A legislative proposal to partially defer a BGE electric rate increase for 11 months will allow the utility to recover its costs over a decade, but leaves unanswered questions about how much the utility and its customers will be paying once the clock runs out next year.
Though negotiations continue, the plan should allow the company to avoid financial peril by requiring customers to repay the deferred amount - something BGE said was essential to avoid a legal challenge on constitutional grounds.
That should calm investors worried that state lawmakers might force the company to undercharge for electricity in a move reminiscent of the 2001 California energy crisis. Pacific Gas & Electric was pushed into bankruptcy after lawmakers in Sacramento imposed rate caps at a time of soaring energy prices.
But the proposal awaiting approval in Annapolis will likely require the utility to take on anywhere from nearly $700 million to $1 billion in debt - depending on how the plan is implemented - and forgo nearly $45 million in annual revenue that it currently is entitled to receive.
The legislation also proposes replacing embattled members of the state Public Service Commission - a move that credit rating services said yesterday raises alarm bells and could lead to higher borrowing costs for the utility for years. Those costs are historically passed on to customers and could result in higher rates than would occur if lawmakers did nothing.
Though optimistic the plan will leave BGE's finances intact, analysts say it could be a long time before Constellation Energy Group, BGE's corporate parent, is able to regain the confidence of Wall Street and the credit markets on which it depends to fund its businesses. The political furor over electric rates also has left in doubt Constellation's $10 billion merger with a Florida utility owner and tarnished the image of a company that in five years climbed from No. 424 to No. 125 on the Fortune 500 list of the nation's largest companies. Constellation's stock fell 32 cents, less than 1 percent, yesterday to close at $52.33.
"Management credibility has taken a beating with the [Maryland] fiasco," said Credit Suisse analyst Dan Eggers, in a recent research note. Constellation "will need to rebuild market confidence."
The proposed legislation contains pain for both BGE and consumers. The increase in the utility's rates would be limited to 15 percent come July 1, when rate caps imposed as part of the state's 1999 move to deregulation will expire. That would require the utility to borrow hundreds of millions of dollars to bridge the gap between the 15 percent increase and the 72 percent rate increase the company says it needs to pay for more expensive power it must buy starting this summer. Analysts and company officials say that debt would leave BGE highly leveraged, making it a riskier investment and potentially restricting its access to capital.
"The most important thing [for legislators to understand] is there's a financial impact for the company when you request us to defer hundreds of millions of dollars," said Kenneth W. DeFontes Jr., president of BGE. "We're already on a credit watch."
However, the debt incurred in the plan would almost certainly be securitized, which means it is guaranteed to be paid back with a fee collected from customers that includes interest charges of about $109 million over 10 years, according to a draft proposal. Such debt comes with a lower interest rate and will have less impact on the company's credit rating than if the utility borrowed money with no legislated guarantee of payback.
By allowing BGE to recover all of its costs, lawmakers avoid an almost certain lawsuit from the utility. By law, utilities must be allowed to recover "prudently incurred" costs.
Legal experts say the utility would have argued that the 72 percent rate increase was the product of a state-mandated energy auction that was part of the move toward a deregulated market.
Under deregulation legislation, BGE and other Maryland utilities were required last winter to secure power supply contracts from the wholesale energy market. The auction was overseen by regulators, consumer advocates and outside consultants - all of whom agreed the process was fair.
The results could have been disastrous to BGE and Constellation had lawmakers opted to extend the current rate caps without allowing for any recovery of costs. Citigroup analyst Greg Gordon estimated the utility would burn through $60 million to $70 million a month under such a scenario. Under those circumstances, power generating companies might have refused to sell BGE power for fear of not getting paid, forcing a California-style meltdown in the state's energy market.
"A key component of the debacle in California was putting the utilities in a position of having to buy high and sell low," said William L. Massey, a former commissioner with the Federal Energy Regulatory Commission who testified yesterday on BGE's behalf.
In addition to higher debt, the legislation calls for BGE to give up $45 million - or about 18 percent of its pretax annual revenue - through a series of givebacks that mirror those contained in previous rate plans proposed by the governor and lawmakers. BGE had previously agreed to the givebacks.
The unanswered question is what will happen to BGE and its customers after the 11 months is up.
The proposed legislation requires a newly constituted PSC to investigate the company's rates and come up with a longer-term rate plan that would bring customers up to market rates in 2008. Whatever plan the new PSC comes up with could require additional borrowing by the company, and include carrying charges for customers that go far beyond the roughly $2 a month currently proposed.
Uncertainty over what a new PSC might do worries credit reporting agencies, who fear Maryland has become a riskier place for utilities to do business. The apparent willingness of lawmakers to intervene in regulatory matters leaves all Maryland utilities vulnerable to further meddling, they said.
"A concern we have in general is the company's flexibility to recover future cost increases," said Ari Kagan, an analyst for Fitch Ratings, which previously downgraded BGE's credit rating because of the legislative furor over rates. "Not just for BGE, but for all utilities operating in Maryland."
Aneesh Prabhu, an analyst for Standard & Poor's in New York, agreed, saying the firing of the PSC is of bigger concern to credit agencies.
"If the constitution of the PSC changes, the first discussion will be, 'Does this change the business environment for BGE,'" he said.
A credit downgrade falls more heavily on utilities than other types of industry because utilities must borrow huge amounts of money to fund improvements to power lines and other infrastructure. On average, labor costs account for about a third of the cost of the goods people buy. But for utilities, only about 7 percent is spent on labor, said Jay Apt, a utility expert at Carnegie Mellon University in Pittsburgh.
"So, an increase in the cost of capital for somebody in the electric power business drives up the cost of power to consumers," he said.
Sun reporter Tricia Bishop contributed to this article.