PCG

PG&E Corporation and Pacific Gas and Electric Company: 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2008, for PG&E Corporation (the holding company) and Pacific Gas and Electric Company (the Utility). The Utility operates as a regulated public utility in northern and central California, providing electricity and natural gas distribution, generation, procurement, and transmission. The Utility serves approximately 5.1 million electricity customers and 4.3 million natural gas customers. The company is regulated primarily by the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC).

Key Financial Metrics (Nine Months Ended Sept 30, 2008)

Note: PG&E Corporation's consolidated figures include the Utility. The Utility's net income is higher due to the elimination of holding company expenses in the consolidated view.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 12% year-over-year for the quarter and 12% for the nine-month period. This was driven primarily by higher electricity procurement costs passed through to customers ($798 million increase for the nine months) and increased base revenue requirements.
• Profitability: Net income for the nine months ended September 30, 2008, increased by 2% ($18 million) compared to the prior year. This increase was driven by a higher return on equity from authorized capital investments, partially offset by higher storm-related costs, increased natural gas system maintenance, and nuclear refueling expenses.
• Cost Increases: Cost of electricity rose 31% for the nine-month period due to a 31% increase in purchased power volume (following the termination of a DWR contract and Diablo Canyon outages) and higher market prices. Cost of natural gas increased 13% due to higher market prices.
• Debt Activity: The Utility repurchased $454 million of pollution control bonds in the first half of 2008 to eliminate interest rate risk. In October 2008 (post-period), the Utility issued $600 million in senior notes at 8.25% due to rising market rates.

Guidance, Outlook, Risks, and Contingencies

• Capital Markets: Management notes significant disruption in capital markets due to financial distress at major institutions. While the Utility maintains access to commercial paper and credit facilities, short-term rates have increased, and long-term debt issuance costs have risen. The Utility plans to incur $3.5 billion to $4.0 billion in additional long-term debt through 2011.
• Regulatory Matters:
  • Cost of Capital: The CPUC adopted a three-year cost of capital mechanism maintaining the current 11.35% ROE and 52% equity structure through 2010.
  • Energy Efficiency: A proposed CPUC decision could deny interim incentive earnings for 2006-2007 programs, potentially resulting in a $14 million reimbursement obligation.
  • SmartMeter: The Utility is seeking approval to recover an additional $572 million for SmartMeter upgrades; a final decision is expected in December 2008.
• Contingencies:
  • Chapter 11 Disputed Claims: The Utility holds a liability of approximately $1.7 billion for remaining disputed claims from the 2000-2001 energy crisis, with $1.2 billion held in escrow.
  • Environmental: Undiscounted environmental remediation liability is approximately $575 million, with an additional $359 million expected to be recoverable in future rates.
  • Nuclear Storage: Construction of a dry cask storage facility at Diablo Canyon is expected to be completed in late 2008, with fuel loading beginning in June 2009. Failure to complete this by 2010/2011 could force curtailment of operations.
  • Tax Matters: Resolution of 2001-2004 IRS audits is expected to result in a $310 million refund and $230 million in after-tax income recognized in Q4 2008.

Key Facts for Investor Verification

• Liquidity Position: Verify the Utility's ability to refinance $600 million of debt maturing in March 2009 and fund $3.6 billion in 2008 capital expenditures amidst tight credit markets.
• Regulatory Recovery: Monitor the CPUC's final decision on the SmartMeter upgrade funding request ($572 million) and the Energy Efficiency incentive claims, as these impact future revenue requirements.
• Disputed Claims Resolution: Track the status of the $1.7 billion Chapter 11 disputed claims liability and the potential transfer of $700 million to the California Power Exchange (PX) from escrow.
• Interest Rate Exposure: Assess the impact of rising interest rates on the Utility's variable rate debt and future refinancing costs, evidenced by the 8.25% rate on October 2008 senior notes.
• Environmental Liabilities: Review the $575 million environmental remediation liability and the uncertainty surrounding potential costs for Diablo Canyon cooling water intake compliance.