D0312035 Order Modifying the Proposed Settlement Agreement of PG&E, PG&E Corp. & the Commission Staff, & Approving the Modified Settlement Agreement

Dissenting Opinion of Commissioner Carl Wood

Pacific Gas & Electric Bankruptcy Proposed Settlement on Item 53b

Today we take an important step in putting the California Energy Crisis behind us - approval of a Settlement Agreement with PG&E that could end its bankruptcy and rehabilitate its credit.

I want to accomplish this goal very much. For my brothers and sisters who work at PG&E, it would dispel the cloud of uncertainty that bankruptcy throws over the collective bargaining relationship. For consumers it would enable us to give greater assurance that the energy supplies on which we all depend will be there at a just and reasonable, affordable price through a fully regulated utility.

I have stated repeatedly that we must do what is necessary to enable PG&E to pay its debts and emerge from bankruptcy, at the lowest reasonable cost to ratepayers and as quickly as possible. Unfortunately, I am concerned that the Majority Decision does neither - it is too expensive and too freighted with legal error to provide firm footing for those next steps.

I proposed an Alternate which I believe is the only way to accomplish the multiple objectives we have for ending the PG&E bankruptcy. The text of that Alternate is attached to this Dissent and incorporated here.

· It provides PG&E with enough cash to settle its debts and emerge from bankruptcy quickly through the sale of bonds.

· It meets all of the credit rating agency requirements for cash flows and other financial ratios to achieve investment grade credit ratings.

· It limits the intrusion of the federal courts on our regulatory ratemaking activity.

· It lowers rates substantially immediately, and does not postpone further rate reductions for nine (9) years.

· It complies in all respects with state laws, unlike the Proposed Settlement Agreement, so that it can survive appellate review and actually be implemented.

The Majority Decision is built around a regulatory asset to enable PG&E to rebuild its capital and repay its debts. The Regulatory Asset is a binding promise by this Commission that we will make ratepayers pay extra money to PG&E to rebuild its capital, over and above what is needed to pay the costs of providing energy service.

It is an extremely expensive way to go, because its creation - the making of the promise - is a taxable event for PG&E. When we issue our order, PG&E will receive income on which it must pay taxes. Under the Peevey proposal, for PG&E to realize $2.21 billion in additional capital, PG&E must receive from ratepayers over $3.8 billion. Put another way, ratepayers must pay $1.70 for each dollar of additional capital. Of all the possible ways to get PG&E the extra money it needs, this is the most expensive way. On top of this, since PG&E would receive the $3.8 billion over time, it will earn a profit on the unamortized regulatory asset balance, on which it also have to pay taxes.

I do not object to the regulatory asset on principle, because I view it as a necessary evil to achieve the objective of rapid emergence from bankruptcy. The basic obligation of this Commission is to use this most expensive approach carefully and judiciously to avoid creating unjust and unreasonable rates that overly burden ratepayers. We should make the regulatory asset no larger than it needs to be to support emergence from bankruptcy. The Majority Decision fails in this regard. It is far too generous with ratepayer money in creating a regulatory asset that is larger than it needs to be. The regulatory asset should be no more than $1.2 billion because that is what is needed to make the investment grade credit metrics and enable PG&E to pay its debts and get out of bankruptcy.

The function of the regulatory asset is to assure that PG&E has sufficient assets to support the capital structure invested in the utility. In traditional cost of service ratemaking, the invested capital of the utility supports its rate base, its plant and equipment used and useful in providing service to the public. In the Settlement Plan, PG&E proposes to refinance its entire company at the time it pays off its allowed claims in bankruptcy. The "allowed claims" include all of its financial debt including first mortgage bonds and all of its remaining liabilities related to the energy crisis and all other activities taken by the utility.¹ Since PG&E has at all times been a solvent debtor, it must make these payments in cash, which it will raise using available cash on hand and the sale of new corporate debt of various maturities. The amount of cash available directly influences the amount of new debt that PG&E must take on in order to pay the allowed claims and therefore the size of the regulatory asset.

As of September 30, 2003, PG&E reported $4.23 billion in cash in the Form 10-Q it filed with the Securities and Exchange Commission. At that time it had remaining only $2.4 billion in remaining first mortgage bonds and approximately $9.3 billion in unsecured debts, characterized as "Liabilities subject to Compromise" in its Form 10-Q.² PG&E needs to raise around $7 billion in new debt in order to have the cash necessary to pay its allowed claims and emerge from bankruptcy, with the exact amount depending on how much of the $4.23 billion is left at the end of the year, assuming prudent management and oversight by the bankruptcy court. We should calibrate the regulatory asset at no higher than needed to support new debt, which we estimate to be approximately $1.2 billion. Cash flows would be based on straight line, rather than mortgage style, amortization in order to assure cash flows at levels appropriate to meet the investment credit ratios for the debt issuances during the life of the regulatory asset.

Calibrating the regulatory asset at this level is consistent with the Commission's prior plan of reorganization. The regulatory asset proposed in that document 18 months ago did not take into account additional headroom of at least $875 million that PG&E would receive over and above cost of service during 2003. Additional headroom over and above that amount would reduce the required size of the regulatory asset, not increase it.

A different way of estimating the appropriate size of the regulatory asset involves recalling the disciplined approach to cost of service that we applied to SCE in the Edison settlement. The regulatory asset is an amount that ratepayers contribute above and beyond the earnings which PG&E is entitled to receive through return on ratebase, giving full effect to PG&E's investments in distribution, transmission and retained utility generation (URG). The retained earnings that PG&E has booked reflect full recovery of costs on a cost-of- service basis for investment in plant in service. The regulatory asset is an additional amount over and above plant in service that supports PG&E's current financial statements.

This increment over and above cost of service can be justified as ratepayer contribution to full financial rehabilitation of PG&E needed to pay its energy crisis-related debts. Another way of saying this is that the regulatory asset represents an additional payment by ratepayers to fully fund PG&E's legitimate recovery in its Filed Rate Doctrine Litigation. ORA has estimated amounts that PG&E has yet to recover at no more than $1.4 billion and as little as $700 million. PG&E's estimate, when adjusted for the admissions of PG&E Witness McManus, is no more than $2.2 billion. A regulatory asset of $1.2 billion is thus in the appropriate range between the ORA and PG&E estimates. The Majority Decision provides a regulatory asset that pays PG&E more than 150 % of its claims, an amount which is not just or reasonable on its face.

A regulatory asset of $1.2 billion is also consistent with the "compromise" that has ratepayers paying 60 % of PG&E's claims with a combination of headroom and regulatory asset. Headroom - or cash above cost of service including authorized earning and taxes - has been around $4.8 billion dollars since 2001. A $1.2 billion regulatory asset with tax gross up would bring the ratepayer contribution to nearly $7 billion dollars - double the amount we paid for Edison's energy crisis debts under that settlement.

A smaller regulatory asset can be amortized more quickly. Rapid amortization is a key element in defending the Modified Settlement Agreement from significant legal infirmities pointed out in the Proposed Decision of Judge Robert Barnett concerning the ability to bind the Commission in the future by a settlement agreement.

As I have demonstrated in Appendix A of my Alternate, this regulatory asset and associated tax gross up meet all of the cash flow and credit metric demanded by the rating agencies.

In this regard, I am concerned that the DRC cash flows will be inadequate to support investment grade ratings and that one of two things will occur -

1) The DRC will not happen; or

2) PG&E will not emerge from bankruptcy because it will have substandard credit metrics after the first year.

I want to make it clear that I support the use of a DRC as a tool to help us reduce ratepayer costs. It is not a substitute for a smaller regulatory asset.

I have prepared a chart comparing cash flows and credit metrics under my proposal and under the DRC as it has been described in the Joint Comments that are basis for the Majority Decision. This chart is attached to this Dissent as Appendix A. It suggests that cash flows after the first year will be significantly less than what rating agencies have wanted to see to support investment grade credit ratings.

If cash flows are reduced in the early years as this suggests, either PG&E does not really need the cash, or the credit metrics will not work. If the former, we are being had; if the latter we are losing the benefit of this "deal." The DRC will not be implemented.

The uncertainty on this score was a strong argument for not going forward today if we had really want to save ratepayers money, using the DRC. Now we have wagered against the house.

Rate Reductions

Like the Peevey Proposal, my Alternate provided a substantial rate reduction in 2004, on the order of $550 million (as compared with the Peevey Proposal reduction f $670 million.) But this is it -- the Majority Decision continues - and actually increases ratepayers costs for the next nine years . The combination of a smaller starting number and a shorter amortization mean that ratepayers would have provided PG&E with $2.3 billion over 4 years, not $5.3 billion over 9 years. The Majority Decision effectively gives away $3 billion dollars that come out of the pockets of Northern California residents and businesses.

PG&E's customers have been stuck with the most expensive possible bail-out.

NON-ECONOMIC ISSUES - THE HOLDING COMPANY

PG&E's parent is the source of much of its trouble. I am pleased that the Majority Decision maintains the AG's litigation against PG&E. However, we need to do more. My Alternate proposed that if PG&E's association with its parent had any negative affect on the rating agencies' view of the utility's credit, we may take steps including compelled divestiture to rectify this. The rating agencies have made it very clear in their recent rating actions on Edison and Sempra that they carefully scrutinize holding company behavior to determine if utility money or business is placed at greater risk. This needs to be actively addressed. The Majority Decision does not do this.

NON-ECONOMIC ISSUES - LEGAL INFIRMITIES

I am very eager to end the bankruptcy quickly and - as I have stated - I am willing to approve a larger regulatory asset to accomplish this. I am concerned that the provisions of the Settlement Agreement pass legal muster, and I am afraid that they do not. I want to focus on three areas:

· It is too one-sided - it imposes obligations on the Commission without imposing similar obligations on PG&E.

· It authorizes a federal court to coerce Commissioners in the performance of their Constitutional duties.

· It restricts the Commission's future regulatory and ratemaking activities for too long.

On rehearing, the Commission must accept the modifications to the Settlement Agreement text I am suggesting. If we fail here, I am concerned that the Settlement Agreement will be illegal and ineffective and will not go into effect.

I will discuss each of these infirmities in more detail:

¹ The current plan proposes to reinstate preferred stock and certain pollution control bonds, in an amount of between $1.1 billion and $1.55 billion. ² PG&E owes the PX and ISO approximately $1.7 billion, and has offsetting claims for refunds against various generators totalling in excess of $3 billion. Any net after-tax recovery will be credited against the regulatory asset. The regulatory asset thus also partly finances the timing difference between emergence from bankruptcy and recovery of refunds, the timing of which is directly controlled by the FERC.