1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 DECEMBER 14, 2016 10 11 PROPERTY TAX APPEAL HEARING 12 LA PALOMA GENERATING COMPANY, LLC (112) 13 NO. 961716 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board of Equalization: Fiona Ma, CPA 3 Chairwoman 4 Diane L. Harkey Vice Chair 5 Jerome E. Horton 6 Member 7 Sen. George Runner (Ret.) Member 8 Betty T. Yee 9 State Controller 10 Joann Richmond Chief 11 Board Proceedings Division 12 13 For Board of Equalization Staff: Dana Brown 14 Tax Counsel III Legal Department 15 16 For the Department: Sonya Yim Tax Counsel III 17 Legal Department 18 Richard Moon Tax Counsel IV 19 Legal Department 20 Richard Reisinger Chief 21 State-Assessed Properties Division 22 23 For the Petitioner: Antreas E. Ghazarossian Representative 24 C. Stephen Davis 25 Attorney 26 27 ---oOo--- 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 DECEMBER 14, 2016 4 ---oOo--- 5 MS. RICHMOND: So our next item is E, 6 Property Tax Appeals Hearing. Item E1, La Paloma 7 Generating Company. 8 Please come forward. 9 MS. MA: Okay. To the Appeals, 10 Ms. Brown. 11 MS. BROWN: Hi there. 12 MS. MA: Hi. 13 MS. BROWN: Good morning, Madam Chairwoman 14 and Members of the Board. My name's Dana Brown, and 15 I'm appearing on behalf of the Appeals Division 16 today. 17 There are two issues in this appeal: 18 The first issue is whether petitioner has 19 shown that the replacement costs less depreciation 20 value indicator fails to account for all 21 obsolescence in the determination of petitioner's 22 2016 Board-adopted unitary value; 23 Second issue is whether petitioner has 24 shown that respondent has failed to properly rely on 25 the value indicators in determining its 2016 26 Board-adopted unitary value. 27 MS. MA: Okay. To the petitioners, welcome 28 to the Board of Equalization. You will have ten 3 1 minutes to make your initial presentation, and then 2 five minutes on rebuttal. Please introduce 3 yourselves for the record, and you may begin. 4 MR. DAVIS: Thank you, Ms. Ma, Members of 5 the Board. Stephen Davis with the Greenberg Traurig 6 firm on behalf of applicant. 7 Seated to my left is Mr. Antreas 8 Ghazarossian, the taxpayer's agent. 9 Mr. David Grant, the controller with the 10 La Paloma Generating facility had originally been 11 scheduled to attend today. He could not do so. 12 La Paloma filed for Chapter 11 bankruptcy protection 13 on December 6th and he is consumed with managing the 14 issues that stemmed from that filing. 15 With those introductions, let me make, if I 16 can, an overview observation. This appeal deals 17 with a valuation of a gas-fired independent 18 power-generated facility. Therefore, we have 19 necessarily the current energy market in California 20 is placed at issue. 21 As we all know, under AB 32 in recent 22 policy, the intent of this state, the policy of this 23 state is to reduce carbon emissions, which result 24 from burning natural gas to generate electricity, to 25 40 percent at the levels that existed in 1990 within 26 the next 13 years. 27 And that means there are going to be 28 natural gas-fired producers that are no longer going 4 1 to be operating. And that is just a necessary 2 consequence, a necessary outcome of this state's 3 energy policy. 4 One of those facilities that will likely 5 not be operating will be the La Paloma Generating 6 facility. It is one of the, um -- I hesitate to use 7 the word victims of our current energy policy, but 8 it certainty is one of the consequences of that 9 policy and our shift to renewable resources. 10 The problem is that their assessment for 11 property tax purposes does not reflect that reality. 12 And what we're really asking the Board to do today 13 is to align the assessment practices with our energy 14 policies and the consequences from some of those 15 policies. 16 So, the basic facts are these: 17 The first is La Paloma does not have a 18 power sale agreement. Its capacity payments are 19 very modest. It receives only $8 million a year in 20 capacity payments. 21 The capacity payment is a payment that's 22 paid to a generator whether or not it's actually 23 generating to compensate it for it being able to 24 generate; that is, in a position to contribute to 25 the grid. That $8 million doesn't even cover the 26 carbon costs. La Paloma pays $19 million a year in 27 carbon costs. They only get $8 million in capacity 28 payments. So right there, they're under water. 5 1 Moreover, the market for energy prices -- 2 that is, the price paid for electricity actually 3 generated and sold -- does not cover the costs of 4 operation. 5 I have two quotes for the Board today. The 6 first one comes from the ISO, the Independent System 7 Operator. This is from their 2015 Energy Report. 8 It's very, very important. And it reads as follows, 9 quote: 10 "The 2015 new revenue estimates for 11 hypothetical combined cycle and combustion 12 turbine units continued to fall 13 substantially below the estimates of the 14 analyzed fixed cost for these technologies. 15 For a new combined cycle unit, net 16 operating revenues earned from the markets 17 in 2015 fell to an estimated $46 per 18 kilowatt year in southern California, 19 compared to annualized fixed costs of $165 20 per kilowatt." 21 Closed quote. 22 So energy prices, unless you have an 23 above-market contractor, an out-of-market 24 contractor, one-third of your actual operating 25 costs. 26 Which brings us to our third fact, which is 27 La Paloma has no net operating income. Zero. They 28 lost $14 million in their first half of the year. 6 1 They caught up a little bit in the third quarter, 2 but they're still more than a million dollars 3 negative. And of course, as I mentioned to you, 4 they filed for bankruptcy protection on December 5 6th. 6 So those are the realities. That is 7 certainly the economic and market realities for this 8 particular generator. 9 Now the assessment, moving over to the 10 assessment, the assessment, based on an income 11 indicator was $73 million. The cost indicator was 12 $232 million. In other words, the cost indicator 13 after adjustment for obsolescence was three times 14 the income indicator, which makes no sense at all as 15 I'll explain in a minute. 16 The overall cost indicator was weighted 60 17 percent and the assessed value was $163.6 million. 18 Now, staff has since made some adjustments. 19 They have continued to maintain that the income 20 indicator should be $73 million, but that the cost 21 indicator is reduced to $178 million and that 22 therefore the overall assessment should be about 23 136. 24 We certainly appreciate the staff's 25 reductions. It's certainly a step in the right 26 direction, but not nearly enough. 27 Um, let me explain what the errors are with 28 the assessments. And I think, based on both the 7 1 appraisal theory and the facts, they simply are not 2 sustainable as valid income indicators. 3 First, the staff uses how do -- how do they 4 get to $73 million, okay, if we're not actually 5 earning any income, how do they get to the 6 $73 million income indicator? Well, in their cash 7 flows they're using energy prices that are not the 8 energy prices that La Paloma actually expected to 9 get in January. They're $6.70 higher than market. 10 We don't get paid $6.70 higher than market. 11 That little premium that staff imputes to the 12 facility raises the net income for one year by 13 $36 million. But it's not real -- it's not real 14 income, we don't get it. We wouldn't be filing a 15 bankruptcy if we were getting that. So there -- the 16 income indicator just isn't based on a reali- -- a 17 real energy expectation. 18 The other problem is on the income -- on 19 the cost indicator, you know, that cost indicator 20 reflects 80 percent obsolescence adjustment. Any 21 time you have to adjust a cost indicator by 80 22 percent, you know there's a problem. And any time 23 the cost indicator is two or three times the income 24 indicator, you know there's a problem. 25 And this is going to be my second quote for 26 you. And this is out of your own handbook AH 501, 27 the basic Appraisal Handbook. Quote: 28 "If a property owner would not or 8 1 economically should not construct a 2 replacement for the existing property if it 3 were destroyed, then a value indicator from 4 the cost approach has little relationship 5 to market value. This occurs when 6 reconstruction would not be economically 7 feasible." 8 Closed quote. 9 Plainly, if you're not making any money, 10 it's not economically feasible to replace the 11 facility. All right. There is no economic 12 justification to support the cost indicator. 13 The income indicators and the cost 14 indicators are not in fact separate because the cost 15 indicator must be tested against economics, and that 16 means the income indicator. 17 The obsolescence adjustments that have been 18 provided, while frankly, um, startling -- an 80 19 percent obsolescence adjustment is huge -- it's 20 still not enough. 21 How do we know this? Well, if you take the 22 income indicator -- I should say the, uh, 23 capitalization rate used by the staff and apply it 24 to the cost indicator, we know how much money we 25 have to earn to support economically the cost 26 indicator. We would have to be earning $22 million 27 a year to justify the staff's cost indicator as 28 adjusted. 9 1 The staff only projects we're going to be 2 making, net out at $12.8 million a year. So just 3 between the staff's own assumptions we're making not 4 even half of what we need to support the cost 5 indicator. So it's not -- it's not a valid 6 reference point. 7 And these are basic appraisal principles 8 and applied to our facts of this particular 9 facility. 10 Finally, the two -- the two indicators are 11 never reconciled, in reality. And the bottom line 12 is nobody would pay 232 million or 178 million 13 dollars for a facility for which they can't earn any 14 money. It's just -- they couldn't get a return on 15 that purchase price, and they couldn't recover their 16 purchase price. So there's just been a huge 17 disconnect between the basis for the appraisal on 18 the one hand and the market realities for this 19 facility on the other hand. 20 Now there has been some discussion, there 21 has been some remarks that, uh -- that staff is 22 uncomfortable with their income indicator because 23 the market for energy is so volatile. But our 24 projections for energy prices has been very steady. 25 And we have provided three different cash flows to 26 the staff, using different assumptions. 27 One, and the main one I think's most 28 important, showing what a reasonable market 10 1 participant would expect. And then two others that 2 were basically, uh, based on an assumption that the 3 ISO would change the market, that we would get a 4 more favorable tariff that would allow us to be paid 5 capacity payments. That never happened. 6 But the reason for the difference in our 7 revenues isn't volatility and energy prices. It's 8 on whether or not we would ever get capacity 9 payments, meaningful capacity payments under a new 10 tariff. So there is no meaningful volatility in 11 energy. Our energy assumptions, prices have been 12 very level and very con- -- and very steady. 13 So, having said all of that, the current 14 assessment just doesn't reflect market conditions, 15 it's not consistent with appraisal theory. 16 La Paloma did submit a cash flow based on a 17 realistic energy assessment, realistic capacity 18 payments. And that shows a zero value, as you 19 wouldn't be surprised since we have a bankruptcy and 20 we have not -- we have no NOI. 21 The actual value of the facility at this 22 point is certainly zero. If the ISO comes back to 23 correct the markets, to correct the tariff 24 structures, to provide some basis to remain in 25 operation, that regulatory change would support 26 value and would support a buyer purchasing the 27 facility. And then it would restore the tax base 28 associated with the facility. But at this point 11 1 there's just nothing there. 2 And what I would ask the Board to do is to 3 align our tax policy with our regulatory policy. 4 Because at this point this facility is one of the 5 ones that is intended, if you will, under our 6 current energy policy to be shut in and that's 7 certainly a worthwhile goal, that we need to line up 8 our tax policies to match that regulatory impact. 9 So we're going to lose some power plants, some 10 gas-fired plants, as a result of our going forward 11 on other issues. 12 So, with that, thank you, Ms. Ma. 13 MS. MA: Okay. Thank you very much. 14 Okay, to the Department, um, you'll have 15 ten minutes to make your presentation. Please 16 introduce yourself for the record. You may begin. 17 MS. YIM: Good morning, Chairwoman Ma and 18 Members of the Board. I'm Sonya Yim from the Legal 19 Department. And next to me is Richard Moon, also 20 from the Legal Department, and Richard Reisinger 21 from the State-Assessed Properties Division. 22 In this case SAPD has appropriately 23 calculated both a cost and an income indicator value 24 to appraise the petitioner's property. Then based 25 on the relative reliability of each method, staff 26 weighted the cost indicator at 60 percent and the 27 income indicator 40 percent. 28 For the cost indicator, staff has taken the 12 1 replacement cost and then calculated and subtracted 2 an appropriate amount of physical depreciation as 3 well as economic and functional obsolescence, which 4 includes accounting for state-wide energy policies 5 and prices. 6 All of these adjustments result in a total 7 reduction to the cost indicator of over 80 percent. 8 Yet petitioner insists that there is even more 9 obsolescence but has not validly shown that any 10 actually exists. Petitioner did provide what they 11 call an income shortfall calculation to measure 12 additional obsolescence, but that calculation not 13 only contradicts Board-published guidance and valid 14 appraisal theory, but it also flies in the face of 15 common sense. And that's because using their 16 calculation, the cost value indicator always ends up 17 being the same as the income indicator. And any 18 difference between the two numbers is automatically 19 labeled as obsolescence. 20 In other words, the cost indicator is 21 essentially rendered irrelevant and whatever value 22 the income method comes up with becomes the total 23 value, even if the data behind it is unreliable. 24 They're essentially complaining that the cost 25 indicator is not as low as the income indicator and, 26 therefore, it must be wrong. This is not reasonable 27 and there's no basis for that. 28 Assessors Handbook 501 says that each 13 1 approach should be independent, should not be forced 2 to agree with each other, and that you should not 3 discard and mislabel the cost -- the cost approach 4 as the income approach. 5 Petitioner also brought up that no one 6 would purchase the property for the cost value. 7 However, no one is claiming that at all; that's not 8 an issue. Rather, what staff did was to calculate 9 both a cost and an income indicator, and they 10 considered their relative merits to get a reasonable 11 total value of the property. 12 That brings us to the issue of the 13 propriety of the 60/40 weighting of the value 14 indicators. In this case the cost method is more 15 reliable than the income indicator because it 16 reflects the current replacement cost of the latest 17 technology with adjustments for depreciation and 18 obsolescence. 19 Additionally, Rule 6 says that it is the 20 preferred method when neither reliable sales nor 21 reliable income data are available; and that is the 22 situation here. It is more reliable than the income 23 indicator in this case because petitioner has 24 admitted that their own income projections are 25 unreliable. 26 They've stated that those projections can 27 change every several months by tens of millions of 28 dollars, and that when the weather changes the 14 1 income projections change with it. They also said 2 the market is extremely volatile with the complexity 3 of pricing, contracts, demand and supply. And this 4 is why petitioner cannot accurately make even 5 short-term income projections. 6 In the last few years their projections 7 compared to their actual income were always off by a 8 range of negative 53 percent to positive 157 9 percent. 10 We also know the income indicator is less 11 reliable here because petitioner gave us three 12 different income projections, each of which were 13 materially different from the other. 14 Petitioner is complaining that SAPD 15 requires them to predict the future with 16 unreasonable precision; however, that's not true. 17 Staff has simply taken into account the volatility 18 of the petition -- of the income as well as 19 petitioner's own inability to predict their income 20 reliably in determining the weight placed on the 21 income indicator. 22 And what makes petitioner's value method -- 23 value request even worse is that they effectively 24 rely 100 percent on the income indicator, but they 25 have not provided reliable data on which to base 26 that. 27 Petitioner's financial statements were 28 independently audited and it showed that its assets 15 1 were not impaired. But to this day they have 2 refused to provide the cash flow projections used by 3 their independent auditors that determine that no 4 impairment of the power plant was necessary. 5 Instead, they provided staff with three 6 different versions of cash flow statements over the 7 course of this year, and they showed that the assets 8 were impaired. Each statement is materially 9 different from the one before, and none of them can 10 be reconciled with the independent auditor's opinion 11 that no impairment exists. 12 That is why staff decided that the best 13 information available to determine the income 14 indicator would be based on the actual historical 15 2015 appraisal income. That's also why it's not 16 reasonable to place the same reliance on the income 17 indicator as the cost indicator, let alone 100 18 percent reliance on the income indicator. 19 Petitioner says that their cash flow 20 statements keep getting worse because on the lien 21 date, January 1st of this year, they expected to 22 make money and they expected that the legal and 23 business environment would turn around in their 24 favor. So that's the information that they gave 25 their auditors. 26 But during the course of this year things 27 didn't turn out so favorably, so they provided 28 different information to staff. 16 1 However, what's at issue in this petition 2 before us today is the lien date of January 1st, 3 2016. That's the information they gave their 4 auditors and it's what they refused to provide to 5 staff. 6 Everything that occurred after that date, 7 such as not having net operating income and filing 8 for bankruptcy, those are relevant for next, uh -- 9 future lien dates but are not relevant for today's 10 petition. 11 We do also want to emphasize that the 12 income indicator is still given significant 13 consideration, 40 percent, but we believe it would 14 be unreasonable to rely on it any more for all the 15 reasons we stated. Particularly since they've 16 withheld the information given to their auditors, 17 which is the best information they had as of the 18 lien date. 19 Lastly, we just want to note that the 20 bankruptcy they filed is for reorganization. It is 21 not for a liquidation or to shut down their plant. 22 Filing Chapter 11 anticipates that they will return 23 to profitability some day and that they do want to 24 hold on to their assets. 25 So for all of these reasons we recommend a 26 twenty thous- -- a 2016 unitary value for petitioner 27 of 136.1 million. 28 MS. MA: Okay. Thank you. 17 1 Okay, Mr. Davis, um, five minutes on 2 rebuttal. 3 MR. DAVIS: Yes. Where to start? 4 First of all, they keep -- we've heard this 5 over and over again from staff, that we're giving 6 different data to the auditors, or the auditors cash 7 flows have not been provided to staff. 8 Our auditors do not provide cash flows. We 9 do not have multiple cash flows. That's utterly 10 untrue. And I specifically interviewed my client 11 about that, and they have reassured me this the 12 case. 13 I sent an email to staff on November 28th 14 explaining exactly the basis, the accounting basis 15 under accounting concepts for why no impairment was 16 recognized. 17 Accounting concepts are not fair market 18 concepts, starting with the fact that you use 19 undiscounted cash flows. All right. They consider 20 not EBITDA cash flow, they consider after 21 depreciation amortization. I mean they're simply 22 apples and oranges. 23 So, number one, there are no multiple cash 24 flows. 25 Number two, our auditors never developed a 26 cash flow. Auditors do not prepare cash flows; they 27 audit books. And the decision to recognize an 28 impairment is -- is delegated to management under 18 1 the FASB rules. And I explained the reason for this 2 in my email, which staff does not mention. 3 Uh, current -- current factor NOI isn't 4 relevant. It's relevant for the next year, 5 according to staff. Untrue. 6 Under the Gill Wineries case you can look 7 at post lien date cash flows for up to a year to 8 validate the opinions of experts that occurred for 9 the prior year. And so one of the ways you test 10 whether or not forecasts are reasonable is to look 11 at actual performance. 12 So, in fact there's express case authority 13 that allows us to consider actual events which we 14 have done. 15 The idea that the income indicator is 16 circular -- or I should say the income shortfall is 17 circular, and it will just get you back to the 18 cost -- uh, to the income indicator is absolutely 19 true. That's exactly what it does. And that's 20 exactly what it's supposed to do. 21 Remember, the handbook which says that the 22 method should be independent, also counsel you to 23 test the economic viability of the cost indicator. 24 So how do you test the independent 25 viability of the cost indicator? How do you get the 26 economics? Cost approach is not value. Cost 27 approach doesn't show current market conditions. 28 The only way to do that is with an income indicator. 19 1 And so what staff characterizes as a flaw, 2 okay, is not a flaw. It's a strength. Because it's 3 the only way that you can tie the cost indicator to 4 current market conditions is through sales of 5 similar properties, and we have none, or the income 6 indicator. That's it. That's how you do it. 7 And yes, under some circumstances that does 8 take you right back to the income indicator. But 9 what that tells you is, is the cost indicator for 10 that property, under prevailing economic conditions, 11 is not a valid method. 12 You can't always use more than one. We'd 13 like to. We'd like to use all three when we can. 14 But you have to have the data to do it. 15 So, I, uh -- this idea of circularity and 16 this idea that there's a flaw in the cost approach 17 by using the income shortfall method is simply bad 18 appraisal, uh, practice altogether. 19 Um, this idea of weighting 60/40, those 20 factors are entirely arbitrary. There's no basis 21 for -- at all why it's 60/40, why it's 55/45, why 22 it's 50/50. 23 Now if the value indicators are correctly 24 done and they were only 5 or 10 percent apart, it 25 really wouldn't matter how you did the weighting, 26 okay. It just wouldn't. When you have hundreds of 27 millions of dollars in difference between your 28 indicators, number one, the indicators aren't valid; 20 1 number two, the weighting then does become 2 important. But the fact is that weighting is 3 entirely arbitrary, and there's never been an 4 explanation offered for it. It's just something 5 that's kind of made up. So that's a flaw. 6 Um -- I'm just looking at my notes one 7 second. 8 Um, those are the main points. If I can 9 respond to questions, I'd be happy to do so. 10 MS. MA: Okay, great. Thank you very much. 11 Okay, Members. Ms. Harkey. 12 MS. HARKEY: Hi. Thank you. 13 I really delved into this because I was 14 interested in the energy policy and how we're going 15 to be dealing with this down the road. I think the 16 Board needs to pay extra special attention, and 17 maybe even our -- our department needs to come up 18 with a formula for this. Because we have as policy, 19 energy policy, we are rendering certain facilities 20 obsolete, totally obsolete, unable to create income 21 with no power sale agreement, which augments, uh, 22 the facility for either the shutdown times or no 23 guaranteed ability to -- to have their power 24 purchased. 25 Um, you know, these -- these facilities 26 were intended to close and they are closing. And 27 the fact that they're closing and the state is not 28 going to be -- I heard a comment that the assets are 21 1 not impaired. Well, if your assets can't be used, 2 I -- I have a problem thinking that they're not 3 impaired. 4 Um, I actually did a little study to see -- 5 or just a quick down and dirty. I did review the 6 department -- California ISO Report. It was large, 7 200-and-some-odd pages. 8 But I -- you know, I do want to reiterate 9 that the 2015 net revenue estimates for hypothetical 10 combined cycle and combustion turbine units continue 11 to fall substantially below the estimates of annual 12 fixed costs for these technologies. 13 Well, if you can't cover your fixed costs, 14 you can't stay open. And unless you're subsidized, 15 which you would be subsidized by a power sale 16 agreement, which some facilities are. And I believe 17 there's only one, SDG&E that's still operating, 18 that's down in -- in southern California area. 19 But this facility has, in essence, been put 20 out of business by the state policy, and that's 21 okay. That was the way the state wanted to go. 22 So I went and looked at what -- what vacant 23 land is up there, because there's nothing else but 24 vacant land. And the land under this facility, 25 assuming that you could -- it wouldn't be a 26 brownfield or something else going on, is 66,000, 27 almost 67,000 an acre. 28 And then I pulled down the energy, 22 1 CaliforniaEnergy.gov La Paloma, the write-up on it. 2 It says that the project site is roughly 23 acres in 3 size, and it's situated near the intersection of 4 Reserve Road and Skyline Road, which puts it in 5 almost Buttonwillow, which is where I looked. 6 And so, you know, land value probably, 7 what, 67 per acre at 23, what's that give you, about 8 a million five, million six? And then maybe some 9 scrap value. Unless this could be refitted somehow, 10 retrofitted somehow to do some other kind of 11 production. 12 So that's -- that's kind of my question to 13 the, um -- the appellant. 14 What could be done with this facility? 15 Could be it retrofitted, put more money into it? 16 Would it operate as any other type of facility that 17 could produce energy or could be profitable? 18 MR. DAVIS: I -- 19 Mr. Ghazar- -- can Mr. Ghazarossian, uh -- 20 MS. HARKEY: Sure. 21 MR. DAVIS: -- answer the question? 22 MS. HARKEY: I'd like to hear from somebody 23 who might know. 24 MR. GHAZAROSSIAN: Yes, the, uh -- 25 MR. DAVIS: Ouch. 26 MS. HARKEY: Well, that wasn't for you. 27 You knew the law and you know -- you understand the 28 appraisal process. And I might tell you, your 23 1 analysis of the appraisal process is spot on. There 2 was nothing wrong with your analysis of the 3 appraisal process. Because the cost and the income 4 were supposed to somehow be pretty close. If 5 they're not, then you've got a problem with one or 6 the other. And taking a 60/40 probably doesn't get 7 you there. 8 But, you know, I appreciate the 9 Department's trying to working with this. I think 10 this is all new, and we've got more cases coming, 11 which is why I'm making a big point of this today. 12 MR. GHAZAROSSIAN: Thank you. 13 The option here is to, uh, dismantle parts 14 of the four, uh -- uh, units there and really 15 mothball them for use or maybe sale down the road to 16 other power plants. 17 So there are, you know, spare parts that 18 will be dismantled if the plant is closed down. But 19 it's -- you're looking at, you know, a few million 20 dollars and then there is the cost to dismantle 21 them. So, um, I think in terms of real value we are 22 looking at very little value. 23 MS. HARKEY: So do I, incidentally. I 24 think very little value. 25 And I think I want to correct the 26 Department. When you go into Chapter 11, it means 27 you're -- you, in essence, put a stop on everything 28 so that you're -- you know, you don't have to keep 24 1 bleeding cash. It's just everything halts. But 2 that doesn't mean that you're gonna be up and 3 operating again. In most instances it doesn't. 4 Reorgs seldom work unless there is a viable 5 business that just really needs a little breathing 6 room to get renegotiated with creditors. And that's 7 really where this goes, to renegotiate with 8 creditors. 9 But in an entity that's not gonna be 10 allowed to operate, in essence, in the state of 11 California, I don't know how you do that. I think 12 that this would probably -- will probably -- if I 13 had to predict, it'll go into a Chapter 7, it'll be 14 sold off for parts, the trustee will take a piece 15 and that'll be that. 16 So, um, I do think we -- we, um -- I got my 17 answer is there any way to upgrade the facility. Is 18 there any way to upgrade this to use it again for 19 something else? It's just parts really. It's made 20 to generate. 21 MR. GHAZAROSSIAN: What we see is that you 22 can do a number of things to upgrade and get back 23 into production, but there is no market for what 24 this is used for. 25 MS. HARKEY: Okay. There is no market. No 26 market for it. 27 Is there a market outside of California, or 28 just not in California, or how does this work? 25 1 MR. GHAZAROSSIAN: You can only sell only 2 within certain geographic limits. And the owners 3 have made pleas to CAISO, to FERC. They have asked 4 other producers to appeal, uh, to CAISO because the, 5 uh -- the implications of what's going on is -- you 6 know, are serious for La Paloma, but they will be 7 serious to others also. 8 MS. HARKEY: Now we do have -- we do have 9 quite a few that will be in the same consequence. 10 And so I -- I've got a problem with the appraisal 11 value, not that the Department isn't trying to work 12 with it, but just that I don't think we have -- I 13 don't think we have a format in which to operate on 14 a facility that in essence the state is putting out 15 of business. 16 I think this is a problem for us. And so, 17 uh, I may come back with some more questions. But, 18 you know, if your energy prices aren't covering your 19 fixed costs, you can only do that so long unless 20 you've got a power sale agreement. And they 21 don't -- their power sale agreement was meant to 22 expire because this facility was meant to go 23 off-line and, um, it has. And what they have 24 levered the property is not a concern of ours. We 25 just need to figure out what the -- what the actual 26 property is worth. And in its current state, if 27 it's not generating income and if it can't be 28 reused, then it's probably land value and parts. 26 1 And I don't know what that is, but I've got 2 a feeling it's, you know, substantially lower than 3 what the appraisal that we're trying to go -- that 4 we're trying to assess. And even thought it was the 5 beginning of 2016, you can go back years. I mean, 6 you do go back and see if your assessment is 7 actually accurate, uh, in hindsight. 8 I understand the projections. I'm not even 9 going to get into that on the income approach, but I 10 think this has a serious problem and we will have 11 more of these cases. 12 So, um, I think it's land value and parts 13 and that's what I think it's worth. And since 14 they're in BK and they're not generating income and 15 they're not going to be allowed to, I don't know 16 what we do here. 17 Thank you. 18 Except I'm not -- I'm not happy with the 19 appraisal. And, like I said, it's no reflection on 20 the Department. I just don't -- I think we need to 21 figure out how we -- how we do this going forward 22 because there's going to be more. 23 MS. MA: Thank you. 24 Ms. Yee. 25 MS. YEE: Thank you, Madam Chair. 26 Couple of questions for the Department. 27 Uh, just looking at the electric generation industry 28 generally, um, this -- are other properties kind of 27 1 comparable to what we're seeing here with La Paloma, 2 in terms of, uh, the impairment or its ability to 3 continue to generate income? 4 MR. REISINGER: Yeah, we have like 52 5 facilities that we assess in the state of 6 California. I think we have 20 or so of the 7 combined cycle facilities that are similar in 8 operation and, um, in technology to La Paloma. 9 We -- I mean this has -- this has been 10 going on for a few years. I mean there's -- there 11 is a transition and there's some -- there's public 12 impetus to develop, um, these renewable resources. 13 So there -- there have been challenges for 14 the combined cycle facilities. There's still a need 15 for them and there always will be a need for a 16 certain amount of -- of this technology because the 17 wind doesn't blow all the time and the sun doesn't 18 shine all the time and we haven't developed, you 19 know, batteries and storage facilities yet that can 20 accommodate the renewable energy. 21 So, I mean we've -- we've been looking at 22 it for the last couple years and we -- we -- we have 23 utilized the information that the assessees give us. 24 I mean when we do our income approach, we generally 25 use information that's provided to us by the 26 assessees. And we have seen in many cases where 27 the -- the projected revenues have declined and 28 that's been reflected in -- in our values. 28 1 But it -- it's -- in this particular 2 industry, it's been difficult for the assessees to 3 do projections if they don't have contracts. And 4 that's one of the reasons why we -- we've never been 5 able to feel comfortable with relying on the, uh -- 6 the income approach to a larger degree because 7 it's -- it's been volatile. And some years they 8 make way more money than they expect, and some years 9 they may less money. And so we -- we've considered 10 that when we determined our -- our reliability of 11 the value indicators. 12 MS. YEE: Mm-hmm. 13 MR. REISINGER: But they are -- they are 14 all tending to be on decline. 15 MS. YEE: Mm-hmm. 16 Just to Ms. Harkey's point, I do think, 17 uh -- I mean this will be a challenging issue for us 18 going forward, obviously, with the energy 19 transition. 20 But I guess to the petitioner's point of 21 wanting to rely, um, solely on the income indicator 22 which -- what would they have to produce that would 23 convince you that that is a proper, um, reliance on 24 the indicator? 25 MR. REISINGER: To weight, we don't -- in 26 this industry for our -- the state-assessed 27 facilities, we don't rely a hundred percent -- we 28 haven't in the past, we've never relied a hundred 29 1 percent on the income approach because of the -- the 2 nature of the projections that we get and the actual 3 volatility and the -- the increases and decreases in 4 revenue over time. 5 One of the things that's problematic about 6 using the income approach a hundred percent is that 7 it is volatile and you could end up having 8 situations where you have a power plant whose value 9 increases and decreases dramatically every year. 10 And I'm not sure how useful that would be, and I'm 11 not sure how practical that would be. 12 MS. YEE: Right. So, in other words, 13 there's just no reliable income stream that they can 14 demonstrate is associated with the -- with the 15 property. 16 MR. REISINGER: That's correct. 17 MS. YEE: Okay. 18 So then, um, part of what I'm having a hard 19 time with petitioner reconciling is that I think the 20 staff did make a couple of adjustments that 21 recognized reduced generation levels, and then also 22 related to the spark spreads. And so it runs a 23 little counter to, you know, I think your position 24 with respect to wanting to rely fully on the income 25 indicator. And, uh, I think the staff's -- the 26 tools that the staff has is really then to reconcile 27 between the two indicators given the information 28 that you provide. 30 1 Now, um, I would agree with you that I 2 don't think this is an industry where we're going 3 to, at least for now, going forward we're ever going 4 to rely a hundred percent on the income indicator. 5 And so it is, I think, really looking at the, uh -- 6 where the energy -- where the industry's 7 transitioning to and what, uh, the likely future use 8 of these properties will be that may have us look at 9 this differently. 10 But, uh, I just don't see -- it just seemed 11 kind of, um, contradictory with respect to your 12 position on relying a hundred percent on the income 13 indicator. 14 MR. DAVIS: May I make an observation? 15 MS. YEE: Mm-hmm. 16 MR. DAVIS: If in fact the market is as 17 volatile as staff is concerned with, that's simply 18 the nature of the market. 19 MS. YEE: And we -- 20 MR. DAVIS: And any -- 21 MS. YEE: -- I think acknowledge that, 22 yeah. 23 MR. DAVIS: And any buyer in the market 24 just has to manage that and that'll affect 25 pricing -- 26 MS. YEE: Mm-hmm. 27 MR. DAVIS: -- and it'll affect prices paid 28 for facilities. 31 1 When we go to a cost approach, which is not 2 adequately adjusted for those conditions, basically 3 what we're doing is we're taking an indicator that 4 is not tied to the market. 5 You know, no power plant in California has 6 been built since 2005 without a power sale 7 agreement. They're not being built. They're not 8 being built because you can't get a return and 9 because you can't finance them. It's just not -- 10 it's not feasible. 11 MS. YEE: Mm-hmm. 12 MR. DAVIS: And the real difficulty is that 13 the cost indicator on its own is simply not -- cost 14 isn't value. You have to economically support that 15 in some manner. And that's -- and that's the 16 problem. If you put 60 percent weight on a 17 nonmarket value component, you're not going to get a 18 market value. 19 And that -- and that's -- that's the real 20 problem. And the only way to test the economics, if 21 you will, for a cost indicator is to use the income 22 indicator. 23 So it almost becomes a labeling exercise. 24 In our market conditions, for these facilities, 25 there's really only one viable method and it 26 admittedly -- and I've -- I've said this during the 27 appeals conference and I'll say it now. Income 28 approach is not easy for these facilities. And I'm 32 1 not suggesting that it is. But it's the only one 2 that we have that actually ties to the market. And 3 that's -- that's the issue. That's the challenge. 4 MS. YEE: Yeah, but that's where it's 5 counter-productive. It's really contradictory 6 because if it is a volatile market, then you can't 7 rely on a steady stream of income. 8 So I think the proper weighting is what the 9 staff has reconciled between the two indicators. 10 So, I guess, Madam Chair with that, I would 11 make a motion to adopt the staff recommendation. 12 MS. MA: Okay. 13 Mr. Runner. 14 MR. RUNNER: Yeah, let me just follow up on 15 a couple -- couple of questions in terms of the 16 process. Because I -- I think we are caught in the 17 issue of a changing industry, uh, and trying to 18 reconcile our own appraisal processes and what -- 19 trying to anticipate what -- how that's going to 20 continue to change, what's going to be the norm out 21 there, um, and therefore creating then, try to 22 establish value for these facilities. 23 Um, just -- so, again, to the Department, 24 so basic -- I think what you had said that we have 25 about 20 similar facilities? 26 MR. REISINGER: Yeah, combined cycle 27 facilities -- 28 MR. RUNNER: Okay. 33 1 MR. REISINGER: -- that were built with the 2 same technology around the same time. 3 MR. RUNNER: Right, okay. 4 And so I guess as I look at that I'm 5 thinking, okay, we have 20 facilities out there. I 6 think -- I think as you indicate, um, I think 7 there's -- there's no doubt that there will be, um, 8 less -- there's a lessening need for those 9 facilities. But there will always be some need for 10 capacity, you know, in regards to that discussion, 11 right? 12 MR. REISINGER: That's correct. 13 MR. RUNNER: Um, and so as a result of 14 that, um, even though you may have 20, the issue is 15 there'd be -- there's a -- there's a -- there's a 16 smaller amount of contracts happening, correct? 17 MR. REISINGER: That's correct. 18 MR. RUNNER: Okay. So then once you get 19 into this situation if you got 20 facilities out, 20 less contracts, then facilities are going to make a 21 decision. Because, again, only certain ones -- I 22 know I can't imagine that for instance the lower 23 number of contracts will now be divided by the same 24 number of facilities, um, because then they will all 25 lose money. Uh, and so what's going to happen is 26 you're gonna have some facilities that will continue 27 to operate, and then you'll have other facilities 28 that can't continue -- that choose to make a 34 1 business decision in regards to don't -- that don't 2 continue to operate. I assume that's the way the 3 market would work. 4 MR. DAVIS: Mm-hmm. 5 MR. RUNNER: Um, so therefore you may have 6 some facilities that actually can work out well okay 7 with -- with, um, income factors in regards to how 8 you do value. But you can have people in the same 9 industry that you can't, simply because there's too 10 many facilities to support the number of contracts 11 out there. And I kind of feel like that's kind of 12 what we're in the midst of right now. 13 So, and when I first started thinking about 14 this I'm wondering, well, maybe you gotta look at 15 this to see where the rest of the industry are, or 16 where the rest of the facilities are. But the fact 17 is, you may have some facilities that indeed can 18 operate successfully because they happen to stay in 19 the business and stay -- keep the contracts and 20 others that don't, and so therefore they're off the 21 market, and therefore they have no revenue, 22 therefore they'd do that. 23 Um, let me just ask, I mean just a -- just 24 a really simple question. If you have a facility 25 that has no contracts, that has no income and, um -- 26 and demonstrates that, say for -- for that year, um, 27 and projects that they probably won't be getting 28 contracts, how do you estab- -- how do you -- would 35 1 we ever see just the income, um, formula used to 2 establish the value? 3 MR. REISINGER: Well, first, I want to 4 clarify that not having a contract doesn't mean they 5 don't have revenue. It just means that they have to 6 bid into the marketplace. 7 MR. RUNNER: Okay. Let's say -- okay, let 8 me -- let me rephrase that. They don't have 9 revenue. 10 MR. REISINGER: Oh, they don't have 11 revenue? 12 MR. RUNNER: Yeah, if they don't have 13 revenue. 14 MR. REISINGER: Well, that would be 15 problematic. 16 MR. RUNNER: Right. 17 MR. REISINGER: Then we'd have a different 18 situation. We wouldn't have an operating asset, so 19 we wouldn't be looking at it in the same regard. 20 MR. RUNNER: Right. Right, right, right, 21 right. 22 So if a facility then says they don't have 23 contracts and they are not going to bid into the 24 market, then the value of it would be the property 25 and surplus? 26 MR. REISINGER: If they're not going to 27 operate and they're going to liquidate, yeah, the 28 value would probably be in line with the market 36 1 value of the land and whatever salvage costs they 2 could -- I mean, excuse me, salvage value they could 3 come up with. 4 MR. RUNNER: Right. 5 MR. REISINGER: But that would -- that 6 would be reduced by whatever remediation would be 7 required. 8 MR. RUNNER: Okay. And the problem that we 9 have with this particular setting then is that there 10 was some income. 11 MR. REISINGER: Well, in two thousand -- I 12 mean they were -- they were still operating. 13 MR. RUNNER: Right. 14 MR. REISINGER: They're still operating 15 now. 16 MR. RUNNER: Right. 17 MR. REISINGER: Um, they were still 18 operating when we did the appraisal. They were 19 still operating throughout 2015. 20 MR. RUNNER: Right. 21 MR. REISINGER: They generated appraisal 22 income in 2015. So as of the lien date, it's -- 23 it's -- it was an operating asset, and it's still an 24 operating asset. 25 MR. RUNNER: And that's kind of part of our 26 issue here is we're trying to establish the value 27 back at the lien date, not looking forward. 28 MR. REISINGER: That's correct. 37 1 MR. RUNNER: Right? 2 MR. REISINGER: It's what -- it's -- it's 3 what the market value or what a potential purchaser 4 would pay on the lien date. 5 MR. RUNNER: On the lien date. 6 MR. REISINGER: Right. 7 MR. RUNNER: So the fact that there was 8 income at that point creates some of the issue for 9 the need for trying to figure out this unique 10 formula for -- for -- for -- 11 MR. REISINGER: That's correct. We 12 consider it an operating asset, so we would apply 13 our standard methodologies for power plants to value 14 it. 15 MR. RUNNER: Okay. 16 MR. REISINGER: It's an operating asset. 17 MR. RUNNER: Let me go to the taxpayer real 18 quick. What -- the issue with the, um -- the issue 19 with not providing the audited financial 20 statements -- right? Isn't what we -- that was our 21 concern, we -- we did not get those? Is that what I 22 understand? 23 MR. REISINGER: I -- I can clarify that. 24 MR. RUNNER: Okay. 25 MR. REISINGER: We never claimed that the 26 auditors prepared cash flow analysis. 27 The way -- the criteria for recognizing an 28 impairment write-down is that the undiscounted cash 38 1 flows over the life of a facility are compared with 2 the net book value of the property. That's the 3 first criteria. 4 And the other criteria is that the market 5 value of the property be less than the book value of 6 the property. 7 And so the auditors came to the conclusion 8 that the criteria number one was not met. So their 9 conclusion was, based on information that the 10 assessee would have -- the petitioner would have 11 given them, was that the undiscounted cash flows 12 exceeded the net book value of the property. And 13 the net book value of the property at 12/31/15 was 14 $419 million. 15 So, there's some cash flow analysis out 16 there somewhere that totals more than $419 million. 17 That's what we were asking for. We wanted to see, 18 'cause somebody -- the auditors came to a conclusion 19 that this cash flow -- 20 MR. RUNNER: So that's what you asked them 21 for? 22 MR. REISINGER: That's what we asked them 23 for. 24 MR. RUNNER: Okay, let me go to the 25 taxpayer. Why -- and what was the issue for not 26 providing it? 27 MR. DAVIS: We did. We gave them all of 28 our audit financial statements for all years. And 39 1 no impairment was recognized. 2 MR. RUNNER: Hold on. Well, let me go 3 back. 4 Is he talking about the same thing you 5 asked for? 6 MR. REISINGER: No. No. 7 MR. RUNNER: Okay. Tell me why that's -- 8 what he's answering is not what you asked for. 9 MR. REISINGER: We are asking for the cash 10 flows that the auditors used to determine there was 11 no impairment. 12 MR. RUNNER: Okay. 13 MR. REISINGER: That's not -- wouldn't 14 necessarily be in the audited financial statements. 15 Just a conclusion that there's no impairment was in 16 the audited financial statements. 17 MR. RUNNER: Okay. So let me -- so -- so I 18 guess I'm trying to make sure that we're talking 19 about, you know, apples and apples here. 20 MR. DAVIS: I explained all of this in an 21 email to staff. 22 MR. RUNNER: Well now explain it to me. 23 MR. DAVIS: I'm -- I'm going to. 24 There were no cash flows. Okay. We can't 25 produce that which was not done, number one. 26 Number two, the company had three different 27 options that they were considering in order to 28 obtain capacity payments at a -- at a above minimal 40 1 level. I think I told you that we only had 2 $9 million or expected to get $9 million this year. 3 Um, and they had three things that were 4 occurring in January when their auditors would do 5 their books for the previous year, that would 6 suggest a more robust cash flow. 7 They were negotiating with the Cal ISO to 8 improve their tariff. They had a plan whereby they 9 could file a complaint and FERC, too, so that FERC 10 would compel the Cal ISO to change their tariff 11 structures to provide a more robust capacity 12 payment. 13 And then finally, they have the Aliso 14 Canyon gas problem, which we all know about, and the 15 gas storage and the shutdown of that gas storage. 16 That was going to create a problem in terms of gas 17 ca- -- gas flow into southern California. 18 And so one -- one way that the effect of 19 restricted gas availability in southern California 20 could have been mitigated was to divert electric 21 generation using natural gas outside of the LA 22 basin. 23 MR. RUNNER: Mm-hmm. 24 MR. DAVIS: Our facility's located on line 25 26, which -- path 26, in which we could've 26 delivered -- 27 MR. RUNNER: So, again, let me -- let me -- 28 so what you're -- the things that you are 41 1 delineating there are all reasons why it is that 2 your -- what would be shown on the lien date is -- 3 is -- is more robust than what was experienced? 4 MR. DAVIS: That's correct, Mr. Runner, by 5 the company. But when we hired outside 6 appraisers -- 7 MR. RUNNER: Isn't that just the challenge 8 of always trying to figure out what the lien date is 9 and what the value of the lien date? 10 MR. DAVIS: Yes and no. Part of it is the 11 company perspective on what -- how they saw things 12 and the way that they -- they were anticipating a 13 change in the market in tariff structures. But a 14 purchaser of the property would have a different 15 view. 16 MR. RUNNER: Okay, let me go back to the 17 staff real quick and follow up on that. 18 So -- so, okay -- so on a lien date you've 19 got this certain amount of unique circumstances that 20 may enhance the value. But those are -- let's say 21 they are not as, uh -- they're not dependable at 22 that point. They're -- they're -- they just happen 23 to maybe give a false impression because they don't 24 all come true or they're not there. 25 How do -- how do we -- how do we compensate 26 for that then? 27 MR. REISINGER: Well, we can't predict the 28 future, so we would utilize the information that -- 42 1 that's available to us. And -- and part of that 2 information -- I'm not sure how the auditors could 3 have come to the -- 4 MR. RUNNER: Don't we -- when you say we 5 can't predict the future, we do know since -- since 6 this is a -- the lien date was last year, we do know 7 what took place through last year. 8 MR. REISINGER: Yes. 9 MR. RUNNER: We do -- it's really not the 10 future, right? It's really just the preceding -- 11 the -- the subsequent months. 12 MR. REISINGER: That's correct. 13 MR. RUNNER: And do we -- does that then 14 affect -- can that affect then our valuing? 15 MR. REISINGER: I -- I guess I'm going to 16 have to ask you to clarify. 17 MR. RUNNER: Well, I -- I -- maybe, 18 hopefully -- 19 MR. REISINGER: Yeah. 20 MR. RUNNER: -- I'm trying to make it clear 21 here. 22 Okay. We have a lien date. 23 MR. REISINGER: Mm-hmm. 24 MR. RUNNER: And then -- and we have 25 circumstances around that lien date that help -- 26 that during the appraisal process give us certain 27 value. 28 MR. REISINGER: Mm-hmm. 43 1 MR. RUNNER: Okay. And so, subse- -- 2 and -- and so in the next months that happen after 3 the lien date, some of those things don't happen. 4 So therefore, did we have a false impression of the 5 value at the lien date? 6 Is that fair? Is that clear? 7 MR. REISINGER: Yes. 8 MR. RUNNER: And then how do -- if we did, 9 how do we adjust for that? 10 MR. REISINGER: Well, we use the best 11 information available as of the lien date. And then 12 we consider information that's provided to us that 13 would -- that should have been known or would affect 14 the value that a potential purchaser would pay 15 around a lien date. 16 So we do consider -- in fact, our -- our -- 17 our income approach actually utilizes, and the way 18 we do it, it's a discounted cash flow analysis. So 19 we actually look at projections into the future. 20 MR. RUNNER: Okay. 21 MR. REISINGER: So -- but we -- we utilize 22 information that's provided to us by the assessee 23 and we consider whatever other information we might 24 have. And -- and a significant piece of information 25 would be the fact that the auditors believed there 26 was no impairment, and -- 27 MR. RUNNER: Okay. 28 MR. REISINGER: -- they look at it more 44 1 closely than -- 2 MR. RUNNER: Okay. Let me just follow up 3 with another question real quick then in regards to 4 the difference in the valuing. Because you all have 5 a value to which you would like to -- that you think 6 is real. 7 Is that based upon -- what do you -- what 8 do you -- is that based solely -- how -- what -- 9 what's your value based on, solely? Or what is it? 10 MR. DAVIS: We asked an independent 11 appraisal firm to tell us what a reasonable buyer 12 would pay, a reasonable well-informed -- 13 MR. RUNNER: Okay. 14 MR. DAVIS: -- buyer would pay in exchange 15 for this property on the lien date. 16 It is not the standard that governs 17 recognizing an impairment for accounting purposes. 18 MR. RUNNER: Mm-hmm. 19 MR. DAVIS: That's the difference. 20 And our -- our outside appraisers -- and we 21 provided this cash flow to staff. Our outside 22 appraiser said nobody's gonna pay a sum based upon 23 revenues that are dependent upon the ISO changing 24 their tariff structure. It's just too 25 speculative. 26 MR. RUNNER: But isn't -- couldn't you -- I 27 mean if you do that -- again, let me just use a -- 28 If you did it based upon the lien date, and 45 1 that's what you want the appraisal on, and then a 2 month after the lien -- and well, of course we're 3 looking retroactively. We're looking back. So I 4 guess that wouldn't really be -- 5 I was going to say, and then there's a 6 series of contracts that come in after the lien 7 date, um, you basically have an appraisal that 8 didn't have all the information. Or he had all the 9 information at the time, but the circumstance 10 changed. 11 MR. DAVIS: You know, Mr. Runner, the 12 question is always the same. What would a buyer do? 13 And it -- 14 MR. RUNNER: So you're assuming the buyer 15 would feel like they might have access to those same 16 contracts. 17 MR. DAVIS: I think the buyer -- 18 MR. RUNNER: So therefore that should be 19 factored into the value. 20 MR. DAVIS: No. I think what you do is you 21 would ask a buyer, a reasonable well-informed buyer 22 whether he expected to be able to obtain those 23 contracts or not. 24 MR. RUNNER: Okay. 25 MR. DAVIS: And our view from our 26 appraisers were -- 27 MR. RUNNER: Okay. 28 MR. DAVIS: -- that there was no basis to 46 1 assume so. 2 MR. RUNNER: I guess, again, what I 3 struggle with is I -- I -- I mean I think -- I -- 4 I -- I get what we're doing. I think we're trying 5 to -- we're trying to do what we think is the right 6 process; I get that. 7 Um, I'm trying to figure out whether or not 8 we have such a decline in the nature of this 9 particular kind of facility that we are not -- we 10 are just not recognizing the change of market, um, 11 and therefore creating some values that may -- may 12 not be there, I think. 13 And, again, I don't -- I don't think it's 14 anything -- I don't think the formulas are wrong. I 15 think everybody can choose their own formulas. I 16 think it's just a matter of trying to speculate what 17 we think's gonna take place. 18 Thanks. 19 MS. MA: Mr. Horton. 20 MR. HORTON: Thank you, Madam Chair. 21 Question of the Department. Can you share 22 with us the adjustments that were made relative 23 obsolescence and why the Department came to the 24 conclusion to make those adjustments? 25 MR. REISINGER: Sure. The -- the -- our 26 standard -- our standard appraisal for process and 27 methodology for power plants is to, annually we 28 determine the replacement costs new for a combined 47 1 cycle facility. So we look at information from the 2 California Energy Commission, the Energy Information 3 Administration. And then we have our own database 4 for plants that were built in California. 5 From that we then subtract, uh, physical 6 depreciation, which is depreciation based on the 7 life of the plant and the remaining economic life of 8 the plant. And for these facilities it's a -- it's 9 been agreed to that they have approximately a 10 25-year life. So we deduct depreciation or the 11 physical depreciation. 12 For this facility the -- the replacement 13 cost new was $905 million. The physical 14 depreciation was $380 million. So we're down to 15 $525 million as a replacement cost value less 16 depreciation, physical depreciation. 17 From that we made adjustments for economic 18 and functional obsolescence. The economic 19 obsolescence adjustments we make, we make two of 20 them. One is, we look at the actual generation 21 level and the projected generation levels for this 22 facility and compare it against the standard or 23 benchmark that we have for these types of 24 facilities. 25 And in this particular case the 26 adjustment -- let me look at the -- the adjustment 27 was 200-some-million dollars relative to the -- we 28 call it an in-utility adjustment. 48 1 So we've compared their projected 2 operations with the standard benchmark operations 3 for a combined cycle facility. Then we made another 4 economic obsolescence adjustment for this facility, 5 recognizing that not only are they generating less 6 electricity than anticipated, but the margins that 7 they're going -- that they're going to recognize in 8 selling their electricity are less than what they 9 would have anticipated when they purchased the 10 facility. 11 So it's called sparks spread, and basically 12 it's the difference between what the electricity 13 price is and the amount of -- the cost of the gas it 14 takes to generate a megawatt hour. 15 And in this particular case, we looked at, 16 um, the -- the sparks spread in 2007/2008 when it 17 was at its peak, which was 20 to 24 dollars. And we 18 compared that to what this facility actually was 19 able to earn, based on information they gave us, in 20 2015, and what their expectations were for 2016. 21 And that's like 11, between 10 and 11. 22 And so we recognized an additional -- so 23 the difference between 11 and 24 is 50 percent. 24 We -- we recognized an additional 50 percent 25 obsolescence relative to the reduced expected 26 margins. 27 The next thing we did is this facility, in 28 the past they've -- they've been able to show us 49 1 that they have some excess operating costs that 2 their facility incurs that some other facilities 3 with the same technology would not incur. And so we 4 made an adjustment relative to that. We just 5 basically determined what it was, what the total 6 would be over the life and discounted it. And 7 that's another $28 million. 8 So we basically, from the replacement costs 9 less depreciation, which is $525 million, we made 10 economic and functional obsolescence of 70 percent 11 to get us down to a replacement cost less 12 depreciation less functional and economic 13 obsolescence of $177 million. 14 So we -- we've -- we've made an attempt to 15 address the economic obsolescence issues that 16 they've brought up, which is they're under-utilized 17 and their margins are low. 18 MR. HORTON: Question of petitioner. Short 19 of using a solely economic analysis, um, what's your 20 position on the adjustments for obsolescence? 21 MR. DAVIS: As I indicated, you know, 22 we're -- we're -- they're certainly welcomed, Mr. 23 Horton. We're glad to see the reductions. Any -- 24 any relief we can get we're thankful for it. The 25 bottom line though is, is they're still simply not 26 enough. 27 Why -- the question that is raised is, 28 again, it's always the same question, What would a 50 1 willing buyer pay? And would a willing buyer pay 2 $178 million for this facility? And if so, why? 3 That's the question. 4 And based on the staff's own analysis and 5 their income indicator, we're only making about half 6 as much income as we need to support paying that 7 much for the -- for the facility. So it's still, as 8 much as we welcome the reductions very much, it's 9 still just not enough. 10 No one would pay the -- there's been no 11 economic demonstration why anybody would pay 12 $178 million for the facility. And that's -- that's 13 where we're at, Mr. Horton. 14 MR. HORTON: Given the, um, facility was in 15 operation, still continues to be in operation, an 16 adjustment for obsolescence, um, to solely use the 17 income approach -- 18 I'm gonna try to frame this in a question. 19 To solely use the income approach, given 20 the volatility of the income going up and down, how 21 would we -- how would -- how would the Department be 22 able to determine the value at any given time 23 without being able to project the income or the -- 24 or the business relationships with -- to be able to 25 develop the contracts. I mean, how do you tie 26 income into the value of the property? 27 I sort of liken this to owning an apartment 28 building, and the apartment building being vacant. 51 1 The mere fact that it has no income doesn't mean 2 that it doesn't have any value or potential value as 3 long as it's operating and we're moving in the 4 direction as anticipated. 5 The anticipation of the buyer certainly 6 would love to be able to purchase it based on the 7 income method, given that the income is, you know, 8 relative to the actual value of the property. 9 But how do you distinguish the two? I mean 10 how do you -- how do you associate just income alone 11 to value? 12 MR. DAVIS: Let me address that, for an 13 apartment building. Because this is a routine 14 problem. 15 MR. HORTON: Yeah, yeah. 16 MR. DAVIS: Comes up all the time. If you 17 rebuild an apartment building or if you have a new 18 apartment building, you may not have it leased up 19 yet, right? And so you always have a gap. 20 Um, and the way that you do that is you go 21 to the market and you find similar rental properties 22 and you impute a revenue. You account for a vacancy 23 period, and you can impute what you expect to be 24 able to rent that property for within a period of 25 time. It's a -- it's a -- it's a routine appraisal 26 problem. 27 MR. HORTON: Mm-hmm. 28 MR. DAVIS: A power plant on the other hand 52 1 is a little bit different in this sense: Our rent, 2 if you will, is what we would earn by generating and 3 selling electricity. And as we've indicated by the 4 ISO, the Independent System Operators indicated that 5 our costs, our revenue, our rent, if you will, is 6 only going to be about a third of our operating 7 costs. That's -- that's -- 8 MR. HORTON: But the facility still has the 9 potential. 10 MR. DAVIS: Can I -- 11 MR. HORTON: I mean let's say -- let's 12 say -- 13 MR. DAVIS: And I -- and I'm going to 14 address that right now. 15 MR. HORTON: Let's say there's a change in 16 the economic market. Let's say the future 17 administration decides to generate more of this 18 product. All of a sudden the whole world changed. 19 And, uh -- and then the Department came in and said, 20 well, based on this new value, uh, based on the 21 income, we're going to increase the value. 22 Inherently that wouldn't necessarily be 23 fair as well. 24 MR. DAVIS: Actually, Mr. Horton, with 25 respect, I'm going to disagree with you. That's 26 what we hope happens. 27 Because the other -- the other revenue 28 component you don't have in an apartment building is 53 1 these capacity payments. Well the capacity payments 2 are decided or determined, if you will, by the 3 regulatory entity. So it's a regulatory component 4 that doesn't exist in a typical real estate deal. 5 And it's the uncertainty of qualifying for 6 that additional component that makes -- is the 7 difficulty for this particular facility. Now, next 8 year, or the year after that perhaps, if the ISO 9 concludes that this facility is going to be required 10 for system or capacity support and we start getting 11 positive revenues and we start running again -- 12 we're running today, but we're not going to run a 13 negative forever, okay. That's going to stop right 14 now. 15 But, uh -- and we start picking up that 16 additional revenue to turn us into an economic 17 viable entity, well at that point in time you could 18 sell that expected revenue stream. And the -- and 19 the -- and this staff would determine the value of 20 that opportunity, and the value would go back on the 21 roll, just as it should. 22 And actually, uh -- 23 MR. HORTON: But the actual assessment 24 value -- 25 Well -- 26 MS. HARKEY: Let me -- I can -- 27 MR. HORTON: I mean I -- I understand the 28 market. I understand the volatility and the 54 1 challenge that the industry is facing. And some 2 time ago when the Department was not taking into 3 consideration the obsolescence, uh, to the degree 4 that the Board thought they should, it was an 5 inherent challenge in the industry itself. 6 But adjusting for obsolescence, and in 7 particularly economic obsolescence, was key in order 8 to be able to establish the value. 9 So, having costs directly associated with 10 just income alone when in fact you have an operating 11 facility that has the potential to generate income 12 if in fact it had the contracts, and therein 13 establishing some sort of value, the fact that it's 14 operating and it has this potential, you're trying 15 to split the baby somewhat is inherently the 16 challenge. 17 MS. HARKEY: You'd have to base it on 18 income. 19 MR. HORTON: And it appears that the 20 Department has attempted to do that. And I mean I 21 would love to hear an argument as to why further 22 obsolescence or further adjustments that adjust 23 the -- that reflects the actual value of the 24 property, considering that you're currently 25 operating, might be in line. 26 MR. DAVIS: To respond to that, I think we 27 could do a better job -- or I should say I think the 28 assessment would be more accurate if they did not 55 1 assume above-market energy prices. 2 MR. HORTON: Okay. 3 MR. DAVIS: I mean that's $6.70 megawatt 4 hour, generates in the first year $35 million of 5 revenue that we're not receiving. 6 So on the one hand there's -- 7 MR. HORTON: Let me ask the Department, 8 your thoughts on that? 9 MR. REISINGER: I'm not exactly sure what 10 he's referring to because we -- for our income 11 approach, we just took the bottom line appraisal 12 income that was generated actually by -- in 2015. 13 So all of the -- I mean it's -- it's an annual 14 number, and so all of the electricity prices and gas 15 prices would be subsumed in that. And that's -- 16 that's the number we used, the prior year's actual 17 results. 18 MR. HORTON: And that was at the time -- 19 that was at the lien date. 20 MR. REISINGER: Yeah, that was the -- the 21 last year's, 2015 actual results. And that was -- 22 so that would have been the last year of operation 23 before the lien date, as of the lien date. 24 MR. HORTON: And, uh, that valuation you 25 can directly associate to this entity. 26 MR. REISINGER: Yes. 27 MR. HORTON: And I'm presuming your 28 argument is, is that that's an average that's not 56 1 reflective of reality for you. 2 MR. DAVIS: It wasn't reflective of future 3 conditions, expected conditions. You know, the 2015 4 was not representative of going forward for 2016. 5 Oftentimes, oftentimes past performance is 6 a good indicator for future performance. I mean 7 that's also a truism for appraisal. On energy 8 prices for '15 to '16, that's not the case. 9 MR. HORTON: They make a decent point 10 there. Your thoughts? 11 MR. REISINGER: Yeah, I mean it's all -- it 12 comes back to the -- the problematic issue of 13 projections into the future. And we don't believe 14 that what we've been given is credible. And so we 15 took the alternative of using the 2015 actual 16 results. 17 And, by the way, the 2015 actual results 18 were the lowest, uh, operational income that that 19 facility's ever had since we've been assessing it. 20 So, in being -- trying to approach this 21 conservatively, we did use the lowest actual results 22 that we've seen for this facility. 23 MR. HORTON: Well, to a point I heard 24 earlier, I believe from Mr. Runner, what was 2016 25 actual results? 26 MR. REISINGER: We don't have -- 27 MR. HORTON: For the industry. We don't 28 have that? 57 1 MR. REISINGER: We don't have 2016, no. 2 MR. HORTON: Makes sense. 3 All right. Well, um, I would renew the 4 motion to adopt staff recommendation. 5 MS. YEE: Second. 6 MS. MA: Okay. We have a motion and a 7 second. 8 MS. HARKEY: I'd like to further a little 9 bit of discussion, only because I want to -- I think 10 you can compare, in essence, an apartment to this if 11 you -- that's -- if that's your frame of thought. 12 If the apartment were condemned -- which in 13 essence our policy has condemned this entity, this 14 type of production -- then you'd be selling the 15 apartment for land value and whatever scrap you 16 could get out of it, minus any brownfield or 17 anything else that might be underneath. 18 So I think -- I think that is the 19 comparison. 20 Um, if you use 2015 income for 2016, that's 21 a general, that considers an ongoing concern. 22 Ongoing concern, ongoing facility, ongoing 23 operations. 24 This was not. 25 Um, their agreement, their, uh, power 26 purchase agreement and their -- their -- what -- the 27 power sale agreement expired. They could not get 28 more power purchase agreements. Power purchase 58 1 agreements are, in essence, as I understood it, 2 they're kind of rationed by the state. So if you 3 don't have a power purchase agreement, you can't 4 sell your power or you can't have a guarantee of a 5 revenue to sell your power. 6 And what they were doing in 2016, I believe 7 you still had a subsidy coming in to cover some of 8 your costs; is that not true? 9 MR. DAVIS: Yes. 10 MS. HARKEY: Yes. So that's why they had 11 more revenue in 2015. Even though it was low, it 12 was still, you know, palatable. 13 In 2016 they did not have that. And so 14 while we use 2015 for an ongoing concern, that would 15 be totally accurate. To use it for going into 2016, 16 is not and -- in this case. 17 So I think you get to the property, the 18 land value and the parts, is what your appraisal is. 19 If it ever comes back into being, then it gets re -- 20 retrofitted, uh, reappraised and -- and whatnot. 21 But right now this is not an ongoing concern. 22 And you can't compare power plants without 23 power purchase contracts with power purchase 24 contracts. They're just -- they're apples and 25 oranges. And I think we've got a lot that don't 26 have them anymore and we're gonna -- that's why 27 we're gonna have several coming to the Board, 28 probably 20 or some. 59 1 So we have -- regardless of what we do in 2 this case, we need to have a different appraisal 3 process for this. This is coming. It's coming big. 4 And I think that, um, it's because of the state's 5 policy on energy and it's meant to happen. And it's 6 all happening as it was intended. And I think you 7 need to -- we need to make some adjustments there. 8 And I'd be happy to work with the 9 Department to try to figure out how to go forward in 10 the future, because I don't think we can continue 11 doing this in assessing in the same manner. It just 12 doesn't make sense. For an ongoing concern it does, 13 but not for a -- not for a condemned property, for 14 lack of better terms. 15 Thank you. 16 MS. MA: So I would agree with Ms. Harkey 17 that, you know, given that many of the similar type 18 of properties in this industry are going into a 19 decline for different reasons, um, it's very hard to 20 assess. 21 And I'm sympathetic of the taxpayers. Um, 22 but given the data that we actually have to work 23 with the assessors, um, I do think they did make an 24 accommodation on the replacement costs of about, you 25 know, $54 million down. 26 I had a long conversation with 27 Mr. Reisinger about why they used the 60/40 28 weighting. Sometimes we see 70/30, 80/20. We're 60 1 really not sure. But based on the explanation I 2 received, it's really according to what type of data 3 they get, uh, how strong they feel it is, how, um, 4 confident they are on relying on the different type 5 of information that they get, is how they weight it. 6 So it is subjective as, you know, we, you know, 7 have -- have all talked about. 8 And it's not really scientific. You know, 9 why isn't it 50/50, you know, versus 60/40, 70/30, 10 right? 11 But, you know, I think that our appraisal 12 team does have a lot of experience in this industry. 13 They've been doing it a long time. I feel like they 14 have tried -- they try to get the best information, 15 the most complete information that they can. And in 16 this case, you know, they did actually accommodate 17 and -- and decrease the replacement costs value by 18 $54 million based on your situation. 19 So I agree with Ms. Harkey. I mean 20 something probably needs to be adjusted to give 21 staff the guidance on how to move forward on cases 22 like yours. But, you know, um, given that, you 23 know, it's just not, um -- you know, it's not 24 clear-cut in this situation, I will also be, um, 25 voting with the staff recommendation on this case at 26 this time. 27 So, okay. So, there is a motion by Ms. 28 Yee, second by Mr. Horton, to, um -- to grant or to, 61 1 uh -- to go with the staff recommendation. 2 Do we want to put this up for a vote? 3 Okay, we're going to put this up for a 4 vote. 5 Ms. Richmond, please call the roll. 6 MS. RICHMOND: Ms. Ma. 7 MS. MA: Aye. 8 MS. RICHMOND: Ms. Harkey. 9 MS. HARKEY: No. 10 MS. RICHMOND: Mr. Horton. 11 MR. HORTON: Aye. 12 MS. RICHMOND: Mr. Runner. 13 MR. RUNNER: No. 14 MS. RICHMOND: Ms. Yee. 15 MS. YEE: Aye. 16 MS. RICHMOND: Motion carries. 17 MS. MA: Okay. Motion carries. 18 Thank you all very much. We look forward 19 to -- 20 MR. DAVIS: Ms. Ma, Members of the Board, 21 thank you very much. You've been very generous with 22 your time this morning. Thank you. 23 MS. MA: Thank you. Thank you. It's very 24 interesting. 25 ---oOo--- 26 27 28 REPORTER'S CERTIFICATE 62 1 2 State of California ) 3 ) ss 4 County of Sacramento ) 5 6 I, Kathleen Skidgel, Hearing Reporter for 7 the California State Board of Equalization certify 8 that on December 14, 2016 I recorded verbatim, in 9 shorthand, to the best of my ability, the 10 proceedings in the above-entitled hearing; that I 11 transcribed the shorthand writing into typewriting; 12 and that the preceding pages 1 through 62 constitute 13 a complete and accurate transcription of the 14 shorthand writing. 15 16 Dated: January 20, 2017 17 18 19 ____________________________ 20 KATHLEEN SKIDGEL, CSR #9039 21 Hearing Reporter 22 23 24 25 26 27 28 63