PG&E Exits Bankruptcy

By Christopher A. Hilen
[April 2004]

On April 12, 2004, three years after filing for bankruptcy protection, Pacific Gas and Electric Company (PG&E) emerged from bankruptcy as an investment-grade, vertically integrated utility fully subject to the ratemaking jurisdiction of the California Public Utilities Commission (the CPUC). The emergence of the San Francisco-based gas and electric utility that serves northern California concludes the largest, costliest, and most complex utility bankruptcy in U.S. history. PG&E’s emergence from bankruptcy at this time portends a broader return to normalcy for California’s electric industry. Its emergence was made possible by the CPUC’s adoption in December 2003 of a settlement agreement PG&E entered into with CPUC staff in June 2003.

PG&E’s bankruptcy was one of the many adverse consequences of the California energy crisis of 2000-2001, during which the wholesale cost of electricity increased to unprecedented levels and for a significant period exceeded the amount that California’s investor owned utilities could recover through retail rates as a result of the California electric restructuring legislation having “frozen” the retail rates. In early 2001, the CPUC authorized two rate increases for both PG&E and Southern California Edison Company (“Edison”) in the aggregate amount of four cents/kwh to recover future power procurement costs, but prohibited the utilities from using the revenue from the prospective rate increase to repay previously incurred wholesale procurement costs. PG&E filed for bankruptcy protection in April 2001. Edison thereafter entered into a settlement with the CPUC that allowed it to continue to recover in retail rates on a going-forward basis approximately $3.6 billion of its unrecovered past wholesale power procurement costs.

PG&E is emerging from bankruptcy under much different conditions than it proposed in its original plan of reorganization. The initial PG&E bankruptcy reorganization proposal advocated the disaggregation of PG&E’s utility businesses into four separate companies, three of which—hydroelectric generation, nuclear generation, and gas transmission—would have been spun off into separate subsidiaries to operate exclusively under the jurisdiction of the Federal Energy Regulatory Commission (FERC), and thereby escaping regulation by the CPUC. Only PG&E’s gas distribution and electric distribution operations would have remained under CPUC jurisdiction. Former CPUC President Loretta Lynch characterized the original PG&E reorganization plan as a “jail break.”

The CPUC vigorously opposed PG&E’s disaggregation plan and countered with a competing reorganization plan that would preserve CPUC regulation over PG&E’s existing regulated assets. Two years of contentious litigation before the Bankruptcy Court, other federal courts, the FERC, and the CPUC ensued. PG&E ultimately entered into a complex settlement agreement with the CPUC staff in June 2003 providing a means for PG&E to pay all creditors in full in cash and to emerge from bankruptcy with an investment grade credit rating (the “Settlement Agreement”). Following expedited hearings before the CPUC on the proposed Settlement Agreement last fall, the CPUC approved it on Dec. 18, 2003, with certain significant modifications. Although the Settlement Agreement was entered into by CPUC staff, it had to be reviewed and approved by the Commissioners. As approved by the CPUC, the Settlement Agreement provides for the following:

• The use by PG&E of almost $4 billion in accrued overcollections to repay creditors.
  
  
• The addition of a $2.2 billion “Regulatory Asset” to PG&E’s rate base to support the issuance of new debt and provide additional cash and earnings for the company. PG&E will earn a return on the Regulatory Asset, which will be amortized on a mortgage-style basis. The Regulatory Asset will be refinanced through the issuance of bonds securitized by a dedicated rate component (DRC) upon adoption of authorizing legislation by the California Legislature (the Regulatory Asset and the DRC provided the basis for PG&E to obtain an investment grade credit rating that allowed it to issue first mortgage bonds used to repay creditors).
  
  
• A guaranteed minimum return on equity of 11.22 percent on the outstanding balance of the Regulatory Asset using a capital structure with a minimum of 52 percent common equity.
  
  
• With respect to PG&E’s rate base other than the Regulatory Asset, a guaranteed floor on its authorized return on equity of 11.22 percent using a capital structure with a minimum of 52 percent common equity during the nine-year term of the Settlement Agreement or until either S&P confers at least an “A-“ credit rating or Moody’s confers an “A3” rating on PG&E.
  
  
• The Commission “agrees to act to facilitate and maintain investment grade company credit ratings for PG&E.”
  
  
• Continued regulation by the CPUC of PG&E’s power generation and California gas transmission assets.

PG&E emerged from bankruptcy with the $2.2 billion Regulatory Asset in place, but it will be refinanced by lower cost bonds secured by a DRC once the California Legislature adopts authorizing legislation that is currently pending. It is estimated that refinancing the Regulatory Asset with DRC securitized bonds will reduce the costs of the settlement to PG&E ratepayers by approximately $1 billion in financing and tax costs over the nine-year term of the Settlement Agreement.

Davis Wright Tremaine played a key role in securing that $1 billion ratepayer cost reduction. A team of DWT attorneys, including Ed O’Neill, Lindsey How-Downing and Jeff Gray, undertook the lead role in contesting the proposed Settlement Agreement on behalf of the consumer group The Utility Reform Network. They succeeded in persuading the CPUC to modify the terms of the Settlement Agreement to require that PG&E refinance the Regulatory Asset with the lower cost DRC securitized bonds.

The Bankruptcy Court confirmed PG&E’s amended bankruptcy reorganization plan based on the CPUC-approved Settlement Agreement the last week of December 2003. In February and March, 2004, the CPUC approved $800 million in rate reductions and changes to PG&E’s tariff to implement the Settlement Agreement. In March, the CPUC denied rehearing of its decision approving the Settlement Agreement.

In March 2004, Standard & Poor’s and Moody’s Investors Service upgraded PG&E’s credit rating to investment grade. The rating agencies’ upgrades were based on the CPUC’s adoption of the Settlement Agreement which is enforceable by the Bankruptcy Court, the Bankruptcy Court’s approval of the reorganization plan incorporating the Settlement Agreement, the stability of cash flows and operating earnings the Settlement Agreement provides over the next nine years, and PG&E’s improved working relationship with the CPUC evidenced by the Settlement Agreement and the CPUC’s adoption of implementing decisions in February and March. Following the credit rating upgrade, PG&E issued $6.7 billion in first mortgage bonds which it used to repay creditors.

In an unusual development, the two commissioners who opposed the adoption of the Settlement Agreement—Loretta Lynch and Carl Wood—are appealing the Bankruptcy Court’s confirmation of PG&E’s bankruptcy reorganization plan. A motion by Commissioners Lynch and Wood to stay the effectiveness of the reorganization plan, and thereby prevent PG&E from emerging from bankruptcy, was denied by the U.S. District Court on April 9, clearing the way for PG&E’s emergence on April 12.

Although PG&E’s emergence from bankruptcy signals a return to normalcy for California’s energy industry, it occurs amid significant regulatory uncertainty over the role of California’s load serving utilities in the generation and procurement of electricity. That regulatory uncertainty, coupled with the heavy debt load of non-utility power producers, continues to impede the development of needed additional power plants in California. These regulatory issues are addressed in a companion Advisory Bulletin.

Published by Davis Wright Tremaine's Energy Law Group

Any questions about this Advisory should be directed to:

Steven F. Greenwald, San Francisco, (415) 276-6528, stevengreenwald@dwt.com

This Energy Advisory is a publication of the Energy Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in energy law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

Copyright © 2004, Davis Wright Tremaine LLP.

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