IV. The Utility Proposals

PG&E, SoCalGas and SDG&E request substantially similar relief adopted in D.05-10-043 and D.05-10-015 to allocate all costs and benefits of hedging to their respective customers. Their petitions seek approval of specific hedging plans for the upcoming winter season. Each utility explains that it would not be permitted to depart from the plan adopted here and that their respective investment decisions would not be subject to reasonableness reviews. Each plan identifies a dollar ceiling to be spent on hedging instruments, the types of hedging instruments that would be purchased and generally over what period, exemplary "strike prices" for each purchase and the potential ratemaking impacts. The utilities state that the dollar ceiling may be exceeded in some instances, depending upon market activity.

Although this decision does not disclose which hedging instruments the utilities intend to purchase, the following types of hedging instruments are among those they may decide to purchase:

· Call Options: A financial instrument that gives the purchaser the right, but not the obligation, to purchase a New York Mercantile Exchange (NYMEX) Henry Hub natural gas futures contract at a predetermined fixed price (or "strike price") on or before a specific date (an "expiration date");

· Put Options: A financial instrument that gives the purchaser the right but not the obligation to sell a NYMEX futures contract at a predetermined fixed price on or before a specific date;

· Futures: A supply contract whereby the buyer is obligated to take delivery and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price at a specified location;

· Basis Swaps: A financial instrument that gives the buyer the obligation to pay or receive the value difference between the purchase price and the settled spread between the NYMEX Henry Hub futures and a defined locational index, such as the Natural Gas Intelligence SoCal index; or

· Fixed Price Swaps: A financial instrument that gives the buyer the obligation to pay or receive the value difference between the purchase price and a natural gas index settlement price. It involves no up-front premium.

The utilities describe their hedging programs as "insurance" against natural gas price spikes. Each utility states it requires this authority in order to better protect its core customers from potential gas price spikes this winter. During the hearing, the utilities provided evidence that natural gas prices are increasing and, more significantly, that prices for natural gas are more volatile and unpredictable than in previous years. One effect of this market volatility is that prices for hedging instruments are substantially higher than in the past.

The utilities seek authority to spend up to specified amounts on hedging instruments during winter 2006-07 and authority to engage in financial transactions that do not require dollar outlays in advance but which might result in additional losses. Without publicly disclosing the liabilities the utilities would incur on behalf of ratepayers, the amounts are substantially larger than amounts authorized in the past and would be used to hedge large portions of their gas supplies. The utilities propose to purchase hedging instruments that would protect against higher prices and also "swaps," which would permit ratepayers to benefit from market prices that are ultimately lower than the prices the utilities paid for existing gas supplies (and simultaneously expose ratepayers to substantial losses under some scenarios). Storage gas could also be hedged.

The utilities would retain authority to include the costs and benefits of hedging instruments within their existing incentive mechanisms at their discretion. The accounting for each individual instrument would be separate, depending on whether it was purchased within or outside the incentive mechanism.

All three utilities requested emergency treatment of their petitions in light of the impending hurricane season. Each seeks retroactive authority to be relieved of liability for any risks or costs associated with hedging instruments purchased since the lapse of authority the Commission granted last October. PG&E has filed an application for long-term mechanisms for hedging outside its CPIM.