Executive Summary:

-CPUC likely to pass rate hikes tomorrow, politicians bowing to the inevitable
-Many questions still unanswered, most notably size/structure of rate increase and past utility debts
-Past undercollect major sticking point, with little help available from transmission deal or long-term contracts
-Reliant seeking relief in circuit court from emergency orders; large generators increasingly angry with Davis' "blame game"
-QFs waiting for details of rate hike; new price formula crucial to SoCal's ability to make payments
-Bankruptcy outlook increasingly complex, but debt rescheduling remains subject to failure

In our late Friday report, we wrote "Davis could order rate hikes as a last ditch effort, but this action would not address the undercollection  issue.  There is still a high chance of bankruptcy by either the larger generators, commercial paper holders, and (less now but still very possible) the QFs as time is running out."  Events are unfolding exactly along these lines.

1.	Why Rate Hikes Now?
CPUC President Lorretta Lynch came out this weekend in favor of rate hikes.  Davis and many legislators recognize that rate hikes are the quickest solution, but that there is a potentially painful political price attached.   Davis will probably come out in support of a structured rate system, passing on most of the hikes to business and industrial users.

Other California politicians are starting to face reality of rate hikes.  The CalEnergy ruling massively reduced their leverage over the creditors, who are now able to sell outside the state, if they can get similar relief from the courts.  And it's not just the QFs--the giant Reliant Energy is appealing to the Ninth Circuit Court in San Francisco against Federal Judge Frank Damrell's series of rulings forcing large generators to continue to sell to California.

2.	What Impact Will the Rate Hikes Have?
Rate rises will stabilize the situation going forward, but there will be a messy scramble to assign blame and liability for past debts.  Some form of rescheduling is a possibility, but there are any number of accidents that could happen and yet result in bankruptcy for the utilities -- if they don't seek protection from creditors themselves.

3.	Undercollection/Net Short Still Unaddressed
All of these developments fail to address the past undercollection or the bond revenue plan.  Still, the passage of rate hikes could speed up the legislature on these fronts as well.  The bulk of the rate hikes will go first to repay the DWR, then to the commercial creditors.  Absent the transmission line deal, the bond revenue plan would have to be restructured to repay the past undercollect.  Long-term power contracts are still relatively meaningless until 2003, when the majority of the contracts kick in.

4.	Large Power Suppliers Losing Patience
Relations are also deteriorating between Davis and the large power suppliers.  Davis for the most part has been very careful to cultivate them during the drawn out negotiations, talking to several of the main CEOs almost daily.  But state legislators and officials are rapidly trying to initiate investigations of alleged market manipulation and overcharging to deflect the growing political heat from themselves.  This is only agitating the larger generators more as every day passes.  If Reliant loses their case, it may also tempt some of the larger generators to force the issue to bankruptcy.  What's more, financial creditors are also waiting with growing impatience, and the utilities themselves are contemplating voluntary bankruptcy.  PG&E in particular simply will not agree to Davis' transmission lines deal as it stands, and a bankruptcy workout may offer the best, albeit uncertain, chance of a return to eventual health someday.

5.	QFs Listening and Waiting
But the largest threat, as we have been saying, is not from the major energy companies.  It is the small companies -- known as QFs -- that will be the triggers if bankruptcy occurs.  Remember these two facts: (1) The QFs are a diverse group of 600 companies, and it only takes three of them to force bankruptcy; and (2) many of them have to move in court quickly or lose any possible standing for future court action.  It is in the interests of a number of creditors to wait and hope that a negotiated settlement can be reached, but others have a large incentive to game the situation and threaten to force bankruptcy.

Other bullish news: PG&E gets extended forbearance until April 13th from its banks, and SoCal announces that it will pay some QFs.  The actual amount of payments to the QFs is still subject to the CPUC  approving a revised pricing formula that is satisfactory to the QFs.  That decision should come tomorrow.

6.	Outlook
Last week we wrote that "the QFs felt there was no point in filing today because they want to see what they can get from the legislature this week and in all likelihood, what they can get from the CPUC hearing next week."  The next 48 hours will be crucial.  Only massive rate hikes (40% or higher roughly) would address the undercollect issue and Davis is unlikely to authorize those.

As one source told us, "the age of denial is (mostly) coming to an end, and that is the main source of hope that California can begin to move forward from this."  But the situation is so complex, and there are so many players and angles involved, that a negotiated solution to the past debt problem will still be complicated and vulnerable to failure.