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"SCIENTECH IssueAlert" <IssueAlert@scientech.com> on 04/20/2001 05:35:54 AM
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Subject: Deal for SCE's Transmission Assets Appears Dead on Arrival






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April 20, 2001

Deal for SCE's Transmission Assets Appears Dead on Arrival

by Will McNamara 
Director, Electric Industry Analysis

[News item from Reuters] California Gov. Gray Davis' billion dollar plan to 
save utility Southern California Edison (SCE) from bankruptcy is in deep 
trouble and could be rejected by legislators. Legislative sources said the 
governor was having so much trouble gathering support for his plan that he 
could not find anyone to sponsor a bill. One Assembly official called the SCE 
bailout plan "the most unpopular piece of legislation in years." 

Analysis: Even when this deal was announced as an "agreement in principle" 
some 50 days ago, it seemed too far-fetched to be possible. The only party 
that clearly seems to benefit from the agreement forged between Gov. Davis 
and SCE is the cash-strapped utility. California energy customers appear to 
get the short end of an expensive stick, while the state seemingly gains 
nothing of value beyond what could amount to a whole new set of 
administrative problems. Thus, despite the hype with which Gov. Davis 
announced this rescue plan for SCE, California legislators-both Republicans 
and Democrats-are saying  "not so fast" and appear to be collectively opposed 
to the plan as it currently stands. As it becomes apparent that the 
California Legislature will not approve this plan, the general consensus is 
that Gov. Davis' offer to SCE is simply a financial bailout for the utility 
that provides no benefit to California residents. 

For background on the details of Gov. Davis' rescue plan for SCE, please 
reference my IssueAlert from 4/11/01. In a nutshell, the state of California 
agreed to buy SCE's 12,000-mile transmission grid, which covers much of the 
southern half of the state, for $2.76 billion, 2.3 times the system's book 
value. SCE would be allowed to use the proceeds to pay off its existing debt, 
restoring it to financial stability.  Both the California Legislature and the 
CPUC need to approve this deal by Aug. 15 or else the agreement is 
terminated. 

In the highly politicized climate under which the California energy crisis 
has unfolded, it is imperative to understand the agendas that each 
stakeholder possesses. For instance, keep in mind that Gov. Davis' political 
career has been severely damaged by the state's energy crisis, and the fact 
that Pacific Gas & Electric Co., California's largest utility company, 
declared bankruptcy has only further tainted the governor's standing. Perhaps 
more than any other goal, Davis wants to keep SCE from also filing for 
Chapter 11 protection. In addition, Davis believes he will be better able to 
solve the crisis if he assumes control over the state's transmission grid 
(much like the state has assumed the role of a power purchasing agent). 
Normally, a measure supported by the Democratic governor could be easily 
approved by California's Democrat-controlled legislature. However, the energy 
issue has divided support for Davis even within his own party. Consequently, 
the governor needs the support of both Republicans and Democrats in order to 
see his rescue plan for SCE pass.  

For its part, there was very little reason why SCE should not have agreed to 
the governor's terms. From multiple standpoints, the utility gains enormously 
from the governor's offer, while at the same time it avoids lengthy and 
costly bankruptcy proceedings. Under the agreement, SCE gains a method for 
pulling itself out of debt, via rate increases that probably would be 
implemented over the next 15 years. Further, its parent company Edison 
International gets to hold on to a reported $4.8 billion that SCE has 
provided to the corporate operation since 1997. (The exception to this is a 
$400 million tax refund that Edison International would give back to SCE). 
While Davis referred to his plan as a  "good, balanced deal," some consumer 
groups have charged that SCE "has taken the governor to the cleaners." 

Meanwhile, California customers clearly lose in the deal because they would 
be forced to ultimately pay for the $2.76 billion that the state needs to buy 
the transmission assets. The state would purchase the lines with bonds that 
would be paid off by transmission fees charged to SCE customers. It is 
presently not clear whether or not those fees, which are already part of 
monthly bills, would be sufficient; therefore, it is likely that rates would 
be increased to support the purchase. In addition, the subtext of the deal is 
that customers would ultimately pay to drive down SCE's debt, which was 
accumulated as a result of unrestricted wholesale power costs charged by 
generators. Consequently, California customers would bear the responsibility 
for prices that FERC has at times deemed "unjust and unreasonable." 

Ultimately, however, it is the California Legislature and CPUC that will have 
the authority to approve the agreement between Gov. Davis and SCE. These two 
agencies must ultimately decide if the plan is good or bad, and weigh the 
impact for various stakeholders. Presently, the legislature in particular is 
finding that there are many questionable aspects about the plan. For 
instance, what value would there be in the California government owning only 
one portion of the state's interconnected transmission system? PGOCorp. has 
walked away from the negotiating table and has expressed little interest in 
selling its transmission lines to the state. No agreement with Sempra Energy 
(parent of San Diego Gas & Electric) has been reached either. Thus, if the 
Gov. Davis / SCE agreement is approved, the state of California would gain 
ownership rights to only a portion of the overall transmission system in the 
state. Many legislators challenge the value of this, especially when it is 
considered that most of the congestion that leads to higher prices within the 
state is concentrated along PG&E's portion of the grid. The counter-argument 
to this point is that, now that its utility is in bankruptcy proceedings, 
PGOmay not have the choice of whether or not to sell its transmission assets 
to the state. The bankruptcy judge would make this decision. Thus, some 
argue, the state may have a better chance of obtaining PG&E's transmission 
assets if it can first complete a deal with SCE.  

The second fundamental problem is that causing California legislators to turn 
their back on the governor's plan is what some have referred to as an 
"obscene bailout" for SCE and its parent company. Some reportedly believe 
that Gov. Davis rushed into an overly generous offer for SCE out of anxiety 
caused by the breakdown in his communications with PG&E. As noted, the $2.76 
billion offer for SCE's assets is about 2.3 times their book value, so many 
legislators are having difficulty reconciling what appears to be an 
inappropriate price tag (and, once again, a cost that taxpayers and 
ratepayers would ultimately have to absorb). Currently, SCE customers pay a 
FERC-approved transmission rate based upon a cost-plus formula. If the state 
pays 2.3 times book value, it would equate to ratepayers paying two times 
over for those same transmission lines. In addition, some legislators, 
including former Democratic allies of Gov. Davis, have suggested that SCE 
should be forced to enter bankruptcy as Pacific Gas & Electric Co. has done. 
Naturally, legislators will approach the issue with their constituents in 
mind, knowing that they will be accountable for how they vote on this plan. 
Looking at the issue from a customer perspective, one could argue that SCE 
declaring bankruptcy would create less financial hardship for California 
customers than bailing out the utility and increasing rates. This will be a 
major political challenge for California legislators to resolve if the 
governor's plan becomes sponsored as a bill. 

If I pull out my crystal ball and be so bold as to make projections in this 
case, I would predict that there is little chance that Gov. Davis' rescue 
plan for SCE will pass in its current form. The energy crisis in California 
has become so politicized that legislators will be very reticent to approve 
any measure that resembles a financial bailout for one of the utilities, 
especially without obtaining something of value for the state in return. It 
is Gov. Davis' personal agenda to obtain control over the state's 
transmission assets, but I don't see this as being a priority for other 
California lawmakers. Thus, the deal will be a tough sell unless some new 
development occurs that puts owning SCE's transmission assets in the state's 
best interest. Considering the many headaches associated with this business, 
and the fact that the state has no expertise in this area, I don't see this 
occurring. Consequently, the game is by no means over for SCE and its 
potential for bankruptcy does not appear to have decreased to any large 
extent. One large California utility is already in bankruptcy court. We could 
be only days or weeks away from seeing SCE head in that direction as well. 

An archive list of previous IssueAlerts is available at
www.scientech.com




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