Subject: California Update #2, 2/23/01
From: [email-masked]
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Date: Fri, 23 Feb 2001 14:22:00 -0800 (PST)

1.	Bankruptcy An Increasingly Attractive Option for Davis

Despite the fact that the lights are on and the snowpack is approaching normal levels after a month of torrential storms, back at the poker table in Sacramento the situation continues to drift toward bankruptcy. Indeed, almost any reading of Governor Gray Davis's political situation after the shock LA Federal Court ruling makes forcing the utilities into bankruptcy his best bet. At least one of the three major power generators (PG&E) seems to agree that bankruptcy is better than cutting the deal on the table now, particularly after yesterday's FERC ruling that it is okay for the company to shift assets around to protect them in case of bankruptcy. 

2.	Davis Wants To Keep Hope Alive Until Analyst Meetings Next Week

Today is crucial in determining the exact odds of a bankruptcy since Davis wants to cut a deal if possible before heading off to lead the National Governor's Association and meet with Wall Street analysts Tuesday and Wednesday. In fact, Davis's desire to have something definitive to say next week is the only reason to believe that bankruptcy can be avoided in California. According to talks with all sides, Davis has offered to buy the electricity grid from the three largest power producers (PG&E, SoCal Edison and San Diego) for something like $7 billion that they could use to pay off most of the money they owe to suppliers and creditors outside their own corporate shells. 

But the questions is why the utilities would want the deal that appears to be on offer and that leaves many people on both sides of the table wondering whether Davis actually wants a deal or an excuse to get back to a situation where he has court-ordered cover to raise electricity rates that he knows are necessary, but politically difficult. According to key Sacramento officials, "Confidence continues to wane in Davis' ability to do this. The plain fact is the stick he's carrying isn't awfully big." Adds another: "The key people here just think the utilities are playing him. Either they're playing him, or he's going to roll on the price, he's going to pay double what the transmission assets are worth. The utilities got away with the same kind of thing before, in 1996 of course." Davis is more astute than that, and a bankruptcy judge could yet be the political cover for a resolution that has been lacking since the utilities lost their court case in Los Angeles. 

3.	Little Support for Transmission Assets Deal

The transmission assets deal doesn't look attractive for anyone. 
Davis has no particular affinity for it, having adopted State Senator Burton's proposal when his own preferred equity warrants idea began to fade. 
The legislature is wary of more state involvement in the power industry, and concerned about the vast investment needed in the network. 
The utilities -- PG&E in particular don't want to sell.

4.	Accounting Ambiguities Appear; State Offers Only Tepid Support for Bond Scheme

"There are also more and more issues quietly emerging about utility accounting methods which the audits didn't pick up" says one California official. "The way they calculate depreciation is very strange. If the accounts were done on a proper GAAP basis instead of some kind of FERC basis they would look different." Even if the deal goes through, the financing could be difficult and very expensive. The state has definitively ruled out putting the full faith and credit of the state of California behind the proposed bonds. State Treasurer Angelides has also been informed it is unlikely they'd qualify for tax-exempt status. 

5.	Small IPP Players Furious

And while the big players talk, there is increasing nervousness among small independent and alternative generators. The small companies have been the biggest losers so far -- their representative, Jan Smutny-Jones, was tossed off the Board of the California ISO, and the closing of the California PX deprives them of the main marketing channel for their power. The CEOs of large companies like Dynegy and Reliant are talking to Davis on a daily basis, but the small companies are out of the loop. They also lack the financial resources and diversity of income streams to resist problems for long. Large companies and the major bank creditors are also aware of the potential political and relationship risks across the US if they get cast in the role of villain in California. For the small companies, however, it is a matter of survival. Some legislators in Sacramento are operating under the assumption that it would take a creditor committee of the large generators to force bankruptcy. Not so. All it takes is three creditors owed at least $11,000 each to apply for bankruptcy. Two small companies, Cal Energy and Ridgewood Power, are already resorting to the courts to try to press for payment. 

If bankruptcy is triggered, there is immense uncertainty about what would happen. No major player we talk to is confident they can predict the outcome, especially after the shock of Judge Lew's unexpected ruling in Los Angeles. It is likely that the issues would have to be decided ultimately by the State Supreme Court. FERC and the Federal government could also be ensnared as writs fly. But to many of the players, that uncertain mess following bankruptcy looks better than certain loss in a bad deal.