PG&E Corp.’s stock price plunged nearly 30% last Thursday to $9.76 and dropped 10% more Friday to end the week at $8.81, following a downgrade of its National Energy Group (NEG) merchant and trading subsidiary to junk by Standard & Poor’s. The downgrade set off ratings triggers in $1.6 billion of NEG obligations.

The activity came after the corporation reported negative earnings for NEG of minus 6 cents/share for the second quarter (compared to 19 cents/share profit for the same quarter last year) and took a writedown of $159 million, or 43 cents/share, on some of its power plant and related trading activity. NEG also took a charge of $61 million, or 16 cents per share, reflecting the cumulative effect of an accounting change adopting a requirement to mark certain power sales and fuel contracts to market in compliance with an interpretation issued by the Financial Accounting Standards Board.

NEG’s CEO Tom Boren told the financial community in a conference call Thursday that the ratings downgrades were driven by the current negative business climate, including depressed forward price curves for power. This carries the double whammy of hurting power supplies not now tied up in long-term contracts, and in making it tough to receive fair market value for asset sales that may be needed to shore up liquidity. S&P also has changed its rating methodology to be tougher, Boren said.

“While we have removed the ratings triggers from the vast majority of our financial agreements, we still have triggers that could be activated after appropriate review periods in various contractual arrangements,” Boren said. “NEG has four categories of obligations that were subject to ratings triggers in the event of a downgrade by one or more of the credit rating agencies to below current levels and below investment grade.”

In the trading area, NEG has about $170 million of exposure opened up by the ratings downgrade, but Boren said the company has sufficient liquidity to cover all of it. Another area covers gas pipeline transportation, surety bonds and storage, which includes some $670 million of obligations that are triggered by the ratings downgrade, he said. “We’re working with counterparties and their lenders to come up with potential solutions.”

Finally, more than half of $1.3 billion in debt obligations tied mostly to new energy plant development have “investment-grade credit rating maintenance requirements,” Boren said. NEG will work with the parties involved to “clear away any technical defaults” that would be triggered by the ratings downgrade.

NEG faces its current financial challenges despite the fact that it had already cut its construction program for this year and next by $2 billion, removed other ratings triggers in other transactions totaling some $1.6 billion, and completed what Boren called “a number of financings” totaling $1.5 billion. The financings included rolling over its still-solidly successful Pacific Northwest interstate pipeline operation’s $125 million revolving loan, and issuing $100 million in notes tied to the gas transmission pipeline operations, which were the only part of NEG to show a profit in the second quarter.

The PG&E non-utility business group also brought into service 1,500 MW of new generation so far this year. “Going forward, however, we’ll take more action,” said Boren, noting the expectation for an oversupply of electricity for several years, depressing spark spreads and returns until forecasted reserve margins are worked off to lower levels that will support new investment.

PG&E Corp.’s overall results showed total net income for the quarter of $218 million, or 59 cents/share, compared to $750 million, or $2.07 per share, in the same quarter last year.

In response to questions, PG&E senior officials indicated there was a complete separation of the NEG finances from the Pacific Gas and Electric Co. utility, which has been in Chapter 11 bankruptcy for the past 16 months. The company collected $366 million in prior uncollected wholesale power and transition costs which it had been required to write off during the energy crisis. Notwithstanding the amounts recovered in recent quarters, the utility’s total uncollected costs remained at $4.7 billion on a pre-tax basis at the end of the second quarter.

NEG’s shaky financial situation will not change the PG&E utility’s current plans to push forward with its reorganization plan, for which creditors will complete their vote Aug. 12. PG&E CEO Robert Glynn said the company has a contingency plan in place and it is in the process of implementing it.

To reflect what its CFO called a “prolonged downturn in the merchant sector,” PG&E lowered its overall earning estimates for 2002 to $2.25-$2.35/share, compared to the $2.50-$2.55/share that was offered earlier in the year.

Standard & Poor’s downgraded NEG’s senior unsecured debt two notches to BB-plus, its highest junk rating, and has the rating on watch for further downgrade. Moody’s rates NEG Baa2, two steps above junk. S&P also announced credit ratings and credit watch revisions to the following PG&E NEG operating units. PG&E Energy Trading Holdings LLC has been placed on Credit Watch Negative and its credit rating revised from BBB+ to BB+. USGen New England Inc. has been placed on Credit Watch Negative and its credit rating has been revised from BBB- to BB+. PG&E Gas Transmission, Northwest Corp. has been placed on Credit Watch Negative and its credit rating has been revised from A- to BBB+.

S&P’s said the downgrades were resulted from adoption of revised “more robust” rating methodologies that are being applied “across the board to this sector” to evaluate credit risk.

Performance on the PG&E NEG’s Northwest natural gas pipeline, which operates almost entirely under long-term contracts, remained solid for the second quarter. The interstate pipeline operations segment of the PG&E NEG contributed 4 cents per share for the quarter, compared with 5 cents per share for the same quarter of 2001.

“I’m [not], and no member of our management team is, one bit satisfied with this earnings performance,” Glynn said. “We know that our investors expect us to deliver even in these difficult times.”

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