximately six years and had significant responsibility for telecommunications matters.  I have also taught economics and regulatory policy at both the undergraduate and graduate levels.

My curriculum vitae, which is appended as Exhibit TLM-1 to this testimony, provides more detail concerning my qualifications and experience.

Q.        What is the purpose of your reply testimony?

A.        The Utility Consumers Action Network (“UCAN”) has asked me to review the opening testimony of AT&T California witnesses Joseph R. Kieren,[1] Frances G. Astuto[2] and L. Byron McDaniel[3] regarding AT&T California’s proposal for recovery of costs associated with the San Diego undergrounding project.  My reply testimony responds to their testimonies and identifies flaws in AT&T California’s cost recovery proposal.

Q.            Please summarize the remainder of your reply testimony.

A.        AT&T California’s proposal for recovery of costs associated with the San Diego undergrounding project is anti-consumer and anti-competitive.  It contains the following flaws:

·                    The cost recovery proposal creates a real risk that San Diego ratepayers will overcompensate AT&T California for the costs of undergrounding.  In particular, there is a significant risk that San Diego basic access line subscribers will be forced to subsidize AT&T California’s installation of “Project Lightspeed” and other network enhancements.  To reduce this risk, the Commission should require AT&T California to exclude from surcharge recovery the cost of any network upgrades (i.e., the installation of any plant with capabilities that exceed the capabilities of the embedded aerial network facilities being replaced).

·                    Contrary to AT&T California’s assertion, the proposal for a flat per-line surcharge does not properly reflect the expected benefits of the undergrounding project.  A surcharge based on total bill size would more closely reflect the expected benefits of the project. 

·                    Regardless of the method of cost recovery the Commission permits, AT&T California should not be permitted to levy any undergrounding surcharge against Universal Lifeline Telephone Service (“ULTS”) customers at all.   AT&T California’s arguments concerning the difficulties of excluding ULTS customers from the surcharge are largely red herrings; a workable solution to the limited logistical issues is readily achievable.

·                    Permitting any surcharge whatsoever is questionable in the context of the soon-to-be-issued draft decision in the Uniform Regulatory Framework (“URF”) rulemaking, which may well deregulate the prices AT&T California charges for some or all of the access line categories to which the company proposes to apply the surcharge.

I elaborate on each of these points in the testimony that follows.

II.                AT&T California Should Not Be Permitted to Recover the Costs of Network Upgrades in Any Surcharge.

Q.        What costs does AT&T California propose to recover through its per-line surcharge?

A.            According to Ms. Astuto, “AT&T California intends to recover labor, material, and administrative costs associated with work performed on the surcharge projects.”[4]  The labor costs include “labor costs associated with the engineering, placing, splicing, inspection, and administration of the surcharge projects, and other minor associated labor costs[, and] … labor for facilities assignments, which assigns specific cable pairs serving [AT&T’s] customers, updating schematic cable and conduit record maps, as well as updating permanent property records for inventory purposes.”[5]  “Material costs will primarily consist of copper cable, fiber cable, serving area interfaces, and serving terminals, and other minor associated material costs.”[6]  Mr. Kieren states that the administrative costs include “development costs associated with billing, records review, and database development and integration.  ….  There will also be a cost associated with engineering and network operations systems, methods & procedures, and ongoing maintenance costs.”[7]

Q.        do you agree that the costs AT&T California proposes to recover through the surcharge correctly represent the costs directly attributable to the undergrounding projects required by the City of San Diego?

A.        No.  The surcharge proposal would overcompensate AT&T California for the costs directly attributable to the required undergrounding projects.  The surcharge proposal includes labor and materials cost recovery for installing new “copper and fiber cables, electronics, and associated items of plant.”[8]  All of these plant categories represent depreciable plant that AT&T California routinely, over time, replaces.  Therefore, the undergrounding project at most requires that AT&T California accelerate its replacement of existing depreciable plant and only causes AT&T California to incur the costs for accelerating the plant placement (which should be less than the total costs).  Further, AT&T California probably will obtain offsetting benefits in the form of lower maintenance costs because new plant indisputably costs less to maintain than does older plant,[9] yet AT&T California has made no provision to reduce the total costs recovered through the surcharge by any maintenance cost savings.

                        Even more troubling is the possibility that AT&T California will charge San Diego basic ratepayers for the costs of installing portions of its already planned network upgrades, such as Project Lightspeed.  A November 2004 Project Lightspeed investor briefing describes the company’s plans to replace copper cables with fiber and electronics extending to within 3,000 feet of the home in existing neighborhoods (a fiber-to-the-node or “FTTN” design) and all the way to customers’ premises for new construction and “selected rehab situations” (a fiber-to-the-premise or “FTTP” design).[10]  The stated purpose of this increased use of fiber and electronics is to permit the company to offer “[i]ntegrated IP voice, high-speed Internet access and video.”[11]  Notably, the original SBC materials announcing Project Lightspeed disclose how the company segments its customers into three groups based on average revenue per customer:  “high-value customers” (who spend between $160 and $200 per month on services from the company itself and other providers, including video providers); “medium-value customers” ($110-$160 per month) and “low-value customers” (under $110 per month).[12]  “Low-value customers” (presumably those who purchase basic local exchange service and at most a minimal amount of vertical features or long-distance services plus, perhaps, basic cable services) constituted fully 35% of SBC’s pre-merger customer base.  Yet, the Project Lightspeed network modernization initiative is projected to “cover” only about 5% of these low-value customers, as opposed to 90% of high-value customers and 70% of medium-value customers.[13]  Forcing basic ratepayers (particularly low-income ULTS customers) to fund the installation of modernized plant with expanded capabilities designed to permit the provision of potentially lucrative video and high-speed data services would be both anti-consumer and anti-competitive.  

Q.        Mr. McDaniel asserts that “[t]he patchwork nature of the City of San Diego’s projects will not allow AT&T California to implement any network enhancements in connection with the program.”[14]  Does this testimony allay your concerns?

A.        No.  Mr. McDaniel’s testimony consists merely of this one bald, unsupported assertion, which seems inconsistent with the policy of the City of San Diego, as stated in an attachment to his testimony.  The City of San Diego Council policy explicitly recognizes the desirability of avoiding a patchwork of underground and aerial facilities and establishes procedures designed to minimize such a patchwork.[15]  Given a little creativity – and perhaps a voluntary choice to extend undergrounding to limited areas immediately adjacent to City-mandated “blocks” (which I understand can include entire neighborhoods), AT&T California may well be able to conduct at least some undergrounding projects for geographic areas that correspond fairly closely to the Distribution Areas that are the basic building blocks of its outside plant design.  The Commission simply cannot rely on Mr. McDaniel’s unsupported assertion to conclude that AT&T California will be unable to fund any part of its planned network upgrades via the undergrounding surcharge.

Q.       How could the Commission minimize this risk of cross-subsidization?

A.        The Commission could instruct AT&T California to exclude from the surcharge base all labor and materials costs for placing any plant that expands the capacity or increases the capability of the aerial facilities being replaced.  To determine whether AT&T California complies with this instruction, the Commission should require the company to pay for an independent third-party audit of its project cost records, performed by engineers and/or accountants who report to the Commission’s Telecommunications Division.  These requirements would help to ensure that AT&T California cannot force San Diego basic ratepayers to subsidize Project Lightspeed or other network enhancements, and the independent audit would also help to ensure that AT&T California does not book other excessive costs to the surcharge balancing account.

III.             A Total Bill Surcharge, Rather than a Per-Line Surcharge, Is Likely to Better Reflect the Expected Benefits of the Undergrounding Project.

Q.        Mr. Kieren states that “Applying the surcharge equally across all common access lines is the most appropriate way to assure that the cost of the surcharge will be distributed fairly over the San Diego population that would receive any benefits from the undergrounding.”[16]  Do you agree?

A.        No.  AT&T California’s proposed per-line surcharge would be regressive (i.e., it would tend to fall disproportionately on lower-income customers).  In contrast, the benefits from the undergrounding are likely to be progressive (i.e., they will tend to inure disproportionately to higher-income customers).  Therefore, under AT&T California’s proposal, lower-income customers will pay a disproportionately high share of the costs of undergrounding, while simultaneously receiving a disproportionately low share of the benefits.

Q.        Why is a per-line surcharge regressive?

A.        The number of telephone lines per residential customer is largely invariant.  Most customers have one wireline telephone access line; a much smaller (and generally decreasing[17]) number of customers have two wireline access lines; very few residential customers subscribe to more than two wireline access lines.  Therefore, a per-line surcharge would result in most customers paying approximately the same amount per month toward the recovery of AT&T California’s San Diego undergrounding costs, regardless of household income.  This is very much like what economists call a “poll tax” or “head tax,” which is the classic example of a regressive tax.  Expressed as a percentage of household income, the impact of a per-line surcharge would be greatest for the lowest-income customers and would gradually decline as household income increases.

Q.       Why do you expect that the benefits of undergrounding would be largely progressive?

A.        The value of property in San Diego will increase when and where utility lines are placed underground.  Property owners – who are disproportionately higher-income individuals and companies – therefore can expect to receive a substantial share of the benefits of undergrounding.  Further, the value of expensive properties such as view homes is especially likely to increase as a result of undergrounding utility lines.  This factor, in turn, tends to give higher-income customers an even greater proportion of the benefits of undergrounding, making the overall benefits more strongly progressive.

Owners of rental property also will be able to reap the benefits of undergrounding through the rents they charge.  Thus, renters (who are disproportionately lower-income individuals) can expect to pay their landlords for any undergrounding benefits they receive.  This process will transfer the benefits of undergrounding from lower-income individuals (renters) to higher-income individuals (owners of rental property), increasing the progressive nature of the undergrounding benefits.

For all of these reasons, I would expect high-income customers to receive a disproportionate share of the benefits of undergrounding.  Expressed as a percentage of household income, the benefits of undergrounding utility lines are likely to be greatest for the highest-income customers and to decline as household income decreases.

Q.            Assume that the cost of undergrounding telephone plant in San Diego will be recovered through some type of surcharge on telephone customers.  Is there any form of surcharge that would better match costs and benefits as compared to AT&T California’s per-line surcharge proposal?

A.        Yes.  On average, total telecommunications bills tend to increase as household income increases, whereas the total number of access lines remains fairly constant as incomes rise.  Therefore, a surcharge on total telecommunications bills for San Diego customers should match the costs and benefits of undergrounding more equitably than does AT&T California’s per-line surcharge proposal.

Q.            Would a total bill surcharge address any other anomaly associated with the AT&T California per-line surcharge proposal?

A.        Yes.  AT&T California proposes to apply its per-line surcharge to Centrex lines and PBX trunks.[18]  PBX trunks serve customer-owned “private branch exchange” switches that, in turn, typically provide the equivalent of multiple Centrex lines for each PBX trunk.  There is no reason to believe that Centrex users will receive more benefit from undergrounding than will PBX users with an equivalent number of end-user “stations,” yet AT&T California’s surcharge proposal would impose a disproportionately high surcharge on Centrex users.  A total bill surcharge likely would reduce, although not eliminate, this disparity.

IV.              ULTS Customers Can and Should Be Excluded from Any Surcharge.

Q.        you suggest above that high-income customers who own real estate in San Diego will reap most of the benefits of undergrounding.  Does this conclusion have any implications for the application of an undergrounding surcharge to ULTS customers?

A.        Yes, it does.  ULTS customers are very low-income customers and are less likely than other customers to be real-estate owners.  Therefore, these customers are the least likely to receive significant benefits from undergrounding.  As AT&T California implicitly acknowledges,[19] it is good public policy to exclude ULTS customers from any undergrounding surcharge.

Q.        Does AT&T California propose such an exclusion?

A.        No.  Mr. Kieren claims exempting ULTS customers is impractical because AT&T California cannot easily apply such an exclusion to competitive local exchange carriers (“CLECs”) that serve ULTS customers via facilities obtained from AT&T California at wholesale prices.[20]

Q.        Is the logistical problem Mr. Kieren identifies a valid reason for applying the surcharge to ULTS customers?

A.        No.  Mr. Kieren does not suggest that it would be difficult for AT&T California to exempt its own retail ULTS customers from the surcharge.  Instead, he relies exclusively on the alleged problems associated with exempting CLEC ULTS customers from the surcharge to justify applying a regressive surcharge to all of AT&T California’s ULTS customers in San Diego.  The CLEC ULTS issue should not drive decisions concerning the surcharge for AT&T California’s ULTS customers.

Mr. Kieren further paints an exaggerated picture of the scope and nature of the CLEC ULTS problem.  Customers subscribing to AT&T California’s ULTS service obtain basic exchange service at a very low price and have little economic incentive to seek competitive alternatives.  With the demise of the unbundled network element platform (“UNE-P”) and the recent mergers that absorbed the two largest CLEC providers of residential service into the two largest California incumbents, I would expect that even the total number of residential customers served by CLECs via UNE loops, resale and local wholesale complete (“LWC”) in San Diego is quite small.  ULTS customers are merely a subset (and a small one) of this already small total.  Therefore, even if AT&T California were to apply the surcharge to all of the wholesale services identified in its proposal, the total scope of the logistical problem Mr. Kieren identifies cannot be very large.

As I explain further below, the real scope of the logistical problem is likely to involve only a small number of resold residential lines.  Further, I describe below a process for allowing CLECs to recover the San Diego undergrounding surcharge from the ULTS fund that would be much simpler and almost certainly less expensive than the cumbersome process described in Mr. Kieren’s opening testimony.  Thus, there is absolutely no logistical necessity for applying the undergrounding surcharge to ULTS customers.

Q.        Mr. Kieren states that AT&T California intends to apply the surcharge to “2-wire voice grade unbundled network element (“UNE”) loops”[21] and suggests that part of the logistical problem involving the exclusion of ULTS customers from the surcharge would relate to customers served via UNE loops.[22]  SHould any surcharge for undergrounding cost recovery be applicable to UNE prices?

A.        No.  Although I am not a lawyer and am not offering a legal opinion, my extensive experience with the UNE pricing rules leads me to believe that any attempt by AT&T California to impose such an adder to UNE prices is likely to be deemed a violation of the pricing rules established by the Telecommunications Act of 1996 and implemented by the FCC.  Furthermore, such an adder would constitute double-counting of costs already reflected in the UNE loop prices approved by this Commission.

Q.        Why would an adder to UNE prices for undergrounding costs constitute double-counting?

A.        In D.04-09-063, the Commission adopted SBC California’s (now AT&T California’s) assumptions about the forward-looking percentage of underground plant and based that decision in part on the company’s arguments about municipal ordinances that require “out-of-sight” telecommunications plant.[23]  Thus, the UNE prices already reflect AT&T California’s own expectations about forward-looking requirements for undergrounding plant, not to mention the full costs for rebuilding the network with all-new cables, electronics, etc.  Because the costs recovered in UNE loop prices are for a brand-new network with a forward-looking percentage of underground plant and not just the costs for a depreciated embedded network, an adder to the UNE loop prices would constitute double-counting.

Q.        If the surcharge does not apply to UNE loops, what is the scope of the remaining logistical problem regarding the exclusion of ULTS customers from the surcharge?

A.        If UNE loops are excluded from the surcharge, the remaining logistical problem regarding the exclusion of ULTS customers from the surcharge is largely, if not entirely, a question of how to address any surcharge imposed on resold lines that a CLEC uses to provide ULTS.[24]  The total number of resold lines in the AT&T California service territory is quite small; the corresponding figure for the San Diego area would be smaller still.  Moreover, the issue of the ULTS surcharge exclusion typically would arise only when dealing with resold residential primary lines (which are in most cases the only lines eligible for ULTS).[25]  For all of these reasons, the number of affected resold lines in San Diego is certainly minuscule.

AT&T California does not offer ULTS for resale; instead, CLECs must obtain residential local service from AT&T California at the full wholesale price (the retail price minus the applicable wholesale discount) and apply for ULTS reimbursement from the ULTS fund.[26]  One straightforward way to address the logistical issue Mr. Kieran raises would be to allow CLECs to recover the San Diego undergrounding surcharge for their retail ULTS customers from the ULTS fund.  AT&T California could then reimburse the ULTS fund whenever it performs its balancing account true-up for actual line counts in San Diego and incorporate that reimbursement into the recalculation of the undergrounding surcharge for the next period.[27]

V.                 The Pending URF Decision Is Likely to Affect the Appropriateness of a Surcharge.

Q.        Mr. McDaniel describes the sequence of events leading to AT&T California’s application and states that the surcharge proposal is the outcome of a Commission-facilitated agreement between the City of San Diego and AT&T California.  He further suggests that the City supports AT&T California’s surcharge proposal.[28]  Does this history justify Commission approval of the proposed surcharge?

A.        No.  All of the events Mr. McDaniel describes, including the City of San Diego resolution he cites as supporting the Application, predate the Commission’s April 7, 2005 issuance of Rulemaking (“R.”) 05-04-005, commonly known as the URF rulemaking.  The Commission’s decision in Phase 1 of this rulemaking – expected to be issued in draft form next month and in final form soon thereafter – could have a substantial effect on the pricing rules for AT&T California’s retail services, including some or all of the services to which AT&T California proposes to apply the per-line surcharge.

Virtually all parties in the URF proceeding agree that at least some existing price caps (such as those for Centrex access lines) should be eliminated.  Therefore, the Commission’s soon-to-be-issued Phase 1 decision in the URF rulemaking is likely to eliminate price caps for at least some of the services to which AT&T California proposes to apply the per-line surcharge.  Subsequent decisions in this or other follow-on proceedings (such as the three-year review of the adopted URF proposed by DRA and other parties[29]) may well further expand the list of price-deregulated retail services.

AT&T California’s own proposal in the URF rulemaking would eliminate Commission-established price caps for all of its retail services except residential primary line services at the time of the Phase 1 decision, and would eliminate even that remaining price cap no later than June 1, 2007.[30]  AT&T California also proposes that it be granted the ability to geographically deaverage prices, both upward and downward.[31]  A Commission decision to adopt the AT&T California proposal in URF, therefore, would render its San Diego surcharge proposal moot as (1) the Commission would have no role in setting prices for any of the affected services and (2) AT&T California would be free to attempt to recover the costs of undergrounding in any manner that market forces would allow.[32]

These possible changes in the fundamental framework under which AT&T California is now regulated suggest that a reconsideration of the rationale for any undergrounding surcharge is timely.  Given the impending change in risk and reward for AT&T and other major incumbents in California, this is the wrong time for the Commission to adopt a surcharge that is projected to be in place for at least 17 years,[33] well beyond the short remaining expected life of the regulatory framework in place today and even beyond the likely life of any new framework the Commission may soon approve.  Therefore, I urge the Commission to ensure that its decision in this proceeding reflects any regulatory changes adopted in the URF rulemaking.

Q.            Surcharges such as local hotel (occupancy) taxes and airport taxes are often placed on the bills of firms that do not have regulated prices.  Why would complete or partial price-deregulation of AT&T California have any bearing on whether the Commission should establish a surcharge for San Diego undergrounding costs?

A.        The proposed San Diego undergrounding surcharge is not a fixed percentage or dollar-and-cent charge imposed by a governmental authority across the board on the products or services of an entire industry group, collected by the companies in that industry and then returned to the governmental authority for public purpose programs.  Instead, the San Diego undergrounding surcharge will produce additional revenues for one particular company, AT&T California, not “tax dollars” to be passed along to the City or any other governmental agency.

Granted, these additional revenues are allegedly required to cover certain capital and operating costs that AT&T California claims it will incur only because of City mandates.  That very rationale, however, puts the Commission back in the business of classic cost-of-service regulation in which it must examine and verify the costs for which AT&T California seeks compensation to ensure that the company does not overrecover costs or cross-subsidize competitive ventures such as the Project Lightspeed data and video services.  Thus, if it adopts a long-lived, cost-based surcharge, the Commission will have created the need for the kind of close regulatory scrutiny of AT&T California’s costs and revenues that is precisely the opposite of the market-oriented regulatory framework contemplated in R.05-04-005.

VI.              Summary of Recommendations.

Q.            Please summarize your recommendations concerning AT&T California’s proposed surcharge.

A.        In light of the pending URF decision, the Commission should consider carefully whether it is appropriate to approve any AT&T California surcharge for recovery of costs associated the San Diego undergrounding projects.  If the Commission does approve a surcharge, the Commission should require AT&T California to exclude the costs of network upgrades from the costs to be recovered through that surcharge and to pay for an independent, third-party audit of the costs booked to the surcharge balancing account.  Finally, any surcharge should be based on total bills, not access line counts, and should not be levied against ULTS customers.

Q.        Does that conclude your reply testimony at this time?

A.        Yes, it does.