Pacific Gas & Electric (PCG)

NOTE 4: RATE REDUCTION BONDS

In December 1997, PG&E Funding, LLC, a limited liability corporation wholly owned by and consolidated by the Utility, issued $2.9 billion of rate reduction bonds. The proceeds of the rate reduction bonds were used by PG&E Funding, LLC to purchase from the Utility the right, known as “transition property,” to be paid a specified amount from a non-bypassable charge levied on residential and small commercial customers (Fixed Transition Amount, or FTA, charges). FTA charges are authorized by the CPUC under state legislation and will be paid by residential and small commercial customers until the rate reduction bonds are fully retired. Under the terms of a transition property servicing agreement, FTA charges are collected by the Utility and remitted to PG&E Funding, LLC. As a result of credit rating downgrades in January 2001, on January 8, 2001, the Utility was required to begin remitting these FTA receipts to PG&E Funding, LLC on a daily basis, as opposed to once a month, as had previously been required.

The rate reduction bonds have expected maturity dates ranging from 2005 to 2007, and bear interest at rates ranging from 6.42% to 6.48%. The bonds are secured solely by the transition property and there is no recourse to the Utility or PG&E Corporation.

The total amount of rate reduction bonds principal outstanding was $870 million at December 31, 2004 and $1.16 billion at December 31, 2003. The scheduled principal payments on the rate reduction bonds for the years 2005 through 2007 are $290 million for each year. While PG&E Funding, LLC is a wholly owned consolidated subsidiary of the Utility, it is legally separate from the Utility. The assets of PG&E Funding, LLC are not available to creditors of the Utility or PG&E Corporation, and the transition property is not legally an asset of the Utility or PG&E Corporation.

NOTE 5: DISCONTINUED OPERATIONS

Effective July 8, 2003 (the date NEGT filed a voluntary petition for relief under Chapter 11), NEGT and its subsidiaries were no longer consolidated by PG&E Corporation in its Consolidated Financial Statements. Under GAAP, consolidation is generally required for entities owning more than 50% of the outstanding voting stock of an investee, except when control is not held by the majority owner. Legal reorganization and bankruptcy represent conditions that can preclude consolidation in instances where control rests with an entity other than the majority owner. In anticipation of NEGT’s Chapter 11 filing, PG&E Corporation’s representatives who previously served on the NEGT Board of Directors resigned on July 7, 2003, and were replaced with Board members who were not affiliated with PG&E Corporation. As a result, PG&E Corporation no longer retained significant influence over the ongoing operations of NEGT.

Accordingly, at December 31, 2003, PG&E Corporation’s net negative investment in NEGT of approximately $1.2 billion was reflected as a single amount, under the cost method, within the December 31, 2003 Consolidated Balance Sheet of PG&E Corporation. This negative investment represents the losses of NEGT recognized by PG&E Corporation in excess of its investment in and advances to NEGT.

On October 29, 2004, NEGT’s plan of reorganization became effective, at which time NEGT emerged from Chapter 11 and PG&E Corporation’s equity ownership in NEGT was cancelled. On the effective date, PG&E Corporation reversed its

NOTE 4: RATE REDUCTION BONDS

        In December 1997, PG&E Funding, LLC, a limited liability corporation wholly owned by and consolidated by the Utility, issued $2.9 billion of rate reduction bonds. The proceeds of the rate reduction bonds were used by PG&E Funding, LLC to purchase from the Utility the right, known as "transition property," to be paid a specified amount from a non-bypassable charge levied on residential and small commercial customers (Fixed Transition Amount, or FTA, charges). FTA charges are authorized by the CPUC under state legislation and will be paid by residential and small commercial

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customers until the rate reduction bonds are fully retired. Under the terms of a transition property servicing agreement, FTA charges are collected by the Utility and remitted to PG&E Funding, LLC. As a result of credit rating downgrades in January 2001, on January 8, 2001, the Utility was required to begin remitting these FTA receipts to PG&E Funding, LLC on a daily basis, as opposed to once a month, as had previously been required.

        The rate reduction bonds have expected maturity dates ranging from 2005 to 2007, and bear interest at rates ranging from 6.42% to 6.48%. The bonds are secured solely by the transition property and there is no recourse to the Utility or PG&E Corporation.

        The total amount of rate reduction bonds principal outstanding was $870 million at December 31, 2004 and $1.16 billion at December 31, 2003. The scheduled principal payments on the rate reduction bonds for the years 2005 through 2007 are $290 million for each year. While PG&E Funding, LLC is a wholly owned consolidated subsidiary of the Utility, it is legally separate from the Utility. The assets of PG&E Funding, LLC are not available to creditors of the Utility or PG&E Corporation, and the transition property is not legally an asset of the Utility or PG&E Corporation.

NOTE 5: DISCONTINUED OPERATIONS

        Effective July 8, 2003 (the date NEGT filed a voluntary petition for relief under Chapter 11), NEGT and its subsidiaries were no longer consolidated by PG&E Corporation in its Consolidated Financial Statements. Under GAAP, consolidation is generally required for entities owning more than 50% of the outstanding voting stock of an investee, except when control is not held by the majority owner. Legal reorganization and bankruptcy represent conditions that can preclude consolidation in instances where control rests with an entity other than the majority owner. In anticipation of NEGT's Chapter 11 filing, PG&E Corporation's representatives who previously served on the NEGT Board of Directors resigned on July 7, 2003, and were replaced with Board members who were not affiliated with PG&E Corporation. As a result, PG&E Corporation no longer retained significant influence over the ongoing operations of NEGT.

        Accordingly, at December 31, 2003, PG&E Corporation's net negative investment in NEGT of approximately $1.2 billion was reflected as a single amount, under the cost method, within the December 31, 2003 Consolidated Balance Sheet of PG&E Corporation. This negative investment represents the losses of NEGT recognized by PG&E Corporation in excess of its investment in and advances to NEGT.

        On October 29, 2004, NEGT's plan of reorganization became effective, at which time NEGT emerged from Chapter 11 and PG&E Corporation's equity ownership in NEGT was cancelled. On the effective date, PG&E Corporation reversed its negative investment in NEGT and also reversed net deferred income tax assets of approximately $428 million and a charge of approximately $120 million ($77 million, after tax), in accumulated other comprehensive income, related to NEGT. The resulting net gain has been offset by the $30 million payment made by PG&E Corporation to NEGT pursuant to the parties' settlement of certain tax-related litigation and other adjustments to NEGT-related liabilities. A summary of the effect on the quarter and year ended December 31, 2004 earnings from discontinued operations is as follows:

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        At December 31, 2004, PG&E Corporation's Consolidated Balance Sheet includes approximately $138 million in income tax liabilities (including $86 million in current income taxes payable) and approximately $25 million of other net liabilities related to NEGT. Until PG&E Corporation reaches final settlement of these obligations, it will continue to disclose fluctuations in these estimated liabilities in discontinued operations. Beginning on the effective date of NEGT's plan of reorganization, PG&E Corporation no longer includes NEGT or its subsidiaries in its consolidated income tax returns.