December 26, 2000 Market Place: Energy Crisis in California Threatens the Stability of Utility Shares By LAURA M. HOLSON

AN FRANCISCO, Dec. 25 — It used to be that utility companies were the safest stocks for investors to buy, slow growers favored for their stable earnings and predictable dividends. But those assumptions no longer apply in California, where newly deregulated utility companies instead share a familiar characteristic with their Internet brethren these days — enormous cash burn — but lack the huge Internet growth prospects that might otherwise keep stock prices afloat.

After a summer that teetered on the edge of an energy debacle, California has again been gripped in recent weeks by a severe energy shortage that on some days has come close to threatening blackouts among 15 percent of California's 24 million utility customers.

With a cold snap in the Pacific Northwest and limited supplies here, utility companies were forced to pay power generators $1,500 per megawatt hour this month — 40 times what they paid last year — as state officials scrambled for as much as one- third of California's energy needs.

Not surprisingly, investors have shunned California utility stocks, including those of the parent companies of Southern California Edison and Pacific Gas and Electric. The primary worry is that the companies will not be able to recoup the $8 billion they have paid to power producers but — for now, at least — cannot collect from customers, because of a rate freeze in effect until March 2002.

Standard & Poors, the rating agency that monitors companies' financial health, warned last week that the utilities were on the verge of bankruptcy and risked bond downgrades to junk status unless something was done quickly to stem losses.

Share prices of the parent companies, Edison International and the PG&E Corporation, have fallen as much as one-third since the beginning of December, though both stocks rebounded a bit on Friday.

Top executives from the utilities met with state officials last week, and Southern California Edison announced on Friday that it would eliminate its fourth-quarter dividend and trim $100 million in spending, including the elimination of 400 jobs, in an effort to stave off bankruptcy.

Such measures, as well as the fact that the Public Utilities Commission in California agreed to hold emergency hearings beginning Wednesday on possible rate increases, have forestalled a financial brownout for the time being. But the situation remains in flux. "It is still probable the ratings will go down," said David Bodek, a utilities credit analyst at Standard & Poor's. "Conserving cash staved off insolvency only for a few weeks, giving them additional time for the crafting and implementation of a strategy."

The fact that politicians will strongly influence the utilities' fate — Gov. Gray Davis, in particular, is stepping up his involvement — further clouds the picture for financial analysts. "When there is a `protect the consumer' mode, the near-term impact on the companies will be much worse," said Jon Raleigh, a power and utilities analyst at Goldman, Sachs.

But even if the Public Utilities Commission approves a rate increase that somehow satisfies both consumer groups and Wall Street, analysts contend that the companies' prospects have changed.

"Even with a constructive outcome, it will likely be difficult for the utilities to argue they need rate relief to avoid bankruptcy, but keep paying the same dividend," said a report issued Friday by Merrill Lynch. At best, the report added, rate increases could make Edison and PG&E "financially viable, but not financially strong." Bankruptcy, Merrill Lynch concluded, is a real but unlikely possibility.

It should also be noted that the utilities' parent companies — power producers in their own rights — have benefited from the high prices being paid for electricity. PG&E paid power generators $4.5 billion more than it could collect from rate payers from June to November, but it earned $1.57 billion more than in the period a year earlier from its own nuclear and hydroelectric generation plants.

That revenue, a company spokesman said, is supposed to be used to pay off debt and other costs associated with deregulation, not to subsidize rates. Still, if the utility companies' bonds are indeed downgraded, the ripples could wash over the nonprofit agency that manages California's power grid and the exchange where electricity contracts are traded.

In particular, the Independent System Operator, which runs the grid, could be required to demand collateral from the utilities in advance of any power purchases made on their behalf. Otherwise, Kellan Fluckiger, the agency's chief operating officer, said power producers could balk at sending electricity to the state, as they did earlier in the month. Resolving that mess required Mr. Fluckiger's boss at the Independent System Operator to go behind Gov. Davis's back and ask federal regulators to order power producers to send electricity to California.

In the end, any resolution seems bound to be messy. Electricity shortages are expected to continue through the summer of 2002, say power executives, when new power plants will come on line. Utility companies will still have concerns about their viability. Consumers will not be happy paying higher rates.

And federal and state regulators have to come to some agreement on a regionwide solution to resolve the West's energy problems.

http://www.nytimes.com/2000/12/26/business/26PLAC.html?printpage=yes

-- Martin Thompson (mthom1927@aol.com), December 26, 2000