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SCIENTECH IssueAlert, October 10, 2000
PG&E's Rate Cap Proposal: Leading the Charge for Re-Regulation, or Protecting
Itself from Economic Disaster?
By: Will McNamara, Director, Electric Industry Analysis
===============================================================

Pacific Gas & Electric Co. (PG&E), in filings with the California Public
Utilities Commission (CPUC) and California Independent System Operator
(Cal-ISO), has requested that a rate cap be placed on wholesale purchases
in the state. The utility is asking the CPUC to lower the current rate
cap from $250 per megawatt hour to $100, or 10 cents per kilowatt hour.
In seeking the rate cap, PG&E is joined by Edison International, the parent
company of Southern California Edison, and The Utility Action Network (TURN),
a ratepayer advocacy group.

ANALYSIS: The current rate cap of $250 per megawatt hour in the wholesale
market of California resulted from the price spikes experienced in San
Diego this summer. As San Diego Gas & Electric had paid off its stranded
costs, the retail rate freeze in its area was lifted and SDG&E customers
were exposed to market-based prices, which doubled and at times tripled
due to increased demand in the state and power supply concerns. PG&E customers
were not exposed to the price spikes because, at the time, PG&E had not
paid off its own stranded costs and was still under a retail rate freeze.

Yet the company has felt the impact from the price spikes just the same.
PG&E buys a great deal of its power on the wholesale market, and as a result
is about $2.2 billion in debt (some figures suggest it is as high as $2.7
billion). Due to the retail rate freeze still in effect, PG&E has been
unable to pass this debt on to customers by raising its rates. In real
terms, PG&E was paying up to 19 cents per kilowatt hour on the wholesale
market this summer, when by law it was only allowed to charge its customers
on average 5 cents per kilowatt hour. In total, PG&E has paid about $2.7
billion more to suppliers than it can bill customers for, and this amount
is growing by hundreds of millions each month. This explains the utility's
motivation in wanting to see the CPUC further lower the cap on wholesale
rates in California.

However, even though PG&E as a whole is in debt, the utility*as well as
other divisions under parent company PG&E Corp.*is still making money off
deregulation in California. For instance, PG&E's Diablo Canyon nuclear
plant has been able to capitalize on the high value of power on the wholesale
market. The utility confirmed recently that altogether its power facilities*
the
ones left after the utility was forced to divest the bulk of its power
assets*still provide about $150 million a month to the utility. In addition,
PG&E Corp.'s unregulated energy commodity trading operation has been doing
very well. And the unregulated National Energy Group*which operates in
markets outside of California, such as Massachusetts, Rhode Island and
New Hampshire*posted a 233-percent profit increase for the second quarter.
Thus, it is important to note the distinction between PG&E and its parent,
PG&E Corp. Ironically, as a whole, PG&E Corp. has stated that it does not
support rate caps, and has opposed the issue when it has surfaced in other
states.

PG&E reported second-quarter earnings of $216 million on $2.3 billion in
revenue, representing a 26-percent increase over the same quarter last
year. Third quarter earnings also reportedly will be strong. This puts
PG&E in an awkward predicament. On one hand, PG&E wants to convince 
shareholders
that the company is doing well and making money from the commodities that
it sells. On the other hand, PG&E is attempting to convince regulators
that it is losing money due to the high wholesale prices that it must pay
for power. In fairness, though, the revenue PG&E has earned cannot come
anywhere near to paying off the massive debt the company has accrued due
to its obligation of serving customers.

PG&E's rate freeze is scheduled to end March 31, 2002, at the very latest,
or sooner if it is determined that PG&E's stranded costs have been repaid,
something that utility executives say may already have taken place. Due
to higher-than-expected revenues and higher-than-market valuations of the
utility's assets, it may very well be the case that PG&E's stranded costs
are already paid off. When this is officially determined by the CPUC, PG&E
will argue that customers should be liable for some or all of the debt
it has assumed while the rate caps were in place. The CPUC has scheduled
a hearing to address these issues on Oct. 19. The core question of these
proceedings will be whether or not PG&E should be allowed to turn over
its debt to customers through rate increases once the rate freeze is lifted.
PG&E wants to be able to retroactively bill customers for its debt, based
on the date which the CPUC determines that PG&E had in fact paid off its
stranded costs, a point groups such as TURN will surely protest.

It may seem surprising that TURN was among the group with PG&E that filed
the petition to lower the rate cap on wholesale prices. Typically, TURN
and PG&E (along with most utilities) are at polar opposites regarding most
issues. However, both agree that wholesale rates are too high and want
to see a new cap put into place, but for completely different reasons.
TURN says that PG&E and other utilities took a risk when agreeing to the
rate freeze and they should not be allowed to pass debts that resulted
from that risk onto customers. TURN continues to retain a watch over the
proceedings related to PG&E's proposal, specifically with regard to the
possibility that the CPUC will allow the utility to raise rates on customers.

Within the course of these new developments, it's important to be clear
on PG&E's motivations. Some California lawmakers and consumer advocates
have called for a complete return to regulation, arguing that deregulation
in California has become a failed experiment. Many have surmised that PG&E's
proposal for wholesale caps is essentially a call to return California
to a regulated structure. I think this is a misinterpretation. PG&E has
very clearly stated that its proposal is a "necessary short-term step to
try to bring prices back in line." PG&E's efforts really shouldn't be viewed
as a move to return California to a regulated market. Rather, PG&E is merely
attempting to protect its own interests. The utility wants to secure temporary
lower rates for the power it needs to buy on the wholesale market and transfer
its debts to customers once the rate freeze is lifted. A return to regulation
via a permanent rate cap would not be in PG&E's best interests as it continues
to sell power from its nuclear plant. In addition, PG&E probably recognizes
that regulation would discourage additional companies from building new
power plants in California, which would not be good for the long-term economy
of the state. This also would do little to lower wholesale prices in 
California.
As we discovered this summer, the less supply, the higher the price for
power.

PG&E's proposal to lower rate caps on wholesale prices is, more than anything
else, an attempt to protect itself from what it perceives as disastrous
economic impact if it is not able to transfer its debt to customers. A
recent Wall Street Journal report inferred that if wholesale prices continue
to exceed what PG&E can charge customers, the utility could become 
"technically
insolvent" sometime next year. It will be interesting to see if the CPUC
has the same perception when it evaluates PG&E's proposal later this month.

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Sincerely,

Will McNamara
Director, Electric Industry Analysis
wmcnamara@scientech.com
===============================================================
Feedback regarding SCIENTECH's IssueAlert should be sent to 
wmcnamara@scientech.com
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