Analyst: California crisis points up regulatory risk

While many aspects of the California situation are unique, an investment analyst with New York's Lehman Brothers said it points up the risk of investing in utilities with uncovered electricity short positions, regardless of the current regulatory compact. Electricity is a highly volatile commodity than can 'ravage a company's balance sheet and bring previously strong companies to bankruptcy in short periods of time,' said Daniel Ford, in notes on the crisis.

Mar 14th, 2001


By the OGJ Online Staff

HOUSTON, Mar. 14�While many aspects of the California situation are unique, an investment analyst with New York's Lehman Brothers said it points up the risk of investing in utilities with uncovered electricity short positions, regardless of the current regulatory compact.

Electricity is a highly volatile commodity than can "ravage a company's balance sheet and bring previously strong companies to bankruptcy in short periods of time," said Daniel Ford, in notes on the crisis. "Regulation is driven by politics and political winds can shift quickly." He predicted New York and New England are the most likely regions of the country to next experience supply problems accompanied by potential financial distress.

As the California electricity crisis drags on, commercial paper holders and owners of small electricity plants pose the biggest threat to forcing the financially ailing Southern California Edison Co. (SCE) and Pacific Gas & Electric into Chapter 11 bankruptcy proceedings, Ford suggested.

He said various creditors have gone without payment for months by the two utilities and patience is growing thin. Some owners of so-called qualifying facilities (QF) already have sued SCE outside California. In a Tuesday conference call, SCE executives said they were continuing to negotiate to extend forbearance agreements with their banks which expire Wednesday and are taking the QF lawsuits very seriously.

The 1978 Public Utility Regulatory Policies Act provided incentives for construction of cogeneration plants�or qualifying facilities�through long-term power purchase agreements between generators and utilities. The price per megawatt paid to these facilities is linked to SCE's avoided cost of energy, and is not based on the spot market.

An additional wildcard was introduced Friday after the California Power Exchange (PX) filed for Chapter 11 reorganization under the US Bankruptcy Code, Ford said. Since the PX served as an electricity clearinghouse for the utilities and suppliers, the Chapter 11 filing could accelerate a bankruptcy filing on the utilities.

Given the complexity of the situation and the state government's unimpressive track record so far, Ford said, it is likely the process will drag on until summer. Up to now, the crisis "has escaped a comprehensive solution numerous times," he said.

"Unfortunately, California has not followed the logical path of raising rates to reflect rising commodity prices. A lack of economically pragmatic politicians and California's successful history of ballot initiatives appear to be the primary forces behind the failure to raise retail rates to reflect wholesale cost."

Nonetheless, Ford said, despite the politically charged atmosphere, rates will likely rise. He also predicted restructuring of QF contracts by the legislature will result in prices averaging $80-%85/Mw-hr for energy and capacity.

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