Two weeks after California Gov. Gray Davis promised that the Golden State would take control of its own "energy destiny," the state appears closer to losing its utilities to bankruptcy than to solving the problem.
"We continue to believe the odds favor a bankruptcy filing by the two largest utilities in California," said
Deutsche Banc Alex. Brown utility analyst Jay Dobson, referring to
PG&E (PCG Quote - Cramer on PCG - Stock Picks), the parent of
Pacific Gas and Electric, and
Southern California Edison, a subsidiary of
Edison International (EIX Quote - Cramer on EIX - Stock Picks).
While the utilities default on payments and edge closer to bankruptcy, the
California Legislature is meeting in special session to craft a solution to help the companies regain their financial footing.
Underscoring the urgency, short supplies of electricity continue to prompt daily threats of rolling blackouts throughout the state.
Legislative or Judicial Solution?
In the state capitol, the California
Senate Energy, Utilities and Telecommunications Committee is considering Assembly Bill 1X, which would give the
California Department of Water Resources long-term authority to purchase power directly from generators for sale to consumers.
The debate highlights the difficult process in reaching a solution. For example, the committee spent more than an hour Monday afternoon debating language regarding the highest price DWR would be allowed to pay for power. Currently, the bill prohibits the purchase of power for more than 5.5 cents per kilowatt hour (equal to $55 per megawatt hour).
The debate not only centers on the price target, but also on whether or not an absolute price cap is feasible. One concern: If no generator is willing to sell power at peak times to the state at or below the cap price, what happens? Under the current proposal, continued blackouts are possible, particularly as generators indicate they can't charge less than 7.5 cents per kilowatt hour.
Clearly, power prices have to come down. And they will as power purchasers and generators enter into long-term supply contracts. Remember, the soaring power prices so vilified by politicians and consumer advocates are a result of purchases on the spot market, where exchanges in the power markets clear at the highest bid. Under California's deregulation scheme, the utilities could not enter into long-term power contracts with generators -- contracts that, in this environment, would have provided much lower prices to the utilities.
However, it is not reasonable to assume generators will sell power to the state at prices well below recent norms. Most analysts say the state will have to pay higher prices for a legislative solution to work.
"Current proposals include a plan that would allow the state to enter into long-term contracts with the generators at no more than $55 per megawatt hour," wrote
Credit Suisse First Boston analyst Neil Stein in a note to clients Monday morning. "Ultimately, we believe a long-term practical solution would allow for power purchases at higher prices."
Another analyst agreed: "We reiterate our strong belief that ... [generating companies] will not enter into long-term contracts at concessionary rates," commented
Morgan Stanley Dean Witter power analyst Kit Konolige.
(Maybe someone in Sacramento is listening. In Monday's hearings, the Senate committee heard proposals to soften the 5.5 cent price cap and adopt the figure as a target. No formal action was taken.)
Unless the state steps in and reaches an agreement with generators on price, at least in the short term, only one option is left for the beleaguered utilities: seeking bankruptcy protection.
"The way to prevent bankruptcy is for the California Legislature to pass laws allowing the recovery of purchased-power costs or an interim state-buying authority," said Deutsche Bank's Dobson.
Davis acknowledges that it's in the state's best interest to keep the utilities from filing for bankruptcy. If either PG&E or Edison sought protection in court, a bankruptcy judge would have broad discretion over the structure and duration of long-term power contracts, a process that could lead to power rates higher than those of any legislative solution.
"Most likely, a bankruptcy judge would encourage the [generating companies] to enter into long-term contracts," Konolige said. "The pricing of these contracts would most likely be deferred to the
Federal Energy Regulatory Commission, which has set a strong precedent of supporting bilateral contracts at market-based rates."
How do you handicap the chances of either? At this point, it's a tossup. "Everyone involved wants to avoid bankruptcy," said one source close to the talks. "And we may be on track to do so. But a deal has to work for everyone, and we are a long way from that."
Regardless, First Boston's Stein believes the problem is close to being resolved. "To the extent the utilities have already begun to default on key debt and power-purchase payments, and [while] the prospect of major power disruptions continues to loom, we believe a resolution could be imminent."
Whether that resolution be legislative or judicial, Stein said he's not sure the state lawmakers have the determination to do what is necessary to keep the utilities out of bankruptcy. "A plan would need to address the utilities' current payment obligations through a retail rate increase or a securitization financing," he said. "At this point, it is unclear if California lawmakers are willing to take these additional steps."
A New Week, a New Plan
As my colleague Peter Eavis
wrote earlier today, the
Los Angeles Times reported that a new proposal is floating around Sacramento -- to help the utilities crawl out from under the $12 billion debt from buying wholesale power at market-based rates and having to resell it to consumers at frozen 1996 price levels -- but it would cost.
Under legislation proposed by
Assembly Speaker Bob Hertzberg and Assemblyman Fred Keeley, both Democrats, the state would authorize the issuance of bonds to pay off the $12 million debt. However, in exchange, the utilities would have to surrender their hydroelectric-generation assets, worth an estimated $5 billion.
While the utilities -- PG&E and Edison -- had tepid reactions to the proposal on Monday, the source close to the negotiations said it is something to consider. "It is a comprehensive plan that addresses the back-debt issue," the source said. "It's the first time the legislature has formally acknowledged the issue. It may not be the solution, but it's a start." Opposition to the proposal likely will focus on the state as a direct power generator.
While the proposal has been described in detail, its status as formal legislation remains unclear. On Monday, Democrat Judy Bowen, the chairwoman of the state
Senate Energy Committee, said there was no plan to integrate the bonds-for-generators proposal into the Assembly Bill 1X. "The proposal described in the
Los Angeles Times this morning will not be placed in AB 1X [today]." By late Monday, a formal bill had not been introduced in the California Legislature.
The clock continues to tick.
Christopher Edmonds
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