Energy Stocks Take Beating Over California Crisis

Energy stocks took a pounding yesterday mainly in reaction to continuing uncertainty over the financial health of California's two largest utilities, Southern California Edison and Pacific Gas and Electric, which got a weak short-term prescription by state regulators (see related story this issue).

The California Public Utility Commission approved a 1 cent/kWh rate increase for the two utilities for 90 days, but credit rating agencies and the utilities themselves said it was not enough. Fitch lowered the credit ratings of the utilities' securities to junk bond status, below investment grade. Standard and Poor's lowered its ratings to one notch above speculative grade and said a further downgrade was possible unless the state legislature, which is in a special session, steps in to save the utilities from bankruptcy.

The sickness infecting California's energy market even spread to the share prices of energy companies with no exposure at all to California. Share prices for KeySpan Corp., a New York gas utility, dropped 9% to $36.31. Shares of NiSource, one of the largest eastern combination utility companies, fell 7% to $27.12. Utilicorp, an energy marketer and combination utility company in the Midcontinent region, saw its share prices plummet 11% to $26. In comparison, share prices of Edison and PG&E, which may declare bankruptcy following yesterday's small interim rate hike granted by regulators, dropped by 12% and 30%, respectively.

"I've had better days," said UBS Warburg Energy Analyst Ronald J. Barone. "All the major marketers have significant reserves in the event of a bankruptcy. I don't think it's that much of a major impact upon the marketers. I tend to think the market is overreacting. You've got Coastal down 7%, El Paso down 6%. Equitable, which doesn't do any business in California, is down 4%. I just think it's indiscriminate wholesale selling. I think California is probably 80% responsible." He noted that gas futures were up yesterday despite forecasts of warm weather. "I do expect a rebound but whether that happens tomorrow or two weeks down the road I just don't know."

In a hastily-called teleconference yesterday morning prompted by a sharp 20% drop in its share price, Dynegy officials said the company's financial exposure to the potential train wreck in the California power market is "insignificant" in its overall financial picture. Following the Dynegy conference call, the company's share price regained a lot of the ground it had lost initially but still settled down $3, or about 6%, to $45.75/share.

Duke Energy also said its exposure was minimal, stating that 90% of its generation in California has been sold forward to a "diversified portfolio of non-utility buyers, who have strong balance sheets and good credit ratings." In addition, Duke said it has credit limits and collateral agreements in place. It has some longer-term contracts with the regulated California utilities at attractive prices but believes its credit practices have positioned it well in the event of credit failure.

"There's a big misconception and some misreporting on our California exposure," said Dynegy President Steve Bergstrom. "Our exposure is 10-12% of our margin for 2001. Even in the bankruptcy scenario, that doesn't go away. In fact, the bankruptcy exposure is really limited to a 60- to 90-day receivable." He said the potential impact would be in "cents per share rather than nickels per share."

Bergstrom noted that in the fourth quarter Dynegy did not run its California power plants very much because of required maintenance. He also noted that Dynegy's exposure is limited by its partnership with NRG. "Our earnings from California for the fourth quarter were relatively small," he said.

The company's remarks on California, however, contrast significantly with the dire predictions Dynegy made to the Federal Energy Regulatory Commission (FERC) in December. In an emergency motion regarding the utilities' creditworthiness, Dynegy told FERC it could "incur $10 million per day in short-run variable costs that the utilities say they are unable to pay. This is not a sustainable situation," Dynegy said. "If generators are required to continue incurring such high out-of-pocket costs to provide power to the state of California with no real prospects of recovery, the result will be not only an unconstitutional taking but ultimately the collapse of the entire supply chain.

"At some point, the financial flood of red ink would sweep even more broadly towards numerous companies up the supply chain, including fuel suppliers, seller of emissions credits, lenders, service providers and equipment vendors, seriously affecting the economy of the Western Interconnection and perhaps the nation."

In the conference call yesterday, however, Dynegy officials downplayed the potential impact on the major generators and marketers, saying all the generators in the state would get "credit deals in a bankruptcy scenario to get paid for future power, and [the utilities] are going to need the same amount of power that they needed last year.

"If you look at the forward prices in California for the third quarter they are $270 to $300/MWh. That tells you the market is going to continue to be short. Even in a bankruptcy scenario they are going to continue to pay us value for the power," said Bergstrom. If the California utilities do go bankrupt it's not a matter of "if but when generators will collect their money."

Dynegy said it expects to significantly beat its fourth-quarter earnings estimates of 22 to 25 cents per share, and should hit the upper range of estimates for 2001 because of its diversified portfolio of assets and activities.

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