III. Specific Authorization Sought In the Petition

PG&E requests specific modifications to the prior Commission authorizations to allow it to:

· Negotiate and commence hedging interest rates as soon as possible for the long-term debt that will be issued under a Bankruptcy Court approved plan of reorganization up to a maximum amount of $7.4 billion.

· Include the costs of the interest rate hedges, including amounts received or paid upon unwinding the hedges and for rollovers, in PG&E's cost of debt for rate recovery purposes.

· Exempt PG&E from the competitive bidding rules for all interest rate hedges.

· Report information on interest rate hedge activity on a quarterly basis.

· Adopt an expedited advice letter process for prospectively determining the reasonableness for rate recovery of individual hedging transactions that are entered into consistent with the expedited advice letter process; and delegate authority to the Energy Division to act on the advice letters as requested in this petition.

A. Proposed Hedging Instruments

PG&E proposed to minimize exposure to potential interest rate increases by using interest rate hedges to hedge, in part, the cost of long-term debt financing upon implementation of an approved bankruptcy plan. D.02-11-030 allows for the use of interest rate swaps, caps, and collars. In this petition PG&E requests authority to extend authorization to the following instruments: (1) forward rate agreements, and (2) options and floors. PG&E described a forward on U.S. Treasuries as an agreement between two parties to buy and sell a specific U.S. Treasury note or bond at a specified price at a later settlement date. An option contract would be an agreement giving the purchaser (PG&E) the right, but not the obligation to buy (call) or sell (put) an asset at a given price (the "strike price"). The option's strike price and maturity date are determined when the contract is entered into, and an "upfront premium" is established for payment from the purchaser to the seller. A buyer would chose to purchase a floor or a cap, which may be in the form of a single or series of put or call options on a specified financial instrument, such as a U.S. Treasury note or bond or an interest rate swap. PG&E asserted that options should be thought of as analogous to an insurance policy, in that an upfront premium is paid in order to limit total payments.

PG&E requested Commission approval to hedge up to $7.4 billion (in notional⁸ amount) prior to a confirmed plan of reorganization, because of the current low interest rate environment and PG&E's expectations of future interest rates in the period when PG&E expects to implement financing to emerge from bankruptcy.

Consistent with the intentions inherent in D.02-11-030, that the bankruptcy proceeding should be resolved as economically as possible, at the lowest possible cost to ratepayers, it is reasonable to consider cost-effective interest rate hedges as a tool to mitigate the final cost of a POR.

B. Proposed Ratemaking Treatment

PG&E specifically seeks confirmation from the Commission that regardless of the direction that interest rates actually move, those costs will be recoverable debt issuance costs. The request would allow PG&E to capitalize all costs of interest rate hedges, including initial fees and settlement costs (including, without limitation, any change in the hedge value between the time of issuance and the time it settles), whether positive or negative amounts, as issuance costs, and that these issuance costs will be included, as are other issuance costs, within PG&E's recorded cost of debt. Proposed rate recovery would be in PG&E's annual cost of capital proceeding or in any other proceeding setting PG&E's cost of capital for ratemaking. To the extent hedging costs increase or decrease the amount of long term debt to be issued, the actual amount of debt issued should be included for ratemaking purposes in determining PG&E's cost of capital.

In D.03-04-035, the Order Modifying Decision No. 02-11-030 and Denying Rehearing as Modified, the Commission found that recovery of financing costs, including interest rate swaps, was correctly left to PG&E's next cost of capital proceeding or general rate case:

"Upon further consideration, we believe that the specific ratemaking treatment of various costs associated with the financing at issue is properly left to more appropriate proceedings, such as PG&E's cost of capital proceeding and its general rate case. The Decision merely authorizes PG&E to issue certain securities, and it probably was error to make assertions about the ratemaking implications of the authorization in the Decision. In any event, PG&E appears to be correct that it was error (although it was not legal error) to imply that PG&E might be at risk for some of the costs associated with the issuance of the securities authorized in the Decision. Specifically, we note that Section 7.2 of the Amended Plan requires PG&E and the Commission to enter into a Reorganization Agreement substantially in the form attached as Exhibit 5 to the Amended Plan. Sections 2.2 and 2.6, among others, of the Reorganization Agreement appear to provide for PG&E's full recovery in rates of all costs associated with the securities the issuance of which the Decision authorizes. Accordingly, we conclude that this Decision in not an appropriate vehicle for ratemaking determinations. Therefore, we will delete the statements, COL, and OP that PG&E finds problematic." (mimeo., pp. 5-6.)

In D.02-11-027, the most recent cost of capital decision for PG&E, the Commission left the underlying proceeding open for PG&E to update its capital structure and cost of capital after emerging from bankruptcy.

"PG&E's A.02-05-022 remains open to true up its test year 2003 ROE with changes in its capital structure, long-term debt and preferred stock costs, and risk that results from it implementing the financing contemplated by a Chapter 11 plan approved by the Bankruptcy Court that enables PG&E to emerge from Chapter 11. Within 30 days after completing any such financing, PG&E shall file a request in this proceeding for authority to true up its test year 2003 capital structure and ROE. That request shall include testimony on its revised capital structure, long-term debt and preferred stock cost, risks, and ROE." (D.02-11-027, dated November 7, 2002, O.P. 10, mimeo., p. 38.)

We will therefore leave any interest rate hedges that result from this decision to the same recovery mechanism as all other costs associated with financing a bankruptcy POR and we will not pre-approve detailed ratemaking recovery for interest rate hedges. PG&E shall file by advice letter to establish a bankruptcy finance hedging memorandum account to record the costs of any interest rate hedges. This memorandum account shall be recoverable in the cost of capital true up. PG&E petitioned for a modification of the third paragraph of Section II.E. in D.02-11-030. D.03-04-035 deleted that paragraph (Ordering Paragraph 1). We will not reinstate a modified version of that language and will address ratemaking recovery of all refinancing costs in the A.02-05-022 true up. We note further that in the Proposed SA, at Section 12⁹ the settling parties propose that hedge costs would be recoverable without further Commission review. The Proposed SA is properly addressed in I.02-04-026.

C. Decision Process to Enter Into Interest Rate Hedges

PG&E proposes that it should have full management authority to enter into a hedge, but that it would "consult" with the Commission's Energy Division and the Commission's bankruptcy financial advisors. PG&E proposes to submit its interest rate hedges as advice letters, subject to an extremely expedited and truncated review and approval process.

"PG&E `s request for authorization to engage in interest hedges is premised on the authority remaining with PG&E to conduct negotiations and to make all commercial decisions concerning the interest hedges, including whether or not to execute a specific hedge. PG&E, however, will consult with Commission staff and the Commission's financial advisor, UBS Warburg LLC, regarding the interest rate hedges if the authorization requested in PG&E's Petition to Modify D.02-11-030 is granted." (See Footnote 2, Petition to Modify, mimeo., p. 2.)

This footnote to the Petition is a significant change from the authority granted in D.02-11-030 where the authority to issue debt and preferred stock was under the direction of, not in consultation with, the General Counsel, Energy Division and the Commission's financial advisors. Nothing in the Petition justifies such a dramatic change of control. The Commission has vested authority to negotiate and place securities in the hands of its Financing Team. For the purpose of approving the interest rate hedges authorized by this decision, the Commission's Financing Team shall be the General Counsel and the Director of the Energy Division.

As PG&E points out, there are three plans before the bankruptcy Court, and only the original PG&E plan would allow PG&E total control over financing decisions. In both the Commission's Amended Plan and the Proposed SA, PG&E would have only a shared role. The Amended Plan's decision-making authority is discussed at length in D.02-11-030, and the details of the Proposed SA are described in Section 13.c.,¹⁰ where it is proposed that the Commission and PG&E direct a joint team. The Petition appears to emphasize PG&E's role in managing the process and de-emphasize the team contemplated in Section 13 of the Proposed SA.

Nothing in the Order Denying Rehearing, D.03-04-035, modified the financial decision-making structure in D.02-11-030 for financing a POR. We are not inclined to do so now. PG&E proposed a "death-march" schedule where it would file an advice letter¹¹ leaving the Energy Division only four business days to review it. PG&E wanted its filing "deemed approved" if not rejected within those four days. Four days is simply inadequate for a thorough review and precludes meaningful review by other interested parties. There is no provision for an advice letter filing in the Proposed SA, and one is not required by the terms of either the Commission's Amended Plan or PG&E's POR. If PG&E believes that it is reasonable to enter into specific interest rate hedges, then it must work collaboratively and concurrently with the Commission's General Counsel and Energy Division Director, who must concur and approve the recommendations of PG&E and its consultants, in order for PG&E to enter into the proposed transaction. By working throughout the negotiation and decision-making process with a Commission Financing Team, PG&E can avoid the delay of an advice letter process, even an expedited one. Further, potential counter-parties will know that they are negotiating with a combined team that already has the Commission's representatives with express authority to negotiate and enter into financial instruments to finance a POR.

D. Exempting Hedges From Competitive Bidding

The Commission granted an exemption from competitive bidding procedures for debt instruments issued pursuant to D.02-11-030 (Ordering Paragraph 7, renumbered Ordering Paragraph 6 by D.03-04-035). PG&E seeks a similar dispensation for interest rate hedges for the same reasons cited in D.02-11-030, where we cited the need for rapid action to take advantage of a limited opportunity. We agree that interest rate hedges require the same flexibility of action and grant the exemption.

In D.02-11-030, we granted PG&E an exemption from the monthly financial reporting requirements embodied in GO 24-B so that it can submit on a quarterly basis the information required by GO 24-B.¹² We will extend that exemption to encompass the interest rate hedges authorized herein. This extension, consistent with D 02-11-030, includes requiring quarterly reporting in lieu of monthly, and allows Energy Division the discretion to require monthly reporting.

E. Specific Modifications to D.02-11-030

In compliance with Rule 47(b),¹³ in Appendix A to the Petition PG&E provided specific wording for the modifications it sought to D 02-11-030. The requisite justification was included in the petition. To the extent adopted or modified as a result of this decision, the separate and different Appendix A to this decision makes the specific modifications to D.02-11-030 to the extent that this petition is granted or modified.