Executive Summary:

SB-7X gives Dept. of Water and Resources given legislative authority to 
undertake short-term power purchases with no price cap through Feb.2nd
New legislation (AB-1X and SB-6X) would seek (1) long-term contracts with 5.5 
cent cap and (2) creation of California Power and Conservation Financing 
Authority
The long-term contracts proposed in AB-1X are likely to be subject to 
significant amendment and renegotiation prior to the Feb.2nd expiration of 
SB-7X.
The authority proposed in SB-6X would have bond issuance powers to finance 
new generation capacity and conservation measures
Negotiations under way on using bond authority for a utility 
bailout--utilities and state government split over debt obligations of 
utility parents
State borrowing plans and power purchases create credit risks for state 
treasury; SoCal Edison misses more payments
Bush Administration opposes price caps, but is supporting state efforts to 
split PG&E into separate gas and electricity companies in order to assure 
continued gas supply
Absent urgent passage of a bailout plan or an agreement on longer-term 
contracts, utility bankruptcy is still the most likely scenario.

For further information, contact Robert Johnston (x39934) or Kristin Walsh 
(x39510).

1. Legislation Passes- Short-Term Measures

SB-7X passed the California State Senate easily.  As we said yesterday, the 
bill gives the state the immediate authority to purchase power via the 
Department of Water and Resources until February 2nd.  The Department will 
have $400 million available to finance power purchases, but there 
expectations that these costs could easily rise to $1 billion by next week.

AB-1X has evolved into a longer-term solution and in its current form, would 
authorize the Department of Water and Resources to enter into long-term 
contracts (as opposed to the 15 day contracts in SB-7X) to buy power at a 
price cap of 5.5 cents per kw/h.  This legislation is not expected to pass 
today and will likely be changed considerably during the upcoming two week 
period covered by SB-7X, when negotiations between generators, the utilities, 
and the state are likely to resume.

2. SB-6X- What Will the State Do With the Bond Authority?

A second piece of legislation currently under consideration --SB 6X--has 
created uncertainty in the markets.  This legislation will create a 
California Power and Conservation Financing Authority with bond issuance 
authority.  The uncertainty concerns whether the new authority will address 
the problem of the $12 billion in outstanding debt owed by the utilities.  
The current text of the legislation focuses only on longer term measures such 
as expanding generation capacity and improving efficiency. Yet the 
legislation also says "the authority may issue bonds, exercise power of 
eminent domain, and enter into joint power agreements and buy, own, and sell 
land and facilities necessary for the financing of a project."  The general 
nature of this language leaves open the possibility of either issuing bonds 
to finance past debts, or using eminent domain or the bond authority to 
finance the utilities as they enter into a Ch.11 proceeding.  While neither 
Davis nor Senate leader Burton are talking about a full $12 billion bailout 
at this point, the idea of using bond money to pay past debts continues to 
circulate in the legislature.

One of the reasons none of the utility creditors have moved to demand 
repayment is that they are being quietly reassured by the Governor's office 
that 
there will be a government-supported debt workout in the near future.

3. Bailout Could Depend on Parents of Utilities Absorbing Losses

The big problem -- and one which have kept the Governor nor the utility 
companies from opting for this solution -- is a massive battle over how much 
of the
 outstanding $12 billion in back debt the holding companies of the two 
utilities will absorb in any restructuring deal. As we have reported, 
something like half 
of that debt is owed by the utilities to their own sister power-generating 
companies within their holding company structure (the partial de-regulation 
allowed the utilities to split into power-generating and power-distributing 
companies so one side of the holding company buys power from the other side) 
-- 
and public opinion polls show overwhelming majorities understand this quite 
well. Davis wants the utility companies to acknowledge the nature of this 
debt, and to absorb some substantial part of the internal debt within their 
corporate structures; we believe he then could be willing to guarantee or 
issue 
bonds to deal with the rest.

As one very senior California political leader explained, getting the utility 
holding companies to eat a substantial part of the debt they owe themselves
 is the key to solving the back debt problem without provoking widespread 
public outrage about a "bailout" of private price-gouging companies with 
taxpayer money. Since 75% of Californians currently blame the utilities and 
the PUC for this crisis (and only 10% blame Davis), this is a crucial
 political stance for the Governor. 

But, of course, absorbing anything like $6 billion in debt would be quite a 
shock to the seemingly healthy holding company and power-generating branches
 of the two utilities, and they began spreading the word that they were quite 
willing to accept bankruptcy. Thus by mid-week, both
sides had pushed themselves toward a resolution in federal bankruptcy court 
that would be a worst case solution for all sides: The country's economy 
would 
suffer from the resulting credit shock, the Governor's political future would 
suffer from the electricity rate increases almost certain to be mandated by a 
bankruptcy judge, while most private sector legal authorities believe the 
utilities corporate holding structure would ultimately be breached during 
bankruptcy
 procedures and they would end up having to absorb some significant amount of 
the debt in the end. In addition, they would most likely face a state 
government 
determined to use state powers of condemnation to enter the power business in 
a major way. 

Senator Burton's SB6X legislation will strengthen those powers dramatically 
to make this point quite explicit. It would set up a "California Power and 
Conservation
 Financing Authority," with the power to issue bonds and invoke eminent 
domain. It would finance new power plants, and "consider the feasibility and 
public
 interest of the state acquiring, operating, and maintaining transmission 
facilities currently owned by investor-owned and municipal utilities." 

As we write this, all sides are trying to construct a path back down from the 
bankruptcy ledge to safe ground, and there is no question the tone has 
shifted 
in the last 24 hours from macho confrontation to "maybe we've run this thing 
out as far as we can." But as we have noted, the chance for miscalculation is
 still quite high. There is no solution agreed to at this time, the stand-off 
over how much debt the state government will absorb versus the utilities' 
holding 
company is continuing, and the technical fact of default still makes it 
possible for some bank to trigger bankruptcy by demanding immediate 
accelerated payment. 

5. Default Update- Thursday

SoCal Edison- $215 million default to California Power Exchange.

After Edison failed to make a $215M electricity payment yesterday, the 
California Power Authority began seizing long-term contacts and reselling 
them to recoup some of the money owed to generators.  PG&E said it expects 
its trading privileges at the Cal. Power Authority to be suspended today, 
leaving them with only its generation from nuclear and hydroelectric sources.

While the ongoing wave of defaults has severely restricted PG&E's and SoCal's 
ability to buy power, the Department of Water and Resources will be able to 
pick up some of the slack, at least in the very short-term.

The state itself may be getting into risky credit territory.  The proposed 
California Public Power Authority would borrow in the neighborhood of $1.3 
billion from the state General Fund in advance of this year's expected fiscal 
surplus, with the loan to be repaid by the authority from expected future 
revenues.  With near-bankrupt utilities and a freeze on rate hikes, it is 
unclear where the revenues would come from.  The amount borrowed and terms of 
repayment will be no doubt examined very carefully by the bond rating 
agencies.

5. Bush Policies

As we reported on Wednesday, the Bush Administration continues to demonstrate 
little interest in getting involved in the California crisis.  
President-Elect Bush surprised state leaders yesterday with his comments, 
which essentially said that excessive environmental regulation was the root 
of the current supply shortage.  Bush and his top officials appear to be 
unanimously opposed to long-term price caps.

However, there is one issue of considerable importance to the administration, 
according to a source close to a top Bush economic advisor.  There is 
significant concern that PG&E's credit problems could cause gas suppliers to 
stop shipments of gas through PG&E's pipeline.   The risk would be that the 
pipeline could "go dry", causing significant and possibly dangerous 
disruptions in California residences and businesses.  To prevent this 
problem, Bush is working with Davis on a proposal to split PG&E into separate 
gas and electric companies. The gas company would be solvent, but the 
electric company would go immediately into Ch.11 following significant 
defaults.