Please contact Kristin Walsh (x39510) or Robert Johnston (x39934) for further clarification.

Executive Summary:

Utility bankruptcy appears increasingly likely next week unless the state can clear three hurdles- agreement on payback for the bailout, rate increases, and further short-term funding for DWR purchases of power.
Disagreement persists between Gov. Davis and Democrats in the legislature on how the state should be paid back for its bailout of the utilities.  The split is over a stock warrant plan versus state ownership of utility transmission assets.
The economics of the long-term contracts appear to show that rate hikes are unavoidable because of the need to amortize the undercollected rates of the utilities during the recent rate freeze period.
Air Quality Management District regulations are under review, but offer limited scope for providing additional generation capacity.
Legislature Democrats are feeling intense pressure from the left-wing consumer groups and are being forced to at least slow, if not stop, Davis's bailout and rate hike plans.  Senator Burton's eminent domain threats against generators, which reflect this pressure, are of little significance.


1.	Bankruptcy Outlook Rising Once Again

A deal to finalize a debt workout continues to be just beyond the reach of the state, the utilities, and their creditors, with time running out on the debt forbearance arrangement set to expire on Tuesday.  

SoCal Edison and PG&E are not paying any of their bills except for payroll.  They are working very hard to keep cash on-hand, and have indicated that they feel that they are very close to an involuntary bankruptcy filing.  Once this filing occurs, they will have 50 days until either the bankruptcy court accepts the filing or the utilities file a voluntary bankruptcy.  

Opinion within the assembly is divided with respect to the outlook for bankruptcy.  Assemblyman Keeley told our source that a filing is likely, but that everything will be resolved during that 50-day period.  Senator John Burton "is in no hurry" to reach a deal with the utilities, as he believes that the State of  California is in a good position to "strong-arm" the utilities.  Burton currently does not intend to cede to the utilities so that they can avoid bankruptcy.   The Senator stated, "bankruptcy would be bad, but not the worst thing possible."  He intends to stick to his position.  Senator Burton also dismissed Governor Davis' end-of-week deadline for striking a deal with the utilities.

Still, bankruptcy can be avoided if a last-minute deal can be struck Monday on:
what the state receives in return for the bailout
the scope of rate hikes (a federal court is expected to rule on the PG&E/SoCal v. CPUC rate undercollection case Monday)
additional financing is made available to the DWR to buy more power until the revenue bonds can be issued in May.

There is a possibility that significant progress on these issues could lead to a further extension of creditor forbearance.  However, the negative tone taken by Standard & Poors and others concerning delays in the legislature suggest that further forbearance will difficult to achieve.  The previous forbearance period was only achieved via a high-level Washington summit which does not appear likely to happen this weekend.

Additional financing for DWR will not be automatically approved by the legislature.  The non-energy expenditures of the California government are now at risk, as there is not yet a rate structure in place to recover the costs being expended on power from the General Fund.

2.	State to Take 2/3 of Utility Debt

While the state seems to have succeeded in forcing the utility parents to eat close to one third of the $12 billion debt, a final deal has been held up on two fronts.  First, it is still unclear what the state will get in return for the utility debt.  It is possible that there will be a mix of stock warrants and/or transmission assets.  A takeover of the transmission assets seems more likely than a takeover of the hydro assets.  The value of these assets still has not been settled.  Second, while the state will be on the hook for $9 billion, it is not clear what mixture of rate hikes and revenue bonds will be used to recover the cost of the bailout.  Finally, expect Davis and other California politicians to work to minimize rate hikes (although the Edison/PG&E v. CPUC case on Monday is likely to force their hand here) and to do everything possible to avoid the appearance of a bailout.  The tangible transmission assets are more politically attractive than the nebulous stock warrants.

No price has been set at which the State would purchase the utilities' transmission assets, which are currently valued at approximately $7-$8 billion.  All of the proceeds though cannot be used to pay off the utilities' debts, as some of the money would go to existing bondholders.  However, IPP sources advise that there is already a bid on the table for these transmission assets that is higher than what the state would offer.

3.	Long-Term Contracts

As noted by the governor in his announcement Tuesday, only 500 MW of the 5,000 MW of power contracted for can come on-line immediately.  Much of the remainder reportedly was contracted in long-term purchases from suppliers who are building power plants.  Some of this will come on-line in approximately two years.

Assemblyman Keeley expressed frustration that he has received a "tablet from on high" from Governor Davis that there must not be a rate increase.  This means that the state must acquire power, not from internal sources or from the market, but through long-term contracts at 7.39 cents/kwh.  This allows 1.213 cents to amortize SoCal Edison's undercollection from the recent rate freeze period.  (The number is slightly different for PG&E.)  This assumption is based on a natural gas price of $7.90 in 2001 and $5.15 in 2005, and an efficiency heating rate of 10,000 - 12,000 in 2001 and 7,200 in 2005.

These numbers were quoted to industry sources, who felt they were unrealistic.  These sources quoted the 2001 price of natural gas as $9.00 - $9.50.  The sources agreed with Keeley's number for the 2001 efficiency heating rate, but they felt that 7,200 in 2005 was very optimistic unless an enormous amount of new generation capacity comes on line.

According to Keeley's numbers and assuming the filed rate case is settled at $7 billion rather than $12 billion, it would take 5 to 6 years to amortize all of the utility undercollection.  A settlement to this case will need to be reached so that the State can figure out how much to charge for power in order to amortize the undercollection.  However, since Assemblyman Keeley's numbers are unrealistic, a rate increase will be necessary.

4.	Air Quality District Exemptions

There have been a few bills introduced to provide exemptions from AQMD (Air Quality Management District) regulations -- AB 20X, AB 28X, AB 31X. Also, Republicans have been asking the Governor to lift the environmental regulations and immediately site the facility in San Jose that was denied by the local government.

Currently there is no contemplation of loosening the AQMD compliance restrictions.  The legislature will not allow "dirtier" plants to
 come on-line.  However, there might be a change in the means of implementation in southern California by moving away from the
 use of credits (this apparently drives up the cost of gas-fired power). 

5.	Democratic Moderates Pressured by Consumer Advocates

  The moderate left (Sen. Burton, the PUC, consumer activists) is afraid of Harvey Rosenfield and his consumers movement.  This is not just because of his initiative.  More important from their perspective, his initiative puts him and the far left in a position to challenge and defeat the moderates in the next election.  Thus, Democrats in the legislature will feel pressured to distance themselves from Davis and slow down any further rate increases or bailout.

6. 	Eminent Domain Would Have A Limited Effect

The threats by Burton to seize generation assets to insure continued power supply are limited.  They only apply to California suppliers.  A
federal order would be needed to seize assets from out-of-state suppliers. There are also Canadian suppliers (such as BC Hydro) who are essentially untouchable.

7.	Smaller IPPs Feeling the Squeeze

Many of the smaller IPPs, which account for approximately 2500 MW of production, appear to be within a few days of running out of cash.  
AB 1X may be amended, possibly sometime this week, to give the smaller producers credit support.