The volatility in the California energy market finally spilledover into the stock market last week. The uncertainty over thefinancial health of California’s two largest utilities, SouthernCalifornia Edison and Pacific Gas and Electric, triggered panic onWall Street over the potential impact on many other energycompanies and even some utility lenders.
Energy stock prices fell sharply during the middle of the weekand then regained some ground on Friday after several majornonutility generators with relatively large positions in Californiastated publicly that they would feel little or no ripple effectfrom the downfall of two major utilities.
The utilities at the center of it all got a weak short-termprescription for their terminal illness on Thursday when theCalifornia Public Utility Commission approved a 90-day, 1 cent/kWhsurcharge to help them begin to recover $11 billion in overpaymentsfor wholesale power.
Credit rating agencies said the surcharge probably would not beenough to prevent insolvency. Fitch lowered the credit ratings ofthe utilities’ securities to junk bond status, below investmentgrade, while Moody’s and Standard & Poor’s were somewhat morerestrained, lowering ratings to a notch above junk grade. BothMoody’s and S&P, however, said a further downgrade was possibleunless the state legislature, which is in a special session, stepsin to save the utilities from bankruptcy with a rate hike and/orspecial bond deal. The downgrades could shut the utilities out ofdebt capital markets, leaving them to rely on the state forfinancial relief.
S&P excluded PG&E’s Transmission Northwest unit andSoCal Ed’s Mission Energy from the downgrading, affirming thecurrent ratings of those units. Also, Transmission Northwest willtake the place of PG&E Corp. as the backer of its holdingsgroup 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 thatcosts are being passed through to customers of subsidiary San DiegoGas & Electric.
Investors pondered the potential implications for the energygroup as a whole and even the nation’s economy. Even the shareprices of energy companies with little or no exposure to theCalifornia crisis were hit hard. Big oil companies fell sharplyWednesday. Share prices for KeySpan Corp., a New York gas utility,dropped 9% Thursday to $36.31. Shares of NiSource, one of thelargest eastern combination utility companies, fell 7%. Utilicorp,an energy marketer and combination utility company in theMidcontinent region, saw its share prices plummet 11%. Incomparison, share prices of Edison and PG&E dropped by 12% and30%, 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 RonaldJ. Barone on Thursday. “All the major marketers have significantreserves in the event of a bankruptcy. I don’t think it’s that muchof a major impact upon the marketers. I tend to think the market isoverreacting.
“You’ve got Coastal down 7%, El Paso down 6%. Equitable, whichdoesn’t do any business in California, is down 4%. I just thinkit’s indiscriminate wholesale selling. I think California isprobably 80% responsible.” He noted that gas futures were upThursday despite forecasts of warm weather. “I do expect a reboundbut whether that happens tomorrow or two weeks down the road I justdon’t know.”
The energy companies even publicly downplayed the impact of theCalifornia crisis on the broader energy market. Some generatorsindicated bankruptcy might not be a bad idea because it wouldguarantee eventual payment of the high energy costs.
In a hastily-called teleconference Thursday morning prompted bya sharp 20% drop in its share price, Dynegy officials said all thegenerators in the state would get “credit deals in a bankruptcyscenario to get paid for future power, and [the utilities] aregoing to need the same amount of power that they needed last year.
“If you look at the forward prices in California for the thirdquarter they are $270 to $300/MWh,” said Dynegy President SteveBergstrom. “That tells you the market is going to continue to beshort. Even in a bankruptcy scenario they are going to continue topay us value for the power,” he said. If the California utilitiesdo go bankrupt, it’s not a matter of “if but when generators willcollect their money.”
He said Dynegy’s financial exposure to the potential financialtrain wreck is “insignificant” in its overall financial picture.”There’s a big misconception and some misreporting on ourCalifornia exposure. Our exposure is 10-12% of our margin for 2001.Even in the bankruptcy scenario, that doesn’t go away. In fact, thebankruptcy exposure is really limited to a 60- to 90-dayreceivable.” 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 runits California power plants very much because of requiredmaintenance. He also noted that Dynegy’s exposure is limited by itsgeneration partnership with NRG.
Financial Flood of Red Ink
The company’s remarks on California, however, contrasted sharplywith the dire predictions Dynegy made to the Federal EnergyRegulatory Commission (FERC) in December. In an emergency motionregarding the utilities’ creditworthiness, Dynegy told FERC itcould “incur $10 million per day in short-run variable costs thatthe utilities say they are unable to pay. If generators arerequired to continue incurring such high out-of-pocket costs toprovide power to the state of California with no real prospects ofrecovery, the result will be not only an unconstitutional takingbut ultimately the collapse of the entire supply chain,” thecompany said. “At some point, the financial flood of red ink wouldsweep even more broadly towards numerous companies up the supplychain, including fuel suppliers, seller of emissions credits,lenders, service providers and equipment vendors, seriouslyaffecting the economy of the Western Interconnection and perhapsthe nation.”
In its conference call last week, however, Dynegy said itexpects to significantly beat its fourth-quarter earnings estimatesof 22 to 25 cents per share, and should hit the upper range ofestimates for 2001 because of its diversified portfolio of assetsand activities and its minimal exposure to the California crisis.Bergstrom was careful to note that although Dynegy is not likely tosuffer from California’s problems, it also is not likely to profitsignificantly. Its earnings growth is coming from other areas suchas gas and propane sales and power generation sales in otherstates.
Following the Dynegy conference call, the company’s share priceregained a lot of the ground it had lost initially but stillsettled 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 inthe state, watched its share price decline from the mid $80s lastmonth to the low $70s last week. On Thursday, the company alsopublicly announced that its exposure to the crisis was minimal.Duke said 90% of its generation in California has been sold forwardto a “diversified portfolio of non-utility buyers, who have strongbalance sheets and good credit ratings.” In addition, Duke said ithas credit limits and collateral agreements in place. It has somelonger-term contracts with the regulated California utilities atattractive prices but believes its credit practices have positionedit 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 throughoutnorthern California generating over 1,200 MW of electricity. OnFriday, Calpine increased its diluted earnings per share estimatesfor the quarter and year ended Dec. 31 to $0.30 and $1.05 pershare, respectively. The company’s stock price was up nearly 10% to$35.62 by mid-day on Friday after having dipped below $30/share onThursday.
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