Pacific Gas & Electric (PCG)

Cost of Electricity

        The Utility's cost of electricity includes electricity purchase costs and the cost of fuel used by its owned generation facilities, but it excludes costs to operate its owned generation facilities, which are included in operating and maintenance expense. Electricity purchase costs and the cost of fuel used by owned generation facilities are passed through in rates to customers. The following table shows a breakdown of the Utility's cost of electricity and the total amount and average cost of purchased power, excluding in each case both the cost and volume of electricity provided by the DWR to the Utility's customers:

        In 2004, the Utility's cost of electricity increased approximately $451 million, or 19%, as compared to 2003 mainly due to the following factors:

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The increase in total purchased power of 2,276 Gigawatt hours, or GWh, and the increase in the average cost of purchased power of $0.006 per kWh in 2004 as compared to 2003 resulted in an increase of approximately $367 million in the cost of purchased power; and



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The cost of electricity increased by approximately $84 million in 2004 as compared to 2003 as a result of a decrease in the proceeds from surplus sales allocated to the Utility in 2004 and an increase in the amount of fuel used in the Utility's owned generation.

        In 2003, the Utility's cost of electricity increased approximately $837 million, or 56%, compared to 2002 mainly due to the following factors:

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The Utility's total volume of electricity purchased in 2003 increased 31% due to the fact that the Utility resumed buying and selling electricity on the open market beginning in the first quarter of 2003 to meet its residual net open position in accordance with its CPUC-approved electricity procurement plan. The increase in total purchased power of 7,697 GWh, which was partially offset by a decrease in the average cost of purchased power of $0.005 per kWh resulted in an increase of approximately $469 million in the cost of purchased power in 2003 compared to 2002;



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In March 2002, the Utility recorded a net reduction of approximately $595 million to the cost of electricity as a result of FERC and CPUC decisions that allowed the Utility to reverse previously accrued ISO charges and to adjust for the amount previously accrued as payable to the DWR for the DWR's 2001 revenue requirement. There was no comparable reduction in 2003; and



•

As the Utility resumed procuring power on behalf of its customers, it was sometimes required to dispatch more electricity than was necessary to meet its retail load, and to sell this additional electricity on the open market. Proceeds from surplus electricity sales, offset by an increase in the amount of fuel used in the Utility's owned generation reduced the total cost of electricity by approximately $227 million in 2003 compared to 2002.

        The Utility's cost of electricity in 2005 will depend upon electricity prices and the amount of the Utility's residual net open position (see the "Risk Factors" section of this MD&A).

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