BILL ANALYSIS 1 1 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 4 2 9 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