4. PG&E's Application to Issue Debt and Preferred Stock

A. Short-Term Debt

i. PG&E's Request

Pursuant to D.04-01-024, the Financing Team authorized PG&E to issue $1.5 billion of short-term debt consisting of (1) an $850 million revolving credit (R/C) facility, and (2) a $650 million A/R financing facility. Both of these facilities expire in 2007. PG&E is authorized to use these facilities as follows:

The letters of credit under the R/C facility are used primarily to provide collateral for (1) natural gas and electricity procurement transactions, and (2) workers' compensation.⁶ The A/R facility provides for the continuous sale of PG&E's customer accounts receivable and functions as a line of credit.

In A.04-05-041, PG&E requests authority to issue $500 million of additional short-term debt, for total short-term debt authority of $2 billion.⁷ PG&E's request consists of $500 million in "new money" and $1.5 billion in refunding authority to repay or replace the $1.5 billion of short-term debt authorized by D.04-01-024. PG&E proposes that the $2 billion be divided evenly between cash borrowing and collateral for energy procurement transactions. PG&E states that its request, if granted, would supersede PG&E's authority to issue $1.5 billion of short-term debt pursuant to D.04-01-024.⁸

PG&E proposes to use the $2 billion of short-term debt for the following purposes: (1) finance gas storage inventories at a level of $200 - $250 million; (2) respond to contingencies such as temporary under-collections of balancing accounts; (3) provide credit support for energy procurement; (4) provide short-term bridge financing for infrastructure construction; (5) self-insurance collateral for workers' compensation; and (6) general working capital. PG&E anticipates that it will gradually increase its procurement of electricity during 2005-2008, and that such procurement may require additional credit support, particularly with respect to the procurement of natural gas for new generation. PG&E is also concerned that its existing authority to issue $1.5 billion of short-term debt will not be sufficient under some circumstances. PG&E states that it can currently borrow a maximum of $200 million in cash under the R/C facility and $650 million in cash under the A/R facility, for a total of $850 million in cash. However, because the A/R facility is securitized by PG&E's accounts receivables, the amount that PG&E can borrow under the facility varies with the monthly level of accounts receivables. Hence, in months when sales are low, the maximum borrowing capacity under the A/R facility can be reduced by $200 million (i.e., from $650 million to $450 million), leaving a combined cash borrowing capacity under both facilities of $650 million (i.e., $450 million under the A/R facility and $200 million under the R/C facility).

PG&E believes there is a reasonable possibility that its need for short-term borrowing could exceed $850 million. For example, higher energy prices or lower sales could lead to greater short-term borrowing. According to PG&E, its monthly cash borrowings during 1999 and 2000 were usually well below $500 million, but climbed to $1.096 billion in February 1999 and $923 million in March 1999. With the onset of the energy crisis, PG&E's monthly borrowings climbed to $917 million in September 2000, and reached $3.086 billion in December 2000. In light of this historical perspective, PG&E believes it is prudent to increase its cash borrowing capacity. PG&E is also concerned that a major disruption in its billings and collections could significantly reduced cash receipts for several days, during which PG&E would have to rely on short-term borrowing to make up the difference. PG&E states that it receives, on average, $50 million of cash receipts from customers per day.

PG&E acknowledges that debt obtained under the R/C facility and A/R facility may be outstanding for up to three years. Nevertheless, PG&E asserts that all debt under these facilities should be treated as short-term debt (i.e., debt that is outstanding for less than one year). This is because PG&E intends to repay such debt in less than one year. In addition, the purpose of these facilities is to finance short-term assets. Finally, these facilities were approved as short-term debt by the Financing Team, despite their multi-year term, because of the short-term function for which they were established.

ii. Discussion

PG&E's request for authority to issue short-term debt is subject to Sections 816, 823(b), 823(c), and 823(d) which provide, in relevant part, as follows:

Section 816: The power of public utilities to issue [debt] is a special privilege, the right of supervision, regulation, restriction, and control of which is vested in the State, and such power shall be exercised as provided by law under such rules as the commission prescribes.

Section 823(b): A public utility may issue notes, for proper purposes and not in violation of any provision of law, payable at periods of not more than 12 months after the date of issuance of the notes without the consent of the commission.

Section 823(c): Notwithstanding the provisions of subdivision (b), no public utility . . . shall, without the consent of the commission, issue notes payable at periods of not more than 12 months after the date of issuance of the notes if such notes and all other notes payable at periods of not more than 12 months after the date of issuance of such notes . . . would exceed in aggregate amount 5 percent of the par value of the other securities then outstanding. In the case of securities having no par value, the par value for the purposes of this subsection shall be the fair market value as of the date of issue.

Section 823(d): No note payable at a period of not more than 12 months after the date of issuance of such note shall, in whole or in part, be refunded by [debt or equity] . . . without the consent of the commission.

The Commission has broad discretion to determine if a utility should be authorized to issue short-term debt pursuant to Sections 816, et seq. The primary standard used by the Commission is whether a utility has demonstrated a reasonable need to issue short-term debt for proper purposes.⁹ Where necessary and appropriate, the Commission may attach conditions to the issuance of short-term debt in order to protect and promote the public interest.

To assess PG&E's need to issue short-term debt, it is useful to consider how much short-term debt PG&E has issued in the past. In D.87-09-056, the Commission authorized PG&E to issue approximately $1.840 billion of short-term debt.¹⁰ Decision 00-10-065 increased PG&E's authority to $3.076 billion in response to skyrocketing prices for wholesale electricity.¹¹ The following table shows how much short-term debt PG&E had outstanding during the two-year period ending with the onset of the electricity crisis in the second half of 2000:

PG&E is currently authorized to issue $1.5 billion of short-term debt. While this is less than what PG&E was authorized to issue prior to the electricity crisis and PG&E's bankruptcy, it appears to be more than enough to meet PG&E's needs under normal circumstances as the above table demonstrates.

PG&E contends that it will need authority to issue more than $1.5 billion of short-term debt when abnormal circumstances occur. We agree that it is prudent for PG&E to maintain financial reserves to cope with extraordinary events such as major natural disasters that temporarily reduce cash remittances from customers or dramatic surges in the price of wholesale gas or electricity. Because the frequency and magnitude of such events is inherently uncertain, we must use our experience and judgment to determine the amount of slack financial capacity that should be maintained to cope with such events. We conclude that authorizing PG&E to issue $500 million of additional short-term debt should provide an adequate financial cushion for many scenarios.

For the preceding reasons, we will authorize PG&E to issue $2 billion of short-term debt, including the amount authorized by Section 823(c). Of this amount, PG&E shall maintain a reserve capacity to issue $500 million of short-term debt that can only be used for the following purposes:

· Procure natural gas and electricity for PG&E's utility customers during spikes in demand and/or the price of gas or electricity.¹²

· Respond to major natural disasters, large scale terrorist attacks, or other cataclysms.

· Provide liquidity during a major disruption of PG&E's ability to bill, collect, and/or process utility customer bills.

PG&E may use the remaining $1.5 billion of short-term debt authorized by this Opinion for the six previously listed purposes.

The authority granted by today's Opinion supersedes PG&E's authority to issue short-term debt pursuant to D.04-01-024. We will not divide PG&E's authority between cash borrowing and collateral for energy procurement transactions. PG&E may choose any combination of the two.¹³ Consistent with Section 824, PG&E shall maintain records to identify the specific short-term debt issued pursuant to today's Opinion and to demonstrate that the proceeds from such debt have been used only for the purposes authorized by today's Opinion.

We note that PG&E's existing $850 million R/C facility and $650 million A/R financing facility will terminate in 2007. Although PG&E expects to repay loans from these facilities within one year, nothing prevents the loans from remaining outstanding until the facilities are terminated.¹⁴ Thus, it is possible that loans from these facilities could be outstanding for longer than one year. Nevertheless, it is appropriate to treat these facilities as short-term debt for regulatory purposes because (1) these facilities have already been deemed to be short-term debt by the Commission's Financing Team, (2) the Commission has previously treated similar financial arrangements as short-term debt, ¹⁵ and (3) today's Opinion restricts the use of these facilities to financing only those assets and needs that are traditionally financed with short-term debt.¹⁶

B. Long-Term Debt & Preferred Stock

i. PG&E's Request

Appendix A of this Opinion shows that PG&E is currently authorized to issue $11.0 billion of long-term debt and equity, and that PG&E currently has outstanding $10.5 billion of long-term debt and equity.¹⁷

In A.04-05-041, PG&E requests authority to issue $2 billion of long-term debt and $200 million of preferred stock. PG&E does not seek evergreen authority for the requested long-term debt and preferred stock.¹⁸ The following table shows when PG&E intends to issue the requested debt and preferred stock and how PG&E intends to use the proceeds.

Although PG&E requests authority to issue $2.2 billion of long-term debt and preferred stock, the above table shows that PG&E has definitive plans for using only $1.538 billion of the requested long-term debt and preferred stock. PG&E anticipates that the balance of the $2.2 billion, or $662 million, may be used to pay down additional debt as it matures and to fund additional capital expenditures beyond those currently forecast. For example, PG&E's current forecast of capital expenditures does not include any money for new generation that is being considered in Rulemaking (R.) 04-04-003 or the advanced metering infrastructure that is being considered in R.02-06-001.¹⁹

PG&E notes that the information in the above table incorporates the anticipated issuance of the Energy Recovery Bonds authorized by D.03-12-035 and Senate Bill (SB) 772, which is currently being considered by the Commission in A.04-07-032. PG&E states that the proceeds from the Bonds will be used to redeem $1.6 billion of two-year bonds due in 2006. PG&E cautions that its long-term debt financing requirements could increase if the Energy Recovery Bonds are not issued as expected. If this were to occur, PG&E expects that its request for $2.2 billion of additional long-term debt and preferred stock will provide sufficient flexibility to enable PG&E to meet its financial obligations while applying to the Commission for additional long-term financing authority.

ii. Discussion

PG&E's request to issue $2.2 billion of long-term debt and preferred stock is subject to Sections 816, et seq., which provide, in relevant part, as follows:

Section 816: The power of public utilities to issue [debt and preferred stock] is a special privilege, the right of supervision, regulation, restriction, and control of which is vested in the State, and such power shall be exercised as provided by law under such rules as the commission prescribes.

Section 817: A public utility may issue . . . [preferred stock], bonds, notes, and other evidence of indebtedness payable at periods of more than 12 months after the date thereof for any of the following purposes and no others:

(a) Acquisition of property.

(b) Construction, completion, extension, or improvement of its facilities.

(c) Improvement or maintenance of its service.

(d) Discharge or lawful refunding of its obligations...

(g) Retirement of or in exchange for one or more outstanding stocks or stock certificates or other evidence of interest or ownership of such public utility, or bonds, notes, or other evidence of indebtedness of such public utility, with or without the payment of cash.

Section 818: No public utility may issue [debt or preferred stock]...unless...it shall first have secured from the commission an order authorizing the issue, stating the amount thereof and the purposes to which the...proceeds thereof are to be applied, and that, in the opinion of the commission, the money, property, or labor to be procured or paid for by the issue is reasonably required for the purposes specified in the order, and that...such purposes are not, in whole or in part, reasonably chargeable to operating expenses or to income.

The Commission has broad discretion under Sections 816, et seq., to determine if a utility should be authorized to issue debt and preferred stock. The primary standard used by the Commission is whether a utility has demonstrated a reasonable need to issue debt and preferred stock for proper purposes.²⁰ Where necessary and appropriate, the Commission may attach conditions to the issuance of debt and preferred stock to protect and promote the public interest.

PG&E has demonstrated that it has a reasonable need to issue $1.538 billion of long-term debt and preferred stock during 2004 -2008 for the following purposes:

· Finance capital expenditures.

· Retire bridge loans.

· Redeem preferred stock.

These purposes are authorized by Section 817 and, as required by Section 818, are not reasonably chargeable to operating expenses or income. Therefore, we will grant PG&E authority under Sections 816, et seq., to issue $1.538 billion of long-term debt and preferred stock for the aforementioned purposes. To provide PG&E with financial flexibility, we will not prescribe how much of the authorized debt and preferred stock must be allocated to each of the authorized purposes. PG&E may allocate the authorized debt and preferred stock among the authorized purposes as PG&E deems necessary. PG&E may also issue any combination of long-term debt and preferred stock, as long as (1) the total amount issued pursuant to this Opinion does not exceed $1.538 billion, and (2) the selected combination results in a capital structure that complies, on average, with the Commission-adopted capital structure during the period the adopted capital structure is in effect for ratemaking purposes.

Consistent with Section 824, PG&E shall maintain records to (1) identify the specific long-term debt and preferred stock issued pursuant to today's Opinion, and (2) demonstrate that the proceeds from such debt and preferred stock have been used only for the purposes authorized by today's Opinion.

PG&E does not request, and this Opinion does not grant, evergreen authority to issue long-term debt and preferred stock. Accordingly, PG&E must file an application to obtain Commission authority to issue debt and equity to refinance, refund, redeem, or otherwise replace any long-term debt and preferred stock issued pursuant to this Opinion.

We decline to grant PG&E authority at this time to issue $662 million of long-term debt and preferred stock (i.e., $2.2 billion - $1.538 billion). PG&E asserts that it needs authority to issue this long-term debt and preferred stock for the following purposes: (1) to finance capital expenditures for advanced meters, (2) to finance additional generation, and (3) to provide financial flexibility in the event that PG&E cannot issue 43.0 billion of Energy Recovery Bonds authorized by SB 772 and D.03-12-035. These matters are currently being considered by the Commission in R.02-06-001, R.04-04-003, and A.04-07-032, respectively. PG&E was unable to forecast when and how much long-term debt and preferred stock needs to be issued for each of the aforementioned purposes. Without such information, we cannot reach the findings required by Section 818. As a result, we are compelled by Section 818 to deny PG&E's request to issue long-term debt and preferred stock for the aforementioned purposes.

We do not intend in this Opinion to prejudge any issues pertaining to advanced meters, additional generation, or the Energy Recovery Bonds that are being considered in other proceedings. Nor do we prejudge PG&E's need to issue additional debt and/or equity after the Commission issues decisions in these other proceedings. PG&E may file another financing application when it can demonstrate a firm and quantifiable need to issue additional debt and/or equity based on Commission decisions issued in these other proceedings.

C. Encumbrance of Utility Property

i. PG&E's Request

PG&E currently has outstanding $6.7 billion of FMBs and $2.469 billion of bank loans and other debt secured with FMBs.²¹ PG&E believes that because of its recent bankruptcy, it may be required by lenders to secure most of its debt with a like amount of FMBs. Thus, PG&E requests authority under Section 851 to issue FMBs to secure the debt requested in A.04-05-041, excluding FMBs issued as primary, and not contingent, obligations of PG&E.

PG&E also requests authority under Section 851 to use its accounts receivable to secure its debt. PG&E anticipates that such transactions would be structured as a true sale for bankruptcy purposes and debt for financial reporting and tax purposes, although other structures may be developed using accounts receivable as security or collateral.²²

ii. Discussion

PG&E's request to encumber utility property is subject to Section 851 which states, in relevant part, as follows:

Section 851: No [utility]...shall...encumber...any part its plant, system, or other property necessary or useful in the performance of its duties to the public, or any franchise or permit or right thereunder...without first having secured from the commission an order authorizing it to do so. Every such...encumbrance...made other than in accordance with the order authorizing it is void....

The Commission has broad discretion to determine if an encumbrance of utility property should be authorized under Section 851. The primary standard used by the Commission is whether the encumbrance will adversely affect the public interest. The Commission may also consider if the encumbrance will serve the public interest. If necessary and appropriate, the Commission may attach conditions to an encumbrance to protect and promote the public interest.²³

We first consider PG&E's request for authority under Section 851 to secure its debt with FMBs. PG&E has a need to issue additional debt for the reasons stated earlier in this Opinion. We have no reason to doubt PG&E's assertion that it will likely be required by lenders to secure most of its debt with a like amount of FMBs. Therefore, we find PG&E's request to be reasonable, and we will grant it. However, if a default occurs and title to any PG&E property, franchise, permit, or right that is necessary or useful in the performance of PG&E's duties to the public is transferred pursuant to FMBs, the thing transferred shall not be removed from utility service without prior authorization from the Commission.

We next consider PG&E's requests for authority under Section 851 to secure its debt with its accounts receivable. There are two somewhat contradictory bodies of Commission precedent that have a bearing on PG&E's request. One body of precedent consists of decisions that have authorized a variety of utilities to use their accounts receivable as collateral to secure their debt. In general, these decisions placed few, if any, restrictions or conditions on the use of accounts receivable as collateral.²⁴ The other body of precedent is confined to PG&E. These decisions, which were issued shortly before and during PG&E's recent bankruptcy, authorized PG&E to pledge its gas customer accounts receivable for the sole purpose of procuring gas supplies for PG&E's core customers, including flowing gas and storage gas.²⁵

We believe that the second body of precedent provides better guidance with respect to PG&E. In retrospect, it was fortunate that PG&E's gas accounts receivable were available to be used as collateral for the procurement of gas for PG&E's customers during PG&E's bankruptcy. If PG&E's gas accounts receivable had already been pledged as collateral for other purposes, it is possible that PG&E would not have been able to procure adequate supplies of gas for its customers,²⁶ thereby causing gas shortages with potentially disastrous consequences for California.²⁷

We conclude that it is in the public interest to ensure that amounts paid by PG&E's customers will always be available to serve as collateral for the procurement of gas and electricity. Therefore, we will limit PG&E's authority to pledge its gas customer accounts receivable to the sole purpose of procuring gas supplies for PG&E's customers, including flowing gas and storage gas. Similarly, we will limit PG&E's authority to pledge its electric accounts receivable to the sole purpose of procuring electric power for PG&E's customers, including any fuels necessary for PG&E's retained generation plants. The restrictions we place on PG&E's authority to pledge its accounts receivable do not apply to the following: (1) the portion of PG&E's accounts receivable that is sequestered for other purposes pursuant to statutes or Commission orders (e.g., accounts receivable that have been or will be pledged to support PG&E's Rate Reduction Bonds and Energy Recovery Bonds), and (2) PG&E's current credit facility of $650 million that is secured by PG&E's accounts receivable.²⁸ PG&E should not renew this credit facility when it expires²⁹ so that the accounts receivable supporting the credit facility can be used for the purposes authorized by today's Opinion (i.e., to serve as collateral for the procurement of gas and electricity).

D. Types of Debt and Preferred Stock

i. PG&E's Request

In A.04-05-041, PG&E requests authority to issue various types of short-term and long-term debt (referred to collectively as "Debt Securities"). The specific types of Debt Securities that PG&E proposes to issue, which are described on pages 8 to 18 of A.04-05-041, are as follows:

1. Secured Debt Securities in the form of FMBs.

2. Unsecured Debt Securities such as debentures and notes.

3. Preferred Securities issued by a subsidiary. The preferred securities would represent an interest in debentures issued by PG&E to the subsidiary and would be guaranteed by PG&E.

4. Overseas Indebtedness sold to foreign investors that would be denominated in U.S. dollars or foreign currencies.

5. Direct Loans obtained from financial institutions such as banks and insurance companies.

6. Revolving Credit and Letter of Credit Facilities obtained from banks and other lenders.

7. Accounts Receivable Financing.

8. Commercial Paper.

9. Extendible Commercial Notes (ECNs) with a maturity of less than 364 days, but at maturity can be extended for a period in excess of one year if not paid or remarketed.³⁰

10. Variable-Rate Debt based on short-term interest rate indices, bankers' acceptances, PG&E's credit ratings, or other factors.

11. Tax-Exempt Debt issued through a governmental body, political subdivision, or other conduit issuer.

12. Debt Securities with one or more of the following features:

a. Redemption Provisions that allow a Debt Security to be redeemed or repaid prior to maturity.

b. Put Options that allow the holders of Debt Securities to require PG&E or an affiliate to repurchase all or a portion of each holder's securities.

c. Sinking Funds.

d. Warrants that entitle the holder to purchase an additional bond, note, debenture, or a share of capital stock.

e. Credit Enhancements such as letters of credit, standby bond purchase agreements, surety bonds, and bond insurance. The cost of credit enhancements will be included in the cost of the Debt Securities.

PG&E states that Debt Securities will have maximum maturities of 49 years for debentures, notes, preferred securities, direct loans, and FMBs. The principal amount, terms, and conditions of each type of Debt Security will be based on market conditions at the time of sale or issuance. The selection of the specific Debt Securities will be based on lowest overall cost to PG&E and its ratepayers.

PG&E says it may issue Debt Securities directly, through an affiliate, in public offerings, or through private placements.³¹ Debt Securities may also be sold directly to investors or to underwriters who, in turn, will offer the Debt Securities to investors. Additionally, Debt Securities may be registered with the Securities and Exchange Commission and listed on a stock exchange.

In conjunction with the issuance of foreign currency securities, PG&E requests authority for itself or an affiliate to enter into forward contracts by which a counterparty would be obligated to pay the foreign currency necessary to make principal and interest payments on the foreign currency security. In return, PG&E and/or an affiliate would pay a counterparty U.S. dollars based on a predetermined formula. The cost of the forward contracts will be included in determining the overall cost of foreign currency securities.

To avoid double counting, PG&E requests that credit enhancements not be counted as outstanding debt. PG&E states that credit enhancements do not result in an additional obligation beyond the actual debt that is issued for cash. For example, if an unsecured bond is issued for $100, PG&E's only obligation is to pay the principal and interest on the $100. If the $100 debt is secured with bond insurance, a mortgage bond, and other forms of credit enhancement, PG&E's total obligation remains at $100 of principal, plus interest on the principal.

Finally, PG&E requests authority to issue preferred stock in one or more offerings with the method of sale, price, dividend rate, liquidation preferences, and other terms and conditions to be determined prior to each offering based on then prevailing market conditions. The rights, preferences, and privileges applicable to each series of preferred stock will be fixed by resolution of PG&E's board of directors and a certificate of determination of preferences will be filed with the California Secretary of State.

ii. Discussion

PG&E's request for authority to issue many different types of Debt Securities and preferred stock using a wide variety of means is subject to Commission approval pursuant to Sections 816, et seq. We recognize that a vast array of debt and equity financial instruments is available in global financial markets. Providing PG&E with discretion choose among the many different instruments and the many different ways to issue debt and preferred stock should enhance PG&E's ability to obtain capital at the lowest possible cost to PG&E and its ratepayers. Therefore, we will grant PG&E authority under Sections 816 - 830 and 830 to issue the types of Debt Securities and preferred stock described in A.04-05-041 using the means identified in the Application. We expect PG&E to utilize this authority in a reasonable manner.

We also grant PG&E's request to not count as debt any credit enhancements (e.g., letters of credit, mortgage bonds, bond insurance, etc.) that do not increase the amount of debt owed by PG&E.³² This is consistent with the Commission's long-established practice.³³

E. Interest-Rate Caps, Collars, Swaps, and Hedges

i. PG&E's Request

PG&E requests authority to use interest-rate caps, collars, swaps, hedges, and other financial instruments to manage the risks associated with interest rate volatility (collectively, "hedges"). PG&E also requests that these hedges not be counted against its authorized debt, since these hedges would not affect the amount of the underlying debt issued.

PG&E states that the terms and conditions of hedges will be based on market conditions at the time such transactions are negotiated. Additionally, hedges entered into by an affiliate may be guaranteed by PG&E. At this time, PG&E has not identified any hedges related to debt that might be issued under A.04-05-041. PG&E submits that it seeks authority for hedges in order to have this option available in the event an appropriate opportunity arises.

ii. Discussion

PG&E's request to enter into hedges to manage interest rate risks is subject to Sections 816, et seq. Consistent with previous Commission decisions,³⁴ we will authorize PG&E to use hedges subject to the following conditions:

1. PG&E shall enter into hedges only when PG&E believes in good faith that the use of hedges will (i) reduce PG&E's cost of capital compared to unhedged Debt Securities, and/or (ii) protect against significant interest rate risks.

2. PG&E will separately report all interest income and expense (as recorded for ratemaking purposes) arising from all hedging transactions in its regular report to the Commission.

3. Hedging transactions will not exceed at any time 20 percent of PG&E's total long-term debt outstanding.

4. All costs associated with hedging transactions shall be subject to review in PG&E's cost of capital proceedings or other appropriate proceedings.

5. Hedges carrying potential counterparty risk must have counterparties with investment grade credit ratings that are two notches higher than PG&E's.

6. PG&E will provide the following available to Commission staff within 30 days of a request: (i) all terms, conditions, and other details of hedge transactions; (ii) PG&E's rationale for the hedge transactions; (iii) PG&E's estimated costs for the "alternative" or unhedged transactions; and (iv) copy of the hedge agreements and associated documentation.

We conditionally grant PG&E's request to not count hedges as outstanding debt.³⁵ Specifically, we will not count hedges against PG&E's authorized debt to the extent the hedges are both (1) recorded as a liability in accordance with generally accepted accounting principles (GAAP), and (2) deemed effective under GAAP in offsetting changes to the fair value or cash flows of the risks being hedged. On the other hand, hedges will be counted against PG&E's authorized debt to the extent they are recorded as liability in accordance with GAAP, but are not deemed effective under GAAP in offsetting changes to the fair value or cash flows associated with the risks being hedged.

F. Exemption from the Competitive Bidding Rule

i. PG&E's Request

Resolution F-616, issued on October 1, 1986, requires utilities to issue debt using competitive bids. The purpose of this requirement, known as the Competitive Bidding Rule, is to reduce the cost of debt. The Resolution also states that requests for an exemption from the Competitive Bidding Rule will be "entertained for debt issues in excess of $200 million, and will only be granted upon a compelling showing by a utility that because of the size of the issues, an exemption is warranted."

PG&E requests an exemption for all debt issued pursuant to this Opinion in excess of $200 million principal amount. PG&E's reasons for the exemption are as follows:

1. Competitively bidding larger issues may result in higher costs due to the fragmenting of the investment banking community into competitive bidding syndicates and the increased risk thereby assumed by each syndicate.

2. The competitive bidding process is fundamentally designed for highly rated, well-known issuers who do not need to avail themselves of the opportunities for communicating to, and receiving market intelligence from, the investment community in order to achieve a successful offering.

3. Competitive bidding may leave PG&E limited and undesirable options for obtaining needed financing.

PG&E notes that Exhibit A of Resolution F-616 exempts the following Debt Securities that are issued on a negotiated basis: securities privately placed with specific lenders; bank term loans; tax-exempt pollution control bonds; and variable-rate debt. PG&E requests that the following Debt Securities also be exempted from the Competitive Bidding Rule because they are typically issued through negotiated arrangements: notes sold through a placement agent on a reasonable efforts basis; trust preferred securities; accounts receivable financings; overseas indebtedness; foreign currency securities; notes; and interest-rate hedges. PG&E states that pursuant to the Competitive Bidding Rule, other fixed-rate Debt Securities in the form of FMBs, intermediate and long-term notes, and debentures of $200 million or less in principal amount (other than tax-exempt securities) that are sold publicly in the domestic market will be offered through competitive bidding.³⁶

To provide added flexibility to take advantage of market opportunities, PG&E requests that the Commission modify the Competitive Bidding Rule to permit PG&E to use the following procedures for those situations where the Rule remains applicable:

1. To shorten the time between the issuance of an invitation for bids and the scheduled receipt of bids to a period which is the shortest time reasonably required to obtain a sufficient number of bids from underwriters or purchasers or groups thereof.

2. To accelerate, postpone, or cancel the scheduled date and time for receipt of bids.

3. To reject all bids submitted.

4. To request the resubmission of bids.

5. To reschedule subsequent receipt of bids.

6. To vary the amount, terms, and conditions of the Debt Securities submitted for bids.

7. To waive the requirement for newspaper publication of the above items.

ii. Discussion

We grant PG&E's request for the previously described exemptions from, and modifications to, the Competitive Bidding Rule. We do so based on (1) the fact that the Commission has routinely granted PG&E and other utilities similar exemptions and modifications³⁷ with no discernable adverse impacts on the utilities, their customers, or the public at large; and (2) PG&E's representation that granting the exemptions and modifications will enable PG&E to obtain debt in a manner advantageous to PG&E and its ratepayers. This Opinion makes no finding regarding the reasonableness of the rates, terms, and conditions of debt issued by PG&E pursuant to the exemptions and modifications granted herein.

G. Use of Subsidiaries

i. PG&E's Request

PG&E requests authority to issue Debt Securities through a type of subsidiary known as a special purpose entity (SPE) when cost savings may be achieved by doing so. Such an entity would be wholly-owned by PG&E and similar to PG&E's existing SPEs.³⁸

PG&E explains that using an SPE to issue debt can reduce the cost of debt when lenders are willing to charge lower interest rates to an SPE that is structurally and legally isolated from the credit risk of the parent utility. In such cases, the interest rate charged by a lender would be based on the credit quality of utility assets that are pledged or sold to the SPE, such as customer accounts receivable, rather than the credit quality of the utility.

Section 701.5 prohibits utilities from issuing bonds, notes, guaranteeing financial transactions, or pledging utility assets on behalf of their subsidiaries, but allows exceptions for transactions that are "for or on behalf of a subsidiary if its revenues and expenses are included by the commission in establishing rates for the [utility]." PG&E maintains that any SPE used in connection with debt issued pursuant to today's Opinion would satisfy the requirements of Section 701.5. PG&E adds that the Commission would have regulatory authority over any SPE created pursuant to today's Opinion, and that the SPE's assets, debt, and equity would be included on PG&E's consolidated balance sheet.

ii. Discussion

PG&E's request to issue debt through subsidiary SPEs is subject to Section 701.5 which states, in relevant part, as follows:

Section 701.5: [N]o electrical [or] gas...corporation, whose rates are set by the commission on a cost-of-service basis, shall issue any bond, note, lien, guarantee, or indebtedness of any kind pledging the utility assets or credit for or on behalf of any subsidiary...The commission may, however, authorize an electrical, gas, or telephone corporation to issue any bond, note, lien, guarantee, or indebtedness pledging the utility assets or credit...[for] or on behalf of a subsidiary or affiliate if it engages in activities which support the electric [or] gas...corporation in its operations or service, these activities are, or will be, regulated either by the commission or a comparable federal agency, and the issuance of the bond, note, lien, guarantee, or indebtedness is specifically approved in advance by the commission. The commission shall not approve the bond, note, lien, guarantee, or indebtedness unless the commission finds and determines that the proposed financing will benefit...the utility and its ratepayers.

We conclude that it is in the public interest to grant PG&E authority under Section 701.5 to issue Debt Securities authorized by today's Opinion through a subsidiary or other SPE when doing so lowers the cost of debt for PG&E and its ratepayers.³⁹ As required by Section 701.5(a), the assets, liabilities, revenues, and expenses of any SPEs established by PG&E pursuant to today's Opinion shall be used by the Commission in setting rates for PG&E. Thus, the SPEs shall be treated as a "regulated subsidiary" for the purpose of applying the Commission's rules for affiliate transactions.⁴⁰ In addition, PG&E must have 100% ownership and control of the SPEs. The Commission shall also have regulatory control over the SPEs and access to the books and records of the SPEs. Finally, PG&E shall not make any profit from the SPEs, except for an authorized return on PG&E's reasonable equity investment in the rate base of the SPEs.

H. General Order 24-B

i. PG&E's Request

General Order (GO) 24-B requires utilities to submit a monthly report to the Commission that contains, among other things, the following information: (1) the amount of debt and preferred stock issued by the utility during the previous month; (2) the total amount of debt and preferred stock outstanding at the end of the prior month; (3) the purposes for which the utility expended the proceeds realized from the issuance of debt and preferred stock during the prior month; and (4) a monthly statement of the separate bank account that the utility is required to maintain for all receipts and disbursements of money obtained from the issuance of debt and preferred stock. To minimize administrative costs, PG&E requests permission to report to the Commission on a quarterly basis all the information required by GO 24-B for any debt and preferred stock issued by PG&E pursuant to this Opinion.

ii. Discussion

In recent years the Commission has routinely authorized utilities to report on a quarterly basis the information required by GO 24-B in order to reduce the utilities' administrative and compliance costs.⁴¹ Therefore, consistent with Commission practice, we will authorize PG&E to report on a quarterly basis all the information required by GO 24-B regarding any debt and preferred stock issued pursuant to this Opinion. However, PG&E shall report this information on a monthly basis if directed to do so by Commission staff.

I. Matters Not Addressed

Today's Opinion does not address the following matters: (1) PG&E's capital structure; (2) the reasonableness of any expenditures made by PG&E with the proceeds of the debt and preferred stock authorized by this Opinion; (3) the ratemaking treatment of the costs associated with the debt, preferred stock, and other financial instruments issued by PG&E pursuant to today's Opinion; and (4) the reasonableness of any costs, terms, or conditions of any debt, preferred stock, and other financial instruments issued by PG&E pursuant to today's Opinion. These matters will be addressed in other proceedings.

⁶ Letter from the Commission's Financing Team dated March 4, 2004, pp. 24 - 30. This letter was provided by PG&E in its Supplement filed on July 16, 2004.

⁷ PG&E's request for $2 billion of short-term debt includes the amount allowed by Section 823(c) (i.e., 5% of the par value of PG&E's outstanding long-term securities).

⁸ PG&E Supplement filed on July 16, 2004, response to Question 19.

⁹ The term "proper purposes" refers to expenditures that are necessary or proper to promote legitimate objects of a public utility of the type concerned. (207 Cal 630 (1929).)

¹⁰ D.87-09-056, 1987 Cal. PUC Lexis 224, *2, *3, and *17. All references to authorized short-term debt include the short-term debt authorized by Section 823(c).

¹¹ D.00-04-057, 2000 Cal. PUC Lexis 391, *3 and *11.

¹² We define a "spike" as an increase in the total monthly cost to procure gas or electricity that exceeds by 50% the monthly average of the preceding 12 months. For example, a "spike" would occur if the demand for gas and the price of gas each increased by 25%, resulting in an increase in the total procurement cost of more than 50%.

¹³ We expect that PG&E's need to provide collateral to support energy procurement transactions should decline as PG&E's credit ratings improve. We expect PG&E to adjust its short-term financing arrangements accordingly.

¹⁴ PG&E Supplement filed on September 28, 2004.

¹⁵ In D.87-09-056, the Commission authorized PG&E to use multi-year bank facilities as short-term debt. This authority remained in effect until PG&E's bankruptcy.

¹⁶ This Opinion does not address the ratemaking treatment of PG&E's short-term debt.

¹⁷ PG&E Supplement filed on July 16, 2004, response to Questions 1, 4, and 23. The quoted amounts of long-term debt and equity include the consolidated debt of PG&E's subsidiaries. The difference between PG&E's authorized versus outstanding debt and equity is due almost entirely to PG&E having less outstanding debt than authorized for (i) the reinforcement of the Tesla electric transmission line, (ii) the undercollection of PG&E's Transition Revenue Account, and (iii) low-income housing.

¹⁸ PG&E Supplement filed on July 16, 2004, Response to Question 6.

¹⁹ PG&E supplement filed on July 16, 2004, response to Question 7.

²⁰ The term "proper purposes" means any expenditures that are necessary or proper to promote legitimate objects of a public utility of the type concerned. (207 Cal 630 (1929).)

²¹ The use of FMBs to secure this debt will "fall away" if the ratings on PG&E's long-term unsecured debt obligations rise to certain specified levels.

²² A.04-05-041, pp. 2, 3, and 12.

²³ D.04-07-023, mimeo., pp. 11-12.

²⁴ See, e.g., D.04-01-009 (San Diego Gas & Electric Company), D.03-11-018 (Southern California Edison Company), and D.01-04-031 (Mountain Utilities).

²⁵ See D.04-02-056, D.03-02-061, D.02-03-025, D.01-06-074, D.01-02-050, and D.01-01-062.

²⁶ PG&E asserted at the time that its ability to procure adequate supplies of gas was dependent on its use of accounts receivable as collateral for gas purchases. (See, e.g., D.04-02-056, Finding of Fact (FOF) 2; D.03-02-061, pp. 3, 4, and FOF 2; and D.01-01-062, FOFs 6, 7, 8, & 10.)

²⁷ D.01-01-062, FOF 9.

²⁸ The $650 million credit facility, which is authorized by D.04-01-024 and the Commission's Financing Team, provides for the continuous sale of PG&E's customer accounts receivable and functions as a line of credit (i.e., allows PG&E to borrow up to $650 million of cash).

²⁹ PG&E's Supplement filed on September 28, 2004, states that the $650 million accounts receivable facility will terminate in 2007.

³⁰ PG&E states that consistent with D.00-04-057, ECNs would be treated as short-term debt.

³¹ Debt Securities sold in private placements may contain provisions for subsequent public registration.

³² Any credit enhancements that increase the amount of debt owed by PG&E shall be counted against PG&E's authorized debt.

³³ See, e.g., D.04-01-009, D.03-12-004, D.03-07-029, D.03-07-008, and D.03-04-030. Also, the Commission's Financing Team concurrence letter dated March 4, 2005, states at p. 5 that "As represented by PG&E and confirmed by UBS and outside bond and bankruptcy counsel, providing long-term bonds as collateral (credit support) or credit enhancement...does not increase the amount of debt owed by PG&E."

³⁴ See, for example, D.95-09-023, D.96-05-066, and D.03-12-004.

³⁵ Consistent with D.02-11-030, Footnote 13, any debt issued by PG&E as part of a transaction involving an interest-rate swap shall be used to determine the amount of authorized and outstanding debt.

³⁶ Because the Competitive Bidding Rule applies only to utilities that have ratings of "A" or higher, PG&E might not competitively bid such fixed-rate bonds and debentures until it meets the minimum bond rating threshold.

³⁷ See, for example, D.04-04-051, OP 4; D.04-01-009, OP 9; D.03-12-004, OP 11; D.03-11-018, OP 11; and D.03-09-020, OP 5.

³⁸ PG&E represents that it has two existing SPEs that are similar to those proposed in A.04-05-041. These are: (1) PG&E Funding LLC, the underlying borrower used to issue the Rate Reduction Bonds authorized by D.97-09-055; and (2) PG&E Accounts Receivable Company LLC, which purchases PG&E's accounts receivable pursuant to the A/R financing facility authorized by D.02-11-030, as modified by D.04-01-024.

³⁹ The Commission granted similar authority in D.95-09-023, D.95-04-024, and D.94-07-062.

⁴⁰ A "regulated subsidiary" is defined as "any subsidiary of a utility the revenues and expenses of which are subject to regulation by the Commission and are included by the Commission in establishing the rates for the utility." (D.93-02-019, 48 CPUC 2d 163, 173. See also R.01-01-001, 2001 Cal. PUC Lexis 46, *25.)

⁴¹ See, for example, D.04-04-041, OP 5; D.04-01-009, OP 11; D.03-12-052, OP 6; D.03-12-004, OP 13; D.03-11-018, OP 13; and D.03-09-020, OP 6.