March 30, 2001

Rate Increase May Not Give Juice to California's Utilities

By John R. Emshwiller Staff Reporter of The Wall Street Journal

Earlier this week, news of a whopping electricity-rate increase in California produced a predictable stock-market response: Shares of PG&E and Edison International soared some 30% as investors saw visions of fresh billions helping companies that have been nearly driven to bankruptcy court by the state's power crisis.

Now for the bad news.

The actions by the California Public Utilities Commission to raise rates "do not offer a comprehensive solution, fail to resolve the uncertainty of the crisis, and may even create more instability." That nabob of negativism comes not from a Wall Street bear but from Gordon R. Smith, president and chief executive of PG&E's Pacific Gas & Electric utility unit.

In a little-noticed statement issued late Tuesday night, after the PUC's rate action earlier that day, Mr. Smith laid out a litany of problems that he believes regulators either failed to resolve or exacerbated. PG&E officials declined to comment beyond the statement.

Mr. Smith's statements could be viewed as a self-serving attempt to win more relief for his utility and its investors. And utility executives traditionally downplay rate boosts, so as not to anger consumers or regulators. Still, some on Wall Street say Mr. Smith has cause for unhappiness in this case.

"Everyone has been saying 'Whoopee, this is great for the utilities.' I don't agree," says Susan Abbott, a managing director at Moody's Investors Services, the big credit-rating agency.

For one thing, says Ms. Abbott, many people don't seem to realize that the money supposed to be produced by the rate increase, an estimated $4.8 billion annually, is principally earmarked to go to the state to reimburse it for power it will be buying -- not to help the utilities pay off debt to power suppliers that have been cutting the two California utilities slack since late last year for unpaid bills. State officials have already asked the Legislature for authority to spend $4.7 billion on electricity.

In January, the state began buying large amounts of power in place of the financially beleaguered utilities, which had accumulated billions of dollars in debt as the result of skyrocketing wholesale electric-power costs that they couldn't pay off through existing rates.

Merrill Lynch analyst Steve Fleishman says that he, like others, initially was buoyed by the news of the PUC actions. But as he learned details of the rate-increase plan, he too concluded that "none of the rate increase can in any way go to deal" with the accumulated liabilities. He now thinks the market overreacted on the upside to the rate-rise news. While the rate rise will help bolster the state's overall electricity-buying capacity, the utilities "are still far from being out of the woods," Mr. Fleishman says.

So far, the stocks of the two utilities have largely kept their gains. In composite trading as of 4 p.m. Thursday on the New York Stock Exchange, PG&E shares fell 58 cents to $12.62, and Edison stock dropped 59 cents to $13. On Friday, before the rate news hit, the stocks traded at $10.65 and $11.20, respectively.

Earlier this month, PG&E warned investors that it may have to take a write-off of as much as $4.1 billion in connection with accumulated liabilities, while Edison estimated a potential charge of as much as $2.7 billion. Such steps by both companies would further complicate already-strained relations with creditors, as well as possibly make any eventual recovery more difficult.

The moment of truth is near: The companies face an initial deadline Monday for reporting their much-delayed fourth-quarter results, which will have to address the issue of their accumulated debt.

Both companies have been delaying reporting their fourth-quarter results for 2000, largely due to the continuing uncertainty over how to treat their huge unfunded liabilities. Under reporting requirements of the Securities and Exchange Commission, the companies are supposed to file their annual reports, which would include fourth-quarter figures, by Monday. However, companies can apply for a one-time, 15-day extension, says an SEC spokesman.

A PG&E spokesman says the company plans to apply for an extension and that it has postponed its annual meeting to May 16 from mid-April. An Edison spokesman says that his company would announce on Monday whether it plans to seek an extension for reporting results.

If reactions to the rate-rise decision are an indication, PG&E might be deeper in the woods than Edison, parent of Southern California Edison Co., the other main California investor-owned utility. Bruce Foster, an Edison vice president, says that while his company has some problems with the PUC actions, they were a "good first start towards getting the financial health of the utilities back in order."

Edison, based in Rosemead, Calif., seems to have a clearer exit strategy from its current financial mess than does its bigger fellow utility to the north. Last month, Edison reached an agreement in principle under which the state would buy its electricity-transmission system for $2.76 billion. Completing this transaction could give Edison a big cash influx to use for paying down its past debts.

PG&E has also been talking with the state about selling its transmission system. But the San Francisco-based company has been publicly much more negative about the idea than Edison. Besides the stated desire by PG&E officials to keep what long has been viewed as an integral part of operations, the company might also worry that it wouldn't realize enough from such a sale to make a serious dent in its piled-up bills, which currently stand at $6.3 billion. For one thing, PG&E's retail rates have been lower than Edison's, leaving it with a correspondingly bigger tab.

PG&E "has a much bigger program of things it needs to take care of" than Edison, says Ed Schuller, director of equity strategy at Sutro. However, some analysts argue that PG&E, overall, has a stronger asset base than Edison from which to operate, a strength that could give it more flexibility in the long run.

California officials could provide PG&E and Edison with new headaches in the weeks ahead. The PUC is in the midst of examining the holding-company structure under which the parent firms and their utility subsidiaries operate. State political leaders and others have raised questions about whether some of the billions of dollars that have gone from the utilities to the parent companies in recent years should be returned. PG&E and Edison officials say the transfers were perfectly proper and used for dividend and tax payments, among other things.

However, analysts say, most of the companies' current stock-market value rests with their nonutility subsidiaries, which are engaged in such activities as operating power plants outside of California. Any attempt by state officials "to grab value out of" the nonutility units "is a problem" for investors, says Merrill Lynch's Mr. Fleishman.

Write to John R. Emshwiller at john.emshwiller@wsj.com

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-- Martin Thompson (mthom1927@aol.com), March 31, 2001