With a competing reorganization plan by state regulators now formally filed in Pacific Gas and Electric Co.’s year-old Chapter 11 bankruptcy case, it is clearer that the quickest, least-legally exhausting solution is a mediated settlement, and that may be the ultimate trump card if both sides are correct in their assessment of the insurmountable legal obstacles facing their opposing positions.

Even before the filing Monday by the California Public Utilities Commission in a federal bankruptcy court in San Francisco, the PG&E utility was already challenging part of the plan calling for elimination of the utility’s authorized return on equity as being in violation of federal and state laws. And the lead attorney for the CPUC was categorically declaring that the utility’s proposed reorganization was flatly “illegal and never going to happen.”

Analysts at Credit Suisse First Boston reacted Tuesday with a settlement prediction, saying they doubt the court will confirm the CPUC alternative plan given its added debt/equity financing. “We believe both sides are posturing and that a negotiated settlement continues to be a likely outcome,” said Scott Pearl, an analyst at CSFB, which is predicting that the “tone” among the utility, regulators and creditors will be shown in the April 24 status conference on the CPUC’s plan, which will have a formal court hearing May 3.

Between the rhetoric by CPUC officials in announcing their alternative plan last Monday, the presenters, including one of the CPUC commissioners in attendance, several times made it clear that the regulators would prefer a settlement, which has an ongoing, albeit confidential, low-key process in mandated mediation ordered several months ago by Bankruptcy Judge Dennis Montali.

While noting a confidentiality restriction on giving any details of the mediation process, the CPUC’s Chief Counsel Gary Cohen said the parties have met, and they intend to meet again now that the CPUC’s alternative plan is filed. “I am hopeful we can reach an agreed-upon solution to PG&E’s situation, because the commission certainly feels that a consensual solution would be better than a litigated solution.”

“The CPUC’s second attempt to develop an alternative bankruptcy plan is no more practical or confirmable than their first plan,” said PG&E in a prepared reaction statement issued late in the day last Monday. “Admitting that their first effort fell $4.5 billion short, their second attempt seeks to close that gap by issuing billions in new debt and through a scheme to issue stock in the utility to raise cash. We believe the CPUC’s plan could not be confirmed or implemented.

“More than a year late, the commission finally recognizes the need to have investment grade utility companies so that the state can exit the procurement business. Yet their plan makes none of the fundamental regulatory commitments needed to achieve or assure investment grade status.”

Chiding the regulators for the proposal to eliminate utility return on equity through 2003, PG&E said employees and small investors would be “greatly harmed,” and it added that the CPUC had already by its actions in the past two years “decimated” the investments of utility investors.

Undeterred, Cohen said the regulatory commission’s proposal — approved by a 5-0 vote in closed executive session — has had positive reaction from creditors, including the official creditors’ committee, and positive reaction from Wall Street, which would have to market new issue of PG&E utility stock (not the holding company’s) and almost $4 billion in additional debt on top of the $11 billion the state still expects to take to market later this year.

“It (our plan) is a surer, sooner bet from the creditors’ point of view,” Cohen said. “Most of the creditors are getting cash so they are not concerned about the utility’s longer-term credit rating.”

Under questioning, the CPUC officials noted that the “investment grade” rating their plan envisions for PG&E’s utility would be at the bottom level of that category based on Standard and Poor’s and Moody’s ratings.

Adding additional debt and equity, the regulators’ proposal would use a combination of cash-on-hand ($2.7 billion), deferred dividends ($1.6 billion), new common utility stock ($1.75 billion) and the rest refinanced or new debt to pay off more than $13 billion owed by the utility to creditors.

The CPUC plan includes the following:

PG&E has maintained that the best way to bring the utility back to creditworthiness, pay off all creditors and not have rate increases is for the non-distribution electric and natural gas assets to be spun off into three separate non-utility subsidiaries of the parent company — power generation, power transmission, and gas transmission pipeline/storage. Company officials have been extremely critical of the regulators alternative as being too unrealistic and too costly.

Two parts of the utility’s plan the CPUC contends would adversely affect ratepayers — one is a estimated $8.6 billion in higher generation rates over 10 years (based on market, rather than cost-based, factors) if the assets are moved to a nonutility subsidiary, and nearly $5 billion in what the regulators’ estimated are below-market value for the total assets that would be transferred under the PG&E plan.

“When PG&E comes out of bankruptcy, which we calculate to be the end of January next year, its financial ratio (debt-equity) will meet the financial criteria of an investment grade utility, and that would allow it to resume buying power for its customers the end of January 2003,” Cohen said.

In response to questions, Cohen said that the CPUC plan has not been shown to Wall Street rating agencies, but generally the regulators have reviewed the broad aspects of it and got a positive response. The CPUC now will talk with the rating agencies about the specific plan it filed with the bankruptcy court. Under state law passed last year, the utilities are to be returned to cost-of-service rates, which will commit regulators to assure that wholesale power costs are fully covered in retail rates in the future, said Cohen in response to another question.

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