The MSA which we approve today follows for the most part the provisions of the PSA. Specifically, we approve:
· a commitment to achieving and maintaining investment credit for the utility in accordance with rating agency metrics
· the use of headroom properly computed through year end 2003 to pay PG&E debts;
· the creation of a regulatory asset as an additional ratepayer contribution to PG&E rehabilitation;
· ratebase treatment for the regulatory asset, including an equity return;
· payment by ratepayers of 60 % of PG&E's legitimate claims;
· a federal court settlement that binds the Commission for the duration of regulatory asset amortization.
We modify the PSA in the following ways:
· reduce the size of the regulatory asset and shorten the amortization period (and the period of federal court supervision)
· eliminate ratepayer contribution of PG&E and Corp. litigation expenses related to the bankruptcy
· like the PD and the Peevey Alternate 2 we eliminate Paragraph 6 relating to PG&E dividends, and we place additional restrictions on the holding company.
· Like the Peevey Alternate 2 we the approve the Environmental Stipulation and augment it with the urban environmental component.
The MSA meets all of the quantitative credit metrics applied by the rating agencies to achieve investment grade credit for PG&E the utility. In addition, "right sizing" the regulatory asset will limit the extent and duration of federal court intrusion on state regulation and will provide meaningful relief to ratepayers sooner.
D. Structure of the Settlement Plan of Reorganization
PG&E's original plan of reorganization in the Bankruptcy Court provided for the disaggregation of PG&E's historic businesses into four separate companies, three of which would be under the regulatory jurisdiction of FERC rather than this Commission. Under the Settlement Plan, PG&E will remain a vertically integrated utility subject to the plenary regulatory jurisdiction of this Commission.11 The MSA clarifies that the parties expect this to be a permanent condition. The Settlement Plan also calls for recapitalizing PG&E, through the retirement of its First mortgage Bonds as well as energy crisis-related obligations and debts. As a result, it will entail the issuance of an unprecedented amount of new debt to accomplish emergence from bankruptcy.12 Successful issuance of this new debt will require ratings of investment grade in order to access capital markets of sufficient depth., and will generate hundreds of millions of dollars in fees for underwriters and investment advisors.
E. Financial Elements
PG&E asserts that restoration, maintenance, and strengthening of PG&E as an investment grade company is vital for the company's future ability to serve its customers. The PSA expressly recognizes this:
The Commission recognizes that the establishment, maintenance and improvement of investment grade company credit ratings is vital for PG&E to be able to continue to provide safe and reliable service to its customers. The Commission further recognizes that the establishment, maintenance and improvement of PG&E's investment grade company credit ratings directly benefits PG&E's ratepayers by reducing PG&E's immediate and future borrowing costs, which, in turn, will allow PG&E to finance its operations and make capital expenditures on its distribution, transmission, and generation assets at lower cost to its ratepayers. In furtherance of these objectives, the Commission agrees to act to facilitate and maintain investment grade company credit ratings for PG&E. (PSA, ¶ 2g.)
In this regard it is important to reiterate that in the MSA, we are focused on achieving investment grade company credit ratings for PG&E the utility. Owing to the bankruptcy of NEG and the continued adherence to a business strategy that exposes it to risks in the wholesale energy markets, Corp.'s credit may be a drag on our efforts to rehabilitate the utility.
1. Regulatory Asset
The PSA establishes a regulatory asset with a starting value of $2.21 billion as a new, separate, and additional part of PG&E's rate base (PSA, ¶ 2). This is an amount over and above what would be provided by a continuation of elevated rates in the manner of the SCE settlement, and is a significant departure from normal cost of service ratemaking that is necessitated by our objective of facilitating PG&E's emergence from bankruptcy. This is another painful compromise we make on behalf of ratepayers.
Under the PSA the regulatory asset would be amortized on a mortgage-style basis over nine years starting on January 1, 2004 (PSA, ¶ 2a). The mortgage-style amortization is intended to make the revenue requirements associated with the regulatory asset relatively constant over its life rather than being front-end loaded as they would under traditional rate base treatment. Because the regulatory asset will not have any tax basis, both the amortization of the regulatory asset and the return on it will be grossed up for taxes (PSA, ¶ 2c).13 The PSA provides a floor on the authorized return on equity (ROE) and the equity component of the capital structure associated with the regulatory asset (PSA, ¶ 2b). While the regulatory asset will earn the ROE on the equity component of PG&E's capital structure as set in PG&E's annual cost of capital proceedings, the ROE will be no less than 11.22 percent and, once the equity component of PG&E's capital structure reaches 52 percent (expected in 2005), the equity component will be set for ratemaking purposes at not less than 52 percent.
The regulatory asset will be reduced dollar for dollar by the net after-tax amounts of any reductions in bankruptcy claims or refunds PG&E actually receives from generators or other energy suppliers (PSA ¶ 2d).
The MSA recognizes the necessity and propriety of a regulatory asset as the central element of a plan to permit PG&E to emerge from bankruptcy and meet the credit and financial health objectives we have articulated. The MSA differs from the PSA in the size of the regulatory asset and the duration of amortization.
The function of the regulatory asset is to assure that PG&E has sufficient assets to support the capital structure invested in the utility. In traditional cost of service ratemaking, the invested capital of the utility supports its rate base, its plant and equipment used and useful in providing service to the public. In the Settlement Plan, PG&E proposes to refinance its entire company at the time it pays off its allowed claims in bankruptcy. The allowed claims include all of its financial debt including first mortgage bonds and all of its remaining liabilities related to the energy crisis and all other activities taken by the utility.14 Since PG&E has at all times been a solvent debtor, it must make these payments in cash, which it will raise using available cash on hand and the sale of new corporate debt of various maturities. The amount of cash available directly influences the amount of new debt that PG&E must take on in order to pay the allowed claims and therefore the size of the regulatory asset.
As of September 30, 2003, PG&E reported $4.23 billion in cash in the Form 10-Q it filed with the Securities and Exchange Commission. At that time it had remaining only $2.4 billion in remaining first mortgage bonds and approximately $9.3 billion in unsecured debts, characterized as "Liabilities subject to Compromise" in its Form 10-Q.15 PG&E needs to raise not more than $8 billion in new debt in order to have the cash necessary to pay its allowed claims and emerge from bankruptcy, with the exact amount depending on how much of the $4.23 billion is left at the end of the year, assuming prudent management and oversight by the bankruptcy court.16 We should calibrate the regulatory asset at no higher than needed to support new debt, which we estimate to be approximately $1.2 billion. Cash flows would be based on straight line, rather than mortgage style, amortization in order to assure cash flows at levels appropriate to meet the investment credit ratios for the debt issuances during the life of the regulatory asset.
Calibrating the regulatory asset at this level is consistent with the Commission's prior plan of reorganization. The regulatory asset proposed in that document 18 months ago did not take into account additional headroom of at least $875 million that PG&E would receive over and above cost of service during 2003. Additional headroom would reduce the required size of the regulatory asset, not increase it.
A different way of estimating the appropriate size of the regulatory asset involves recalling the disciplined approach to cost of service that we applied to SCE in the Edison settlement. The regulatory asset is an amount that ratepayers contribute above and beyond the earnings which PG&E is entitled to receive through return on ratebase, giving full effect to PG&E's investments in distribution, transmission and retained utility generation (URG). The retained earnings that PG&E has booked reflect full recovery of cost on a cost of service basis for investment in plant in service. The regulatory asset is an additional amount over and above plant in service that supports PG&E's current financial statements.
This increment over and above cost of service can be justified as ratepayer contribution to full financial rehabilitation of PG&E needed to pay its energy crisis-related debts. Another way of saying this is that the regulatory asset represents an additional payment by ratepayers to fully fund PG&E's recovery in its Filed Rate Doctrine Litigation. ORA has estimated amounts that PG&E has yet to recover at no more than $1.4 billion and as little as $700 million. PG&E's estimate, when adjusted for the admissions of PG&E Witness McManus is no more than $2.2 billion. A regulatory asset of $1.2 billion is thus in the appropriate range between the ORA and PG&E estimates.
A regulatory asset of this magnitude is also consistent with the PSA's "compromise" that has ratepayers paying 60 % of PG&E's claims with a combination of headroom and regulatory asset (see below, pp. ).
A smaller regulatory asset can be amortized more quickly. Rapid amortization is a key element in defending the MSA from significant legal infirmities pointed out in the Proposed Decision of Judge Robert Barnett (see below pp. )
The PSA provides that the Utility Retained Generation (URG) rate base established by D.02-04-016 shall be deemed just and reasonable and not subject to modification, adjustment or reduction (other than through normal depreciation) (PSA, ¶ 2f). Similarly, the value of the regulatory asset and URG rate base are not to be impaired by the Commission taking them into account when setting PG&E's other revenue requirements and resulting rates or PG&E's authorized ROE or capital structure. We approve these elements of the PSA.
The proposed settlement acknowledges that the headroom, surcharge, and base revenues accrued or collected by PG&E through the end of 2003 have been or will be used for utility purposes, including paying creditors in PG&E's Chapter 11 case (PSA, ¶ 8a). Those past revenues will no longer be subject to refund. The PSA establishes both a floor and a ceiling on 2003 headroom revenues. PG&E will be authorized to collect at least $775 million, but not more than $875 million (both pretax), of headroom (PSA, ¶ 8b). The Commission will adjust 2004 rates to refund any overcollection or make up any undercollection.
3. Ratemaking Matters
The proposed settlement provides for PG&E's retail electric rates to remain at current levels through 2003, and then be adjusted effective as of January 1, 2004 (PSA, ¶ 3a). As of January 1, 2004, the TCBA and other Assembly Bill 1890 ratemaking accounts will be replaced by the regulatory asset and cost-of-service ratemaking resulting from the proposed settlement (PSA, ¶ 2e).
PG&E's capital structure and authorized ROE will continue to be set in annual cost of capital proceedings, but until PG&E the utility achieves a company credit rating of either A- from Standard & Poor (S&P) or A3 from Moody's, the authorized ROE will be no less than 11.22 percent and the equity ratio will be no less than 52 percent (PSA, ¶ 3.b.). (PG&E claims that this capital structure, with its 52 percent equity ratio, is necessary to support the investment grade credit metrics contemplated by the proposed settlement. (Ex. 112, pp. 7-6, 7-16, PG&E/Murphy.) The MSA retains this aspect of the PSA, with the significant clarification that any drag on PG&E's credit rating resulting from its association with Corp. will result in increasing the separation between PG&E and Corp. including deconsolidation and/or divestiture.
PG&E is given a two-year transition period to achieve the 52 percent equity ratio. Until that time, PG&E's equity ratio for ratemaking purposes will be its Forecast Average Equity Ratio (as defined in the PSA, but no less than 48.6 percent (PSA, ¶ 3.b.).
4. Dividends and Stock Repurchases
Under the PSA, PG&E agrees not to pay any dividend on common stock before July 1, 2004 (PSA, ¶ 3.b.). PG&E has told the financial community that it does not expect to pay a common stock dividend before the second half of 2005. Under the PSA, other than the capital structure and stand-alone dividend conditions contained in the PG&E holding company decisions (D.96-11-017 and D.99-04-068), the Commission agrees not to restrict the ability of the boards of directors of either PG&E or PG&E Corporation to declare and pay dividends or repurchase common stock (PSA, ¶ 6). The MSA treats this issue differently, due to the importance of conservative management in maintaining financial strength and creditworthiness. (See below, pp. )
F. Dismissal of Energy Crisis-Related Disputes
As part of the PSA, PG&E will dismiss its pending Rate Recovery Litigation18 against the Commission (PSA, ¶ 9). In that litigation, PG&E had sought recovery from ratepayers of approximately $9 billion in unrecovered costs of purchasing power during the energy crisis. (Exs. 120 and 120c, PG&E/McManus.) The Commission will resolve Phase 2 of PG&E's pending Annual Transition Cost Proceeding (ATCP) application without any disallowance (PSA, ¶ 9). In the ATCP, ORA contends that PG&E incurred approximately $434 million of unreasonable power procurement costs and recommends disallowance of that amount.
G. Environmental Provisions
The PSA contains environmental benefits. First, PG&E commits to protect its approximately 140,000 acres of watershed lands associated with its hydroelectric system, plus the 655 acre Carizzo Plains in San Luis Obispo County, through conservation easements or fee simple donations (PSA, ¶ 17a). PG&E estimates that lands subject to this commitment are worth approximately $300 million.19 The determination of how best to protect these lands will be made by the board of a new California non-profit corporation (PSA, ¶ 17b). Under the Land Conservation Commitment Stipulation (Ex. 181), this non-profit corporation will be named the Pacific Forest and Watershed Lands Stewardship Council (the Stewardship Council). The Stewardship Council's governing board will consist of representatives from the Commission, the California Resources Agency, ORA, the State Water Resources Control Board, the California Farm Bureau Federation, the California Department of Fish and Game, the California Forestry Association, the California Hydropower Reform Coalition, the Regional Council of Rural Counties, the Central Valley Regional Water Quality Board, Association of California Water Agencies, The Trust for Public Land, and PG&E, and three public members named by the Commission. The U.S. Department of Agriculture-Forest Service and U.S. Department of Interior-Bureau of Land Management will together designate a federal liaison who will participate in an advisory and non-voting capacity. (Ex. 181, paragraph 10a.) The Stewardship Council will be funded with $70 million through rates over 10 years (PSA, ¶ 17c). This funding will cover both administrative expenses and environmental enhancements to the protected lands. The governing board of the Stewardship Council will develop a system-wide plan for donation of fee title or conservation easements.
The second environmental commitment is that PG&E will establish and fund a clean energy technology incubator. This new, California non-profit corporation will be dedicated to supporting research and investment in clean energy technologies primarily in PG&E's service territory (PSA, ¶ 18a). PG&E will provide shareholder funding of $15 million over five years (PSA, ¶ 18b) and will work with the Commission to attract additional funding (PSA, ¶ 18c).
H. Conditions Precedent to Effectiveness of Settlement Plan
Commission approval of the PSA as well as final, nonappealable approval of all rates, tariffs, and agreements necessary to implement the Settlement Plan and PSA are conditions to the effectiveness of the PSA (PSA, ¶ 37) and the Settlement Plan (PSA, ¶ 16b), respectively.
The PSA expressly provides that receipt of investment grade company credit ratings from both S&P and Moody's is a condition to the Settlement Plan becoming effective (PSA, ¶ 16a). The plan provides that this condition cannot be waived. (Ex. 101, pp.1-15, PG&E/Smith.) The MSA preserves this feature, in recognitioin of the fact that PG&E must issue an unprecedented amount of new debt in order to emerge from bankruptcy under the Settlement Plan.
I. Other Provisions
1. Assignability of DWR contracts
The settlement agreement provides that "[I]f the Commission desires it, PG&E agrees to accept assignment of or to assume legal and financial responsibility for the DWR Contracts" subject to certain conditions, including that "(a) PG&E's Company Credit Rating, after giving effect to such assignment or assumption, shall be no less than "A" from S&P and "A2" from Moody's; (b) the Commission shall first have made a finding that, for purposes of assignment or assumption, the DWR Contracts to be assigned or assumed are just and reasonable; and (c) the Commission shall have acted to ensure that PG&E will receive full and timely recovery in its Retail Electric Rates of all costs of such DWR Contracts over their life without further review. (PSA ¶ 7) The PSA has no limitation on the discretion of the Commission to review the prudence of PG&E's administration and dispatch of the DWR Contracts, consistent with applicable law.
2. Interest Rate Hedging
To allow PG&E to take advantage of the current low interest rate environment, the proposed settlement authorizes the actual reasonable cost of PG&E's interest rate hedging activities to be recovered in rates without further review (PSA, ¶ 12). The Commission recently issued D.03-09-020 in its Bankruptcy Financing Order Instituting Investigation (Investigation 02-07-015) authorizing PG&E to initiate interest rate hedging for any approved and confirmed plan of reorganization.
With the exception of certain pollution control bond-related obligations and outstanding preferred stock, the Settlement Plan contemplates that all of PG&E's existing trade and financial debt will be paid in cash (PSA, ¶¶ 13a and 14). The financing will not include any new preferred or common stock (PSA, ¶ 13b). The cash to pay creditors will come from a combination of cash on hand and new long- and short-term debt issuances.
4. Fees and Expenses
PG&E will reimburse the Commission for its professional fees and expenses in the Chapter 11 case. (PSA, ¶ 15). The Commission will authorize PG&E to recover these amounts in rates over a reasonable time, not to exceed four years (id.). PG&E will not reimburse PG&E Corporation for its professional fees and expenses in the Chapter 11 case. Providing that Corp.'s cost be borne solely by shareholders through a reduction in retained earnings is an indirect way of forcing ratepayers to bear these costs due to the action of the mandated 52% capital structure. The mandated equity component means that ratepayers will make up in any future year any "reduction" in retained earnings and thus will repay Corp. We do not authorize this. Further, we do not authorize recovery of PG&E's expenses relating to the bankruptcy. PG&E's decisions in this area were made without regard to the public interest, but were in pursuit of a corporate strategy that placed ratepayers and the public at risk. PG&E must write off these amounts through a one-time charge to earnings.
As part of the Settlement Plan, PG&E will release claims against the Commission, the OCC, and Corp. On November 20, 2003 Attorney General Bill Lockyer wrote the Commission and each Commissioner reminding us that the people of the State of California have significant claims against Corp. which a settlement with PG&E should not impair. The MSA expressly modifies the PSA, ¶ 24 to confirm that the claims of the people of State of California under the Business and Professions Code and the claims of the City and County of San Francisco, collectively the "17200 Law Enforcement Actions" are not effected in any way by the MSA that settles disputes between PG&E and the Commission.
6. Bankruptcy Court Supervision
The PSA ensures that the settlement will be enforceable by the Bankruptcy Court for its full nine-year term (PSA, ¶¶ 20-23, 30, and 32).
In paragraph 20 of the PSA, the Commission waives "all existing and future rights of sovereign immunity, and all other similar immunities, as a defense" and consents to the jurisdiction of any court, including a federal court, for any action or proceeding to enforce the Settlement Agreement, the Settlement Plan, or the Bankruptcy Court's confirmation order.
In paragraph 22 of the PSA, the Commission and PG&E agree that the Bankruptcy Court shall retain jurisdiction over them "for all purposes relating to the enforcement of this Agreement, the Settlement Plan and the Confirmation Order."
We do not undertake these waivers lightly, and intend to limit their operation to the minimum duration necessary to extract PG&E from bankruptcy. This is the principal effect of reducing the size of the regulatory asset and the duration of its amortization.