IV. Other Issues

In addition to approval of the change of control, Joint Applicants seek authority regarding three other matters, which we review below.

A. The Proposed Debt Financing

Pursuant to Pub. Util. Code §§ 816, 817, 818, 823, and 851, which require such approval, Joint Applicants request Commission authority to enter into a secured, long-term bank financing, the proceeds to be used to acquire Western Hub and to refinance interim construction financing provided LGS by WHP. Negotiations are underway with two banks (SB Bank Deutsche Genossenschaftsbank AG and Union Bank of California, N.A. [the Banks]) to arrange a debt financing for LGS of up to $175 million to supplement the equity capital from AMS and ArcLight (i.e., $25 million each, $50 million total). Joint Applicants have supplied the Indicative Terms and Conditions (Exhibit 11 to the Application) and request authority to enter into a debt financing arrangement on these terms with the Banks, once the Banks have finished their due diligence and upon execution of definitive documents. Should the current negotiations fail for reasons now unknown, Joint Applicants seek authority to enter into a debt financing arrangement with other lenders on substantially similar terms as those stated in the Indicative Terms and Conditions.

The Application describes the debt financing arrangement sought as a medium-term loan (a "construction mini-perm project finance facility"). This means that the loan initially may be extended to finance construction and after completion of construction, the term loan then becomes a "miniature permanent" loan, which in the instant case would be repayable in five years. However, if construction of the Lodi Facility has been completed prior to our decision on the Application, then the construction portion of the loan would never be drawn.¹²

Interest rates and other charges in connection with the debt financing proposal appear to require market rates and arm's-length negotiation between the parties, as Joint Applicants contend. While the substantial debt acquisition will increase the debt in LGS' capital structure, Joint Applicants argue that higher debt levels are not unreasonable for an independent gas storage utility. They also point out that the financing terms are similar to those the Commission approved in 1997 in another proceeding, which unlike this one, concerned captive ratepayers; it also concerned substantial unregulated operations. (In re: Application of Red and White Fleet to Transfer to Blue & Gold Fleet, D.97-06-066, (1997) 72 CPUC2d 851; 1997 Cal. PUC LEXIS 229, *43-51.)

We agree that the Commission need be less concerned about the capital structure of an independent gas storage utility like LGS, where the owners bear the risk for the Lodi Facility's success, and where customers are not captive but have other market choices - but we stress that this is not to say we have no interest in reviewing capitalization issues (and other indicia of financial viability) as we consider a proposed transfer of control.

Two additional factors favorably influence our consideration of this proposal. First, Joint Applicants represent that the $20 million performance bond we ordered in D.00-05-048 will remain in place to assure appropriate decommissioning should that prove necessary, however unlikely it now appears. To ensure this security continues, we will require Joint Applicants to provide the Director of the Commission's Energy Division clear representation that the bonding entities will bond LGS and the Lodi Facility under its new ownership. This representation must be in writing, must be verified, and must be submitted prior to any change of control.

Second, the Banks' financial analysis regarding the sizing of the debt financing is based on a conservative assessment of LGS' cash flow (i.e., cash to operate the Lodi Facility and to make payments to the Banks under the debt financing arrangement), since it relies only on the aggregate demand charges which LGS' customers must pay for storage contracts for firm service. These contracts include demand charges payable whether or not a customer uses the storage, as well as volumetric usage charges payable when a customer injects or withdraws gas from the Lodi Facility.

Considering the LGS' position as an independent gas storage utility, we conclude that these aspects of the proposed debt financing are reasonable, and we will not impose a debt/equity ratio more typical of a monopoly public utility on LGS' capital structure. We will require that LGS provide a copy of the final debt financing arrangement to the Director of the Commission's Energy Division, whether LGS and the other parties to the transaction obtain debt financing on these terms from the Banks or from alternative lenders. Our authority today applies to the financing terms disclosed in the Application and attached Exhibits. LGS shall secure our approval, pursuant to Pub. Util. Code § 851 and other relevant statutes, before executing a financing agreement that contains substantially different terms and/or conditions.

B. Proposed Affiliate Transactions

Joint Applicants propose two additional contractual arrangements, both of which would involve transactions between LGS and marketing affiliates they propose to form. Joint Applicants represent that the Banks that are extending the debt financing require these contractual arrangements as further security.

The first proposal concerns the Lodi Gas Marketing (LGM) Storage Agreement. According to the Application, at the time the debt financing arrangement closes, LGS does not expect the storage available at the Lodi Facility to be fully subscribed. Thus, upon such closing, Joint Applicants propose that AMS and ArcLight contract for any firm storage that remains uncommitted to third parties via LGM, a separate limited liability company which AMS and ArcLight would form and which WHP would own. LGM would enter into a firm service storage contract with LGS for any unsubscribed firm storage, which would be subject to release for subscription by third parties in periodic open seasons.¹³ The LGS/LGM contract rate would be a market-based rate, no less than the rates charged to existing third-party customers or those future customers who subscribe in the periodic open seasons that LGS will offer.

Under the second proposal, referred to as the LGM Marketing Contract, LGS would post daily all available interruptible capacity and make this subscribed but unused capacity available to other customers who agree to pay appropriate usage charges. Joint Applicants state that maximization of storage capacity in this way is critical to support the equity investment by AMS and ArcLight. They propose that LGS contract with LGM to provide such marketing services because, they state, the Banks will not permit LGS to market this interruptible capacity in order to avoid the risk of any liability not specifically identified and quantified in the connection with the debt financing arrangement. Joint Applicants propose that LGM bear 100% of any liability associated with the marketing of the interruptible capacity and in return, be entitled to 95% of all profit, with LGS taking the remaining 5%.

Both arrangements trouble us because they require contracts between LGS and an affiliate regarding the marketing of LGS' core utility business, the provision of gas storage services. Therefore, these proposals raise larger concerns about the potential for affiliate abuse than do the agreements for construction oversight and management of day-to-day operations. While it is true that our 1997 Affiliate Transaction Rules do not apply to LGS at present, at the time we granted that exemption we put LGS (as well as Wild Goose) on notice that we intended to examine application of those Rules to independent gas storage. As noted above, we do not want to prejudge R.01-01-001. Without a fuller record, we conclude we should not approve, even provisionally, a regulatory regime that could provide LGS with economic and competitive opportunities that we have barred Wild Goose from exploring. We decline to approve the LGM Gas Storage Agreement and the LGM Marketing Agreement. If AMS, ArcLight and the Banks conclude that investment in LGS, as otherwise proposed, lacks sufficient security or could fail to produce the economic returns sought, LGS should seek a different merger partner.

C. Exemption from Affiliate Transaction Rules & Other Reporting Requirements

Joint Applicants ask for confirmation that LGS' exemption from the Affiliate Transaction Rules will continue if we approve the change of control and also request exemption from or the relaxation of other reporting requirements.

In addition to a review of the Affiliate Transaction Rules, R.01-01-001 also is examining the general reporting requirements for utility-affiliate transactions adopted in 1993 by D.93-02-019. These requirements, known as the Interim Affiliate Reporting Requirements, remain in effect today. As modified or interpreted by decisions issued after D.93-02-019, the requirements apply variously to all electric, gas, and telecommunications utilities regulated by the Commission. Thus, while LGS has a current exemption from the Affiliate Transaction Rules, it remains subject to the Interim Affiliate Reporting Requirements, as well as to other disclosure and filing requirements contained in the Commission's General Orders (GOs) and under Pub. Util. Code § 587. LGS seeks relief from the following:

· GO 65-A: This general order requires submission of "each financial statement prepared in the normal course of business" by a utility with annual operating revenues of at least $200,000 and the "annual report and other financial statements issued to its stockholders".

· GO 77-K: This general order requires submission of data on the compensation of officers and employees, dues and donations, and legal fees.

· GO 104-A: This general order requires the filing of what is usually meant as an "annual report."

· Pub. Util. Code § 587, which concerns reports on transactions with affiliates as implemented by D.93-02-019 (adopting the Interim Affiliate Reporting Requirements), and most recently, D.99-05-011 (confirming the continued application of the 1993 rules).

At the time Joint Applicants filed their Application, Wild Goose enjoyed an exemption from the requirements of GO 65-A and GO 77-K, pursuant to D.00-12-030, and was authorized to comply with GO 104-A by filing a simplified annual report containing the information listed in Exhibit A of that decision (i.e., the type of information the Commission currently requires from competitive local telecommunications carriers and interexchange telephone utilities). D.00-12-030 also narrowed the reporting requirement on Wild Goose under Pub. Util. Code § 587 by limiting reports on affiliate transactions to those in the direct chain between itself and its parent. However, as a condition of amendment of Wild Goose's CPCN, Wild Goose Expansion rescinds the exemption from GO 65-A and GO 77-K and requires more rigorous compliance with GO 104-A and Pub. Util. Code § 587.

As we consider this proceeding, we are mindful that one of our regulatory goals is to treat similarly situated utilities in a similar way and thus avoid creating a competitive advantage for one over another merely by applying different regulatory policies. LGS competes for some of the same noncore customers as Wild Goose does. LGS is subject to the same market-based ratemaking regime. Thus, pending our reexamination in R.01-01-001, we will continue to exempt LGS, like Wild Goose, from the Affiliate Transaction Rules. We see no reason, at this time, to grant LGS authority to comply with GO 65-A, GO 77-K, or GO 104-A in a different fashion than Wild Goose. Accordingly, we decline to exempt LGS from GO 65-A and GO 77-K and will require continued, full compliance with GO 104-A and Pub. Util. Code § 587, rather than the simplified compliance sought.

D. CEQA

Under the California Environmental Quality Act (CEQA) and Rule 17.1 of the Commission's Rules of Practice and Procedure, we must consider the environmental consequences of projects that are subject to our discretionary approval. (Pub. Resources Code § 21080.) It is possible that a change of ownership and/or control may alter an approved project, result in new projects, or change facility operations, etc. in ways that have an environmental impact. Based upon the record, the transfer of control at issue in this proceeding will have no significant effect on the environment for a number of reasons. The Lodi Facility will continue to be developed and operated as previously authorized by this Commission, all environmental mitigation measures contained in the certified EIR will continue to apply, and all monitoring requirements and restrictions imposed in D.00-05-048, which certified the EIR, will continue. Therefore, the proposed project qualifies for an exemption from CEQA pursuant to § 15061(b)(3)(1) of the CEQA guidelines and the Commission need perform no further environmental review. (See CEQA Guidelines § 1506(b)(3)(1).)

D.00-05-048 restricts persons and entities with a beneficial interest in LGS or its present owners from monitoring the implementation of the environmental mitigation measures. The restriction applies to such persons and entities, defined as anyone

... who beneficially owns any security of, or has received during the past five years or is presently entitled to received at any time in the future more than a de minimus amount of compensation for consulting services [from LGS or its owners]. (D.00-05-048, Ordering Paragraph 16.)

We will continue to apply this restriction to such persons and entities following the transfer of control and we will extend the same restriction to LGS' new owners and their consultants.