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November 13, 2001



Updates on Enron / Dynegy Merger, SCE Rescue Plan and Muni Vote in San Francisco


By Will McNamara
Director, Electric Industry Analysis


[Today's column includes analysis on three separate news items.] 

EnronOnline and Dynegydirect to Merge 

[News item from Energy Info Source] Online energy trading EnronOnline will merge with smaller rival Dynegydirect after its parent company Enron Corp. agreed to a $9-billion takeover by Dynegy Inc. The integration of the two platforms will take about six to nine months, Dynegy said. In the meantime, the two will continue to operate separately. On both EnronOnline and Dynegydirect, traders can only deal with Enron and Dynegy, respectively. 

Analysis: This is the first step in what may ultimately be a challenging integration of the various businesses between Dynegy and Enron. Although the merger makes sense for both companies, especially considering Enron's financial instability and its limited options at this juncture, it must be acknowledged that the two companies have very different corporate cultures, and the process of conjoining those different cultures may be a major task. The companies have developed two distinct approaches to online trading, as illustrated by their independent electronic exchanges. Although it will be interesting to see how the separate exchanges become conjoined and assimilate their two separate customer accounts, one thing that EnronOnline and Dynegydirect have in common is that they rely on principal-based transactions. 

It is important to note that Enron gained the first-strike advantage when it developed EnronOnline, the first electronic-trading exchange, well ahead of its competitors. Dynegy later followed this trend and created Dynegydirect about a year later. The latest available information indicates that EnronOnline has recorded transactions that exceed $590 billion in notional value. Since its inception in November 2000, Dynegydirect has recorded $33 billion in notional transactions. Enron trades various commodities on EnronOnline, led by electricity and natural gas, but also including bandwidth and paper. EnronOnline is a proprietary trading exchange. In other words, in every transaction that takes place on EnronOnline, Enron participates as either a buyer or a seller. 

Dynegydirect was launched in October 2000, a year after EnronOnline became operational. Dynegydirect is much smaller than EnronOnline, although it is growing. The exchange recorded nearly $10 billion in transactions in the third quarter. Like EnronOnline, Dynegydirect is also principal-based. In other words, Dynegy is a participant in all of the transactions, either as a buyer or a seller. Unlike EnronOnline, which is completely online, Dynegydirect allows customers to conduct their transactions with Dynegy over the telephone. It is important to note that Dynegy strategically became involved in two different kinds of online trading. The first is the proprietary, one-to-many format on Dynegydirect, in which Dynegy participates in all transactions as either a buyer or a seller. The second venue is an anonymous, many-to-many format in which Dynegy participates along with multiple buyers and sellers. This operation takes place on TradeSpark. Dynegy had previously invested $25 million in eSpeed, the trading systems developer that created the infrastructure on which TradeSpark operates. 

As a whole, the online trading market appears to be riding the wave of a major growth spurt. A study conducted by AMR Research showed that 600 energy-trading exchanges existed in April 2000. This number grew to 1,500 by September 2001. A separate report conducted by Forrester Research indicates that online trading in wholesale markets increased 750 percent from 1999 to 2000. The same report projects that online trading volume will continue to grow, leaping from a $400-billion market in 2000 to a $3.6-trillion market in 2005. Without question, the combined force of Enron and Dynegy will gain a market edge in many sectors of the energy industry, including the online trading market. 


SCE Allowed to Proceed with Rescue Plan 

[News item from Energy Info Source] A federal judge on Nov. 9 refused to delay a settlement between Southern California Edison (SCE) and state regulators designed to allow the utility to recover $3.3 billion of its debts and to keep it from bankruptcy. U.S. District Judge Ronald Lew said delaying the deal, as requested by a consumer group, would risk harming the state's second-largest utility, its creditors and the public. Judge Lew, who approved the settlement on Oct. 5, called the arguments for a stay advanced by consumer group The Utility Reform Network (TURN) "repetitive" and "without merit." 

Analysis: This is a victory for SCE in the painstaking process of establishing a rescue plan for the utility with the state of California. Two weeks ago, a federal appeals court had temporarily blocked a settlement between SCE and state power regulators that would keep electric rates at record highs for the next two years. The 9th U.S. Circuit Court of Appeals granted TURN two weeks to argue against the settlement. The settlement would help SCE, the state's second-largest utility, pay more than half of its estimated $6-billion debt by continuing to charge Edison customers higher rates imposed last May. The judge's decision now has blocked any additional counter claims by TURN, at least on the current judicial level, and it appears that SCE is free to move forward with its CPUC-endorsed rescue plan. 

It is important to note that the original settlement deal between SCE and the state of California emerged out of negotiations that had taken place between SCE and the CPUC in an effort to resolve previous litigation. SCE had sued state regulators at the CPUC after they refused to allow the utility to raise rates and recover billions of dollars it had spent buying power on behalf of customers at soaring prices in the wholesale market. SCE's lawsuit argued that the regulators broke federal law and unconstitutionally took its property by not letting it bill customers for the full cost of their electricity. At the present time, SCE's total debt is marked at about $6.35 billion in power procurement-related liabilities due to state law that prohibited it from recovering the high costs of wholesale electricity through retail electric rates. Under the agreement reached between SCE and the CPUC, SCE would be allowed to pay down about $3 billion of its back debt of $6.35 billion. 

In exchange for being protected from bankruptcy proceedings, SCE agreed to a rate freeze and a promise by utility executives to not pay shareholders a dividend until the debt is paid off. SCE's rates were raised by approximately 42 percent in 2001 and will remain frozen through 2003 unless the utility pays off its debts sooner. In exchange, SCE agreed it would use cash on hand and any revenue beyond what it needs to cover operating expenses to pay off its old debts; pay no dividends on its common stock through 2003 or until its back debts are fully paid; and drop a lawsuit against state regulators claiming the CPUC had violated federal law by failing to raise retail rates to reflect the underlying cost of wholesale power. From its perspective, officials at Edison International (the parent company of SCE) expressed confidence that the settlement deal would allow the utility to accumulate enough cash and gain financing by the middle of the first fiscal quarter of 2002 to pay its debt to banks, bondholders and power generators. 


Tally of Absentee Ballots Changes San Francisco Municipalization Vote 

[News item from Reuters] Two ballot measures aimed at establishing a public power system in San Francisco and unplugging utility Pacific Gas & Electric Co. have gone down in defeat, officials said on Nov. 12. 

Analysis: The tally of absentee ballots in the Nov. 6 municipalization vote in San Francisco changed at least part of the outcome in this election. As noted in a previous IssueAlert, Proposition I, which sought to set up a Municipal Utility District in San Francisco and neighboring Brisbane, was defeated. However, originally it was believed that the separate measure known as Proposition F, which would have established a Municipal Water and Power Agency in San Francisco alone, had passed by a slim margin. Upon counting the absentee ballots, the San Francisco Department of Elections announced that this measure was defeated by a scant 533 votes. 

Obviously, Pacific Gas & Electric Co. is quite pleased with the revised outcome of this election. In response to the finalized vote, representatives from the utility said, "This outcome affirms that there is no strong sentiment in favor of the takeover of PG&E's distribution system in San Francisco." There may be some validity to this statement, considering that one could argue that with the bankruptcy of Pacific Gas & Electric and the recent California energy crisis, conditions could have favored a pro-municipalization vote, and yet the measure still failed. However, let's not forget that it was defeated by only 533 votes, which indicates that the issue regarding the establishment of a public power system in the area is far from over. 

The defeat of the municipalization issue in San Francisco can be attributed to several factors. First, it must be acknowledged that PG&E Corp., the parent company of bankrupt Pacific Gas & Electric, spent about $1 million on advertising to defeat the measure. However, arguably voters responded to claims by Pacific Gas & Electric Co. that the municipalization plan was unrealistic. The utility claimed that a (MUD) Municipal Utility would be ill-equipped to handle the complex electricity infrastructure that Pacific Gas & Electric has managed for years, and that a city-run bureaucracy would not be able to compete with big league energy players. In addition, the new MUD would have to purchase Pacific Gas & Electric's transmission assets and also buy wholesale power without the benefit of long-term contracts, which represent two hefty investments that would end up costing consumers in the long run. 


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