\u201cYap & zap.\u201d That\u2019s what I call those invisible electric fences. You know, a dog charges you, teeth bared, barking all the way. Then suddenly the pooch skids to a cartoon stop, fearing zapping punishment. We have an economic version of the yap & zap in California. State regulators are one side, and utility legal departments on the other, trying to plant barriers in between. The regulatory side of the fence aims to zap bankruptcies from utility affiliates, and parent companies, before they leap over to bite ratepayers in the butt. On the utility side sits a sanguine old dog believing that the financial separations between regulated and unregulated companies will keep creditors from tearing the flesh off their solvent hides by containing losses in the company on the other side of the fence. In an attempt to ensure that, both the California Public Utilities Commission and utilities have fortified their economic \u201cring-fencing\u201d over the last decade. These changes may soon be put to their first test since the 2000-01 energy crisis. Edison International revealed earlier this month that subsidiary Edison Mission has $500 million in debt that it cannot repay (Current, Aug. 10, 2012), hinting at bankruptcy. It believes that the debts of its Edison Mission energy subsidiary won\u2019t affect utility finances. \u201cWe make clear that when [Mission] was set up and [the way it] has been managed, it was always intended to be a growth and diversification platform for Edison International. It was established to have its own separate credit ratings and capital structure (as opposed to financing that is guaranteed by the parent company),\u201d according to Edison spokesperson Charles Coleman. \u201cBy having a separate board and having a clear policy of not making any new investments in, or taking money out of [Mission], those are signs of structural separateness.\u201d Edison declined further interview. Such financial separations have not been challenged since Pacific Gas & Electric declared bankruptcy in 2001. With all of PG&E\u2019s billions, its nuclear power plants, the transmission system, at stake during the 2000-01 bankruptcy--some of which the utility won, and some lost--regulators have been evolving their version of ring-fencing. It\u2019s been done through taking steps to control what the commission calls \u201caffiliate transactions.\u201d In deregulation days, Edison threatened to declare bankruptcy due to a $3.9 billion debt. The parent company was worried that the utility would tank, so it created Mission Energy Holding to raise capital that was distinct, and, in effect, ring-fencing protection from Edison International and the utility. Pacific Gas & Electric did declare bankruptcy, in April 2001. Four months earlier, PG&E Corp. ring-fenced its National Energy Group. The separate group obtained its own credit rating. It borrowed money when the utility couldn\u2019t. Ring-fencing worked in PG&E Corp.\u2019s favor. The bankruptcy allowed $5.2 billion to be transferred to the parent company from the utility. It never went back into ratepayer pockets (Current, Oct. 17, 2003). The attorney general alleged that by ring-fencing the parent corporation from its subsidiaries, the company violated a deal with the commission to give \u201cfirst priority\u201d to PG&E\u2019s capital needs. That didn\u2019t work. \u201cAt no time\u201d during or post deregulation \u201cdid any of their respective holding companies provide an infusion of capital,\u201d according to the commission in 2004. Since then, it\u2019s been the other way around for Edison\u2019s and PG&E\u2019s holding companies. They\u2019ve increasingly relied on the financially strong, regulated utility for income. What may or may not be a complication if current methods of ring-fencing are tested is that the federal government took a hands-off approach to leashing utilities, throwing the slack back to states. A federal layer of separation used to be in place to help prevent utility financial abuses during the time that a few utilities monopolized the U.S. But, the Public Utility Holding Company Act was rescinded in 2005. Before, a state could petition the Securities & Exchange Commission for alleged financial shenanigans, now there is no appeal. Utilities more recently have pushed at the barriers that are supposed to separate ratepayer funds, the obligation to serve, and corporate parent profit motives. In the pre-Sempra days in 1986, SoCal Gas\u2019 parental unit was Pacific Enterprises (nee Pacific Lighting). Enterprise invested in Thrifty drug and Big 5 sports. That led to huge losses. Enterprise cut 90 percent of its staff and sold everything but SoCal Gas and another utility in 1992. That made regulators nervous. Commissioners feared the economic fallout would land on the utility. First and foremost to regulators is that utilities don\u2019t mix up their \u201cobligation to serve\u201d priorities with their obligation to profit. Yet, no fence can keep the two apart. The obligation to serve requires a financially healthy utility\u2019s capital and a healthy utility needs profit-seeking investors. After SoCal Gas\u2019 anxiety, came deregulation\u2019s nervous breakdown. As they created a competitive market, regulators were under the impression that utilities would be making scads of money under deregulation. The commission was concerned that massive profits should accrue to ratepayers\u2019 interest instead of elsewhere in a corporate structure. That presumption turned out to be rather backwards. With that financial paradigm shift, the commission has been modifying its affiliate transaction rules. The latest update was in 2006. For instance, affiliate transaction rules now are aimed to \u201censure a utility\u2019s financial integrity is protected from the riskier market ventures of its unregulated affiliates and holding company parent.\u201d The commission imposed rules that prohibit information sharing between entities, it separates accounts, and the entities cannot share physical offices. It also required audits of the required separations. Oddly, audits haven\u2019t been completed in five years, according to the commission. The last and only one was PG&E in 2007. Despite the lack of review, that tinkering calms Wall Street\u2019s nerves. Analysts find California affiliate transaction rules, in effect, provide the conceptual yap & zap. Standard & Poor\u2019s analysts assured the commission that the financial community is not concerned about the potential Edison Mission bankruptcy\u2019s effect on the utility because it is \u201cadequately ring-fenced,\u201d according to Karen Paull, CPUC attorney. For a utility to be brought into a position in which it could be called on to bail out a bankrupt subsidiary, creditors would have to show that the utility and subsidiary are so financially entangled that there\u2019s no daylight between them, said one financial analyst. It requires \u201csubstantive consolidation\u201d in bankruptcy court so two or more entities are treated as one. It appears, so far, that Edison and regulators have built a strong enough fence to protect the utility from an Edison Mission insolvency. Time will tell. But, just like deregulation turned financial assumptions upside down, in the longer term, Edison\u2019s fence could be tested the other direction. In the case that the utility\u2019s San Onofre Nuclear Generating Station remains out of service, and if, as some policy makers and stakeholders threaten (see sidebar page 3), shareholders be responsible for all outage costs, and the utility\u2019s $1.2 billion in ratebase for the plant be cut, then the fence may zap other entities from financially rescuing the utility like detouring a St. Bernard carrying a brandy flask. And it could beg a repeat of a post-deregulation commission that catered to Wall St.\u2019s nervousness--giving utilities pretty much everything they asked in order to keep investors from abandoning regulated utilities. Editors\u2019 note: Current\u2019s 2003 booklet on PG&E\u2019s bankruptcy, including ring-fencing, is available for free, please email us with your mailing address firstname.lastname@example.org. We charge $5 for shipping & handling.