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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Pacific Gas & Electric Bankruptcy — The Shoe Finally Falls

power plant

Pacific Gas & Electric, one of America’s largest utilities, finally filed for chapter 11 bankruptcy on January 29, after weeks of waiting. The company already had missed one long term bond payment. And bond rating agency S&P lowered the utility’s bond ratings to “D,” as in default, even before the filing. That is the lowest possible rating for any fixed income security.

But this is an electric utility with about $50 billion of net plant facing fire related liabilities of $20-30 billion according to press reports. And conventional lenders not surprisingly have walked away. No one wants bonds in default. And an equity sale at currently depressed prices would be cripplingly dilutive. PG&E has had to resort to debtor-in-possession financing, which gets to the head of the line when the time comes to collect. Bankruptcy under chapter 11, the company hopes, will permit an orderly process of sorting out its liabilities.

Said in a different way, bankruptcy was inevitable. But bankruptcy is temporary. It’s like a month long stay in a convalescent center following an accident. The issue isn’t really what one did in hospital. The real question is what can you do afterwards? The same question faces us here with PG&E’s electric utility franchise.

From a short term operating perspective, bankruptcy protections—with its ready access to incremental debtor in possession financing—is preferable to hanging on and hoping.

What does all this mean?

First, why is it different this time? The state’s regulators are constrained in ways they have not been before. The liability itself is too large to deal with in traditional ratemaking terms. Ordinarily the state PUC would have created a deferred asset on the company’s books. This new asset would entitle PG&E to a new revenue stream to be collected via higher consumer prices. We do not believe rate increases of the magnitude implied by traditional regulatory response are even remotely possible.

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Second, assume for the moment hefty increases to electric utility bills throughout PG&E’s service area. That would increase the appeal of residential and commercial solar increases significantly. We think it would only take a 5% customer loss for rating agencies to start talking about an industry “death spiral” — where fewer and fewer customers are forced to shoulder the existing utility cost burden, resulting in still higher prices and still fewer customers.

Third, you can only buy what someone wants to sell. Municipalization is typically the other option. If management and the board ask for say between 1 ½ and 2 times book value that puts the asking price for the electric utility alone in the $75 to $100 billion range. But more important than price, we have seen that private sector utility managers can fight municipalization efforts for protracted periods of time, so don’t hold your breath. (See city of Boulder, CO in its dispute with utility XCEL.) And the city of San Francisco has expressed no eagerness in this regard and has committed only to issue a report later in the year.

Selling PG&E’s assets for the price suggested would solve most of the company’s problems, giving it enough cash to pay the $30 billion of lawsuits, pay off creditors and leaving something for shareholders, maybe. But it needs a buyer, and the buyer paying that inflated price would have to raise the price of electricity, we suspect, to earn a decent return on that inflated investment. That is another way of saying that the consumer could end up paying, one way or another.

This leaves us with another question. If electric utility competition is really coming, why not just let it happen?

As for a government purchase of the properties, even municipal service monopolies, like trolley cars, can experience enormous declines in value as newer technologies displace them almost entirely. Distributed solar plus storage is the sort of disruption that could begin to do the same to PG&E’s electric utility franchise, whether owned by PG&E or by the government.

Virtually everyone wants electricity. Relatively few care about the corporate provenance of the provider. Putting the public purse behind an electric utility franchise possibly well into its technological twilight years makes little sense.  Where does this leave PG&E’s shareholders?

By Leonard Hyman and William Tilles for Oilprice.com

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