II. Description of the PSA Terms and Conditions

A. Structure of the Proposed Settlement Plan of Reorganization

PG&E's original plan of reorganization in the Bankruptcy Court provided for the disaggregation of PG&E's historic businesses into four separate companies, three of which would be under the regulatory jurisdiction of FERC rather than this Commission. Under the Settlement Plan, PG&E will remain a vertically integrated utility subject to the plenary regulatory jurisdiction of this Commission⁷ as modified and limited by the terms of the Proposed Settlement Agreement.

B. Financial Elements of the PSA

1. Establishment of a Regulatory Asset

The PSA establishes a regulatory asset with a starting value of $2.21 billion as a new, separate, and additional part of PG&E's rate base (PSA, ¶ 2). The regulatory asset will be reduced dollar for dollar by the net after-tax amounts of any reductions in bankruptcy claims or refunds PG&E actually receives from generators or other energy suppliers. The regulatory asset will be amortized on a mortgage-style basis over nine years starting on January 1, 2004 (PSA, ¶ 2a). The mortgage-style amortization keeps the revenue requirements associated with the regulatory asset relatively constant over its life rather than being front-end loaded as they would under traditional rate base treatment. Because the regulatory asset will not have any tax basis, both the amortization of the regulatory asset and the return on it will be grossed up for taxes (PSA, ¶ 2c).⁸ The PSA provides a floor on the authorized return on equity (ROE) and the equity component of the capital structure associated with the regulatory asset (PSA, ¶ 2b). While the regulatory asset will earn the ROE on the equity component of PG&E's capital structure as set in PG&E's annual cost of capital proceedings, the ROE will be no less than 11.22 percent and, once the equity component of PG&E's capital structure reaches 52 percent (expected in 2005), the equity component will be set for ratemaking purposes at not less than 52 percent.

The PSA provides that the Utility Retained Generation (URG) rate base established by D.02-04-016 shall be deemed just and reasonable and not subject to modification, adjustment or reduction (other than through normal depreciation) (PSA, ¶ 2f). Similarly, the value of the regulatory asset and URG rate base are not to be impaired by the Commission taking them into account when setting PG&E's other revenue requirements and resulting rates or PG&E's authorized ROE or capital structure.

2. Profits Accruing to PG&E⁹

The proposed settlement acknowledges that the headroom, surcharge, and base revenues accrued or collected by PG&E through the end of 2003 have been or will be used for utility purposes, including paying creditors in PG&E's Chapter 11 case (PSA, ¶ 8a). Those past revenues will no longer be subject to refund. The PSA establishes both a floor and a ceiling on 2003 headroom revenues. PG&E will be authorized to collect at least $775 million, but not more than $875 million (both pretax), of headroom (PSA, ¶ 8b). The Commission will adjust 2004 rates to refund any overcollection or make up any undercollection.

3. Ratemaking Matters

The proposed settlement provides for PG&E's retail electric rates to remain at current levels through 2003, with a reduction effective as of January 1, 2004 (PSA, ¶ 3a)¹⁰. As of January 1, 2004, the TCBA and other Assembly Bill 1890 ratemaking accounts will be replaced by the regulatory asset and the ratemaking resulting from the proposed settlement (PSA, ¶ 2e).

PG&E's capital structure and authorized ROE will continue to be set in annual cost of capital proceedings, but until PG&E achieves a company credit rating of either A- from Standard & Poor (S&P) or A3 from Moody's, the authorized ROE will be locked in at 11.22 percent (after tax, with shareholders paying the tax on this profit) and the equity ratio will be no less than 52 percent (PSA, ¶ 3b). PG&E claims that this capital structure, with its 52 percent equity ratio, is necessary to support the investment grade credit metrics contemplated by the proposed settlement. (Ex. 112, pp. 7-6, 7-16, PG&E/Murphy.)

PG&E is given a two-year transition period to achieve the 52 percent equity ratio. Until that time, PG&E's equity ratio for ratemaking purposes will be its Forecast Average Equity Ratio as defined in the PSA, but no less than 48.6 percent (PSA, ¶ 3b).

4. Dividends and Stock Repurchases

Under the PSA, PG&E agrees not to pay any dividend on common stock before July 1, 2004 (PSA, ¶ 3b). PG&E has told the financial community that it does not expect to pay a common stock dividend before the second half of 2005, but the PSA does not require or mention such a deferral. Under the PSA, the Commission agrees not to restrict the ability of the boards of directors of either PG&E or PG&E Corporation to declare and pay dividends or repurchase common stock (PSA, ¶ 6).

C. Dismissal of Energy Crisis-Related Disputes

As part of the PSA, PG&E will dismiss its pending Rate Recovery Litigation¹¹ against the Commission based on the federal filed rate doctrine (PSA, ¶ 9). In that litigation, PG&E had sought recovery from ratepayers of approximately $9 billion in unrecovered costs of purchasing power during the energy crisis. (Exs. 120 and 120c, PG&E/McManus.) The PSA also requires the Commission to act outside the record of another currently pending regulatory proceeding by requiring the Commission to will resolve Phase 2 of PG&E's pending Annual Transition Cost Proceeding (ATCP) application without any disallowance (PSA, ¶ 9). In the ATCP, ORA contends that PG&E incurred approximately $434 million of unreasonable power procurement costs and recommends disallowance of that amount.

D. Environmental Provisions

Under the PSA, PG&E commits to protect approximately 140,000 acres of watershed lands associated with its hydroelectric system, plus the 655 acre Carizzo Plains in San Luis Obispo County, through conservation easements or fee simple donations (PSA, ¶ 17a). PG&E estimates that lands subject to this commitment are worth approximately $300 million.¹² The determination of how best to protect these lands will be made by the board of a new California non-profit corporation (PSA, ¶ 17b). Under the Land Conservation Commitment Stipulation (Ex. 181), this non-profit corporation will be named the Pacific Forest and Watershed Lands Stewardship Council (the Stewardship Council). The Stewardship Council's governing board will consist of representatives from the Commission, the California Resources Agency, ORA, the State Water Resources Control Board, the California Farm Bureau Federation, the California Department of Fish and Game, the California Forestry Association, the California Hydropower Reform Coalition, the Regional Council of Rural Counties, the Central Valley Regional Water Quality Board, Association of California Water Agencies, The Trust for Public Land, and PG&E, and three public members named by the Commission. The U.S. Department of Agriculture-Forest Service and U.S. Department of Interior-Bureau of Land Management will together designate a federal liaison who will participate in an advisory and non-voting capacity. (Ex. 181, paragraph 10a.) Ratepayers will pay $70 million over ten years to fund the operation of this Stewardship Council (PSA, ¶ 17c). This funding will cover both administrative expenses and environmental enhancements to the protected lands. The governing board of the Stewardship Council will develop a system-wide plan for donation of fee title or conservation easements.

The second environmental commitment involves PG&E establishing and funding a clean energy technology incubator. This new, California non-profit corporation will be dedicated to supporting research and investment in clean energy technologies primarily in PG&E's service territory (PSA, ¶ 18a). PG&E will provide shareholder funding of $15 million over five years (PSA, ¶ 18b) and will work with the Commission to attract additional funding (PSA, ¶ 18c).

E. Conditions Precedent to Effectiveness of Settlement Plan

Commission approval of the PSA as well as final, nonappealable approval of all rates, tariffs, and agreements necessary to implement the Settlement Plan and PSA are conditions to the effectiveness of the PSA (PSA, ¶ 37) and the Settlement Plan (PSA, ¶ 16b), respectively. All such commission appraisals of rates, tariffs, and other unspecified agreements could take considerable time, during which time any rate reductions would presumably be on hold.

The PSA expressly provides that receipt of investment grade company credit ratings from both S&P and Moody's is a condition to the Settlement Plan becoming effective (PSA, ¶ 16a). The plan provides that this condition cannot be waived. (Ex. 101, pp.1-15, PG&E/Smith.)

F. Other Provisions

1. Interest Rate Hedging

The proposed settlement authorizes the actual reasonable cost of PG&E's interest rate hedging activities to be recovered in rates without further review (PSA, ¶ 12). The Commission recently issued D.03-09-020 in its Bankruptcy Financing Order Instituting Investigation (Investigation 02-07-015) authorizing PG&E to initiate interest rate hedging for any approved and confirmed plan of reorganization. As provided in the PSA, UBS Warburg and Lehman Brothers will be entitled to all commissions and fees for conducting such hedging without reasonableness review by this Commission (PSA, ¶ 13 d, f). Ratepayers will pay for all such fees and commissions for this hedging, without any parameters or limits.

2. Financing

With the exception of certain pollution control bond-related obligations and outstanding preferred stock, the Settlement Plan contemplates that all of PG&E's existing trade and financial debt will be paid in cash (PSA, ¶¶ 13a and 14). Essentially, the settlement creates a complete refinancing of the company, rather than reinstatement of existing debt. The financing will not include any new preferred or common stock (PSA, ¶ 13b). The cash to pay creditors will come from a combination of cash on hand and new long- and short-term debt.

3. Fees and Expenses

PG&E will reimburse the Commission for its professional fees and expenses in the Chapter 11 case without the need for an application (PSA, ¶ 15). The Commission will authorize PG&E to recover these amounts in rates over a reasonable time, not to exceed four years (id.). Similarly, PG&E will reimburse PG&E Corporation for its professional fees and expenses in the Chapter 11 case, but that cost will be borne solely by shareholders through a reduction in retained earnings (id.), except for those costs shifted to the ratepayers by the operation of the GAAP accounting provisions of the PSA (PSA , ¶ 1y). Fees, commissions and other payments to Lehman Brothers and to UBS Warburg are locked in and expressly allowed under the PSA. (¶¶ 12, 13.

4. Releases

As part of the Settlement Plan, PG&E will release claims against the Commission, the OCC, and PG&E Corporation (PSA, ¶ 24). The Commission agrees to release PG&E and PG&E Corp. from all claims, actions, or regulatory proceedings (¶ 10).

5. Bankruptcy Court Supervision

The PSA requires that the settlement will be enforceable by the Bankruptcy Court for its full nine-year term (PSA, ¶¶ 20-23, 30, and 32) rather than entering into a judgment and releasing the continuing jurisdiction of the bankruptcy court. Instead, the Commission and PG&E agree that the Bankruptcy Court shall retain jurisdiction over them "for all purposes relating to the enforcement of this Agreement, the Settlement Plan and the Confirmation Order." (PSA , ¶ 22)

The Commission waives "all existing and future rights of sovereign immunity, and all other similar immunities, as a defense" and consents to the jurisdiction of any court, including a federal court, for any action or proceeding to enforce the Settlement Agreement, the Settlement Plan, or the Bankruptcy Court's confirmation order. (PSA, ¶ 20)