PUC May Probe Utilities’ Rule Compliance

Adding significantly to the financial and political risks facing California’s three big utilities, the state Public Utilities Commission said Monday that it is considering whether the companies have violated the rules allowing them to diversify into unregulated businesses.

Starting in the mid-1980s, the PUC authorized the creation of holding companies, in which the utilities were relegated to the status of subsidiaries. The new companies were permitted to pursue other, unregulated businesses--as long as those activities did not compromise the utilities’ ability to serve customers and the capital needs of the utilities remained the top priority of the new corporations.

The PUC said that at its regular meeting Thursday it will consider investigating whether the companies--Southern California Edison, San Diego Gas & Electric and Pacific Gas & Electric--have complied with those rules and whether the rules need to be rewritten. SCE formed its holding company, today known as Edison International, in 1988; SDG&E; formed a company, later to be merged into Sempra Energy, in 1986; and PG&E; formed PG&E; Corp. in 1997.

It is unclear what remedies the PUC could impose if it did find that the utilities have violated the rules. Each time it approved the creation of holding companies, the commission reserved the right to reconsider its action “at any time when facts warrant such a change,” presumably including rescinding the approvals. But that would lead to such major corporate upheavals that it probably is not practical.

Two independent audits of Edison and PG&E; released by the PUC last week scrutinized the financial interrelationships between the utilities, their parents and their unregulated corporate cousins. Among other things, the audits documented that in recent years almost all the net income of the parents was traceable to utility profits. The audits did not suggest there was anything improper in the relationships, however.

Moreover, the relationship between the utilities and parents has come under intense scrutiny in recent weeks as state officials and the Legislature turn to whether and how to help Southern California Edison and Pacific Gas & Electric recover from their crushing debts. Among the issues is whether the parent corporations should be forced to contribute cash or assets to cover the $7.2 billion in net deficits the utilities have accumulated in the wholesale energy market over the last eight months.

The audits released last week showed that in the first two years of deregulation, Southern California Edison and Pacific Gas & Electric transferred billions of dollars in cash to their parents.

Much of that money represented “headroom”--the surplus generated by electricity rates fixed by the Legislature and the PUC when the cost of power was low. Under the terms of deregulation, the utilities were permitted to apply the surplus to their so-called “stranded costs”--uneconomical contracts with alternative energy producers and cost overruns on nuclear plant construction--at the end of every month. After those costs were completely paid off, but no later than March 2002, the rates were to be unfrozen.

The holding companies used the funds for traditional corporate purposes: They paid dividends to their own shareholders, implemented share repurchases, retired debt and financed the purchase of assets for their unregulated subsidiaries.

That process meant, however, that when the cost of power soared well beyond what the utilities received from the frozen rates, as happened starting in May, the utilities had no cash reserve with which to cover the ever-mounting deficits.

No one, including the auditors, has suggested that the utilities did anything illegal or improper in transferring the sums. The transfers were done in accordance with procedures approved by the PUC and were disclosed in regular corporate filings to the Securities and Exchange Commission.

But consumer advocates and some state legislators have argued that the transfers mean, in effect, that utility ratepayers covered the existing deficits in advance. To the extent the holding companies benefited from the transfers, they say, they should be required to repay the money in part by providing cash or assets to a recovery fund.

The holding companies have strongly resisted such suggestions, which they say would be tantamount to “confiscating” corporate assets to cover debts properly owed by utility customers.

But the companies, which maintain that their deficits are the result of market forces beyond their control, also are clearly sensitive about how these transfers are viewed by the public.

“There’s an idea out there that the parent-company shareholders have had this tremendous ‘windfall,’ so why should they be bailed out?” said Ron Olson, an attorney for Edison. “But ‘windfall’ and ‘bailout’ are loaded words.”

The complicated holding company structures were proposed by the utilities to facilitate their expansion into new businesses in areas not normally subject to PUC jurisdiction. These included, for example, investing in power plants outside the state.

Among other things, as SCE asserted before the PUC, the new structure would help ratepayers because it “minimizes the possibility of inadvertent subsidies between [the] regulated [utility] and unregulated businesses.”

But to win permission, the utilities had to promise that the ratepayers would continue to come first. “The capital requirements of the utility,” the PUC wrote in its Edison approval decision, “ . . . shall be given first priority” by the holding company’s board. Above all, the companies were to ensure that the utilities would never “subsidize” the outside businesses.

Since then, the financial relationships between the utilities and their parents have never been far from the PUC’s thoughts.

“This has been a continuing issue since the holding companies were formed,” PUC Commissioner Carl Wood said.

It has gained in importance now that the utilities are deeply in debt after years of providing healthy cash infusions to the holding companies.

The audit of Edison by the accounting firm of KPMG showed, for example, that the cash fueling Edison International’s business growth from January 1996 through November 2000--including the first three years of deregulation--came almost entirely from the utility.

In that period, the auditors found, Edison International received $300 million in dividends from its unregulated businesses, which operated as Mission Group, but $4.7 billion from SCE. Over the same period, Edison International invested $2.5 billion in capital in Mission Group--apparently including as much as $400 million in equity--and only $153 million in SCE. Other than that, the audit found, “no significant funds” flowed from the parent to the utility in the five years under examination.

A similar pattern existed at PG&E;, according to its auditor, Barrington-Wellesley Group. From 1997 through 2000, the auditors said, some $4.6 billion flowed from Pacific Gas & Electric to its parent, which invested at least $800 million of it in its unregulated subsidiaries. No similar investment was made by the parent in the utility.

The parent even benefited from tax overpayments made by the utility. From 1997 through 1999, the auditors found, the utility overpaid PG&E; Corp. $663 million for income tax it theoretically owed the government. The overpayment occurred because the utility calculated its own tax liability as though it were a stand-alone corporation. PG&E; Corp. then made a second calculation of the entire holding company’s tax due, which turned out to be less than the utility’s figure.

The holding company, however, pocketed the overpayment instead of refunding it to its utility subsidiary.

“Historically, cash has flowed in only one direction, from PG&E; to PG&E; Corp., and then to the unregulated affiliates,” the auditors wrote.

These flows would not necessarily raise questions, were it not for the holding companies’ recent efforts to protect these unregulated businesses from the impact of the utilities’ woes. Both Edison and PG&E; have instituted so-called “ring-fencing” provisions designed to prevent bankruptcy courts or anyone else from using the unregulated assets to cover the utilities’ debts. In Mission Group’s case, the protected assets include $895 million in cash the subsidiary held as of the end of November.

Consumer advocates have contended that these steps--taken in both cases after the utilities’ conditions were already dire--violate the PUC’s requirement in approving the holding companies that they give “first priority” to the “capital requirements of the utility.”

“Our interpretation is that the holding company is entitled to benefit from cash generated by the utility until the utility needs it,” said Matthew Freedman, an attorney for the Utility Reform Network. “That time is now.”

The companies, however, say the mandate applies only to the utilities’ capital expenditure programs--the construction of power plants, maintenance of equipment, and so forth--and does not require the parent to cover the utilities’ operating deficits.

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Power Points

Background

The state Legislature approved electricity deregulation with a unanimous vote in 1996. The move was expected to lower power bills in California by opening up the energy market to competition. Relatively few companies, however, entered that market to sell electricity, giving each that did considerable influence over the price. Meanwhile, demand has increased in recent years while no major power plants have been built. These factors combined last year to push up the wholesale cost of electricity. But the state’s biggest utilities--Pacific Gas & Electric and Southern California Edison--are barred from increasing consumer rates. So the utilities have accumulated billions of dollars in debt and, despite help from the state, have struggled to buy enough electricity.

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Daily Developments

* Gov. Gray Davis said there would be a plan by week’s end to avert the bankruptcy of utilities by trading bond money for their assets.

* Southern California Edison halted the sale of 307 coastal acres in Ventura County and is considering the sites for new power plants instead.

* The governor used his emergency authority to claim $150 million worth of contracts held by PG&E; just as a creditor was about to take them.

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Verbatim

“It is my goal to make sure that whatever the state receives in return has comparable value.”

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--Gov. Gray Davis

Complete package and updates at www.latimes.com/power

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More Inside

Help for Utilities: Governor, legislators promise a plan to avert bankruptcy of Edison, PG&E;, A3

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* NATURAL GAS PRICES DROP

Economic fears and forecasts of warmer weather helped send natural gas prices down 15%. C1