Backlash
California has been a textbook case on what not to do with
deregulation. And some states are backing away from their plans ?
particularly with Pacific Gas and Electric's declaration of
bankruptcy in early April which shocked independent power
suppliers.
But many states might find trouble regardless of whether they avoid the same pitfalls as California, and adopt the successful policies of other states, thanks to unpredictable market forces.
What distinguishes California from the rest of the states is the deregulated wholesale market coupled with a regulated wholesale market.
Exacerbating the situation, California hadn't built a power plant in over a decade, and those plants owned by utilities were sold off.
Neighbouring Nevada has taken steps to ensure that its utilities do not meet the same fate as California. The state legislature approved a bill on April 18 that allows utilities to use deferred accounting to ease fears of rate hikes during the summer but assures lenders, investors and power suppliers the utilities will continue to meet their financial obligations. The bill also repeals electric deregulation in Nevada and places a moratorium on the sale of power plants in the state.
Under the provisions of the legislation, rates would be continued at their April 1 levels, reflecting all recent increases to date, and remain stable until early next year, at which time they would be adjusted to reflect the actual costs of wholesale power and fuel over that period. If wholesale costs remain high, the legislation allows for rate hikes to be spread out over several years.
Jack Finn, spokesman for Nevada Governor Kenny Guinn, tells Project Finance: ?Utilities will be able to recover 100% of their costs of fuel but the impact on the retail level won't be felt all at once by ratepayers.? However, Finn notes that not all utilities are locked into long-term fuel supply contracts.
Walt Higgins, chairman, president and chief executive of Sierra Pacific Resources, the parent company for the state's two largest utilities, Sierra Pacific Power and Nevada Power Company, notes: ?There were many investors, power developers, citizens and potential business prospects who have been waiting to see if Nevada would deal with this issue ? and they now have their answer.?
But assertions of well-being by the Nevada power executive are not shared universally. In fact, a source at Sierra says, ?we have had broad concerns expressed by lenders over the last few days. We would call the legislation a return to traditional rate-making. However, without the legislation we would have been in a bad state.?
It is a similar story in New Jersey. Herbert H Tate, former president of the state's board of public utilities, testified before the Senate economic growth committee that the state has avoided problems experienced by California through a hybrid form of deregulation ? prices are capped to the consumer until 2003; utilities are not required to divest of generation assets; forward long-term bilateral contracts or similar hedging arrangements are allowed; utilities are not required to purchase energy on the spot market or through a power exchange.
But Tate stopped short of guaranteeing that New Jersey is immune to power shortages. ?Our restructuring efforts and the combined planning have significantly reduced New Jersey's exposure to the conditions that have led to California's energy crisis.?
?There is no question that the California power crisis has impacted the US energy market. There is a high level of investor uncertainty over continuation of revenue streams and that has had some impact across the US,? says Peter Gaw, executive vice-president and managing director for integrated energy at ABN Amro.
Is California an isolated banking scenario?
?For the bank market, that uncertainty has been isolated to lending into the California market. But it would be naive to think that if California's issues are not resolved that investor nervousness would not spread to other parts of the US market. While the dynamics of individual regional markets in the US are diverse, there may be some spill-over from California.
The problem with California from a lending perspective is the lack of a long-term strategy,? says Gaw. ?I would say, in general, the energy and power markets in the US are currently are experiencing high capital needs.
This is the first sustained development of capacity in California in 15 or 20 years. The demand is unprecedented. However, there will be widespread concern from banks and investors until there is greater clarity as to strategy in that market?.
On the up side, Gaw believes the power market has benefited from meltdown in the telecommunications sector. There is deal flow in the pipeline as equity investors look for investment opportunities in energy. ?Aside from California, energy seems to be a hot sector ? although investors have become much more selective, differentiating among US regional markets.
?However, the depth of investment is not what it was before the California crisis. Some investors have run to the sidelines. Spreads are up with diminished liquidity,? adds Gaw.
Improvement in the California power market will spur investors to look more favourably at the power sector.
According to Deutsche Bank vice-president Jay Dobson, ?lenders may be concerned but they are not radically worried. I would not say the California phenomenon is creeping eastward.
What happened in California, with a fixed retail and deregulated wholesale environment is unique to that state. However, New York and Massachusetts are in a somewhat similar situation.
?Prices have to rise as the cost of fossil fuel rises. Everyone worries about New York, with prices rising as spot market prices increase. While there are heightened credit concerns about the utilities, those risk issues are manageable. I would be surprised if anything approaching the California situation transpired in New York.?
Dobson claims that ?lenders are not worried' is an understatement. Deutsche Bank' has tagged as ?strong buy? companies that are firmly entrenched in the California market.
One of those companies is Calpine, which inked a $4.6 billion 10-year deal with California to supply some 5,000 MW of electricity. While Calpine downplayed its California business in reporting its 1Q earnings, net income was $94.8 million for the quarter ended March 31, representing a 424% increase over 2000 first quarter net income of $18.1 million. At April 6, Calpine had accounts receivable from Pacific Gas and Electric Company of approximately $270 million and notes receivable of approximately $69 million, both arising from power sales under long-term qualifying facility (QF) contracts.
Reliant Energy also posted 1Q operating income of $216 million, compared to an operating loss of $22 million for the first quarter of 2000.
Gross margins for the wholesale group rose by $343 million from the same quarter of last year. The company says this increase was primarily due to increased revenues from energy and ancillary services, the addition of Mid-Atlantic assets and strong commercial and operational performance in other regions.
California ? the sequel
But in the meantime, California is facing another crisis ? this one being a May 8 deadline. The California state treasurer has arranged a $4.125 billion bridge loan to repay the general fund and to purchase power before bonds can be sold this summer. The loan offer expires on May 8. So far this year, the state of California has spent about $5 billion purchasing power on behalf of financially-strapped utilities.
Underwriters include JP Morgan ($2.5 billion), Lehman Brothers ($1.0 billion), and Bear Stearns ($625 million). Of the bridge amount, $1.6 billion is expected to be tax-exempt.
Rate of taxable debt is projected to be 5.77 percent, based on the March 30, 30-day Libor rate of 5.02% plus 75bp. The tax-exempt rate is expected to be 1% lower at 4.77%. Projected blended interest rate is 5.38%.
If the interim loan cannot be repaid by August 29, the loan converts to a term loan with a final maturity of August 29, 2004. The interest rate on the term-out loan will initially be prime rate (currently 8%) and will increase as follows if the loan is not paid off by the following dates: February 28, 2002 (primate rate plus 1%), August 29, 2002 (prime rate plus 2%).
Kathy Calfo, the state's deputy treasurer, says the legislature is being asked to approve an emergency bond issue amount of $10 billion, rather than another amount based on a calculation of ratepayer revenues available for repayment.
Sources maintain that the ability of California officials to solve their problems will have an impact on other states. Currently, the California Public Utilities Commission is deadlocked in a fight with the state's utilities regarding allocation of revenues to repay the debt.
Meanwhile, the governor's plan to save California's number two utility, nearly bankrupt Southern California Edison (SCE), is running into problems in the legislature. The state of California penned an agreement to acquire SCE's 12,000-mile transmission grid, which covers much of the southern half of the state, for $2.76 billion, 2.3 times the system's book value. SCE would be allowed to use the proceeds to pay off its existing debt, restoring it to financial stability. Both the California Legislature and the CPUC need to approve this deal by August 15 or else the agreement is terminated.
The ability to push the SCE deal through the legislature is as much a political issue for the governor as it is an energy issue. With the bankruptcy of Pacific Gas and Electric, Governor Davis lost some credibility.
Bankruptcy of the number two player SCE would be devastating for Davis.
Under the Davis plan, taxpayers would be required to shoulder the $2.76 billion that the state needs to buy SCE's transmission assets. The state would pay for this acquisition with bonds that would be paid off by transmission fees charged to SCE customers.
In addition, the plan calls for SCE's parent company Edison International to keep almost $5 billion that SCE has contributed to the parent since 1997.
Bankers are watching to see if the plan to bail out the cash-strapped utility will fly. Sources say it won't. The sole beneficiary is the utility, with the biggest losers being taxpayers. Politicians tagged as providing an escape valve for the utility on the backs of taxpayers already paying a high cost for electricity could be facing career changes.
But many states might find trouble regardless of whether they avoid the same pitfalls as California, and adopt the successful policies of other states, thanks to unpredictable market forces.
What distinguishes California from the rest of the states is the deregulated wholesale market coupled with a regulated wholesale market.
Exacerbating the situation, California hadn't built a power plant in over a decade, and those plants owned by utilities were sold off.
Neighbouring Nevada has taken steps to ensure that its utilities do not meet the same fate as California. The state legislature approved a bill on April 18 that allows utilities to use deferred accounting to ease fears of rate hikes during the summer but assures lenders, investors and power suppliers the utilities will continue to meet their financial obligations. The bill also repeals electric deregulation in Nevada and places a moratorium on the sale of power plants in the state.
Under the provisions of the legislation, rates would be continued at their April 1 levels, reflecting all recent increases to date, and remain stable until early next year, at which time they would be adjusted to reflect the actual costs of wholesale power and fuel over that period. If wholesale costs remain high, the legislation allows for rate hikes to be spread out over several years.
Jack Finn, spokesman for Nevada Governor Kenny Guinn, tells Project Finance: ?Utilities will be able to recover 100% of their costs of fuel but the impact on the retail level won't be felt all at once by ratepayers.? However, Finn notes that not all utilities are locked into long-term fuel supply contracts.
Walt Higgins, chairman, president and chief executive of Sierra Pacific Resources, the parent company for the state's two largest utilities, Sierra Pacific Power and Nevada Power Company, notes: ?There were many investors, power developers, citizens and potential business prospects who have been waiting to see if Nevada would deal with this issue ? and they now have their answer.?
But assertions of well-being by the Nevada power executive are not shared universally. In fact, a source at Sierra says, ?we have had broad concerns expressed by lenders over the last few days. We would call the legislation a return to traditional rate-making. However, without the legislation we would have been in a bad state.?
It is a similar story in New Jersey. Herbert H Tate, former president of the state's board of public utilities, testified before the Senate economic growth committee that the state has avoided problems experienced by California through a hybrid form of deregulation ? prices are capped to the consumer until 2003; utilities are not required to divest of generation assets; forward long-term bilateral contracts or similar hedging arrangements are allowed; utilities are not required to purchase energy on the spot market or through a power exchange.
But Tate stopped short of guaranteeing that New Jersey is immune to power shortages. ?Our restructuring efforts and the combined planning have significantly reduced New Jersey's exposure to the conditions that have led to California's energy crisis.?
?There is no question that the California power crisis has impacted the US energy market. There is a high level of investor uncertainty over continuation of revenue streams and that has had some impact across the US,? says Peter Gaw, executive vice-president and managing director for integrated energy at ABN Amro.
Is California an isolated banking scenario?
?For the bank market, that uncertainty has been isolated to lending into the California market. But it would be naive to think that if California's issues are not resolved that investor nervousness would not spread to other parts of the US market. While the dynamics of individual regional markets in the US are diverse, there may be some spill-over from California.
The problem with California from a lending perspective is the lack of a long-term strategy,? says Gaw. ?I would say, in general, the energy and power markets in the US are currently are experiencing high capital needs.
This is the first sustained development of capacity in California in 15 or 20 years. The demand is unprecedented. However, there will be widespread concern from banks and investors until there is greater clarity as to strategy in that market?.
On the up side, Gaw believes the power market has benefited from meltdown in the telecommunications sector. There is deal flow in the pipeline as equity investors look for investment opportunities in energy. ?Aside from California, energy seems to be a hot sector ? although investors have become much more selective, differentiating among US regional markets.
?However, the depth of investment is not what it was before the California crisis. Some investors have run to the sidelines. Spreads are up with diminished liquidity,? adds Gaw.
Improvement in the California power market will spur investors to look more favourably at the power sector.
According to Deutsche Bank vice-president Jay Dobson, ?lenders may be concerned but they are not radically worried. I would not say the California phenomenon is creeping eastward.
What happened in California, with a fixed retail and deregulated wholesale environment is unique to that state. However, New York and Massachusetts are in a somewhat similar situation.
?Prices have to rise as the cost of fossil fuel rises. Everyone worries about New York, with prices rising as spot market prices increase. While there are heightened credit concerns about the utilities, those risk issues are manageable. I would be surprised if anything approaching the California situation transpired in New York.?
Dobson claims that ?lenders are not worried' is an understatement. Deutsche Bank' has tagged as ?strong buy? companies that are firmly entrenched in the California market.
One of those companies is Calpine, which inked a $4.6 billion 10-year deal with California to supply some 5,000 MW of electricity. While Calpine downplayed its California business in reporting its 1Q earnings, net income was $94.8 million for the quarter ended March 31, representing a 424% increase over 2000 first quarter net income of $18.1 million. At April 6, Calpine had accounts receivable from Pacific Gas and Electric Company of approximately $270 million and notes receivable of approximately $69 million, both arising from power sales under long-term qualifying facility (QF) contracts.
Reliant Energy also posted 1Q operating income of $216 million, compared to an operating loss of $22 million for the first quarter of 2000.
Gross margins for the wholesale group rose by $343 million from the same quarter of last year. The company says this increase was primarily due to increased revenues from energy and ancillary services, the addition of Mid-Atlantic assets and strong commercial and operational performance in other regions.
California ? the sequel
But in the meantime, California is facing another crisis ? this one being a May 8 deadline. The California state treasurer has arranged a $4.125 billion bridge loan to repay the general fund and to purchase power before bonds can be sold this summer. The loan offer expires on May 8. So far this year, the state of California has spent about $5 billion purchasing power on behalf of financially-strapped utilities.
Underwriters include JP Morgan ($2.5 billion), Lehman Brothers ($1.0 billion), and Bear Stearns ($625 million). Of the bridge amount, $1.6 billion is expected to be tax-exempt.
Rate of taxable debt is projected to be 5.77 percent, based on the March 30, 30-day Libor rate of 5.02% plus 75bp. The tax-exempt rate is expected to be 1% lower at 4.77%. Projected blended interest rate is 5.38%.
If the interim loan cannot be repaid by August 29, the loan converts to a term loan with a final maturity of August 29, 2004. The interest rate on the term-out loan will initially be prime rate (currently 8%) and will increase as follows if the loan is not paid off by the following dates: February 28, 2002 (primate rate plus 1%), August 29, 2002 (prime rate plus 2%).
Kathy Calfo, the state's deputy treasurer, says the legislature is being asked to approve an emergency bond issue amount of $10 billion, rather than another amount based on a calculation of ratepayer revenues available for repayment.
Sources maintain that the ability of California officials to solve their problems will have an impact on other states. Currently, the California Public Utilities Commission is deadlocked in a fight with the state's utilities regarding allocation of revenues to repay the debt.
Meanwhile, the governor's plan to save California's number two utility, nearly bankrupt Southern California Edison (SCE), is running into problems in the legislature. The state of California penned an agreement to acquire SCE's 12,000-mile transmission grid, which covers much of the southern half of the state, for $2.76 billion, 2.3 times the system's book value. SCE would be allowed to use the proceeds to pay off its existing debt, restoring it to financial stability. Both the California Legislature and the CPUC need to approve this deal by August 15 or else the agreement is terminated.
The ability to push the SCE deal through the legislature is as much a political issue for the governor as it is an energy issue. With the bankruptcy of Pacific Gas and Electric, Governor Davis lost some credibility.
Bankruptcy of the number two player SCE would be devastating for Davis.
Under the Davis plan, taxpayers would be required to shoulder the $2.76 billion that the state needs to buy SCE's transmission assets. The state would pay for this acquisition with bonds that would be paid off by transmission fees charged to SCE customers.
In addition, the plan calls for SCE's parent company Edison International to keep almost $5 billion that SCE has contributed to the parent since 1997.
Bankers are watching to see if the plan to bail out the cash-strapped utility will fly. Sources say it won't. The sole beneficiary is the utility, with the biggest losers being taxpayers. Politicians tagged as providing an escape valve for the utility on the backs of taxpayers already paying a high cost for electricity could be facing career changes.
Request a Demo
Interested in IJGlobal? Request a demo to discuss a trial with a member of our team. Talk to the team to explore the value of our asset and transaction databases, our market-leading news, league tables and much more.