July 1, 2004 - From the July, 2001 issue

To Save or Not To Save So Cal Edison? Edison's Bob Foster Offers a Perspective

For weeks, legislators have haggled over what to do with beleaguered utility Southern California Edison. Two competing versions of Governor Davis' original proposal-to buy Edison's transmission lines for $2.76 billion and allow the utility to issue revenue bonds to repay the rest of its debt-have dominated the Capitol floor debate. The Assembly bill, sponsored by Speaker Robert Hertzberg and Assemblyman Fred Keeley, trims at least $300 million from the Governor's offer, attempts to increase the use of green energy, and allows Edison customers to opt for cheaper direct-access service. Senators Richard Polanco and Byron Sher are behind the proposal supported in the Senate, which would give the State a five-year option to buy Edison's grid. MIR is pleased to share here the perspective of Edison's Bob Foster. On page 4 we also excerpt a Which Way, LA? radio program on the same subject-Edison's fate.

Bob Foster

Despite two weeks of hearings and an August 15th deadline, it seems the California Legislature will not vote on the proposed rescue deal for Southern California Edison before its summer recess. Bob, what's the essence of the Edison legislation debate? What's at stake? What are the likely outcomes?

The majority of legislators in California do not want to see Edison go bankrupt. They believe it's bad for the State, bad for the economy, and will wind up coming back to hurt the State financially-all of which is probably correct.

The issue is: How do you get the State out of the business of buying electricity without declaring bankruptcy for Southern California Edison?

The Governor's Memorandum of Understanding (MOU) is one possibility. The question is, after the Legislature has made all its changes, will it still enable Edison to resume the buying of electricity?

The Senate has also passed a measure, which I believe is an odd structure. It would essentially put Edison at risk for $1 billion dollars by allowing for a securitization. Edison could sell bonds to pay back banks and independent qualifying facilities, but would not be allowed to securitize the amount owed to the Power Exchange, meaning the generators. The question there is the same: With that kind of exposure, will we be able to relieve the State from the business of buying electricity?

My answer is no. For one thing, the number is too large to bear as a risk. And two, half of what makes it possible to take over buying electricity is to have a clear and understandable structure that gives confidence to financial institutions-so that what took place in the Year 2000 does not happen again. That structure is in the Assembly version of the bill, but not in the Senate.

In a recent Which Way LA? discussion [See page 4] Senator Machado asked an important political question: "Why isn't it better for the State and the consumers to allow Edison to go bankrupt?"

There are a number of reasons. Aside from the usual ones-that it's bad for the State's reputation, for the business climate, etc.-there is one really essential problem: the bankruptcy courts are there to protect creditors. Senator Machado may not understand that the State, the Public Utilities Commission, and the consumers have absolutely no standing in a bankruptcy court. Bankruptcy law is designed to do two things: to preserve the ongoing enterprise and to satisfy creditor claims.

A common misunderstanding in bankruptcy is that everybody takes pennies on the dollar of the claims. That may be true in Chapter 7 filings, and it might even be true in many Chapter 11s. But if you look at the history of bankruptcies for electric utilities-the most recent being El Paso Electric, which filed in 1992 and didn't exit until three-and-a-half years later-the creditors wound up getting 100 cents on the dollar, and fees totaled over $100 million. I might also add that El Paso is one-tenth the size of Edison, and was a no-asset case, meaning their liabilities exceeded their assets. In the case of Edison, our assets exceed our liabilities.

If Edison were to file for bankruptcy, the likely outcome would be the court gives the State two choices: either raise rates to satisfy creditor claims (which the State has been reluctant to do so far) or the court will dispose of assets to pay creditor claims. The most readily marketable assets we have are our power generating facilities. Prior to the market becoming dysfunctional, three of them were under contract to be sold. Those assets could very likely be put on the block and sold, with the proceeds going to pay creditors.

So what happens to the State at this point? Well, if the assets that produce the cheapest power for customers are sold, they'll likely be sold to the same entities that produced this problem in the first place, putting the State of California at a far less defensible position if the market goes out of control again. Right now, those plants produce power at four cents per kilowatt-hour; if sold, it's highly unlikely they'll sell into the market at that price.

Secondly, our bankruptcy is estimated to take between three and five years. That means the State of California would be in the business of buying electricity for a long time, putting the budget and all the services it provides at risk. California has already spent $8 billion, and the Governor is hoping to pass a bond issue to take care of that $8 billion. But suppose something goes wrong in the future? The General Fund will surely be called on again to buy electricity.

Assemblyman Fred Keeley argued that point in the Which Way LA? show, and went on to state, "We are much better off hammering out a deal that protects consumers, reduces the debt, ensures the possibility of rate reductions, and makes sure that any settlements go to the ratepayers and consumers of California. In a Federal bankruptcy court, the beneficiaries are going to be the creditors." How is it that Assembly leader Keeley has been unable to date towin the day with his colleagues?

What the Assembly leadership has been experiencing is that there are other interests at play, like the transmission issue. For example, the Keeley bill includes the transmission sale, while the Polanco bill just gives the option. In general, the sale of the transmission system is not a popular deal with members. They consider it contradictory to want the State out of the power-buying business, only to turn around and put the State into the transmission business. (However, that's not what it does-we would still maintain and operate the system; only the ownership would change.)

My guess is that if the Keeley bill were amended to remove the transmission system, it would get much more favorable treatment.

Elaborate on the transmission ownership issue. Who would win if there were a transaction involving the State and the transmission lines?

It's a very complex issue. Originally, the proponents believed that if the State owned the entire transmission system, California would be free from the Federal Energy Regulatory Commission's authority and could establish its own rates and conditions. But there are also those who argue that the transmission sale would be conditioned by FERC to require open access, meaning anyone could get on the system, and nondiscriminatory tariffs, meaning you couldn't discriminate against one generator or buyer over another.

What most advocates are now emphasizing is that owning the entire transmission system would give the State a greater degree of control. California could finance upgrades with tax-free financing, and may be able to be its own regional transmission organization while still maintaining flexibility on service arrangements.

The transmission system is a common-carrier business. It's a federally regulated portion of the system, and I would just leave it to the advocates to say what they think are the real benefits.

Also on the Which Way LA? program was Matt Freedman from TURN. His central concern is what percentage of the debts Edison itself will be responsible for. Elaborate on how that question is framed and what your position is.

Under the Assembly version, Edison would assume a $500-million responsibility; under the Senate version, a $1-billion risk. We could talk about who's right and who's wrong and what the right amount is. But I believe very persuasively that there is no reduction that's justified-all we did was borrow money so that customers could continue to receive service. We bought power at 30 cents and sold it at 6 cents. That was not the deal under AB 1890, and that was not the way the regulatory system was supposed to work. But we did it to serve customers.

Now, after the fact, people are telling us we have to take some haircuts. We understand the political realities. But there are also the financial realities that if you want us to resume business, we're going to have to be creditworthy, preferably at investment grade. You cannot do that if you've taken a huge amount out of the balance sheet.

During a recent State Senate Energy Committee hearing, Chairwoman Debra Bowen asked Harry Schneider of the Consumers Union, "What would you suggest is the appropriate balance? What would you like to see happen here?" And Mr. Schneider answered: "There are a number of levers that the State hasn't taken. One of them is to push back on the suppliers and say, ‘You know, we think the State of California can learn from countries where shortages are a normal course of business. So, Mr. Generator, we're going to shut down between 12 and 2 PM, and we're just not going to take your power during those hours.' People all over the world live with that and so do businesses, and they thrive." He's saying that there should be two hours out of each business day where we just shut everything down?


The truth is, the holding company couldn't withstand that kind of haircut and still be able to function. Since deregulation hit, the only money that's gone to our holding company has been tax payments, ordinary dividends, and the proceeds from the sale of assets. The utility then used those proceeds to pay down the debt because it downsized. Basically, in order to pay back equity, we bought back shares.

Utilities are required to keep a 50/50 debt-equity ratio. In the beginning, when we went to purchase a capital asset, we would obtain equity and max it with debt. Then when we sold the assets, we'd be required to take the book value and pay off the debt and the equity. That's the appropriate, PUC-approved use of those funds. In fact, PUC staff urged us to buy back more shares to have a more leveraged utility.

None of those dollars went into any investment outside the State. They all went to pay down debt and equity because we had become a smaller company. The notion that there is some pot of money sitting at the holding company that was somehow produced from deregulation is flat wrong.

Bob, let's take a half-step back. I know that everyone's been asking these questions for over a year, but you are extremely knowledgeable about the history of our deregulation scheme in California. Could you give us your analysis of what went wrong and what the proper fix is re deregulation?

A lot of people unfairly and incorrectly criticize AB 1890. Most observers agree that the major causes of this problem were the sale of power plants without a contract back, the requirements to buy on the spot market, and the absence of long-term contract authority on the part of the utilities. None of those are in 1890. They were all regulatory decisions.

In hindsight, while you probably would have changed a number of provisions to 1890, the heart of this problem lies in the regulatory policies established by the Public Utilities Commission in 1997 and 1998. When those policies proved to be inadequate, the PUC did not react quickly enough to solve the problem.

The Governor has suggested David Freeman-a long-time advocate of public power-as a likely candidate to head a public power authority for California. Is Public Power the Answer? Is Freeman the right one for such a job?

Right now, the "California Public Power Authority" is basically a shell of an institution.

Most policymakers don't want the State in the power business because the State is required to do all its business in public. You cannot negotiate these contracts in public. The players in this environment are very adroit, smart, well-schooled entities; you can't just publicize what your needs are for the next five years and expect the seller not to manipulate you on price.

The Department of Water Resources has been going crazy trying to deal with this problem. It was a horrible thing to ask them to do, and they've done a tremendous job given their resources. But every other day there's a story about some conflict of interest or someone getting paid too much or contracts that are too high. It's just not a business that most policymakers want the State to continue.

While I respect Mr. Freeman a great deal, I don't see a real appetite on the part of the Governor and the Legislature to pursue the dream of a public power authority.

A lot of media attention has been focused on PG&E and Edison. But what about SDG&E? What position are they in? Is their position similar?

SDG&E is in a different position. One of the benefits they've had is that they were out of the rate freeze-theoretically, they ended all their obligations under 1890's stranded cost recovery. They did amass a sizeable under-collection by borrowing money to buy power for customers, but their under-collection was an obligation of ratepayers. The question is, How is that obligation going to be paid?

For decades, regulation of the electric utility industry has worked to take the business cycle out of the equation for customers and the company. Most industries go through cyclicals, a certain boom-bust cycle. We're seeing it in the tech industry right now, and we've seen it in defense, oil, and a variety of other commodities and businesses in the past. There are periods of surplus, which drive the price down. Then gradually, the surplus gets whittled away, demand increases, price goes up, more businesses are attracted, more supply comes in, and the whole cycle starts again. The idea of regulation was to take that out of the equation so that customers would be protected in times of shortage, and companies would be buffered in times of surplus, creating a certain equilibrium.

There have always been price spikes. There was a time in the early ‘80s when Canadian natural gas prices doubled in one day. But those prices weren't simply passed through to customers. With regulation, when a utility experienced that kind of price increase, they'd absorb the increase, borrow the money, and deliver the gas or electricity to customers. Then at the end of the year, the borrowed money would be trued up, or passed through onto rates. The difference is that it's over a long period of time. Customers don't see the huge spike in prices; instead, they get a gradual upward sloping basically following inflation. The same was true in times of surplus too-the over-collection was gradually returned to ratepayers.

It's generally agreed upon that we need to have that kind of structure in whatever legislation we pass because the financial community no longer trusts California. They're not going to lend money to anyone in California unless they know that money is going to be paid back over a reasonable period of time.

In order to increase electron generation capcity, we're seeing a series of peaking plants being fast-tracked throughout the State. Your comments?

First of all, they're not all peaking plants. Two of the three-Yuba City and Pittsburgh-are full-blown combined cycle plants that can operate at base load. The Sunrise Plant-which we broke every record to get sited in time-is a combined cycle plant, but will operate in simple-cycle mode for the first two years because the State needed power for this summer and next.

Bringing this to a close, Bob, do you think the political institutions we have in place-with term-limits, two-thirds vote requirements on budgets, etc.-provide a workable governance mechanism for resolving the complex energy crisis now on the Capitol's plate?

This is a remarkably difficult issue to resolve with the legislative process. My opinion is that it was more appropriately dealt with by the Administration and the regulatory agencies. But on the whole, the Legislature has done a reasonable job of grappling with an extraordinarily complex issue with a tremendous impact on the economy and people's everyday lives.

It's unlikely we'll get a finished product until after the recess. But during that time, we're going to be working hard with the Administration, the newly established Assembly working group, and the other players involved to craft a solution that makes sense for everyone.


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