STATE OF CALIFORNIA

PUBLIC UTILITIES COMMISSION

505 VAN NESS AVENUE

SAN FRANCISCO, CA 94102-3298

November 18, 2003 Agenda ID #2983

Ratesetting

TO: PARTIES OF RECORD IN INVESTIGATION 02-04-026

Enclosed is the proposed decision of Administrative Law Judge (ALJ) Barnett, previously designated as the principal hearing officer in this proceeding. Also, enclosed are two alternate decisions of President Peevey. At this time, President Peevey supports Alternate 2. Alternate 1 is issued in order to give the Commission a full range of options. The decisions will not appear on the Commission's agenda for at least 30 days after the date they are mailed. This matter was categorized as ratesetting and is subject to Pub. Util. Code § 1701.3(c). Pursuant to Resolution ALJ-180 a Ratesetting Deliberative Meeting to consider this matter may be held upon the request of any Commissioner. If that occurs, the Commission will prepare and mail an agenda for the Ratesetting Deliberative Meeting 10 days before hand, and will advise the parties of this fact, and of the related ex parte communications prohibition period.

The Commission may act at the regular meeting, or it may postpone action until later. If action is postponed, the Commission will announce whether and when there will be a further prohibition on communications.

When the Commission acts on the proposed decisions, it may adopt all or part of them as written, amend or modify them, or set them aside and prepare its own decision. Only when the Commission acts does the decision become binding on the parties.

Parties to the proceeding may file comments on the proposed decisions as provided in Article 19 of the Commission's "Rules of Practice and Procedure." These rules are accessible on the Commission's Website at http://www.cpuc.ca.gov. Pursuant to Rule 77.3 opening comments shall not exceed 15 pages. Finally, comments must be served separately on the ALJ and the Assigned Commissioner, and for that purpose I suggest hand delivery, overnight mail, or other expeditious method of service.

/s/ ANGELA K. MINKIN

Angela K. Minkin, Chief

Administrative Law Judge

ANG:jva

ALJ/RAB/jva DRAFT Agenda ID #2983

Ratesetting

Decision PROPOSED DECISION OF ALJ BARNETT (Mailed 11/18/2003)

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Order Instituting Investigation into the ratemaking implications for Pacific Gas and Electric Company (PG&E) pursuant to the Commission's Alternative Plan of Reorganization under Chapter 11 of the Bankruptcy Code for PG&E, in the United States Bankruptcy Court, Northern District of California, San Francisco Division, In re Pacific Gas and Electric Company, Case No. 01-30923 DM. (U 39 M)

Investigation 02-04-026 (Filed April 22, 2002)

(See Appendix D for Appearances.)

OPINION REJECTING THE PROPOSED SETTLEMENT
AGREEMENT OF PACIFIC GAS & ELECTRIC COMPANY
AND THE COMMISSION STAFF, AND APPROVING A
MODIFIED SETTLEMENT AGREEMENT

TABLE OF CONTENTS

Title Page

OPINION REJECTING THE PROPOSED SETTLEMENT AGREEMENT OF
PACIFIC GAS & ELECTRIC COMPANY AND THE COMMISSION STAFF, AND APPROVING MODIFIED SETTLEMENT AGREEMENT 22

Summary 22

I. Introduction and Background 22

II. Procedural History 1010

III. Description of the PSA Terms and Conditions 1313

A. Structure of the Settlement Plan of Reorganization 1313

B. Financial Elements of the PSA 1313

1. Regulatory Asset 1414

2. Headroom 1515

3. Ratemaking Matters 1515

4. Dividends and Stock Repurchases 1616

C. Dismissal of Energy Crisis-Related Disputes 1717

D. Environmental Provisions 1717

E. Conditions Precedent to Effectiveness of Settlement Plan 1818

F. Other Provisions 1919

1. Interest Rate Hedging 1919

2. Financing 1919

3. Fees and Expenses 1919

4. Releases 2020

5. Bankruptcy Court Supervision 2020

IV. Standard of Review 2020

V. Lawfulness of the PSA 2424

A. The Purpose of the Commission v. The Purpose of the Bankruptcy Court 2424

B. The Commission's ability to Bind Future Commissions 2727

1. Jurisdiction of the Bankruptcy Court 3232

2. Conflict of Laws 3333

3. Consistency with Assembly Bill 1890 and § 368(a) 3434

TABLE OF CONTENTS

Title Page

VI. Whether the Proposed Settlement Agreement Is in the Public Interest 3636

A. Adequacy of a Settlement Proposal in Achieving Feasible Plan of Reorganization 3636

1. The Modified PSA Will Allow PG&E to Emerge Promptly
From Bankruptcy 3737

2. The Rating Agencies (S&P and Moody's) 3939

B. Fairness and Reasonableness 4141

1. Relationship of Settlement to Parties' Risks of Achieving
Desired Results 4141

2. The Risk, Expense, Complexity, and Likely Duration of
Further Bankruptcy Litigation 4242

3. Reasonableness of Settlement of Other Claims and Litigation 4545

4. Reasonableness of Rates 4848

5. Adequacy of Representation In the Settlement Process 4949

6. Release of PG&E Corporation 5050

C. Public Interest 5151

1. The Regulatory Asset 5151

2. Headroom 5252

3. Dividends 5353

4. Credit Rating 5454

5. Financing 5757

6. Environmental Matters 5757

(a) The Land Conservation Commitment (LLC) 5757

(b) The Stewardship Council 5858

(c) Environmental Opportunity For Urban Youth 6161

(d) Clean Energy Technology Commitment 6262

VII. The TURN Dedicated Rate Component Proposal 6363

VIII. Rulings of the Administrative Law Judge (ALJ) 6767

IX. Comments on the Proposed Decision 6767

X. Assignment of Proceeding 6868

Findings of Fact 6868

Conclusions of Law 7373

ORDER 7474

Appendix A Proposed Settlement Agreement
Appendix B Approved Settlement Agreement (Redlined)
Appendix C Approved Settlement Agreement
Appendix D List of Appearances

OPINION REJECTING THE PROPOSED SETTLEMENT
AGREEMENT OF PACIFIC GAS & ELECTRIC COMPANY
AND THE COMMISSION STAFF, AND APPROVING
MODIFIED SETTLEMENT AGREEMENT

Summary

This decision rejects the Proposed Settlement Agreement (PSA) offered by Pacific Gas & Electric Company (PG&E), PG&E Corporation, and the Commission staff. The reasons for rejection include: 1) it purports to bind the Commission for nine years, 2) it unnecessarily cedes Commission jurisdiction to the Bankruptcy Court, 3) it guarantees PG&E an investment grade credit rating for nine years, and 4) it guarantees PG&E's dividends for nine years. This decision approves a Modified Settlement Agreement which deletes the rejected conditions and approves all the other financing arrangements of the PSA, including a monetary settlement of $7.2 billion which includes a regulatory asset of $2.21 billion.

I. Introduction and Background

On April 6, 2001, PG&E filed a voluntary case under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of California. PG&E asserts that it was compelled to seek relief in the Bankruptcy Court because, as a result of the energy crisis beginning in May 2000 and because its retail electric rates were frozen, it was unable to recover approximately $8.9 billion of electricity procurement costs from its customers, resulting in billions of dollars of defaulted debt and the downgrading of its credit ratings by all of the major credit rating agencies.

PG&E and its parent, PG&E Corporation, filed a plan of reorganization for PG&E (as amended and modified, the PG&E Plan). This Commission filed a plan of reorganization for PG&E. Subsequently, the Commission and the Official Committee of Unsecured Creditors (the OCC) filed their Third Amended Plan of Reorganization for Pacific Gas and Electric Company (the Commission Plan). On November 18, 2002, the Bankruptcy Court commenced a hearing on confirmation of the competing plans. During the confirmation hearing, the Bankruptcy Court, on March 4, 2003, ordered a judicial settlement conference and, on March 11, 2003, stayed all proceedings with respect to confirmation of the competing plans to facilitate the settlement process. As a result of that process, a Proposed Settlement Agreement (PSA, the subject of this proceeding) was reached, the terms of which are incorporated by reference into a plan of reorganization dated July 31, 2003. The stay has been continued indefinitely pending further order of the Bankruptcy Court.

It is important to understand that although this Commission filed a plan of reorganization for PG&E, the Commission did not participate in the settlement discussions which culminated in the PSA. The settlement discussions were conducted by a small number of the Commission staff, who were not authorized to bind the Commission. The PSA is before us for approval. (Appendix A.)

The background of the energy crisis in California has been recounted many times in the decisions of this Commission and the courts. An excellent exposition of the events leading up to the energy crisis and PG&E's bankruptcy is found in the recent California Supreme Court decision Southern California Edison Company v. Peevey ((2003) 31 Cal. 4^th 781). That exposition of events is equally applicable to PG&E. We repeat the Court's exposition here, with minor modifications to denote effects on PG&E.

The essential background of this case lies in California's attempt, beginning in 1996, to move the system for provision of electrical power from a regulated to a competitive market, the crisis caused in mid-2000 to early 2001 by soaring prices for electricity on the wholesale market, and the urgency legislation enacted in January 2001 in response to that crisis.

Assembly Bill No. 1890 (1995-1996 Reg. Sess.) (hereafter Assembly Bill 1890), which became law in 1996 (Stats. 1996, ch. 854), was intended to provide the legislative foundation for "California's transition to a more competitive electricity market structure." (Assembly Bill 1890, § 1, subd. (a).) The new market structure included the creation of the California Power Exchange (CalPX), which was to run an "efficient, competitive auction" among electricity producers, and the Independent System Operator, which would control the statewide transmission grid. (Id., § 1, subd. (c).) The state's main investor-owned electric utility companies (Southern California Edison Company (SCE), PG&E, and San Diego Gas & Electric Company (SDG&E) (hereafter the utilities) were expected to divest themselves of substantial parts of their generating assets, while retaining others at least during the period of transition. (Id., § 10, adding Pub. Util. Code, former § 377.) Under the Assembly Bill 1890 scheme as implemented, all generators, including the utilities, sold their power through the CalPX; the utilities also bought, through that exchange, the electricity they needed to supply their retail customers. (Cal. Exchange Corp. v. FERC (In re Cal. Power Exchange Corp.) (9th Cir. 2001) 245 F.3d 1110, 1114-1115.)

Because this competition among producers was expected to bring down wholesale prices, the utilities believed that some of their generating assets, which they had built or improved with California Public Utilities Commission (PUC) approval, would become "uneconomic," in that the costs of generation (and of certain long-term contracts between the utilities and other generators) would be higher than prevailing wholesale rates would support. The costs associated with these potentially uneconomic assets are also known as "stranded costs" or "transition costs." The Legislature, in Assembly Bill 1890, intended to allow for "[a]ccelerated, equitable, nonbypassable recovery of transition costs" (Stats. 1996, ch. 854, § 1, subd. (b)(1)) and thereby to "provide the investors in these electrical corporations with a fair opportunity to fully recover the costs associated with commission approved generation-related assets and obligations" (Pub. Util. Code, § 330, subd. (t)). The legislative scheme for doing so without subjecting consumers to increased rates was complex, but consisted in its essentials of the following:

Under Pub. Util. Code § 367,¹ PUC was to identify and quantify potentially uneconomic costs (i.e., the PUC-approved costs that "may become uneconomic as a result of a competitive generating market"). The identified costs were to be recoverable through rates that would not exceed "the levels in effect on June 10, 1996," and the recovery was not to "extend beyond December 31, 2001." (§ 367, subd. (a).) The component of rates dedicated to recovery of transition costs was nonbypassable, i.e., it had to be paid to the utility whether the consumer bought power from the utility, from a generator in a single direct transaction, or from a generator in an aggregated direct transaction with other consumers. (§§ 365, subd. (b), 366, 370.)

Section 368 required each utility to propose, and PUC to approve, a "cost recovery plan" for the costs identified in § 367 that would set rates at June 10, 1996, levels, with a 10 percent reduction for residential and small commercial customers. Section 368, subdivision (a) continues: "These rate levels . . . shall remain in effect until the earlier of March 31, 2002, or the date on which the commission-authorized costs for utility generation-related assets and obligations have been fully recovered. The electrical corporation shall be at risk for those costs not recovered during that time period."

PUC implemented this cost-recovery scheme in part by creating, for each electric utility, a transition cost balancing account (sometimes herein referred to as a TCBA), in which the PUC-identified stranded costs were tracked. Transition costs were not to be forecast, but rather entered in the transition cost balancing account as the PUC determined them. Costs associated with utility-retained generating assets were to be determined by comparing the book value of the assets with their market valuations, a process to be completed by the end of 2001. These uneconomic generating costs were to be netted against the benefits of any economic generating assets (those having higher market than book value). The difference between rate revenue and the utility's other (nongeneration-related) costs was designated the utility's "headroom" and was to be credited against the stranded costs in the transition cost balancing account. The portion of each rate serving as headroom was designated the competition transition charge. (In re Pacific Gas & Electric Co. (1997) 76 Cal. P.U.C.2d 627, 646-653, 740-744.)

In the first few years of the transition period, the utilities recovered much of their stranded costs. SDG&E was found to have recovered all its transition costs, ending the rate freeze for that utility under § 368. SCE and PG&E, however, were still subject to the rate freeze when, in the summer of 2000, power procurement prices, and particularly prices on the CalPX spot market, rose drastically. They incurred huge debts buying electricity through the CalPX. (Cal. Exchange Corp. v. FERC (In re Cal. Power Exchange Corp.), supra, 245 F.3d at p. 1115.)

In November 2000, as the wholesale price and supply problems continued, SCE brought its federal action against PUC. In essence, SCE claimed the rate freeze imposed by Assembly Bill 1890 was now depriving SCE of its right, under federal law, to recover the costs of purchasing electricity for its customers. More particularly, SCE claimed the freeze rates had become unconstitutionally confiscatory and violated the federal "filed rate" rule, which assertedly allows a utility to recover in state-regulated retail rates the costs of purchases made under federally approved tariffs.

PUC granted SCE and [PG&E] emergency rate relief in early 2001. Deeming the crisis one "that involves not only utility solvency but the very liquidity of the system," PUC in January 2001 authorized a temporary surcharge of one cent per kilowatt-hour. (Application of Southern California Edison Co. (2001) Cal. P.U.C. Dec. No. 01-01-018, pp. 1-4.) Two months later, still finding that "SCE's and PG&E's continued financial viability and ability to serve their customers has been seriously compromised by the dramatic escalation in wholesale prices," PUC made the January increase permanent and authorized an additional three cents per kilowatt-hour increase. (Application of Southern California Edison Co. (2001) Cal. P.U.C. Dec. No. 01-03-082, pp. 2-4.) PUC refers to these increases collectively as the "four cent surcharge," a usage we adopt. (The surcharge amounted to an average increase of 40 percent in retail rates.) PUC's March 2001 decision, while authorizing an increase to pay for ongoing power purchases, did "not address recovery of past power purchase costs and other costs claimed by the utilities." (Id., at p. 2.)

The Legislature also took action in January 2001, in an extraordinary session called to address the power crisis. In that session's Assembly Bill No. 1 (Stats. 2001, 1st Ex. Sess., ch. 4; hereafter Assembly Bill 1X), the Legislature authorized the state Department of Water Resources to begin buying power for customers of SCE and PG&E. (Id., § 4, adding Wat. Code, §§ 80100-80122.) In Assembly Bill No. 6 of that Session (Stats. 2001, 1st Ex. Sess., ch. 2; hereafter Assembly Bill 6X), the Legislature amended several provisions of Assembly Bill 1890, halting at least temporarily the transition to a competitive electricity market. In particular, Pub. Util. Code § 377, as first enacted by Assembly Bill 1890, had provided that PUC would continue regulating the utilities' retained nonnuclear generating assets "until those assets have been subject to market valuation," after which they would be sold off unless the utility convinced the PUC their retention was in the public interest. (Stats. 1996, ch. 854, § 10.) As amended by Assembly Bill 6X, § 377 provides that all the remaining generating assets are subject to PUC regulation and may not be sold until January 1, 2006, at the earliest. (Assembly Bill 6X, § 3.) Similarly, as enacted by Assembly Bill 1890, Pub. Util. Code § 330, subdivision (l)(2) had provided that the generating assets "should be transitioned from regulated status to unregulated status through means of commission-approved market valuation mechanisms." (Stats. 1996, ch. 854, § 10.) Assembly Bill 6X deleted this language, leaving only the general statement that "[g]eneration of electricity should be open to competition." (Id., § 2.) PUC subsequently issued decisions, based on Assembly Bill 6X, reestablishing cost-based rate regulation of SCE's (and PG&E's) retained generating assets and modifying restrictions on the use of the four-cent surcharge. (E.g., Application of Southern California Edison Co. (2002) Cal. P.U.C. Dec. No. 02-04-016, p. 2; Application of Southern California Edison Co. (2002) Cal. P.U.C. Dec. No. 02-11-026, pp. 11-16.) (End of Court's exposition, 31 Cal 4^th 781, 787 to 791.)