View:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT 1
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended December 31, 1995
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from to
Exact
Name of
Commission Registrant IRS Employer
File as specified State of Identification
Number in its charter Incorporation Number
- ---------- -------------- -------------- --------------
1-3779 SAN DIEGO GAS &
ELECTRIC COMPANY California 95-1184800
1-11439 ENOVA CORPORATION California 33-0643023
101 ASH STREET, SAN DIEGO, CALIFORNIA 92101
- ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (619)696-2000
--------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
Title of each class on which registered
- ------------------- ---------------------
San Diego Gas & Electric Company
Preference Stock (Cumulative)
Without Par Value (except $1.70 and $1.7625 Series) American
Cumulative Preferred Stock, $20 Par Value (except 4.60% Series) American
Enova Corporation
Common Stock, Without Par Value New York and Pacific
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
San Diego Gas & Electric Company None
Enova Corporation None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K. [ ]
Exhibit Index on page 34. Glossary on page 42.
Aggregate market value of the voting stock held by non-affiliates of the
registrant as of January 31, 1996:
Enova Corporation Common Stock $2.8 Billion
San Diego Gas & Electric Company Preferred Stock $18 Million
Common Stock outstanding without par value as of January 31, 1996:
Enova Corporation: 116,563,375
San Diego Gas & Electric Company: Wholly owned by Enova Corporation
ENOVA CORPORATION
SAN DIEGO GAS & ELECTRIC COMPANY
FORM 10-K/A
AMENDMENT 1
The undersigned registrants hereby amend Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations, of its Annual Report
Report for 1995 on Form 10-K as set forth in the pages attached hereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this amendment to be signed on its behalf by the
undersigned thereunto duly authorized.
ENOVA CORPORATION
SAN DIEGO GAS & ELECTRIC COMPANY
Date: February 5, 1997 By:_____/s/F.H.Ault______________________
(Signature)
F.H. AULT
Vice President and Controller
ENOVA CORPORATION PARENT COMPANY OF SDG&E
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
On December 6, 1995, San Diego Gas & Electric Company announced the
formation of Enova Corporation as the parent company for SDG&E, an
operating public utility, and unregulated subsidiaries. On January 1,
1996, Enova Corporation became the parent of SDG&E. SDG&E's
outstanding common stock was converted on a share-for-share basis
into Enova Corporation common stock. SDG&E's debt securities,
preferred stock and preference stock were unaffected and remain with
SDG&E. On January 31, 1996, SDG&E's ownership interests in its
subsidiaries were transferred to Enova Corporation at book value,
completing the parent company structure. The consolidated financial
statements include SDG&E and its subsidiaries and, therefore, also
reflect what is now Enova and its subsidiaries. Beginning on January 1,
1996, SDG&E's financial statements for periods prior to 1996 will be
restated to reflect the net results of non-utility subsidiaries as
discontinued operations in accordance with Accounting Principles Board
Opinion No. 30 "Reporting the Effects of a Disposal of a Segment of
Business."
SDG&E is engaged in electric and gas businesses. It generates and
purchases electric energy and distributes it to 1.2 million customers
in San Diego County and an adjacent portion of Orange County,
California. It also purchases and distributes natural gas to 700,000
customers in San Diego County and transports gas for others. SDG&E has
diversified into other businesses. Enova Financial, Inc., invests in
limited partnerships representing approximately 800 affordable-housing
projects located throughout the United States. Califia Company leases
computer equipment. The investments in Enova Financial and Califia are
expected to provide income tax benefits over the next several years.
Enova Energy, Inc., is an energy management consulting firm offering
services to utilities and large consumers. Pacific Diversified Capital
Company is the parent company for non-utility subsidiaries, Phase One
Development, Inc., which is engaged in real estate development, and
Enova Technologies, Inc. Enova Technologies, whose ownership was
transferred directly to Enova Corporation after December 31, 1995, is
in the business of developing new technologies generally related to
utilities and energy, including certain research transferred from the
utility. Enova International was formed after December 31, 1995, to
develop and operate natural gas and power projects outside the United
States. Additional information regarding SDG&E's subsidiaries is
described in Notes 1 and 3 of the notes to consolidated financial
statements.
OPERATING REVENUES Electric revenues did not change significantly in
1995 or in 1994, decreasing less than one percent each year. Gas
revenues decreased 10 percent in 1995, reflecting lower purchased-gas
prices and lower sales volume due to warmer weather and an increase in
customers' purchases of gas directly from other suppliers (for whom
SDG&E provides transportation).
Revenues from diversified operations increased in 1994, primarily
due to Califia's leasing activities.
OPERATING EXPENSES Electric fuel expense decreased 30 percent in 1995
and 18 percent in 1994. The decrease in 1995 was primarily due to
lower prices for natural gas and the shifting of energy supply sources
from generation to purchased power as a result of nuclear refuelings
during the year. The decrease in 1994 was due to lower prices for
natural gas and the replacement of fossil fuel generation with lower-
cost nuclear generation.
Purchased-power expenses decreased in 1995, reflecting a decrease
in purchased-power prices, offset by higher volumes. The 5 percent
increase in 1994 was primarily due to increased purchases from higher-
cost, independent power producers.
Gas purchased for resale decreased 23 percent in 1995 and 12
percent in 1994. The decrease in 1995 was primarily due to lower
prices for natural gas and lower sales volumes due to warmer weather
and an increase in customers' purchases of gas directly from other
suppliers (for whom SDG&E provides transportation). The decrease in
1994 was due to lower natural gas prices and lower sales volumes due
to customers' purchases of gas directly from others.
The changes in maintenance expenses reflect unusually low charges
in 1994, a year which included no nuclear plant refuelings.
OTHER INCOME AND DEDUCTIONS Other income and deductions increased in
1995 and decreased in 1994. These changes, including the change in
"Other-net," were primarily due to the 1994 writedowns described in
Note 2 of the notes to consolidated financial statements.
EARNINGS 1995 earnings per common share were $1.94, compared to $1.17
in 1994 and $1.81 in 1993. Earnings per common share from continuing
operations were $1.94 in 1995, compared with $1.71 in 1994 and $1.89
in 1993. The increase in earnings in 1995 is due to numerous offsetting
factors, including the 1994 writedowns, the increased utility authorized
rate of return and changes in incentive awards for performance-based
ratemaking and demand-side management programs. The increase in earnings
in 1994 was the result of several offsetting factors, including
lower operating and maintenance expense, performance-based
ratemaking awards and lower utility authorized return.
18
Earnings per share for the quarter ended December 31, 1995, were
$0.50 compared to $0.47 for the same period in 1994. Earnings per
share from continuing operations for the quarter were $0.45 in 1995
and $0.49 in 1994. The latter decrease is due to numerous offsetting
factors, including changes in incentive awards for performance-based
ratemaking and demand-side management programs, and the increased
authorized rate of return.
Califia and Enova Financial's contributions to earnings for the
year were $0.17 in 1995, $0.15 in 1994 and $0.09 in 1993. The impact
of the remaining subsidiaries on earnings from continuing operations
was not material.
LIQUIDITY AND CAPITAL RESOURCES
Utility operations continue to be a major source of liquidity. In
addition, financing needs are met primarily through issuances of short-
term and long-term debt, and of common and preferred stock. These
capital resources are expected to remain available. Cash requirements
include plant construction and other capital expenditures;
subsidiaries' affordable-housing, leasing and other investments; and
repayments and retirements of long-term debt. In addition to changes
described elsewhere, major changes in cash flows are described below.
CASH FLOWS FROM OPERATING ACTIVITIES The major changes in cash flows
from operations among the three years result from changes in
regulatory balancing accounts, income taxes, and accounts payable and
other current liabilities. The changes related to regulatory balancing
accounts were due primarily to changes in prices for natural gas. The
changes related to income taxes (and other current assets) were due
primarily to the differences in timing of income tax payments related
to regulatory balancing account activity in 1994. The changes related
to accounts payable and other current liabilities were due primarily
to greater demand-side management activity in December 1995, lower
employee incentive compensation and lower construction activity in
December 1994.
Quarterly cash dividends of $0.39 per share have been declared
for each quarter during the year ended December 31, 1995. The dividend
payout ratio for the years ended December 31, 1995, 1994, 1993, 1992
and 1991 were 80 percent, 130 percent, 82 percent, 81 percent and 79
percent, respectively. The increase in the payout ratio for the year
ended December 31, 1994, was due to the writedowns recorded during
1994. Additional information regarding the writedowns is provided in
Notes 2 and 3 of the notes to consolidated financial statements. The
payment of future dividends is within the discretion of the directors
and is dependent upon future business conditions, earnings and other
factors. Net cash flows provided by operating activities currently are
sufficient to maintain the payment of dividends at the present level.
CASH FLOWS FROM FINANCING ACTIVITIES SDG&E had only short- and
intermediate-term financing needs during 1995 and does not expect to
issue any intermediate-term debt in 1996. The utility did not issue
stock or long-term debt in 1995, except for refinancings, and does not
plan any issuances in 1996, other than refinancings. Subsidiaries
Enova Financial, Califia, Pacific Diversified Capital and Phase One
Development repaid $40 million in long-term debt in 1995 during the
ordinary course of business. To date, it has not been determined
whether the nonutility subsidiaries will issue debt in 1996.
SDG&E's utility capital structure is one factor that has enabled
it to obtain long-term financing at attractive rates. The following
table shows the percentages of capital represented by the various
components. The capital structures are net of the construction funds
held by a trustee in 1992 and 1993.
1991 1992 1993 1994 1995 Goal
- -----------------------------------------------------------
Common equity 47% 47% 47% 48% 49% 45-48%
Preferred stock 5 5 4 4 4 5-7
Debt and leases 48 48 49 48 47 46-49
- -----------------------------------------------------------
Total 100% 100% 100% 100% 100% 100%
___________________________________________________________
In December 1995, Standard & Poor's and Moody's Investors Service
affirmed the ratings of SDG&E following the CPUC's decision on
restructuring California's electric utility industry. Moody's affirmed
its long-term bond rating of A1 and stable outlook. Standard & Poor's
affirmed its long-term bond rating of A+ and negative outlook.
Standard & Poor's said the outlook would remain negative pending
further study of the financial implications of the restructuring
decision, as well as the potential for modification or approval by the
governor and the California Legislature.
On December 19, 1995, the Securities and Exchange Commission
approved SDG&E's application to delist its preferred and preference
stock from the Pacific Stock Exchange. All SDG&E preferred and
preference stock is now listed on the American Exchange only.
On January 15, 1996, SDG&E redeemed its $7.20 series preference
stock. The entire $15 million issue was called for mandatory
redemption at $101 per share.
DERIVATIVES SDG&E's policy is to use derivative financial instruments
to reduce its exposure to fluctuations in interest rates and foreign
currency exchange rates. These financial instruments are with major
investment firms and, along with cash and cash equivalents and
accounts receivable, expose SDG&E to market and credit risks. These
risks may at times be concentrated with certain counterparties. SDG&E
presently contemplates use of similar instruments to reduce its
exposure to fluctuations in natural gas prices. SDG&E does not use
derivatives for trading or speculative purposes.
19
SDG&E periodically enters into interest rate swap and cap
agreements to moderate its exposure to interest rate changes and to
lower its overall cost of borrowing. These swap and cap agreements
generally remain off the balance sheet as they involve the exchange of
fixed- and variable-rate interest payments without the exchange of the
underlying principal amounts. The related gains or losses are
reflected in the income statement as part of interest expense. SDG&E
would be exposed to interest-rate fluctuations on the underlying debt
should other parties to the agreement not perform. Such non-
performance is not anticipated. At December 31, 1995, SDG&E had two
such agreements, including an index cap agreement on $75 million of
bonds maturing in 1996, and a floating-to-fixed-rate swap associated
with $45 million of variable-rate bonds maturing in 2002.
SDG&E's pension fund periodically uses foreign currency forward
contracts to reduce its exposure from exchange-rate fluctuations
associated with certain investments in foreign equity securities.
These contracts generally have maturities ranging from three to six
months. At December 31, 1995, the pension fund held forward Yen-U.S.
Dollar contracts totaling $20 million. SDG&E's pension fund is exposed
to credit loss if the counterparties fail to perform. Such non-
performance is not anticipated.
Additional information on derivative financial instruments is
provided in Note 9 of the notes to consolidated financial statements.
CASH FLOWS FROM INVESTING ACTIVITIES Cash used in investing activities
in 1995 included utility construction expenditures and payments to its
nuclear decommissioning trust. Construction expenditures, excluding
nuclear fuel and the allowance for equity funds used during
construction, were $221 million in 1995 and are estimated to be $220
million in 1996. The company continuously reviews its construction,
investment and financing programs and revises them in response to
changes in competition, customer growth, inflation, customer rates,
the cost of capital, and environmental and regulatory requirements.
Among other things, the level of expenditures in the next few years
will depend heavily on the impact of the CPUC's industry restructuring
decision, on the timing of expenditures to comply with air emission
reduction and other environmental requirements, on the company's plan
to transport natural gas to Mexico and, on the scope of Enova
Technologies' investment in new technologies. These matters are
discussed below.
Payments to the nuclear decommissioning trust are expected to
continue until SONGS is decommissioned, which is not expected to occur
before 2013. Although Unit 1 was permanently shut down in 1992, it is
expected to be decommissioned concurrently with Units 2 and 3.
REGULATORY MATTERS
ELECTRIC RATES In April 1995, the CPUC issued its decision on SDG&E's
May 1995 Energy Cost Adjustment Clause Application, approving an $81
million decrease in electric rates effective May 1, 1995. The decrease
reflects, among other things, lower fuel and purchased-power costs and
the return of previous overcollections from customers. The $81 million
ECAC decrease was combined with previously approved increases for cost
of capital ($31 million) and base rates ($41 million), resulting in an
authorized system average electric rate of $0.0987.
In October 1995, SDG&E filed its 1996 ECAC rate request with the
CPUC for an $18 million decrease in electric rates which, if approved,
would result in an authorized system average electric rate of $0.0967
on June 1, 1996. The request reflects lower forecasted prices for fuel
and purchased power, lower cost of capital, balancing account activity,
and inflation and customer growth based on SDG&E's performance-based
ratemaking Base Rates Mechanism formula. Settlement discussions are
currently ongoing among SDG&E, the CPUC's Division of Ratepayer
Advocates and other parties.
In December 1995, the CPUC found SDG&E operations to be
reasonable for the record period August 1, 1992, through July 31,
1993, except for $1.8 million associated with a wholesale transaction.
This is the last comprehensive reasonableness review, since
performance-based ratemaking (see below) limits such reviews to those
issues causing expenses to fall outside certain parameters.
GAS RATES In July 1995, the CPUC issued its decision on SDG&E's June
1995 application to lower core gas rates by $16 million, effective
August 1, 1995. The decrease was based on the decline in gas prices to
levels below the Biennial Cost Allocation Proceeding's price forecast
that became effective January 1, 1995, and lowered the gas portion of
a typical residential SDG&E natural gas bill by $1.60 per month or 6.5
percent.
In December 1995, the CPUC authorized SDG&E to implement a $21
million natural gas refund as a result of balancing account
overcollections from lower-than-expected natural gas commodity costs.
The typical customer's refund, distributed in February 1996, averaged
$22. In December 1995, the CPUC also authorized a $25 million natural
gas rate increase for residential and small-business customers. In
January 1996, the typical customer's gas bill increased approximately
$1.78 per month, primarily due to an increase in natural gas
transportation prices from Southern California Gas and an update of
balancing account activity.
20
PERFORMANCE-BASED RATEMAKING In December 1995, the CPUC issued its
decision, authorizing rewards of $3.7 million for electric generation
and dispatch (G&D) and $3.8 million for gas procurement based on first-
year (August 1993 through July 1994) results of performance-based
ratemaking (PBR). The CPUC also found SDG&E's nuclear and gas-storage
operations reasonable for the same period.
In October 1995, SDG&E filed reports with the CPUC on the results
of its electric generation and dispatch and gas procurement mechanisms
for the year ended July 31, 1995. SDG&E's fuel and purchased-power
expenses fell below the benchmarks for these mechanisms by a total of
$27.9 million ($2.8 million for G&D and $25.1 million for gas). In its
filing for a rate adjustment effective June 1, 1996, SDG&E requested a
total shareholder reward of $3.4 million ($0.8 million for G&D and
$2.6 million for gas) and that the remainder of these savings be given
to customers through lower rates.
In July 1995, the CPUC authorized $7 million in rewards to
shareholders as a result of SDG&E's exceeding CPUC-approved 1994
benchmarks under the base-rates PBR mechanism. Performance measures in
the base-rates mechanism measures include customer satisfaction,
national rates comparison, system reliability and employee safety.
These PBR rewards are recorded in advance of receipt only when
the entire reward will be collected in rates within 24 months of the
CPUC's approval.
The gas procurement and G&D mechanisms are effective under a
previously authorized two-year experiment that began in August 1993.
Both have been extended until the Division of Ratepayer Advocates and
the Commission Advisory and Compliance Division file their final
reports for the year ended July 31, 1995 (expected during the first
quarter of 1996). Thereafter, SDG&E will be applying for an extension
and modification in conjunction with the restructuring of California's
electric utility industry (see "Competition" below), and the existing
mechanisms are expected to remain in place until the CPUC acts on the
application. The base-rates mechanism was established as a 5-year
experimental mechanism that is intended to run from January 1994
through December 1998.
COST OF CAPITAL In November 1995, the CPUC issued its decision
authorizing SDG&E, Pacific Gas and Electric, Southern California
Edison, Southern California Gas and Sierra Pacific Power 11.60 percent
returns on common equity for 1996. (SDG&E's was 12.05 percent in
1995.) SDG&E's resulting rate of return on ratebase is 9.37 percent,
compared to 9.76 percent in 1995.
In October 1995, SDG&E filed a proposal with the CPUC to
implement a mechanism to establish its cost of capital beginning in
January 1997. Each October, SDG&E's authorized rate of return would be
adjusted if single A bond rates change by 1 percent or more from the
prior year's benchmark. A 100-basis-point change in single A bond
rates would result in a one-half percent change in SDG&E's return-on-
equity. In addition, SDG&E's embedded costs of debt and preferred
stock would be adjusted to reflect SDG&E's outstanding long-term debt
and preferred stock at each September 30 if the return-on-equity
adjustment described above is triggered. The adjustments would be
effective on January 1 of the following year. The proposal suggests a
3-year trial period during which SDG&E's authorized capital structure
would not change.
SAN ONOFRE NUCLEAR GENERATING STATION SDG&E is currently recovering its
existing capital investment in San Onofre Nuclear Generating Station
Unit 1 over a 4-year period that began in November 1992, when the CPUC
issued a decision to permanently shut down the unit. The decision
authorized Southern California Edison (majority owner and operator of
SONGS) and SDG&E to recover their investments in Unit 1, of which
SDG&E's share was $111 million. SDG&E is recovering its investment,
earning a return of 9.1 percent. At December 31, 1995, $18 million
remained to be recovered.
In January 1996, the CPUC approved the accelerated recovery of
SONGS Units 2 and 3 existing capital costs. The decision allows SDG&E
to recover its investment of approximately $750 million over an 8-year
period beginning in 1996, rather than over the anticipated operational
life of the units, which is expected to extend to 2013. During the 8-
year period, the authorized rate of return on the equity portion of
the investment will be 90 percent of SDG&E's embedded cost of debt and
the return on the debt-financed component will be at 7.52 percent
(SDG&E's 1995 authorized cost of debt). The decision includes a
performance incentive plan that encourages continued, efficient
operation of the plant during the 8-year period. During this period,
customers will pay about $0.04 per kilowatt-hour. This pricing
structure replaces the traditional method of recovering the units'
operating expenses and capital improvements. This is intended to make
the units more competitive with other sources.
COMPETITION
ELECTRIC - CALIFORNIA In December 1995, the CPUC issued its policy
decision on the restructuring of California's electric utility
industry to stimulate competition and reduce rates. Beginning in
January 1998, customers can buy their electricity through a power
exchange that will obtain power from the lowest-bidding suppliers.
The exchange is a spot market with visible pricing. Consumers also
may choose to continue
21
to purchase from their local utility under
regulated tariffs. As a third option, a cross section of all customer
groups (residential, industrial, commercial and agricultural) will be
able to go directly to any energy supplier and enter into private
contracts with generators, brokers or others (direct access).
As the direct access mechanism has many technical issues to be
resolved, a five-year phase-in is planned. All California electricity
customers of investor-owned utilities will have the option to purchase
generation services directly by 2003. Key points of the CPUC decision
as it relates to SDG&E include:
- An independent system operator (ISO) will schedule power
transactions and access to the state transmission system, enabling
competing power producers to have equal opportunity to deliver their
supplies. Participation in the power exchange or "pool-based"
wholesale electricity market will be voluntary for buyers and sellers,
except for the investor-owned utilities. The ISO and the power
exchange will be separate, independent entities under Federal Energy
Regulatory Commission jurisdiction.
- Utilities will be allowed to fully recover their "stranded"
costs incurred for facilities approved by the CPUC, purchased-power
and other contracts, and regulatory assets through the establishment
of a non-bypassable competition transition charge (CTC) which all
customers will be assessed.
- Utilities will continue to have the obligation to provide
distribution service to all customers and provide least-cost
generation service to those customers who do not choose the direct-
access option. Performance-based regulation rather than cost-of-
service regulation will be used to encourage efficient utility
operation.
- Utilities will continue to have direct control and operation of
the distribution business and procurement of generation services for
customers who continue to purchase from the utility, which will
continue to be regulated by the CPUC. Transmission facilities will be
owned by the utilities and operated by the ISO.
- For purposes of transition cost recovery, rates for customers
taking bundled utility service (energy, transmission and distribution
included into one rate) will be capped at levels consistent with
January 1, 1996, revenue requirements. Including the CTC, rates cannot
exceed the cap and, therefore, recovery of the CTC is limited by the
cap. If rates not including the CTC meet or exceed the cap for a
particular period, no CTC can be recouped, but rather will be
accumulated in a balancing account for future recovery (see below).
- The CPUC supports a non-bypassable surcharge to fund public
policy programs.
The decision identifies three primary sources of transition
costs: uneconomic utility-owned generating assets (that portion of
fossil units not recoverable in the energy price), existing purchased-
power obligations (including qualifying facilities), and regulatory
assets and obligations (including deferred operating costs and
deferred taxes). By September 1996, the utilities must identify and
value investments for inclusion in a transitional balancing account,
subject to CPUC review and approval. The transition-balancing account
can be adjusted through 2003 for errors or omissions. Collection of
any investment-related transition costs must be completed by 2005.
Thereafter, participation in the power exchange by investor-owned
utilities will be voluntary.
The decision allows for recovery of all remaining generation
investment costs, with a reduced rate of return on any investment-
related transition costs. The rate of return for the debt component
would be equal to the utility's embedded cost of debt and the rate of
return on the equity component would be equal to 90 percent of the
embedded cost of debt. SDG&E's authorized cost of debt is 7.52 percent
for 1995. The CPUC reduced the rate of return to reflect the
perception of lower risk, due to the non-bypassable CTC on
distribution customers, and the reduced risk that the plants will be
found no longer used and useful and removed from rate base.
The CPUC's concerns over market-power problems may require
investor-owned utilities to divest themselves of a substantial portion
of their generating assets. PG&E and Edison are required to file plans
to voluntarily divest themselves of at least 50 percent of their
fossil-fueled generating assets through a spin-off or sale to a non-
affiliated entity. SDG&E is not included in this requirement, as the
CPUC does not perceive these market-power problems in San Diego. In
order to encourage the voluntary divestiture or spin-off of a
utility's fossil generation, the decision provides for a 0.1 percent
increase in equity return for each 10 percent of fossil plants
disposed of in excess of the mandatory percentage.
In addition, the utilities are required to file plans with the
CPUC to implement direct access and new or revised PBR proposals.
Plans to establish the power exchange and ISO are also required to be
filed by the utilities with both the CPUC and the FERC, as the FERC
has jurisdiction over the exchange, the ISO and interstate
transmission.
The California Legislature has passed a resolution forming an
oversight committee to ensure the legislature's involvement in the
policies presented by the CPUC, and that the policies comply with
federal and state laws, and achieve the objectives both of competition
and the various social programs that are currently funded through
utility rates.
The CPUC is currently working on building a consensus on the new
market structure with the California Legislature, the governor,
utilities and customers.
ELECTRIC-FEDERAL In March 1995, the FERC issued a proposed rule that,
if adopted, would require all public utilities to offer wholesale
"open-access" transmission service on a nondiscriminatory basis. In
addition, public utilities would be
22
required to functionally price
their generation and transmission services separately. The FERC also
stated its belief that utilities should be allowed to recover the
costs of assets and obligations made uneconomic by the changed
regulatory environment. Although SDG&E's cost-recovery mechanisms are
not currently under the jurisdiction of the FERC, the recognition by
the FERC of the propriety of such cost recovery supports the CPUC's
similar position.
In October 1995, SDG&E filed for approval of its open-access
tariffs for its service territory with the FERC in conjunction with
its request for a marketing license for Enova Energy. In December
1995, the FERC issued a draft order approving SDG&E's open-access
tariff, but rejecting Enova Energy's filing. This limits Enova Energy
to cost-based rates. All non-rate terms and conditions were accepted
subject to the outcome of the FERC's restructuring rulemaking.
Final approval of the FERC's rule and the CPUC's industry-
restructuring plan would result in the creation of a bid-based
wholesale electricity spot market with open-access transmission. The
FERC is expected to issue a final rule during the first half of 1996.
GAS The ongoing restructuring of the gas utility industry has allowed
customers to bypass utilities as suppliers and, to a lesser extent, as
transporters of natural gas. Currently, non-utility electricity
producers and other large customers may use a utility's facilities to
transport gas purchased from non-utility suppliers. Also, smaller
customers may form groups to buy gas from another supplier. SDG&E
would face significant competition if a major pipeline were to operate
in or near SDG&E's service territory.
In September 1995, SDG&E signed an agreement with Pacific
Enterprises International, an affiliate of Southern California Gas,
and Proxima, a Mexican company, to develop and operate natural gas
distribution networks in Baja California, Mexico. Representing SDG&E
will be an Enova Corporation subsidiary, Enova International.
In November 1995, Mexico issued new regulations allowing
privately owned companies, including companies with foreign ownership,
to participate in infrastructure projects involving natural gas
transportation, storage and distribution. Previously, these activities
were conducted by the government-owned oil company, Pemex.
In November 1995, the three-company consortium submitted a
Statement of Interest to the Mexican government requesting a permit to
distribute natural gas in the city of Mexicali and surrounding areas.
Other companies have also expressed an interest in the project. Under
the new regulations, the government will conduct a bidding process
before a permit is issued. If the consortium is awarded the permit, it
will have an exclusive right to distribute natural gas in that region
for 12 years.
The proposed project would deliver gas to Mexicali through the
pipeline network of Southern California Gas in the Imperial Valley. The
initial capital will be $10 million to $15 million, and the initial
load will be about 10 million cubic feet per day, serving mostly
industrial customers. The proposed pipeline network would be
continuously expanded to serve residential and commercial customers.
EFFECTS OF REGULATION SDG&E currently accounts for the economic effects
of regulation in accordance with Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation," under which a regulated utility may record a regulatory
asset if it is probable that, through the rate-making process, the
utility will recover that asset from its customers. In the event that
recovery of specific costs through rates becomes unlikely or
uncertain, whether resulting from the effects of competition or
regulatory actions, it could result in the writeoff of portions of
these regulatory assets. In addition, once the restructuring
transition is final, SDG&E may not continue to meet the criteria for
applying SFAS 71 to all of its operations in the new regulatory
framework.
As the restructuring of the industry evolves, SDG&E will become
more vulnerable to competition. However, based on recent CPUC
decisions, recovery of stranded costs is provided for, including
recovery of investment in SONGS Units 2 and 3, and SDG&E does not
anticipate incurring a material charge against earnings for its
generating facilities, the related regulatory assets and other long-
term commitments. In addition, although California utilities' rates
are significantly higher than the national average, SDG&E has a lower
concentration of industrial customers and for 7 years has been the
lowest-cost provider among the investor-owned utilities in California,
which make its customers a less likely target for outside competitors.
RESOURCE PLANNING
BIENNIAL RESOURCE PLAN UPDATE PROCEEDING In December 1994, the CPUC
issued a decision ordering SDG&E, Pacific Gas and Electric and
Southern California Edison to proceed with the BRPU auction. SDG&E was
ordered to begin negotiating contracts (ranging from 17 to 30 years)
to purchase 500 mw of power from qualifying facilities at an estimated
cost of $4.8 billion beginning in 1997. In February 1995, the FERC
issued an order declaring the BRPU auction procedures unlawful under
federal law. In July 1995, the CPUC issued a ruling encouraging SDG&E,
PG&E and Edison to reach settlements with the auction winners.
Settlement discussions are ongoing. Additional information on
potential stranded costs and SDG&E's purchased-power commitments is
described in Notes 10 and 11 of the notes to consolidated financial
statements.
23
SOURCES OF FUEL AND ENERGY SDG&E's primary sources of fuel and
purchased power include natural gas from Canada and the Southwest,
surplus power from other utilities in the Southwest and the Northwest,
and uranium from Canada. SDG&E expects its fuel and purchased-power
costs to remain relatively low in the next few years due to the
continued availability of surplus power in the Southwest and the
continued availability of natural gas. Although short-term natural-gas
supplies are volatile due to weather and other conditions, these
sources should provide SDG&E with an adequate supply of low-cost
natural gas. SDG&E is currently involved in litigation concerning its
long-term contracts for natural gas with certain Canadian suppliers.
SDG&E has settled with one supplier. SDG&E cannot predict the outcome
of the litigation with the other suppliers, but does not expect that
an unfavorable outcome would have a material effect on its financial
condition or results of operations.
ENVIRONMENTAL MATTERS
SDG&E's operations are conducted in accordance with federal, state and
local environmental laws and regulations governing hazardous wastes,
air and water quality, land use and solid-waste disposal. SDG&E incurs
significant costs to operate its facilities in compliance with these
laws and regulations, and to clean up the environment as a result of
prior operations of SDG&E or of others. The costs of compliance with
environmental laws and regulations are normally recovered in customer
rates. However, the CPUC's decision for restructuring the California
electric utility industry (see above) will change the way utility
rates are set and costs are recovered. Depending on the final outcome
of industry restructuring and the impact of competition, the costs of
compliance with future environmental regulations may not be fully
recoverable.
Capital expenditures to comply with environmental laws and
regulations were $4 million in 1995, $5 million in 1994 and $8 million
in 1993, and are expected to aggregate $38 million over the next 5
years. These expenditures primarily include the estimated cost of
retrofitting SDG&E's power plants to reduce air emissions. They do not
include potential expenditures to comply with water-discharge
requirements for the Encina, South Bay and SONGS power plants, which
are discussed below.
HAZARDOUS WASTES In May 1994, the CPUC approved a mechanism for
utilities to recover their costs to clean up hazardous waste
contamination at sites at which the utility may have responsibility or
liability under the law to conduct or participate in any required
cleanup. Basically, the mechanism allows utilities to recover 90
percent of their cleanup costs and any related costs of litigation
with responsible parties, and 70 percent of their costs related to
obtaining recovery of such cleanup costs from insurance carriers
providing coverage for such costs.
SDG&E disposes of its hazardous wastes at facilities owned and
operated by other entities. Operations at these facilities may result
in actual or threatened risks to the environment or public health.
Where the owner or operator of such a facility fails to complete any
corrective action required by regulatory agencies to abate such risks,
applicable environmental laws may impose an obligation on SDG&E and
others who disposed of hazardous wastes at the facility to undertake
corrective actions.
This type of obligation has been imposed upon SDG&E with respect
to the Rosen's Electrical Equipment Supply Company site located in
Pico Rivera, California. In December 1993, SDG&E received notification
that the California Department of Toxic Substances Control (DTSC)
considered SDG&E and eight other entities to be potentially
responsible parties (PRPs) liable for any required corrective action
regarding polychlorinated biphenyls contamination at the Rosen's site.
The site was operated between approximately 1948 and 1984. As a part
of its operations, Rosen's acquired and scrapped used electrical
transformers. SDG&E sold some of its used electrical transformers to
Rosen's. The DTSC considers SDG&E to be responsible for about 7
percent of the transformer-related contamination at the site. SDG&E is
continuing to investigate this matter. In December 1995, the DTSC
issued an Imminent and Substantial Endangerment Determination and
Remedial Action Order to SDG&E and 10 other PRPs requiring them to
assess and remove the risks of contamination from the site. However,
SDG&E and the other PRPs have been negotiating with Rosen's and the
DTSC to effect, before April 20, 1996, an alternative consent order
which would separate the development of the cleanup plan from the
actual cleanup. This would provide the PRPs with greater flexibility
to manage and implement the required actions. Based on available
information, SDG&E is unable to estimate the range of liability, if
any, it may have for the necessary corrective action at this site.
During the early 1900s SDG&E and its predecessors manufactured
gas from oil at its Station A facility and at two other small
facilities in Escondido and Oceanside. In 1995, SDG&E commenced an
environmental assessment of Station A. Some significant amounts of
residual by-products from the gas-manufacturing process have been
discovered on portions of the facility during the assessment. However,
the magnitude of such contamination has yet to be determined. The
assessment will be completed in 1996, at which time the extent of any
required remediation activities and a range of costs will be
determined. Sufficient information is not currently available to
estimate cleanup costs. The Escondido facility has been remediated at
a cost of approximately $3 million during the period of 1990 through
1993. A site closure letter for this
24
facility has been obtained from
the San Diego County Department of Environmental Health Services.
However, contaminants similar to the ones found on the Escondido site
have been observed on adjacent parcels of property. SDG&E will assess
these contaminants in 1996.
SDG&E has identified various other sites for which it may bear
some responsibility or liability for any corrective action that may be
required under federal, state or local environmental laws. SDG&E may
be held partially or indirectly responsible for remediation of some of
these sites. However, SDG&E is unable to estimate the extent of its
responsibility, if any, for remediation. Furthermore, the timing for
assessing the costs of remediation at these sites and the number and
identities of other parties that may also be responsible (and their
respective responsibilities and abilities to share in the cost of the
remediation) are also unknown.
ELECTRIC AND MAGNETIC FIELDS (EMF) SDG&E and other utilities are
involved in litigation concerning electric and magnetic fields. An
unfavorable outcome of this litigation could have a significant impact
on the future operations of the electric utility industry, especially
if relocation of existing power lines is ultimately required. To date,
science has demonstrated no cause-and-effect relationship between
cancer and exposure to the type of EMFs emitted by utilities'
transmission lines and generating facilities. To respond to public
concerns, the CPUC has directed the California utilities to adopt a
low-cost EMF-reduction policy that requires reasonable design changes
to achieve noticeable reduction of EMF levels that are anticipated
from new projects. However, consistent with the major scientific
reviews of available research literature, the CPUC has indicated that
no health risk has been identified with exposure to EMFs.
AIR QUALITY In 1996, SDG&E must begin to comply with nitrogen dioxide
emission limits that the San Diego Air Pollution Control District
imposed on electric generating boilers through its Rule 69. Under the
initial rule, SDG&E would have been required to retrofit each of its
nine boilers with expensive pollution-control equipment to reduce
nitrogen dioxide emissions and to maintain the total nitrogen oxide
emissions from the entire system below a prescribed emissions cap
(having graduated emission reductions to be achieved through 2001).
The capital costs of compliance with the initial rule were expected to
be approximately $110 million. However, in December 1995, the district
amended the rule to remove the individual boiler retrofit
requirements, but retained the system-wide emissions cap with further
system-wide emission reductions to be achieved by 2005. The estimated
capital costs for compliance with the amended rule are approximately
$60 million. The California Air Resources Board (ARB) expressed
concern that the amendments to Rule 69 did not meet the requirements
of the California Clean Air Act. However, the ARB withheld any formal
objections pending its review of SDG&E's Rule 69 compliance plan to be
submitted in 1996. The ARB may seek to overturn some or all of the
Rule 69 amendments or to otherwise impose more restrictive emissions
limitations, which would cause SDG&E's Rule 69 compliance costs to
increase.
In 1990 the South Coast Air Quality Management District (AQMD)
passed a rule which will require SDG&E's older natural gas compressor
engines at its Moreno facility to either meet new stringent nitrogen
oxide emission levels or be converted to electric drive. In October
1993, the AQMD adopted a new program called RECLAIM, which replaced
existing rules and requires SDG&E's natural-gas compressor engines at
its Moreno facility to reduce their nitrogen oxide emission levels by
about 10 percent a year through 2003. This will be accomplished
through the installation of new emission-monitoring equipment,
operational changes to take advantage of low-emission engines and
engine retrofits. SDG&E has concluded negotiations with the AQMD that
resulted in the reclassification of three of these engines and
eliminated the need for certain expensive monitoring equipment for
those engines. The cost of complying with RECLAIM may be as much as $3
million.
WATER QUALITY In 1989, SDG&E submitted applications to the San Diego
Regional Water Quality Control Board to renew the discharge permits
for its South Bay and Encina power plants. Supplemental applications
were submitted in 1993. These discharge permits are required to enable
SDG&E to discharge its cooling water and certain other treated and
nontreated nonhazardous wastewaters into the Pacific Ocean and into
San Diego Bay. The permits are, therefore, prerequisites to the
continued operation of its power plants as they are now configured.
Increasingly stringent cooling-water and wastewater discharge
limitations may be imposed in the future, and SDG&E may be required to
build additional facilities to comply with these requirements. Such
facilities could include wastewater treatment facilities, cooling
towers or offshore- discharge pipelines.
SDG&E anticipates that the regional board will issue a new permit
for SDG&E's South Bay power plant in 1996. Pending the regional
board's action, the previous permit remains effective.
The regional board issued SDG&E a new discharge permit for its
Encina power plant in November 1994. However, SDG&E's application for
an exception to certain thermal-discharge requirements is still
pending until the completion of thermal studies to be conducted in
1996. If SDG&E's exception application is denied, SDG&E could be
required to construct offshore-discharge facilities at a cost of up to
$75 million.
25
The California Coastal Commission required a study of the
offshore impact on the marine environment from the cooling-water
discharge by SONGS Units 2 and 3. The study concluded that some
environmental damage is caused by the discharge. To mitigate the
environmental damage, the California Coastal Commission ordered Edison
and SDG&E to improve the plant's fish-protection system, build a 300-
acre artificial reef to help restore kelp beds and restore 150 acres
of coastal wetlands. SDG&E may be required to incur capital costs of
up to $30 million to comply with this order. The new pricing structure
contained in the CPUC's decision regarding accelerated recovery of
SONGS Units 2 and 3 (see "San Onofre Nuclear Generating Station"
above) accommodates these added mitigation costs. In addition, SDG&E
and Edison have asked the California Coastal Commission to reconsider
and modify this mitigation plan to reduce the size of the artificial
reef and shorten the monitoring period. Negotiations are ongoing.
WOOD-POLE PRESERVATIVES The Pacific Justice Center (Pacific), a for-
profit law firm, and the Mateel Environmental Justice Foundation
(Mateel), a nonprofit corporation, claim that SDG&E and other
utilities and parties have violated California's Safe Drinking Water
and Toxic Enforcement Act (Proposition 65) by failing to warn persons
who may come into contact with the preservatives used in treated wood
utility poles and by allowing such preservatives to be released into
sources of drinking water. Some preservatives used in woodpoles are
included on California's list of chemicals known to cause cancer or
reproductive harm. Proposition 65 requires that prior warning be given
to individuals who may be exposed to such chemicals unless the
exposure will not pose a significant risk and that these substances
not be released into sources of drinking water in significant
quantities or otherwise in violation of the law. Violations of the
Proposition 65 warning requirement can result in penalties of up to
$2,500 per violation. SDG&E believes, on the basis of studies and
other information, that exposure to wood poles containing these
preservatives does not give rise to a significant risk and, therefore,
no warning is required and that significant quantities of these
preservatives are not released to any source of drinking water. SDG&E
and the other utilities and parties have responded to the claims by
denying their validity. In June 1995, Mateel, represented by
Pacific, filed a complaint in San Francisco Superior Court against
Pacific Bell, PG&E and two wood-pole manufacturers alleging the
violations noted above. Although SDG&E was not named in this lawsuit,
it is anticipated that Mateel may file a separate lawsuit against
SDG&E and other utilities on the same grounds. SDG&E is cooperating
with PG&E, Pacific Bell and others to achieve an effective and
favorable resolution of this matter.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of." This statement, which is effective for 1996 financial
statements, requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review of recoverability, the entity
should estimate the future cash flows expected to result from the use
of the asset and its eventual disposition. As discussed above and in
Note 11 of the notes to consolidated financial statements, the CPUC
has issued a decision for restructuring the California electric
utility industry to stimulate competition and has indicated that the
California utilities will, within certain limits, be allowed recovery
of regulatory assets, the excess carrying amount of existing utility
plant and obligations under long-term purchased-power contracts over
fair-market value over a transition period that ends in 2005. As a
result of this and preliminary indications from the FERC on recovery
of transition costs arising from industry restructuring, SFAS 121 is
not currently expected to have an adverse impact on SDG&E's financial
condition or results of operations. However, this may change in the
future as restructuring, deregulation and competitive factors take
effect in the electric utility industry.
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation." SFAS 123 is effective for 1996 financial
statements and establishes a fair-value-based method of accounting for
stock-based compensation plans. SFAS 123 provides a voluntary
alternative to the provisions of Accounting Principles Board Opinion
25, "Accounting for Stock Issued to Employees." However, it requires
pro forma disclosure of the stock-based compensation arrangement's
impact on net income and earnings per share as though SFAS 123's fair-
value provisions had been adopted. SDG&E currently issues restricted-
stock awards under its Long-Term Incentive Plan and expects to adopt
the disclosure-only requirement of SFAS 123. Additional information on
SDG&E's stock-based compensation plans is provided in Note 7 of the
notes to consolidated financial statements.