Sempra Unit Pulls in Profit, and Scrutiny

While the state’s two largest utilities, Pacific Gas & Electric Co. and Southern California Edison Co., are struggling for survival, the parent of San Diego Gas & Electric Co. is racking up record profit from the state’s energy crisis, thanks in part to a subsidiary that buys and sells energy on the wholesale market.

In the last 18 months, Sempra Energy’s trading subsidiary has raked in $310 million in profit. That’s $120 million more than the sum Sempra paid for the trading outfit 3 1/2 years ago. And analysts expect profit to climb higher as the trading arm continues to take advantage of volatile energy markets in California and across the United States.

The trading activities of San Diego-based Sempra are drawing increasing scrutiny from regulators and consumer watchdogs who question why the state is doling out attractive energy contracts to a company that already is flush with cash. Records recently revealed that a Sempra power generator sold all its capacity at attractive prices over an extended period to the California Department of Water Resources, which has been procuring power for the state’s largest utilities.

“Sempra has become like the multimillionaire that refuses to tip,” said Michael Shames, executive director of the Utility Consumers’ Action Network in San Diego. “There seems to be a fundamental violation of the principle of fairness whereby Sempra’s trading arm is hugely profitable at the expense of consumers.”

Sempra insists its trading business is a worldwide operation that deals in not just electricity but oil, gas and other commodities. Only a small portion of the trading unit’s profit comes from California and the Western region, said company spokesman Doug Kline.

State records revealed this month that Sempra Energy Trading--and several other wholesale electricity merchants--charged California some of the highest prices for electricity during the first three months of the year. Sempra officials say they were only procuring power for the state when supplies were critically low, but critics want Sempra to refund the alleged overcharges.

Separately, Sempra is battling lawsuits that it conspired with several gas and pipeline companies to eliminate competition, drive up natural gas prices and discourage the construction of electricity generating plants in California.

Sempra’s activities have come under scrutiny because critics say its trading subsidiary was influential in driving wholesale electricity prices to levels that helped ignite California’s energy crisis. These high prices helped saddle its own SDG&E;, PG&E; and Edison with billions of dollars in debt.

PG&E; and Edison also have energy-trading businesses, though they are not as lucrative as Sempra’s.

California’s 1996 deregulation law created a competitive marketplace where more than 100 energy traders now buy and sell electricity. Energy traders serve as middlemen, buying power from generators and reselling them to utilities and commercial power users. Some middlemen are connected to firms that own power plants, but others are speculators, such as Morgan Stanley Capital Group.

Traders may buy a block of electricity a day, month or year ahead of time and resell it to another broker, a city or a utility. In California’s energy crisis, a single electron might be traded a dozen times before it reaches a ratepayer’s home.

Sempra acquired a trading unit when it bought American International Group Inc. for $190 million in 1997. Sempra Energy Trading earned $13 million in 1998 and $19 million the next year.

As the energy crisis exploded, Sempra Energy Trading’s profit soared to $155 million in 2000. For the first two quarters of this year, the trading unit has accounted for $155 million in profit.

Critics say Sempra can maximize profit for its trading arm--and various other business units--by knowing the direction of the market.

For example, if executives in Sempra’s trading arm know that its sister subsidiary, Southern California Gas Co., is planning to buy large supplies of gas for storage, they could structure their trades to take advantage of anticipated higher prices, consumer watchdog groups say.

“What you have is a back-room, cottage industry for information whereby affiliates and generators of the same holding company secretly trade in a market that they have been able to manipulate to exact exorbitant profits at the expense of those customers who don’t have access to that information,” Shames said. “It’s classic insider trading for which people like Michael Milken served time in jail, and yet these holding companies get to build palaces.”

Sempra and its subsidiaries have denied allegations of insider trading and insist that all of the company’s activities have been legal. Strict Public Utilities Commission rules prohibit Sempra from sharing information among its business units, said Chairman and Chief Executive Stephen L. Baum.

Baum, however, acknowledged that it isn’t “particularly healthy” for Sempra’s trading arm to sell electricity in the California market, where purchases by the state are eventually billed to SDG&E; ratepayers.

“I don’t like being embarrassed to announce earnings in some of my business units of Sempra because people are suffering in San Diego in the electricity crisis,” Baum said. “That’s not a healthy corporate situation.”

Baum has hinted that the parent company might decide to spin off Sempra Energy Trading or other business units to create shareholder value and avoid perceived conflicts of interest.

For now, the parent company is contesting allegations that Sempra’s business units are cashing in on insider knowledge.

In a recent filing with the state Public Utilities Commission, a group of primarily municipal generators detailed how the Gas Co. may have acted to drive up the price of gas for customers so it could rake in additional profit.

In mid-2000, the gas utility paid $16.5 million for option contracts that entitled it to buy gas at the end of the year. The contracts gave the Gas Co. an incentive to buy “abnormally high” volumes of gas at the California border during the winter months, said Norman Pedersen, an attorney for the Southern California Generation Coalition.

High border purchases by the Gas Co. drove up border prices, Pedersen said, allowing the utility to take in $70 million from the deal.

The Gas Co. has vigorously denied that the $70-million gain was related to California border transactions.

“Customers were not only protected by, but directly benefited from [our] . . . options programs,” the utility’s lawyers said in a response filed with the PUC.

Under a state incentive program that rewards utilities for keeping costs down, the Gas Co. is required to split savings--such as the $70 million--50-50 with ratepayers whenever the company’s gas costs fall slightly below market levels. Because the Gas Co. has consistently beaten the market, those savings have multiplied nearly tenfold during the state’s power crisis.

Pedersen’s clients, which include the Los Angeles Department of Water and Power, want the PUC to reconsider the incentive program, saying that it “may have contributed to recently disproportionately high border prices” and higher gas costs.

Last month, the Gas Co. told the PUC it would accept only $30 million of the $106 million it was due under the state incentive program. In return the state must agree to continue the incentive program, according to the Gas Co. proposal.

Analysts who follow Sempra’s stock, which is trading near its 52-week high, said Sempra is being unfairly targeted for being successful.

Merrill Lynch energy analyst Donato Eassey said Sempra moved more quickly than PG&E; and Edison to take advantage of the state’s law that deregulated California’s energy market and invested the proceeds in trading and other profitable operations.

“There is nothing illegal about making profits,” said Eassey, who recently upgraded Sempra’s stock to “buy.” “People in California need to pay the damn bill and shut up.”