TAXATION MATTERS

The IRS has completed its audit of PG&E Corporation’s 1997 and 1998 consolidated federal income tax returns and has assessed additional federal income taxes of approximately $79 million (including interest). PG&E Corporation has filed protests contesting certain adjustments made by the IRS in that audit and currently is discussing these adjustments with the IRS’ Appeals Office. PG&E Corporation does not expect final resolution of these appeals to have a material impact on its financial position or results of operations.

In the fourth quarter of 2003, PG&E Corporation made an advance payment to the IRS of $75 million relating to the 1999 and 2000 audit. The IRS completed its audit of PG&E Corporation’s 1999 and 2000 consolidated federal income tax returns during the third quarter of 2004. As a result of the completion of this audit, PG&E Corporation received a refund from the IRS of $14 million in January of 2005.

The IRS is auditing PG&E Corporation’s 2001 and 2002 consolidated federal income tax returns. In September 2004, the IRS issued notices of proposed adjustments that propose to disallow $104 million of synthetic fuel credits claimed on these tax returns. In addition, the IRS has proposed to disallow abandonment losses deducted on the 2002 tax return related to certain NEGT assets. These assets were transferred to NEGT lenders in the third quarter of 2004. In addition, the IRS has challenged other deductions related to NEGT prior to its Chapter 11 filing. PG&E Corporation is disputing the IRS’s proposed adjustments and will contest these disallowances if the IRS continues to assert its current position.

PG&E Corporation has accrued $52 million associated with NEGT related tax liabilities. In addition, PG&E Corporation has accrued a $41 million liability to cover potential tax obligations relating to non-NEGT issues raised in outstanding tax audits. The Utility has accrued $62 million to cover potential tax obligations for outstanding tax audits. Considering these reserves, PG&E Corporation does not expect the resolution of these matters to have a material impact on its financial position or result of operations.

All IRS audits of PG&E Corporation’s federal income tax returns prior to 1997 have been closed.

TAXATION MATTERS

The Internal Revenue Service, or IRS, has completed its audit of PG&E Corporation’s 1997 and 1998 consolidated federal income tax returns and has assessed additional federal income taxes of approximately $81 million (including interest).  PG&E Corporation has filed protests contesting certain adjustments made by the IRS in that audit and currently is discussing these adjustments with the IRS’ Appeals Office.  PG&E Corporation does not expect final resolution of these appeals to have a material impact on its financial position or results of operations.

In the fourth quarter of 2003, PG&E Corporation made an advance payment to the IRS of $75 million relating to the 1999 and 2000 audit.  The IRS completed its audit of PG&E Corporation’s 1999 and 2000 consolidated federal income tax returns during the third quarter of 2004.  As a result of the completion of this audit, PG&E Corporation received a refund from the IRS of $14 million in January of 2005.

The IRS is auditing PG&E Corporation’s 2001 and 2002 consolidated federal income tax returns.  They have indicated that they plan to complete their audit and issue a Revenue Agent Report in the second or third quarter of 2005.  During their examination, the IRS has issued several proposed adjustments that PG&E Corporation is currently disputing.  The IRS adjustments include disallowance of synthetic fuel credits claimed on these tax returns.  In addition, the IRS has proposed to disallow a number of deductions, the largest of which is abandonment losses/worthless deductions claimed on the 2002 tax return related to certain NEGT assets.  These assets were ultimately transferred to NEGT lenders in the third quarter of 2004.  If the IRS includes all of its proposed adjustments in the final Revenue Agent Report, the alleged tax

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TAXATION MATTERS

        The IRS has completed its audit of PG&E Corporation's 1997 and 1998 consolidated federal income tax returns and has assessed additional federal income taxes of approximately $79 million (including interest). PG&E Corporation has filed protests contesting certain adjustments made by the IRS in that audit and currently is discussing these adjustments with the IRS' Appeals Office. PG&E Corporation does not expect final resolution of these appeals to have a material impact on its financial position or results of operations.

        In the fourth quarter of 2003, PG&E Corporation made an advance payment to the IRS of $75 million relating to the 1999 and 2000 audit. The IRS completed its audit of PG&E Corporation's 1999 and 2000 consolidated federal income tax returns during the third quarter of 2004. As a result of the completion of this audit, PG&E Corporation received a refund from the IRS of $14 million in January of 2005.

        The IRS is auditing PG&E Corporation's 2001 and 2002 consolidated federal income tax returns. In September 2004, the IRS issued notices of proposed adjustments that propose to disallow $104 million of synthetic fuel credits claimed on these tax returns. In addition, the IRS has proposed to disallow abandonment losses deducted on the 2002 tax return related to certain NEGT assets. These assets were transferred to NEGT lenders in the third quarter of 2004. In addition, the IRS has challenged other deductions related to NEGT prior to its Chapter 11 filing. PG&E Corporation is disputing the IRS's proposed adjustments and will contest these disallowances if the IRS continues to assert its current position.

        PG&E Corporation has accrued $52 million associated with NEGT related tax liabilities. In addition, PG&E Corporation has accrued a $41 million liability to cover potential tax obligations relating to non-NEGT issues raised in outstanding tax audits. The Utility has accrued $62 million to cover potential tax obligations for outstanding tax audits. Considering these reserves, PG&E Corporation does not expect the resolution of these matters to have a material impact on its financial position or result of operations.

        All IRS audits of PG&E Corporation's federal income tax returns prior to 1997 have been closed.

        Prior to July 8, 2003, the date that NEGT filed for bankruptcy protection, PG&E Corporation recognized federal income tax benefits related to the losses of NEGT and its subsidiaries. However, after July 7, 2003, under the cost method of accounting PG&E Corporation has not recognized additional income tax benefits for financial reporting purposes with respect to the losses of NEGT and its subsidiaries even though it must continue to include NEGT and its subsidiaries in its consolidated income tax returns. After its equity ownership in NEGT was cancelled 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. In addition, any remaining deferred tax assets related to NEGT or its subsidiaries, were reversed as discontinued operations in the Consolidated Statements of Operations at

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the time PG&E Corporation's equity interest in NEGT was cancelled. See Note 5 of the Notes to the Consolidated Financial Statements for further discussion.

        In addition to the reversal of deferred tax assets referred to above, and based on preliminary information provided by NEGT, PG&E Corporation anticipates paying approximately $86 million of consolidated federal tax obligations. This includes federal income taxes on NEGT activities through the effective date of NEGT's plan of reorganization.

        PG&E Corporation and NEGT have entered into a separate agreement under which they have agreed to take certain actions and cooperate with each other with respect to certain tax matters, including future tax returns and audits.

        For the year ended December 31, 2003, PG&E Corporation increased its valuation allowances against certain state deferred tax assets related to NEGT or its subsidiaries due to the uncertainty of their realization. During this period, valuation allowances of approximately $24 million were recorded in discontinued operations, and approximately $5 million was recorded in accumulated other comprehensive loss. No valuation allowances were recorded in the three-month period ended December 31, 2003 or during 2004.

        At December 31, 2003, PG&E Corporation had $420 million of California net operating loss, or NOL. The California NOLs were fully utilized in 2004.