State Inches Ever Closer to Losing Control

WASHINGTON —  As California has slipped ever deeper into its electricity crisis, Gov. Gray Davis has calmly repeated a three-part mantra: Everything possible will be done to keep the state’s two big utilities from going bankrupt; consumers will not pay a penny more for their power, and Sacramento will not be party to any kind of corporate bailout.

But by late Tuesday, the state had moved several giant, perhaps irrevocable, steps closer to all three outcomes, and was on the verge of losing much of the control it once exercised over its energy future.

Southern California Edison, the state’s second-biggest utility, acknowledged in federal securities filings that it was skipping payments due Tuesday and was close to going bust. Pacific Gas & Electric Co. said in similar filings last week that it is not far behind.

Legal experts and national credit rating agencies warned that if either or both of the companies went over the financial edge, California could end up at the mercy of a federal bankruptcy judge who could effectively mandate the kinds of consumer rate hikes and bailouts that Davis had pledged would never occur.

“The bankruptcy law gives the utilities the power to beat the tar out of their creditors,” said Harvard bankruptcy expert Elizabeth Warren. “But once they do, it’s very hard for a state not to approve the rate hikes or whatever else it takes to make a bankruptcy reorganization work.

The Scramble for a Solution

“I mean, what else do they have in mind? To have the electric fairy come in and produce power for free?”

Tuesday’s rush of events followed a breakdown of talks among the state and federal governments, the beleaguered utilities and the state’s major power suppliers late Saturday, and a scramble since then in Sacramento to come up with a workable plan for the state to help the utilities by buying cheap power and reselling to the firms.

Davis and others continued to assert that their efforts were going well. But developments far beyond Sacramento appeared to be moving very distinctly against the state.

Sources close to the now-suspended talks between federal and state officials suggested that divisions at Saturday’s session were so deep that it appears unlikely the state will ever be able to buy power for its proposed 5 1/2 cents per kilowatt-hour. According to Davis, that is the most the state is willing to pay, and the most that independent experts have said could be charged without raising rates to consumers.

Those sources, who spoke only on condition that they not be identified, said power supply executives who participated in the weekend talks told the governor the best they could offer was 6 1/2 to 7 1/2 cents per kilowatt-hour. And even that price would come with strings attached, they said.

The state would have to sign 10-year contracts, something that state officials and consumer advocates charge would lock in high prices long after they were justified. And the price would apply only to power during periods of average demand, which one supplier estimated would cover about one-third of Edison’s and PG&E;’s combined needs. The price for “on-call” power required during periods of peak demand would be substantially higher, they said.

“Fundamentally, the parties agreed the numbers did not work,” said one federal official who participated in the talks.

As if the division over prices were not enough, another gulf appeared to be opening Tuesday, this one between Sacramento and Wall Street.

Financial experts greeted with derision the utility overhaul measure introduced in the state Legislature late in the day. Merrill Lynch & Co. analyst Steve Fleishman called the bill “skeletal” and “disappointing.”

“A lot of the detail that people need to feel comfortable is just not there. The bill says nothing at all about . . . the near-term liquidity issues,” Fleishman said, referring to the fact that the utilities are almost out of cash.

There was still more bad news for the state. Analysts said the timing of Edison’s decision to skip almost $600 million in payments due Tuesday hinted at how complicated a decision by the utility to go bust would be.

Edison acted although by its own account it still has almost $1.2 billion on hand, enough to pay its immediate bills. Bankruptcy experts said the decision signals that Edison lawyers believe the utility will not receive the kind of treatment that keeps other, more conventional firms operating under court protection.

In more conventional cases, courts encourage banks to resume lending to troubled companies under bankruptcy protection by stopping past lenders from collecting on old debts, and by promising new lenders that their debts will be the first to be paid.

But Edison is unlikely to receive that kind of treatment because the firm not only has old debts, it also incurs new ones every time it buys additional power. New lenders are unlikely to take much comfort from a court-ordered promise that they would be the first in line to be paid today, because someone else is likely to move to the head of the line tomorrow.

“Somebody else is going to have to help, and the somebody is going to be the state,” said John B. Nolan, a Hartford, Conn., lawyer who played a central role in one of the biggest utility bankruptcies of recent years, that of Public Service Co. of New Hampshire.

“I’ve never liked the term ‘bailout,’ ” said Kenneth N. Klee, a UCLA law professor who was involved in the Public Service Co. case. In the end, investors and bondholders will have to pay much of the cost of an Edison or PG&E; bankruptcy, he said, but “the state will wind up stepping up” too.

Finally, with Edison, and perhaps PG&E;, moving closer to bankruptcy, the state faced for the first time the prospect of losing what little control it still has over its energy future.

Although state officials and some commentators have said in recent weeks that bankruptcy filings might leave Sacramento’s influence largely undimmed, a bond rating agency strongly disagreed. And a close look at the New Hampshire case suggests that the optimistic assessment is largely unfounded.

Edison’s Bonds Given ‘Junk’ Status

An Edison bankruptcy “would reduce the role of the governor, the Legislature and the CPUC, as all substantive actions would be under the direction of the bankruptcy court,” Moody’s Investors Service, one of the nation’s two major credit-rating agencies, warned as it downgraded $9.3 billion of Edison’s bonds to “junk” status.

“If anything,” Moody’s said, a bankruptcy “would greatly complicate the state’s power problems.”

It would “likely cause customers’ rates to increase above the current levels and . . . [make] rolling brownouts a common occurrence for some period of time.”

Analysts said the prospect of such dire consequences probably would encourage a bankruptcy judge to use the full limits of his or her authority to ensure that the utilities keep operating and the power keeps flowing. Several cited the Public Service Co. case in arguing that doing so could very well require huge rate hikes of consumers.

In that case, New Hampshire’s major utility went broke after running up multibillion-dollar bills constructing the Seabrook nuclear power plant. Federal bankruptcy Judge James Yacos did not mandate rate hikes. But analysts said he presented New Hampshire officials with an offer they couldn’t refuse: All the other parties had agreed to keep the utility going, but only if the state would swallow a big rate hike. The state had to choose between accepting the bargain or becoming the spoiler.

“Yacos actually wrote an opinion that said a bankruptcy judge could set rates all by himself,” said Nolan, the Hartford lawyer who represented Northeast Utilities, which ultimately bought Public Service Co. “That never got implemented. But it shook people up so much” that everyone finally agreed to a settlement.

The cost to New Hampshire consumers, according to Nolan: a seven-year rate hike of 7.5%, a far bigger bite than the 90-day, 9% increase approved by California authorities.

“You had a situation that was a lot like what Davis faces,” Nolan said. “You had consumers who didn’t want to pay for what they perceived to be somebody else’s mistakes, and a company that had done things with the express approval of the state.”

Everybody had to kick in to resolve the New Hampshire bankruptcy, Nolan said. And everybody is going to have to do the same in California, he predicted.

“I don’t see how Gray Davis thinks he’s going to keep the electricity flowing without raising rates and helping to pay off the old debts,” he said.

*

Times staff writer Richard Simon in Washington contributed to this story.