Power Price Spike Sends Edison Into Quagmire of Debt.

As power prices on the open market have skyrocketed this summer, Southern California Edison is going deeper and deeper into debt -- completely wiping out recent gains in the company's stock price.

Edison has racked up more than $1 billion in "under-collections," in which it cannot recover from its customers the full cost of buying power.

That's because in the last three months, the average price of power on the open market has run four to five times last summer's levels, but the rate Edison charges its customers has stayed frozen thanks to provisions in the 1996 state law deregulating the state's electric utility industry.

This revenue shortfall has forced the utility and its parent company, Edison International, to postpone paying off $1.15 billion in remaining debt in preparation for full deregulation of the state's electricity market; the shortfall is in fact adding to that debt month by month.

This in turn has prompted Wall Street rating agencies to place the firm on watch for a possible credit rating downgrade. The stock closed on Sept. 20 at $21.94, the same level it was trading at the end of August. (The stock had run up afterward in response to an announcement by billionaire investor Warren Buffet that he had made an investment in Edison.)

"If this under-collection continues, Edison is going to face liquidity pressure (a cash shortage)," said Lori Woodland, director of global power ratings for Fitch Inc., formerly Fitch Investor's Service. "The leverage is rising each month and the cash-flow situation is tightening."

Indeed, according to Edison spokesman Gil Alexander, the company's debt had increased $350 million to $1.5 billion by the end of July. And because wholesale power prices have continued to rise since then, the total debt has undoubtedly increased by several hundred million more.

Unofficial outside estimates say that when the higher August and September wholesale power prices are factored in, the under-collections have totaled about $1.1 billion -- effectively doubling Edison's debt during a period in which the utility was supposed to be paying it down.

This under-collection could threaten the company's long-term stock performance, as investors mull the slight but distinct possibility that some debt will have to be written off.

But the impact may spread far beyond Wall Street. Edison's business and residential customers could find themselves being hit with higher power bills, possibly before full deregulation kicks in on March 31, 2002.

PG&E's test case

On that front, much depends on what happens with Pacific Gas & Electric, the giant utility serving Northern California. PG&E has been even harder hit by this under-collection crisis than Edison, racking up $700 million in under-collections a month, or $2.2 billion since mid-June. In the last two weeks, in response to downgrade warnings similar to those targeting Edison, PG&E's stock tumbled 28 percent to $22.81 a share at the Sept. 20 close.

PG&E officials have mounted an aggressive and very public campaign to persuade state regulators to allow them to lift the rates it charges to customers before the March 31, 2002 deadline. Under the 1996 deregulation law, rates for customers at PG&E, Edison and San Diego Gas & Electric must remain frozen at June 1996 levels until all of the utilities' debts are paid off or March 31, 2002, whichever comes first.

SDG&E, which is the smallest of the three utilities, finished paying off its debts this spring, ending the rate freeze for SDG&E customers. Throughout the summer, residents and businesses in San Diego and southern Orange counties have been paying full market prices for power and have seen their bills triple or even quadruple. This has caused a huge political backlash and has also prompted calls for the repeal of the law deregulating California's electric utility industry.

PG&E Chief Executive Gordon Smith was quoted last week as saying he wants to spread out a rate hike over a longer period of time, rather than hitting customers all at once in April 2002, like what happened to SDG&E customers this summer. But to do so would mean starting to increase rates by next spring, and that would require a change in the deregulation law.

Electricity market observers and consumer advocates believe that if the state Public Utilities Commission grants PG&E permission to lift rate caps early, similar permission would probably also be given to Southern California Edison.

"If the PUC lifts the rate freeze for PG&E, that would seem to be a powerful argument to grant Edison the same deal," said Dan Nix, deputy director of the energy information and analysis division of the California Energy Commission.

Extending the deadline

For now, though, Edison officials are taking a different tack. They have been publicly mum on the issue of lifting the rate freeze early; instead, they are lobbying state officials to extend the March 31, 2002 deadline, to allow for more time to pay off Edison's debts.

"That's the most palatable solution, to extend the rate freeze," said Arthur O'Donnell, editor and associate publisher of the Bay Area-based California Energy Market newsletter. "But that will only work if prices go down in a couple of years. If they stay higher, particularly next summer, that would only deepen the hole Edison is now in."

When deregulation of the state's electricity market began in April 1998, Edison had $5.25 billion in debt incurred through investments -- mostly for alternative power contracts -- that it hoped to repay by the end of the four-year window allowed under deregulation.

Under the state's 1996 deregulation law, the special charges that Edison and the other utilities have placed on customer bills to pay off the debts must come off as of April 1, 2002.

Through this spring, Edison had paid down $4.1 billion of the debt, largely through the sale of generating assets and a special charge it was allowed to place on customer bills. Edison officials were confidently predicting they would pay off their debts early, like SDG&E did.

But then came this summer's power crisis, which is the result of a classic supply-demand crunch. Power use has soared, thanks to a hotter-than-normal summer, a robust economy that has factories running at full steam and increasing levels of computer use. But power supplies have remained constant or even decreased somewhat because no new power plants have been built in 11 years and other Western states have drawn off some of the power that would have been destined for California.

As a result, wholesale power prices have skyrocketed, topping $700 per megawatt hour earlier this summer (last summer's peak was $40 per megawatt hour). In response, the state Legislature last month, approved a bill capping wholesale prices at $500 per megawatt hour; that could go down to $250 per megawatt hour under regulatory orders from the PUC.

In the short run, these price caps could help Edison and the other utilities by reducing the spread between wholesale prices and the frozen customer rates. But the caps might not be effective, because the state has no authority to order out-of-state generators to sell more power in California.

"If you're a generator outside California, you have no incentive to sell into California at these capped prices," Fitch's Woodland said. "It could backfire by creating even more of an electricity shortage and thereby worsening the supply problem."

Edison spokesman Alexander maintains that in spite of all these difficulties, Edison still intends to pay down all its debts by March 31, 2002.

But in the eyes of many outside observers, that's by no means certain. It would require that power prices return to normal levels this fall and stay there over the next 18 months.

Already, there are indications that won't happen. The price of natural gas, which powers many of the state's generation facilities, is at a 10-year high; this price spike is expected to keep wholesale power prices somewhat elevated over the next several months, even as demand tapers off.

And then there's next summer. Most observers predict that if next summer is even slightly above average, temperature-wise, the state's power system would experience a crisis even more severe than this year. That's because overall demand levels are likely to be higher while supplies are expected to remain constant. Even the price caps enacted by the Legislature could come off if there are too many rolling blackouts like the one that hit the Bay Area in June.

"This whole situation is very, very volatile," O'Donnell said. "Nobody wants to be a fall guy, to be the deep pockets for this problem. That's why it's proving to be so difficult to come up with a solution."