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