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April 11, 2001

SCE Agrees to Sell Transmission Assets to California 

by Will McNamara 
Director, Electric Industry Analysis

At a joint press conference with Governor Gray Davis, Edison International 
Chairman, President and CEO John Bryson announced agreement on a plan to 
restore Southern California Edison (SCE) to financial health. "The negotiated 
resolution with the Governor is far preferable for our company, our employees 
and for our customers than is going into bankruptcy," Bryson said. The key 
part of the agreement is that the state will receive a primary utility asset*
SCE's 12,000 mile transmission system. SCE employees will operate and 
maintain the system through a contractual arrangement with the state. 

Analysis: Only days after Pacific Gas & Electric Co., its California utility 
counterpart, declared bankruptcy, SCE announced what is being billed as a 
pact with the State of California that should keep it out of bankruptcy 
court. From all appearances, this seems to be a strong deal for SCE, as it 
not only keeps the utility financially solvent but also removes it from a 
line of business that remains rather uncertain and financially unrewarding. 

First, let's establish the key aspects of the agreement. Keep in mind that 
the California Legislature, the California Public Utilities Commission (CPUC) 
and federal regulators must approve this deal. Edison International (NYSE: 
EIX), the parent of SCE, has agreed to sell the utility's transmission assets 
to the State of California for $2.76 billion. The confirmed price tag that 
the state is paying for SCE's lines seems like a generous offer because it is 
about 2.3 times the system's current book value of $1.2 billion (the original 
cost, less any accumulated depreciation (OCLD) recorded in SCE's books). 
Since transmission rates are based on an allowed rate of return on OCLD, it 
is uncertain that SCE's current transmission rates will provide sufficient 
revenues for the state to cover its purchase cost. 

The sale includes only SCE's transmission assets. It appears that SCE will 
remain in the distribution business and continue delivering power to 
customers and running generation. Both the state and SCE have agreed to 
commit to no less than $3 billion of capital investment in utility 
infrastructure over the next five years, which presumably includes upgrades 
to the transmission system and new generation capacity. It is not entirely 
clear at this time how the $3 billion in capital investment will be shared 
between the State of California and SCE. 

Edison officials also have agreed to sell cost-based (not market-based) 
electricity to the state from power generated at SCE plants. Edison Mission 
Energy, the unregulated subsidiary of Edison International, is also obligated 
to sell output from its Sunrise power plant exclusively to California under 
cost-based pricing. Although SCE divested much of its power assets under 
agreements with the CPUC, it still shares ownership of the San Onofre Nuclear 
Plant Units 1, 2 and 3 with San Diego Gas & Electric (SDG&E), and shares in 
the Palo Verde, Mohave and Four Corners generating stations. SCE also owns 
hydroelectric facilities and the Pebbly Beach generating facility. The 
Sunrise Mission power project is a gas-fired power plant that is currently 
under construction. Reportedly, the Sunrise plant is expected to provide 
about 320 MW of electricity during peak periods of demand this summer. 
According to the Memorandum of Understanding between SCE and the California 
Department of Water Resources, "SCE's generation assets*including all energy, 
capacity, ancillary services, and any combination thereof*will be committed 
to cost-based ratemaking for SCE's bundled service customers." In addition, 
SCE is prohibited from selling any of these generation assets until Dec. 31, 
2010. 

Also included within the agreement is SCE's commitment to dismiss all pending 
lawsuits against the CPUC related to market prices in California. Edison 
International also has agreed to refund $400 million to the utility unit that 
reportedly had been paid in dividends to the parent company. 

The $2.76 billion that the state is paying SCE for its transmission assets 
can be used to pay pre-existing debt to creditors, including power generators 
that have previously sold power to SCE. This is the essential benefit that 
the utility receives in the deal and it is a considerable achievement given 
that the liquid capital theoretically should stave off bankruptcy 
proceedings. It is also important to note that this is the first revenue 
stream that has been specifically earmarked for SCE's pre-existing debts. 
Recent rate increases that have been approved by the CPUC can only be applied 
to subsequent debts incurred by the utility. In addition, SCE will be allowed 
to issue bonds to recover a "substantial portion" of the approximate $5 
billion in debt that the utility has accrued due to uncollected purchases of 
wholesale power. The agreement should return SCE's debt to investment grade, 
making it easier for the company to raise money to fund future operations. By 
reducing its debt load, Edison CEO John Bryson remains confident that SCE 
"can borrow to pay out [remaining] debts." 

SCE Chairman and CEO Stephen Frank expressed confidence that a final 
agreement could be reached "before the end of the year," although the 
California Legislature reportedly has agreed to expedite its own review of 
the agreement and provide approval before summer temperatures begin to wreak 
havoc on the California market. If for any reason the sale of the 
transmission assets has not been completed within two years, SCE is obligated 
to sell to the state its hydroelectric generation facilities instead (at a 
to-be-determined price). Although the deal is expected to proceed, some 
concerns have been raised about federal issues related to interstate 
commerce. In addition, the fact that Pacific Gas & Electric Co.*with which 
SCE has often been intertwined*remains in bankruptcy court could also 
complicate the agreement between SCE and the state.  

News of the agreement immediately caused Edison shares to increase by about 
$2.16, or 24 percent, to $11.08 on April 9. As of the close of trading on 
April 10, Edison shares were priced at about $11.38.  

For its part, SCE said that it was "racing toward" an agreement with the 
governor to avoid being forced into an involuntary bankruptcy. Yet, for some 
time, SCE has been more willing to sell its transmission assets than PGOever 
appeared to be. In fact, I wrote in the 2/26/01 IssueAlert that Gov. Davis 
had reached an "agreement in principle" with SCE regarding the sale of the 
transmission lines. Most of the key elements of the agreement that has been 
agreed to by both parties have been in the works for over two months.  

PGOCorp. issued a statement that it was pleased that SCE had been able to 
reach an agreement with Gov. Davis, but said that the agreement did not 
change its own direction toward bankruptcy court. According to a report on 
CBS.MarketWatch.com, Fitch analysts have suggested that the sale of SCE's 
transmission assets to the state of California could in fact lend a 
"framework" that might be used in Pacific Gas & Electric Co.'s bankruptcy 
proceedings. What this might mean is that Federal Judge Dennis Montali, the 
official overseeing Pacific Gas & Electric Co.'s bankruptcy, might rely upon 
the agreement between SCE and the State of California to mandate a similar 
deal for PG&E.  Gov. Davis commented that the SCE deal could serve as a basis 
for separate agreements with SDG&E, and eventually PG&E, if they choose to 
come back to the negotiating table. In fact, the state could submit a plan to 
Judge Montali outlining a purchase of PG&E's transmission assets, which the 
judge could ultimately enforce. 

An argument could be made that the agreement SCE has reached with the State 
of the California provides benefits to the utility that go beyond protecting 
it from bankruptcy. One could argue that SCE benefits by being able to exit 
the transmission business altogether, which in many ways can cause tremendous 
problems for the companies that choose to remain in this business. 
Transmission operations also typically offer a low rate of return; in SCE's 
case, according to its most recent 10K filing, its transmission business 
resulted in a return on equity of 9.68 percent. SCE had proposed that the 
return on equity for its transmission assets be set at 11.6 percent, which 
FERC rejected (FERC has ultimate authority over transmission service 
pricing). Thus, the question could be raised of why SCE would even want to 
remain in the transmission business, given this low return on equity. Behind 
the scenes, SCE could very well have previously made the determination that 
its transmission business was not a valuable part of its overall operation. 
This could be representative of an international trend, as regulatory 
agencies in Australia and Great Britain have also set lower limits on the 
average transmission network charges that utilities can implement. 

Moreover, the State of California does not bring extensive operational 
expertise to its new role as a transmission owner. Thus, the state is wise to 
keep SCE employees in charge of the operation and maintenance of the 
transmission system. This substantially reduces the risk for the state, which 
is a prudent move. From the state's perspective, it gets an asset in exchange 
for a bailout, which makes its investment in SCE beneficial. However, the 
transmission business will present unique challenges for the state, such as 
raising capital for transmission improvements and siting procedures. The 
state may quickly learn why the transmission business is perceived as being 
so challenging, and why it is difficult to entice companies to build new 
transmission lines (especially considering the low rate of return that the 
transmission business offers). On the other hand, by assuming the role of a 
transmission system owner, the State of California will be in a position to 
obtain competitive information about the activities of power generators in 
the state. This could result in a significant advantage for the State of 
California if it remains in its current power-buying role.  

An archive list of previous IssueAlerts is available at
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