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Memorandum June 19, 2008 1. The current policy argument in favor of gross revenue franchise fees is usually centered on the conservation incentive component to the franchise fee. The argument is that a person can reduce the franchise fee, as well as its overall gas or electric bill, by conserving. The counter to that argument is that there are limits to how much a household or business can conserve and the savings in the franchise fee context is small. Nevertheless, the conservation aspect of the gross revenue basis is one reason some cities still choose this method over the meter fee approach that is a fixed fee regardless of usage (below). Residents most benefiting from a gross revenue approach would be those who live south during the winter months and use the bare minimum gas sufficient to prevent pipes from freezing in the home during January and February. 2. A gross revenue fee captures growth in the city due to the company's probable increase in gross revenues derived from the higher utility needs from more business and residential dwellings. This typically converts to more revenues for the city if gas or electric prices remain constant or increase and the franchised utility continues to be the substantial provider of the gas or electricity to customers in the city, as opposed to (in a deregulated environment) merely delivering the commodity to the customer, who buys it from other sources. The latter arrangement is more common in the gas industry. Under current law, neither gas nor electric residential customers have the right to purchase the gas or electricity from any source other than the franchised utility. Gas business customers have had such rights since 1988 so the market is stable in that regard. Therefore, under the largely monopoly regulation environment governing gas and electric utilities, growth in the city will mean growth in the utility's gross revenues. Cons: 1. This type of franchise fee design has become less common in recent years because it can be seen as disproportionately hard on large users, such as large businesses. Utilities are competition conscious even though deregulation has slowed or stopped due to the scandals in recent years by Pacific Gas & Electric's bankruptcy and Enron's market manipulation. Competition for large employers on a utility's electric load instead of some alternative form of energy and its location within a city have resulted in utilities and cities agreeing on rate designs that are not heavily weighted on its largest employers /customers, as the percent of gross revenue method tends to be. "Demand rate" customers for electric utilities are the largest customers because their demands create the need for the production of the most expensive energy delivery (hot days in July and August for electric utilities and cold days in January for gas utilities). A very large employer located in a city may constitute a very large percentage of the gross revenues earned by that utility. To counter this effect, some cities and utilities have agreed to a lower percentage fee applied to large customers than to residents. 2. Another criticism of the gross revenue method in recent years has been a result of the spiking of gas and electric prices that are passed through to customers. Gas and electric utilities "pass through" components of their rates based on the price they pay for gas or 335300v1 JMS LN140 -105