---------------------- Forwarded by Susan J Mara/SFO/EES on 09/27/2000 09:12 
AM ---------------------------


Susan J Mara
09/27/2000 11:11 AM
To: Douglas Condon/SFO/EES@EES
cc: Martin Wenzel/SFO/HOU/EES@EES, James M Wood/HOU/EES@EES, George 
Waidelich/SFO/EES@EES, Gary Mirich/HOU/EES@EES, Mona L Petrochko/SFO/EES@EES, 
Jeff Dasovich/SFO/EES@EES, John Woodman/SFO/EES@EES, Edward Hamb/HOU/EES@EES, 
Dennis Benevides/HOU/EES@EES, Lyle White/HOU/EES@EES, James D 
Steffes/NA/Enron@Enron 
Subject: Re: Risk Management 101  

Don't you love Bob Glynn referring to AB 1890 as providing "Mutually Assured 
Destruction"?



Douglas Condon
09/27/2000 10:33 AM
To: Martin Wenzel/SFO/HOU/EES@EES, James M Wood/HOU/EES@EES, George 
Waidelich/SFO/EES@EES, Gary Mirich/HOU/EES@EES, Mona L Petrochko/SFO/EES@EES, 
Susan J Mara/SFO/EES@EES, Jeff Dasovich/SFO/EES@EES, John 
Woodman/SFO/EES@EES, Edward Hamb/HOU/EES@EES, Dennis Benevides, Lyle 
White/HOU/EES@EES
cc:  
Subject: Risk Management 101

Where were these discussions when AB1890 was being created?


                   California Utilities' Losses
                   On Electricity Pose Risk

                   By REBECCA SMITH 
                   Staff Reporter of THE WALL STREET JOURNAL

                   California's two biggest utilities are losing so much 
money buying electricity
                   in the state's deregulated market that they have run up 
deficits equivalent to
                   half their net worth in just four months.

                   If the cost of wholesale power continues to exceed the 
price these utilities
                   are allowed to bill their customers, as currently seems 
likely, they could
                   become technically insolvent sometime next year. That 
would put pressure
                   on regulators to orchestrate a multibillion-dollar public 
bailout, similar to
                   the "too big to fail'' response that in the past pushed 
governments to rescue
                   banks.

                   Such a scenario is quietly being discussed by bond-rating 
concerns that
                   recently reduced their credit outlooks for Pacific Gas & 
Electric Co., a unit
                   of San Francisco-based PG&E Corp., and Southern California 
Edison, a
                   unit of Edison International of Rosemead, Calif. Bond- 
rating concerns say
                   they aren't sure how much additional debt can be borne by 
the two
                   affected utilities before they will have difficulty paying 
their bills.

                                        "If this is just a seasonal 
aberration, the utilities
                                        can get through it," says Lori 
Woodland,
                                        analyst for Fitch IBCA. "If it goes 
on for six or
                                        nine months, it's a very serious 
situation."
                                        Adds A.J. Sabatelle, senior credit 
officer at
                                        Moody's Investors Service Inc.: "At 
some
                                        point, you have a financial crisis."

                                        The utilities say they are having no 
difficulty
                                        meeting expenses and don't envision 
problems
                                        in servicing their debts. But they 
are vigorously
                   lobbying state and federal regulators to change the rules 
of the game,
                   hoping somehow to raise rates to make up for the 
shortfall. The California
                   utilities' experience may be a harbinger of what could 
happen in other
                   states where wholesale power prices have surpassed the 
amount that
                   utilities are allowed to charge their ratepayers.

                   For now, utilities are making ends meet by going to the 
financial markets to
                   borrow money. PG&E, a giant utility that serves one out of 
every 20
                   Americans, is seeking approval to increase its debt 
capacity by $1.4
                   billion. It is borrowing $200 million, while Edison is 
tapping $250 million
                   from the commercial paper market. "This is going to be a 
long, tough
                   road," says Jim Scilacci, chief financial officer for 
Southern California
                   Edison.

                   Today's situation represents a complete turnabout from 
what was expected
                   when California deregulated its energy market on March 31, 
1998, which
                   opened electricity pricing to competition. California 
tried to give its utilities
                   a competitive edge nationally by deregulating faster than 
other states and
                   by creating a mechanism to allow investor-owned utilities, 
such as PG&E
                   and Edison, to quickly pay down debts incurred to serve 
customers under
                   the old regulatory system.

                   To do this, the state legislature set
                   retail rates at high levels, which, at
                   first, generated fat surpluses for the
                   utilities. As the money piled up,
                   utilities used it to pay down debts for
                   generation facilities that were
                   otherwise unprofitable in the new
                   deregulated world. By the end of this
                   June, PG&E and Edison together
                   had collected more than $12 billion
                   and were on track to finish paying
                   down debts well ahead of the March
                   31, 2002, deadline set by the
                   legislature. At that point, rate freezes
                   were to end and retail prices were to
                   fluctuate with the market.

                   But all that went out the window in June, when wholesale 
power prices
                   surged, topping the rates the utilities were allowed to 
charge retail
                   customers. Average prices at state-sanctioned energy 
markets were four
                   to five times the prices of a year earlier, and three to 
four times the level
                   utilities could charge customers.

                   The accumulated shortfall has been so enormous at PG&E, 
that analysts
                   expect its deficit to exceed $3 billion by Oct. 31, more 
than half its
                   shareholder equity of $5.7 billion, which is defined as 
assets minus
                   liabilities. Southern California Edison finished August 
with a deficit of $2
                   billion, equivalent to almost two-thirds its net worth of 
$3.2 billion. The
                   utilities, though they have been accumulating deficits, 
aren't required to
                   report these as losses on their earnings statements.

                   That leaves utilities in a bind. They want to end the rate 
freeze to be able to
                   pass on the real cost of electricity to consumers. But 
should the freeze end
                   before the statutory deadline of 2002, they get clobbered. 
That is because
                   they will immediately have to book a loss on their 
power-purchase deficits.
                   What's more, they can't use the proceeds from planned 
power-plant sales
                   to cover those losses; instead, should the freeze end, 
they will be obliged
                   to refund some of the proceeds to ratepayers. In PG&E's 
case, the refunds
                   could total $500 million, while in Edison's case, the 
amount is $254 million.

                   Publicly at least, utility executives insist a mechanism 
will be found to let
                   them recoup the money spent on electricity.

                   Consumer advocates are gearing up for the fight. Nettie 
Hoge, executive
                   director for San Francisco consumer group Utility Reform 
Network, says
                   ratepayers shouldn't end up footing the bill for a deal 
cut by utilities that
                   benefited them before prices shot up.

                   Utility executives are now distancing themselves from the 
legislation that
                   got them into such a mess, which was drafted with their 
assistance. PG&E
                   Chairman Robert Glynn says it is best not to "overanalyze" 
the "old deal."
                   Instead, he says, regulators and legislators should sit 
down with utilities and
                   construct a new agreement, since "it's in the broad 
interests of the state not
                   to have critical energy infrastructure look like a leper."

                   Mr. Glynn says the current deal offers "mutually assured 
destruction" to
                   both utilities and ratepayers. Something must be done, he 
says, or
                   consumers throughout most of the state will experience "a 
San Diego-style
                   rate shock." The utility serving that city, San Diego Gas 
& Electric Co.,
                   ended its freeze a year ago and began passing wholesale 
power costs
                   directly through to ratepayers. Legislators intervened 
this summer,
                   however, and temporarily capped retail rates when monthly 
power bills
                   nearly tripled. The utility, a unit of Sempra Energy, is 
also accumulating a
                   deficit as a result.

                   So long as banks and bond markets believe the utilities 
will be repaid, they
                   will be able to borrow, analysts say. "Until we hear 
politicians of
                   consequence state otherwise, our position is that we 
believe the utilities will
                   be made whole," says Richard Cortright, a director at 
Standard & Poor's
                   corporate ratings group.

                   But that opinion could change if it looks like the 
utilities will have to
                   swallow a big loss. The result: lower credit ratings that 
would raise
                   borrowing costs and could trigger a downward spiral. 
"You're talking
                   about top-rated companies, though," said Ms. Woodland of 
Fitch IBCA.
                   "To get to insolvency, a lot would have to happen."

                   In the meantime, utilities are doing all they can to 
control the hemorrhaging.
                   They have gotten authority from regulators to buy more 
power under
                   long-term contracts at fixed prices, reducing their 
vulnerability to
                   spot-market volatility. And they have petitioned federal 
regulators to
                   declare California's market so badly flawed that 
generators should be
                   denied market pricing and, even, ordered to pay refunds.

                   Nevertheless, several forces are working against them. 
Although they can
                   sign bilateral contracts, prices remain high for those as 
well. What's more,
                   they can't buy less power than their customers need. If 
they don't buy
                   enough, the California Independent System Operator, the 
organization
                   responsible for reliability, will step in and make 
purchases for them and
                   send them the bill.

                   Perhaps the biggest problem facing PG&E and Edison, 
though, is one of
                   timing. The California legislature is out of session until 
December, and
                   regulators haven't even really started to address the 
issue formally. In the
                   meantime, the utilities' deficit is growing by tens of 
millions of dollars daily.

                   Write to Rebecca Smith at rebecca.smith@wsj.com