III. Utility Requests for Rate Relief

SCE and PG&E continue to seek additional rate increases to improve cash flow and to pay for future costs of power for their customers. PG&E claims it needs to increase retail rates by an additional two cents-per kWh. PG&E claims that the one-cent interim rate increase granted in D. 01-01-018 has not improved its financial circumstances, that it is unable to access credit to keep current with its maturing debts, and that its bonds are now rated as junk bonds. PG&E has defaulted on some wholesale power payments and claims that it cannot pay additional power bills that are coming due. PG&E is also experiencing problems securing natural gas for its gas customers, and claims problems with trade creditors in the normal course of business.

SCE originally sought a 10% rate increase in this proceeding, which it subsequently modified to a 30 % rate increase as described above. SCE's remaining request, after the one-cent per kWh increase granted to it in D.01-01-018, totals a 20% rate increase, or two cents per kWh. SCE claims that failure to grant the remaining 20% increase will prevent the utility from meeting its past and present financial obligations.

Consumer groups argue that no additional rate increase is warranted at this time.⁵ These parties generally argue that the utilities have not justified the need to burden customers with further increases given the various sources of funds and other remedies available to the utilities.

A. Independent Financial Assessments Confirm the Utilities' Current Financial Distress

In order to assess the utilities' claims concerning the extent and urgency of their financial problems, the Commission hired independent financial consultants as authorized in D.00-12-067. KPMG LLP (KPMG) conducted the review of SCE and Barrington-Wellesley Group, Inc. (BWG) conducted the review of PG&E. The consultants published their initial reports on January 29 and January 30, 2001, respectively.

The reports covered the following general areas:

· Credit and Default Relationships

· Power Purchases and Cash Flows

· Cash Conservation Activities

· Accounting Mechanisms to Track Stranded Cost Recovery

· Inter-Company Cash Flows

· Affiliate Earnings in the California Energy Market

· Federal Income Tax Refunds

The reports confirm that the utilities are experiencing serious financial shortfalls in the revenues necessary to provide adequate electric service to their customers.

1. PG&E Report Findings

The BWG report concludes that PG&E has accurately described its borrowing capability, credit condition and potential events of default. BWG concludes that PG&E cannot obtain the credit it needs. BWG confirms that PG&E and its parent, PG&E Corp. have lost access to the commercial lending markets and are using their bank lines of credit to pay maturing commercial paper as it comes due.

The principal and interest payments due on PG&E's debt in 2001 total $3.2 billion. BWG reports that PG&E has exhausted its borrowing capability under existing lines of credit and is on the verge of defaulting many of its loan agreements. Under its short-term credit agreements, PG&E is required to make payments when due and will be in default if accounts payable arising in the ordinary course of business of $100 million or more become overdue. PG&E Corp.'s loan agreements contain default provisions that are similar to those of PG&E regarding the payment of debts when due.

Credit rating downgrades in January 2001 by Standard & Poor's and Moody's below minimum investment grade ratings for PG&E and PG&E Corp constitute an event of default under the PG&E Corp. bank lines of credit agreements and under one of PG&E's bank line of credit agreements. Beginning January 16, 2001, the banks have refused to allow drawdowns under the PG&E and PG&E Corp. credit agreements, and PG&E and PG&E Corp are not paying maturing commercial paper obligations as they come due.

BWG also found that PG&E would likely have positive cash reserves at least through March 2001. BWG projected PG&E's daily cash balances for the period through March 30, 2001 using a range of market clearing prices. On March 15, the Commission reopened the record to update PG&E's financial balances. The update indicates that PG&E's cash balance increased significantly from $827 million on January 31, 2001 to $2.508 billion as of March 8, 2001.⁶ During the same period, PG&E's outstanding obligations due and in default increased from $1.542 billion on January 31, 2001 to $3.324 billion on March 8, 2001. Notwithstanding the one-cent increase granted on January 4, 2001, PG&E has failed to use the revenues produced from that surcharge to pay for ongoing power purchase costs.

2. Edison Report Findings

KPMG reports that SCE has used all available lines of credit and has been unable to extend or renew credit as obligations become due. SCE's share of secured and unsecured debt due in 2001 is $242 million. Under SCE's loan agreements debt becomes immediately due and payable on default. Credit rating agencies downgraded SCE's credit ratings on most of its rated indebtedness to below investment grade during January 2001. SCE suspended payment of certain obligations, including payments for electric power, and has not declared dividends on its preferred stock that normally would have been declared in February and March 2001. Notwithstanding the one-cent increase on January 4, 2001, SCE has failed to use the revenues produced from that surcharge to pay for ongoing power purchase costs.

KPMG forecasted SCE's cash flow using a range of assumptions regarding power costs and payment timing. KPMG reported that under those assumptions, tested, SCE would improve its cash flow position and retain cash at least through March 31, 2001. More recent information indicates that SCE's cash balance improved slightly from $1.5 billion at the end of January 2001 to $1.6 billion by early March 2001. The amounts in default increased from $1.24 billion to $1.77 billion over the same period.

The Edison and PG&E Reports suggest that even with the emergency increase in rates and the actions of the DWR to purchase a substantial portion of the energy for their loads, the utilities' financial condition has not become stable. When the utilities begin to segregate revenues from existing rates applicable to DWR purchases and remit them to DWR pursuant to AB1X and our decision D.01-03-081 also issued today, pressure on utility finances will inevitably increase. We will order utilities to resume payments to QFs on a going-forward basis; this will ratchet up the pressure even more. We have come to the bitter moment when the record shows that additional ratepayer money must be provided to protect the taxpayers' commitments through the CDWR power purchases and to prevent utility financial meltdown.

B. Rates Must Be Increased, Subject to Certain Conditions

1. The Current Financial Emergency Requires Additional Rate Revenues

The Commission's first duty is to assure that customers of California utilities receive reliable, safe service at reasonable rates. The findings of BWG and KPMG generally confirm the utilities' claims of current financial distress. Both have defaulted on various financial commitments and find it increasingly difficult to secure any credit.

Some parties argue that the Commission should not assume that its first responsibility is to promote utility financial health. This is a legitimate observation, but the current circumstances and the action we take today do not implicate that issue. The emergency in the electric industry affects more than utility finances. The Commission must protect the state's energy system, which is essential to the state's economy and the welfare of its families and businesses. Moreover, the Commission takes expedited action to fulfill its implicit responsibility to ensure the viability of the State's General Fund pursuant to the power purchase authority granted CDWR in AB1X.

SCE's and PG&E's financial problems have compromised the integrity of the state's electrical system. The utilities are in debt to the ISO and to power sellers that will not or cannot sell additional power unless they are paid. The state's energy supply system is further compromised because some suppliers have also refused to sell PG&E natural gas that it needs to purchase for its natural gas customers. Blackouts across the state on March 19 and 20 were attributable in part to the refusal of energy suppliers, including qualifying facilities (QFs), to sell electricity to the ISO and the utilities. While the failure of some of these suppliers to provide available power to the grid may stem from their desire to maximize profits, others say they are on the verge of insolvency as a result of the utilities' failure to pay. Whether or not the power sellers' actions are lawful, and whether or not we approve of those actions, without a rate increase it will become increasingly difficult to keep the lights on in California. However, we intend to continue to pursue remedies against power sellers charging unjust and unreasonable prices.

Although the state's wholesale markets continue to permit power sellers to receive extraordinary prices for the power they sell, the recent passage of AB1X, authorizing CDWR to purchase electric power and sell it to retail customers and local publicly owned electric utilities, has provided some financial relief to the utilities by reducing the volume of the power purchases they must make at unjust and unreasonable prices.

The utilities would rely on CDWR to purchase all of their net short electricity requirements.⁷ Indeed, SCE suggests it requires no rate increase if CDWR were to purchase all of its net short power requirements. But AB1X continues the utilities' obligation to serve their customers. We cannot and will not relieve them of that fundamental statutory obligation. Further, although CDWR has assumed responsibility to purchase some of the utilities' power requirements, it has not committed to purchase all net short power requirements. For the Commission to assume here, for the purpose of setting rates, that CDWR will purchase all future net short electricity requirements would be the equivalent of ordering it to do so. Such an action would require authority the Commission does not possess. AB1X is permissive, not mandatory, with regard to CDWR's authority to purchase power for utility customers' use.

Even if CDWR does purchase the entire net short, we disagree with Edison's claim that this would allow rates to remain unchanged. CDWR must be paid for the electricity it provides, and some of that power is likely to be expensive.

Rather than increasing rates, some parties propose other ways of easing the utilities' financial distress. For example, some parties advocate reducing QF prices, exploring the use of over-funded pension programs, requiring infusions of capital from the utilities' holding companies, or restructuring the way the utilities are reimbursed for nuclear power. While there may be many logical places to turn for additional cost savings or cash, our evaluation of resources necessary for continued power purchase cannot rely solely on uncertain or future possibilities. In the future we can refund revenues that exceed costs, but a bankruptcy or financial collapse of the state's energy system would cause wide-ranging, undesirable consequences.

2. This Rate Increase is Authorized Subject to Conditions

In this decision we order emergency rate relief to SCE and PG&E in order to assure the continued viability of California's electric power supply, to safeguard the viability of the State's General Fund, and to minimize credit-related supply disruptions.

We first affirm that AB1X makes permanent the one-cent rate increase granted on January 4, 2001. This amount is part of the existing rates that are allocated between CDWR and the utilities.

We also grant an increase of three cents per kWh to be collected by SCE and PG&E, subject to several conditions. Revenue generated by the rate increases will be applied only to electric power costs that are incurred after the effective date of this order. We will direct the utilities to enter the revenues from the rate increases into balancing accounts and the revenues will be subject to refund if, at a later date, we determine that the utilities failed to use the funds to pay for future power purchases. We reiterate that the revenues the utilities have collected and continue to collect from the one-cent per kilowatt-hour rate increase authorized on January 4, 2001 must be used to pay for power purchases and not for any other costs incurred by the utilities. Upon receipt of and analysis and comment on DWR's revenue requirement, which has yet to be provided to this Commission, we will act promptly to further allocate a portion of these increases to CDWR.

As AB1X requires, the rate increase approved today will not apply to residential usage below 130% of baseline rates. In addition, we exempt CARE-eligible customers from these rate increases, as we discuss more fully below.

We impose one final condition on the utilities' authority to retain the revenues generated from this rate increase. This condition is based on the likelihood that refunds of overcharges can be obtained from generators and sellers if such refunds are aggressively sought.

The California Independent System Operator's (ISO) report of March 21, 2001 confirms many of the concerns this Commission has raised in its own proceedings and before FERC with regard to the impact on wholesale electricity market prices of generators' and power sellers' market behavior. Where these activities result in higher wholesale prices and compromise system reliability, the interests of the State's utilities, consumers and taxpayers are aligned.

We expect the utilities to join with the State and take any and all actions necessary to assure that California and its utility customers realize refunds for or repayment or disgorgement of power seller overcharges. The utilities possess market information and expertise that place them in a unique position to understand market behavior and to pursue legal remedies. To date, however, the utilities appear to have been hesitant to take legal action against the generators and sellers who are responsible for, and have profited by, the utilities' financial distress.

We therefore make today's rate increase subject to refund in two circumstances. First, to the extent that generators and sellers make refunds for overcollections, those refunds should either be passed through ratepayers or applied to unrecovered power purchase costs, as we discuss more fully below. Second, to the extent that any administrative body or court denies refunds of overcollections in a proceeding where recovery has been hampered by a lack of cooperation from a utility, today's rate increases will also be subject to refund. The reason for this condition is simple: we cannot authorize a rate increase for the purpose of remedying the adverse consequences of the utilities' financial distress and at the same time ignore another significant source of revenue that would remedy such distress. If utilities do not actively seek to reduce the financial burden caused by the purchase of power at unjust and unreasonable prices, by pursuing refunds or recovery or disgorgement of excess profits from unlawfully obtained power prices, we will not continue to force California's consumers and businesses to shoulder that burden.

We affirm the assigned ALJ's instructions to PG&E and Edison to provide monthly reports (due on the 15^th of each month) that detail their efforts to pursue FERC-related remedies and to pursue lawsuits against generators or marketers of electricity and natural gas. (TR: 34, January 10, 2001 PHC.) We direct PG&E and Edison to provide monthly reports on their efforts in state and federal forums, beginning April 1, 2001 and continuing for twelve months. A subsequent decision will analyze these reports, together with the question of specific requirements to enforce this condition.

3. AB 1890 Rate Controls Remain Effective

The actions we take today do not end the rate controls established by AB 1890. AB 1890 set up a mechanism under which utility-submitted cost recovery plans that included frozen rates would remain in effect until the Commission found that certain conditions existed or until March 31, 2002, whichever is earlier. We are not prepared to find here that the specific cost recovery requirements mandated by the statute have been met.

In addition, recent legislation enacted in January and February 2001 addresses electricity market conditions and utility financial distress that AB 1890 neither anticipated nor provided for. These new laws respond to the current emergency and provide enhanced authority for this Commission to set retail rates for electric power to provide for the recovery of revenues expended by CDWR for power purchases that it makes, despite the fact that the AB 1890 rate controls remain in effect.

Thus, while the rate control provisions of AB 1890 provide consumer protections that remain in effect, we must also respond to immediate circumstances and the potentially dire consequences of inaction. Nothing in AB 1890 provides that all limits on utility rates are ended if, for unforeseen reasons, and in response to further legislative direction, the Commission increases rates to prevent the collapse of the electric system. As we have stated consistently in our decisions, only two events end all the consequences of the rate freeze: (1) recovery of all specified transition costs,⁸ or (2) March 31, 2002.

PG&E and Edison argue that the AB 1890 rate controls have ended because, they claim, their transition costs have been fully recovered under the accounting mechanisms of Resolution E-3527. They allege that all stranded costs have been fully recovered, and therefore the law requires that the AB 1890 rate controls end on or before the date of our decision.

Both also cite policy reasons why the Commission should declare an end to AB 1890 rate controls. PG&E states that nothing is to be gained, and much is potentially lost, by prolonging the uncertainty over whether the AB 1890 controls have met their statutory triggers. Specifically, PG&E asserts that continuing AB 1890 rate controls exacerbates the concerns of lenders and creditors that their position may deteriorate if they do not take PG&E into bankruptcy. Edison states that there is a broad consensus among parties, citing to TURN and ORA, to end these rate controls and that no legal or policy reason exists to delay.

ORA states that the AB 1890 rate controls have ended on a prospective basis because AB1X and AB6X together make retail ratepayers responsible for the cost of any wholesale power procured by CDWR, whether a rate freeze is needed or not. Without this intervening legislation, ORA argues that the AB 1890 rate freeze could only be lifted if the Commission fails to adopt TURN's accounting proposal.

TURN states that AB1X renders the AB 1890 rate freeze largely irrelevant and, therefore, the Commission should declare the freeze over as of the date of the statute's enactment. TURN states that AB1X is premised on the notion that each utility's generation rate component will exceed the costs of its own generation resources, providing a component that will become the California Procurement Adjustment that flows to CDWR, rather than additional revenue made available to the utility for transition cost recovery. Further, AB1X provides for rate increases if the generation rate component is insufficient to meet CDWR's procurement costs, a provision that cannot be reconciled with a continuing rate

freeze. In the absence of AB1X, TURN states the rate freeze would not be over for either utility under any reasonable set of assumptions and appropriate accounting practices.

Parties that do not support a determination that the rate freeze has ended for either PG&E or Edison include Aglet, CIU, CLECA, CMTA, Farm Bureau, Los Angeles, and SMUD. All state that the conditions of AB 1890 have not been met. In addition, Farm Bureau cautions the Commission against arbitrarily ending the rate controls without the utilities accepting that costs incurred during the rate freeze cannot be recovered from customers. SMUD urges the Commission to adopt measures to mitigate the real and potential exercise of market power by PG&E and other generators prior to lifting the rate controls. CLECA states the Commission would be best served by awaiting further guidance from the administration and the Legislature before deciding whether the conditions of AB 1890 have been met.

FEA, while not taking a position on whether the conditions necessary for lifting the rate the rate freeze, states that the Commission needs to reaffirm clearly that, consistent with the intent and requirements of AB 1890 and prior decisions, any uncollected balances at the end of rate freeze cannot be collected from customers and must be written off by the utilities under Financial Accounting Standards Board (FASB) 71.

We find that under AB 1890 the rate freeze has not ended for either PG&E or Edison. As discussed in Section IV below, we will require SCE and PG&E to "true-up" their operating costs and profits for the period of the AB 1890 rate controls, as proposed by TURN. SCE and PG&E have not recovered all of their stranded costs under any scenario put forth by any party, given these accounting adjustments.

We recognize that, conceptually, the rate freeze mandated in AB 1890 may be incompatible with recent legislation. Further, we agree with CIU that to find existing AB 1890 statutes inconsistent with AB1X, and to take action based on that conclusion, would be to repeal by implication. These statutes can be harmonized by recognizing that the commonly referred to "AB 1890 rate freeze" is actually a term of art for a complex set of accounting and cost recovery standards that when met, could usher in a new method of ratemaking, largely left undefined by the provisions of AB 1890.

To end the rate control mechanisms imposed by AB 1890 would require us to address the disposition of the balances in the Transition Cost Balancing Account (TCBA). We intend to monitor the balances remaining in the TCBA and will consider how to address remaining balances as we continue with these proceedings. We recognize that the magnitude of remaining balances may not have been contemplated in the AB 1890 cost recovery schemes. We will consider other approaches. For example, as we stated early in this decision, to the extent that generators and sellers make refunds for overcharges, those refunds should either be passed on to ratepayers or applied to capital cost recovery. In addition, legislative and negotiated changes relating to enhanced stranded cost recovery are now underway and may significantly affect the ultimate treatment and disposition of these costs. In this period of legislative re-examination of the premises and operation of AB 1890's restructuring statutes, it would be premature and unwise to opine as to the ultimate disposition and treatment of these accounts. We direct the utilities to maintain the regulatory accounting mechanisms as detailed below, but we explicitly draw no conclusions as to the ultimate treatment flowing from legislative or regulatory changes that could well involve the amounts tracked in those accounts. Indeed, as with so many aspects of AB 1890, the extent of the actual consequences of the legislation may well have been unintended and certainly unforeseen by those supporting the AB 1890 stranded cost recovery constraints at the time.