The Lights Are On but the Problem's Not Over

The lights are shining but the problem's not over.

That was the message from California Gov. Gray Davis as he signed emergency legislation Friday allowing the state's Department of Water Resources (DWR) to purchase power to meet California's electricity needs. "This bill gives California the authority needed to buy and sell power," he said. "Now we have the short-term authority to negotiate lower rates, purchase power, and keep the lights on."

The legislation appropriates $400 million for the DWR to purchase power for the next two weeks and sell it to the state's beleaguered utilities -- Pacific Gas & Electric, a PG&E (PCG Quote - Cramer on PCG - Stock Picks) subsidiary, and Edison International's (EIX Quote - Cramer on EIX - Stock Picks) Southern California Edison -- at cost. The plan should keep the utilities out of bankruptcy court while legislators, power generators and the utilities work toward a longer-term solution.

Investors and analysts are cautiously optimistic about the progress. "We're not out of the woods yet, but I'm very pleased, and a little surprised, with the progress," said Jeff Dietert, power analyst at Simmons & Company, a Houston energy research boutique.

There's still plenty of work to be done and time is short. The action today buys the state about two weeks, at the outside, to craft and implement a long-term solution to its power woes.

That solution is likely to be found -- in Sacramento government lingo -- in Assembly Bill 1X, legislation that provides permanent authority for the DWR to enter into long-term contracts with generators.

However, two significant issues must be overcome for the legislation to effectively address the current crisis.

First, in its current form the legislation calls for the DWR to purchase power for a price not to exceed $55 per megawatt hour -- the maximum price that would not require the state to raise retail rates. However, the generating companies that supply California power have made it clear they can't deliver power at that price without contracts that guarantee such prices over at least eight to 10 years. The governor appears unwilling to enter into contracts longer than three years.

A compromise will be difficult. "Most generators have been adamant in seeking contracts at a rate above [that] demanded by the state," Credit Suisse First Boston analyst Paul Patterson told clients Friday morning. "Some generators have stated that [the state's rate] would be below their generation costs, even if extended over a period of several years."

While generators have come down from their initial demands of about $100 per megawatt hour, their current target price of $70 leaves the parties far apart. "Price could be a major sticking point," says one source close to the negotiations. "The state's expectations may be unrealistic, especially if they want to control the structure of the product."

Davis may be willing to negotiate, at least marginally. In a sign he might consider alternatives, Davis indicated earlier this week that not all power bought by the state must be at or below his target price. The California Senate will continue to consider price issues in hearings and debate Monday morning.

The other major issue is the nearly $12 billion in debt the California utilities have amassed since November by buying wholesale power on the spot market as prices soared, while at the same time being forced to provide power to retail customers at rates frozen at 1996 levels.

One solution is securitization, with the state allowing the utilities to issue long-term bonds to recover the costs over 10 to 15 years. The bonds would likely be paid for through a surcharge on California electricity rates, something both the governor and Legislature have opposed.

However, California Sen. Diane Feinstein, a Democrat with close ties to Gov. Davis, suggested yesterday that such a plan was an important part of a comprehensive solution to the crisis.

That message may be getting through to Sacramento. "There has been some behind-the-scenes discussions on the issue today," said the source.

Another possible solution, proposed by California Assemblyman Fred Keeley, would have the DWR sell power to the utilities at $55 per-megawatt hour, and the utilities in turn would sell the power at currently approved rates: about $64 per-megawatt hour for PG&E and $76 for Edison. The spread could be used to pay down each company's debt.

However, that plan works only if power prices remain well below the current rate authorizations, something not likely to happen.

The bottom-line: California utilities live to play another week as the proverbial light remains at the end of the tunnel. But with each passing day without an agreement, that light dims.

The risks remain enormous. "Although the state has acted to avert further major power disruptions," says First Boston's Patterson, "we believe the risk of bankruptcy for the utilities remains very high, particularly in the absence of a long-term solution that would allow them to pay their upcoming bills."

As Tom Bodett says, "We'll leave the light on for you."

The CPUC's Dim Bulb

In what has to be one of the most bizarre regulatory moves of the California saga, the California Public Utilities Commission, or CPUC, issued a temporary restraining order against both Pacific Gas & Electric and Southern California Edison, requiring them to operate.

CPUC Chair Loretta Lynch said the action is prudent, given the utilities' financial plight. "We're taking this step out of an abundance of caution," she said.

However, John Bryson, chairman and CEO of Edison International, calls the CPUC's action "an insult to the ethic of the 13,000 employees of SCE who have worked to keep the lights on for their customers."

And, he says, Lynch should look in the mirror if she is looking to place blame. "In fact, SCE has borrowed billions of dollars, which threatens the company's solvency, through 8 1/2 months of inaction and delay by the CPUC, in order to continue to serve its customers."

It's been a long week in California and maybe we can blame the blackouts or power surges for the CPUC's impious and impetuous action today. However you look at it, it doesn't exude positive energy.

Coming soon: A look back at the issues and problems that culminated in a flickering of the lights in California this week and what the future holds for California's electricity restructuring and deregulation across the country.