X. Capital Structure

Capital structure is comprised of long-term debt, preferred stock, and common equity.⁴ Because the level of financial risk that PG&E faces is determined by the proportion of its debt to permanent capital, or its leverage, the goal is to ensure that the adopted equity ratio is sufficient to maintain reasonable credit ratings and to attract capital.

PG&E's capital structure policy is driven primarily by two objectives. The first objective is to maintain financial flexibility so that a sufficient amount of liquidity exists to withstand adverse business events and to fund on-going capital requirements. The second objective is to minimize financing costs by taking advantage of the tax benefits of debt, which avoid the higher costs of capital associated with excessive levels of leverage. To achieve these objectives,

PG&E considers factors such as bond rating, event risk, dividend policy, and business strategy to arrive at a targeted single-A bond rating.

PG&E derives its core capital structure by removing the capital attributable to Diablo Canyon, which for ratemaking purposes has been previously segregated by the Commission from PG&E's utility business. With no plan to change its current authorized capital structure, PG&E proposes to use the identical capital structure that the Commission approved in its prior year's cost of capital proceeding. That capital structure consists of 46.20% long-term debt, 5.80% preferred stock, and 48.00% equity. PG&E estimates that its pre-tax interest coverage ratio, including short-term debt interest, will be approximately 4.11 and 4.17 times earnings for 2000 and 2001, respectively, a sufficient coverage of ratios to maintain its targeted single-A debt rating. No party objects to PG&E continuing to use its adopted 2000 test year capital structure for its 2001 test year.

We concur with the parties. PG&E's 2001 capital structure consisting of 46.20% long-term debt, 5.80% preferred stock, and 48.00% equity is consistent with the law, in the public interest and should be adopted. The next step in determining a fair ROE is to establish reasonable long-term debt and preferred stock costs.