February 16 - 22, 2001

Kicking Assets

Crisis catches state utilities counting cash

by Greg Goldin

From its inception in 1996, energy deregulation in California had been, above all else, the near-silent transfer of $20 billion from consumers’ pocketbooks to the bank accounts of the state’s three investor-owned utilities. That vast sum flowed to Pacific Gas and Electric, Southern California Edison, and, to a lesser extent, to San Diego Gas and Electric, as silently as the invisible hand of the marketplace would, as the architects of deregulation promised, bring electricity rates down by 20 percent no later than March 2002. That was the deadline for California’s IOUs, as they are aptly named, to be freed of the reins of regulation administered by the Public Utilities Commission.

The placid transition from regulated to unregulated businesses was interrupted just once, in the fall of 1998, when the Ratepayer Revolt, headed by Harvey Rosenfield, mounted a ballot initiative to undo deregulation, losing badly at the polls, outspent by the IOUs $30 million to $1 million.

Then, suddenly, at the end of last year, the silence was pierced by the shrill claims of PG&E and SCE that they were broke. The free market in energy prices had gone wild, forcing the utilities to pay far more for electricity than they could charge their customers under the state Legislature’s mandated rate freeze. By January, it seemed possible that two IOUs — firms thought to be among Wall Street’s safest bets, where pension funds and county financial officers had parked hundreds of millions of dollars because the utilities’ guaranteed rate of return made their stocks appear invulnerable to economic mood swings — were on the verge of collapse. Bankruptcy became the watchword for corporate giants whose combined global revenues in 1999 exceeded $40 billion, and whose portfolios were valued at roughly $67 billion.

This imminent implosion was taken for granted by Sacramento, especially after a wave of rolling blackouts in mid-January drove home the point that the IOUs couldn’t — consumer advocate Rosenfield charged “wouldn’t” — deliver power. Whether it was a sinister strategy of “blackout blackmail” or the more benign “cash flow” crisis Governor Gray Davis spoke of, one thing was certain: The state of California was getting into the power-buying business. It would spend $1.096 billion between January 17 and February 10 (or a little less than half the $2.5 billion that out-of-state power companies spent to buy the in-state generating capacity that provided them with nearly $1.2 billion in windfall profits in 2000). Another $500 million was being sought last week, and the total drain on the state’s general fund could top $4 billion by May. Under intense pressure, the Legislature on January 31 would further authorize $10 billion in bonds in order to assume the power-buying role formerly filled by the investor-owned utilities — letting the IOUs off the hook for the only part of their business where they take chances, and shifting the risk of a volatile electricity market onto taxpayers and consumers.

Like it or not, some kind of deal also would have to be brokered between the governor and the utilities to address the $11.1 billion in energy costs that, in the swift passage of summer into fall and fall into winter, had transformed PG&E’s and SCE’s stellar credit ratings to junk bonds. Davis, while vowing that he was “in no mood” and had “no inclination to bail out anyone,” admitted in a press conference early last week that in exchange for “something of commensurate value,” the state would have “to provide a cash infusion to utilities so they can be viable . . . in order to perform functions that the state would otherwise have to absorb.”

The utilities, meanwhile, staked a take-no-prisoners negotiating stance. The massive debt, they argued, wasn’t even theirs. “We never signed on to subsidize consumers’ consumption,” Robert Foster, vice president of SCE, told the Weekly. Ratepayers should “pick up the tab” for skyrocketing energy prices. “They consumed the power,” the utility executive said flatly. The utilities went to federal court to make that case, filing suit to force the state PUC to retroactively lift the cap on utility rates.

While the governor huddled in closed-door negotiations with the IOUs and the Legislature sponsored a raft of “urgency” bills, the question arose, how broke are they? An economist at Credit Suisse First Boston, whose clients included power generators selling electricity to the state, and who was now a key adviser to Assembly Speaker Bob Hertzberg (D–Sherman Oaks), had his own mischievous answer. “The rolling blackouts in California are more likely to soften up the Legislature and the voters to the need for a rate increase than they are indicative of a permanent ‘when the lights went out in California’ scenario,” the analyst wrote. “The ‘unthinkable’ rarely will be permitted to happen.”

It is easy to see why PG&E and Edison appear broke. Quite simply, neither company has the cash to pay its debts. A pair of independent audits, commissioned and issued by the PUC at the end of January, agreed that had PG&E and SCE continued to do business as usual — meeting their obligations to buy power and to pay their debts — they would have run out of money by the beginning of February. As it was, the companies defaulted on a number of loans, easing the cash crunch. Edison’s “cash conservation” plan, for instance, left it with $1.2 billion on hand. PG&E stated in a January 17 Securities and Exchange Commission filing that it had “current cash reserves of $347 million.” True, their anemic cash supplies prevented them from paying for the power they’d bought in last year’s soaring market, but with the state taking over power purchasing, what remained of the IOUs’ business — generating and transmitting power — would extend their life spans, both audits concluded, at least until March 30. In short, although the utilities’ stocks had tumbled on Wall Street, the companies were not yet terminal.

In fact, the imbalance was only a distorted glimpse at the bottom line of a single item on the IOUs’ complex ledger books. “It’s like picking out one line item on the balance sheet, and saying this is all that matters,” SCE’s chief financial officer, Ted Carver, told Dow Jones News Service last October.

Totting up the recent “undercollected” energy expenditures against the incomes of PG&E and SCE revealed that, contrary to their assertions, deregulation was nothing less than a moneymaking machine for the utilities. Under the deregulation scheme devised by the utilities and passed unanimously in 1996 by the state Legislature, PG&E and SCE have amassed approximately $21.8 billion. Much of it — $13 billion, according to an estimate by The Utility Reform Network (TURN) — was extracted from consumers forced to pay off an earlier round of bad debts the utilities incurred by investing billions in nuclear-power plants. Those megawatt megablunders are the “stranded assets” so often spoken of in the formal argot of deregulation, and those losses have been recuperated, until last month, by taking advantage of the gap between an artificially high electricity rate and the real cost of delivering power. The IOUs accumulated the rest of the staggering sums by selling some of their power plants, by making unprecedented profits on the generating capacity they hadn’t sold off, and by a one-time $5.4 billion cash infusion granted by the Legislature in return for providing residential customers a 10 percent “rate reduction.”

The IOUs, in other words, have been awash in cash. A hefty portion of that money has moved seamlessly from the regulated utilities to their unregulated parent holding companies, and from there just as seamlessly to shareholders, in the form of dividends and stock repurchases. KPMG, the accounting firm tapped by the PUC to conduct the audit of SCE, revealed that SCE’s holding company, Edison International (EIX), “does not have any revenue-generating operations. EIX is dependent upon dividends from its subsidiaries . . . Of the approximately $5 billion in dividends and transfers received from subsidiaries for the 4-year, 11-month period ended November 30, 2000, approximately $4.75 billion was attributable to SCE.” Meanwhile, during that same span of time, “no significant funds flowed from EIX to SCE.” PG&E Corp., the parent of PG&E, enjoyed a similarly extractive relationship with its subsidiary. “Since the holding company was formed [in 1997], PG&E Corp. has not provided cash, credit or other financial assistance or support to PG&E,” Barrington-Wellesley Group, a management-consultant firm, found in its audit. Between 1997 and 1999, PG&E gave $4 billion to its parent, which in turn spent $2.7 billion to buy back stock and another $1.5 billion to pay dividends. BWG revealed, “In the first nine months of 2000, PG&E generated $1.8 billion in cash, of which $632 million was transferred to PG&E Corp. for common-stock repurchases and dividends.”

The holding companies also charged their subsidiaries for an extra $2 billion in taxes, according to the BWG audit and testimony last Friday before the state Legislature by Edison chief John Bryson. The parent corporations calculated what the regulated utilities owed as “stand-alone” companies, but when they paid the IRS, they filed consolidated returns for all their businesses. Conveniently, the actual tax due on a consolidated basis was less than the amount transferred up the corporate ladder. The holding companies pocketed the difference. From 1998 to 2000, SCE paid its parent slightly more than $1 billion for taxes. The total corporate taxes the parent paid were just $3 million. Edison spread the surplus among its deregulated businesses, including the cash-rich Edison Mission Energy.

“It was absolutely in compliance with the tax laws ä and the PUC rules,” Bryson told the Assembly energy-oversight committee.

Where the regulated utilities’ profits once gave the conglomerates huge tax benefits, their recent “losses” will now translate into equally large tax refunds. PG&E Corp. is expecting between $500 million and $1 billion from the IRS, and Edison is counting on a refund check of roughly $500 million.

These whopping sums flowing from the ratepayer-financed regulated utilities to the unregulated shareholder-owned parent companies are, the IOUs have argued to the Federal Energy Regulatory Commission, virtually untouchable. True or not, the upward flow has fueled unprecedented profits. Combined, since deregulation began, the two holding companies have posted $6 billion in after-tax profits.

As Senate President Pro Tem John Burton (D–San Francisco) put it, “Basically, they took the money and ran. Had they not done that, they would not be in the financial problem they’re in.”

So, are the IOUs broke? Not exactly, says TURN attorney Matt Freedman. To begin, the $12 billion in cumulative “losses” on electricity purchases, Freedman argues, must be compared with the $21.8 billion in “stranded costs” the utilities have received. This would be the normal accounting procedure SCE CFO Carver would expect. Through December of last year, Edison had $4.5 billion in electricity costs that it had been unable to pass on to customers. But on the plus side of its ledger, in the stranded-assets account, the company still retained nearly $3.4 billion. The balance, Freedman says, is $1.02 billion, roughly 75 percent less than Edison claims. The figures for PG&E, available through December, indicate a net “undercollection” of $3.76 billion, not the $6.7 billion claimed.

“What we are suggesting,” Freedman says, “is that the shareholders eat some of that. The utilities cannot walk away with their pockets bulging.”

What the massive influx of “stranded assets” money allowed the parent holding companies to do — apart from dole out dividends, buy stocks and dodge their mounting power-purchase liabilities by appearing to have no money — was go on a worldwide buying spree. With their stocks rising and their cash flow impeccable, Edison International and PG&E Corp. were in a position to borrow, and to acquire unregulated assets. According to a January 2001 analysis of SEC filings conducted by Public Citizen, Edison International spent more than $10 billion gobbling up power plants in England, New Zealand, Puerto Rico, Illinois and Massachusetts. Beginning in 1999, PG&E Corp. shelled out at least $9 billion on generating facilities nationwide.

One conduit for Edison International’s explosive growth into unregulated markets is the Mission Group, a wholly owned subsidiary. According to the KPMG audit, the Mission Group has approximately $895 million in cash — assets consumer advocates say were bootstrapped into existence through the transfer of money from the regulated utility — and, the audit concludes, the $40 billion holding corporation has the resources to borrow a minimum of $4 billion to cover its debts. The holding company, in other words, is far from broke.

Considering the real wealth of these companies, Harvey Rosenfield suggests Edison “bail itself out,” by slashing executive salaries and multimillion-dollar bonuses, eliminating its $2 million in campaign contributions and its lobbying of state officials, and divesting itself of $10 billion in post-“deregulation” acquisitions, including its $25 million logo at Edison Field, home of the Anaheim Angels.

Edison V.P. Foster rejects the notion that the PUC freeze might force the utilities to absorb losses. “When wholesale costs went wild, we were at risk of losing all our ‘headroom.’ But what we were not at risk for was the price of electricity piercing the frozen rate level, going to 18 or 20 cents, when all we could collect was 6.2 cents.” And now, Foster says, consumers must pay.

Thus far, Edison’s and PG&E’s pleas of insolvency have held sway in the state capital. When the Legislature fell three votes short of passing the governor’s $10 billion power-purchasing bond issue, the bill’s sponsor, Assemblyman Fred Keeley (D–Santa Cruz), warned, “If we don’t do this, the imminent bankruptcy of the utilities is so awful . . . it is almost unimaginable.”

Unfortunately, that may be the sentiment that guides the inevitable bailout to come.

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-- Martin Thompson (mthom1927@aol.com), February 15, 2001