1. Summary

In this decision, we adopt an incentive framework for the effective utilization of natural gas price "hedging."¹ The following utilities are respondents: Pacific Gas and Electric Company (PG&E), San Diego Gas & Electric Company, Southern California Gas Company (SoCalGas), and Southwest Gas Corporation (SWG) (collectively, the "utilities").

This rulemaking was initiated to examine the California gas utilities' gas cost incentive mechanisms and the treatment of hedging under those incentive mechanisms, pursuant to Decision 07-06-013. We examine the regulatory treatment currently in effect for natural gas hedging to determine if it should be modified to provide better incentives to manage costs prudently. Our goal is to adopt a regulatory treatment of hedging that provides flexibility to accommodate changing market conditions and risk factors over time.

We address whether, or to what extent, the costs or payouts from natural gas hedging plans should be incorporated into the utilities' existing gas procurement incentive mechanisms or whether other means should be utilized to ensure that utilities manage hedging in the best interests of customers.

The utilities' use of hedging has grown substantially in recent years. Through the 1990s, the monthly indices for natural gas prices were relatively stable, and measures to mitigate price volatility were of a lesser concern. Gas prices have exhibited greater volatility since the year 2000, however, with particularly large fluctuations in the winters of 2000-2001 and 2005-2006. Ratepayers have been required to bear all of the risks and payouts (if any) associated with the expanded use of winter hedging since 2005. We conclude that the utilities will have an incentive to hedge more cost-effectively, however, where they share in the financial consequences of hedging.

For PG&E, we adopt the provisions of the Proposed Settlement as presented in this proceeding. Consistent with the Settlement, we will allocate a share of PG&E's gas winter hedging transactions to its "Core Procurement Incentive Mechanism," (CPIM) thereby sharing hedging risks and rewards between ratepayers and shareholders.

For SoCalGas, we adopt a treatment that is not based upon any settlement, but that relies upon the underlying record developed in the proceeding. On that basis, we conclude that there should be some sharing of hedging risks and rewards between SoCalGas' shareholders and ratepayers, subject to limits on maximum shareholder risk. Accordingly, we allocate 25% of transactions from the SoCalGas' winter hedging program into its Gas Cost Incentive Mechanism (GCIM), providing sharing of risk and reward with ratepayers. The remaining 75% of winter hedging transactions will be charged or credited as applicable to ratepayers. For SWG, we shall not adopt any changes in its regulatory incentive program at this time given the limited nature of the SWG program for mitigating price risk, as explained further below.

In this decision, we address:

· the hedging guidelines and policies each utility uses, and whether statewide guidelines and policies should apply to all California gas utilities;

· whether hedging costs should be re-integrated into the utilities' existing procurement incentive mechanisms, and if so, how;

· whether a separate incentive mechanism should be designed for hedging costs relative to a market benchmark to encourage better management;

· the processes whereby the utilities' hedging activities should be monitored, reviewed, and/or approved by the Commission;

· whether exclusion of hedging cost recovery from the incentive mechanisms results in reduced risk to shareholders. If so, what, if any, changes should be adopted; and

· what timetable should apply for transitioning from current rules and processes to revised arrangements adopted herein.

¹ As explained in further detail herein, hedging is a form of price insurance used to protect customers from excessive swings in natural gas prices.