BILL ANALYSIS SB 429 Page A Date of Hearing: July 7, 2003 ASSEMBLY COMMITTEE ON UTILITIES AND COMMERCE Sarah Reyes, Chair SB 429 (Morrow) - As Amended: April 30, 2003 SENATE VOTE : 27-3 SUBJECT : Public Utilities: acquisition or control. SUMMARY : Requires holding companies to assure the financial health of subsidiary public utilities and specifically grants the Public Utilities Commission (PUC) jurisdiction to enforce these provision against holding companies. Specifically, this bill : 1)Authorizes PUC to enforce any condition agreed to by a public utility as part of an application to merge, acquire, or control any public utility or an application to issue stocks and stock certificates, or other evidence of interest or ownership, or bonds, notes, or other evidence of indebtedness. 2)States that PUC's power to enforce this provision applies to the public utility and to any corporation holding a controlling interest in the utility. 3)Requires that a corporation holding a controlling interest in an electrical or gas corporation, must: a) Give first priority to the capital requirements of the utility necessary to meet the utility's obligation to serve. b) Infuse sufficient capital into the utility to enable the utility to perform its obligation to serve. c) Maintain a balanced capital structure in the utility and may not transfer retained earnings to the controlling interest when doing so would decrease the utility's net equity. 4)Requires that the divided policy of a electric corporation or gas corporation controlled by a parent company must be set by the public utility's board of directors as if the utility was a stand alone company. SB 429 Page B EXISTING LAW : 1)Requires approval from PUC before a corporation may merge, acquire, or control a public utility doing business in California. 2)Requires a public utility to obtain PUC approval prior to issuing stock or debt payable over a term longer than one year. 3)Prohibits a public utility from selling, leasing, assigning, or mortgaging any property necessary or useful in the performance of its duties to the public without prior approval from PUC. FISCAL EFFECT : Unknown. COMMENTS : Existing law requires PUC to authorize the formation of a utility holding company if the holding company will control a public utility doing business in California. In the late 1980's and early 1990's, all three investor owned utilities (IOU's) in California sought and obtained authorization of PUC to establish holding companies. In authorizing the creation of the holding companies, PUC imposed conditions that: 1)Each holding company give "first priority" to the capital requirement necessary to meet the public utility's obligation to serve. 2)Each utility maintain a balanced capital structure in the utility and may not transfer retained earnings to the controlling interest when doing so would decrease the utility's net equity. 3)The divided policy of a electric corporation or gas corporation controlled by a parent company must be set by the public utility's board of directors as if the utility was a stand alone company. <1> All the provision were based on an overriding requirement that --------------------------- <1> See PUC Decisions D.88-01-063 (SCE), D.96-11-017 (PG&E) and D98-03-073 (SDG&E/Sempra). SB 429 Page C the creation of a holding company result in "rate payer indifference" -- a ratepayer should not be placed in a better or worse position as a result of the creation of the holding company. These conditions reflect concern by PUC 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. This measure codifies these provision plus an addition explicit requirement that the holding company infuse capital into the utility as need by the utility to meet its obligation to serve. What is a holding Company? A holding a company is corporation that is formed for the expressed purpose of controlling other corporations by ownership of a majority of their voting stock shares. In the case of the three IOU's in California and their respective holding companies, the holding companies own 100% of the common stock of the utility. Investors can only buy stock in the holding company. All three California holding companies were created to separate both the legal and rate making positions of unregulated enterprises from the regulated public utility. This separation was intended to protect the ratepayers from any risks associated with the new enterprises. In the case of Pacific Gas and Electric (PG&E), the holding company is know as Pacific Gas and Electric Corporation, which owns 100% of the shares in Pacific Gas and Electric Company (the regulated utility), and National Energy Group (a merchant generator and natural gas pipeline company). For Southern California Edison (SCE), the holding company is Edison International, which owns Southern California Edison (the regulated utility), Edison Mission Energy (a merchant generator) and several other unregulated companies. In San Diego, San Diego Gas and Electric (SDG&E) (the regulated utility) is owned by Sempra Energy which also owns Southern California Gas Company (also a regulated utility), Sempra Energy Solutions (an energy service provider), Sempra Energy Resources (a merchant generator), Sempra Energy International (a merchant SB 429 Page D generator and infrastructure provider), Sempra Energy Trading (a commodities trading company), Sempra Communications (a fiber optics company), and Sempra Financial (a financing firm). Cause of the problem During the energy crisis in 2000 and 2001, wholesale electric costs skyrocketed, causing severe financial difficulties for PG&E and SCE as they were forced to cover these costs under a retail rate freeze which was implemented as a part of California's deregulation statutes. IOU's were not able to cover their costs and the state was forced to step in and buy power on their behalf. PG&E filed for Chapter 11 bankruptcy protection, while SCE threatened a bankruptcy filing and pursued a negotiated financial settlement both legislatively and at PUC, where they were eventually successful. While the financial position of the utilities deteriorated, the holding companies' finances remained relatively stable. In 2001, PUC opened an investigation to determine whether transfers of money to the utilities' holding companies and the failure of the holding companies to infuse capital into the public utilities to help the utilities meet their operating capital needs violated PUC conditions in the holding company formation decisions.<2> To date, PUC has made no determination that any utility or holding company violated the first priority condition. However, PUC issued a decision that it may order the holding companies to provide the necessary capital to pay the utility's cost of electricity.<3> The utilities have appealed this decision to the California Court of Appeals. The focus of the appeal is, what is the scope of "capital" required under the first priority decision. PUC argues that first priority condition requires the holding companies to infuse all types of capital into the subsidiary utility, including both equity capital -- capital used to finance investment level projects such as new infrastructure, and operational capital -- money needed to finance ordinary operating expenses. The utilities and their holding companies assert that the "first priority" condition only requires the holding company to give "first priority" to any equity capital needs of their utility --------------------------- <2> I.01-04-002. <3> D.02-01-039. SB 429 Page E subsidiaries before making investments in their non-utility subsidiaries. Operational expenses are to be recovered in rates; the wholesale costs of purchasing and delivering electricity should be covered by retail rates and not by the shareholders. First Priority of what Capital? This bill codifies PUC interpretation of the first priority condition by requiring a holding company to infuse sufficient capital of any type to enable the utility to meet its obligation to serve. Supporters of this bill argue the intent of the first priority language was always to apply to all types of capital. They contend that the broad interoperation is necessary to protect ratepayers by insuring that the holding companies reinforce their utility subsidiaries in bad times. This would be consistent with the principle of ratepayer disinterest in assuring that the holding company cannot be used to shield operational cash from the utility. IOUs argue that the first priority language in the holding company decisions was to apply only to equity capital. The conditions were not intended to apply to operating capital. Operating cost have always been recovered from the ratepayer. If this measure were to be enacted PUC would have the authority to force the holding company to transfer money to the utility even in cases where the instability at the utility was the result of an inadequate rate base. Additionally, while the holding companies are entitled to a return on their investment of equity capital in the utility, there is no provision to allow for shareholders to be paid back any infusion of operational costs or earn any return on use of that capital. Power to Enforce Holding Company Decisions The holding companies have also challenged the authority to the PUC to enforce the first priority conditions. They argue that PUC has no authority over the holding companies since the SB 429 Page F holding companies do not fall into the definition of a public utility. According to the holding companies, the initial holding company decisions constitute contracts between PUC and the holding companies. As a contractual matter, the issue should be litigated in court and not at PUC. This issue is currently being decided by a California Court of Appeals. This bill explicitly grants PUC the power to enforce provision in the holding company agreements against both the utility and the holding company. Under the California Constitution, the Legislature has plenary power to confer additional jurisdiction and authority upon PUC. Under provision in all three holding company agreements PUC imposed and the holding companies agreed to all of the provision incorporated in this bill with the exception of the requirement to infuse operating capital from the holding company to the utility. Presumably since these terms were already agreed to by each of the holding companies they should not be opposed to clarifying PUC power to enforce the provisions agreed to in the holding company decisions. Impacts on investment The holding companies contend that a requirement that they transfer operating capital to the utility will result in a downgrade of their credit ratings and will limit their access to capital markets to make needed infrastructure investments. Investors may be unwilling to loan money to the holding companies if capital held by the holding company, which may have been generated by or intend for use by, unregulated subsidiaries is forever subject to demands by PUC that it be transferred to the utility. Investors will not provide money to a company where there is little assurance of recovering the investment or earning a return on that money. According to a recent Lehman Brothers analysis, this measure "appears to be a short-sighted land grab that will inevitably raise uncertainty and therefore result in higher debt and equity capital costs?" IOUs also fear that these bill would allow PUC to avoid the politically unpopular decision to raise rates when needed to cover increased costs, and instead force the holding company and the shareholders to transfer money to the utility to cover the utilities current revenue needs. SB 429 Page G REGISTERED SUPPORT / OPPOSITION : Support California Public Utilities Commission Office of Ratepayer Advocates (ORA) The Utility Reform Network (TURN) Coalition for California Utility Employees (CUE) Opposition Asian Business Coalition AABE Southern California Chapter Carpinteria Valley Chamber of Commerce City of Lindsay California Black Chamber of Commerce Consumer Coalition of California Coalition for California Utility Employees (CUE) Economic Council of Pass Area Communities Economic Development Corporation serving Tulare County Greater Antelope Valley Economic Alliance Hall & Company Inland Empire Manufacturer's Council Kings County Economic Development Corporation Los Angeles County Federation of Labor, AFL-CIO Ojai Valley Chamber of Commerce & Visitors Center Orange County Taxpayers Association Pacific Gas & Electric Palmdale Chamber of Commerce Ridgecrest Chamber of Commerce Sempra Energy Southern California Edison The Coalition of California Utility Employees (CUE) Tulare Chamber of Commerce Verizon Visalia Chamber of Commerce YMCA of Corona-Norco 2 individuals Analysis Prepared by : Edward Randolph / U. & C. / (916) 319-2083