Subject: California Update 3/06/01
From: [email-masked]
To: [email-masked], [email-masked]
Cc: [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked]
Date: Tue, 6 Mar 2001 08:04:00 -0800 (PST)

Executive Summary
? If no comprehensive deal is reached by April 9th, chances of bankruptcy 
increase due to a one day "opt-out" clause in all long-term power contracts. 
? PG&E and State locked in tough negotiations, several issues on the table:
 PUC-imposed requirement forcing PG&E to ultimately be responsible for 
California energy supplies
 Price of the grid; state - 2.3 times book value vs. PG&E - 4 times book value
? PG&E will not use any of the $1B secured last week to help their ailing 
utility.
? Davis's announcement of long term power contract didn't include some 
details:
 Of the 8,800 megawatts secured this far, only 6,000 are available this 
summer 
 Some of the "long term contracts" are really only for three months
 None of the contracts prevent California from buying peak demand on the spot 
market
? One the same day Davis announced long term contracts, Davis also quietly 
announce a 10% rate hike.
? FERC may be the wild card in approving this deal.
 
PG&E
Transmissions deal
One thing that is still uncertain is PG&E.  Bankruptcy may still be a likely 
alternative if current negotiations to buy PG&E's share of the electric 
transmission grid fail to produce a deal by April 9 (when all long-term power 
contracts being negotiated have a one-day "opt-out" clause they can exercise 
unilaterally if a "comprehensive solution" has not been reached by the state 
and its major utilities).  According to sources close to senior PG&E 
officials, PG&E made it clear that any hope for a politically acceptable deal 
on the transmission lines depends on the California government's willingness 
to make a major financial commitment it has been completely unwilling to make 
until now. 

PG&E will not make a final deal to sell its grid unless Davis agrees to 
relieve it of the PUC-imposed requirement to be the "electricity buyer of 
last resort."  Current state regulations make the utility companies 
ultimately responsible for generating or purchasing enough electricity at all 
times to supply California's energy needs.  As long as the state steps in and 
makes those purchases, as it has for the past three months, the utilities are 
shielded from absorbing the losses generated by paying premiums for spot 
market power and selling to consumers who are shielded by low rate ceilings.  
But, PG&E officials are worried 1) this summer's supply and 2) Davis's 
concern over how fast he is draining the state's budget surplus.  If things 
get into a crunch this summer and Davis makes a new decision that the state 
will pay only for the electricity it buys through long-term contracts, then 
PG&E will be left holding the bag. 

Thus, as part of the negotiations over buying the electricity grid, PG&E is 
demanding a "comprehensive solution" that includes not being liable for cost 
differentials between the spot market purchase and what consumers are allowed 
to pay.  State officials are in no mood to grant that kind of "get out of 
jail free" card, so the two sides remain locked in extremely tough 
negotiations that are complicated by three other factors: (1) PG&E's public 
behavior and welter of announcements in the past few days that seem to 
encourage suppliers to force involuntary bankruptcy; (2) State legislative 
demands that the price Davis negotiate for PG&E's part of the electricity 
grid be no more than 2.3 times revenues from the grid; and (3) the FERC must 
"positively approve" any grid purchase by the state of California. 

The principal concern on the price front is that PG&E wants to sell the 
electricity grid for nearly four times the estimated book value of their 
transmission, while consumer groups insist that two times book value is the 
politically acceptable limit.  "We see 2.3 times book value as an absolute 
upper bound. There is no way PG&E will get more than that, whatever they 
think," according to the leader of one main consumer groups.  "We are going 
to try to force any deals down to about 2.0 in any case." Negotiators for 
Davis are also trying to 'proposition-proof' any transmission deal to protect 
against a later ballot proposal.  They think there are ways to do that, but 
not if the price of PG&E's part of the grid triggers a ballot initiative.  
Remember, if Davis's eventual solution triggers a ballot initiative, he will 
be running for re-election on the same ballot as a public initiative designed 
to overturn his solution.

On the Sacramento front - no one understands PG&E's motives
The one question no one in Sacramento can figure out is what kind of game 
PG&E is playing.  In a three day period PG&E made a series of announcements 
that left everyone scratching their heads. 
? Late Thursday, PG&E officials leaked information to California papers that 
they had agreed in principle to sell their part of the electricity 
transmission grid to the state, which seemed like obvious good news, but then 
made it clear in discussions that the price they were asking was at least 30% 
above what the state was currently offering.  While a deal can still be done, 
anything like the $10 billion PG&E wants would be very hard to get through 
the California legislature which needs to approve any purchase. 
? Late Friday, PG&E officials announced that they had secured a $1 billion 
loan for the parent company (not the electricity utility) and would use the 
money to pay off bondholders, other creditors and to return $161 million to 
shareholders in a new dividend payout.  Not a cent of that money was 
earmarked to help the struggling electricity orphan of PG&E and that left at 
least one rating agency convinced that the company was more ready to send the 
utility into bankruptcy than had been previously understood. 
? Over the weekend, PG&E leaked a story claiming that it was willing to pay 
off its energy suppliers' debt for 15 cents on the dollar right now.  For 
generators who are having to make decisions each morning about whether to 
start legal actions that protect their rights in any eventual bankruptcy 
action or hold off on the assumption that the politics of this process will 
"make them whole" in a couple of months, that kind of trial balloon is 
extremely unnerving.

Thus, in a very short time period, PG&E's corporate owners showed they could 
access public credit markets with relative ease and then showed that they 
were unwilling to use these funds to smooth the way toward a solution to the 
energy crisis.  Davis has demanded that all of the major utilities absorb at 
least a part of the $13 billion debt they have accumulated since last summer 
and PG&E's fund-raising will harden and deepen those demands.  As one senior 
political official told our source "just when you think the corporate 
leadership of that company has insulted us as completely as possible, they 
come up with something even more outrageous." 

PG&E's actions also complicate the broader solution Davis is trying to 
construct to solve California's problems.  State Democrats doubt they will 
get Republican support for a deal, which means a vote will fall short of the 
two-thirds majority necessary for immediate enactment (resulting in 90 days 
for the legislation to go into effect).  Additionally, in the past 48 hours, 
many Sacramento sources have reported that forcing creditors to take a less 
in any debt payback is gaining substantial support with the legislators and 
may be crafted into any legislation to authorize Davis to purchase the 
electricity grid.

Long-term Contracts - Davis didn't tell the whole truth
Yesterday, Davis announced that he had signed "long-term" power deals for 
8,800 megawatts of power, out of a total 12,000 megawatts he wanted to sign 
eventually. According to the press release, Davis is now 75% of the way 
toward his long-term goal and has already solved the hardest part of 
California's energy crisis. This means consumers would maybe pay more than 
necessary five years from now, but these contracts "guaranteed" that 
consumers would pay less for the next three years.  What Davis failed to 
highlight was that of the 8,800 megawatt commitment, actually only 6,000 
megawatts are available this summer (when demand is expected to 45,000 
megawatts); and some of these "long-term contracts" are actually only good 
for three months.  None of these contracts, however, keep California from 
having to buy the most expensive peak demand electricity on the spot market.

Davis Agrees on New Consumer Electricity Rate Hikes for Next Year
While the media was concern with Davis's announcement of long term contracts 
for California, of less concern to the media was Davis's quietly announced a 
decision to let rates rise again for electricity consumers. The state will 
accept the 10% emergency surcharge levied on consumers in January as a 
permanent increase as well as an additional 10% increase for consumers that 
will take effect early 2002 when the old 1996 rate cut legislation expires. 
That would bring the average charge to about 8 cents a kilowatt hour. 

FERC
The other major danger to the transmission line deal is that the Federal 
Energy Regulatory Commission can block the deal simply by failing to approve 
it in a positive vote. Senior California officials and legislators doubt that 
FERC has jurisdiction, and believe that FERC would not dare stop a deal. But 
they may be wrong. "The deal can only go through if FERC specifically signs 
off on the deal. Its power over transmission deal is absolute, no matter what 
anyone says," according to source close to the President. There are three 
possibilities: 1) FERC could "pocket veto" it by not even putting it on 
agenda for discussion; 2) the deal is put on the agenda but it gets voted 
down. The Democrat on the commission, William Massey, has already said he is 
opposed to it; or 3) the Commission could approve it but with condition that 
Davis has to agree to bring the lines into a regional grid system.

One complicating factor in the FERC decision, however, is that its chairman 
Curt Hebert, who is adamantly opposed to the transmission line sale, may not 
be around long enough to have his say. "Hebert is definitely not a shoo in 
for the FERC chairman position," says one Washington official. Two other 
appointments to the Commission will soon be named, this official notes, and 
one of them "could easily become chairman."