Fair Value Measurements

6 Months Ended

Jun. 30, 2012

Fair Value Measurements

NOTE 8: FAIR VALUE MEASUREMENTS

PG&E Corporation and the Utility measure their cash equivalents, trust assets, and price risk management instruments at fair value. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:

Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – Other inputs that are directly or indirectly observable in the marketplace.

Level 3 – Unobservable inputs which are supported by little or no market activities.

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Assets and liabilities measured at fair value on a recurring basis for PG&E Corporation and the Utility are summarized below (money market investments and assets held in rabbi trusts are held by PG&E Corporation and not the Utility):

	Fair Value Measurements
	At June 30, 2012											At December 31, 2011
(in millions)	Level 1		Level 2		Level 3		Netting (1)			Total		Level 1		Level 2		Level 3		Netting (1)			Total
Assets:
Money market investments		$ 245		$ -		$ -		$ -			$ 245		$ 206		$ -		$ -		$ -			$ 206
Nuclear decommissioning trusts
U.S. equity securities		891		8		-		-			899		841		8		-		-			849
Non-U.S. equity securities		330		-		-		-			330		323		-		-		-			323
U.S. government and agency securities		709		142		-		-			851		744		156		-		-			900
Municipal securities		-		57		-		-			57		-		58		-		-			58
Other fixed-income securities		-		179		-		-			179		-		99		-		-			99
Total nuclear decommissioning trusts (2)		1,930		386		-		-			2,316		1,908		321		-		-			2,229
Price risk management instruments (Note 7)
Electricity		-		75		70		20			165		-		92		69		8			169
Gas		-		6		2		(6	)		2		-		6		-		(3	)		3
Total price risk management instruments		-		81		72		14			167		-		98		69		5			172
Rabbi trusts
Fixed-income securities		-		27		-		-			27		-		25		-		-			25
Life insurance contracts		-		69		-		-			69		-		67		-		-			67
Total rabbi trusts		-		96		-		-			96		-		92		-		-			92
Long-term disability trust
U.S. equity securities		4		13		-		-			17		13		15		-		-			28
Non-U.S. equity securities		-		13		-		-			13		-		9		-		-			9
Fixed-income securities		-		136		-		-			136		-		145		-		-			145
Total long-term disability trust		4		162		-		-			166		13		169		-		-			182
Total assets		$ 2,179		$ 725		$ 72		$ 14			$ 2,990		$ 2,127		$ 680		$ 69		$ 5			$ 2,881
Liabilities:
Price risk management instruments (Note 7)
Electricity		$ 312		$ 220		$ 152		$ (315	)		$ 369		$ 411		$ 289		$ 143		$ (441	)		$ 402
Gas		14		10		-		(16	)		8		31		13		-		(32	)		12
Total liabilities		$ 326		$ 230		$ 152		$ (331	)		$ 377		$ 442		$ 302		$ 143		$ (473	)		$ 414
(1) Includes the effect of the contractual ability to settle contracts under master netting agreements and margin cash collateral. (2) Excludes $210 million and $188 million at June 30, 2012 and December 31, 2011, respectively, primarily related to deferred taxes on appreciation of investment value.

Valuation Techniques

The following describes the valuation techniques used to measure the fair value of the assets and liabilities shown in the table above.

Money Market Investments

PG&E Corporation invests in money market funds that seek to maintain a stable net asset value. These funds invest in high quality, short-term, diversified money market instruments, such as U.S. Treasury bills, U.S. agency securities, certificates of deposit, and commercial paper with a maximum weighted average maturity of 60 days or less. PG&E Corporation’s investments in these money market funds are valued using unadjusted prices for identical assets in an active market and are thus classified as Level 1. Money market funds are recorded as cash and cash equivalents in PG&E Corporation’s Condensed Consolidated Balance Sheets.

Trust Assets

The assets held by the nuclear decommissioning trusts, the rabbi trusts related to the non-qualified deferred compensation plans, and the long-term disability trust are composed primarily of equity securities, debt securities, and life insurance policies. In general, investments held in the trusts are exposed to various risks, such as interest rate, credit, and market volatility risks.

Equity securities primarily include investments in common stock, which are valued based on unadjusted prices for identical securities in active markets and are classified as Level 1. Equity securities also include commingled funds composed of equity securities traded publicly on exchanges across multiple industry sectors in the U.S. and other regions of the world, which are classified as Level 2. Price quotes for the assets held by these funds are readily observable and available.

Debt securities are primarily composed of U.S. government and agency securities, municipal securities, and other fixed-income securities, including corporate debt securities. U.S. government and agency securities primarily consist of U.S. Treasury securities that are classified as Level 1 because the fair value is determined by observable market prices in active markets. A market approach is generally used to estimate the fair value of debt securities classified as Level 2. Under a market approach, fair values are determined based on evaluated pricing data, such as broker quotes, for similar securities adjusted for observable differences. Significant inputs used in the valuation model generally include benchmark yield curves and issuer spreads. The external credit ratings, coupon rate, and maturity of each security are considered in the valuation model, as applicable.

Price Risk Management Instruments

Price risk management instruments include physical and financial derivative contracts, such as power purchase agreements, forwards, swaps, options, and CRRs that are traded either on an exchange or over-the-counter. (See Note 7 above.)

Power purchase agreements, forwards, and swaps are valued using a discounted cash flow model. Exchange-traded forwards and swaps that are valued using observable market forward prices for the underlying commodity are classified as Level 1. Forwards and swaps transacted in the over-the-counter market that are identical to exchange-traded forwards and swaps or are valued using forward prices from broker quotes that are corroborated with market data are classified as Level 2. Long-dated power purchase agreements that are valued using significant unobservable data are classified as Level 3. These Level 3 contracts are valued using either estimated basis adjustments from liquid trading points or techniques, including extrapolation from observable prices, when a contract term extends beyond a period for which market data is available.

Exchange-traded options are valued using observable market data and market-corroborated data and are classified as Level 2. Over-the-counter options are classified as Level 3 and are valued using a standard option pricing model, which includes forward prices for the underlying commodity, time value at a risk-free rate, and volatility. For periods where market data is not available, the Utility extrapolates observable data using internal models.

The Utility holds CRRs to hedge the financial risk of CAISO-imposed congestion charges in the day-ahead market. CRRs are valued based on prices observed in the CAISO auction, which are discounted at the risk-free rate. Limited market data is available in the CAISO auction and between auction dates; therefore, the Utility uses models to forecast CRR prices for those periods not covered in the auctions. CRRs are classified as Level 3.

Transfers between Levels

PG&E Corporation and the Utility recognize any transfers between levels in the fair value hierarchy as of the end of the reporting period. There were no transfers between levels for the three and six months ended June 30, 2012.

Level 3 Measurements and Sensitivity Analysis

The Utility’s Market and Credit Risk Management department is responsible for determining the fair value of the Utility’s price risk management derivatives. Market and Credit Risk Management reports to the Chief Risk Officer of the Utility. Market and Credit Risk Management utilizes models to derive pricing inputs for the valuation of the Utility’s Level 3 instruments. These models use pricing inputs from brokers and historical data. The Market and Credit Risk Management department and the Controller’s organization collaborate to determine the appropriate fair value methodologies and classification for each derivative. Inputs used and fair value of Level 3 instruments are reviewed period over period and compared with market conditions to determine reasonableness. Valuation models and techniques are reviewed periodically.

CRRs and power purchase agreements are valued using historical prices and significant unobservable inputs, respectively, derived from internally developed models. Historical prices include CRR auction prices. Unobservable inputs include forward electricity prices. Significant increases or decreases in any of those inputs would result in a significantly higher or lower fair value, respectively. All costs related to Level 3 instruments are expected to be recoverable through customer rates; therefore, there is no impact to net income resulting from changes in the fair value of these instruments. (See Note 7 above.)

(in millions)	Fair Value at June 30, 2012				Valuation Technique	Unobservable Input	Range
Fair Value Measurement	Assets		Liabilities
Congestion revenue rights		$ 70		$ (8)	Market approach	CRR auction prices		$ (6.11) - $ 92.13
Power purchase agreements		$ -		$ (144)	Discounted cash flow	Forward prices		$ 6.74 - $ 63.54

Level 3 Reconciliation

The following tables present the reconciliations for Level 3 price risk management instruments, net, for the three and six months ended June 30, 2012 and 2011.

	Price Risk Management Instruments
(in millions)	2012		2011
Liability balance as of April 1		$ (99)		$ (312)
Realized and unrealized gains (losses):
Included in regulatory assets and liabilities or balancing accounts (1)		19		32
Liability balance as of June 30		$ (80)		$ (280)
(1) Price risk management activity is recoverable through customer rates. Therefore, net income was not impacted by realized amounts. Unrealized gains and losses are deferred in regulatory liabilities and assets.

	Price Risk Management Instruments
(in millions)	2012		2011
Liability balance as of January 1		$ (74)		$ (399)
Realized and unrealized gains (losses):
Included in regulatory assets and liabilities or balancing accounts (1)		(6)		119
Liability balance as of June 30		$ (80)		$ (280)
(1) Price risk management activity is recoverable through customer rates. Therefore, net income was not impacted by realized amounts. Unrealized gains and losses are deferred in regulatory liabilities and assets.

Financial Instruments

PG&E Corporation and the Utility use the following methods and assumptions in estimating fair value for financial instruments:

• The fair values of cash, restricted cash, net accounts receivable, short-term borrowings, accounts payable, customer deposits, and the Utility’s variable rate pollution control bond loan agreements approximate their carrying values at June 30, 2012 and December 31, 2011, as they are short-term in nature or have interest rates that reset daily.

• The fair values of the Utility’s fixed-rate senior notes and fixed-rate pollution control bond loan agreements, PG&E Corporation’s fixed-rate senior notes, and the ERBs issued by PERF were based on quoted market prices at June 30, 2012 and December 31, 2011.

The carrying amount and fair value of PG&E Corporation’s and the Utility’s debt instruments were as follows (the table below excludes financial instruments with carrying values that approximate their fair values):

	June 30, 2012				December 31, 2011
(in millions)	Carrying     Amount		Level 2   Fair Value		Carrying     Amount		Level 2   Fair Value
Debt (Note 4)
PG&E Corporation		$ 349		$ 377		$ 349		$ 380
Utility		10,894		13,173		10,545		12,543
Energy recovery bonds (Note 4)		223		226		423		433

Nuclear Decommissioning Trust Investments

The Utility classifies its investments held in the nuclear decommissioning trusts as “available-for-sale.” As the day-to-day investing activities of the trusts are managed by external investment managers, the Utility does not have the ability to sell its investments at its discretion. Therefore, all unrealized losses are considered other-than-temporary impairments. Realized gains and losses on the nuclear decommissioning trust investments are refundable or recoverable, respectively, through customer rates. Therefore, trust earnings are deferred and included in the regulatory liability for recoveries in excess of ARO. (See Note 3 above.) There is no impact on the Utility’s net income or accumulated other comprehensive income.

The following table provides a summary of available-for-sale investments held in the Utility’s nuclear decommissioning trusts:

(in millions)	Amortized   Cost		Total   Unrealized   Gains		Total   Unrealized   Losses		Total Fair     Value (1)
As of June 30, 2012:
Equity securities
U.S.		$ 325		$ 576		$ (2)		$ 899
Non-U.S.		197		137		(4)		330
Debt securities
U.S. government and agency securities		748		104		(1)		851
Municipal securities		54		3		-		57
Other fixed-income securities		174		5		-		179
Total		$ 1,498		$ 825		$ (7)		$ 2,316
As of December 31, 2011
Equity securities
U.S.		$ 334		$ 518		$ (3)		$ 849
Non-U.S.		194		131		(2)		323
Debt securities
U.S. government and agency securities		798		102		-		900
Municipal securities		56		2		-		58
Other fixed-income securities		96		3		-		99
Total		$ 1,478		$ 756		$ (5)		$ 2,229
(1) Excludes $210 million and $188 million at June 30, 2012 and December 31, 2011, respectively, primarily related to deferred taxes on appreciation of investment value.

The debt securities mature on the following schedule:

(in millions)	As of June 30, 2012
Less than 1 year		$    17
1-5 years		420
5-10 years		250
More than 10 years		400
Total maturities of debt securities		$ 1,087

The following table provides a summary of activity for the debt and equity securities:

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
(in millions)
Proceeds from sales and maturities of securities		$ 315		$ 281		$ 666		$ 1,007
Gross realized gains on sales of securities held as available-for-sale		7		9		14		29
Gross realized losses on sales of securities held as available-for-sale		(5)		(3)		(8)		(6)