SCE-PG

Business Context and Reporting Period

Company: Southern California Edison Company (SCE)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Six months ended June 30, 2008 (Unaudited)
Business Overview: SCE is an investor-owned utility regulated by the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC). It provides electricity to retail customers in central, coastal, and southern California. The company operates two reportable segments: the rate-regulated Electric Utility and Variable Interest Entities (VIEs), which are gas-fired power plants.

Key Financial Metrics

Liquidity: As of June 30, 2008, SCE had $1.5 billion available under its $2.5 billion credit facility. Short-term debt was $800 million. The company maintains investment-grade credit ratings (A2/P-2 from Moody's, A/A-2 from S&P).

Material Changes vs. Prior Period

• Revenue Growth: Operating revenue increased by $424 million (9.1%) year-over-year. This was driven by a $257 million increase in balancing account over/under collections (recognizing prior year overcollections) and a $159 million increase in sales for resale due to higher excess energy volumes.
• Operating Income Decline: Operating income decreased by $93 million (12.1%). Despite revenue growth, higher fuel and purchased power costs were only partially offset by regulatory adjustments. Fuel expense rose $151 million due to higher natural gas costs at the Mountainview plant and VIEs.
• Net Income Decline: Net income available for common stock decreased by $18 million (5.5%). This was primarily due to lower operating income, partially offset by a lower effective tax rate (25% in 2008 vs. 25% in 2007, but with specific 2007 tax benefits not recurring) and lower interest expense.
• Cash Flow Reduction: Net cash provided by operating activities decreased by $552 million. The primary driver was Energy Resource Recovery Account (ERRA) undercollections in 2008 compared to overcollections in 2007, caused by higher natural gas and power prices exceeding forecasted levels used in current rates.
• Debt Activity: SCE issued $600 million in long-term debt in January 2008 to repay commercial paper. It also repurchased $212 million of auction rate bonds and converted them to variable rate mode.

Guidance, Outlook, Risks, and Contingencies

Regulatory and Rate Outlook

• 2009 General Rate Case (GRC): SCE requested a 2009 base rate revenue requirement of $5.162 billion, representing a $695 million increase over current rates. The CPUC Division of Ratepayer Advocates (DRA) recommended a significantly lower increase of approximately $19 million. A final decision is expected before year-end 2008.
• ERRA Trigger Application: Due to higher gas and power prices, the ERRA balancing account is projected to be undercollected by 14.5% by year-end 2008. SCE expects to file a trigger application in Q3 2008 to increase customer rates before year-end.
• FERC Transmission Incentives: FERC approved incentives for three major transmission projects (DPV2, Tehachapi, Rancho Vista), allowing 100% recovery of construction work in progress (CWIP) in rates. Implementation began March 1, 2008, subject to refund on ROE reasonableness.

Material Risks and Contingencies

• CPUC Performance Incentive Investigation: A CPUC Presiding Officer's Decision (POD) ordered SCE to refund $136 million and pay a $40 million statutory penalty related to misreporting of customer satisfaction and employee safety data (1997-2003). SCE has appealed this decision. Potential refunds and penalties range from $52 million to $388 million. SCE has accrued the lower end of this range.
• Tax Disputes: SCE is engaged in ongoing examinations and administrative appeals with the IRS and state authorities for tax years 1994-2005. Unrecognized tax benefits totaled $1.991 billion as of June 30, 2008. A settlement could potentially increase earnings by $70-$80 million and cash flows by $300-$350 million.
• Environmental Remediation: Recorded liability for 24 identified sites is $59 million. SCE estimates cleanup costs could exceed this by up to $155 million. Most costs are expected to be recovered through customer rates.
• Legal Proceedings:
  • Navajo Nation Litigation: Claims for damages related to coal supply agreements for the Mohave Generating Station, seeking damages of not less than $600 million plus treble damages and punitive damages. The case was reinstated in March 2008.
  • Climate Change Litigation: Native Village of Kivalina filed a complaint alleging global warming impacts, seeking damages between $95 million and $400 million.
• Renewable Portfolio Standard (RPS): California law requires 20% renewable procurement by 2010. SCE forecasts compliance via flexible rules but faces potential penalties up to $25 million per year if targets are missed.

Investor Verification Checklist

• Rate Case Outcome: Monitor the CPUC's final decision on the 2009 GRC, specifically the approved revenue requirement versus the $5.162 billion request.
• ERRA Rate Adjustment: Verify the timing and magnitude of the rate increase resulting from the ERRA trigger application expected in Q3/Q4 2008.
• CPUC Penalty Appeal: Track the status of the appeal regarding the $136 million refund and $40 million penalty order; assess the risk of the upper-end penalty range ($388 million).
• Tax Settlement: Watch for updates on the "global" settlement negotiations with the IRS, which could materially impact cash flows and earnings.
• Capital Expenditures: Review the execution of the $19.9 billion capital plan (2008-2012), particularly the Solar PV Program and transmission projects, and their regulatory recovery status.
• Commodity Hedging: Assess the impact of volatile natural gas prices on the ERRA balancing account and the effectiveness of the company's hedging program.