PG&E’s ProposedBankruptcy Settlement

Excess Costs andSavings Potential with DRC Bond Issuance

The Utility Reform NetworkSeptember 3, 2003

9-03-03

The Utility Reform Network 2

Overview

• PG&E’s goals for emerging from bankruptcy can be met at a lower cost for ratepayers

• PG&E’s settlement proposal is expensive• DRC Structure creates substantial savings

potential• Enabling Legislation is a tool to:

– Provide further assurances to the financial community– Speed implementation– Maximize savings

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The Utility Reform Network 3

The Proposed Settlement is Expensive

• PG&E’s stated goals sound attractive– Pay claims 100%– Achieve investment grade ratings– Maintain CPUC jurisdiction– Dismiss pending litigation– Reduce rates

• But the structure as proposed is very expensive• Modifications can likely yield substantial cost

savings while meeting stated goals

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The Utility Reform Network 4

Overview of the Settlement

• Pay all creditor and preferred stock claims in full – use cash on hand resulting from headroom collection

2001-2003– issue new long term debt sufficient to pay remaining

claims– collect costs of new debt in rates

• Problem: – existing rate base will not support the amount of debt

required to pay all claims• PG&E’s solution: add $2.21 billion to rate base

– sets rates well above cost of service to allow for investment grade ratings

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The Utility Reform Network 5

PG&E’s Stated Rationales for the Regulatory Asset are Suspect

• Rationale #1: Regulatory asset is needed to obtain investment grade ratings– TURN’s analysis shows that a DRC structure can

meet the same financial criteria at a much lower cost

• Rationale #2: The cost of the settlement is appropriate recovery of PG&E’s unrecovered costs– TURN’s analysis shows that from both an accounting

and regulatory perspective, PG&E’s shareholders will recover more than 100% of legitimate unrecovered costs

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The Utility Reform Network 6

Cost Recovery Under the Settlement

Unrecovered costs vs. PG&E's ultimate recovery under PSA

145%142%

124%121%

$-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

Under Reco

very

per PG&E 10-K

PSA Low Reco

very

PSA High R

ecove

ry

Under Reco

very

per Tra

nsition A

cct B

al

PSA Low Reco

very

PSA High R

ecove

ry

$ m

illi

on

s

Under Recovery

Regulatory Asset Collection

Headroom Collection

Accounting Basis (after tax)

Regulatory Basis (pre tax)

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The Regulatory Asset is an Expensive Financing Mechanism

• The Reg Asset is not a source of cash to pay creditors, but is instead only support for raising additional debt using a traditional utility structure– Adding $2.2 billion to rate base raises only $1.1 b in debt at a 50/50

debt/equity ratio– Only $2.1 billion of $5.2 billion excess cost goes to service debt in

capital structure– Remaining $3.1 billion goes to taxes and equity return

• The cost of the Reg Asset is based on the utility’s cost of capital– Debt portion likely to be rated BBB for PG&E as it emerges from

bankruptcy– Equity portion based on allowed ROE (PG&E has proposed 11.2%) plus

taxes• The Reg Asset is an “instant” addition to rate base with no

shareholder investment or risk required– Rate base will increase nearly 15% upon implementation (from nearly

$15 billion to $17 billion)

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The cost of the regulatory asset is primarily equity return

Regulatory Asset -- Cost Components

$-

$100

$200

$300

$400

$500

$600

$700

$800

2004 2005 2006 2007 2008 2009 2010 2011 2012

$ m

illio

ns

Common Return (incl. taxes)

Common Return of Capital (incl. taxes)

Preferred return (incl. taxes)

Preferred Return of Capital (incl. taxes)

Debt interest

Debt Amortization (incl. taxes)

DEBT INTEREST AND AMORTIZATION

EQUITY RETURNS (cash and earnings cushion for debt lenders)

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The Utility Reform Network 9

Rates under the proposed settlement are well above cost of service

Annual Ratepayer Costs Above Cost of Servicepost-emergence, $ millions

Proposed Settlement

$-

$100

$200

$300

$400

$500

$600

$700

$800

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$ m

illi

on

s

Proposed Settlement

Total costs in excess of cost of service = $5.3 billion

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The Utility Reform Network 10

Rates under the proposed settlement are in excess of previous proposals through 2012

Annual Ratepayer Costs Above Cost of Servicepost-emergence, $ millions

Settlement Agreement vs. PG&E Spin-Off Plan and CPUC Proposal prior to settlement

$-

$100

$200

$300

$400

$500

$600

$700

$800

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$ m

illio

ns

Excess Costs under Settlement Agreement

Range of excess costs under PG&E Spin-Off

Excess Costs under CPUC Plan

Savings (Costs) vs. Settlement Agreement

1st year 2004 Nine years 2004-2012 2004-2015

CPUC Plan vs. PSA ($6) million $1.5 billion $1.2 billion

PG&E Spin-Off Plan vs. PSA 2-19 million $0.5-$1.3 billion ($0.9) – $0.5 billion

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The Utility Reform Network 11

PG&E Earnings are projected to be substantially above pre-crisis levels

Common Stock Earnings Pre-Crisis vs. After Emergence from Bankruptcyunder Proposed Settlement

(percentages are percent increase over average annual earnings, 1997-1999)

21%

31%

37% 38% 37%38% 37% 37%

-

200

400

600

800

1,000

1,200

1997 1998 1999 2004 2005 2006 2007 2008 2009 2010 2011

$ m

illio

ns Common Stock Earnings prior to energy crisis

Projected Common Stock Earnings postemergence

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The Utility Reform Network 12

PG&E’s own projections show dividends more than double pre-crisis levels

Common Stock Dividends prior to energy crisis and projected post-emergence

0

200

400

600

800

1000

1200

1400

1600

1998 1999 2000 2005 2006 2007 2008 2009 2010 2011

$ M

illi

on

s

Common Stock Dividends prior to energycrisis

Projected Common StockDividends/Repurchases post emergence

shaded area shows $1.7 billion in foregonedividends 01-04 allocated 06-11

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The Utility Reform Network 13

Proposed Modifications to Settlement

• Achieve stated goals• Pay claims 100%• Achieve investment grade ratings• Maintain CPUC jurisdiction• Dismiss pending litigation• Reduce rates

• Reduce cost of raising funds needed to pay claims while achieving investment grade ratings

• Use an alternative financing structure to reduce interest costs

• Allow for additional savings potential

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The Utility Reform Network 14

Raise funds through DRC

• Use dedicated rate component (DRC) as support for some or all of the debt needed to raise funds to pay claims

• DRC debt is not counted against utility credit quality

• Savings vs. Regulatory Asset:– Interest rate savings – Improves the credit quality of the utility by reducing

the utility’s debt load– Eliminate the regulatory asset and the cost of the

built-in “Cushion”• Moves utility much closer to true cost of service

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How the DRC works• A “Dedicated Rate Component” is included in the utility’s tariff

– This rate is sufficient to pay principal and interest on the DRC bonds– The funds collected are required to be used for the sole purpose of paying

amounts due on the bonds– The DRC tariff is permanent until the bonds are paid in full

• The certainty of payment increases the security of the bonds and reduces interest charges

• Enabling legislation increases certainty that the tariff will stay in place– Enhances the strength of the CPUC’s promise to include the tariff in rates– Provides assurance that tariff will not be modified in the future

• Legislation provides key assurances to the financial community– Assures highest credit rating possible– Lowers interest costs

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The Utility Reform Network 16

Savings Potential with a DRC

• Savings are a function of:– Size of the issuance:

• TURN Proposal is $2.03 billion

– Term and amortization schedule• TURN Proposal is 9 year term (matching Reg Asset)• Level amortization for shorter average life• Cost of DRC declines over time (vs. increasing cost of Reg Asset)

– Interest rate spreads and ROE savings• DRC will likely be AAA rated

– Additional savings that accrue:• TURN’s structure meets same financial criteria as Settlement for

investment grade rating• Elimination of regulatory asset and unnecessary financial “cushion”

for investment grade ratings

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The Utility Reform Network 17

Capital Structure Comparison

• Both structures raise enough cash to pay claims in full

• Reg asset artificially increases rate base to support debt requirement

• ERB raises debt off-balance sheet and improves utility debt ratio

Sources of Funds to Pay Claims (1-1-2004) PSA ERB

New Long Term Debt 7,704$ 5,679$ New Short Term Debt 500$ 500$ Energy Recovery Bonds (ERBs) -$ 2,025$ Cash 2,487$ 2,487$ Reinstated Pollution Control Bonds 1,159$ 1,159$ Reinstated Preferred Stock 420$ 420$

Total Sources 12,270$ 12,270$

Resulting Utility Long-Term Debt at 1-1-2004 PSA excl. Reg Asset

PSA incl. Reg Asset

ERB

Long-term debt 8,863$ 8,863$ 6,838$

Average ratebase excluding settlement regulatory asset 14,778$ 14,778$ 14,778$ Average balance, settlement regulatory asset -$ 2,139$ -$

Average ratebase including settlement regulatory asset 14,778$ 16,917$ 14,778$

Long term debt (at 1-1-04) as % of 2004 average rate base 60.0% 52.4% 46.3%

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The Utility Reform Network 18

Cost Comparison

Total Savings vs. PSA = $2.8 billion

Source: McDonald Partners, Inc.

PSA Bankruptcy Asset Revenue Requirement

-

100200

300

400

500600

700

800

2004 2005 2006 2007 2008 2009 2010 2011 2012

(in

$m

illio

ns

)

Bankruptcy Regulatory Asset Deferred Taxes

Return on Asset Taxes on Return

ERB Revenue Requirement

-

100

200

300400

500

600

700

800

2004 2005 2006 2007 2008 2009 2010 2011 2012

(in

$m

illio

ns

)

ERB Underlying Recovery Deferred Taxes ERB Interest

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The Utility Reform Network 19

Rate Reductions and Cumulative Savings

Rate Reductions are double those under Settlement Agreement

Source: McDonald Partners, Inc.

Average Bundled Rate, cents/kWh

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

PSA 13.73 13.42 13.38 13.22 13.25 12.99 13.43 13.03 12.68 12.68

ERB 13.73 13.11 13.06 12.85 12.85 12.57 12.99 12.56 12.18 12.13

Additional Rate Reduction, ERB

0.31 0.32 0.37 0.39 0.42 0.44 0.47 0.51 0.55

Average Bundled Retail RateUnder PSA and ERB Structure

10.50

11.00

11.50

12.00

12.50

13.00

13.50

14.00

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

(in

ce

nts

/kW

h)

PSA ERB

Cumulative Savings to Ratepayers$2.8 Billion

-

500

1,000

1,500

2,000

2,500

3,000

2004 2005 2006 2007 2008 2009 2010 2011 2012

(in

$ m

illi

on

s)

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The Utility Reform Network 20

Shareholder Returns Still Exceed Historical Norms

Source: McDonald Partners, Inc.

PG&E Common Dividends

$0

$200

$400

$600

$800

$1,000

$1,20019

98

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

(in

$m

illi

on

s)

PSA Energy Recovery Bonds

corrected

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The Utility Reform Network 21

Summary

• PG&E’s settlement structure is very expensive• A DRC structure creates substantial savings• TURN’s recommendations to the CPUC provide:

– $2.8 billion in savings – Double the rate reductions

• Enabling Legislation is a tool to:– Provide further assurances to the financial community– Speed implementation– Maximize savings