SCE-PG

Business Context and Reporting Period

Company: Southern California Edison Company (SCE)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
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 through a rate-regulated electric utility segment and a Variable Interest Entities (VIE) segment consisting of non-rate-regulated gas-fired power plants.

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

Note: Operating margins are not explicitly stated as a percentage in the filing text; however, operating income decreased despite revenue growth due to higher fuel and purchased power costs.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenue increased $493 million year-over-year, driven primarily by higher retail billed revenue ($22 million increase) and sales for resale ($133 million increase). However, balancing account under-collections reduced recognized revenue compared to prior year over-collections.
• Expense Increases:
  • Fuel Expense: Increased $257 million due to higher gas costs at the Mountainview plant and VIEs, and higher coal costs at Four Corners.
  • Purchased Power: Increased $680 million, driven by higher bilateral energy purchases, higher QF expenses, and increased ISO-related costs.
  • Regulatory Adjustments: Provisions for regulatory adjustment clauses decreased $475 million, reflecting net unrealized losses on economic hedging activities ($131 million in 2008 vs. gains of $14 million in 2007) and higher net under-collections of fuel and power costs.
• Non-Operating Charges: Other nonoperating deductions increased $83 million, primarily due to a $49 million after-tax charge related to a CPUC decision on performance incentives (refunds and penalties).
• Cash Flow Decline: Operating cash flow decreased $1.17 billion, mainly due to Energy Resource Recovery Account (ERRA) under-collections in 2008 compared to over-collections in 2007.
• Debt Position: Short-term debt increased significantly ($1.06 billion) as SCE borrowed against its credit facility in September 2008 to bolster liquidity amidst global financial market instability.

Guidance, Outlook, Risks, and Contingencies

Management Commentary and Outlook

• Liquidity Strategy: In response to severe credit tightening and market volatility, SCE borrowed $958 million under its credit facility in September 2008 and issued $500 million in bonds in October 2008. As of September 30, 2008, available liquidity was $1.89 billion ($1.26 billion cash/equivalents + $628 million credit facility availability).
• 2009 General Rate Case (GRC): SCE requested a 2009 base rate revenue requirement of $5.21 billion (a $739 million increase). A final decision is expected prior to year-end 2008. The request includes recovery for capital expenditures, operating costs, and pension contributions.
• Capital Expenditures: 2008 capital expenditures are expected to be lower than the $2.1 billion forecast due to delays in transmission investments. The 5-year forecast (2008-2012) remains up to $19.9 billion.
• Pension and Trusts: Volatile markets caused a 22% decline in pension trust assets and a 21% decline in postretirement benefit trust assets. Unless markets recover, future contributions and expenses will increase, though costs are expected to be recovered through rates.

Key Risks and Contingencies

• Regulatory Investigations:
  • Performance Incentives: CPUC decision required refunds/forfeitures of $83 million in incentives and bonuses, plus a $30 million penalty. A second phase regarding system reliability is ongoing.
  • Global Tax Settlement: Negotiations with the IRS for tax years 1986-2002 are in progress. Resolution could reduce unrecognized tax benefits by up to $1.3 billion or increase earnings/cash flows by $70-$80 million and $300-$350 million respectively, depending on the outcome of balancing account over-collection claims.
• Environmental and Climate Change:
  • Remediation: Recorded liability is $47 million; costs could exceed this by up to $167 million.
  • Climate Litigation: Subject to lawsuits regarding GHG emissions (e.g., Kivalina case) and state regulations (AB 32) which may require significant capital expenditures.
• Counterparty Risk: Lehman Brothers Holdings filed for bankruptcy; a subsidiary is a lender in SCE's credit facility ($106 million commitment). Lehman declined funding requests for recent borrowings. SCE is monitoring counterparty ability to perform on power-purchase contracts.
• Nuclear Operations: Ongoing NRC inspections at Palo Verde require corrective actions and increased O&M costs ($23 million estimated increase 2008-2009). Spent nuclear fuel storage capacity is being managed pending DOE acceptance.

Investor Verification Checklist

• Liquidity Sufficiency: Verify the status of the $2.5 billion credit facility and the impact of the Lehman Brothers bankruptcy on available borrowing capacity.
• 2009 Rate Case Outcome: Monitor the CPUC's final decision on the 2009 GRC, specifically the approved revenue requirement and treatment of pension/decommissioning costs.
• Tax Settlement Progress: Track the status of the "Global Settlement" with the IRS, as resolution could materially impact cash flows and earnings.
• ERRA Balancing Account: Monitor the Energy Resource Recovery Account under-collection balance ($181 million as of Sept 30, 2008) and potential need for emergency rate adjustments if it exceeds the 5% trigger.
• Capital Market Access: Assess SCE's ability to refinance debt and fund capital expenditures given the volatile credit environment and rising borrowing costs.
• Regulatory Penalties: Review the final financial impact of the CPUC performance incentive investigation and any potential penalties from the system reliability phase.