BILL ANALYSIS 1
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SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE
DEBRA BOWEN, CHAIRWOMAN
SB 429 - Morrow Hearing Date:
April 22, 2003 S
As Introduced: February 20, 2003 FISCAL B
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DESCRIPTION
Current law provides the California Public Utilities Commission
(CPUC) with broad authority to regulate public utilities and to
do everything necessary and convenient in exercising that
authority.
Current law authorizes the CPUC to levy penalties against
utility holding companies when it finds the holding company's
utility subsidiary has made an imprudent payment to, or received
a less than reasonable payment from, the holding company or any
of its affiliates.
This bill requires the capital requirements of the electric or
gas corporation, as determined by the CPUC, to be given first
priority for any holding company approved to have a controlling
interest in an electric or gas corporation
This bill requires the CPUC - when it determines capital is
required to meet the electric or gas corporation's obligation to
serve - to order the holding company to infuse sufficient
capital of any type it deems necessary into the utility.
BACKGROUND
Formation of the Holding Companies
Since the mid-1980's, California's investor-owned energy
utilities (IOUs) have sought to form holding companies for
purposes of diversification. The holding companies become the
sole owner of the utilities and often times use utility profits
to fund other ventures. In its simplest form, for example,
Pacific Gas & Electric (PG&E) Corporation is a holding company
with two separate divisions, PG&E Company and PG&E National
Energy Group. Investors can only buy stock in PG&E Corporation.
The CPUC has to approve all holding company requests before such
a company can be created. The first to apply was the San Diego
Gas and Electric Company (SDG&E) in 1985. SDG&E was concerned
its monopoly position was eroding, and, consequently, it feared
the company was losing its traditional status as a safe
investment. To maintain its ability to attract investors, SDG&E
believed it needed to seek new lines of business outside of its
utility operations. Forming a holding company would facilitate
the integration of non-utility ventures into the corporation by
providing improved access to financing and establishing a clear
separation between utility and non-utility operations. The
company argued this wouldn't adversely effect the public
interest because it would have no effect upon its utility
operations or service to customers.
Formation of the holding company was hotly debated at the CPUC.
The entity now known as the Office of Ratepayer Advocates (ORA)
argued a holding company was not necessary for SDG&E to
diversify, that it could jeopardize future CPUC oversight, that
it would complicate proper regulatory oversight, and that a
holding company would provide no benefits to ratepayers.
Utility Consumer Action Network (UCAN), a San Diego-based
consumer group, argued a holding company would divert company
resources and management from SDG&E's utility operations, which
would inevitably create conflicts of interest between the needs
of the utility and its corporate siblings. In the end, the CPUC
agreed to permit the formation of the holding company, subject
to numerous conditions (see D.86-03-090). Those conditions
included a financial requirement - which is at the heart of this
bill - known as the "first priority" condition:
"The capital requirements of the utility, as
determined to be necessary to meet its obligation to
serve, shall be given first priority by the Board of
Directors of the holding company and SDG&E."
This condition, and others, reflect concern by the CPUC that
diversification through a holding company could have adverse
consequences to utility ratepayers, so the conditions were
designed to ensure the financial health of the utility remains
paramount. SDG&E agreed to this condition, though it ultimately
suspended its pursuit of a holding company because of
disagreements over other conditions the CPUC sought to attach to
the request.
The CPUC's SDG&E holding company decision was the basis for
later holding company decisions for all three major IOUs (see
D88-01-063 for Southern California Edison (SCE), D.95-12-018 for
SDG&E, D.96-11-017 and D.99-04-068 for PG&E). Each of these
decisions contain many conditions virtually identical to those
found in the original SDG&E decision discussed above, including
the first priority condition. The CPUC's concerns about the
financial health of the utility in a holding company structure
has been consistent, as has the holding company's acceptance of
these conditions.
California's Energy Crisis
In late 2000 and early 2001, California's energy crisis was in
full flower. Wholesale electric costs were skyrocketing,
causing the utilities severe financial difficulties as they
labored to cover these costs after agreeing to a retail rate
freeze as a part of California's deregulation statutes.
IOUs weren't able to buy power, causing the state to step in
first with a $400 million emergency appropriation to cover less
than two weeks worth of power purchases, then later with a
directive to require the Department of Water Resources to
temporarily assume power buying responsibilities on behalf of
California's electricity customers. The CPUC raised electric
rates by over 40% to help cover the ongoing cost of power. PG&E
filed for Chapter 11 bankruptcy protection, while SCE threatened
a bankruptcy filing and pursued a negotiated financial
settlement both legislatively and at the CPUC, where they were
eventually successful.
While the financial position of the utilities became precarious,
the utility holding companies managed to stay out of harms way.
Both PG&E Corporation and Edison International, the holding
companies for PG&E and SCE, used a technique known as "ring
fencing" to shield the holding company assets, making them
unavailable to help the utility. In April 2001, the CPUC
initiated an investigation into whether PG&E Corporation, Sempra
Energy, and Edison International complied with the conditions
contained in the decisions which allowed their creation,
including the first priority condition.
The holding companies have objected to the CPUC's investigation,
arguing the CPUC has no jurisdiction over the holding companies
because the holding companies aren't public utilities. They
also contend the term "capital" means equity capital , not
operating capital , which is what the IOUs needed during the
energy crisis. While the holding companies failed to inject
additional operating funds into their utilities during the
energy crisis, there was no failure to provide adequate equity
capital. Hence, the holding companies argue they weren't in
violation of the first priority condition, according to the
holding companies.
In January 2002, the CPUC found there was no basis for limiting
the meaning of capital to equity capital in any of the holding
company decisions. The holding companies challenged this
decision to the Appellate Court in December 2002, but hearings
on the issue have yet to be held.
COMMENTS
1.Questions Before The Court . As noted in the "Background"
section, there are two basic questions before the court right
now. The first is whether a utility holding company is also a
public utility and is therefore subject to regulation by the
CPUC. The second is whether the term "capital" as used in the
first priority condition attached to the formation of each
holding company means all capital , including equity and
operating capital, or just equity capital .
2.Is A Utility Holding Company A Public Utility? The holding
companies argue they are not public utilities. Therefore, they
believe the holding company decision is a contract between
them and the CPUC, and is therefore only enforceable through a
court. While this question will be resolved by the court, the
Public Utilities Code seems clear. PU Code Section 216
defines a "public utility" as any "electrical corporation."
PU Code Section 218 defines an "electrical corporation" as an
corporation owning or controlling any electric plant for
compensation. Because the utility holding companies own 100%
of the stock of their underlying electric utilities - and
therefore own and control the electrical corporation which
owns the electric plant - it's difficult to see how holding
companies couldn't be defined as public utilities.
Further, it would seem odd to statutorily permit the CPUC to
authorize the creation of an entity (such as a holding
company) that it would then have absolutely no regulatory
authority over. If indeed the courts find this to be the
case, the author and committee may wish to consider barring
the CPUC from allowing the creation of any holding companies.
3.Codifying A Current Requirement - And More . This bill
codifies the first priority condition as established by the
CPUC's decisions approving the formation of the holding
companies and adds to it a requirement that the CPUC order the
holding company to infuse capital into the IOU if the CPUC
finds the IOU needs the capital to meet its obligation to
provide service.
The CPUC's holding company decisions impose a number of other
requirements beyond the "first priority" condition covered by
this bill that are designed to ensure the utility always meets
its statutory obligation to serve its customers, including the
following two:
The holding company shall maintain a balanced capital
structure in the utility, as determined to be
reasonable by the Commission in the utility's most
recent general rate case. The utility shall not
permit retained earnings to be transferred to the
holding company where doing so would decrease its net
equity ratio below that last adopted in a general rate
proceeding.
The dividend policy of the utility shall continue to
be set by the utility Board of Directors as though the
utility were a comparable stand-alone utility company.
While the CPUC never invoked these conditions during the 2001
electricity crisis, it's not difficult to imagine that both of
these circumstances may have arisen at one time or another.
The author and committee may wish to consider whether it would
be appropriate to codify these requirements in this bill as
well.
4.What Does It All Mean? It's not clear what practical effect
requiring the CPUC to enforce the first priority condition
would be in today's environment. The threshold question is
whether any of the holding companies are financially capable
of providing capital. Sempra is financially healthy and could
infuse additional capital into SDG&E, but Edison International
and PG&E Corporation are much weaker financially and aren't
currently considered investment-grade credit risks. (PG&E's
National Energy Group, the other major subsidiary of PG&E
Corporation, has itself narrowly avoided bankrupty.)
Another interesting question is whether the additional capital
a holding company would be required to provide to the IOU is
considered an "investment," and therefore subject to repayment
by ratepayers with a return? Or is it considered part of the
operating expense which the utility was at risk for during the
rate freeze period established by the electric restructuring
statutes? Edison International has an agreement with the CPUC
that purports to settle the electric restructuring issues,
which may make the question moot with regard to SCE. The
question as it applies to PG&E Corporation will likely be
answered by the bankruptcy court.
5.Would This Constitute A Taking? It's argued by some that this
bill may be an unconstitutional "taking" by failing to provide
an IOU or a holding company with an opportunity to earn a fair
return on a mandated investment. That concern seems misplaced
because this proposed statute is part of a larger body of
statutes that collectively provide the utility with a fair
opportunity to earn a return on its investment.
6.How Have Holding Companies Performed? The diversification
efforts of the utilities, which led to the creation of the
holding companies, have ironically been largely a disaster for
shareholders. Both Edison International and PG&E Corporation
shares are down around 50% over the past five years, with
major losses stemming from poor returns on investments in
power plants located in other states and countries.
7.Are Holding Companies A Recipe For Conflicting Goals &
Interests? The energy crisis pointed out a number of inherent
conflicts existing inside a holding company - 1) The need to
allocate capital between the utility and its affiliates; 2)
Business strategies which benefit the unregulated affiliates
at the expense of the utility; 3) Diversion of management
attention and resources; and, 4) Potential self-dealing, just
to name a few. It's difficult to see how the existence of
utility holding companies benefited utility ratepayers during
the crisis or how they benefit those same ratepayers today.
8.Technically Speaking. The intent of this bill is to codify
the effect of the CPUC's holding company decisions by
embedding a specific section of the decisions in statute to
make it clear the CPUC has the power to enforce the provisions
of its decisions. However, the author and committee may wish
to consider adding codified intent language to make it clear
that bill simply reflects current regulation.
The first paragraph of the bill (Page 3, Lines 1-6)
specifically references electric and gas holding companies and
articulates the authority of the CPUC to enforce conditions it
places on authorizations awarded pursuant to Public Utilities
Code Section 854. This may inadvertently create an inference
that the CPUC doesn't have authority to enforce holding
company decisions for telecommunications or water utilities,
or that the CPUC doesn't have authority to enforce conditions
placed upon authorizations obtained pursuant to sections other
than 854. The author and committee may wish to consider
clarifying the first section of this bill to ensure it doesn't
inadvertently remove the CPUC's authority to enforce all of
its holding company decisions.
9.Related Legislation. SB 888 (Dunn), which is pending in this
committee, contains provisions that are substantially similar
to this bill. However, SB 888 also contains a number of
provisions and issues that aren't related to the narrow
holding company subject matter addressed by this measure.
POSITIONS
Sponsor:
Author
Support:
None on file
Oppose:
Sempra Energy
Southern California Edison
PG&E
Randy Chinn
SB 429 Analysis
Hearing Date: April 22, 2003