SDG&E; Holding Company Proposal Raises Questions

Based on the track records of two California public utilities that created holding companies and subsequently branched out into non-regulated businesses, San Diego Gas & Electric Co., which last week announced a plan to create a holding company, will remain heavily anchored in energy-related endeavors.

Pacific Telesis, the holding company created during the breakup of AT&T;, has created new units that are chasing the growing cellular phone market, publishing newsletters and magazines, and providing real estate and financial services.

Although that diverse activity sounds dramatic, only 1,000 of Pacific Telesis’ 75,000 employees work for units other than Pacific Bell and Nevada Bell.

Pacific Lighting, which owns Southern California Gas Co., has been in business for more than 50 years, but the company, although active in energy exploration and residential home building, still relies on its regulated energy business for 75% of its operating income.

“We’re not going to take our eyes off of the utility side of the business,” promised Tom Page, SDG&E; chairman, president and chief executive, immediately after announcing his holding company proposal last week. “You will see a very slow addition of people on the non-utility side of the business, and there will be no mass migration of people from the utility side.”

On hand to make sure that an exodus of top management does not occur will be the California Public Utilities Commission and the San Diego-based Utilities Consumer Action Network.

“The utility is subject to regulation by the PUC and it always will be,” stated Bruno Davis, director of the PUC’s evaluation and compliance division. “It’s just that instead of being owned by diversified owners, it will be owned by the parent company.”

Still, SDG&E; is the first major utility to come before the PUC with a holding company proposal.

(Sierra Power, which supplies a minor portion of California’s energy requirement is owned by a corporation that received PUC permission to create its Nevada-based holding company.)

PUC officials said they have the authority to ensure that SDG&E--and; any other utility that comes on the scene with a holding company plan--doesn’t borrow from utility operations to pay for non-utility business growth.

“It’s going to make a lot more work for us, and it makes the whole relationship more complicated,” said William Ahern, director of the PUC’s public staff division, which acts as the public’s advocate during commission proceedings.

Although the PUC has the authority to regulate the holding-company-owned utility, “the practicalities of it are another thing,” Ahern said.

The PUC often runs into “difficulties” when it tries to get information on how Pacific Telesis divides regulatory and non-regulatory work among its corporate staff, Ahern said.

“We have to watch the transactions between utilities and the unregulated companies,” Ahern said. “We have to watch them carefully to see that they’re not getting an unfair advantage from the use of utility people, property, etc.”

Ahern said the practicalities of watchdogging Pacific Telesis prove burdensome when “they have business transactions with a bunch of fast-moving entrepreneurs. I have to send my auditors in there, to make sure of what’s going on at the utility, and they have to look at both ends. The entrepreneurs start saying, ‘What are these regulatory auditors doing in my office?’ They don’t realize we have to (do the reviews).”

PUC’s Davis cautioned that SDG&E;’s management resources will “presumably be depleted” as the holding company demands more management time and attention.

“There could be questions about the efficiency of utility operations while this new organization is on a learning curve,” Davis said.

UCAN Director Gary DeLoss said that kind of activity underscores the need to “erect very strong barriers to prevent the regulated side of the company from subsidizing the unregulated side. I can see what management’s motivation is. They want to be able to invest in the unregulated businesses where they can get a higher return on investment.”

But, DeLoss warned, “higher return . . . goes along with higher risk. And from the consumer point of view, we’re very concerned that risky investments don’t upset the holding company and end up hurting the utility part of the business.”

If future holding company real estate speculation goes awry, for example, UCAN does not want management asking regulators for generous rate hikes to cover non-regulated losses.

Another view is taken by the Edison Electric Institute, a Washington-based utility industry trade association. The holding company concept is the most effective way to ensure that “the electric business is paid for by the electric customers, and that the diversified businesses are being paid for by the diversified customers,” according to Douglas Bauer, institute vice president.

Holding companies “help make the internal accounting of how staff time and money is spent very explicit,” Bauer said. “Any risk that might be associated with the diversified concerns is borne by the risk venturers, the owners of common stock.”

That is true to a point, argued the PUC’s Ahern. “If they go into highly risky things and jeopardize the capital rating of the utility, we’d be concerned because we don’t want (either side) to become a money drain.”

Page argued that SDG&E;’s stock would become unattractive to investors if the utility didn’t create a holding company and failed to venture into non-regulated businesses.

He said shareholders and ratepayers alike will benefit from SDG&E;’s entry into markets where the utility can utilize its accumulated finance and energy-related knowledge.

PUC’s Davis said he sees a “positive side” to diversification.

“If the utility, by moving successfully into other businesses, could reduce risk to stockholders, then demand for SDG&E;’s stock would be higher.”

That reasoning echoed past statements by Pacific Telesis Chairman and Chief Executive Donald E. Guinn, who has argued that “diversification improves our ability to sustain long-term real earnings growth. Our new, diversified businesses have no ‘authorized’ return on equity. Their potential is limited only by the ingenuity and hard work of the managers who run them.”

Page has already cautioned his management team that, as the proposed holding company operations grow, competition in new, non-regulated markets will force non-utility managers to shed the staid practices developed during decades in the regulated environment.

UCAN’s DeLoss remains unimpressed with that kind of entrepreneurial spirit. “I wouldn’t want to say that utility holding companies should be banned in California,” he said. “There are already two in California, so there is precedent for it.

“But SDG&E; is a very special case, given its history of bad management. The PUC should have some kind of (special) review. If PUC doesn’t have (that kind of review), we’ll seek it.”