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As bankruptcy looms, PG&E's gas utility offers complex mix of strength, risks

As PG&E Corp. heads toward a bankruptcy filing, the company will be contemplating an array of restructuring options. Potentially on the table is a sale of its gas utility division, a business with a sizable customer base in a tumultuous regulatory environment.

PG&E Corp. and its utility subsidiary, Pacific Gas and Electric Co., on Jan. 14 filed a 15-day notice that the companies plan to seek reorganization under Chapter 11. In an SEC filing, PG&E Corp. said it plans to work with its main state regulator, the California Public Utilities Commission, and "other stakeholders over the course of the Chapter 11 reorganization cases to explore various structural alternatives that have the potential to lead to improved safety and service for customers and to maximize the value of PG&E's businesses."

The parent company's market capitalization tanked in the weeks and months leading up to the bankruptcy plan announcement as liabilities related to deadly California wildfires loomed larger and larger. The shares fell 47% in 2018 and then dropped by nearly half again on the morning of Jan. 14, falling below $10 after trading near $50 as recently as November 2018.

S&P Global Ratings and Moody's both downgraded PG&E Corp. and Pacific Gas and Electric from investment-grade credit ratings to speculative grade in light of the tens of billions of dollars in liabilities the company could face from the wildfires in 2017 and 2018.

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In its multinotch downgrade, S&P Global Ratings pointed to the "political and regulatory environment," saying the company has "limited" options for managing the full suite of its operational, financial and regulatory risks. Moody's highlighted that PG&E Corp. is "increasingly reliant on extraordinary intervention by legislators and regulators."

Many of the issues the company is facing that leave it at the mercy of state regulators and lawmakers are focused on the electric side. The relationship between PG&E's power equipment and the Camp Fire — the deadliest wildfire in California history — remains under investigation, and how recent legislation on managing costs for 2017 wildfire damage will be applied to power utilities is still unclear.

To manage some of the expected liabilities, PG&E Corp.'s restructuring could involve parting with its gas division. Some analysts have noted that PG&E's gas business appears to be the more stable division of the utility, even though state regulators recently alleged that the utility had falsified tens of thousands of gas safety records over five years, exposing the company to potential penalties.

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Gas utilities in recent M&A deals have fetched sizable premiums. Southern Co. purchased AGL Resources in 2016 at a nearly 38% premium over the gas company's share price the day before the merger was announced. AGL's customer base at the time was roughly comparable to PG&E's gas customer count, with about 4.5 million each. PG&E's gas business is one of the largest in the country.

Duke Energy Corp. finalized its purchase of Piedmont Natural Gas the same year, paying a 42% premium to the gas company's stock price the day before the deal announcement.

In each of those deals, the buying companies were electricity-focused and cited potential synergies with the acquisition targets, noting geographic and regulatory overlaps between the companies. If PG&E's gas division were separated from the electric side of the business, that particular synergy opportunity would not be in play.

Still, PG&E Corp.'s gas business has brought in multibillion-dollar revenues every year, and the $17 billion gas utility plant in service is a substantial rate base on which to earn returns. California has been adamant in the wake of the deadly 2010 gas explosion on a PG&E pipeline in San Bruno, Calif., that the state's utilities invest in upgrading their gas pipeline infrastructure. These investments have enhanced rate base for the utilities.

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While wildfire cost allocation has thrown a wrench into California's regulatory approach to power utilities, Regulatory Research Associates — a group within S&P Global Market Intelligence — broadly considers California's regulatory environment "constructive" from an investor standpoint.

RRA rates state regulatory environments as below, at or above average, paired with a 1, 2 or 3 rating, with 1 representing the strongest rating and 3 the weakest within the category. California's utility regulatory environment ranks as above average, albeit as a level 3, according to RRA.

The state's utility regulatory environment has improved steadily over roughly the past two decades, the RRA ranking indicates. California was ranked as a level-1 below-average state in 2001.