PG&E's Transformation into Golden State Energy
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- Jul 13, 2020 11:06 am GMTJul 8, 2020 7:57 pm GMT
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Beleaguered California utility PG&E’s emergence from bankruptcy is hardly the end of its woes. In fact, given the circumstances, the event could be the beginning of a fresh set of problems for the utility and pave the way for a dramatic reinvention.
PG&E has an onerous task ahead after recent events. The San Francisco company is saddled with a litany of complaints about its operations and finances and has almost $39 billion in debt on its books. The current situation, in which a pandemic has toppled the country into an economic crisis (leading to nonpayment of utility bills) and the future spectre of climate change has become an urgent present reality, has created circumstances that could cause further problems for the utility.
Not surprisingly, the California government has already placed PG&E on notice by passing SB 350, a law that takes direct aim at the power company by allowing the state government to convert it into a nonprofit for failure to fulfill its mission of providing safe and reliable power to customers. "No more business as usual for PG&E," said California Governor, Gavin Newsom, adding that the bill's passage marked a "critical step in the transformation of PG&E into a utility that is accountable to those it serves - the people of California."
If PG&E messes up again, it will be replaced by a publicly-owned nonprofit called Golden State Energy. The move is expected to bring about major changes to the utility’s governance structure and avenues for financing.
How Will Things Change if PG&E Becomes a Nonprofit?
Current board appointments at PG&E are made with shareholder approval. Institutional investors and hedge funds, who are among the top ten owners of the utility in the markets, are key players in this process. For example, PG&E’s last board reshuffle in 2019 was mainly approved by three investment firms - Abrams Capital Management, Knighthead Capital Management, and Redwood Capital Management - who together owned 10 percent of the bankrupt utility. Some have dubbed the three investors “vulture capitalists” because they swooped in to buy the utility’s shares after it declared bankruptcy.
The new entity will initially have a nine-member board that will subsequently transition to a six-member format. Out of those six, three will be elected by the nonprofit’s customers and the remaining appointed by the government.
The other important change in PG&E’s proposed reinvention to a nonprofit is a modification of its avenues to raising funds. In order to service its current debt load and finance operations, the utility generally taps public markets through a slew of bond and equity offerings. Golden State Energy will not have direct recourse to public markets. Instead, it will raise funds through debt offerings via the California Infrastructure and Economic Development Bank, an agency that funds public infrastructure projects and serves as a backstop for small business loans. Bonds issued by the agency are tax-exempt and do not require SEC registrations, making them accessible to the general public. In Golden State Energy’s case, such bonds also have the potential to establish a direct link between investors, in this case the general public, and infrastructure improvement projects.
Perhaps, the biggest advantage of this form of financing is that it will keep hedge funds and institutional investors, some of who have profited from both sides of the bankruptcy, at bay. The tax-exempt nature of such bonds makes them attractive to investors. But their power to sway decisions at the nonprofit will be limited due to the reconstituted board structure.
Public ownership is also expected to smoothen the transition towards renewable energy for utilities. As long as utilities are beholden to investors, they opt for the most profitable and cost-effective power generation source to ensure that they have funds to cover operational costs and dividend payouts. Fossil fuels have remained the power generation source of choice for most utilities during the last century and the early years of this one.
Even though they have achieved cost parity with fossil fuels, renewable energy sources still face myriad problems, from outdated infrastructure to intermittency problems that prevent their integration into the electric grid. The profit motive will be eliminated in a nonprofit utility with diverse stakeholders, providing a clearer and more-focused pathway towards grid decarbonization. For example, it might become easier to implement the provisions of programs like the Green New Deal, which has broad public support, for utilities.
Other aspects of PG&E’s operations will continue to remain the same, meaning it will still have to seek regulatory approval for its rate base and investments into new technologies and infrastructure.
What’s the Catch?
The advantages of public ownership are, however, offset by the basic economics of scale and vertical integration. Utilities that are owned by the public have fewer avenues to raise funds and limited budgets that are focused on providing services to their immediate community of customers. These constraints mean that such utilities are unable to make expensive investments or acquisitions, thereby limiting the scope of their operations. In turn, this affects their ability to scale up.
Previous academic research has highlighted the issue but within a different context. A 1996 paper by researchers at the University of Florida and Korea Institute for Industrial Economics and Trade found that operational costs at small, publicly owned utilities are directly proportional to their output. This is in contrast to privately owned utilities (or utilities that derive funding from markets and private players), which have an inverse relationship between costs and output. “In particular, we find that publicly-owned utilities have lower costs than privately-owned utilities at lower output levels and have higher costs at high output levels,” the authors wrote. According to them, publicly-owned utilities have lower generation costs per KwH at lower output levels. This is primarily because subsidies, in the form of tax-exempt municipal bonds, enable profits. But that advantage diminishes as utility systems scale and begin servicing large geographic areas.
Real-world data seems to bear out this research. The Energy Information Agency (EIA) last year released data that compared the number of customers served by each type of utility. One hundred and sixty-eight investor-owned utilities served 110 million customers, or approximately 72 percent of people connected to the grid, in 2017. There were 1,958 publicly-owned utilities in that same year and they served only 24 million customers. Eight hundred and twelve cooperatives accounted for the remaining 20 million customers.
“There’s no motivation to maximize returns and extract value (for publicly-owned utilities) from the community because all [of the board’s] activities are for the benefit of people in OPPD territories,” Eric Williams, board member at Omaha Public Power District Board (OPPD), told Energy News last year. Those motivations will be similar for Golden State Energy and may result in reduced funding at its disposal.
Will Golden State Energy be able to operate at the same scale as its predecessor under the constraints imposed in raising funds? Chances are unlikely. To that end, we might see more municipal utilities emerge in California’s grid. The Energy News article I linked to earlier discusses the case of the Winter Park Electric Utility Department in Florida. Winter Park purchases power from several producers and uses Duke Energy’s transmission lines. Golden State Energy may work on a similar model, cutting back its operations in several Northern California jurisdictions while utilizing its infrastructure to form a connective tissue between multiple municipal grids.