XVIII. California Gas Transmission
Risk Management Program

A. Summary

PG&E requests authority to continue the use of the existing Commission-approved California Gas Transmission (CGT) Risk Management Program beyond 2003. The program uses financial derivative instruments to manage the price and revenue risks associated with gas transmission and storage assets.

PG&E also proposes certain modifications to the program. The first modification is to increase the authorized derivative trading limit from $200 million to $400 million of the gross market value of the derivatives, and to increase the trading volume at any point in time from 800 MMcf/d to 1000 MMcf/d. PG&E asserts that the dollar limit is necessary to cover commodity prices and high price volatility as experienced during 2000 and 2001. The volume limit is needed to reflect the recent pipeline expansion of the Redwood path. PG&E notes that all of the gains and losses resulting from financial derivative trading activities will continue to be borne by PG&E's shareholders.

The second proposed modification to the CGT Risk Management Program is to reduce the restrictions on trading financial derivatives with certain customers. PG&E is currently restricted from trading financial derivatives with its customers or affiliates. PG&E requests that the restriction be applied only to retail customers, and that two non-retail exceptions be recognized and authorized. The first non-retail exception is for wholesale marketers, who are large, nationally recognized companies. PG&E contends that this group does not need to be protected against PG&E by restricting the trading of financial derivative instruments. The second non-retail exception is for marketing affiliates of PG&E's retail transportation and market storage customers. These retail customers include some of PG&E's largest end-users of gas, such as electric generators and oil refineries. Due to the current customer restrictions, PG&E has not been able to enter into financial derivative arrangements with these marketing affiliates, who are separate legal entities. PG&E requests that the customer restriction no longer apply to these marketing affiliates.

PG&E's third proposed modification is for the Commission to authorize the use of weather derivatives, electricity derivatives, and other derivatives developed by the financial market which many emerge as viable tools for CGT to manage its risk.

PG&E also requests elimination of the current sunset date of December 31, 2003, so that forward hedge positions can be entered into before 2004. PG&E contends that these modifications are needed to manage the price and revenue risks in the marketplace.

PG&E contends that the evidence supports continuing the CGT Risk Management Program with the proposed modifications for 2004 and beyond.

B. Discussion

No parties have expressed any opposition to PG&E's request to continue the CGT Risk Management Program, or to the proposed changes which it seeks.

The CGT Risk Management Program was first authorized in D.98-12-082 when we granted PG&E authority to use natural gas-based financial instruments to manage the price and revenue risks associated with its natural gas transmission and storage assets. This authority was modified in D.99-04-013. As part of the Gas Accord II Settlement Agreement adopted in D.02-08-070, the CGT Risk Management Program was extended through the Gas Accord II period.¹⁰⁸

We have reviewed the three decisions which addressed the CGT Risk Management Program, and the reasons why certain conditions were imposed. Since a gas structure is being adopted in today's decision for 2004 and 2005, the CGT Risk Management Program should also be extended through December 31, 2005. This will allow PG&E to continue to manage the price and revenue risks associated with its natural gas transmission and storage assets.

As for PG&E's request to make three changes to the CGT Risk Management Program, the first change to increase the dollar limit and trading volume reflect conditions that now exist or have occurred in the past. That change will be adopted.

The second change is to change the restriction with whom PG&E can trade derivatives. Instead of restricting trading with retail customers and affiliates, PG&E seeks to restrict trading with retail customers only, and that two non-retail exceptions be recognized and authorized. The first non-retail exception is for wholesale marketers. The second non-retail exception is for marketing affiliates of PG&E's retail transportation and market storage customers. We have considered the reasons why the restrictions on trading with retail customers and affiliates were originally imposed in D.98-12-082. We do not believe that changing the restriction to allow trading of financial derivatives with wholesale marketers and marketing affiliates of PG&E's retail transportation and storage customers will result in market power or anticompetitive impacts. Accordingly, the second change to the CGT Risk Management Program will be adopted.

The third change that PG&E requests is for the Commission to authorize the use of weather derivatives, electricity derivatives, and other derivatives that may be developed by the financial market to manage its risk. We will allow PG&E to use these additional derivatives. Since the quarterly reporting requirements remain in place, the reports will allow us to monitor the use of these additional derivatives. The third change to authorize PG&E to use these kinds of derivatives will be adopted.

PG&E also requests elimination of the current sunset date of December 31, 2003, so that forward hedge positions can be entered into before 2004. Since we are adopting a gas structure through 2005, the authority allowing PG&E to use derivatives should be extended as well. The authority granted in today's decision to allow PG&E to use derivatives shall expire on December 31, 2005.

PG&E is authorized to continue using financial derivative instruments to manage price and revenue risks pursuant to the CGT Risk Management Program that was approved in D.98-12-082, as modified in D.99-04-013, as extended by D.02-08-070, and as changed by today's decision. This authority for PG&E to use financial derivatives shall expire on December 31, 2005 unless further extended by the Commission.