PG&E's Rate Cap Proposal: Leading the Charge for Re-Regulation, or

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=09"IssueAlert" <IssueAlert@scientech.com<
=0910/10/2000 06:32 AM
=09=09=20
=09=09 To:=20
=09=09 cc:=20
=09=09 Subject: PG&E's Rate Cap Proposal: Leading the Charge for Re-Regulat=
ion, or=20
Protecting Itself from Economic Disaster?

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SCIENTECH IssueAlert, October 10, 2000
PG&E's Rate Cap Proposal: Leading the Charge for Re-Regulation, or Protecti=
ng=20
Itself from Economic Disaster?=20
By: Will McNamara, Director, Electric Industry Analysis
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Pacific Gas & Electric Co. (PG&E), in filings with the California Public=20
Utilities Commission (CPUC) and California Independent System Operator=20
(Cal-ISO), has requested that a rate cap be placed on wholesale purchases=
=20
in the state. The utility is asking the CPUC to lower the current rate=20
cap from $250 per megawatt hour to $100, or 10 cents per kilowatt hour.=20
In seeking the rate cap, PG&E is joined by Edison International, the parent=
=20
company of Southern California Edison, and The Utility Action Network (TURN=
),=20
a ratepayer advocacy group.

ANALYSIS: The current rate cap of $250 per megawatt hour in the wholesale=
=20
market of California resulted from the price spikes experienced in San=20
Diego this summer. As San Diego Gas & Electric had paid off its stranded=20
costs, the retail rate freeze in its area was lifted and SDG&E customers=20
were exposed to market-based prices, which doubled and at times tripled=20
due to increased demand in the state and power supply concerns. PG&E=20
customers=20
were not exposed to the price spikes because, at the time, PG&E had not=20
paid off its own stranded costs and was still under a retail rate freeze.

Yet the company has felt the impact from the price spikes just the same.=20
PG&E buys a great deal of its power on the wholesale market, and as a resul=
t=20
is about $2.2 billion in debt (some figures suggest it is as high as $2.7=
=20
billion). Due to the retail rate freeze still in effect, PG&E has been=20
unable to pass this debt on to customers by raising its rates. In real=20
terms, PG&E was paying up to 19 cents per kilowatt hour on the wholesale=20
market this summer, when by law it was only allowed to charge its customers=
=20
on average 5 cents per kilowatt hour. In total, PG&E has paid about $2.7=20
billion more to suppliers than it can bill customers for, and this amount=
=20
is growing by hundreds of millions each month. This explains the utility's=
=20
motivation in wanting to see the CPUC further lower the cap on wholesale=20
rates in California.

However, even though PG&E as a whole is in debt, the utility=01*as well as=
=20
other divisions under parent company PG&E Corp.=01*is still making money of=
f=20
deregulation in California. For instance, PG&E's Diablo Canyon nuclear=20
plant has been able to capitalize on the high value of power on the wholesa=
le=20
market. The utility confirmed recently that altogether its power facilities=
=01*
the=20
ones left after the utility was forced to divest the bulk of its power=20
assets=01*still provide about $150 million a month to the utility. In addit=
ion,=20
PG&E Corp.'s unregulated energy commodity trading operation has been doing=
=20
very well. And the unregulated National Energy Group=01*which operates in=
=20
markets outside of California, such as Massachusetts, Rhode Island and=20
New Hampshire=01*posted a 233-percent profit increase for the second quarte=
r.=20
Thus, it is important to note the distinction between PG&E and its parent,=
=20
PG&E Corp. Ironically, as a whole, PG&E Corp. has stated that it does not=
=20
support rate caps, and has opposed the issue when it has surfaced in other=
=20
states.

PG&E reported second-quarter earnings of $216 million on $2.3 billion in=20
revenue, representing a 26-percent increase over the same quarter last=20
year. Third quarter earnings also reportedly will be strong. This puts=20
PG&E in an awkward predicament. On one hand, PG&E wants to convince=20
shareholders=20
that the company is doing well and making money from the commodities that=
=20
it sells. On the other hand, PG&E is attempting to convince regulators=20
that it is losing money due to the high wholesale prices that it must pay=
=20
for power. In fairness, though, the revenue PG&E has earned cannot come=20
anywhere near to paying off the massive debt the company has accrued due=20
to its obligation of serving customers.

PG&E's rate freeze is scheduled to end March 31, 2002, at the very latest,=
=20
or sooner if it is determined that PG&E's stranded costs have been repaid,=
=20
something that utility executives say may already have taken place. Due=20
to higher-than-expected revenues and higher-than-market valuations of the=
=20
utility's assets, it may very well be the case that PG&E's stranded costs=
=20
are already paid off. When this is officially determined by the CPUC, PG&E=
=20
will argue that customers should be liable for some or all of the debt=20
it has assumed while the rate caps were in place. The CPUC has scheduled=20
a hearing to address these issues on Oct. 19. The core question of these=20
proceedings will be whether or not PG&E should be allowed to turn over=20
its debt to customers through rate increases once the rate freeze is lifted=
.=20
PG&E wants to be able to retroactively bill customers for its debt, based=
=20
on the date which the CPUC determines that PG&E had in fact paid off its=20
stranded costs, a point groups such as TURN will surely protest.

It may seem surprising that TURN was among the group with PG&E that filed=
=20
the petition to lower the rate cap on wholesale prices. Typically, TURN=20
and PG&E (along with most utilities) are at polar opposites regarding most=
=20
issues. However, both agree that wholesale rates are too high and want=20
to see a new cap put into place, but for completely different reasons.=20
TURN says that PG&E and other utilities took a risk when agreeing to the=20
rate freeze and they should not be allowed to pass debts that resulted=20
from that risk onto customers. TURN continues to retain a watch over the=20
proceedings related to PG&E's proposal, specifically with regard to the=20
possibility that the CPUC will allow the utility to raise rates on customer=
s.

Within the course of these new developments, it's important to be clear=20
on PG&E's motivations. Some California lawmakers and consumer advocates=20
have called for a complete return to regulation, arguing that deregulation=
=20
in California has become a failed experiment. Many have surmised that PG&E'=
s=20
proposal for wholesale caps is essentially a call to return California=20
to a regulated structure. I think this is a misinterpretation. PG&E has=20
very clearly stated that its proposal is a "necessary short-term step to=20
try to bring prices back in line." PG&E's efforts really shouldn't be viewe=
d=20
as a move to return California to a regulated market. Rather, PG&E is merel=
y=20
attempting to protect its own interests. The utility wants to secure=20
temporary=20
lower rates for the power it needs to buy on the wholesale market and=20
transfer=20
its debts to customers once the rate freeze is lifted. A return to regulati=
on=20
via a permanent rate cap would not be in PG&E's best interests as it=20
continues=20
to sell power from its nuclear plant. In addition, PG&E probably recognizes=
=20
that regulation would discourage additional companies from building new=20
power plants in California, which would not be good for the long-term econo=
my=20
of the state. This also would do little to lower wholesale prices in=20
California.=20
As we discovered this summer, the less supply, the higher the price for=20
power.=20

PG&E's proposal to lower rate caps on wholesale prices is, more than anythi=
ng=20
else, an attempt to protect itself from what it perceives as disastrous=20
economic impact if it is not able to transfer its debt to customers. A=20
recent Wall Street Journal report inferred that if wholesale prices continu=
e=20
to exceed what PG&E can charge customers, the utility could become=20
"technically=20
insolvent" sometime next year. It will be interesting to see if the CPUC=20
has the same perception when it evaluates PG&E's proposal later this month.=
=20

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Sincerely,

Will McNamara
Director, Electric Industry Analysis
wmcnamara@scientech.com
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