ML020730025

Response by Pacific Gas & Electric Company & PG&E Corporation to Term Sheet Submitted by California Public Utilities Commission for Proposed Chapter 11 Plan for Pacific Gas & Electric Company (Supporting Declaration of Kent Harvey Filed Con

ML020730025
Person / Time
Site:	Diablo Canyon
Issue date:	02/20/2002
From:	Lopes J Dewey Ballantine, LLP, Howard, Rice, Nemerovski, Canady, Falk & Rabkin, Pacific Gas & Electric Co, Weil, Gotshal & Manges, LLP
To:	Office of Nuclear Reactor Regulation, US Federal Judiciary, Bankruptcy Court, Northern District of California
References
01-30923 DM, 94-0742640
Download: ML020730025 (22)

Text

1 JAMES L. LOPES (No. 63678) 6' JEFFREY L. SCHAFFER (No. 91404) 2 GARY M. KAPLAN (No. 155530)

HOWARD, RICE, NEMEROVSKI, CANADY, 3 FALK & RABKIN A Professional Corporation 4 Three Embarcadero Center, 7th Floor San Francisco, California 94111-4065 5 Telephone: 415/434-1600 Facsimile: 415/217-5910 6

Attorneys for Debtor and Debtor in Possession 7 PACIFIC GAS AND ELECTRIC COMPANY 8 WEIL, GOTSHAL & MANGES LLP 767 Fifth Avenue 9 New York, New York 10153 (212) 310-8000 10 DEWEY BALLANTINE LLP 11 Two Houston Center 909 Fannin Street, Suite 1100 12 Houston, Texas 77010 (713) 576-1500 HOWARD 13 7v" 14 Attorneys for Co-Plan Proponent

" EGvýak PG&E CORPORATION

_ - 15 UNITED STATES BANKRUPTCY COURT 16 NORTHERN DISTRICT OF CALIFORNIA 17 SAN FRANCISCO DIVISION 18 19 In re Case No. 01-30923 DM 20 PACIFIC GAS AND ELECTRIC Chapter 11 COMPANY, a California corporation, HEARING 21 Debtor.

22 Date: February 27, 2002 Time: 1:30 p.m.

23 Federal I.D. No. 94-0742640 Place: 235 Pine Street, 22nd Floor San Francisco, California 24 25 RESPONSE BY PACIFIC GAS AND ELECTRIC COMPANY AND PG&E CORPORATION TO TERM SHEET SUBMITTED BY CALIFORNIA 26 PUBLIC UTILITIES COMMISSION FOR PROPOSED CHAPTER 11 PLAN FOR PACIFIC GAS AND ELECTRIC COMPANY 27

[SUPPORTING DECLARATION OF KENT HARVEY FILED CONCURRENTLY]

28 PG&E'S RESPONS.-.TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN

1 TABLE OF CONTENTS 2 Page 3 I. INTRODUCTION 1 4 II. FACTUAL BACKGROUND 2 5 III. DISCUSSION 3 6 A. THE TERM SHEET IS NEITHER CREDIBLE NOR VIABLE. 3 7

B. THE TERM SHEET CONTAINS A SHORTFALL OF FOUR 8 AND ONE-HALF BILLION DOLLARS, IS NOT FEASIBLE AND IS UNCONFIRMABLE ON ITS FACE. 5 9

1. Projected Available Cash Must Be Reduced By 10 Approximately $710 Million Based on the Failure to Account for Income Taxes Payable on Utility Residual 11 Generation Revenues ("Headroom"). 5 12 2. Projected Available Cash Must Be Reduced by Approximately $650 Million Based on the Failure to HWD 13 Account for Income and Property Taxes Paid in December 2001. 6 "G%'.NUD 14

3. Projected Available Cash Must Be Decreased by $500 15 Million Based on the Failure to Provide for the Cash Needed for PG&E's Budgeted Capital Expenditures in 16 2002. 6 17 4. Projected Available Cash Must Be Decreased by Approximately $220 Million Based on Understatement 18 of Postpetition Interest Obligations. 7 19 5. Projected Cash Needed to Pay Debt on the Effective Date Must Be Increased by More Than $1 Billion Based 20 on Understatement of Class 5 (General Unsecured)

Claims. 7 21

6. Projected Cash Needed to Pay Debt on the Effective 22 Date Must Be Increased Based on the Improper Proposed Reinstatement of Debt of Over $940 Million. 7 23

7. Projected Cash Needed to Pay Debt on the Effective 24 Date Must Be Increased by $500 Million Based On Improper Characterization of Class 6 (ISO, PX and 25 Generator) and Class 7 (ESP) Claims. 8 26 8. Summary of Adjustments Required to Correct Errors in Term Sheet. 9 27 C. THE PLAN CONTEMPLATED BY THE TERM SHEET 28 WOULD SERIOUSLY IMPAIR PG&E'S OPERATIONS. 10 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 TABLE OF CONTENTS 2 Page 3 1. The CPUC's Contemplated Plan Would Impair PG&E's Ability to Invest in Infrastructure to Ensure System 4 Reliability. 11 5 2. The Term Sheet Fails to Resolve the Power Procurement 11 Problem.

6 D. THE CPUC'S CONTEMPLATED PLAN IMPROPERLY 7 SEEKS TO TRANSFER VALUE FROM PG&E'S EQUITY SECURITY HOLDERS TO RATEPAYERS. 12 8

E. THE CPUC'S PLAN WOULD DETRIMENTALLY IMPAIR 9 THE RIGHTS OF A SUBSTANTIAL BODY OF CREDITORS AND EQUITY HOLDERS, WHICH, AT A 10 MINIMUM, WILL LEAD TO PROTRACTED LITIGATION THAT WILL DELAY RESOLUTION OF THIS CASE. 13 11 F. THE TAKING OF THE DEBTOR'S RETURN ON 12 INVESTMENT VIOLATES STATE AND FEDERAL LAW. 14 13 G. THE CPUC'S FORECASTED TIMELINE FOR HOV41M CONFIRMING ITS CONTEMPLATED PLAN IS WK UNREALISTIC. 15 IV. CONCLUSION 16

.. O.O' 15 16 17 18 19 20 21 22 23 24 25 26 27 28 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN

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1 TABLE OF AUTHORITIES 2 Page(s) 3 4 Cases 5 Bluefield Water Works & Improvement Co. v. Public Service Commission, 262 U.S. 679 (1923) 14 6

Duquesne Light Co. v. Barasch, 488 U.S. 299 (1989) 14 7

FederalPower Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944) 14 8

MississippiPower & Light Co. v. Moore, 487 U.S. 354 (1988) 14 9

NantahalaPower & Light Co. v. Thornburg, 476 U.S. 953 (1986) 14 10 Napa Valley Electric Co. v. RailroadCommission, 251 U.S. 366 (1920) 14 11 12 Statutes HCVA/ 13 17 NCNU 14 11 U.S.C. §1121(c)(3) 11 U.S.C. §1129(a)(11) 5 Afzza.,. 15 California Public Utilities Code §399.2(c) 15 16 17 18 19 20 21 22 23 24 25 26 27 28 PLAN PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11

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1 Pursuant to the Bankruptcy Court's Memorandum Decision Regarding Preemption and and 2 Sovereign Immunity filed on February 7, 2002 (the "Preemption Decision"), Pacific Gas 3 Electric Company, the debtor and debtor in possession in the above-captioned Chapter 11 4 case (the "Debtor" or "PG&E"), and PG&E Corporation ("Parent") (collectively, the 5 "Respondents") hereby respond (the "Response") to the "Proposed Plan Term Sheet" (the regarding 6 "Term Sheet") submitted by the California Public Utilities Commission ("CPUC")

as 7 the CPUC's proposed alternative to the pending First Amended Plan of Reorganization, 8 modified to date (the "PG&E Plan"), jointly propounded by PG&E and its Parent.

9 10 L 11 INTRODUCTION 12 The Court authorized the CPUC to file a proposed Term Sheet to allow the Court to to the PG&E RKIE HOWAR 13 determine if the CPUC could propose aprimafacie,confirmable alternative 4IK 14 Plan. The Term Sheet fails to satisfy this burden. It contains material errors and 15 deficiencies which render it neither credible nor confirmable.

$2 16 First and most importantly, the Term Sheet overstates available cash by more than 17 billion and understates claims which must be resolved by over $2.5 billion. The resulting 18 $4.5 billion shortfall is fatal to the CPUC's overall proposal. The Court need go no further 19 than this critical threshold fact to conclude that the plan described in the Term Sheet is 20 patently defective and unconfirmable.

21 Second, although the $4.5 billion shortfall alone precludes confirmation of CPUC's to 22 alternate plan, the Term Sheet also fails to come to grips with its own stated intention Term 23 return PG&E to financial health and restore its creditworthiness. The proposal in the 24 Sheet in fact does the opposite. Among other things, it (1) deprives PG&E of adequate 25 funds for capital investments needed to carry on its utility functions, (2) deprives it of a 26 return on its equity capital during the period prior to the effective date and immediately 27 thereafter, (3) spawns a litigation trust for the avowed benefit of ratepayers (who this Court creditors 28 has twice found are not creditors) with the intent of embroiling generators, other PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 and PG&E and its equity holders in litigation into the foreseeable future and (4) fails to 2 address entirely how PG&E would be able to accomplish the resumption of the power 3 procurement function that the proposal contemplates.

4 lI.

5 FACTUAL BACKGROUND' 6 1. On April 6, 2001, PG&E filed a voluntary petition under Chapter 11 of the 7 Bankruptcy Code. PG&E continues to manage and operate its business and property as a 8 debtor in possession pursuant to Sections 1107 and 1108 of the Bankruptcy Code.

9 2. On February 4, 2002, the Court filed its Amended Order Further Extending 10 Exclusivity Period for Plan of Reorganization (the "Second Exclusivity Order"). The 11 Second Exclusivity Order provides that PG&E shall maintain plan exclusivity until June 30, 12 2002, or such time at the Court enters a further order on the CPUC's motion to terminate HOWARD 13 exclusivity so that it may file a competing plan. The Order further directed the CPUC to file RtE w 14 with the Court and serve on all parties by February 13, 2002, a term sheet regarding its 15 contemplated Chapter 11 plan. The Order provides (¶ 3) that:

16 "Such term sheet shall specify, inter alia, (i) the proposed classification of all claims and interests, (ii) theproposed treatment of all claims and interests, (iii) 17 the proposed means for implementation of such plan (including, without limitation, specificity regarding how particular claims will be satisfied, reinstated 18 or refinanced), and (iv) a timeline for proposing and seeking approval of the plan 19 contemplatedby the CPUC."

3. At the January 16, 2002 hearing that resulted in the Second Exclusivity Order, the 20 Court stated that it expected the CPUC in the Term Sheet to present a credible and viable 21 plan:

22 "I think it would be enormously inappropriate and an enormous burden on this 23 estate and the professionals to allow a plan that is hopelessly unconfirmable to be filed[;] not because it might be misconstrued outside of this courtroom[,] in the 24 press or in the marketplace[.] [T]hose are concerns enough indeed[;] but because it is not appropriate in my mind as a bankruptcy matter to distract the attention of 25 people working on what at least at this point is still a primafacie,viable, confirmable plan that PG&E has sponsored." (Tr., 95:21-96:5) 26 27 'The evidentiary basis and support for the facts set forth in this Response are herewith.

28 contained in the Declaration of Kent Harvey filed concurrently PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 1I PLAN 1 4. As discussed below, the Term Sheet falls well below even the minimum 2 requirements established by the Court.

3 III.

4 DISCUSSION 5 A. THE TERM SHEET IS NEITHER CREDIBLE NOR VIABLE.

6 The Term Sheet presents a purportedly simple approach to exiting bankruptcy 7 reinstate certain debt and other obligations, take existing cash along with cash to be received 8 from retaining existing rates in effect until January 31, 2003, and use the cash balance at that 9 date to pay the remaining claims. The Term Sheet thus starts with an adjusted aggregate 10 claim amount of $12.659 billion, reinstates (or reestablishes obligations to be dealt with in 11 the ordinary course) $5.795 billion of that amount, and then uses estimated cash on hand of 12 $6.864 billion at January 31, 2003 to pay the remaining claims.

13 By Respondent's estimation, this analysis of sources and uses falls short by at least 14 $4.5 billion dollars, based on an overstatement of available cash of $2.0 billion and an

, 15 understatement of obligations to be paid out of cash on the proposed effective date of $2.5 16 billion. The CPUC's "framework" cannot reasonably be "tweaked" to remedy this 17 tremendous gap in dollars and resulting shortfall. Under the CPUC's framework, to raise the 18 sufficient cash to emerge from bankruptcy to meet the CPUC's January 31, 2003 target date, 19 rates would have to be materially increased effective on March 1, 2002. This plainly is not 20 part of the CPUC's contemplated plan. Alternatively, in order to correct the $4.5 billion in 21 mistakes in the Term Sheet, the CPUC would have to revamp its proposal to finance the cash 22 shortfall on the effective date. Given that PG&E will have a sub-investment grade ('junk")

23 credit rating large capital investment requirements, and significant working capital 24 requirements, PG&E would be unable to finance a shortfall of the magnitude under the Term 25 Sheet proposed by the CPUC.

26 2On the contrary, the Term Sheet provides that existing rates will remain in effect until 27 at least January 31, 2003, and gives no indication that a material rate increase is 28 contemplated.

PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 The Term Sheet also offers inadequate explanation as to the manner in which the 2 approximately $5.8 billion of obligations will be reinstated or refinanced. Nor are there any 3 cash flow projections provided to establish PG&E's ability to service these obligations under 4 the CPUC's contemplated plan. Indeed, there is no assurance that the CPUC would establish 5 a rate structure to enable PG&E to meet such obligations, let alone earn a fair rate of return.

6 Rather, the Term Sheet contemplates that PG&E will have to wait until all Allowed Claims 7 have been "satisfied in full" to "return" to a conventional, and minimum constitutional, cost 8 of service ratemaking framework in which the utility is provided a reasonable opportunity to 9 earn a compensatory return on its capital.3 In addition to unjustifiably penalizing PG&E's 10 equity interest holders, such treatment will inevitably relegate PG&E to a sub-investment 11 grade credit rating for years. Obtaining an investment credit rating is crucial to PG&E's 12 ongoing viability and its ability to meet its utility obligations in a cost effective manner.

HOVYRD 13 Furthermore, and equally troubling from a reliability perspective, the Term Sheet, by N 14 using virtually all of PG&E's cash to repay creditors and creating an environment where FEUK

&RAON Ah,, C-. 15 access to the capital markets is problematic, will hamper PG&E's ability to invest in 16 necessary infrastructure in order to continue to provide basic utility service to its customers, 17 and may at the same time force the State to stay in the power procurement business 18 indefinitely.

19 Finally, the CPUC's contemplated plan also detrimentally impairs the rights of a 20 significant body of creditors, deprives PG&E's estate of property, and impairs the rights and 21 interests of equity holders. At a minimum, even putting aside the fatal problem of the $4.5 22 billion shortfall, the Term Sheet is a recipe for protracted litigation that will delay resolution 23 of this case far beyond any timeline associated with the PG&E Plan.

24 25 3 The Term Sheet provides (at 3) that "[t]he [CPUC] would establish a cost-of-service rate structure that will provide PG&E with an opportunity to recoup its costs and earn a 26 reasonable return on its assets consistent with state law. This cost-of-service rate structure would become effective after all Allowed Claims and dividend and sinking fund payments in 27 respect of PG&E's Preferred Stock Equity Interests have been satisfied in full (together with postpetition interest, where applicable)."

28 PG&E'S RESPONSE TO TERM SHEET SUBMTITED BY CPUC FOR PROPOSED CHAPTER 11 PLAN I B. THE TERM SHEET CONTAINS A SHORTFALL OF FOUR AND ONE HALF BILLION DOLLARS, IS NOT FEASIBLE AND IS 2 UNCONFIRMABLE ON ITS FACE.

3 A Chapter 11 plan must be determined to be feasible under Section 1129(a)(1 1) of the 4 Bankruptcy Code in order to be confirmed.4 Without further analysis, the obvious and 5 material errors in the cash available and the debts to be paid on January 31, 2003 render the 6 plan contemplated by the Term Sheet fatally flawed due to lack of feasibility. For the 7 reasons set forth below, the available cash balance must be decreased by more than $2.0 8 billion and the cash obligations must be increased by at least $2.5 billion,. leaving a shortfall 9 of over $4.5 billion.

10 1. Projected Available Cash Must Be Reduced By Approximately $710 Million Based on the Failure to Account for Income Taxes Payable on 11 Utility Residual Generation Revenues ("Headroom").

12 The Term Sheet (in Schedule 3 of Exhibit B) forecasts approximately $1.75 billion of over a 14 month period HCqD 13 "utility residual generation revenues" that are projected to accrue N'm&RABMKI qý4k 14 (from December 1, 2001 through January 31, 2003). While Respondents have doubts about Aid..

• 15 the aggressive assumptions that appear to underlie the CPUC's estimates, even if accepted as 16 accurate, the Term Sheet fails to reflect the state and federal income taxes that PG&E is 17 required to pay with respect to this income. Such taxes, which are payable at the rate of 5

18 40.75%, would amount to approximately $710 million. Accordingly, the initial available 19 cash projected under the Term Sheet must be reduced by at least this $710 million amount.

20 21 22 23 4 Section.1 129(a)(1 1) provides that "[t]he court shall confirm a plan only if all of the following requirements are met: ... [c]onfirmation of the plan is not likely to be followed by 24 the liquidation, or the need for further financial reorganization, of the debtor or anyproposed successor to the debtor under the plan, unless such liquidation or reorganization is 25 in the plan." 11 U.S.C. § 1129(a)(1 1).

5 Conceptually, this headroom is available to pay for recovery of previously incurred 26 power procurement costs which are tax deductible. However, PG&E has previously taken these tax deductions, so that the resulting tax benefits are already reflected in the Term 27 Sheet's initial cash balance. The tax benefit associated with this deduction was transferred of 2001.

28 from the Parent to PG&E in the first quarter PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 2. Projected Available Cash Must Be Reduced by Approximately $650 Million Based on the Failure to Account for Income and Property 2 Taxes Paid in December 2001.

3 The Term Sheet (in Schedules 1, 3 and 4 of Exhibit B) overstates initial projected cash 4 available by failing to reflect payments of $650 million made by PG&E in December of 5 2001 for income and property taxes. At December 31, 2001, PG&E's cash balance 6 amounted to approximately $4.22 billion, as compared to the approximately $4.88 billion 7 amount as of November 30, 2001 reflected on the Term Sheet. Accordingly, the initial 8 available cash projected under the Term Sheet must be reduced by this $650 million amount.

9 3. Projected Available Cash Must Be Decreased by $500 Million Based on the Failure to Provide for the Cash Needed for PG&E's Budgeted 10 Capital Expenditures in 2002.

11 The Term Sheet's analysis of cash available to pay claims fails to account for capital 12 expenditures in excess of depreciation by PG&E. PG&E's annual capital expenditures in 13 2002 (as described Appendix C to PG&E's Disclosure Statement) are expected to be AN

&¢PAR04N 14 approximately $1.5 billion. Based on annual depreciation of approximately $1 billion, this W~K 15 requires approximately $500 million of incremental cash sources to fund annual capital 16 expenditures, such as new distribution lines or gas pipeline replacements. By assuming that 17 all of PG&E's return on investment will be accrued to fund payments to creditors, the Term expenditures. 6 18 Sheet fails to include any funds in excess of depreciation for these capital 19 Such expenditures are critical to PG&E's fulfillment of its obligation to serve its customers.

20 PG&E anticipates that the need for increased infrastructure investment in its system, 21 particularly in electric transmission, will continue for the foreseeable future. Accordingly, 22 the initial available cash projected in the Term Sheet should be reduced by an additional 23 $500 million to reflect expected 2002 capital expenditures, net of annual depreciation.

24 6 The Term Sheet (in Footnote 8 to Schedule 3 of Exhibit B) provides that "the 25 [CPUC's] plan will provide for a credit facility to fund capital expenditures, working capital and, if necessary, distributions to unsecured creditors." However, it goes on to state that 26 "[t]he plan as presented assumes that the credit facility is undrawn at confirmation." There is no adequate basis to presume that PG&E will be successful in obtaining such a credit 27 facility. In fact, given PG&E's impaired credit under the CPUC's contemplated plan, it is be available.

28 likely that no line of credit would PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 4. Projected Available Cash Must Be Decreased by Approximately $220 Million Based on Understatement of Postpetition Interest Obligations.

2 "3 The Term Sheet (in Schedule 3 of Exhibit B) forecasts postpetition interest of $282 4 million with respect to PG&E's mortgage bonds and $746 million with respect to other 5 claims, or a total of $1.028 billion. In fact, based on the provisions set forth in the Term 6 Sheet, the amount of postpetition interest is approximately $1.251 billion, an understatement 7 of $223 million. Since the Term Sheet provides for the payment of all postpetition interest 8 in cash, the initial available cash projected in the Term Sheet must be decreased by 9 approximately $220 million to account for payment of the understated postpetition interest.

10 5. Projected Cash Needed to Pay Debt on the Effective Date Must Be Increased by More Than $1 Billion Based on Understatement of Class 5 11 (General Unsecured) Claims.

12 The Term Sheet (in Schedule 2 of Exhibit B) "adjusts" Class 5 (General Unsecured)

HOWAR PIKE 13 Claims by reducing them by $1.06 billion (from $4.57 billion to $3.51 billion) from the 1i 4 amount set forth in the First Amended Disclosure Statement pertaining to the PG&E Plan (as dfRABON 15 amended, "PG&E's Disclosure Statement"). Footnote 3 to Schedule 2 explains that such 16 reduction reflects the reclassification of $1.06 billion of QF claims to administrative expense 17 claims. However, PG&E's Disclosure Statement already reflects this adjustment. Thus, the

.18 Term Sheet erroneously understates Class 5 Claims by $1.06 billion. Since the Term Sheet 19 provides for the payment of all Class 5 Claims in cash, the Term Sheet's projected cash 20 requirements on the effective date must be increased by $1.06 billion to account for payment 21 of the understated Class 5 Claims.

22 6. Projected Cash Needed to Pay Debt on the Effective Date Must Be Increased Based on the Improper Proposed Reinstatement of Debt of 23 Over $940 Million.

24 The Term Sheet (in Schedules 1, 2 and 5 of Exhibit B) reflects reinstated obligations of 25 approximately $5.8 billion. However, of these amounts, approximately $940 million cannot 26 be reinstated. This includes the following:

27 (1) $333 million (1992 Series A) of PG&E's Secured First Mortgage Bonds (Class 3) 28 cannot be reinstated under the CPUC's contemplated plan, because such debt matures by its PG&E'S RESPONSE TO TERM SHEET SUBMM1TED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 7

1 terms on March 1, 2002, well before the effective date of the CPUC's contemplated plan.

2 (2) The Term Sheet also proposes to reinstate Letter of Credit Backed PC Bond Claims 3 and Letter of Credit Bank Claims (Classes 4d and 4e under the PG&E Plan) aggregating 4 $610 million, although such debt cannot be reinstated. If the Letter of Credit Banks do not 8

5 agree to the CPUC's proposed plan, and it is unlikely that they will, such claims would not 6 be subject to reinstatement, as the Letter of Credit Banks cannot be forced to renew or 7 extend these letters of credit, all of which expire by their own terms in 2002 or 2003, and as 8 to which the Letter of Credit Banks can trigger draws on the Letters of Credit (based on 9 existing defaults under the Letter of Credit Reimbursement Agreements) and redeem the 10 Letter of Credit Backed PC Bonds.

11 Accordingly, the Term Sheet's proposed effective date cash requirements must be 12 increased by approximately $940 million to account for payment in cash of the foregoing HOWýRD 13 debts which are not subject to reinstatement.

RKWE ckAof 14 7. Projected Cash Needed to Pay Debt on the Effective Date Must Beof

&RIAN<IN Increased by $500 Million Based On Improper Characterization

. 15 Class 6 (ISO, PX and Generator) and Class 7 (ESP) Claims.

16 The Term Sheet (in Exhibit A at 6) estimates Class 6 (ISO, PX and Generator) Claims 17 at $1.07 billion and Class 7 (ESP) Claims at $420 million. These are the same estimated 18 amounts set forth in PG&E's Disclosure Statement, which reflects estimated reductions of 19 $400 million and $100 million, respectively, for refunds that the FERC is expected to order.

20 However, the Term Sheet (at 3) provides for establishment of a litigation trust for the sole 21 benefit of PG&E's ratepayers (rather than creditors), and would assign to the litigation trust 22 "affirmative recoveries related to refund claims pending before the FERC." Thus, if the 23 CPUC intends to credit the FERC refunds to the litigation trust (for the benefit of 24 ratepayers), such $500 million in estimated refunds necessarily would not be available to 25 7 Indeed, PG&E has brought a motion, scheduled to be heard on February 26, 2002, to 26 modify the cash collateral stipulation with the indenture trustee for the mortgage bonds to provide for the timely payment of the bonds maturing on March 1, 2002.

27 8 The Letter of Credit Banks are unlikely to prefer extending new letters of credit to a sub-investment grade entity, given their ability to require a full cash payment.

28 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 offset Class 6 and Class 7 Claims. Accordingly, the $500 million in estimated FERC 2 refunds already reflected as an offset in the Class 6 and 7 Claims in the PG&E Plan must be 3 added back to the Class 6 and Class 7 claims as stated in the Term Sheet, thereby raising the 4 cash requirements on the proposed effective date by $500 million to account for payment in 5 cash of such obligations.

6 8. Summary of Adj ustments Required to Correct Errors in Term Sheet.

7 In order to correct the foregoing errors in the Term Sheet, the following adjustments 8 aggregating more than $4.5 billion 9 must be made to the Term Sheet:

9 (1) Projected initial cash available to pay creditors must be reduced by more than $2.0 10 billion (based on failure to account for approximately $710 million of taxes payable on 11 utility residual generation revenues, failure to account for payments of approximately $650 12 million in December 2001 for income and property taxes, failure to provide for net capital 13 expenditures of approximately $500 million in 2002 and understatement of postpetition Cvwx 14 interest of approximately $220 million).

15 (2) Projected cash requirements for creditor payments on the effective date must be 16 increased by over $2.5 billion (based on understatement of $1.06 billion in Class 5 (General 17 Unsecured) Claims, required payment of approximately $940 million of debt not subject to 18 reinstatement and understatement of $500 million in Class 6 (ISO, PX and Generator) and 19 Class 7 (ESP) Claims).

20 The necessary adjustments to the CPUC's figures will result in a shortfall of more than 21 $4.5 billion between the obligations under the CPUC's contemplated plan and the resources 22 9 In addition to the clear and demonstrable significant factual errors discussed above 23 resulting in a $4.5 billion shortfall, several assumptions underlying the Term Sheet appear to be highly optimistic, and if not achieved, would require, on top of this $4.5 billion gap, yet 24 additional sources of cash to pay claims on the proposed effective date. The CPUC assumes that $1.7 billion in "utility residual generation revenues" will be raised over the 14-month 25 period ending January 31, 2003. Commonly referred to as "headroom," these revenues are ueqal to the difference between the Debtor's overall rate level (i.e., the frozen rate) and the 26 various utility costs that have been authorized for recovery in rates. Headroom is difficult to estimate because it re uires a forecast of all of the events that will affect the costs a utility 27 will incur. Given thelack of back-up data accompanying is realistic. the Term Sheet, Respondents are forecast whether the CPUC's 28 1unable to assess PG&E'S RESPONSE TO TERM SHEET SUBMITED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 available to satisfy such obligations. Moreover, this $4.5 billion gap cannot be financed 2 under the CPUC's framework. Thus, the CPUC's contemplated plan is not feasible and is 3 unconfirmable on its face.

4 While the foregoing, by itself, makes the CPUC's contemplated plan infeasible, there 5 are a number of additional grounds that prevent such a plan from being viable.

6 C. THE PLAN CONTEMPLATED BY THE TERM SHEET WOULD SERIOUSLY IMPAIR PG&E'S OPERATIONS.

7 8 PG&E would not be a viable utility company under the CPUC's contemplated plan.

9 The CPUC has not proposed a single step in its Term Sheet to help restore PG&E's 10 investment grade credit rating or address the fundamental cause of its financial decline, i.e.,

11 the failure of the regulatory process, which is critical to the feasibility of any plan. The 12 capital markets and the rating agencies currently have no basis to believe that the CPUC will 0

WRD 13 implement structural regulatory reforms to restore the financial, health of PG&E.1 Indeed, RE14 tALK the CPUC's proposal appears to make matters worse by requiring significant spending

&RAN(N 15 reductions or forcing PG&E to attempt to borrow money with no clear means of repaying it.

16 While the Term Sheet apparently contemplates compelling PG&E to resume power 17 procurement on behalf of its customers, it fails to deal with the fact that PG&E will be 18 hampered as an effective participant in power markets until it has regained an investment 19 20 10 Standard& Poor's recently opined: "although the [CPUC's] reorganization plan to whether PG&E will 21 purports to address [PG&E's] defaulted obligations, it is silent as exhibit long-term financial performance consistent with investment grade ratings.

22 Therefore, under the CPUC proposal, it remains unclear whether and when PG&E's ratings will be restored to investment grade .... If the CPUC plan is adopted, future credit quality 23 will hinge upon the CPUC's establishment of a clear track record of regulatory decisions that 24 translates into strong and predictable cash flows following the conclusion of the bankruptcy proceedings and the end of bankruptcy court oversight. PG&E's defaulted obligations and 25 its bankruptcy filing were caused by power-procurement costs that greatly exceeded revenues in 2000 and 2001. The financial challenges created by the extreme difference between revenues and expenses were compounded by the absence of timely redress by state 27 officials, including, but not limited to, the CPUC." ("Regulator's Plan for Pacific Gas &

28 Electric Reorganization May Not Help Credit Quality" (Standard & Poor's 2/14/02))

PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 grade credit rating.

2 In short, Respondents do not believe that the Court will be able to make the required 3 findings that the entity that would emerge from reorganization protection under the CPUC's 4 alternative plan would be a financially viable going-concern.

5 1. The CPUC's Contemplated Plan Would Impair PG&E's Ability to 6 Invest in Infrastructure to Ensure System Reliability.

7 As discussed above, PG&E expects to invest approximately $1.5 billion each year in 8 its electric and gas systems for the next several years to ensure utility service to the 9 approximately 13 million persons its serves in Northern and Central California." The plan 10 contemplated by the Term Sheet would, at a minimum, risk drastic cuts in PG&E's capital 11 budgets for 2002 and several years thereafter, which could have significant impact on system 12 reliability.

HOWARD 13 While the Term Sheet contemplates PG&E securing a credit facility to fund, inter alia, RKE NaMW 14 capital expenditures and working capital, based on the lack of assurance regarding PG&E's ARW 15 creditworthiness, such a credit facility, in combination with the more than $4.5 billion 16 necessary to fund the Term Sheet, would not be available to PG&E under the Term Sheet 17 proposed by the CPUC. This assumed credit facility is critical to the viability of the CPUC's 18 contemplated plan, for if PG&E is unable to adequately address its working capital needs, 19 PG&E cannot fulfill its obligations as a utility to serve its customers.

20 2. The Term Sheet Fails to Resolve the Power Procurement Problem.

21 The Term Sheet states that its contemplated plan will allow PG&E to resume 22 procurement of power for its customers, but fails to describe how it will allow this to 23 happen. Under the tariffs of the California Independent System Operator ("ISO"), PG&E is 24 foreclosed from purchasing power through the ISO's markets unless it is rated investment 25 grade or is able to post collateral, including cash, letters of credit or surety bonds. The 26 1 This is somewhat higher than recent spending levels, which have averaged $1.25 27 billion over the last three years, principally due to greater investments in electric transmission capacity additions.

28 FOR PROPOSED CHAPTER 11 PLAN PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC

1 CPUC's contemplated.plan does neither. First, nothing in the CPUC plan will restore PG&E 2 to investment grade status. 12 Second, the CPUC's contemplated plan and PG&E's 3 noncreditworthy status thereunder would leave PG&E with inadequate resources for posting 4 collateral or pre-paying for necessary obligations (e.g., natural gas supplies for core gas 5 customers, electrical energy and ancillary services procured for electric customers and 6 workers compensation liabilities). At best, PG&E would be unable to procure sufficient 7 power and gas on anything other than a monthly or "spot" basis. Therefore, its customers 8 would be directly exposed to the price volatility of the gas and power markets beyond the 9 current month. PG&E would also be unable to engage in any price risk management 10 activities on behalf of customers. As a result, under the CPUC's contemplated plan, the 11 State's exit from the power procurement business is put at risk.

12 D. THE CPUC'S CONTEMPLATED PLAN IMPROPERLY SEEKS TO TRANSFER VALUE FROM PG&E'S EQUITY SECURITY HOLDERS HGWARD 13 1 TO RATEPAYERS.

caN¢ 14 The overriding theme of the CPUC's contemplated plan is to transfer value from

. 15 PG&E's equity security holders to the ratepayers, whom the Court has previously 16 determined are not creditors of the bankruptcy estate.

17 For example, the Term Sheet provides for the transfers of numerous claims belonging 18 to the estate (including proceeds from the Rate Recovery Litigation, recoveries from refund 19 claims pending before the FERC and other claims against sellers of electricity in the 20 wholesale market) to a litigation trust for the benefit of ratepayers.

21 The Term Sheet, by appropriating the value of PG&E's Rate Recovery Litigation 22 against the CPUC and transferring the first $1.75 billion in recovery to ratepayers through 23 the litigation trust, attempts to use the Bankruptcy Court to take an asset owned by the estate 24 12 In fact, the CPUC's contemplated plan would leave PG&E in worse financial 25 condition than Southern California Edison ("Edison"), which has recently been rated sub investment grade by both Moody's and Standard & Poor's under its settlement with the 26 CPUC. See "Southern California Edison's Rating Raised, Off CreditWatch; Outlook Developing (Standard & Poor's 2/8/02); "Moody's Assigns a (P)Ba2 Senior Secured Rating 27 to Southern California Edison Company's Credit Facilities" (Moody's Investors Service 2/8/02).

28 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 (whose value would otherwise inure to the Debtor's equity holders in view of the full 2 payment of creditor claims) to seek recompense for the CPUC's illegal refusal to allow 3 PG&E to recover FERC-approved wholesale power costs. This aspect of the CPUC's 4 contemplated plan is designed to moot the significant financial exposure that the CPUC 5 faces in the Rate Recovery Litigation.

6 The CPUC fails to articulate any basis for the transfer of these valuable estate assets 7 without consideration for the benefit of parties who are not entitled to receive any property 8 of the estate under controlling bankruptcy law.

9 E. THE CPUC'S PLAN WOULD DETRIMENTALLY IMPAIR THE RIGHTS OF A SUBSTANTIAL BODY OF CREDITORS AND EQUITY 10 HOLDERS, WHICH, AT A MINIMUM, WILL LEAD TO PROTRACTED LITIGATION THAT WILL DELAY RESOLUTION OF THIS CASE.

11 12 The Plan contemplated by the Term Sheet proposes to reinstate more than $4 billion of 13 claims that would not be subject to reinstatement under the PG&E Plan, including $3.3 RUE 14 billion of mortgage bonds that would be paid fully in cash under the PG&E Plan. Given that

&IRAMNU A.,a. 15 these bondholders originally purchased bonds that were rated "A" or better (by both 16 Moody's and Standard & Poor's) and the CPUC's contemplated plan would have their credit 17 rating be well into the speculative range, the Debtor and its financial advisors estimate that, 18 based on current market conditions, the mortgage bonds would reasonably be expected to 19 trade at a material discount of their par value upon consummation of the CPUC's 20 contemplated plan. This reflects a defacto diminution of value and economic impairment 21 that, at best, would lead to protracted litigation by such creditors seeking to protect their 22 interests in a solvent debtor case under bankruptcy law.

23 The CPUC's contemplated plan would also deprive PG&E's common shareholders 24 from receiving any dividends until at least 2004 and transfer numerous valuable claims 25 belonging to the estate (whose value would otherwise inure to equity holders in view of the 26 full payment of creditor claims) for the benefit on non-stakeholders, without any 27 consideration.

28 Such creditors and equity security holders are extremely unlikely to accept this inferior PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 treatment. Thus, at a minimum, the CPUC's contemplated plan is likely to result in 2 protracted litigation regarding the proposed treatment of a substantial body of creditors and 3 equity security holders, in addition to litigation regarding feasibility and other confirmation 4 issues.

5 F. THE TAKING OF THE DEBTOR'S RETURN ON INVESTMENT 6 VIOLATES STATE AND FEDERAL LAW.

7 The CPUC's contemplated plan proposes to deprive PG&E of approximately $1.2 8 billion attributable to the Debtor's authorized utility return on investment and use these 9 funds to pay creditors.13 The proposal violates the fundamental tenet of the "regulatory 10 compact" that public utilities are entitled to recovery of their costs of service plus the 11 opportunity to earn a reasonable rate of return.1 4 The CPUC proposal would appropriate not 12 only the Debtor's return on utility distribution operations subject to the CPUC's jurisdiction, transmission HCW.RD 13 but would further take the returns authorized by the FERC for PG&E's electric PXM 5

u 14 business (which is subject to exclusive FERC ratemaking jurisdiction).'

,*.ý C--15 The CPUC has long recognized under Bluefield Water Works & Improvement Co. v.

16 PublicService Commission, 262 U.S. 679 (1923), and the FederalPower Commission v.

17 Hope Natural Gas Co., 320 U.S. 591 (1944), that PG&E's return "should also be reasonably 18 sufficient to assure confidence in the financial soundness of the utility, and adequate, under 19 13 The "cash on hand" balances relied upon by the CPUC also include PG&E's return 20 on ratebase stretching back to December 2000. Thus, the CPUC's contemplated plan would 21 deprive PG&E of any return on investment for over three years.

14 Under the Fourteenth Amendment of the United States Constitution, a utility cannot 22 be forced to continue operations at a loss. Napa Valley Elec. Co. v. Railroad Comm 'n, 251 U.S. 366, 369(1920). Rather, rates must be set at a level that allows a utility a reasonable 23 opportunity to recover its cost of service. Duquesne Light Co. v. Barasch,488 U.S. 299, 308 (1989) ("if the rate does not afford sufficient compensation, the State has taken the use of 24 utility property without paying just compensation and so violated the Fifth and Fourteenth Amendments.")

25 15 The proposed deprivation of the Debtor's return on investment authorized for electric transmission service under federally filed and approved rates violates the "Filed Rate 26 Doctrine" and is therefore inconsistent with federal law, unlawfully interferes with interstate commerce and would result in an unlawful taking of the Debtor's property. See Nantahala 27 Power & Light Co. v. Thornburg,476 U.S. 953 C1986); MississippiPower & Light Co. v.

(1988).

28 Moore, 487 U.S. 354 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER I1 PLAN 1 efficient management, to maintain and support its credit, and to enable it to raise the money duties."'16 2 necessary for the proper discharge of its public 3 The CPUC proposal is unlawful and would require bankruptcy court preemption of 4 the CPUC's own decisions, state law, the California Constitution, federal law and the United 5 States Constitution. But for potential bankruptcy court preemption, the CPUC would be 17 proposed in the Term Sheet.

6 legally estopped from implementing the ratemaking that is 7 G. THE CPUC'S FORECASTED TIMELINE FOR CONFIRMING ITS CONTEMPLATED PLAN IS UNREALISTIC.

8 In its Term Sheet (in Exhibit C), the CPUC forecasts filing its proposed plan and 9

disclosure statement by April 15, 2002, having a confirmation hearing by September 16, 10 2002 and having its plan become effective by January 31, 2003. The projected timeline is 11 completely unrealistic, in view of, inter alia, (1) the facial unconfirrnability of the plan 12 contemplated by the Term Sheet based on feasibility and other grounds, (2) the CPUC's 13 acknowledged failure to even begin negotiating with PG&E, the Creditors' Committee or RIMA CND 14 8 any creditor or interest holder constituency regarding its proposed contemplated plan,' and APgin - 15 (3) the anticipated protracted litigation with respect to the CPUC's contemplated plan and 16 disclosure statement.

17 Based on the CPUC's failure to propose a viable alternative to the PG&E Plan, 18 authorizing the CPUC to file a detailed plan and disclosure statement would not only be 19 20 16 The CPUC's contemplated plan violates state law. Public Utilities Code Section 21 399.2(c) specifies that "[e]ach electrical corporation shall have a reasonable opportunity to fully recover from all customers of the electrical corporation...: (1) Reasonable 22 investments in its electric distribution grid. (2) A reasonable return on the investments in its distribution grid."

23 electric distribution grid. (3) Reasonable costs to operate its electric 17 Conversely, the CPUC, in its settlement with Edison, authorized Edison to recover 24 for other unrecovered over $3 billion from ratepayers to pay its debts and compensateonitinvestment costs. Under the settlement, Edison does not forfeit its return and there are broad allowances and assurances for capital expenditures. In addition, the CPUC has 25 in transition costs as part of that authorized Edison to recover several billion dollars 26 settlement. These same costs go unrecovered for PG&E under the Term Sheet.

18 Footnote 1 to the Term Sheet states that "[t]he terms hereof have yet to be negotiated 27 with PG&E, the Official Committee of Unsecured Creditors appointed in this chapter 11 28- case, or other key constituencies."

PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1 fruitless, but would be unnecessarily dilatory and wasteful. Prolonging the inevitable will additionally 2 decision to discontinue consideration of the CPUC's contemplated plan on two separate 3 cause harm to the efficient processing of the PG&E Plan. The CPUC has urging these agencies 4 occasions filed motions at the FERC and the other regulatory agencies in light of the 5 to suspend their review of the PG&E Plan implementation applications PG&E's 6 potential for the CPUC's "competing" plan. These tactics threaten to damage the end of the year.

7 ability to consummate the PG&E Plan and pay its creditors in full by further hamper 8 The Court itself has recognized that the CPUC should not be permitted to 19 PG&E Plan under such circumstances.

9 PG&E's pursuit of confirmation of the 10 IV.

11 CONCLUSION an enormous 12 Respondents concur that it would be "enormously inappropriate and unconfirmable to be filed." Tr., 95:22 13 burden on this estate to allow a plan that is hopelessly WRDX omissions that 14 "canlw 24. The Term Sheet is unworkable. It contains $4.5 billion of errors and

&RAW<N adjustments to the 15 result in a "sources and uses" shortfall that cannot be fixed through or otherwise ensure 16 financials. The contemplated plan does not make PG&E creditworthy ability to meet 17 its post-reorganization viability. The contemplated plan endangers PG&E's PG&E to a 18 its obligation to serve by limiting its capital expenditures and fails to restore The 19 financial -position that will allow it to effectively resume power procurement.

value in the 20 contemplated plan takes from the equity holders and impermissibly transfers opposed by many 21 estate to ratepayers. The "maximum reinstatement" strategy is likely to be 22 of the financial creditors who will assert that reinstatement of debt in a severely weakened, framework is 23 non-investment grade company impairs their interests. The CPUC's proposed 24 25 19 In the Term Sheet, the CPUC contends that its submission of its Term Sheet for the not be deemed a waiver of its purpose of proposing a Chapter 11 plan in this case should explain 26 sovereign immunity. The CPUC does not even attempt to how its submission of a proposed plan for purposes of obtaining confirmation thereof by the Banlauptcy Court does 27 not constitute consent to this Court's jurisdiction, particularly in light of the oblCgatuons plan.

the CPUC under its proposed 28 proposed to be undertaken by CHAPTER II PLAN PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED 1 patently unconfirmable. By its own admission, the CPUC has had adequate time, resources 2 and data to prepare its Term Sheet. 20 Therefore, it should not be granted an opportunity to 3 submit a revised Term Sheet.

4 For all of the foregoing reasons, Respondents respectfully request that this Court make 5 and enter its order:

6 1. Finding that the Chapter 11 plan contemplated by the Term Sheet is uniconfirmable 7 as a matter of law.

8 2. Providing that with respect to the CPUC (as the Court has previously ruled with 9 respect to all other parties), the period during which PG&E maintains plan exclusivity 10 pursuant to Section 1121(c)(3) of the Bankruptcy Code is extended until June 30, 2002, or 11 such later date as the Court hereafter may order based upon a subsequent motion filed on or 12 before June 30, 2002.

H iRD 13 3. Providing for such other and further relief as the Court deems just and appropriate.

RIM CANtD 14 ///

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24 25 20 For example, at the January 16, 2002 hearing on PG&E's exclusivity motion, the CPUC represented as follows: "In terms of the timing, we have spent months, and the 26 [CPUC] has very extensive staff that is intimately familiar with PG&E's fi'ancial affairs .... The Energy Department staff has spent months putting together termsheets."

27 "We have the numbers. We continue to update the numbers, but this is not a pie-in the-sky 28 plan." (Tr., 59:16-22; 61:17-18)

PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN 1

DATED: February'o, 2002 2 Respectfully, 3 WELL, GOTSHAL & MANGES LLP 4

DEWEY BALLANTINE LLP 5

Attorneys for Co-Plan Proponent 6 PG&E CORPORATION 7

8 HOWARD, RICE, NEMEROVSKI, CANADY, FALK & RABKIN 9 A Professional Corporation 10 By: ;Pov-v%7: ok9>I---*

11 U JAMES L. L(ýVES 12 Attorneys for Debtor and Debtor in Possession PACIFIC GAS AND ELECTRIC COMPANY HOWARD 13 WD 022002/2-1419915/Y11/976829/v2 EANkD1 14

, 15 16 17 18 19 20 21 22 23 24 25 26 27 28 PG&E'S RESPONSE TO TERM SHEET SUBMITTED BY CPUC FOR PROPOSED CHAPTER 11 PLAN