Hmmm... This could have serious repercussions for any company with significant energy exposures in California...
interactive.wsj.com
September 27, 2000
California Utilities' Losses
On Electricity Pose Risk
By REBECCA SMITH
Staff Reporter of THE WALL STREET JOURNAL
California's two biggest utilities are losing so much money buying electricity
in the state's deregulated market that they have run up deficits equivalent to
half their net worth in just four months.
If the cost of wholesale power continues to exceed the price these utilities
are allowed to bill their customers, as currently seems likely, they could
become technically insolvent sometime next year. That would put pressure
on regulators to orchestrate a multibillion-dollar public bailout, similar to the
"too big to fail'' response that in the past pushed governments to rescue
banks.
Such a scenario is quietly being discussed by bond-rating concerns that
recently reduced their credit outlooks for Pacific Gas & Electric Co., a unit
of San Francisco-based PG&E Corp., and Southern California Edison, a unit
of Edison International of Rosemead, Calif. Bond- rating concerns say they
aren't sure how much additional debt can be borne by the two affected
utilities before they will have difficulty paying their bills.
"If this is just a seasonal aberration, the utilities
can get through it," says Lori Woodland, analyst
for Fitch IBCA. "If it goes on for six or nine
months, it's a very serious situation." Adds A.J.
Sabatelle, senior credit officer at Moody's
Investors Service Inc.: "At some point, you
have a financial crisis."
The utilities say they are having no difficulty
meeting expenses and don't envision problems
in servicing their debts. But they are vigorously
lobbying state and federal regulators to change
the rules of the game, hoping somehow to raise rates to make up for the
shortfall. The California utilities' experience may be a harbinger of what
could happen in other states where wholesale power prices have surpassed
the amount that utilities are allowed to charge their ratepayers.
For now, utilities are making ends meet by going to the financial markets to
borrow money. PG&E, a giant utility that serves one out of every 20
Americans, is seeking approval to increase its debt capacity by $1.4 billion. It
is borrowing $200 million, while Edison is tapping $250 million from the
commercial paper market. "This is going to be a long, tough road," says Jim
Scilacci, chief financial officer for Southern California Edison.
Today's situation represents a complete turnabout from what was expected
when California deregulated its energy market on March 31, 1998, which
opened electricity pricing to competition. California tried to give its utilities a
competitive edge nationally by deregulating faster than other states and by
creating a mechanism to allow investor-owned utilities, such as PG&E and
Edison, to quickly pay down debts incurred to serve customers under the old
regulatory system.
To do this, the state legislature set
retail rates at high levels, which, at
first, generated fat surpluses for the
utilities. As the money piled up,
utilities used it to pay down debts for
generation facilities that were
otherwise unprofitable in the new
deregulated world. By the end of this
June, PG&E and Edison together had
collected more than $12 billion and
were on track to finish paying down
debts well ahead of the March 31,
2002, deadline set by the legislature.
At that point, rate freezes were to
end and retail prices were to fluctuate
with the market.
But all that went out the window in
June, when wholesale power prices
surged, topping the rates the utilities were allowed to charge retail
customers. Average prices at state-sanctioned energy markets were four to
five times the prices of a year earlier, and three to four times the level
utilities could charge customers.
The accumulated shortfall has been so enormous at PG&E, that analysts
expect its deficit to exceed $3 billion by Oct. 31, more than half its
shareholder equity of $5.7 billion, which is defined as assets minus liabilities.
Southern California Edison finished August with a deficit of $2 billion,
equivalent to almost two-thirds its net worth of $3.2 billion. The utilities,
though they have been accumulating deficits, aren't required to report these
as losses on their earnings statements.
That leaves utilities in a bind. They want to end the rate freeze to be able to
pass on the real cost of electricity to consumers. But should the freeze end
before the statutory deadline of 2002, they get clobbered. That is because
they will immediately have to book a loss on their power-purchase deficits.
What's more, they can't use the proceeds from planned power-plant sales to
cover those losses; instead, should the freeze end, they will be obliged to
refund some of the proceeds to ratepayers. In PG&E's case, the refunds
could total $500 million, while in Edison's case, the amount is $254 million.
Publicly at least, utility executives insist a mechanism will be found to let
them recoup the money spent on electricity.
Consumer advocates are gearing up for the fight. Nettie Hoge, executive
director for San Francisco consumer group Utility Reform Network, says
ratepayers shouldn't end up footing the bill for a deal cut by utilities that
benefited them before prices shot up.
Utility executives are now distancing themselves from the legislation that got
them into such a mess, which was drafted with their assistance. PG&E
Chairman Robert Glynn says it is best not to "overanalyze" the "old deal."
Instead, he says, regulators and legislators should sit down with utilities and
construct a new agreement, since "it's in the broad interests of the state not
to have critical energy infrastructure look like a leper."
Mr. Glynn says the current deal offers "mutually assured destruction" to both
utilities and ratepayers. Something must be done, he says, or consumers
throughout most of the state will experience "a San Diego-style rate shock."
The utility serving that city, San Diego Gas & Electric Co., ended its freeze
a year ago and began passing wholesale power costs directly through to
ratepayers. Legislators intervened this summer, however, and temporarily
capped retail rates when monthly power bills nearly tripled. The utility, a unit
of Sempra Energy, is also accumulating a deficit as a result.
So long as banks and bond markets believe the utilities will be repaid, they
will be able to borrow, analysts say. "Until we hear politicians of
consequence state otherwise, our position is that we believe the utilities will
be made whole," says Richard Cortright, a director at Standard & Poor's
corporate ratings group.
But that opinion could change if it looks like the utilities will have to swallow
a big loss. The result: lower credit ratings that would raise borrowing costs
and could trigger a downward spiral. "You're talking about top-rated
companies, though," said Ms. Woodland of Fitch IBCA. "To get to
insolvency, a lot would have to happen."
In the meantime, utilities are doing all they can to control the hemorrhaging.
They have gotten authority from regulators to buy more power under
long-term contracts at fixed prices, reducing their vulnerability to
spot-market volatility. And they have petitioned federal regulators to declare
California's market so badly flawed that generators should be denied market
pricing and, even, ordered to pay refunds.
Nevertheless, several forces are working against them. Although they can
sign bilateral contracts, prices remain high for those as well. What's more,
they can't buy less power than their customers need. If they don't buy
enough, the California Independent System Operator, the organization
responsible for reliability, will step in and make purchases for them and send
them the bill.
Perhaps the biggest problem facing PG&E and Edison, though, is one of
timing. The California legislature is out of session until December, and
regulators haven't even really started to address the issue formally. In the
meantime, the utilities' deficit is growing by tens of millions of dollars daily.
Write to Rebecca Smith at rebecca.smith@wsj.com
KJC |
