The California Supreme Court (search), weighing the state's failed deregulated energy market for the first time, ruled Thursday that regulators lawfully imposed an electricity rate increase by as much as 40 percent in 2001.

The justices said the California Public Utilities Commission (search) neither violated deregulation rules nor breached open meeting laws when commissioners approved the rate hike in private to settle a lawsuit from Southern California Edison Co (search).

At stake was at least $3 billion in customer utility fees.

The settlement with the PUC allowed Edison, and also Pacific Gas & Electric Co. (search), to collect a surcharge to cover their costs of delivering power. The PUC settled the federal suit with Edison in October 2001 to help Edison pay debts by maintaining for two more years a temporary rate increase approved a year earlier.

Consumer groups challenged the settlement after Edison and PG&E amassed billions in debts when wholesale electricity rates soared beyond the frozen retail rates that utilities could recover from customers in 2000 and 2001 under deregulation (search) rules. State lawmakers and Gov. Gray Davis debated for months what role the state should play in the utilities' future, but legislation to bail them out failed and the PUC responded after being sued.

The utilities argued that federal energy rules demand they get compensated for the electricity they are selling. To settle Edison's suit, the PUC extended the surcharge in a private meeting, allowing both utilities to generate billions in new revenues.

PG&E kept its suit against the PUC alive, and rather than settle, decided to file for bankruptcy protection. Proceeds from PG&E's rate hike are now being factored into its proposed deal to restore its solvency.

The Utility Reform Network (search), a consumer watchdog group, challenged the PUC's settlement with Edison, alleging that it violated open meeting laws and electricity regulations.

PG&E has 4.6 million residential and commercial customers in Northern and Central California. Edison serves 4.3 million Southern California customers.

The case is Southern California Edison v. Lynch, S110662.