[BETA] Fortnightly

So the Federal Energy Regulatory Commission (FERC) won't break up the electric utility industry. But it may happen anyway (em if not at the FERC's direction, then perhaps under pressure from state regulators who, some say, are threatening to link stranded-cost recovery to vertical disaggregation.

What would a breakup mean for bonds and bondholders?

As we reported last month ("New Corporate Structures Place Bondholders at Risk," May 1, 1996, p. 8), restructuring may hold surprises for the highly leveraged and capital-intensive electric utility industry. Bondholders, who have relied upon generating assets for collateral, may see their security vanish in a spinoff or reorganization. Will the debt follow the plant? Is that a good idea?

In its December policy decision on electric restructuring, the California Public Utilities Commission (CPUC) told Pacific Gas and Electric Co. (PG&E) and Southern California Edison Co. (Edison) to file plans for a voluntary sale or spinoff of at least half their fossil-fired generating assets.1 At the same time, it asked PG&E, Edison, and San Diego Gas and Electric Co. (SDG&E) to comment on the "feasibility, timing, and consequences" of corporate restructuring to "distinguish activities and assets" with respect to generation, transmission, and distribution.2

Corporate unbundling (em a full breakup in the style of the AT&T divestiture (em offers the ultimate fast track to a fully competitive electric market. But regulators may find that remedy too drastic. The FERC settled on functional unbundling (em an idea described by MIT professor Paul Joskow as "to behave as if they aren't vertically integrated." In fact, some commentators doubt whether the FERC has authority to force a full corporate divestiture.3

Of course, that hasn't stopped others from asking for more. Last year, the Justice Department's Antitrust Division and the staff of the Federal Trade Commission urged the FERC to consider mandatory operational unbundling (separating ownership from control) instead of enforcing regulations "to control behavior" under a functional regime.4

Many view a full breakup as inevitable, putting generation, transmission, and distribution in separate hands. Even FERC Commissioner William L. Massey has acknowledged as much in his many "stump" speeches on FERC merger policy: "I feel certain that some utility executives are merging in anticipation of disaggregation or even divestiture."5

Or, as New York lawyer David Falck puts it: "You can't stop the movement toward disaggregation. It's going to happen. You can only understand the process."

Cracking the Safe

"We've been looking at a lot of trust indentures lately. But we haven't met a mortgage that we can't disaggregate."

So says M. Douglas Dunn, a partner at the law firm of Milbank, Tweed, Hadley & McCloy. Dunn is talking about the arcane world of bond mortgages and mortgage trust indentures, which lay out rules on bonding ratios, impairment of security, and whether and to what extent the utility can replace bond collateral with replacement property in the event the corporation becomes separated from a sizable chunk of its assets.

Dunn is cautious, but optimistic. "Most utilities don't want to upset the bondholders," he says. "Someday they will need to go back to the market