Diverging Edison, PG&E; Strategies Will Generate Different Futures

Southern California Edison and Pacific Gas & Electric are the doppelgangers of California’s electricity crisis, haunting each other down a deregulated road to financial ruin.

But in recent months, the state’s biggest electricity utilities have chosen quite different paths that will lead to quite different futures.

PG&E;, a subsidiary of San Francisco-based PG&E; Corp., in early April put its faith in U.S. Bankruptcy Court. Edison and its Rosemead-based parent, Edison International, pursued a rescue through Gov. Gray Davis, the state Legislature and the California Public Utilities Commission.

Now both firms await key court rulings, one in Bankruptcy Court and the other expected at the U.S. 9th Circuit Court of Appeals, that will determine how each company will look once its massive electricity debts are erased.

If they are successful in their separate plans, the two insolvent utilities would be free to seek profit in ways that mirror the divergent philosophies that drove them even before California launched its deregulated electricity market in 1998, analysts say.

PG&E; Corp., the aggressive highflier, would be split into two companies: a large generation company free of restrictive state regulation and a smaller electricity and gas distribution operation. Edison International, which has struggled in the unregulated world, would keep its utility mainly under the umbrella of state regulation but also maintain an unregulated unit allowed to build and buy power plants and other assets around the world.

“We’ll all look back in five years to determine if one company made a better decision than the other,” said Brian Youngberg, senior utility analyst with investment firm Edward Jones in St. Louis. “It may prove that both made the right decision for their particular situation.”

Each company stoutly maintains that its approach is the right one for its unique set of circumstances. But through a gentleman’s agreement between the chief executives, the firms have declined to discuss one another’s strategies.

The utilities’ many critics feel no such qualms.

“PG&E; is locked in a deadly political and economic struggle with both the governor and state regulators,” UC Irvine economist Peter Navarro said in a speech Thursday to the Commonwealth Club in San Francisco. “In these battles, PG&E;’s strategy is clear: Cut its regulated side loose after using the bankruptcy process to transfer as much of the assets of the regulated side to its profit-making subsidiary.

“As for Edison, its lobbyists and lawyers have pulled off a political miracle. Rebuffed by the state Legislature, they have managed to engineer a lucrative bailout that will help keep California’s rates high for years.”

Once United, Now Diverged

For a time, Edison and PG&E; were a matched set. They helped write the landmark 1996 legislation, AB 1890, that opened the state electricity market to competition, pushed the utilities to sell most of their power plants and held out the promise that Edison, PG&E; and Sempra Energy’s San Diego Gas & Electric could recover all of their investments in nuclear and other assets that would become uneconomical in a no-holds-barred market.

When electricity generators began charging record power prices in May 2000, Edison and PG&E; began accumulating twin piles of debt because AB 1890 had frozen the retail rates charged to households and small businesses.

The two utilities, which together serve 24 million Californians, both petitioned state regulators for the right to raise rates in 2000 but were rebuffed. Both ran out of cash in mid-January and could not find a generator willing to continue to sell them electricity, forcing the state to begin buying a portion of the power consumed by their customers.

PG&E;’s energy debts surpassed $9 billion, Edison’s topped $5 billion, and both filed federal lawsuits seeking to force the Public Utilities Commission to raise rates so all wholesale power costs, past and future, would be paid by customers. When the PUC granted about 40% in rate increases this year, the money was earmarked for future power purchases, not back debts.

Gov. Davis sent emissaries to negotiate a way out of the mess. But PG&E; grew frustrated with the process and sought protection from its creditors in U.S. Bankruptcy Court on April 6. Days later, Edison agreed to a Davis-brokered deal to sell its transmission lines to the state for $2.8 billion and float bonds to pay past electricity costs.

There, the paths diverged.

PG&E; sought a business-based solution focused by federal bankruptcy law on the rights of creditors, not ratepayers. Edison relied on politics, an arena in which consumer activists and the power of the ballot box cannot be ignored. Their approaches were so at odds that every time one would gain ground, the other would seem to lose momentum.

Edison’s deal ran into overwhelming opposition in the Legislature, which adjourned Sept. 15 without passing a rescue plan. Impatient creditors threatened involuntary bankruptcy.

PG&E;’s fortunes further brightened Sept. 20 when it filed its exclusive plan of reorganization with the full support of its creditors committee.

The plan, if accepted by the bankruptcy judge, would allow it to keep customer rates steady and still pay all of its $13 billion in creditor claims, a process the utility hopes to complete by the end of next year.

The utility’s power plants, electricity grid and gas pipelines, at present regulated by the PUC, would be transferred to the parent company and would be subject to less-restrictive federal regulation, although electricity and natural gas would be sold to the utility under a 12-year, fixed-rate contract.

The drastically smaller utility, which would continue to distribute electricity and gas to customers under PUC rules, would be spun off into a separate company. Most important, the parent company, unburdened by PUC limits on borrowing, could return to Wall Street for financing of new bonds and loans to retire the debt.

Meanwhile, unknown to all but a few Edison and PUC insiders, a rope to pull Edison from its financial quagmire was quietly being woven. After 10 days of intense negotiations initiated by the PUC after lawmakers abandoned the Edison rescue, a deal was struck Tuesday.

Under the plan, posed as a settlement of Edison’s federal lawsuit against the PUC, the utility would pay nearly $6.4 billion in debts early next year using cash on hand, new borrowings, $1.2 billion in funds that would otherwise have gone to shareholder dividends and money generated by customer rates.

The payback is possible because of a sharp decline in the price of natural gas, which generates much of California’s electricity, thereby leaving breathing room between what customers pay and what it costs to produce electricity. (Although the state is supplying about one-third of Edison’s electricity needs through long-term contracts, another third is supplied by small, alternative generators whose prices are determined by the cost of natural gas.)

Utilities Await Credit-Worthy Status

The PG&E; plan still must be approved by U.S. Bankruptcy Judge Dennis Montali and federal regulators. The Edison lawsuit settlement was accepted Friday by U.S. District Judge Ronald S.W. Lew, but consumer advocates have vowed to appeal his decision to the 9th Circuit Court.

If Edison and PG&E; get all that they seek, they could return to the task of buying some electricity for their customers shortly after being deemed credit-worthy by Wall Street debt-rating agencies. Both plans would pay all past electricity debt--a prerequisite for an investment-grade rating--but also would load the respective companies with new debt.

As PG&E; Corp. Chief Executive Robert D. Glynn Jr. explained in a recent interview: “The [alternative] we chose keeps the business in two California companies, as opposed to selling it off to who knows who; it keeps the employees running the business that they know how to run; and it keeps the assets that exist today committed for the long term to the consumers who depend on it today.”

The utility “will still be a giant and strong company,” but its prospects remain tied to the economic growth of Northern and Central California, he acknowledged.

Edison Chief Executive John E. Bryson told journalists Wednesday that the settlement means “we can become credit-worthy, we can repay creditors, we can avert bankruptcy, and, most important, we will get on with the business of providing affordable, safe power to our customers.”

Consumer advocates contend that PG&E; would get 5 cents a kilowatt-hour under its proposed long-term contract for power that costs much less to produce--and after 12 years would be free to charge whatever it wants.

By the time Edison finishes paying its debts, perhaps as early as the end of 2003 but no later than the end of 2005, the rate freeze will have ended and it too will be able to charge market rates for the electricity it generates, although under some PUC scrutiny.

To be sure, what both utilities will be able to get for the power they generate will be dictated by the market at the time. But no one is hazarding a guess what that will look like, given the collapse early this year of the California Power Exchange, the state’s primary electricity market, and the overwhelming influence of the state’s $43 billion in long-term contracts signed since January.

Edison would retain its legal obligation to serve its utility customers with its power plants--it still co-owns the San Onofre nuclear power plant, among other assets--but the PG&E; parent would not once the 12-year contract has ended.

Steven Fleishman, a Merrill Lynch utility analyst in New York, said the PG&E; plan “appears both viable and favorable for shareholders” and allows “strong, sustainable growth businesses to emerge from the bankruptcy process.”

The Edison settlement “looks strong,” he said. But he cautioned that Edison International and Edison Mission Energy, its unregulated power plant development business, have been forced during the crisis to take on high-cost debt that will depress earnings for a time.

Lehman Bros. analyst Daniel Ford said that where the Edison settlement may result in a quicker path to the state exiting the power business, the PG&E; bankruptcy plan offers the advantage of reducing the company’s earnings risk from “punitive actions” by state regulators. Applying the Edison terms to PG&E; would drag out the PG&E; recovery because the San Francisco utility has bigger electricity debts and lower rates, he said.

Consumer advocate Michael Shames said it is too early to tell which company will benefit most from each proposed settlement, but he added that PG&E; has more fences to mend.

“PG&E; is in the equivalent of a divorce proceeding with the state of California,” said Shames, executive director of the Utility Consumers’ Action Network in San Diego. “It is a company that over the long term will pay dearly for its short-term tantrum. . . . I have seen that regulators have very long memories.”