California Crisis Sends Ripples Across Wall Street

The volatility in the California energy market finally spilled over into the stock market last week. The uncertainty over the financial health of California's two largest utilities, Southern California Edison and Pacific Gas and Electric, triggered panic on Wall Street over the potential impact on many other energy companies and even some utility lenders.

Energy stock prices fell sharply during the middle of the week and then regained some ground on Friday after several major nonutility generators with relatively large positions in California stated publicly that they would feel little or no ripple effect from the downfall of two major utilities.

The utilities at the center of it all got a weak short-term prescription for their terminal illness on Thursday when the California Public Utility Commission approved a 90-day, 1 cent/kWh surcharge to help them begin to recover $11 billion in overpayments for wholesale power.

Credit rating agencies said the surcharge probably would not be enough to prevent insolvency. Fitch lowered the credit ratings of the utilities' securities to junk bond status, below investment grade, while Moody's and Standard & Poor's were somewhat more restrained, lowering ratings to a notch above junk grade. Both Moody's and S&P, however, said a further downgrade was possible unless the state legislature, which is in a special session, steps in to save the utilities from bankruptcy with a rate hike and/or special bond deal. The downgrades could shut the utilities out of debt capital markets, leaving them to rely on the state for financial relief.

S&P excluded PG&E's Transmission Northwest unit and SoCal Ed's Mission Energy from the downgrading, affirming the current ratings of those units. Also, Transmission Northwest will take the place of PG&E Corp. as the backer of its holdings group trading operations. These units, S&P said, were "fenced" off, legally and structurally from actions of the parent companies. S&P also affirmed the ratings of Sempra Energy, saying that costs are being passed through to customers of subsidiary San Diego Gas & Electric.

Investors pondered the potential implications for the energy group as a whole and even the nation's economy. Even the share prices of energy companies with little or no exposure to the California crisis were hit hard. Big oil companies fell sharply Wednesday. Share prices for KeySpan Corp., a New York gas utility, dropped 9% Thursday to $36.31. Shares of NiSource, one of the largest eastern combination utility companies, fell 7%. Utilicorp, an energy marketer and combination utility company in the Midcontinent region, saw its share prices plummet 11%. In comparison, share prices of Edison and PG&E dropped by 12% and 30%, respectively, on Thursday, continuing massive declines to near $10/share from 52-week highs above $30.

"I've had better days," said UBS Warburg Energy Analyst Ronald J. Barone on Thursday. "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 Thursday 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."

The energy companies even publicly downplayed the impact of the California crisis on the broader energy market. Some generators indicated bankruptcy might not be a bad idea because it would guarantee eventual payment of the high energy costs.

In a hastily-called teleconference Thursday morning prompted by a sharp 20% drop in its share price, Dynegy officials said 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," said Dynegy President Steve Bergstrom. "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," he said. If the California utilities do go bankrupt, it's not a matter of "if but when generators will collect their money."

He said Dynegy's financial exposure to the potential financial train wreck is "insignificant" in its overall financial picture. "There's a big misconception and some misreporting on our California exposure. 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 short-term 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 generation partnership with NRG.

Financial Flood of Red Ink

The company's remarks on California, however, contrasted sharply 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. 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," the company said. "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 its conference call last week, however, 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 and its minimal exposure to the California crisis. Bergstrom was careful to note that although Dynegy is not likely to suffer from California's problems, it also is not likely to profit significantly. Its earnings growth is coming from other areas such as gas and propane sales and power generation sales in other states.

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 for the day Thursday. Its shares were up 5% by mid-day Friday to $47.75.

Duke Energy, another one of the unregulated power producers in the state, watched its share price decline from the mid $80s last month to the low $70s last week. On Thursday, the company also publicly announced that its exposure to the crisis was minimal. Duke said 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.

Also displaying no ill effects from the crisis was San Jose, CA-based Calpine Corp., which operates 26 power plants throughout northern California generating over 1,200 MW of electricity. On Friday, Calpine increased its diluted earnings per share estimates for the quarter and year ended Dec. 31 to $0.30 and $1.05 per share, respectively. The company's stock price was up nearly 10% to $35.62 by mid-day on Friday after having dipped below $30/share on Thursday.

Rocco Canonica

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