The Proposed Settlement Agreement (PSA) between PG&E (hereafter generally referred to as PG&E), PG&E Corp. (hereafter referred to as Corp.) and our staff offers the promise of allowing PG&E to emerge quickly from bankruptcy protection in a proceeding now pending in the United States Bankruptcy Court for the Northern District of California as a financially strong utility subject to the directives in California laws and the continuing jurisdiction of this Commission. The timely resolution of PG&E's financial difficulties and the PSA come before this Commission pursuant to a background of unprecedented developments, and our careful consideration of their related consequences is of utmost importance to the ratepayers of PG&E and the citizens of California.
We intend to resolve the bankruptcy in full partnership with PG&E and to resume a mutually supportive relationship between the regulatory bodies of California and the utility management of PG&E for the benefit of Northern California residents and businesses, and investors in PG&E's utility businesses. This relationship must be based on openness and transparency of financial and operational dealings in order to insure their integrity, a commitment to prudent management of assets and resources entrusted to the utility, and an appreciation for the importance of sound earnings and credit for both the long and the short run. At the very outset we must also recognize the extremely heavy burden now being borne by ratepayers in Northern California, and take steps to reduce that burden, over both the short and the long term. PG&E must fully embrace our regulatory authority, as we have fully embraced painful measures, including high rates and approval of the MSA, in order to rehabilitate PG&E. We must and will move forward together.
To delve yet again into the facts and forces that led to the dysfunctional wholesale electricity market in California during the period from mid-2000 to early 2001 serves no purpose here. A succinct and readable summary of the market behaviors, and responsive actions taken by the California Legislature, as well as State and federal regulators, is contained in the recent opinion of the California Supreme Court in Southern California Edison Co. v. Peevey (2003) 31 Cal. 4th 781. A more comprehensive picture is contained in the March 3, 2003 and March 20, 2003 filings of the California Parties in the Refund proceedings before FERC.1 As noted in that opinion, this Commission deemed the energy crisis one that involved not only utility solvency but the very reliability of the State's electrical system.2 This Commission took unprecedented steps to increase retail electric rates twice in three months - once on January 4, 2001 and again on March 27, 2001 - in an amount that represented 4 cents per kilowatt hour on average, over $8 billion annually for the retail customers of the investor-owned utilities. By that time, PG&E and SCE had already been stripped of their cash and credit and were dependent on the State of California for supply of a significant portion of the electric energy needed to meet their retail loads, pursuant to state legislation.
A. Background - PG&E Bankruptcy
PG&E and SCE responded differently to the financial difficulties they faced. PG&E filed for Chapter 11 bankruptcy protection on April 6, 2001, shortly after the second of the two retail rate increases and before the enhanced cash flows from those rates could be applied to ease its financial situation. The bankruptcy filing constituted an event of default on PG&E's senior securities, which compounded the severity of its problems.3
Numerous creditors and other parties, including the Commission, appeared (in the Commission's case, subject to its sovereign immunity rights and defenses under the 11th Amendment of the U.S. Constitution and related principles). PG&E asserted that as a result of the energy crisis beginning in May 2000 and because its retail electric rates were frozen, it was unable to recover approximately $9 billion of electricity procurement costs from its customers, resulting in billions of dollars of defaulted debt and the downgrading of its credit ratings by all of the major credit rating agencies. PG&E's decision to seek Bankruptcy Court protection came in the wake of its earlier decision to sue this Commission in federal district court to recover these costs under a "filed rate doctrine" theory See PG&E v. Lynch, No. C-01-3023-VRW, N.D. Cal. (the "Rate Recovery Litigation"). On behalf of the customers of the two utilities the Commission vigorously defended this action- and a similar lawsuit filed by SCE. The costs and complexities of this litigation were tremendous. The outcome was uncertain.
1. PG&E Plan of Reorganization
On September 20, 2001, PG&E and Corp., as co-proponents, filed a plan of reorganization (PG&E Plan) in PG&E's bankruptcy case. The PG&E Plan provided for the disaggregation of PG&E's businesses into four companies, three of which would have been regulated by the Federal Energy Regulatory Commission (FERC). The Commission and others opposed the PG&E Plan. The PG&E Plan was amended and modified a number of times.
It was an exceedingly bold proposal that went far beyond the traditional and usual purpose of resolving creditor claims and returning the utility to financial viability. As noted in the Commission staff's opening brief, PG&E's proposed plan of reorganization was expansive in the extreme, and threatened its ratepayers in three ways. First, it would have disaggregated the utility and would have divested this Commission of authority over significant aspects of PG&E's operations. Second, it had potentially disastrous environmental consequences. Finally, it would have locked in, for twelve years, power purchase costs that would have resulted in high retail rates, and then would have left PG&E's power purchase costs to the markets that were largely responsible for PG&E's financial predicament in the first place.
The Commission's formal response to PG&E's proposal in the Bankruptcy Court was strong and swift. As Commissioner Lynch noted in her declaration supporting our opposition:
"In its proposed plan, PG&E demands sweeping declaratory and injunctive relief against the Commission. The Commission believes PG&E's purpose is to carry out a frontal assault upon the State of California as a government and regulator, as PG&E seeks to preempt no fewer than 15 core statutes and laws essential to the health and safety of California's citizens." This strategy was referred to as "the regulatory jailbreak".
PG&E's proposed plan of reorganization would have removed its hydroelectric generation facilities, natural gas transmission assets and nuclear facilities from state regulatory control through a court-approved corporate reorganization, carried out in despite of state regulatory law and procedure. It was based on a broad view of the bankruptcy court's power to pre-empt state law, a view vigorously opposed by the Commission. PG&E's proposal raised the potential that the Commission would be unable to ensure the provision of basic service in case of an energy supply or capacity crisis; the potential that the pricing of service for captive customers would undermine the availability of affordable service for California citizens and necessitate the widespread use of alternative fuels, thereby creating adverse impacts on the environment; and adverse effects to the safety and welfare of California residents through the loss of local regulation.
The Commission opposed PG&E's plan as violative of state law, and unauthorized by federal law. As a result, the Commission argued, it was neither confirmable nor feasible.
The Commission's positions have been largely vindicated by events. The Ninth Circuit Court of Appeals has firmly rejected the sweeping approach to express pre-emption of state regulatory laws on which PG&E's disaggregation proposal depended, and created new legal uncertainties. Pacific Gas and Electric Company v. People of the State of California, Nos. 02-16990 and 02-80113, issued November 19, 2003.
On July 8, 2003, Corp.'s unregulated subsidiary PG&E National Energy Group (NEG) filed for bankruptcy in a Maryland federal court. In connection with that filing Corp. has abandoned its investment and its ownership rights in NEG, which makes the proposed reorganization plan for PG&E potentially infeasible. After these events, the PG&E Proposed Plan could not be the basis for rehabilitating PG&E as a debtor in bankruptcy under any set of circumstances, as the Commission has long contended. These events provide the context and backdrop for our approval of the MSA as an effective method of rehabilitating PG&E as a sound, fully regulated utility in cooperation with the utility's management.
2. Joint Plan (CPUC and Official Committee of Unsecured Creditors)
In response to the PG&E Proposed Plan, on April 15, 2002 the Commission authorized the filing of its original plan of reorganization for PG&E (Original CPUC Plan). It was crafted to permit PG&E to emerge from bankruptcy by repaying creditor claims in full while avoiding the negative consequences of the PG&E plan. Among other things, the Original CPUC Plan would have raised funds to pay PG&E's creditors through "headroom" revenues4 and the issuance of new debt and equity securities, while at the same time maintaining PG&E as a vertically integrated utility subject to regulation by the Commission. Subsequently, the Commission and the Official Creditors Committee (OCC) filed an amended plan of reorganization for PG&E, dated August 30, 2002 (as amended, Joint Amended Plan) (supplemented by a "Reorganization Agreement" to be entered into by the Commission and PG&E).
The Joint Amended Plan created a regulatory asset of 1.75 billion dollars which -- when added to the significant profits provided by high retail rates through the end of 2002 (both authorized earnings and headroom) - raised sufficient funds to pay PG&E's allowed claims after reinstatement of mortgage debt.
The Joint Amended Plan was opposed by PG&E- and thus the battle over the business structure of a PG&E yet to be restored to financial viability was launched on a second major front, with legions of lawyers and financial experts poised to do battle before the Bankruptcy Court to prove the relative merits and flaws of the two competing plans. Lengthy and contentious trials proceeded on the plans.
Bankruptcy Court confirmation hearings on the competing plans of reorganization started on November 18, 2002. On November 21, 2002, during the trial on the Joint Amended Plan, PG&E made a motion for judgment against the Joint Amended Plan, on the grounds, inter alia, that the Reorganization Agreement proposed by the Commission would violate California law because it would bind future Commissions in a manner allegedly contrary to the Public Utilities Code and decisions and regulations of the Commission. On November 25, 2002, the Bankruptcy Court denied PG&E's motion, finding that the Commission did have the authority to enter into the Reorganization Agreement and to be bound by it under California and federal law. (Ex. 122, CPUC Staff/Clanon, Exhibit C.)
It was against this backdrop that the Bankruptcy Court ordered the initiation of a judicially supervised settlement conference between PG&E and the Commission staff in March of this year. On March 11, 2003, the Bankruptcy Court entered an order staying further confirmation and related proceedings to facilitate a mandatory settlement process. Pursuant to orders by the bankruptcy judge, parties to the settlement discussions are prohibited from disclosing information regarding or relating to the settlement discussions.5, On June 19, 2003, PG&E and the Commission staff announced agreement on a Proposed Settlement Agreement which would form the basis of a new plan of reorganization to be filed by PG&E in the Bankruptcy Court that embodies the terms and conditions contained in the PSA (the Settlement Plan).6 PG&E, Corp. and the OCC as co-proponents filed the Settlement Plan and disclosure statement for the plan with the Bankruptcy Court. The PSA constitutes an integral part of the Settlement Plan and is incorporated in the plan by reference. The Commission is not a proponent of the Settlement Plan, although the Plan is premised on approval of the PSA by the Commission as a condition precedent. The Bankruptcy Court has stayed all proceedings related to the Commission's Joint Amended Plan and the PG&E Plan, until a confirmation hearing on the Settlement Plan.
B. Background - The SCE Settlement and High Rates
We do not undertake our consideration of the PSA in a void. In conducting their settlement negotiations, our staff and PG&E were aware of the settlement we entered into with SCE to restore that utility's financial viability and end its litigation against the Commission, as well as the Joint Amended Plan. The success of the SCE settlement has been demonstrated by the fact that Edison has repaid its energy crisis debt, lowered its rates by 13 % and received favorable ratings action (upgrade to investment grade) from Fitch, Moody's and Stanadard and Poor (S&P).
Under the terms of the SCE settlement, the Commission committed to keeping in effect the elevated rates approved in January and March 2001 until SCE's energy crisis-related debts were paid, or the end of 2004. SCE committed to applying all cash above cost of service (operating expenses and after tax return on rate base) to payment of its debts, which were collected in the Procurement Related Obligations Account (PROACT). The settlement placed significant limits on SCE's approved capital spending and suspended common and preferred dividends until the PROACT was paid. The settlement made no other changes to SCE's corporate or capital structure. SCE paid off the PROACT in July 2003 (after 21 months) and has received investment grade credit ratings from all rating agencies.
The SCE settlement was entered into as a settlement of federal court litigation between SCE and the Commission; the authority of the Commission to enter into the settlement under state law was confirmed by the California Supreme Court on August 26, 2003,7 following approval of the settlement under federal law by the 9th Circuit in November 2002. 8
The basic structure of the SCE settlement is the benchmark against which we evaluate the PSA and the basis for the modifications to the PSA which we approve today. The SCE settlement applied a rigorous cost of service metholodology to SCE's operations and utilized all of the revenue generated by rates in excess of cost of service to pay SCE's energy crisis-related debts and restore its credit. Through a mutual regime of economic and financial dicipline on the part of Edison and an unswerving commitment to maintain rates at the level needed to pay off SCE debt, the Commission and Edison cooperatively restored SCE's credit and financial metrics in less than two years. This included financing SCE capital program through revenues from current rates without resort to the capital markets and provided sufficient earnings to enable SCE to significantly exceed the targeted equity ratio for cost of service ratemaking. At the end of July 2003, SCE reduced its rates by an average 13% across its entire system and will reduce them further as it recovers refunds from merchant generators and other malefactors.
By resorting to bankruptcy, PG&E has erected additional obstacles to restoration of its credit over and above those faced by SCE. Nevertheless, PG&E has managed to finance its entire capital program and to retire more than a billion dollars in mortgage debt while amassing a significant cash reserve, as it defrayed a half billion dollars in litigation cost and operated its business on an ongoing basis as a debtor in possession without significant interruption or stress. The high rates approved by the Commission in March 2001 have done their job for both SCE and PG&E.
PG&E has had the benefit of the same high rates as SCE. ORA contends that maintaining rates at current levels and accurately accounting for cash and headroom already collected, PG&E can achieve the same result as Edison - payment of its energy crisis related debt and emergence from bankruptcy without significant resort to new financing - within 12 to 18 months. CLECA supports this approach, adding that its members would be willing to endure extra months of current rates if at the end of the period it could receive rate reductions on the same scale as Edison.
Despite the attractiveness of this approach, we consider that there is real value in enabling PG&E to emerge from bankruptcy as soon as possible and restoring stability and normalcy to our regulatory relations. The question now is how to bring PG&E along the final steps to emerge from bankruptcy, restore its credit and reduce its rates as soon as possible. In approving the MSA, we recognize that we will have to do more for PG&E, and that PG&E will have to do more for the people of California.
C. Background - Basic Concerns
In reaching our decision approving the MSA, we are informed by a complete record developed by the efforts of a number of parties during eight days of hearing in this proceeding. These parties directed their showings to the overall issue to whether the PSA is fair, just and reasonable, and in the public interest. In assessing these presentations, we pay particular attention to the following goals that have been at the heart of our opposition to PG&E's plan of reorganization:
1. Does the settlement result in PG&E abandoning its effort to evade adherence to state laws and our jurisdiction?
2. Does the settlement resolve energy crisis-related litigation between PG&E and the CPUC?
3. Does the settlement result in a return to cost-of-service ratemaking and lower rates for PG&E's ratepayers?
4. Does the settlement result in PG&E's creditors being paid in full and restoration of PG&E's credit as investment grade ?
The PSA as modified to become the MSA provides satisfactory answers to each of these questions.