II. Procedural Background

The Commission initiated I.02-11-040 through an Order Instituting Investigation (OII) issued on November 21, 2002. The purpose of the investigation is to examine if there were reasons, in addition to manipulation by El Paso Natural Gas Company (El Paso or EPNG) and its marketing affiliate, El Paso Merchant Energy (EPME), for the gas price spikes that occurred in California from March 2000 through May 2001. I.02-11-040 named SoCalGas and SDG&E as Phase I Respondents. In Phase II, we will address the transactions of PG&E, PG&E Energy Trading, Southwest Gas Corporation (Southwest Gas), Alenco Gas Services, Inc., Conwest Exploration, Ltd., Southern California Edison Company (Edison), and Edison Mission Energy. Respondents in Phase II are Southwest Gas, PG&E, and Edison.

The impetus for this investigation arose in Application (A.) 00-06-023, in which the Commission assessed SoCalGas's operation during Year 6 of its GCIM. In response to concerns raised by Edison and SCGC, we found in D.02-06-023 that further investigation was warranted into the causes of the extreme border price spikes in December 2000 through spring 2001 and directed Energy Division to prepare an OII for our consideration. We subsequently issued OII 02-11-040.

The OII states that the focus of Phase I of this proceeding is investigatory and fact-finding, to investigate the past conduct of the respondents with regard to gas price spikes at the California border from March 2000 through May 2001. We stated that, if the investigation reveals that the conduct of respondents contributed to the gas price spikes at the California border during the named period, the Commission may modify or eliminate the respondents' gas cost incentive mechanisms, reduce the amount of shareholder award for the period involved, or order respondents to issue a refund to ratepayers to offset the higher prices paid. In addition, if the investigation reveals that statutory laws, or rules or orders of the Commission were violated, the Commission may enter into an adjudicatory phase of this investigation.

SoCalGas and SDG&E filed an application for rehearing of the OII 02-11-040. These parties objected to the phasing of the proceeding, in particular, to having been named as the sole respondents in Phase I. SoCalGas and SDG&E contended that in D.02-06-023 the Commission had rejected arguments that SoCalGas and its GCIM were responsible for the high gas prices experienced by California in the winter of 2000/2001. In D.03-05-040 denying the application for rehearing, we responded that:

They appear not to grasp the significance of the fact that this OII was ordered as far back as D.02-06-023, in SoCalGas' Year Six GCIM proceeding. Thus despite what the record in that case allowed us to conclude regarding allegations by Edison and SCGC about SoCalGas' market manipulations, we still saw reason to order this investigation. This meant we were absolving no one from possible involvement in the gas price spikes problem.

Consistent with D.03-05-040, we view our preliminary findings in D.02-06-023 concerning SoCalGas' GCIM and its actions leading up to and during the California energy crisis as nonbinding, because we did not have a complete record at that time. Our decision to issue this OII put all parties on notice that we would be reexamining this matter, and the OII set this matter for hearing to provide ample opportunity for all parties to more thoroughly address these issues.

A prehearing conference was held on January 9, 2003.

On February 27, 2003, we issued an OII initiating I.03-02-033 to evaluate the business activities of SDG&E, SoCalGas, and their holding company (Sempra) and consolidating that investigation with I.02-11-040. In D.03-09-040, while recognizing some limited overlap in the two proceedings, we deconsolidated the two investigations.

The scope of Phase I of I.02-11-040, as established by the OII, the April 16, 2003 scoping memo, and an August 1, 2003 administrative law judge's (ALJ) ruling, includes the following issues and non-inclusive sub-issues:

1. Did SoCalGas and/or SDG&E play a role in causing the increase in California border prices between March 2000 and May 2001 (the subject period)?

a. Did loans by SoCalGas' Gas Acquisition Group to noncore customers with repayment due in the winter of 2000/2001 affect border prices during the subject period?

b. Did the management of storage (injection/withdrawal) and/or associated storage services provided by SoCalGas' Gas Acquisition Group and/or SDG&E affect border prices during the subject period?

c. Did SoCalGas and/or SDG&E report false trades and/or false prices to the trade press? Did any such false reporting to the trade press affect border prices during the subject period?

d. Did the procurement behavior of SoCalGas and/or SDG&E affect border prices during the subject period?

e. Were hedging activities by SoCalGas' Gas Acquisition Group during the subject period influenced by the group's loaning behavior?

f. Did SoCalGas' Gas Acquisition Group benefit from higher border prices due to gas sales it made to third parties?

g. Did any of SoCalGas' short-term or long-term capacity releases arranged during the subject period, including releases to entities serving markets outside of California, contribute to the high border prices or provide evidence of an intent to tighten interstate pipeline capacity to California?

2. Did any of SoCalGas and SDG&E's affiliates or their parent company, Sempra, play a role in causing the increase in border prices? Did concerns about affiliates or the parent's financial position cause SoCalGas and/or SDG&E to take actions that may have increased gas costs?

h. Did loans by SoCalGas' Gas Acquisition Group to noncore customers with repayment due in the winter of 2000/2001 affect border prices during the subject period?

i. Did Sempra Energy Trading (SET) take positions in the electric market that allowed it or any of its affiliates to unjustifiably benefit from increased border prices during the subject period?

j. Did SET become aware of SoCalGas' gas hedging activities during the subject period? If so, did SET use that knowledge to its benefit?

k. Did SET report false trades and/or false prices to the trade press? Did any such false reporting to the trade press affect border prices during the subject period?

l. Did SoCalGas, SDG&E, and SET share information?

3. What were the primary factors that caused the increase in border prices? In addition to the increase in gas costs caused by El Paso's actions, what other factors may have caused gas prices to increase to such high levels? Did recently acknowledged inaccurate reporting of gas price information to energy trade publications by energy trading companies have any effect on published index prices?

m. Did El Paso's actions, specifically its withholding behavior, cause a change in the demand for the services (third party sales, loans, and storage) of SoCalGas' Gas Acquisition Group and Gas Operations Department during the subject period?

n. Did any of the rules of SoCalGas' Gas Operations Department, e.g., imbalance rules and related penalties, affect border prices during the subject period?

o. Did activities in the electric marketplace and electricity price increases affect border prices during the subject period?

4. Did SoCalGas' and SDG&E's gas cost incentive mechanisms (GCIMs) create perverse incentives to increase or otherwise manipulate natural gas prices at the California border? Did SoCalGas' Year 7 and Year 8 operations under the GCIM enable it to exercise market power and/or anticompetitive behavior? If so, should these incentive mechanisms be modified or eliminated to prevent such activity?

p. Does PG&E's gas cost incentive mechanism provide stronger or otherwise preferable incentives for the utility to purchase reliable, low-cost natural gas supplies for core customers? Would the provisions of PG&E's gas cost incentive mechanism have provided better protections than those provided by SoCalGas' and SDG&E's gas cost incentive mechanisms during the subject period? Should SoCalGas' and/or SDG&E's gas cost incentive mechanism be modified to incorporate any components of PG&E's gas cost incentive mechanism?

A March 10, 2004 ALJ ruling bifurcated Phase I. The current Phase I.A addresses issues 1, 3, and 4 in the scoping memo. Issues regarding whether the Sempra non-utility affiliates such as SET, or their parent company, Sempra, played a role in causing the natural gas price spikes at the California border during the subject period and, more specifically, whether concerns about affiliates' or the parent's financial position caused SoCalGas and/or SDG&E to take actions that may have increased gas costs (Issue 2) are being addressed in Phase I.B. We expect that Phase I.B may shed further light on the other issues in the scoping memo. Discovery regarding Phase I.B is on-going and Phase I.B evidentiary hearings are not scheduled at this time.

We will address after hearings in Phase I.B whether Sempra or SET influenced SoCalGas or SDG&E to take actions that may have contributed to high border prices and whether there was a sharing of confidential information between the regulated companies and their parent or affiliates. However, there is already evidence in the Phase I.A record that a significant amount of confidential information was regularly reported to the Sempra Energy Risk Management Oversight Committee (ERMOC) and specifically to Mark Randle, Sempra's Vice President of Risk Management. Randle was a member of SoCalGas' Gas Acquisition Committee, which met monthly and discussed market conditions, SoCalGas' purchasing, storage, and hub activities, and SoCalGas' performance under its GCIM. The ERMOC sets corporate policies and procedures for risk management and approves all major risk positions. After the ERMOC gave SoCalGas approval to increase its daily risk limits for its winter hedges, SoCalGas reported its hedging activities daily to Sempra Risk Management throughout the winter of 2000/2001 (Exhibit 90, Att. 4-2).

This evidence raises numerous questions regarding what Sempra or SoCalGas affiliates might have done with this information, and the amount of influence or control Sempra exerted over SoCalGas throughout the California energy crisis. It also raises very serious issues concerning potential violations of the Commission's standards of conduct governing the relationship between SoCalGas and its affiliates. Rather than address these issues here, we will address them after the hearing in Phase I.B is completed and we can review a complete record on these issues.

Several Phase I.A issues are uncontested. No party presented evidence that SoCalGas or SDG&E reported false trades or false prices to the trade press. SoCalGas and SDG&E presented testimony that, while they do not have access to full information on the subject, the inaccurate reporting of gas price information by energy trading companies does not appear to have substantially affected price indices for the California border, the Permian basin, or the San Juan basin.

No party other than SoCalGas presented any testimony regarding SoCalGas' capacity releases. SoCalGas describes that, pursuant to the 1996 BCAP decision, 1,044 MMcfd of SoCalGas' firm capacity rights are allocated to core customers, to cover a normal year's gas demand, and SoCalGas' Capacity Products group brokers the remaining 407 MMcfd allocated to the noncore. SoCalGas explains that it did not release any of the firm interstate capacity allocated to the retail core during the subject period and that it released all interstate capacity allocated to the noncore and core aggregators on a nondiscriminatory basis to the highest bidder. No party alleged that SoCalGas' imbalance rules were improper or that, by themselves, they increased border prices during the subject period.

No party alleges that any actions of SDG&E contributed to the gas price spikes. SDG&E explains that it filled its 6 Bcf of firm storage by the start of the winter season and drew its inventory down to zero over the course of the winter, that it had no forward financial position at the border except for back-to-back transactions that gave no opportunity for financial profit, and that it had limited gas sales in comparison to its purchases at the border. No party recommends that SDG&E's Performance Based Ratemaking (PBR) incentive mechanism be modified.

Eight days of evidentiary hearings were held in Phase I.A between June 29 and July 15, 2004. SoCalGas/SDG&E, Edison, PG&E, and the Office of Ratepayer Advocates (ORA) presented witnesses. The parties filed opening and reply briefs. The Phase I.A record was reopened twice, first to address the administrative treatment of certain exhibits and transcripts and second to address two additional exhibits propounded by Edison and certain information requested by the assigned ALJ, and an additional day of evidentiary hearings was held on October 25, 2004. The parties filed supplemental opening and reply briefs. Phase I.A was submitted on November 4, 2004.

On November 10, 2004, SoCalGas and SDG&E filed a motion to admit additional evidence into the Phase I.A record. We affirm the ALJ ruling denying that motion.

SoCalGas and SDG&E request that final oral argument before the Commission be scheduled.