More tax dollars likely earmarked to bolster utilities

Don Diaz, Contributing Editor

Utilities continue to falter in the wake of debacles such as Pacific Gas and Electric (NYSE:PCG) and California Edison’s ongoing implosions. Across the nation, taxpayers are being tasked with the extra burden of financing either worst-case bailouts, or less-extreme subsidies necessary as a result of poor cash management. California’s Gov. Gray Davis is seeking as much $23 billion (with some figures as high as $58 billion when long-term contracts are accounted for) in new taxes and rate increases in order to pay for the failed utilities’ astronomical losses over the past two fiscal years. In New Jersey, Public Service Electric and Gas (NYSE:PEG) and its parent company have piled up nearly $5 billion in debt as a result of their investment in the Hope Creek Nuclear Power Plant. Sliding energy prices, regulatory issues, fierce competition, and ever growing questions over accounting credibility continue to dog sector firms, exacerbating their declines.

The unfolding Enron scandal also remains as an albatross to utilities, acting to dry up sources of much-needed capital. Credit rating services have lowered most of the sector’s outstanding debt to junk status, drastically limiting their ability to borrow from Wall Street’s institutional investors. Fitch Ratings recently slashed New Jersey’s Public Service Electric and Gas’s bond rating to “negative” from “stable”, with similar downgrades likely for the state’s two other major utility providers. As a consequence, New Jersey’s taxpayers may be asked to fund as much as $9 billion in bad debts from its three largest utility firms. This tax would roughly amount to $1,200 per every New Jersey resident, representing the highest tax increase in the state’s history.

Overbuilding of generating facilities likewise figures heavily into the sector’s ever-increasing necessity for taxpayer subsidies. AES Corp.’s (NYSE:AES) unfinished $800 million (projected cost upon completion) Redland, Calif. plant stands as a grim reminder of the state’s current power glut. The firm squandered over $100 million before it was forced to halt construction of its facility in May, furloughing approximately 500 workers. AES Corp.’s actions highlight a trend that has been in place for much of the year, underscoring the larger problem of oversupply, which is unlikely to abate until after 2003. Debt continues to mount among sector members as a result, with little relief in the way of traditional Wall Street restructuring, despite the present environment of hyper-low interest rates.

The nation’s baleful regulatory prospects remain mired amid uncertainty, compounding negative factors pressuring utilities. The Federal Energy Regulatory Commission’s (FERC) ongoing struggle with often-inflexible state commissions has acted to undermine what would otherwise prove to be positive sector developments. Firms within the group are moving to strengthen balance sheets, attempting to enhance shareholder equity. These actions, over time, should ease the current supply glut, while keeping prices under control.

Still, near-term fundamentals among utilities point to further need for taxpayer endowments. Capital shortfalls, and worst-case bankruptcies, among merchant energy providers will likely continue to warrant these subsidies from state and federal sources. Conversely, emerging sector trends to bolster liquidity, such as asset sales, may function to stem the current tide of bailouts and downgrades.

Diaz is an independent industry analyst with 15 years of experience in the financial and energy markets.

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