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PG&E Corporation (PCG)
Q4 2006 Earnings Call
February 22, 2007 11:30 am ET

Executives

Gabriel B. Togneri - Vice President, Investor Relations
Peter A. Darbee - Chairman of the Board, President, Chief Executive Officer
Thomas B. King - President and Chief Executive Officer of
Pacific Gas and Electric Company
Bill Morrow - President, Chief Operating Officer, Pacific Gas and Electric Company
Christopher P. Johns - Chief Financial Officer, Senior Vice President, Treasurer
Chris Warner - Lawyer

Analysts

Lasan Johong - RBC Capital Markets
Ashar Khan - SAC Capital
Rudy Tolentino - Morgan Stanley
Douglas Fischer - A.G. Edwards & Sons
Michael Lapides - Goldman Sachs
Andrew Levi - Bresden
Ryan Watson - Stanfield Capital
Reza Hatefi - Polygon Investment Partners

Presentation

Operator

Good morning and welcome to the PG&E Corporation fourth quarter earnings conference call. At this time, I would like to introduce your host, Mr. Gabe Togneri. Thank you. Have a great conference and go ahead, Mr. Togneri.

Gabriel B. Togneri

Thanks. Good morning and welcome to our 2006 year-end earnings call. This is a simultaneous webcast and conference call and all participants are currently in listen-only mode. A replay of the webcast may be accessed from the PG&E Corporation’s homepage after the call and our earnings press release, which we issued earlier today, is posted on our website along with supplemental tables including Regulation G reconciliations.

We have also provided these materials through an 8-K filing with the SEC and we will file our Form 10-K reports for both the corporation and Pacific Gas and Electric Company today.

I will remind you before we begin the discussion that our prepared remarks and the Q&A session will contain forward-looking statements based on assumptions and expectations that reflect information currently available to management. As we discussed in more detail in our earnings press release, actual results may differ materially from those forward-looking statements. We encourage you to review our SEC filings to obtain additional information and to better understand the many factors that could influence future results.

Now, given that this is our call to wrap up 2006, we have a slightly larger slate of speakers to take us through the results and other highlights. They are: Peter Darbee, Chairman and CEO of PG&E Corporation; Tom King, CEO of Pacific Gas and Electric Company; Bill Morrow, President and Chief Operating Officer of Pacific Gas and Electric Company; and Chris Johns, Senior Vice President and CFO. Other members of the team are also available if needed to answer questions.

Now I will turn the call over to Peter Darbee.


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Peter A. Darbee

Thanks, Gabe, and thank you all for joining us. This has been a year of outstanding progress towards our financial and operational goals. Total net income for the fourth quarter was $170 million or $0.48 per share. So for 2006, we delivered $2.57 per share in earnings from operations. That is $0.02 above the high-end of our 2006 guidance range.

We provided our investors with a total annual shareholder return of more than 31%. This exceeds by a significant margin the 2006 return on the S&P 500, the S&P Electrics, and the S&P Multi-utility Index, despite the excellent performance of the utilities sector overall.

We intend to build on the momentum we have created in 2006. Accordingly, we are increasing 2007 guidance to the range of $2.70 to $2.80 per share. Chris Johns will discuss our guidance and detailed financial results later in the call. Right now, I would like to highlight a few important accomplishments that exemplify the year’s success and underpin our direction for 2007.

As you know, we have been focused on building our reputation with customers and our credibility with decision makers. Working with key stakeholders, those efforts have enabled us to achieve a number of successes in 2006 for the benefit of customers and the business.

For example, we kicked off the installation of over 10 million advanced meters as part of our Smart Meters initiative to help our customers save energy and money. We recently broke ground on the first new PG&E owned power plant in 20 years, named the Gateway Generating Station, formerly known as Contra Costa 8. We also have approval for additional new generating resources, including other PG&E owned facilities.

We are taking care of our employees with a pension settlement that will fully fund our retirement plans and, assuming a successful resolution of our 2007 general rate case, we will have a foundation to support crucial distribution investment and improvements in customer service over the next four years.

We helped shape historic environmental policy with Assembly Bill 32, California’s Global Warming Solutions Act, and a month ago, we joined with a clean energy group and other business leaders to support a federal greenhouse gas cap and trade program introduced in legislation by Senator Feinstein of California and Senator Carper of Delaware.

Leadership in these and other areas is strengthening our company and it is attracting talented individuals to PG&E. For example, we added eight new officers to our management team in 2006 and wished farewell to a similar number of officers in retirement. These new additions are people who share our values and commitment to being at the forefront of industry change.

Importantly, we are building a team that takes the best of our current employee base and adds to it individuals who bring talent, experience and new ideas from other companies and industries.

Yesterday, the Board elected Tom King and Bill Morrow to positions of increased responsibility effective July 1. This action is aligned with our goal of being the nation’s leading utility and reflects our commitment to deploy our talent where it can have the greatest impact for customers and shareholders. As President of PG&E Corporation, Tom will oversee the existing utility business as well as strategic growth opportunities for the company. As President and CEO of the utility, Bill will lead and manage all of the utilities’ operations and will continue to report to Tom.

In the end, we always had to come back to our goals -- delighted customers, energized employees, and rewarded shareholders. We believe we are delivering in each of these areas and we are confident that even more success in 2007 and beyond will be realized.

With that, I would like to turn it over to Tom King who will expand on our 2006 accomplishments.

Thomas B. King

Thanks, Peter. We are committed to providing our customers with better, faster, and more cost-effective service. A key part of this commitment is building new infrastructure and designing energy efficiency programs to support clean, reliable energy.

We continue to deliver on these commitments with plans for one of the cleanest, most efficient generation portfolios in the nation. Currently today, over 50% of our electric portfolio has zero carbon emissions.

In 2006, we signed additional projects that will provide as much as 1,100 megawatts of new renewable energy coming online in the next few years. These contracts will add enough renewable resources to bring the percentage of renewable energy in our portfolio from 12% today up to approximately 18% by the end of this decade. This is very good progress towards our goal of 20% renewable electricity by 2010.

Our 2007 renewable portfolio standards solicitation will target another 2% of renewable resources. We are also focused on the transmission access needed to deliver this renewable power and we are monitoring the land acquisition and construction of these renewable resources.

At the same time, we are continuing to invest in utility-owned generation. Regulatory decisions in 2006 provided approvals for $1.3 billion of incremental cash-fired generation investment to increase the capacity of our electric system and ensure reliability.

The Gateway, Humboldt, and Colusa projects, which were approved in the third and fourth quarter of 2006, represent 1,350 megawatts of new state-of-the-art facilities that will come online by the end of this decade.

In that same time period, we will balance these facilities with an additional $1 billion of additional funding for energy-efficiency programs. These programs are anticipated to displace the need for over 600 megawatts of conventional generation.

Most recently in December, we filed our next long-term resource needs forecast with the California Public Utilities Commission for a period beyond 2011. These resources are important to serving customers reliability but just as important, they will also replace older, inefficient plants like the nearly 80-year old Hunters Point generation station.

For example, working with the City of San Francisco and the citizens of Hunters Point, Hunters Point bayview neighborhood, we kept our promise to shut down the Hunters Point plant last August while improving the overall reliability in the service area. These reliability improvements were done through significant transmission upgrades and additional investments.

We have also been at the forefront of our support for the State’s energy policies, like the California Solar Initiative. No other utility has connected as many solar customers to the grid as PG&E. Today, we have more than 14,000 customers using the Sun’s energy.

We also introduced some new conservative rates, conservation rates and environmental programs in 2006 to provide our customers with additional options.

Under our Climate Smart program, customers can elect to pay a small fee on their monthly bills. This money will fund independent environmental projects that remove equivalent greenhouse gases from the atmosphere. By 2009, we anticipated over 200,000 residential customers and businesses will participate in this new rate.

Our agricultural diesel engine conversion incentive rate helps farmers shift their irrigation pumping stations from diesel engines to clean electricity from the PG&E system. This will result in carbon reductions of 650,000 tons over what would have been the lifetime of these diesel engines, and these emission reductions are banked on behalf of PG&E customers.

These new investments in innovations are the right thing for our customers and our company. Our actions are making a measurable impact on the communities, how they view us, and how they value the services that we deliver.

Now, I am pleased to introduce Bill Morrow, who will provide a few comments on our operations and specifically, our transformation efforts. Bill.

Bill Morrow

Thanks, Tom, and good morning, everyone. In the next few minutes, I will just cover some brief elements around business transformation, and as I hope that you are aware, this program has a three-fold objective. To start with, it is improving the service levels to our customers, it is to improve the efficiency of our operations, and finally to improve the agility and effectiveness of the organization.

In a nutshell, we are on schedule with where we had planned to be at this point and we are also encouraged by some of the early results that we have.

At this point in our multi-year program, we have deployed over 30 of the 77 initiatives, and these have led to measurable improvements. For example, our customer segmentation, account management and new service processes have moved our JD Power customer satisfaction for business into the range of first quartile performing companies for electricity, and we just learned in the last couple of days that JD Power has ranked us tied for number one in the West for the recent gas survey rankings for business and fourth overall out of the 38 utility companies surveyed.

On the residential side, the process changes we have made in our call centers, our new online and credit card payment options, and the streamlined communication processes have driven up our residential JD Power customer satisfaction scores as well.

In addition to customer service improvements, we have also made a number of in-roads to greater cost efficiencies. Our supply chain management initiatives last year resulted in savings of over $125 million and we did this while exceeding our supplier diversity goals of over 20%.

Our seven resource management centers are now up and running to share workloads and improve productivity and we have also deployed industry first techniques in performing maintenance and repairs using bare hands on live wires that eliminate the need to take the customers out of service and therefore expand vast resources in the process.

Our agility and effectiveness improvements are also coming through. You heard Peter and Tom now talk about a number of successes that we have had with environmental leadership and energy procurement, but it is also showing up in many other areas of the organization.

As an example, our Diablo Canyon Power Plant had a record-setting generation year, producing over 18 million gigawatt hours, the best in its history.

So while our progress is encouraging, we know that we have a lot to do and that we must do better in order to become the leading utility in the United States. To help us get there, we are going to introduce an even more systematic and disciplined approach to drill down on those areas where we see opportunity or where we need further focus and improvement.

Our transformation effort is going to be an iterative and ongoing one where we will be in a constant pursuit of improvement.

With that, let me turn this over to Chris who will talk about our financials.

Christopher P. Johns

Thank you, Bill. I will review our fourth quarter and year-end results and then discuss our guidance and other developments.

For the fourth quarter, PG&E Corporation earned $152 million, or $0.43 per diluted common share on a GAAP basis. This compares to $180 million, or $0.49 per diluted share for the fourth quarter of 2005.

On a non-GAAP basis, quarterly consolidated earnings from operations were $170 million, or $0.48 per diluted common share. This compares to $179 million or $0.49 per diluted share for 2005.

This result is consistent with the expectations we shared with you during our third quarter earnings call, namely that fourth quarter spending levels would be higher than the other quarters as a result of anticipated spending on our transformation efforts and deferred maintenance associated with the summer heat storm.

For the full year, we earned $2.76 per diluted common share on a GAAP basis, and this compares to $2.37 per diluted share for 2005. On a non-GAAP basis, consolidated earnings per share from operations were $2.57. This compares to $2.34 per diluted share for 2005, almost a 10% increase in year-over-year EPS from operations.

The specific quarter-over-quarter changes in earnings per share from operations were driven by a number of factors which are provided in detail in Table 4 of our supplemental earnings package. However, I will quickly highlight a few of those factors for you.

First, as a result of the stock repurchases we completed in 2005, we have a positive $0.02 per share impact from lower shares outstanding. In addition, you will recall that in the fourth quarter last year, we had a refueling outage at Diablo Canyon. The refueling outage and the associated expenses this year occurred in the second quarter, resulting in a quarter-over-quarter positive variance of $0.07 per share for the fourth quarter.

The positive effects for the quarter were offset by negative factors such as the carrying cost credit, the cost of employee benefit plans, and the AEAP settlement, which had a positive effect in the fourth quarter of 2005, was no similar positive event in 2006.

A full year earnings walk is also provided in Table 4 of our earnings package. This includes a number of items we have discussed on previous earnings calls and includes the benefit of lower shares outstanding for the full year, the effect of our increased authorized return on equity, and strong park and lend revenues in our gas transmission business during the year.

For 2006 as a whole, these positive effects were partially offset by items such as the carrying cost credit associated with our energy recovery bonds.

Beyond the items we have highlighted in earnings from operations, there are also approximately $18 million of severance accruals, or about $0.05 per share, that impacted this quarter’s and the year’s earnings. These severance costs reflect the best estimate of our consolidation of various positions associated with our transformation efforts.

In 2006, our financial performance exceeded our expectations and our targets. As we look at 2007, we are building off of our strong 2006 results and are raising the bar on our performance, increasing our guidance range by $0.05 to $2.70 to $2.80 per share from operations.

The primary assumptions supporting our updated guidance are: a final 2007 general rate case decision consistent with the proposed settlement agreement; and earning our authorized return on equity on a projected rate base of approximately $17.3 billion for 2007.

We continue to target at least 7.5% average annual growth in EPS from operations over the 2007 to 2010 period, assuming approval of the 2007 general rate case settlement request and projected capital expenditures for that period.

As always, a reconciliation of our guidance for 2007 earnings per share from operations to projected GAAP earnings per share can be found in our supplemental materials.

I will move on now to a couple of key items of interest: the recent proposed decision and alternate in the 2007 general rate case and the 2006 financial results of our transformation efforts.

On February 13th, we received two proposed decisions in our 2007 general rate case. One was issued by the administrative law judge supervising the case, and an alternate decision was issued at the same time by Commissioner Bonds, who is the assigned commissioner for the GRC.

The ALJ’s proposed decision reduces the 2007 base revenue requirement proposed in the settlement agreement by approximately $43 million, primarily related to tax benefits associated with dividends on the employee stock ownership plan and the removal of certain items from rate base.

The alternate decision by Commissioner Bonds accepts the settlement in full.

Both decisions recommend the attrition provision proposed in the settlement agreement. You will recall that it is $125 million on average in 2008, 2009, and 2010.

For a decision to become final, it needs to be put to a vote by the full commission. Under the CPC rules, a final decision could be voted on as early as March 15, 2007.

We remain convinced that our GRC request is consistent with the public interest and the level of service and reliability desired by our customers.

Now to give you an update on transformation. In 2006, we spent approximately $265 million on our transformation initiatives, slightly less than the projections we shared with your in the second half of last year. Of this amount, $107 million was expense and $158 million was capital invested in our business.

From those efforts, we generated about $175 million in benefits, including the strategic sourcing initiatives that Bill mentioned earlier. That was $60 million in expense savings and about $115 million in capital savings.

We expect the savings we reinvested in transformation will continue to pay dividends going forward in operating efficiency improvement and customer service enhancement to meet our net benefit targets through 2010.

For 2007, we expect to continue to move closer to break-even for the year overall in transformation spending and benefits. This will position us to deliver net positive benefits as planned, beginning in 2008.

With that, I would like to turn it back to Peter.

Peter A. Darbee

Thanks, Chris. As you can see, our progress in 2006 was very strong. In line with our vision, we began to distinguish PG&E as a leading utility. On that point, I would like to close with some context for the strong stance we have taken on greenhouse gas emissions, energy efficiency, and demand side management.

We are at the forefront of these issues because it is consistent with our vision and it is consistent with our values, and it also fits with our overall strategy, which emphasizes operational excellence and taking care of our customers.

We see a direct correlation between running the business efficiently and effectively, as we are doing with transformation, and running it cleanly. We also know that these issues go straight to the heart of meeting our customer expectations at PG&E, and we believe that increasingly, the way companies in our industry manage their environmental performance is going to separate top performers from others.

They will be seen differently by customers, by regulators, and by investors. There are a number of studies showing companies that are the most responsible when it comes to the environment also tend to deliver greater value to shareholders over the longer term than that of their peers.

We have also seen research that shows this is an area becoming a significant factor in attracting talent to an organization. This in fact has been our experience. We are now able to attract talent that never before would consider a job with PG&E or one in our industry, and we have seen very encouraging responses from our customers in communities, both in surveys and in feedback we get by word of mouth.

In the time since we emerged from the energy crisis and bankruptcy, the number of customers who view PG&E favorably has risen from 39% to 65%, and we are seeing the impacts not only with our customers but also in the following areas: the excitement and readiness of our employees to embrace change; invitations by legislators and regulators to participate in a dialog that is shaping our business environment; and various opinion leaders, third parties, a number of whom have been recognizing PG&E for its leadership.

We are very proud to have received a number of awards for our efforts in 2006, and in January, 2007, we became one of only three other companies in the 30-year history of the Natural Resources Defence Council to be recognized by them for our ongoing record of environmental leadership.

It feels great to be recognized for our efforts, but what is even better is to be seen as having these accomplishments recognized and resonate with third parties, and that is what is happening.

When in July, we joined our regulators, 15 other California electric and gas utilities, state policy makers and other key stakeholders in support of the DOE on the National Action Plan for Energy Efficiency. We are working with the U.S. Climate Action Partnership on the historic greenhouse gas legislation, signed by Governor Schwarzenegger, and we are supporting federal cap and trade measures like those proposed by Senators Feinstein and Carper and embraced by the Clean Energy Group and the U.S. CAP group.

For three decades of environmental and clean energy excellence, it is important to recognize that these create important advantages for the company. It is strengthening our reputation for customers. It is a calling card that has opened doors for us to be part of the conversations with policy makers and other leaders who are shaping the future, and it is a source of new possibilities for our shareholders.

We believe our sector is on the brink of major changes and California is likely to be at the center of these changes. New technologies and new approaches to providing, using, and valuing energy sources will bring new opportunities and I am confident through our efforts we will continue to deliver substantial tangible rewards for our customers, our shareholders, and our communities.

Now we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Lasan Johong with RBC Capital Markets. Please proceed.

Lasan Johong - RBC Capital Markets

Thank you. Good morning. Nice year.

Peter A. Darbee

Are you there?

Lasan Johong - RBC Capital Markets

Yes. Hello? Hello?

Peter A. Darbee

Hello?

Operator

Just one moment. Mr. Johong, please proceed.

Lasan Johong - RBC Capital Markets

Thank you. Good morning. Very nice year. Maybe I am being too crafty, but does Tom’s promotion signal that there might be an acquisition coming soon?

Peter A. Darbee

No is the answer to the question. What we have identified is that there are great opportunities both in the area of strategic growth that does not constitute mergers and acquisitions. Of course, there is some merger and acquisition activity out there in the industry, but let me give you an example.

As we have looked at the business, what we have seen is there are a tremendous number of opportunities that relate to our core business and really are extensions of that business that might be pursued without merger and acquisition activity.

For example, one of the things we have really focused on is in California, there are more plug-in hybrid vehicles than in almost all the other states combined. So one area for example that we would be interested in growing the business would be with respect to plug-in hybrid vehicles. Things like that are things that Tom would pursue, and there are other opportunities as well.

The fact that we have changed his position and moved him up to the President of PG&E Corporation, one should not draw a linkage between that and assume or believe that it implies that we are going to do a transaction, or are in the midst of one.

Lasan Johong - RBC Capital Markets

I see. Interesting. Your greenhouse gas position, or your position on greenhouse gas issues and controlling it, is very well-documented and obviously very laudable as well. How do you see nuclear energy being part of that and how does PG&E look to maybe expand on its nuclear opportunities?

Peter A. Darbee

We believe that nuclear and the nuclear option needs to be on the table for the United States of America and there are two reasons for that. One is because of the environment and the other is because of energy security. For example, if there are more nuclear plants, there is more capacity to provide energy for plug-in hybrids, and that would reduce our dependence on foreign sources of oil.

However, in California, there is a law in place that prohibits us and anyone else from building additional nuclear in the state, so long as there is not a long-term solution with respect to the spent fuel. So right now, it is illegal and not something that anybody can really pursue.

We think it is an option for the rest of the United States, but we do not see it as an option for the state in terms of additional nuclear. We remain quite pleased with the performance of Diablo Canyon and feel that that’s a tremendous resource for the people of California, and a clean one at that.

Lasan Johong - RBC Capital Markets

But that does not prohibit you from pursuing ventures outside of California, nor putting pressure on Washington to get these issues resolved.

Peter A. Darbee

That’s correct.

Lasan Johong - RBC Capital Markets

Okay. Thank you.

Gabriel B. Togneri

Next question.

Operator

Our next question comes from the line of Ashar Khan with SAC Capital. Please proceed.

Ashar Khan - SAC Capital

Good morning. Congratulations. Could you just tell us in the ’07 guidance, how much is your B credit assumed? The credit that comes off -- I might not have the wording right, but the credit rate --

Christopher P. Johns

I believe the credit for 2007 is about $56 million. That is after tax and that includes both the ERBs and the RRBs.

Ashar Khan - SAC Capital

Could you give us, based on the rate case, what the rate base would be? Because the rate base would be in 2008.

Peter A. Darbee

Ashar, we are not going out past 2007 at this point. [There are] different things that could happen under the general rate case, so right now the only public guidance that we have is around the 2007 number, which was around 17.3. Anticipate that we will finalize what our capital expenditure programs look like and our growth looks like after we get the final rate case hopefully here in mid-March.

Ashar Khan - SAC Capital

If I could just ask you, is it fair to assume that if we assume that the rate case decision comes in at the end of March, I know you can retroactively get those revenues, but from an accounting purposes and for GAAP purposes, are you able to record those in the first quarter, or are those earnings going to be more in the second, third and fourth quarters?

Peter A. Darbee

Ashar, you are correct. The way the proposed orders are written, it would all be retroactive to January 1st. From an accounting perspective, you are also correct that if for whatever reason we would not get a final order until after we have issued our first quarter earnings report, then we would not be able to recognize those until we get a final order.

Ashar Khan - SAC Capital

Thank you.

[Multiple Speakers]

Christopher P. Johns

-- so there would be no loss of earnings for the year.

Operator

Our next question comes from the line of Rudy Tolentino with Morgan Stanley. Please proceed.

Rudy Tolentino - Morgan Stanley

Can you give me an update on the T-09 rate case, where that stands at the moment?

Thomas B. King

Yes, and Chris, if you want to add to it, have at it, but we have a settlement within the rate case that was just recently filed. It is an all-party settlement, so we would expect probably second-half of 2007 to get that finalized in the order.

Chris Warner

We do expect FERC to act and the next settlement effective by May 1st.

Rudy Tolentino - Morgan Stanley

And what is the financial impact, if you can give me guidance on that?

Chris Warner

We expect under the settlement to receive about a $74 million revenue increase. That is compared to our request of $113 million.

Christopher P. Johns

And the ramifications of that are included in the guidance that we just gave for 2007.

Rudy Tolentino - Morgan Stanley

Okay. Thank you very much.

Operator

Our next question comes from the line of Doug Fischer with A.G. Edwards. Please proceed.

Douglas Fischer - A.G. Edwards & Sons

Thank you, and good morning. Just a couple of questions. Can you isolate a factor or two that contributed to the higher guidance as it related to the FERC settlement?

Secondly, maybe some kind of comment on the overall M&A environment as you see it from a pricing, regulatory, et cetera viewpoint, just a general sense of how you see the world.

Christopher P. Johns

As far as 2007 guidance in general, we did raise it by the nickel and that is reflective of the rate base of 17.3 and assuming that we earn our authorized return of 11.35% under the California jurisdiction, and that does include the assumption that we earn somewhere around the 12% level on the FERC piece of the business. So those are the key drivers as to raising the guidance for 2007.

Peter A. Darbee

On the M&A front, I think our observation is if you look at what happened with Exxon public service enterprises in New Jersey, and if you look at FPL Constellation, what you are seeing is that the state commissioners are going to play a very significant role in M&A transactions.

You also see that there is a little bit of the we call it the car wash effect here, which is that the car goes through the car wash once and sometimes loses a little paint, and then you go through it again and you lose more and more paint. We saw that during the energy crisis in California where each constituency wanted to grab more and more of the economics, and each time they did it was like a run through the car wash.

What we saw was that regulators asked for more and more. We saw that in Exxon public service enterprises in New Jersey, so our belief is that may open the door where people will try and work on a deal maybe with selective regulators beforehand, before the announcement of a definitive agreement, so that they have a package that works from a political regulatory standpoint as well as works for shareholders. So that is one thought we have.

The second is this has had a chilling effect on the level of M&A and I think some companies have felt it, so it is a lot riskier proposition to go out there and announce a deal and a lot less certain that one will go through.

I think what we have seen is from the FERC level, sort of an encouraging environment, certainly not a discouraging environment, but what has happened is state regulators have jumped in and said “we are going to play a key role here and we are perfectly willing to prevent a transaction from happening”.

Douglas Fischer - A.G. Edwards & Sons

Any thoughts as to what you would find attractive or unattractive, just on a very macro level, from an M&A standpoint in terms of regulated versus unregulated, location, et cetera?

Peter A. Darbee

I am not going to comment on that but I think we have been pretty consistent with an articulation that our strategy is one of regulated companies. We like running regulated companies, so that would be one thing.

The other point I would make going back to my earlier comments is that many of us or a number of us from the company’s management are from the telecommunications industry and what we saw was that there used to be a pretty basic offering in telecommunications. And then what happened is people export. They saw all sorts of new ways to create revenue and earnings opportunities by building new products off of the core business. And also you can do that at a low risk, or a lower risk than mergers and acquisitions.

One of the things that our company will be doing is looking hard at all of the different ways that we can provide more and different services to our customers but also realize additional earnings opportunities. So I think you can expect that from us as you move forward in the future, and that is one of the things that Tom King will be focused on.

Douglas Fischer - A.G. Edwards & Sons

Thank you.

Operator

Your next question comes from the line of Michael Lapides with Goldman Sachs. Please proceed.

Michael Lapides - Goldman Sachs

One easy question, just on the capital structure. I noticed that short-term borrowings popped up a good bit from the third quarter levels to now. Could you just talk about that and talk about plans for the cap structure going forward?

Christopher P. Johns

Our short-term borrowings generally will towards the end of the year because of the gas purchasing that we have to do and as we have gone through, we do have a little hedging in there and so we may have to put some collateral out associated with that. That is pretty normal that we would see our short-term borrowing levels jump up during the winter season.

Other than that, we continue to focus on managing the capital structure to the 52% level that is the target with the California Public Utilities Commission.

Michael Lapides - Goldman Sachs

And just a little push-back on the short-term borrowing, if I go back last year or so, same time period in ’05, short-term borrowings were only $250 million, $260 million and gas prices were almost double what they are now in the fourth quarter of last year.

Christopher P. Johns

Yes, that is true, and I think though that if you look back in ’05, we also were coming -- as we were coming out of the bankruptcy, we had just done the refinancing and so we had cash available and did not need to go to the short-term markets at that point in time. We have since worked down and targeted having zero cash on hand as a utility and rely much more on the short-term debt markets.

Michael Lapides - Goldman Sachs

Thank you.

Operator

The next question comes from the line of Andrew Levi with [Bresden] Corp. Please proceed.

Andrew Levi - Bresden

I just need a little clarification because I guess I am not as familiar with the story as I should be, but the first question you had with the gentlemen from RBC as far as the promotion and why and the whole M&A question, could you just explain why he asked that question relative to the gentlemen’s background who was appointed head of utility?

Peter A. Darbee

I’m not sure I fully understand the question.

Andrew Levi - Bresden

The question that you got from the guy from RBC was basically inferring that because of the change in management, that there could be a possibility that you guys may make some type of acquisition, so I just want to understand the gentlemen’s background and why that question was asked.

Peter A. Darbee

I cannot explain why the question was asked. You would have to go to that person offline to do that. But let me talk a little bit about Bill Morrow’s background.

Bill Morrow was the number two person at Vodafone, a $150 billion company. There were even suggestions that he might one day become the number one person, so he is a very capable executive. When we brought him into the company, we felt that he had the potential to become the CEO of Pacific Gas and Electric Company. That has been something that we have contemplated all along.

The second thought is that we have been very engaged in the transformation of our company. That is the entire re-invention of the company and have 70 different initiatives to undertake that. What that’s meant is that takes up the full time of the CEO of the utility and Bill is undertaking that process, so he is moving in to do that.

Historically, we have not had as much time as we would have liked on growth initiatives, and I refer to the fact that that may be as we are looking forward at new growth initiatives, that Tom will have the ability to do that.

If we talk about Tom King and his background, he has spent a lot of time with respect to the natural gas transmission and the pipeline business. He was with our national energy group, which was an unregulated venture, then moved over and has headed our utility group for a couple of years, and now we feel is quite capable to exploit those growth opportunities.

But Tom’s experience has been in the electric utility industry and the gas transmission business.

Andrew Levi - Bresden

Is there any desire on your part to expand out of California on the utilities side?

Peter A. Darbee

What we have said is we want to be the leading utility in the United States and we have left it at that, really. We do not comment on M&A plans.

What I will say is we have done a few things -- let me give you another example of building off the core business. In the holding company, we have participated in the Pacific Connector project, which is a project consistent with Tom’s background, where there is the pipeline running north and south in California and then extends -- we don’t own it now -- up to Canada and the Pacific Connector project is a project that goes over to the Pacific Coast and potentially could tie into an L&G [trammel] and that is a developmental project and we are engaged in it and that is an example of something that relates to the core business that Tom King would oversee.

Andrew Levi - Bresden

So really the focus more at this point is within California, is that correct? Or within Nevada or Arizona or Oregon, or even just looking at the surrounding states?

Peter A. Darbee

I am not going to answer a question of a menu of what we may or may not do.

Andrew Levi - Bresden

I am not saying for M&A, I am saying as far as infrastructure type stuff.

Peter A. Darbee

Clearly in California, that is our focus right now.

Andrew Levi - Bresden

Okay. Great. Thank you.

Operator

The next question comes from Ryan Watson with Stanfield Capital. Please proceed.

Ryan Watson - Stanfield Capital

I was wondering if you guys could offer up some comments on developments or how you see the resource adequacy market playing out over time? There have been a lot of public press releases with utilities in California signing longer term power contracts, which is the prudent thing to do. I just want to know if you could comment on in light of that, if it is really even necessary for an RA market to go forward, or how you see that playing out. Thank you.

Thomas B. King

I will respond to that. First of all, if you go back and look at the activity that we have had over the last couple of years, we did file with the commission for an incremental a little over 2200 megawatts. We have approval on that. We will construct and own roughly 50% of that.

We have also, roughly just a month or so ago, filed for a new resource plan that will take us from 2011 forward. We are targeting roughly around 2300 megawatts in that plan. So the bottom line to the question is we are very active in ensuring that there is resource adequacy that is built and constructed. We think the utilities will play a key role in making that happen and we are undertaking that through a competitive process with solicitations. Based on the discussions and the responses to the solicitation, we make a determination whether we will own and construct or propose that we contract, and we will just continue to do that, the phases that we think are appropriate and at the level of incremental megawatts that match the state and our forecast for resource need.

Ryan Watson - Stanfield Capital

I was also thinking along the lines of your thoughts on how the RA market plays into a potential development of a capacity market, like a structure you have similar in the Northeast? And if you see that, the capacity market, being necessary, considering the fact that you guys are putting a lot of effort and time and resources into actual physical resources. Could you maybe comment on how you see the capacity market playing out, or the potential for a capacity market in California?

Thomas B. King

I think the overall response to that is that we think the potential for the capacity market is there and we are working with the market players, other utilities, and we will be a key participant in how that can be constructed and implemented as we go forward.

Ryan Watson - Stanfield Capital

Okay. Thank you.

Gabriel B. Togneri

Amanda, any other questions?

Operator

We do have a question from the line of Reza Hatefi with Polygon Investments. Please proceed.

Reza Hatefi - Polygon Investment Partners

Good morning. Could you remind us, what is your first rate base?

Christopher P. Johns

It is around 15% of the total rate base.

Reza Hatefi - Polygon Investment Partners

Also, I’m sorry if I missed this earlier, but as far as a corporate-wide equity ratio, when you talk about 52% at the utility, are you still also targeting to maintain 52% on a corporate level?

Christopher P. Johns

It is around that size. We have talked about in the past that we have our convertible debt as the holding company and that we do not anticipate having utilizing it for any other debt. It is a holding company, so we are still right around that same level.

Reza Hatefi - Polygon Investment Partners

How do you account for the convertible? Do you treat that as half equity, half debt when you think about your corporate capital structure?

Christopher P. Johns

No, at this point, we just have it as the debt. That is the way we look at it right now.

Reza Hatefi - Polygon Investment Partners

Are you still maintaining the guidance of no equity issuance but potential use of the drip back and forth through 2010?

Christopher P. Johns

We have not provided any updated comments post 2007. We do not anticipate needing to utilize any equity in 2007 other than what might come out of stock option exercises during this year, but we have not provided any updates to what our needs may be post 2007.

Reza Hatefi - Polygon Investment Partners

Finally, earlier somebody was asking about post-2007. Are you going to be giving some updates post the rate case getting finalized?

Christopher P. Johns

Yes, we would anticipate that once we have an opportunity to look at the final rate case, we will be back in talking to the investment community, as we have traditionally done, giving a lot of transparency to what the future plans look like once we get to take into consideration the final general rate case.

Reza Hatefi - Polygon Investment Partners

Thank you very much.

Operator

There are currently no questions remaining.

Gabriel B. Togneri

All right. Well, let me just thank everybody for their continued interest in PG&E Corporation and we will look to talk to all of you soon. Thanks again.


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