Pacific Gas & Electric (PCG)

The Utility’s Plan of Reorganization and Settlement Agreement

The Utility’s plan of reorganization under Chapter 11 became effective on April 12, 2004, or the Effective Date. The plan of reorganization incorporated the terms of the settlement agreement approved by the CPUC on December 18, 2003, and entered into among the CPUC, the Utility and PG&E Corporation on December 19, 2003, to resolve the Utility’s Chapter 11 proceeding, or the Settlement Agreement. At March 31, 2004, the Utility recorded approximately $4.9 billion of regulatory assets established under the Settlement Agreement (including a $2.2 billion, after-tax, regulatory asset ($3.7 billion, pre-tax) referred to in this annual report as the Settlement Regulatory Asset) and a related pre-tax gain of approximately $4.9 billion on recognition of these regulatory assets. The Settlement Agreement authorizes the Utility to earn an 11.22% rate of return on equity on its rate base, including these regulatory assets. As described below, because the Utility refinanced the remaining unamortized after-tax balance of the Settlement Regulatory Asset through the issuance of approximately $1.9 billion of energy recovery bonds, the Utility will no longer earn this 11.22% rate of return on the Settlement Regulatory Asset as it is no longer a part of rate base.

The Settlement Agreement has a term of nine years that began on the Effective Date. Although the Utility’s operations are no longer subject to the oversight of the bankruptcy court, the bankruptcy court retains jurisdiction to hear and determine disputes arising in connection with the interpretation, implementation or enforcement of (1) the Settlement Agreement, (2) the plan of reorganization, and (3) the bankruptcy court’s December 22, 2003 order confirming the plan of reorganization. In addition, the bankruptcy court retains jurisdiction to resolve remaining disputed claims held in escrow of approximately $1.7 billion at December 31, 2004. See Note 2 of the Notes to the Consolidated Financial Statements for further discussion.

In March 2004, in anticipation of its emergence from Chapter 11, the Utility issued $6.7 billion in first mortgage bonds, or First Mortgage Bonds, and, together with its consolidated subsidiaries, obtained $2.9 billion in credit facilities, in order to finance the plan of reorganization. Upon the Effective Date, the Utility paid all valid claims, deposited funds into escrow accounts for the payment of disputed claims upon resolution, and reinstated certain obligations. The Utility expects to fund its operating and capital expenditures substantially from internally generated funds. In addition, available credit facilities are considered adequate to meet these operating requirements and seasonal fluctuation in working capital.

Federal and state court appeals of the bankruptcy court’s December 22, 2003 order confirming the plan of reorganization and the CPUC’s approval of the Settlement Agreement remain pending. PG&E Corporation and the Utility believe these appeals and petitions are without merit. Under applicable federal precedent, once the plan of reorganization has been “substantially consummated,” any pending appeals of the confirmation order should be dismissed. If, notwithstanding this federal precedent, the bankruptcy court’s confirmation order or the Settlement Agreement is subsequently overturned or modified, PG&E Corporation and the Utility’s financial condition and results of operations could be materially adversely affected. See Note 2 of the Notes to the Consolidated Financial Statements for further discussion.

The Utility's Plan of Reorganization and Settlement Agreement

        The Utility's plan of reorganization under Chapter 11 became effective on April 12, 2004, or the Effective Date. The plan of reorganization incorporated the terms of the settlement agreement approved by the CPUC on December 18, 2003, and entered into among the CPUC, the Utility and PG&E Corporation on December 19, 2003, to resolve the Utility's Chapter 11 proceeding, or the Settlement Agreement. At March 31, 2004, the Utility recorded approximately $4.9 billion of regulatory assets established under the Settlement Agreement (including a $2.2 billion, after-tax, regulatory asset ($3.7 billion, pre-tax) referred to in this annual report as the Settlement Regulatory Asset) and a related pre-tax gain of approximately $4.9 billion on recognition of these regulatory assets. The Settlement Agreement authorizes the Utility to earn an 11.22% rate of return on equity on its rate base, including these regulatory assets. As described below, because the Utility refinanced the remaining unamortized after-tax balance of the Settlement Regulatory Asset through the issuance of approximately $1.9 billion of energy recovery bonds, the Utility will no longer earn this 11.22% rate of return on the Settlement Regulatory Asset as it is no longer a part of rate base.

        The Settlement Agreement has a term of nine years that began on the Effective Date. Although the Utility's operations are no longer subject to the oversight of the bankruptcy court, the bankruptcy court retains jurisdiction to hear and determine disputes arising in connection with the interpretation, implementation or enforcement of (1) the Settlement Agreement, (2) the plan of reorganization, and (3) the bankruptcy court's December 22, 2003 order confirming the plan of reorganization. In addition, the bankruptcy court retains jurisdiction to resolve remaining disputed claims held in escrow of approximately $1.7 billion at December 31, 2004. See Note 2 of the Notes to the Consolidated Financial Statements for further discussion.

        In March 2004, in anticipation of its emergence from Chapter 11, the Utility issued $6.7 billion in first mortgage bonds, or First Mortgage Bonds, and, together with its consolidated subsidiaries, obtained $2.9 billion in credit facilities, in order to finance the plan of reorganization. Upon the Effective Date, the Utility paid all valid claims, deposited funds into escrow accounts for the payment of disputed claims upon resolution, and reinstated certain obligations. The Utility expects to fund its operating and capital expenditures substantially from internally generated funds. In addition, available credit facilities are considered adequate to meet these operating requirements and seasonal fluctuation in working capital.

        Federal and state court appeals of the bankruptcy court's December 22, 2003 order confirming the plan of reorganization and the CPUC's approval of the Settlement Agreement remain pending. PG&E Corporation and the Utility believe these appeals and petitions are without merit. Under applicable federal precedent, once the plan of reorganization has been "substantially consummated," any pending appeals of the confirmation order should be dismissed. If, notwithstanding this federal precedent, the bankruptcy court's confirmation order or the Settlement Agreement is subsequently overturned or modified, PG&E Corporation and the Utility's financial condition and results of operations could be materially adversely affected. See Note 2 of the Notes to the Consolidated Financial Statements for further discussion.

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