Whether the Proposed Settlement Agreement Is
in the Public InterestN. Adequacy of a Settlement Proposal in Achieving
Feasible Plan of Reorganization
The Bankruptcy Code requires any plan of reorganization to be feasible - to allow a debtor to successfully emerge from bankruptcy. To be feasible, a proposed plan must be such that if implemented it will leave the debtor in a situation where it is not likely that the reorganization will be followed by unanticipated liquidation or further reorganization:
Before the bankruptcy court may confirm a plan of reorganization, 11 U.S.C. § 1129(a)(11) requires that it find that the plan is not likely to be followed by unanticipated liquidation or further reorganization. In other words, the plan must be feasible. Under this feasibility test, the bankruptcy court must look to the plan's projected income, expenses, assets and liabilities and determine whether the plan will leave the estate financially stable. In re Pizza of Hawaii, Inc., 40 B.R. 1014, 1017 (D. Hawaii 1984).
A necessary corollary of this requirement is the requirement that the provisions of any proposed plan of reorganization can, in fact, be implemented:
[T]he feasibility test contemplates the probability of actual performance of the provisions of the plan. Sincerity, honesty, and willingness are not sufficient to make the plan feasible, and neither are any visionary promises. The test is whether the things which are to be done after confirmation can be done as a practical matter under the facts. In re Clarkson, 767 F.2d 417, 420 (8th Cir. 1985).
It is the Bankruptcy Court which ultimately will determine whether any given proposed plan is feasible. And it is clear that the Commission should not authorize any settlement unless the Commission believes that the settlement is likely to result in a feasible plan. For the reasons detailed below, the MSA satisfies this requirement.
1. The MSA Will Allow PG&E to Emerge Promptly From Bankruptcy
The MSA24 is fair, just and reasonable and in the public interest. First, it adopts a regulatory asset and the cash flows associated with it, and therefore will pay creditors in full, and improve PG&E's credit metrics. Second, the MSA calls for the amortization of the regulatory asset over four years. Third, it offers the state significant environmental benefits.25 Fourth, it provides for reduction of the regulatory asset on account of any refunds obtained from energy suppliers. Finally, it contains PG&E's commitment not to unilaterally attempt to disaggregate.26
There are provisions in the MSA that enhance PG&E's fiscal soundness. These elements are: the ratemaking treatment associated with the regulatory asset; the assurances of recovery of headroom within a certain range27 in 2003;28 acknowledgement by the Commission that the URG rate base established by D.02-04-016 shall be deemed just and reasonable and not subject to modification;29 imputation of a capital structure to PG&E;30 and a Commission commitment not to discriminate against PG&E as compared with other utilities;31 and the assured recovery of the full amount that PG&E sought in the ATCP.32 With those financial and regulatory benefits in place we are confident PG&E the utility will be able to emerge from bankruptcy and continue to provide safe, reliable service.
2. The Rating Agencies (S&P and Moody's)
PG&E says that it is essential that PG&E's credit be rated investment-grade upon emergence from bankruptcy. It believes that these entities' blessing of the plan, through the assignment of investment-grade credit ratings, is crucial to feasibility. PG&E's witnesses testified: "It is critical for PG&E to meet at least minimum investment-grade ratings"33 if emergence is to take place at all. "PG&E needs access to the liquidity and efficiency of the investment grade debt market in order to raise the approximately $8 billion required to emerge from Chapter 11."34
Investment-grade credit ratings are important not only to achieving a feasible plan of reorganization, but also to ensuring on an ongoing basis that PG&E can reliably and efficiently raise capital to finance construction of new infrastructure, accommodate seasonal fluctuations in cash collections and disbursements, and meet its obligations to serve customers.35 "Continuous access to the capital markets and access to low cost capital facilitates the funding of power procurement activities as well as the capital expenditures necessary to sustain the safety and reliability of a utility's operations."36
Among the important longer-term benefits PG&E and ratepayers can expect from PG&E obtaining creditworthy status are a lower cost of debt.37 Because there would be a greater amount of capital available and a lower risk associated with investment grade debt compared to junk-rated debt, the cost of investment grade debt is considerably less. As shown in the testimony of Paul J. Murphy (Chapter 7), PG&E's ability to issue investment grade debt under the Settlement Plan saves ratepayers approximately $2.1 billion in interest costs over 10 years (compared to junk-rated debt)."38 Thus the lower cost of a utility's debt translates into lower rates, all else being equal.39
There would also be lower transaction costs associated with an investment grade rating.40 A company that is non-investment grade must generally post collateral to engage in purchase transactions. "Investment grade credit ratings are critical for activities such as power procurement; without investment grade ratings, PG&E would need to post additional collateral, further increasing its cost of operations."41 "To acquire firm pipeline capacity, PG&E recently had to post nearly $20 million of collateral, representing three months of payments. Had PG&E been investment grade, it would not have had to post collateral." Moreover, a utility with a "junk bond" rating would likely have to provide security or put up cash as collateral in various contracts (such as for energy supply) or to meet certain regulatory commitments (such as environmental remediation requirements). "Indeed, under such conditions, energy procurement through long-term contracts, even if accessible to a weak utility, creates a new set of problems. If they include mark-to-market provisions, periodic market swings could jeopardize the utility's remaining but limited credit capacity. In addition, a financially-weak utility would inevitably face less favorable terms at higher cost and for a more limited duration."42
Also investment grade credit ratings for PG&E should require lower working capital requirements,43 should facilitate the construction of new power supplies for its customers,44 and are crucial in order for PG&E to carry out its public purpose responsibilities in an appropriate manner in the future."45 And, as witness Murphy notes: "[t]he utility industry is capital-intensive. PG&E's financial forecast highlights this fact with regard to PG&E: over $8 billion of capital expenditures are expected during the next five years. Ease of access to the debt market on reasonable terms to fund such expenditures serves the interests of customers as well, since investment-grade debt is significantly more economical than non-investment-grade debt."46 Staff Witness Paul Clanon concurred, concluding that "[n]on-investment grade credit ratings are bad for ratepayers."47 Thus adopting a long-term goal of maintaining and improving PG&E's credit ratings is good public policy and indeed it is the Commission's "duty and authority to guarantee that the electric utilities would have the capacity and financial viability to provide power to California consumers." Southern California Edison Co. v. Peevey, supra, 31 Cal. 4th at 793.
O. Fairness and Reasonableness
1. Relationship of Settlement to Parties' Risks of Achieving Desired Results
For more than three years, the Commission and PG&E have been in continuous litigation against each other before the state appellate courts, the federal courts, and the Bankruptcy Court. A settlement between PG&E and the Commission would end this litigation and resolve claims totaling billions of dollars made by PG&E against the Commission and ratepayers.
Prior to the settlement, both the Commission and PG&E faced risks and consequences depending on the outcome of PG&E's litigation claims and proposal to disaggregate itself through the asserted preemptive authority of the Bankruptcy Court. On the one hand, PG&E filed a complaint in federal court seeking authority to recover billions of dollars of undercollected costs (which PG&E now estimates at $11.8 billion) from retail ratepayers and to transfer its assets outside the regulatory reach of the State of California. On the other hand, the Commission and other agencies of the State, including the State Attorney General, continue to fight PG&E's proposals, vowing to carry their opposition beyond the federal trial court and Bankruptcy Court to the highest appellate levels. In addition, the Commission had proposed an alternative plan of reorganization in the Bankruptcy Court, and had obtained the support of the OCC for its alternative plan. PG&E just as vigorously opposed the Joint Amended Plan, and threatened to carry its opposition to the highest appellate levels. There was skepticism regarding the feasibility of either plan of reorganization. The litigation costs incurred by both sides were enormous, and threatened to mount to even higher levels, given the likelihood of additional appellate litigation. In short, both parties faced enormous risks that they would fail to achieve their desired results unless they reached a settlement.
2. The Risk, Expense, Complexity, and Likely Duration of Further Bankruptcy Litigation
From the perspective of the Commission and ratepayers, the risks of continued litigation in PG&E's bankruptcy proceeding and the federal court are that some combination of the Bankruptcy Court and federal district and/or appellate courts ultimately may approve PG&E's request for injunctive relief, as well as its proposal to disaggregate its traditional utility business into four separate entities, three of which would be permanently outside the jurisdiction of the Commission. has decided the express preemption issues in the Commission's favor on November 19, 2003.
The 9th Circuit held that the only state laws expressly pre-empted by the Bankruptcy Code would be " otherwise applicable non-bankruptcy law, rule or regulation relating to financial condition..." under Section 1142(a) of the Bankruptcy Code. This reasoning necessarily excludes the nonbankruptcy provisions of the Public Utilities Code relating to rates, service, transfers and encumbrances of property, security issuances, corporate structure, etc.
The decision of the Bankruptcy Court on implied pre-emption utilized an approach not inconsistent with the Ninth Circuit's reasoning. Memorandum Decision Regarding Preemption and Sovereign Immunity, February 7, 2002, In Re. Pacific Gas and Electric Company, Bankruptcy Case No. 01-30923DM, United States Bankruptcy Court, Northern District of California.48 As interpreted by the 9th Circuit, the Bankruptcy Code expressly pre-empts only within the narrow scope described by BC 1142(a). This narrow scope is, however, consistent with the position frequency articulated by Judge Montali that normal state utility rate regulation processes, including accounting procedures that might be considered to broadly affect "financial condition" ought not be interfered with by the federal courts.
The concern that the Commission's costs and delays of further litigating against PG&E are likely to be massive, given the possibility of appeals through several layers of the federal court system, possibly all the way to the U.S. Supreme Court, is somewhat mitigated by this ruling. On the other hand, PG&E's risks, expenses, and delays are increased by the 9th Circuit ruling. Even if it were to prevail in persuading the Bankruptcy Court to impliedly or expressly preempt state law and in so doing limit the Commission's jurisdiction, the Commission has vowed to appeal and further challenge PG&E's plan through the courts. The mutually cooperative approach to rehabilitation of PG&E's credit evinced by the MSA enables both PG&E and the Commission to return to the business of serving the people of California, while fully preserving state regulatory authority.
In short, further litigation between PG&E and the Commission in and beyond the Bankruptcy Court would be costly, complex and lengthy, potentially delaying any resolution as the case winds its way through the federal appellate court system, no matter who prevails at the trial court level. It is time to take off the badge and put down the guns.
3. Reasonableness of Settlement of Other
Claims and Litigation
PG&E presented testimony that identified $11.8 billion in unrecovered costs of utility service which it claims are to be recoverable from retail electric ratepayers. (Exs. 120 and 120c, PG&E/McManus.) PG&E asserts that it is likely to prevail on its claims before the Commission and/or the state and federal courts. (Exs. 120, 120c, 121, PG&E/McManus.) PG&E cites the ruling of Judge Walker in PG&E v. Lynch, which held that the "cost of wholesale energy, incurred pursuant to rate tariffs filed with FERC, whether these rates are market-based or cost-based, must be recognized as recoverable costs by state regulators and may not be trapped by excessively low retail rates or other limitations imposed at the state level." (Ex. 120 and 120c, PG&E/McManus.) PG&E also presented testimony on its claims for cost recovery under state law. (Ex. 120 and 120c, PG&E/McManus.) This testimony asserts that even if its undercollected costs are not classified as wholesale costs protected by the Filed Rate Doctrine under federal law, the costs are still legitimate costs of utility service that PG&E is legally entitled to recover in full from retail ratepayers under California state law.
The Commission staff presented testimony arguing that PG&E was unlikely to prevail in PG&E v. Lynch. (Ex. 122, p. 17, CPUC Staff/Clanon.) The staff relied on the testimony of an expert who argued that Judge Walker's ruling was incorrect. The Commission staff estimated that the net present value of the estimated ratepayer contribution to the settlement would be $7.129 to $7.229 billion. (Ex.122, p. 9, CPUC Staff/Clanon.)49 The components of these ratepayer contributions use the same time frames and components that PG&E used to estimate its claims, i.e. the period from the beginning of the energy crisis to the present. This period treats PG&E's 2001 and 2002 pre-tax headroom revenues under the Commission's surcharge revenue decisions as a ratepayer contribution under the settlement. The Commission staff then quantified the net present value of the regulatory asset, including the costs of taxes and return on the asset. Using the Commission staff's estimate of ratepayer contributions, the proposed settlement would allow ratepayers to settle PG&E's $11.8 billion in pre-settlement claims at a cost of $7.1 to 7.2 billion, or about 60 cents on the dollar, with PG&E giving up $4.6 billion in claims.
In its testimony, ORA questioned the accuracy of PG&E's calculation of undercollected costs in light of headroom revenues reported in PG&E's regulatory balancing accounts. (Ex. 139, ORA/Reid, Danforth; Ex. 187, ORA/Bumgardner.) By ORA's calculation, PG&E had collected $694 million more in headroom revenues during 2001- 2002 than PG&E estimated in its testimony. (Ex. 187, ORA/Bumgardner.) In response, PG&E said that the difference between ORA and PG&E was that ORA did not take into account anticipated additional costs or reductions in revenue that PG&E had accrued and reported in its SEC financial reports under generally accepted accounting principles (GAAP), but that had not yet flowed through PG&E's regulatory balancing accounts.
ORA estimated the ratepayer contribution under the settlement using the same time frame and components as Commission staff, to be in the range of $9.0 to $9.1 billion, $1.9 billion higher than Commission staff. (Ex. 139, ORA/Reid, Bumgardner; Ex. 187, ORA/Bumgardner.) ORA estimated the amount of headroom received by PG&E in 2001 and 2002 to be $694 million more than PG&E's estimate. We accept ORA's adjustment for 2001-02 headroom.
PG&E includes in its $11.8 billion claim amounts representing $444 million for the cost of bankruptcy litigation for itself and its parent Corp. PG&E and Corp. decided to undertake bankruptcy litigation rather than continuing to work with the Commission to achieve a discipline workout of its debts using its revenues from the high rates that the Commission approved in March 2001, as Edison did. The decision to take Chapter 11 while still solvent and to attempt to use Chapter 11 to achieve regulatory and political objectives that it could not achieve under state law was a risky and ultimately futile action undertaken by PG&E's management when other less destruction and aggressive measures were available. Ratepayers ought not pay the cost of this imprudent action by PG&E and Corp. We have already violated the non-discrimination principle by affording PG&E more ratepayer support than we afforded Edison, in the form of a regulatory asset. We ought not compound it by defraying PG&E's litigation costs.
These two adjustments reduce the level of PG&E's claims by $.444 billion and increase headroom contribution by .694 billion. Ratepayers' headroom contribution of $4.8 billion, which is over and above normal earnings based on cost of service, when augmented by an additional $1.2 billion in the form of a regulatory asset and $810 million in associated taxes means that ratepayers will be paying over sixty percent (60%) of PG&E's legitimate claims of $11.36 billion.
The only other parties presenting any detailed testimony on the strength and quantification of PG&E's claims were The Utility Reform Network (TURN) and the City and County of San Francisco (CCSF). TURN's testimony relied primarily on the legal position taken by the Commission staff's outside expert as well as the position TURN itself took before the California Supreme Court in the SCE case. TURN also alleged that PG&E's estimate of undercollected costs was inflated. CCSF assumed that PG&E's undercollected procurement costs should be netted against $2.5 billion in power generation revenues identified in the same exhibit. (Ex. 138, p. 6, CCSF/Barkovich.)
PG&E argues that although it is possible for the Commission to quantify the amount of PG&E's various claims that the utility would be giving up under the settlement, it is not so easy to compare those claims to the costs ratepayers would bear under the settlement. This is primarily because before any comparison can be done, the costs of the settlement to ratepayers must be netted against the quantifiable and unquantifiable benefits that ratepayers will receive directly from the settlement itself. In this regard, one of the direct and quantifiable benefits to ratepayers under the settlement is that they receive rate relief effective January 1, 2004 in an amount that represents the difference between the cost of the regulatory asset and the headroom in existing rates. We estimate that difference to be around $230 million dollars. (See Appendix A1).
4. Reasonableness of Rates
Analysis of the reasonableness of the settlement must include the rates themselves. The proposed rates under the PSA were originally forecasted to be:50
Current |
2004 |
2005 |
2006 |
2007 |
2008 | |
| Bundled Rate (cents/Kwh) |
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The initial revenue reduction in 2004 was updated by PG&E, which more recently forecast the revenue reduction in 2004 to be approximately $670 million, resulting in a projected 12.91 cents per kWh rate for 2004. (Ex. 117b, p.10-3.)
The Scoping Memo in this proceeding excluded any detailed examination of rates and ratemaking, except that which is necessary to raise the cash to implement the Settlement Plan. All ratemaking proceedings are inherently complex undertakings that require many judgment calls. When other ratemaking proceedings are taken into account, including PG&E's GRC, the DWR 2004 Revenue Requirement Proceeding, the adjustment for actual 2003 headroom (as distinguished from the MSA's assumption of $875 million) projected system average rates for PG&E under the MSA are expected to be lower than current rates in 2004, and will decline rapidly after that due to the amortization of the regulatory asset over 4 years. Rates under the settlement agreement lie between the rates ratepayers would have seen under PG&E's disaggregation plan and the Joint Amended Plan were either to be implemented. (Ex. 122, p. 10, Staff/Clanon) Accordingly, as to anticipated rates, the MSA satisfies our concern that the settlement fall within the "reasonable range of outcomes" that would result had the case proceeded to trial. (See, Southern Calif. Edison Co., D.02-06-074.)
5. Adequacy of Representation In the Settlement Process
Adequacy of representation is a legal requirement for approval of a settlement, under the Commission's precedents. Re Pacific Gas and Electric Company, 30 CPUC 2d 189, 222 (D.88-12-083, 1988)(Diablo Canyon)); Rule 51.1. The Commission evaluates this issue utilizing legal concepts developed for use in class actions under Rule 23, Federal Rules of Civil Procedure, where the legal interests of persons are decided despite their absence. Id. at 221-23.
The PSA was negotiated without the presence of any consumer representatives or advocates. In this regard it is absolutely without precedent in the annals of the Commission. The proceedings in this docket to enable us to evaluate the merits of the settlement are therefore critical, and enables us to "delve" more deeply than we otherwise might, to satisfy ourselves that the unrepresented consumer interests have not been sold short. The MSA is the result of that scrutiny.
The PSA was negotiated by staff of the Commission, under the judicial supervision and mediation of a United States Bankruptcy Court Judge. According to Judge Newsome, "...[Y]ou should know that the staff of the Public Utilities Commission, who participated in the settlement process, in my opinion, displayed diligence, competence and professionalism. I do not believe that they overlooked opportunities to reduce costs to ratepayers, even as they agreed that the company should be restored to financial health." (Ex. 146, p.2). This testimonial does not by itself satisfy the legal requirements for adequacy of representation.
The presence and involvement of Commission staff is important but not dispositive. There is no question regarding the motives, independence, or professional competence of the governmental representatives in the negotiations. Second, the Commission staff has represented the Commission in the Bankruptcy Court on the Commission's own plans of reorganization for PG&E. Finally, the Commission staff has played a prominent role in representing the Commission before the Legislature, the investment community, the rating agencies, and other constituent groups throughout the California energy crisis. We do not doubt the technical, financial, and ratemaking expertise of the Commission staff. However, the staff serves several interests that may be in conflict with the interest of ratepayers, including the balancing of investor and consumer interests and the institutional interest of husbanding its scarce resources in an adverse budget climate. This may have called for intervention as a matter of right in the bankruptcy proceeding, once a settlement that impacted rates came on the table. Trbovich v. United Mine Workers,(1971),404 U.S. 528. It was a major reason for the scope of post-settlement proceedings in this OII permitting modifications to the PSA.
PG&E argues that the active participation of an independent, competent Commission staff in the settlement is a significant indication of the overall reasonableness and fairness of the PSA. In addition to the Commission staff, other governmental participants have endorsed the environmental provisions of the PSA, particularly the Land Conservation Commitment. (Ex. 181.)
Considering adequacy of representation from a different angle, whether or not representation was adequate in the bankruptcy settlement negotiations is now moot because the PSA has been examined in this proceeding and has resulted in the MSA. In this investigation, where we approve the MSA, it is clear that ratepayers have been adequately represented by, among others, ORA, TURN, Aglet, and CCSF. We find that the Commission and ratepayers had adequate representation in the post-settlement process, in accordance with our prior precedents, to the extent that it has resulted in the PSA.
6. Release of PG&E Corporation
Paragraph 10 of the PSA states in part: "PG&E and PG&E Corporation, on the one hand, and the Commission on the other, will execute full mutual releases and dismissals with prejudice of all claims, actions or regulatory proceedings arising out of or related in any way to the energy crisis or the implementation of AB 1890 listed on Appendix C hereto." CCSF says the release language should be modified to exclude Corp. It believes there is no need for any release of claims against PG&E Corporation in this proceeding, because such claims have nothing to do with helping PG&E resolve its bankruptcy. More importantly, it contends, the Commission currently has no pending proceedings against Corp. and certainly none that are listed in Appendix C. Nor has Corp. any claims against the Commission. CCSF argues that this release goes not to the Commission's claims, but to the pending actions against PG&E Corporation brought by the California Attorney General and the City and County of San Francisco in the Superior Court. The Commission, CCSF maintains, should not provide Corp. with this very significant release as Corp. is not providing any consideration for the proposed release. The California Attorney General joins in this request. We accede to it and modify Appendix C of the PSA accordingly.
P. Public Interest
1. The Regulatory Asset
Rate treatment of the regulatory asset should preserve the transparency of cost of service ratemaking for PG&E's normal operations. The regulatory asset should be amortized through a surcharge whose duration is as short as possible, in order to be consistent with the Edison settlement approach and in order to minimize the duration of federal court supervision after PG&E has emerged from bankruptcy to the payment of its debts.
The regulatory asset represents income to PG&E contributed by ratepayers to support additional debt and equity in PG&E's capital structure needed to pay its debts and emerge from bankruptcy. The net amount of the regulatory asset therefore must to be grossed up for taxes, and that amount amortized over a period of four (4) years or less. Achieving these objectives requires that the regulatory asset be appropriately sized to achieve the objective of raising cash to end the bankruptcy.
This objective is made more difficult by the fact that there are significant uncertainties in the timing of receipt and disbursement of cash in connection with energy crisis-related litigation. The settlement plan includes a disbursement of nearly $1.7 billion to resolve PG&E's obligations to the ISO and PX, which obligations are paid out of the bankruptcy estate on a gross basis. However, future resolution of the PX bankruptcy and settlement of ISO claims may result in a portion of these monies being returned to PG&E, which was a major seller into the PX until the PX's demise in January 2001, or netted out in settlements with generators. In addition, PG&E, like all other wholesale buyers during the California Energy Crisis has substantial refund claims which have been pending at the FERC for over three (3) years, and in the case of certain RMR payments, have been pending at the FERC for nearly five (5) years.
PG&E may receive significant amounts from these sources, although the amount and timing is uncertain. The continued receipt of substantial headroom revenues coupled with the ability to offset cash requirements with the expected receipt of FERC-ordered refunds, PX derived settlements and ISO adjustments suggest that a few months' delay might significantly reduce the need to raise new cash in the financial markets as a precondition to emergence from bankruptcy. The PSA recognizes this eventuality by dedicating expected proceeds from these sources to reduction of the regulatory asset. A question remains whether the PSA by proposing in effect to finance the timing difference between the raising of cash to pay claims and the receipt of cash in settlement of claims is not excessively burdening ratepayers, because of the substantial effect of grossing up a larger regulatory asset than would be needed, by delay of even of a few months.
The rush to approve the PSA, and the right sizing of a regulatory asset to achieve early emergence from bankruptcy, must be justified by compelling policy reasons.
The regulatory asset has been described above. It is $1.2 billion, amortized over not more than four (4) years. It has been sized to provide for the revenue, cash flow, and capital structure requirements that will enable PG&E to emerge from bankruptcy as an investment grade company.51 This asset, when combined with the headroom, provides a $6.8 billion ratepayer financial contribution (Ex. 122, p. 8.) As we have discussed above, this is a reasonable compromise of the economic differences of the proponents of the PSA. We also recognize that the settlement provides for net-of-tax generator refunds or offsets received by PG&E in 2003 or thereafter, which may offset dollar for dollar the amount of the regulatory asset. (PSA ¶ 2d) This is a further potential benefit for ratepayers. We understand that these generator refunds or offsets are not "headroom" under the settlement and will applied solely to reduce the regulatory asset. This further feature of the design of the regulatory asset is also in the public interest.
Resolving PG&E's bankruptcy, even at the expense of accelerating an additional $1.2 billion raepayer contribution in the form a the regulatory asset advances the state's overall goal of restoring stability to the commercial and institutional infrastructure by which we provide essential services to Californians. Although PG&E has demonstrated the ability to operate over the past 2 ½ years in bankruptcy as debtor in possession, we are determined to achieve normalcy even at additional cost. We have right sized the regulatory asset to demonstrate that our determination is real but also informed.
2. Headroom
The PSA's definition of headroom is:
"PG&E's total net after-tax income reported under Generally Accepted Accounting Principles, less earnings from operations, plus after-tax amounts accrued for bankruptcy-related administration and bankruptcy - related interest costs, all multiplied by 1.67, provided that the calculation will reflect the outcome of PG&E's 2003 general rate case (A.02-09-005 and A.02-11-067)."
The Commission's definition of headroom is found in Re Proposed Policies, etc., (1996) D.96-12-076, 70 CPUC 2d 207:
"Freezing rates stabilizes collected revenues (subject to sales variation), and declining costs create "headroom," i.e., revenues beyond those required to provide service, that can be applied to offset transition costs. The utilities' reasonable costs of providing service are currently identified as their authorized revenue requirements. (70 CPUC 2d at 219.)
"In general, headroom revenues consist of the difference between recovered revenues at the frozen rate levels (including the reduced rate levels for residential and small commercial customers beginning in 1998) and the reasonable costs of providing utility services, which for convenience we refer to as the authorized revenue requirement." (70 CPUC 2d at 223.)
Clearly, the PSA definition is not the same as the Commission's definition. Nevertheless, the MSA adopts the definition in the PSA. When PG&E submits its filing to the Commission to implement the MSA, PG&E must demonstrate to the satisfaction of the Commission that PG&E has fairly and accurately accounted for the headroom. Any headroom revenues in excess of the $875 million cap for 2003 are credited to PG&E's ratepayers as a rate reduction in 2004. We have made the 2001-02 adjustments suggested by ORA.
3. Dividends
Paragraph 6 of the PSA provides as follows:
6. Dividend Payments and Stock Repurchases. The Parties acknowledge that, for the Parent, as PG&E's shareholder, to receive the benefit of this Agreement, both PG&E and its Parent must be able to pay dividends and repurchase common stock when appropriate. Accordingly, the Parties agree that, 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 shall not 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.
This paragraph is not in the public interest and is stricken in the MSA. It says the Commission "shall not restrict" PG&E from paying dividends or repurchasing common stock. There are numerous possibilities as to reasons why parties could challenge the reasonableness of PG&E's dividend practices or PG&E's rates. For example, it is possible that PG&E may engage in unreasonable and imprudent conduct. Depending upon the size of the disallowance of costs, this could limit PG&E's ability to collect revenues from its ratepayers that would be necessary for dividend payments. PG&E also may be financially unable to perform all of its public service obligations under section 761 of the Public Utilities Code, including investing in new generation, if it paid unreasonably high dividends. Under either of these examples, Paragraph 6 of the PSA could restrict the Commission from ruling against PG&E concerning any allegations of unreasonable dividend practices. There are many other possibilities where this issue could arise.
Paragraph 6 is not reasonable and is not in the public interest, because it is unreasonable to expect the Commission to agree blindly (i.e, without knowing all future circumstances) to preclude future Commissions from deciding future issues. The Commission cannot know at this time if, in the future, parties will raise issues relating to the reasonableness of PG&E's dividend practices or PG&E's rates, or the prudency or legality of PG&E's conduct which could limit PG&E's ability to collect revenues necessary for dividends. We cannot know if due to its dividend practices in the future, PG&E were to have insufficient funds to perform its public service obligations. Under traditional cost-of-service ratemaking PG&E should be able to provide dividends or repurchase common stock. PG&E and SCE lost their creditworthiness and stopped paying dividends during the energy crisis due to skyrocketing wholesale procurement costs and market manipulation. However, as the California Supreme Court explained in Southern California Edison Co. v. Peevey, supra, 31 Cal.4th at 795, the passage of AB 6X in January 2001 "allowed PUC to regulate the rates for power so generated pursuant to ordinary `cost-of-service' ratemaking. PUC was thus authorized to permit SCE such recovery of past costs as necessary to render the utility financially viable and to ensure SCE would be able to continue serving its customers through electricity generated in its retained plants." The Court contrasted the "competitive price-reduction approach" of AB 1890 with the cost-of-service rate regulation restored by AB 6X, which reemphasized the Commission's "duty and authority to guarantee that the electric utilities would have the capacity and financial viability to provide power to California consumers." Id. at 793.
Therefore, we have every reason to believe that in all likelihood, under our cost-of-service ratemaking authority, PG&E will be able to declare and pay dividends. That being said, we cannot predict the future, and we find it unreasonable for a settlement provision to preclude the Commission from deciding in the future whether or not PG&E's dividend or common stock repurchase practices are reasonable.
4. Credit Rating
PSA paragraph 2g. states:
g. 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 a 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.
The commitment in Paragraph 2g must be modified to provide an explicit commitment by PG&E's management that mirrors the Commission's commitment. As discussed above, we agree that it is in the public interest for PG&E to achieve and maintain an investment grade credit rating. Therefore, the Commission will act to facilitate and maintain such an investment grade credit rating for PG&E, which is part of the Commission's task in setting rates that are just and reasonable. Quoting FPC v. Hope Natural Gas Co., supra, 320 U.S. at 603, the California Supreme Court in 20th Century Insurance Company v. Garamendi (1994) 8 Cal.4th 216, 294 stated that the regulated entity has a legitimate concern that "there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock...[The return on equity] should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital."
Consequently, the Commission is already obligated in setting just and reasonable rates to authorize a sufficient return on equity for the utility to maintain its creditworthiness. To commit to act to maintain PG&E's creditworthiness, as provided in this paragraph 2.g., is consistent with the law. However, as discussed above, we feel compelled to clarify that the Commission's commitment does not require the Commission to guarantee creditworthiness when there are factors threatening PG&E's investment grade credit rating besides the Commission's actions. The commitment to maintain investment grade is equally a responsibility of PG&E's management.
We may authorize a sufficient return on equity, but imprudence or unreasonable conduct by PG&E or Corp. may be the cause of PG&E not maintaining its creditworthiness. For example, we must take into account the imprudence or unreasonable costs of a utility when we set rates. See City and County of San Francisco v. PUC (1971) 6 Cal.3d 119, 129. If PG&E's own imprudence were to result in a disallowance that threatened PG&E's investment grade credit rating, it is PG&E's actions that would be responsible for this threat. External forces in the marketplace may also threaten PG&E's creditworthiness. We reiterate that this paragraph as modified does not mean that the ratepayers will always have to pay higher rates to guarantee PG&E's investment grade credit rating. Indeed, we interpret this paragraph in this way, because we must also balance the consumers' interests in setting just and reasonable rates. 20th Century Insurance Company v. Garamendi, supra, 8 Cal.4th at 294. For example, we must take into account the imprudence or unreasonable costs of a utility when we set rates. See City and County of San Francisco v. PUC (1971) 6 Cal.3d 119, 129. If PG&E's own imprudence were to result in a disallowance that threatened PG&E's investment grade credit rating, it is PG&E's actions that would be responsible for this threat.
As discussed above, however, we do not foresee this being a realistic problem in light of the decades in which PG&E and the other California utilities have had outstanding credit ratings, even when the Commission has on occasion disallowed imprudently incurred costs.
There is a further dimension to the credit rating issue, the restraint on the Commission's ability to adjust authorized equity returns on ratebase in annual cost of capital proceedings found in Paragraph 3.b. Pursuant to that paragraph, until PG&E achieves specified ratings several notches above the minimum investment grade level, the authorized ROE cannot be adjusted from its current level of 11.22 percent after tax. We accede to that principle, recognizing the importance of stable earnings for maintaining the utility's credit, but with a significant modification to the paragraph.
Fitch,52 Moody's53 and S&P54 have recently upgraded Southern California Edison to an investment grade credit rating. S&P has recently downgraded Sempra.55 In all four ratings actions the relationship between the utilities and the holding companies was an important issue, one that did not reflect positively on the utilities' credit ratings. S&P's comments in its press release are instructive:
Standard & Poor's Rating Services said yesterday that it lowered its corporate credit rating of Sempra Energy (Sempra) to BBB+ from A-.
Standard & Poor's also lowered its corporate credit rating of Sempra's utility subsidiaries, Southern California gas Co. (SoCal Gas) and San Diego Gas & Electric (SDG&E) to `A' from `A+."...
"The lowered ratings reflect Standard & Poor's expectations that consolidated financial ratios will not longer meet the benchmark for the `A-` rating, given the increasing shares of cashflows from the nonregulated businesses compared to the utility operations."
The ratings reflect the consolidated profile of the utilities and the unregulated ventures, which include energy trading, merchant generation, and energy related investments in Mexico and South America....." Stnadard & Poor's Release dated October 7, 2003.
The Commission must have the ability to separate PG&E and its holding company, including divestiture if necessary, if the holding company is preventing PG&E from making the ratings that would free our regulatory authority. We are providing ample cash flows and earnings from ratepayers to achieve outstanding credit metrics. We need the ability to assure ratepayers and the public that their money is being prudently used by managers subject to their regulatory control, and we need PG&E's cooperation in addressing any negative influences on its credit stemming from the holding company. This is the essence of cooperation and mutual support. Paragraph 3.b. is modified to reflect this understanding.
5. Assignability of DWR Contracts
Section 7 of the PSA provides for PG&E's agreement to the assignment and legal and financial responsibility for the DWR Contracts, subject to certain conditions precedent, as discussed earlier. Staff Witness Clanon testified that PG&E is currently dispatching most of these contracts and that it made sense from a policy perspective to put financial responsibility in with operational responsibility. Inasmuch as DWR's presence in the electricity power procurement business was an emergency measure, he further testified that such assignment was consistent with the Commission's policy of getting DWR out of the business as quickly as possible. (RT: 424: 2-19) We conclude that it is in the public interest for DWR to get out of the business as quickly as possible, consistent with the conditions for assignment set forth in this provision.
6. Environmental Matters
The PSA gives the people of California control over, and access to, 140,000 acres of land associated with PG&E's hydroelectric facilities (PSA ¶ 17), without compromising the ability of PG&E to generate electricity from those facilities. In 1999 PG&E proposed to sell these lands to the highest bidder. The PSA would remove forever that possibility, and replace the spectre of loss of public control with the promise of perpetual public access. The PSA's provisions for PG&E's either donating the land or granting conservation easements go much further than simply maintaining the status quo - the people of California can look to a partnership of the environmental community, state and local governments, and environmental stewardship organizations to preserve the lands and improve public access where desirable.
The proposed corporation and its governing board established in the PSA will ensure that PG&E complies with the requirement to donate the lands or grant conservation easements and will provide significant public (and Commission) oversight and participation into improvements made to the lands and the lands' ultimate disposition. Membership of the governing board would include representatives from PG&E, the Commission, the California Department of Fish and Game, the State Water Resources Control Board, the California Farm Bureau Federation, and three public members to be named by the Commission, plus others. This board should play an historic role in the protection of California's environment. The PSA expressly provides that enhancements to the lands not interfere with PG&E's hydroelectric operations, maintenance, or capital improvements. Funding is provided by $70 million to be paid over ten years, to be recovered in retail rates.
(a) The Stewardship Council
Fourteen parties served testimony regarding the land conservation commitment taking a diversity of positions and making numerous suggestions for improvement. Consequently, the presiding Administrative Law Judge (ALJ) encouraged the parties to resolve their differences through a stipulation. The ALJ waived the notice requirements of Rule 51 (Stipulations).
On September 25, 2003, Association of California Water Agencies, California Farm Bureau Federation, California Hydropower Reform Coalition, California Resources Agency, ORA, Regional Council of Rural Counties, State Water Resources Control Board, Tuolumne Utility District, U.S. Department of Agriculture-Forest Service, which are parties, and non-parties California Forestry Association, California Wilderness Coalition, Central Valley Regional Water Control Board, Mountain Meadows Conservancy, Natural Resources Defense Council, Northern California Council Federation of Fly Fishers, The Pacific Forest Trust, Inc., Planning and Conservation League, Sierra Club California, Sierra Foothills Audobon Society, Sierra Nevada Alliance, Trust for Public Land and U.S. Department of Interior-Bureau of Land Management presented to the Commission a "Stipulation Resolving Issues Regarding The Land Conservation Commitment" (the Land Conservation Commitment Stipulation (Ex. 181)), that implements Paragraph 17 and Appendix E of the Settlement Agreement and constitutes an enforceable contract among those parties.
Several parties had indicated that the governing board of the Stewardship Council,56 as proposed in the PSA, would be more effective and representative if it was expanded to include the fuller array of interests and expertise of the public agencies, local government and trade associations, environmental organizations, and ratepayer organizations who have worked on the watershed land protection issue. The stipulation provides that, after its formation, the by-laws will be amended to provide that, in addition to the five members provided for in the PSA, the governing board will include one representative each from the California Resources Agency, the Central Valley Regional Water Quality Control Board, Association of California Water Agencies, Regional Council of Rural Counties, California Hydropower Reform Coalition, The Trust for Public Land, ORA, and California Forestry Association. (Ex. 181 ¶ 10(a).) In addition, 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. The Commission will name three additional board members to further provide for public representation. This board ensures that all of the key constituencies are represented in the development and implementation of the land conservation plan.
The stipulation provides that decisions of the governing board will be made by consensus, that meetings will be public, and that there is a dispute resolution process. The stipulation delineates a planning and assessment process that will examine all of the subject lands in the context of their watershed and county. For each parcel, the plan will assess its current natural resource condition and uses, state its conservation and/or enhancement objectives, whether the parcel should be donated in fee or be subject to a conservation easement, or both, that the intended donee has the capability to maintain the property interest so as to preserve or enhance the beneficial public values, that the donation will not adversely impact local tax revenue, assurance that known contamination be disclosed, appropriate consideration of whether to split the parcel, a strategy to undertake appropriate physical measures to enhance the beneficial public values, a plan to monitor the impacts of disposition and implementation of the plan, and an implementation schedule. Consistent with Appendix E to the PSA, the plan may also consider whether land "without significant public interest value" should be sold to private entities with few or no restrictions. The stipulation does not alter § 851 authority. Any proposed disposition will be presented to the Commission for public notice, hearing, and approval. The stipulation is expected to enhance the existing environmental and economic benefits of the Watershed Lands and Carizzo Plains on an overall basis.
We agree that the LCC as supplemented by the LCC stipulation will provide ratepayers with substantial benefits and is in the public interest. PG&E will undertake a study of all of these lands to determine current public values, and to recommend strategies and measures to preserve and enhance such values in perpetuity. PG&E will then implement such strategies and measures within six months after final receipt of all required government approvals no longer subject to appeal. The planning process, including surveys and inspections of 140,000 acres, will likely cost $20 million or less (Ex. 127a, pp. 4-5, CHRC/Sutton), and thus the balance of the $70 million will be available to implement physical measures, such as planting of trees to enhance fish and wildlife habitat and water quality, construction or improvement of recreational access, and protection of Tribal or other historical sites. The LCC limits the discretion of PG&E to take inconsistent action in future proceedings.
The State Water Resources Control Board argues that the term "beneficial public values," as used in Appendix C of the PSA, be modified to state that any agricultural, sustainable forestry and outdoor recreation uses on transferred lands "must be environmentally sensitive." (SWRCB Op. Br. at 6.) PG&E opposes this modification, it argues that the term "environmentally sensitive" is hopelessly vague and, rather than clarifying the land conservation commitment, would only result in more confusion and debate. It asserts that the language in Appendix E has been crafted to give the Stewardship Council direction and the flexibility to determine how best to preserve and enhance the beneficial public values of the lands. The combination of state agency representation on the governing board with consensus voting, as well as the Commission's § 851 approval process and CEQA review, will ensure that recreational uses that unduly harm the environment are not permitted. We agree with PG&E's reasoning.
(b) Environmental Opportunity For Urban Youth
The Greenlining Institute has asked us to expand the LCC to address the needs of low-income urban PG&E ratepayers. A majority of PG&E's ratepayers live in urban areas, not in the Sierra foothills, where the vast majority of the 140,000 acres are located. In order to ensure that environmental benefits of a substantial nature are realized by PG&E's urban ratepayers, our modified Settlement Agreement will augment the $70 million devoted to environment activities by $30 million. These additional funds shall be expended to provide a wilderness experience for urban youth, especially disadvantaged urban youth, and to acquire and maintain urban parks and recreation areas. We direct that the acquisition of such parks and recreation areas be focused on creating an environment that will particularly serve the needs of urban low-income youth.
Of the $30 million, to be expended in equal installments over 10 years, we will expect approximately 1/3 would be used to provide seed money that would establish a permanent program for young people who are least likely to enjoy the wonder of California's natural beauty. This program would allow disadvantaged, inner city youth to experience the environment in nature's own setting. The program would select young citizens in an urban setting, and provide the means to visit these watershed lands for a week or two. While there, they would be exposed to living in the outdoors and see how the actions of man interact with animal and plant life, both favorably and unfavorably. The 2/3 balance of the $30 million would be used to acquire urban parks and recreation areas for inner city youth. We will use our three appointments to the Stewardship Council to champion this $30 million allocation, among their other duties.
(c) Clean Energy Technology Commitment
Under the PSA, PG&E will establish a shareholder-funded non-profit corporation dedicated to supporting research and investment in clean energy technologies primarily in PG&E's service territory. (PSA ¶ 18.) The non-profit corporation's governing board will include Commission-selected appointees, PG&E-selected appointees, and appointees jointly selected by the Commission and PG&E. PG&E proposes an initial endowment of the non-profit corporation at $15 million over five years (not to be recovered in rates). We view this commitment as part of the Commission's, and the State's, ongoing policies encouraging energy efficiency, demand response, renewable generation, and the entire range of more environmentally-friendly options for meeting load growth. However, $15 million is inadequate. We believe an additional $15 million (not to be recovered in rates) will assure adequate planning and funding.
| In $Millions | |
| 2001 and 2002 Pre-Tax Headroom | $3,200 |
| 2003 Pre-Tax Headroom | $775 to $875 |
| NPV of the Regulatory Asset | $2,210 |
| NPV of the Tax Component of the Regulatory Asset | $944 |
| Estimated Ratepayer Contribution | $7,129 to 7,229 |
