CALIFORNIA'S UTILITIES

may have spent the week on the brink of financial disaster, but Merrill Lynch is convinced the crisis is past. And after a day of powerful gains in the stocks, it looks like the rest of Wall Street agrees.

On Wednesday, independent power providers bidding in a state-sponsored auction offered to supply long-term electricity to the state for an average of $69 per megawatt hour. That's higher than the state politicians were hoping for, but less than what most analysts were predicting.

Armed with the news, Merrill Lynch analyst Steve Fleishman came out early Thursday with a note saying that $69 is a figure the state's utilities can afford. "We sense the tide is turning," he said, and promptly raised his ratings on both Edison International, the parent of Southern California Edison, and PG&E to Accumulate from Neutral.

Fleishman predicts the chances the two companies will declare bankruptcy are now "25% or less," down from 50-50 odds a few days ago. Hardly the kind of news to reassure the widows and orphans packed into those stocks. But good news nonetheless.

Shares of both Edison and PG&E skyrocketed Thursday. Edison closed 35.3% higher at $12.69, while PG&E rose 30.8% to $13. Both companies have seen their share values evaporate since California's power crisis reared its ugly head in November. Even with Thursday's gains, both remain almost 60% off their 52-week-highs.

The auction isn't the only thing Fleishman was crowing about. He's also encouraged by the fact that pressure is building nationwide and in Washington for California's politicians to get the crisis resolved as soon as possible. Analysts suspect the state will somehow find a way to securitize or effectively guarantee the overwhelming amount of debt racked up by the two utilities. Because a botched deregulation plan has prohibited them from passing along the skyrocketing costs of power to their customers, the companies have accumulated nearly $12 billion in debt. They'd likely have to give up some of their assets to get the state's backing, but solving the debt problem would most certainly diminish the threat of bankruptcy.

Absent that threat, Fleishman argues that the two companies have significant value. He estimates that Edison's nonutility business is worth $8 to $10 a share, while PG&E's is worth $12 to $13 a share. That point seemed to resonate on Wall Street. Merrill's note smoked out a couple of others on Thursday. "We believe momentum is building toward a constructive end to the crisis," said Goldman Sachs analyst Jonathan Raleigh. If "comprehensive legislation is passed," he declared, the two utilities' share prices could more than double over the next 12 months.

That, of course, is a big if. These companies are hardly out of the woods. The odds of either of them declaring bankruptcy are still higher than the chances of drawing two pair in a hand of poker. And the state needs to pass a complex package of laws and regulations very quickly to ensure the crisis doesn't continue.

Even if California's politicians, including Gov. Gray Davis (frequently mentioned as a Democratic candidate for president one day), get legislation passed, it might not necessarily be laws in the best interest of utility shareholders. California's rate payers, already incensed at rolling power blackouts, will be even angrier if the state forces them to completely bail out the utilities.

There's enough uncertainty that some institutional investors remain unable to pull the trigger.

"Are we looking at it? Absolutely," says Tim Ghriskey, who manages $4 billion for Dreyfus. "Have we done it? No." There's no way to know what will ultimately happen, Ghriskey says. "We don't want to be stuck in a situation where we lose everything."

Fleishman admits that investing in these utilities is only appropriate for very high-risk investors. And it's worth noting that Merrill has done financing for Edison in the past three years.

"It's not something you bet your retirement on," he said.