III. Returning the Respondent Utilities To Full Procurement

Both the Commission and the legislature have clearly expressed their intent to return the respondent utilities to full procurement on January 1, 2003, consistent with the utilities' statutory obligation to serve their customers. The utilities' obligation to serve customers is mandated by state law and is part and parcel of the entire regulatory scheme under which the Commission regulates utilities under the Public Utilities Act. (See, e.g. Pub. Util. Code Sections 451, 761, 762, 768, and 770.) As we explained in D.01-01-046, a bankruptcy filing or the threat of insolvency has no bearing on this aspect of state law. Even utilities that

file for reorganization must serve their customers. The public's safety, and the economy's health will be impaired if the utilities avoid their obligation to serve.

In this section, we address the utilities' capability to meet their obligation to serve. Pursuant to the Proclamation issued by the Governor of the State of California on January 17, 2001, SB7 and AB1X 1, the state stepped forward in early January and February 7, 2001 to buy power on behalf of end-use customers on an emergency basis.⁷ California took this unprecedented step due to the financial distress PG&E, Edison, and SDG&E were experiencing as a result of the combination of extreme market dysfunctions, AB 1890 rate freeze requirements, because many of the merchant sellers refused to sell to the utilities, and the federal government (through the Federal Energy Regulatory Commission (FERC)) had not issued a comprehensive must-offer order requiring merchant sellers to sell power to the utilities.⁸ Since then the state, through DWR, has procured all the residual net short (RNS) requirements directly for utility customers by buying power to meet all energy needed beyond the utilities' own retained generation. DWR has entered into long-term contracts that secure substantial amounts of energy through 2008 and, through the end of 2002, is buying power through the Independent System Operator (ISO). As a result of these actions, we must recognize that the procurement responsibilities Edison, PG&E, and SDG&E will face on January 1, 2003 are substantially less than those they faced in 2000. Today, in excess of 90% of bundled service energy requirements are provided by existing DWR and utility contracts as well as

utility retained generation. Further, in anticipation of Edison, PG&E, and SDG&E resuming full procurement on January 1^st, the Commission recently granted the utilities permission to use more of the state's credit, interest free, to cover their projected procurement needs in 2003 - 2008. (See D.02-08-071, issued August 26, 2002.)

Edison and PG&E assert that they cannot resume full procurement until they have an investment grade credit rating. Edison contends that without an investment grade credit rating, there is no assurance that it will be able to effectively procure power. PG&E states that it needs investment quality credit status in order to attract prospective suppliers and avoid the punishing cash and collateral demands placed on uncreditworthy purchasers. SDG&E has an investment grade credit rating but argues that it should not be returned to the procurement role until at least one, and preferably both, of the other two utilities are returned to that role.

We do not agree that Edison and PG&E need to obtain an investment grade credit rating prior to resuming the procurement role. We share the goal of Edison and PG&E regaining an investment grade rating, but this is not a necessary precondition to resuming procurement. In fact, many in the energy industry today do not have an investment grade credit rating and are able to conduct business. On the record developed in this proceeding, CCC states that its members are willing to enter contracts with both utilities. In its opening brief, Sempra Energy (SER) (SER) states "if the Commission were to adopt procurement rules and mechanisms providing reasonable assurances to sellers that they will not face undue exposures to defaults or payment delays resulting from regulatory uncertainties or litigation, SER would make its offers to Edison accordingly, regardless of any actions taken by Moody's and/or Standard & Poor with respect to Edison's credit rating." Therefore, in this decision we adopt

procedural processes and timely cost recovery mechanisms that are designed to make Edison and PG&E capable of entering into procurement transactions without undue regulatory uncertainties.

Both Edison and PG&E have strong cash flow and a stable and secure revenue stream; these are attributes that should make them very attractive to merchant generators and energy trading companies who produce and sell electricity. As we explain below, Edison's financials quantitatively meet investment grade standards and it is on the verge of regaining an investment grade rating; the ratemaking treatment adopted here supports that effort. PG&E is presently in bankruptcy but under our proposed Plan of Reorganization, PG&E will be able to quickly emerge from bankruptcy as a creditworthy entity, because it will meet the quantitatively objective criteria for investment grade ratings.

Aglet presented convincing evidence demonstrating that utility arguments regarding procurement risks in 2003 are exaggerated and that both Edison and PG&E can resume procurement today without an investment grade rating. ORA and the CEC come to the same conclusions. We need not wait for the rating agencies to act before ordering the utilities to resume procurement. We expect Edison and PG&E to exercise the transitional authority we granted in D.02-08-071 by securing sufficient capacity contracts for their projected residual net short requirements. As a result, we expect that their procurement needs in 2003 and beyond will be well within their ability to finance. After this transitional procurement, the remaining RNS can be met through a combination of directly contracting with wholesale energy suppliers and by making purchases in the spot energy markets administered by the ISO.⁹ We briefly discuss here why each are viable options for Edison and PG&E.

We recognize that several of the major wholesale energy traders and generators that operate in California are in financial trouble today. As examples, we cite here, articles in the general public press on Calpine, Dynergy, Duke Energy, Enron, Mirant, Reliant, and Williams Company. Current energy prices remain at or below low historical averages and these energy sellers operate in largely unregulated, price volatile markets with low liquidity and high leverage. It is reasonable to conclude that these companies will find that entering into contracts with Edison and PG&E will be very attractive. Edison and PG&E will be operating in a regulated arena with ratemaking mechanisms that ensure timely and stable cost recovery. Both utilities also have strong cash positions and cash flow, arising from current rates authorized well above current operating costs. Collateral, in the form of bank letters of credit or other financial instruments, is currently available to both companies. Each company could for example agree to pay more rapidly than on a monthly billing basis, thus reducing perceived risks of failure to pay. As we discuss below, Edison has been able to quickly pay down its accrued debt and PG&E is positioned to do the same.

To the extent that RNS is not met through contracting with wholesale traders and generators, PG&E and Edison can also procure remaining RNS in the ISO markets. Because they do not now meet the ISO's accepted credit criteria, both utilities will need to post security amounts as set forth under Section 2.2.3.2 of the ISO's tariff.¹⁰ The utilities each submitted exhibits estimating the collateral they would need in order to participate in the ISO markets and procure necessary resources to meet their load. We grant here the motions of PG&E and Edison to have these exhibits entered into evidence as Exhibits 139C and 140C. We compare these exhibits with our own analysis of ISO collateral requirements and the cash balances and collateral analysis presented by Aglet.

Pursuant to the ISO tariff, Edison and PG&E must post security for an estimated liability for outstanding charges based on trading volumes, the grid management charge, and other market charges for the preceding 60-90 day settlement period. (ISO tariff Section 2.2.7.3.) The outstanding liability for the 60-90 day settlement period will fluctuate continuously. The collateral required for the utilities to conduct purchased power and meet contract obligations will be largely influenced by the allocation of DWR contracts among the utilities, the amount of power left to be procured absent DWR backing, and overall market prices. We recognize that PG&E and Edison will require flexibility in posting the security amounts, because the amount will vary considerably depending on, for example, energy prices, the degree of forward hedging, and seasonal variations.

We find that the assumptions in Exhibits 139C and 140C are speculative and also may represent high estimates as the amounts needed will vary based on energy prices and supplier terms. Also, as we granted more transitional authority in D.02-08-071 than either Edison or PG&E requested, we believe the level of collateral requirements that must be posted to resume resource procurement and participate fully in the ISO will likely be less than PG&E and Edison predict. As we move closer to January 1, 2003, we expect that the accuracy of the estimated collateral requirements will continue to improve.

Aglet provides convincing evidence that Edison's and PG&E's recent recorded earnings, cash positions, and anticipated cash flows compare favorably with the collateral and procurement amounts required, even using the high estimates of Exhibits 139C and 140C. Aglet testifies that PG&E's available cash has grown from $126 million at the end of 2000 to $2.582 billion in April 2001 to $4.495 billion at the end of April 2002. PG&E's quarterly earnings have risen from losses in fourth quarter 2000 and first quarter 2001 to earnings of $737 million in third quarter 2001; $557 million in fourth quarter 2001; and $590 million in first quarter 2002. Aglet also notes that due to its bankruptcy PG&E cannot use available cash to repay pre-petition debts, but it can use the cash for post-petition procurement operations. Procurement is a necessary and normal part of a utility's business and therefore, we do not think bankruptcy court approval is required for PG&E to resume its procurement responsibilities. However, if PG&E believes it requires approval of the U.S. Bankruptcy Court, it should petition for approval immediately.

Edison's available cash totaled $1.303 billion in March 2002, after paying more than $3 billion in past due payments to debt holders and energy providers. Its quarterly earnings totaled $651 million in third quarter 2001, $2.304 billion in fourth quarter 2001, and $142 million in first quarter 2002. Edison testifies that it expects to recover all undercollections under its settlement agreement before the end of 2003. Exhibit 52C shows that Edison's estimated cash positions at the end of 2002 and at the end of 2003 exceed reference case 2003 procurement costs and base or reference case collateral needs. Also in evidence is Standard and Poor's February 20, 2002 report that states Edison's cash flows are consistent with investment grade.

Based on the above discussion, we find Edison and PG&E are capable of resuming full procurement and, under their continuing obligation to serve, should do so beginning on January 1, 2003. We direct Edison and PG&E to take whatever steps are necessary to post the required ISO collateral in order to resume Scheduling Coordination and purchase of the net-short. The utilities should also post the contract and procurement related collateral required to secure resources to meet their loads. We expect that PG&E and Edison will efficiently manage their collateral requirements in a manner that is beneficial to ratepayers. Edison and PG&E should update their collateral requirement estimations, specifically accounting for ISO security requirements and other contract and procurement related collateral costs, in their modified procurement plan filed on November 12, 2002.