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 19:04:00 -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."