Pacific Gas & Electric (PCG)

Transition from Frozen Rates to Cost of Service Ratemaking

Beginning January 1, 1998, electricity rates were frozen as required by the California electric industry restructuring law. In 2001, in response to the California energy crisis, the CPUC increased frozen rates by imposing fixed surcharges. As a result of the Settlement Agreement and various CPUC decisions, the Utility’s electricity rates as of January 1, 2004, are no longer frozen and are determined based on its costs of service, including periodic adjustments to rates to reflect changes in sales or demand compared to forecast sales or demand. The Utility’s electricity and natural gas distribution rates in 2004 reflected the sum of individual revenue requirement components including:

•                  Base revenue requirements to recover its basic business and operational costs for electricity and natural gas distribution operations and for electricity generation operations as set by the CPUC in the Utility’s 2003 GRC;

•                  The allowed rates of return as set in the Utility’s annual cost of capital proceedings at the CPUC;

•                  Revenue requirements for the recovery of the regulatory assets (including an 11.22% return on equity) provided under the Settlement Agreement;

•                  Revenue requirements for recovery of electricity and natural gas procurement costs as authorized by the CPUC;

•                  Revenue requirements authorized by the FERC in the Utility’s transmission owner rate cases and to recover charges imposed on the Utility for services provided by the California Independent System Operator, or ISO; and

Transition from Frozen Rates to Cost of Service Ratemaking

        Beginning January 1, 1998, electricity rates were frozen as required by the California electric industry restructuring law. In 2001, in response to the California energy crisis, the CPUC increased frozen rates by imposing fixed surcharges. As a result of the Settlement Agreement and various CPUC decisions, the Utility's electricity rates as of January 1, 2004, are no longer frozen and are determined based on its costs of service, including periodic adjustments to rates to reflect changes in sales or demand compared to forecast sales or demand. The Utility's electricity and natural gas distribution rates in 2004 reflected the sum of individual revenue requirement components including:

•

Base revenue requirements to recover its basic business and operational costs for electricity and natural gas distribution operations and for electricity generation operations as set by the CPUC in the Utility's 2003 GRC;



•

The allowed rates of return as set in the Utility's annual cost of capital proceedings at the CPUC;



•

Revenue requirements for the recovery of the regulatory assets (including an 11.22% return on equity) provided under the Settlement Agreement;



•

Revenue requirements for recovery of electricity and natural gas procurement costs as authorized by the CPUC;



•

Revenue requirements authorized by the FERC in the Utility's transmission owner rate cases and to recover charges imposed on the Utility for services provided by the California Independent System Operator, or ISO; and



•

The revenue requirements of the California Department of Water Resources, or DWR, to meet the DWR's obligations under its long-term electricity procurement contracts entered into during the energy crisis when the California investor-owned electric utilities were unable to procure electricity.

        Changes in any individual revenue requirement will affect customers' electricity rates and the Utility's revenues. As a result, the Utility's net income is more predictable under cost-of-service ratemaking than under the previous rate freeze.

        In December 2004, the CPUC approved the Utility's first annual electricity rate true-up to adjust rates to reflect over- and under-collections in the Utility's major electricity balancing accounts (including electricity procurement), and consolidate various other 2005 electricity revenue requirement changes authorized by the CPUC and the FERC. These rate changes, implemented on January 1, 2005, contemplated an increase in electricity revenues of approximately $274 million as compared to 2004 revenues at previously adopted rates. On February 7, 2005, the Utility requested the CPUC to approve a rate decrease, to be effective on March 1, 2005 of approximately $73 million, as compared to January 1, 2005 rates, to reflect the issuance of energy recovery bonds discussed below.