BILL ANALYSIS                                                                                                                                                                                                    



                                                                       


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          |SENATE RULES COMMITTEE            |                  SB 18XX|
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                                 THIRD READING


          Bill No:  SB 18XX
          Author:   Burton (D)
          Amended:  7/19/01
          Vote:     27 - Urgency

           
           SENATE ENERGY, U.&C. COMMITTEE  :  10-0, 7/19/01
          AYES:  Bowen, Alarcon, Battin, Dunn, Murray, Poochigian,  
            Sher, Speier, Vasconcellos, Vincent

           SENATE APPROPRIATIONS COMMITTEE  :  Not available


           SUBJECT  :    Department of Water Resources:  electricity:   
          bond financing order

           SOURCE  :     Author


           DIGEST  :    This bill requires the revenue bond repayment  
          mechanism for electrical power to include a State  
          Department of Water Resources Bond Set-Aside, as specified.

           ANALYSIS  :    Existing law, AB 1X, authorizes the State  
          Department of Water Resources (DWR) to contract with an  
          electrical corporation to transmit or provide for the  
          transmission of, and distribute the power ad provide  
          billing, collection, and other related services, as the  
          agent of DWR, on terms and conditions that reasonably  
          compensate the electrical corporation for its services, and  
          requires the California Public Utilities Commission (PUC),  
          at the request of DWR, to order such actions.  Existing law  
          authorizes DWR to issue revenue bonds for certain purposes  
          not to exceed a certain amount, containing specified terms  
                                                           CONTINUED





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          and conditions, upon authorization by written determination  
          of DWR and with the approval of the Director of the State  
          Department of Finance and the State Treasurer.  Existing  
          law permits DWR to have the PUC issue finance orders to  
          recover revenue requirements, and delegates to DWR the  
          authority to determine if the revenue requirements are just  
          and reasonable.  Existing law requires DWR, before the  
          issuance of bonds, to establish a mechanism to ensure that  
          the bonds will be sold at investment grade ratings and  
          repaid on a timely basis from pledged revenues.  Certain of  
          these provisions enacted by Senate Bill 31 of the 2001-02  
          First Extraordinary Session become effective on August 13,  
          2001.

          There were three reasons for allowing this.  First, this  
          provision was created when the state had to assume the  
          utilities' power procurement role.  At the time the state  
          had to issue bonds to finance costly wholesale purchases.   
          Without an agreement to pass the costs without thorough PUC  
          review, lenders would not finance those purchases.  Second,  
          a utility is a for-profit entity which, without PUC review,  
          would be an unregulated monopoly with no incentive to keep  
          costs down.  In contrast, DWR is a non-profit entity which  
          would have no reason to increase costs.  Third, as a  
          non-profit entity, DWR has an elected boss (the Governor)  
          who could be held accountable for DWR's performance, just  
          as any municipal utility.

          In order to complete the financing of the DWR costs,  
          lenders are requiring a rate agreement with the PUC.  The  
          rate agreement contains provisions requiring the PUC to  
          pass through the costs of DWR's power purchase contracts  
          without review and in an expedited manner.  The agreement  
          also contains provisions for passing through costs of  
          specified demand management programs (i.e., the 20/20  
          program), as well as expenses for legal, consulting, and  
          technical review.

          This bill requires the bond repayment mechanism to include  
          a DWR Bond Set-Aside, as defined fixed by an irrevocable  
          PUC bond financing order, sufficient to pay the costs of  
          issuing, servicing, and retiring the bonds, and to be  
          adjusted as required, applicable to all electric power  
          delivered in this state by an electrical corporation  







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          subject to the jurisdiction of the PUC.  This bill requires  
          the total of DWR Bond Set-Asides to be designated as a  
          separate rate component of a retail and user's bill for  
          electrical services and requires any DWR Bond Set-Aside to  
          consist of and be derived from a portion of the rate levels  
          in effect on August 31, 2001.  The bill establishes the DWR  
          Bond Repayment Fund, to be continuously appropriated to DWR  
          and available for the purpose of the payment of principal,  
          premium, if any, and interest on bonds and associated  
          issuance costs, thereby making an appropriation.  The bill  
          requires the revenues form the DWR Bond Set-Aside to be  
          deposited in the DWR Bond Repayment Fund.

          Existing law requires DWR to establish and revise certain  
          revenue requirements relating to the purchase and sale of  
          electric power and to advise the PUC as DWR determines to  
          be appropriate.

          This bill defines the term "revenue requirements."  The  
          bill entitles the PUC to any information necessary to  
          review the revenue requirements of DWR and requires the PUC  
          to conduct at least one public hearing and provide an  
          opportunity for public comment on the revenue requirements  
          prior to their adoption.

          This bill revises certain of the provisions enacted by SB  
          31 of the 2001-02 First Extraordinary Session and makes  
          other conforming changes.

          The bill defines "administrative costs" to mean those  
          reasonable expenses, including any consulting, legal,  
          technical, or engineering services, incurred by DWR in  
          administering the law.  The administrative costs of DWR  
          incurred in administering this law may only be paid for  
          from appropriations by the Legislature.  DWR may not incur  
          administrative costs in excess of those appropriations.

          The bill defines "DWR Bond Set-Aside" means a rate to  
          recover a separate dedicated revenue stream fixed by a PUC  
          bond financing order.  The total of all DWR Bond Set-Asides  
          shall be designated as a separate rate component of a  
          retail end-user's bill for electrical services.

          This bill defines "revenue requirements" to  mean only the  







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          revenue necessary to pay the actual costs for any of the  
          following:

          1.Purchasing power.

          2.Contracting for the purchase of power.

          3.Administrative costs.

          4.Purchasing natural gas as required pursuant to a contract  
            for the purchase of power.

          5.Using transmission or distribution facilities prior to  
            the delivery or utilization of purchased power, including  
            scheduling and other related expenses.

          6.Amounts to enable DWR to comply with Section 80134.

          Makes certain load management or reduction program  
          expenditures authorized and receivable.

          This bill specifies that "revenue requirements" does not  
          include costs incurred under conservation, load management,  
          or other programs implemented by the PUC, DWR, or any other  
          entity.

          This bill is an effort to develop alternative to the rate  
          agreement and to lower the cost of borrowing for  
          ratepayers.  Instead of a rate agreement, this bill crates  
          a dedicated payment stream for the bonds, known as the  
          Set-Aside.  The Set-Aside provides better security to  
          bondholders which should reduce the cost of the bonds and,  
          therefore, the cost to ratepayers.  However, because DWR's  
          contracts are also secured by the bonds, a bond only  
          surcharge arguably makes the contracts less secure.  This  
          could lead to contractor claims of contract impairment  
          which, in turn, could lead to damages against the state.   
          Such claims could cast some uncertainty on the bonds,  
          potentially jeopardizing their issuance.

          The Senate Energy, Utilities and Communications Committee  
          analysis made the following comments:

           Rate Agreement  .  One of the primary benefits of a  







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          bonds-only surcharge is the avoidance of a rate agreement.   
          While AB 1X provides that any reasonableness review of  
          DWR's contracts will be performed by DWR, the statute does  
          not authorize DWR to engage in demand management programs  
          and requires administrative costs to be reviewed as part of  
          the budget.  However, if the rate agreement is approved,  
          there will be no legislative or PUC oversight of any of  
          those costs, nor any opportunity for public comment for as  
          long as bonds are outstanding.  If a rate agreement can be  
          avoided, there will be opportunities to review and alter  
          the various demand management and administrative costs  
          contained in the agreement.  In either event, the power  
          contract costs remain an obligation of DWR and may not be  
          altered except by mutual consent of DWR and the contractor.

           Direct Access  .  This bill indirectly preserves the  
          opportunity to discuss the potential for direct access.  As  
          part of the $13.4 billion bond issuance, the lenders have  
          required that direct access be ended.  The reason for this  
          is that contract payments have a priority over bond  
          payments.  If customers leave the utility to pruchase  
          electricity elsewhere, then DWR will sell fewer kwhs which  
          will raise DWR's unit costs, which will then require higher  
          rates for DWR poer.  This bill make alternative electric  
          suppliers more attractive, leading to more customer losses  
          and even higher rates.  This death spiral of rate increases  
          jeopardizes the viability of DWR's entire power procurement  
          program and hence the security of repayment of the bonds.   
          To protect against this circumstance lenders have demanded  
          that direct access be ended, as the PUC is permitted to do  
          under AB 1X.

          If, instead of the rate agreement, the bonds have a  
          separate, non-bypassable Set Aside, as envisioned in this  
          bill, the lenders have no need to end direct access because  
          the Set Aside is non-bypassable.  Therefore, direct access  
          customers will remain obligated for the bond payments.   
          However, the question of who pays for the DWR contract  
          costs remains.  The PUC can simply end direct access,  
          and/or the Legislature can establish appropriate rules.   
          Either way direct access remains open for discussion under  
          this bill.

           Contract Impairment  .  The major concern over this bill is  







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          whether it impairs DWR's contracts.  The impairment  
          argument results from a provision contained in most, if not  
          all, of the contracts which says the following:

            "Payments under this Agreement shall constitute an  
            operating expense of the (Electric Power) Fund payable  
            prior to all bonds, notes or other indebtedness secured  
            by a pledge or assignment of the Trust Estate or  
            payments to the generaly fund."

          The effect of this section is to make contract payments a  
          priority over bond repayment.  This bill does not violate  
          this provision because the bond repayments are not made  
          from the Electric Power Fund but rather from a new fund  
          called the DWR Bond Repayment Fund.  Because this fund,  
          rather than the Electric Power Fund, pays the bond costs  
          the agreement is arguably not violated.  Further, the  
          proceeds of the bond sale are deposited in the Electric  
          Power Fund, providing cash to ensure the contracts can be  
          repaid.

          Other argue that this bill creates at least a reasonable  
          argument that the power purchase contracts are impaired  
          because the contractors believed that their payments were  
          secure since they had a priority over the bonds, on which  
          the state would never default.  By only securing the bonds  
          through a dedicated surcharge (Set Aside) their security is  
          lost and the contracts are therefore impaired.  This would  
          lead to litigation, or arbitration as specified in the  
          contracts, which could result in significant damages.   
          Either way the sale of the bonds could be impaired,  
          jeopardizing repayment of the General Fund.

          Though the impairment argument may be legitimate, no  
          impairment could occur unless this bill becomes law.

           Contract Renegotiation  .  Some commenters have urged that  
          the DWR renegotiate its contracts as they are relatively  
          expensive compared to current market prices.  Whether this  
          bill helps or hurts any renegotiation effort is a matter of  
          judgement.  Some argue that the threat of this bill will  
          encourage the contractees to renegotiate while others argue  
          that this bill poisons the atmosphere making renegotiation  
          difficult.







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           FISCAL EFFECT  :    Appropriation:  Yes   Fiscal Com.:  Yes    
          Local:  Yes

          DLW:cm  7/19/01   Senate Floor Analyses 

                       SUPPORT/OPPOSITION:  NONE RECEIVED

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