On February 16, California Governor Gray Davis unveiled the framework of a recovery plan for California's investor-owned utilities. The state proposes to buy transmission lines for a not-yet-agreed sum from investor-owned utilities and give those utilities a mechanism for financing their debt and making payment to creditors, generators and suppliers of renewable energy. In return, the state will receive substantial contributions from the holding companies to contribute to the debt utilities have incurred.

California officials will not comment on the amount the government expects to pay for the transmission lines. Neither would Davis be pushed by reporters at a press conference ? the price is ?a lot less than you guys have written here in this paper?. Speculation is that ? if the government were to buy either the utilities or some of their assets ? the price would be about $7 billion. That amount has been widely reported and bankers and equities analysts have been using that number as a benchmark. Davis says the price tag will be a ?multiple of book value? ? although that amount is subject to interpretation. ?Book value? generally is equivalent to acquisition cost plus or minus amoritisation or accretion ? and it may differ substantially from market value. In essence, the governor's comments reveal little about the price tag or his knowledge of accounting principles.

The principal value of state ownership of the transmission is that the state can operate more cheaply and efficiently. ?We can get tax exempt financing that's not available to the utilities?, says Davis. The state would not acquire lines operated by municipal authorities or those run by the federal government, which combined account for 40% of the state's transmission lines.

The governor notes that some $3 billion to $4 billion has passed from utilities back to the parent companies of those same utilities. He added that a ?substantial? amount should come back to the utilities to help them meet their obligations. ?It's not in my judgement fair just to shift the money to a parent and say, ?we're out of money you have to bail us out.' That's not the way this transaction is designed. We want shared paying contribution from all parties. The result being solvent utilities, functioning utilities ? utilities that are credit worthy but utilities that recapture some of the benefits they passed out to their holding company.

?We're in negotiations. I'm not saying the utilities are in love with this idea. But it's not a new idea. It's been on the table for the last couple of months. I think they're well aware that they should make a substantial contribution.?

The scheme does not call for rate increases, Davis says. Rather, a portion of existing rates will be specifically designated to allow utilities to finance their receivables, thereby allowing them to make payments to their creditors, generators and the sources of renewable power. Simply, utilities will be permitted to structure future flow securitisations of the designated amount in the same fashion that utilities securitise stranded costs. Sources suggest that taxpayer groups will fight what they consider to be corporate welfare tooth-and-nail ? with the same verve that has traditionally accompanied moves to securitise utilities' stranded costs.

The state also will extend from five to 10 years the length of time the utilities provide power from their own native generation at very reduced rates, technically called ?cost plus rates?. In addition the state would pledge to obtain conservation easements from watershed areas surrounding hydro facilities that utilities own. The governor's proposal insists on dismissal of all litigation against the state, asking that high rates be passed on immediately to consumers.

The governor's back is to the wall. While the state of California was flush with a $6.3 billion budget surplus at yearend 2000, the state treasury is being drained. Government coffers were emptied by about $1 billion to cover power purchases made by the state for January. At this rate, California would go bust in time for this year's July 4th Independence Day celebration.

The state's two major investor-owned utilities ? Edison International and PG& E Corp ? have run up some $12 billion in undercollections since last summer. Among things that have become crystal clear is that Davis ? often touted as a potential presidential candidate ? now believes that the public sector must play a pivotal role in the state's energy policy.

But that's not the end of the story. The party line at both utilities is that officials have the proposal under review. Neither utility has endorsed the governor's plan. Responding to a reporter's question after the press conference called to introduce the plan, Davis said, ?We are in active negotiations with the utilities. These will be very aggressive discussions. We're taking the talks to a new level and I expect we'll have some positive news at some point early next week.? He adds, ?Whether they (the utilities) want to change some of the particulars, we'll see throughout the negotiating process.?

All calls to Edison and PG&E officials were referred to their respective corporate communications machines for the usual babble. Proposals are ?under review? and ?being analysed?, respectively.

While the California energy market looks like a bad place to do business, things are not always what they seem. ?If you have a merchant power plant in California, there is substantial value to that asset. The issue is whether you will get paid enough for your output. The state should create a climate for companies to earn substantial money. That is the issue. There is no need for the state to provide guarantees for companies that may make investments in the sector. The issue is whether the government will interfere in the business,? according to Paul Patterson, Credit Suisse First Boston's energy analyst.

?The only real real issue for us is, will the utilities be permitted to recoup what they have spent,? maintains Laurie Woodland, director in rating agency Fitch's global energy division.

While the California government labours to keep Edison International and PG&E Corp out of bankruptcy court, at least three groups of creditors had formed committees to evaluate alternatives. Reliant Energy, Dynegy and Mirant announced in mid-February that they were forming a creditors committee to explore options for receiving payment by the California Independent System Operator (ISO) and California's investor-owned utilities. The group said formation of the committee was in response to what they characterised as slow progress toward the implementation of a comprehensive long-term solution to California's electricity crisis.

The first option for the creditors would be to pursue bankruptcy, remembering that trade creditors usually take a big hit in bankruptcies. The other option would be to remain patient until some form of resolution develops. A Mirant spokeswoman says the group views pushing for bankruptcy as a ?last resort.?

?My hope from the outset has been to avoid bankruptcy. Bankruptcy means that a federal judge will be making decisions that I am privileged to make with both parties here in Sacramento. So it is my hope that the proposal today will avoid the need for bankruptcy, provide some assurance to the customers, creditors and generators that they'll be receiving payments and allow us to go forward without the fear that everything will collapse. I hope and believe this takes bankruptcy off the table,? says Davis.

Another group pushing for resolution is the Coalition of Alternative Energy Producers, an ad hoc group of eight wind, solar, geothermal, biomass and landfill gas electricity generators that also have formed a creditors committee to consider their options. Southern California Edison has failed to pay the group some $210 million for power generated since November. Taken together, the group produces 2,400MW of electricity ? enough to power approximately 2.4 million homes. The coalition includes: Caithness Energy, CalEnergy, CalWind Resources, Coram Energy Group, enCco, FPL Energy, Ogden Energy Group, and Wintec. A spokesperson for that group maintains that even if the utilities are driven to bankruptcy, coalition members expect to be paid ?dollar for dollar.?

Brian O'Sullivan, director of wind farm operator Coram Energy Group, says, ?I would much rather work with the private sector than the government.? However, he adds that Edison has not provided Coram with adequate transmission capacity to carry the amount of energy the utility has contracted to buy. ?Edison is 90% of the stress?. O'Sullivan believes that the government's takeover of transmission lines is not a panacea. ?But it will mean a change in the manner in which business is done. The government will make the process an open highway ? and they will make it bigger?.

A matter of hours after Davis made his proposal, a group of natural gas-fired electricity generators that supply 340 MW of power under long-term qualifying facility contracts to Southern California Edison announced the formation of the Southern California Edison Qualified Facility Creditors Committee.

The committee noted that since November 2000, Edison has failed to pay its members more than $100 million for energy provided to the company and its customers, a material breach of contractual obligations. The committee noted that while a major effort has been made by California policymakers to resolve the concerns of out-of-state generators, little has been done to meet the serious problems of in-state generators. Moreover, several member QF generators already have been forced to shut down due to an inability to secure fuel, resulting in an additional reduction in California's severely constrained power supply. The committee includes Berry Petroleum Co, OLS Energy ? Chino, OLS Energy ? Camarillo, Carson Cogeneration Co, Mojave Cogeneration Co, Procter & Gamble Paper Products Co, Sithe Energies Inc. US Borax and Willamette Industries.

California officials said this week that they expect to have 5,000 new megawatts on-line this summer; another 5,000 on-line next summer; and 20,000 by the end of 2004. Most of those facilities will take the form of traditional power plants. But co-generation and distributor generation and renewable energy sources also will be tapped.

A proposed legislative package for distributed generation, co-generation and renewable energy includes rebates, tax credits and commercial loan guarantees for renewal energy programmes going forward. But none of these ambitious initiatives will solve California's lingering and more immediate energy issues.

With the state expecting to supply about one-third of California's needs, and believing that the public sector could negotiate from a better position than the two financially-strapped utilities, the Department of Water Resources recently attracted 37 bids from power suppliers averaging 6.9 cents/kWh ? higher than expectation of 5.5 cents but closer to current retail rates and well below what the utilities had been paying on the spot market. However, that average is misleading as it contains a number of variables, including multiple bids and bids for peak and non-peak usage.

For example, Reliant Energy submitted six proposals for quantities up to 3,500MW. The company emphasised that the rigidity of the bidding terms restricted the amount of power the company could offer at the lowest possible price in its main bid. Still, the company submitted five more proposals.

The proposal Reliant Energy submitted that largely conforms to the qualifications laid out in the request for proposals provides for up to 500MW of on-peak energy. As an alternative, by separating the cost of natural gas from the cost of converting that fuel into electricity, Reliant Energy also included in its proposals offers to provide electric generation capacity at 1.6 cents per KwH for 10 years or 2 cents per KwH for five years, not including the price of natural gas to fuel its power plants. In order to offer this price, the California Department of Water Resources (DWR) would buy the natural gas and Reliant Energy would convert it into electricity. The lower the price at which DWR would be able to secure natural gas, the lower the total cost would be. The company was only able to offer up to 500MW that largely conforms to the bid qualifications because those strict qualifications made it difficult for suppliers to manage fuel cost risks.