ML13309A437

Enova Corp 1997 Annual Rept

ML13309A437
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Site:	San Onofre
Issue date:	12/31/1997
From:	Baum S, Felsiger D SAN DIEGO GAS & ELECTRIC CO.
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If EN OVA I

PDRi

Table of Contents Financial Highlights A Letter from Stephen L. Baum

2.

A Letter from Donald E. Felsinger

4.

The Enova Companies

5.

Enova Corporation Financial Statements

23.

Shareholder Reference Guide 6o.

Boards of Directors

62.

Management Team 63.

Enova Corporation Organization Enova Corporation San Diego Gas & Electric Sernpra Energy Solutions*

Enova International Serpra Energy Trading*

Enova Financial Califia Pacific Diversified Capital

• by 7 Enoa Coporaton and Enova Corporation (NYSE: ENA) is Sempra Energy Trading (formerly AIG a leading energy management com-Trading Corp.), jointly owned with pany providing electricity, natural Pacific Enterprises, is one of the gas and value-added products and largest U.S. participants in market services in the United States and ing and trading physical and finan Mexico.

cial energy products, including nat ural gas, power, crude oil and associ SUBSIDIARIES ated commodities.

San Diego Gas & Electric (SDG&E) is an operating public utility engaged Enova Financial invests in limited in the electric and natural gas busi-partnerships representing approxi nesses. SDG&E has 1.2 million elec-mately 1,200 affordable-housing tric meters and 720,000 natural gas properties throughout the United meters serving 3 million consumers States and Puerto Rico.

in San Diego and southern Orange counties.

Califia leases computer equipment.

Its lease portfolios are expected to Sempra Energy Solutions (formerly provide cash flows from tax deduc Energy Pacifc), jointly owned with tions, rents and residual values Pacific Enterprises, includes Enova through the year 2ooo.

Technologies and the retail opera tions of Enova Energy. Sempra Pacific Diversified Capital is the Energy Solutions provides a broad parent company of Phase One suite of energy-related products and Development, which has been services in California and throughout involved in real estate development.

the nation.

Enova International develops and operates energy infrastructure projects, including natural gas dis tribution systems, outside the United States.

E NO VA COR PORATION I,

Financial Highlights In thousands of dollars except per share amounts 1997 1996 Change Operating revenues

$ 2,217,007

$ 1,993,474

+ 11.2 %

Operating expenses

$ 1,872,837

$ 1,658,511

+ 12.9%

Earnings applicable to common shares 25 1,607 230,927

+ 9.0%

Average common shares outstanding (thousands) 114,322 116,572 1.9 %

Earnings (loss) per common share"^

SDG&E 2.03 1.85

+ 9.7%

Enova Financial 0.15 0.11

+ 36.4%

Califia 0.0 6 0.08 25.0 %

Other affiliates (0.04)

(o.o6)

+ 33.3 %

Total 2.20 I.98

+ II Dividends declared per common share 1.56 1.56 Retail energy sales Electric (billions of kilowatt-hours) 16.7 I6.o

+ 4.4%

Gas (millions of therms) 520 523 o.6%

Number of utility employees*

3,576 3,688 3.0 %

9 Return on common equity 16.3%

14.9%

+ 9.4 %

Basic and diluted earnings per hare.

Earnings Per Common Share Number of Utility Employees*

Retained Earnings*

From Continuing Operations in millions of dollars

$2 40 4200

$800 2.00 6o i.60 2800 1.20 2 100 400

,80 400 200 0.40 701 0.00 a

91 94 95 96 97 91 94 95 96 97 95 94 95 96 97

• At December.3 1

2.

E N

O VA C0 R

P0R ATI 1 O N

1997 Anwial Report A Letter from Stephen L. Baum ENOVA CORPORATION HAD A GREAT YEAR, achieving record earnings in 1997. Earnings were up II percent to $2.20 per common share from $1.98 per share in 1996. Our record earnings reflect San Diego Gas &

Electric's strong performance in exceeding several incentive targets estab lished by the California Public Utilities Commission.

Also, in December 1997, we received the cash proceeds from the sale of

$658 million in rate-reduction bonds to cover a portion of our competitive transition costs.

Our record earnings, and the cash infusion from the bond sale, form a solid foundation for our company as we position ourselves for the new competitive energy marketplace that is developing nationwide.

Enova Corporation has been successful because we have had the vision and determination to embrace and manage change, shaping our company for tomorrow's marketplace.

One of the first bold steps in our competitive strategy is to merge with Pacific Enterprises, the parent company of Southern California Gas Company, as we announced in October 1996. This merger allows us to expand our size, scope and financial strength to compete against the largest energy companies in the world.

We are well along in the regulatory approval process and we expect the merged company to be fully operational in the summer of 1998. The Stephen L. Baum combined company will have a new name -

Sempra Energy -

and serve 20 million consumers through 6 million meters. The expected combined equity of the new company will be almost $6 billion.

Sempra Energy will have a substantial cash flow from both operations and proceeds from the rate-reduction bonds. We anticipate beginning with no bank debt at the parent company. Additionally, we expect the merger to create $i.i billion in net savings and cost avoidances over the next io years, which we have proposed to the California Public Utilities Commission be divided equally, over io years, between the shareholders of Sempra Energy and the customers of its utility subsidiaries, SDG&E and Southern California Gas Company.

We, however, are not waiting for final approvals of the merger to prepare for future competition. In December 1997, we completed the joint acquisition with Pacific Enterprises of AIG Trading Corp. (now called Sempra Energy Trading), one of the largest U.S. natural gas and power traders. This acquisi tion immediately positions us as a major player in the energy business by establishing a strong energy-commodity trading business with risk manage ment expertise to support our retail marketing efforts.

ENOVA CORPO RATION 3

Also with Pacific Enterprises, we formed a joint venture, Energy Pacific (now called Sempra Energy Solutions), which is successfully marketing energy ser vices and products in the competitive market, as well as pursuing energy infrastructure projects.

Enova International has begun to build Enova Corporation's global presence with projects that will bring much-needed natural gas to industrial and resi dential customers in Mexico. In 1997, Enova International and its partners won a bid to purchase and expand the natural gas distribution system in Chihuahua, Mexico. The company and its partners also delivered the first natural gas to Baja California customers as part of the Mexicali gas distribu tion system. Enova International is pursuing other opportunities to build and operate natural gas and utility infrastructure in Latin America.

We also have begun to build a competitive energy generation business out side of the regulated utility. We are partnering with Houston Industries to develop the El Dorado power plant near Las Vegas. Power from this 480 megawatt combined-cycle, gas-fired facility will be sold in the new competi tive markets opening up throughout the western United States.

All this activity has proceeded while we have been completing the proposed merger. The current headquarters of Enova Corporation and SDG&E will become the headquarters of Sempra Energy -

San Diego's only Fortune 500 company.

Our strategic initiatives are aimed at building a winner, a new energy com pany that will excel on both the regulated and unregulated sides of the energy business.

Most importantly, at Enova Corporation, we believe that the creation of shareholder value should be the principal measure of success in the new energy marketplace -

and, with the steps we are taking, we will accomplish this objective.

Within the next decade, we plan to be one of the top five energy service companies in the creation of shareholder value in North America. This is an aggressive goal -

but one that I believe is well within our reach.

Stephen L. Baum Chairman and Chief Executive Officer Enova Corporation

4, ENO VA CORPORA T

ION 1 9 9 7 Annual Report A Letter from Donald E. Felsinger ACCEPTING AND MANAGING CHANGE is the key to success in the restructured electric utility industry. At SDG&E, adapting to change has been -

and continues to be -

a vital part of the company's fabric.

SDG&E is Enova Corporation's core subsidiary, accounting for approxi mately 98 percent of its revenues in 1997. Industry restructuring has changed the role of SDG&E -

from generation, transmission and distribu tion of energy to an energy delivery company. State regulators have moved the generation business into the competitive arena.

This evolution is almost complete, thanks to careful planning. Early on, SDG&E realized the advantages of purchasing, rather than generating, energy. In fact, for the past to years, SDG&E has pursued a business strategy that concentrates on the distribution and transmission of power, not genera tion. In 1997, we purchased 68 percent of our energy system requirements.

To complete the transition, in November 1997, we announced plans to auc tion SDG&E's generating assets and use the proceeds to pay down competi tive transition costs -

so that shareholders' past investments in generating assets will be recovered more quickly.

We will be auctioning off our two fossil fuel power plants -

the South Bay plant in Chula Vista and the Encina plant in Carlsbad -

as well as our 20-percent stake in the San Onofre Nuclear Generating Station and long term power contracts. We expect the auction process for the fossil fuel plants and power contracts to be completed by the end of 1998.

Donald E. Felsinger The key role of SDG&E will be to continue to provide safe, reliable service, one of our core competencies. SDG&E has maintained high customer satis faction levels while raising employee productivity to the highest level of any utility in the country. Increased efficiency has come through automa tion, reduced expenditures and new revenue enhancements.

As part of our planned succession strategy, Edwin A. Guiles has been pro moted to president of SDG&E. Ed has served in a broad range of manage ment posts with SDG&E and Enova over the past 25 years, most recently acting as senior vice president of Enova Corporation. As president, he will continue to guide the utility toward its goal of being a world-class energy delivery company.

It is with considerable pride that I reflect on the significant accomplish ments of SDG&E and assume my new role as president and chief operating officer of Enova Corporation. Now, I will devote all my energies to growing our unregulated businesses -

which will be critical to our future success as the competitive market unfolds.

Donald E. Felsinger President and Chief Operating Officer Enova Corporation

E NOVA CORPORATI ON 5

The Enova Companies SDG&E FOR MORE THAN IOO YEARS, San Diego Gas &

Building on a Electric has been responsible for the generation, trans Solid Foundation mission and distribution of energy to homes and busi nesses in San Diego and southern Orange counties.

With restructuring of the electric utility industry in California, electric generation has been opened up to competition, while transmission is being overseen by an Independent System Operator to ensure reliability and open access to the system.

With these changes, SDG&E is focusing on distribution services -

the delivery of gas and electricity to homes and businesses; including the responsibility for the safety and reliability of that delivery and the mainte nance of the system.

Although it is true that customers may choose another company as their electric supplier, it is equally true that SDG&E will continue to be the electric supplier for those customers who choose not to switch. Either way, all residential and small-commercial customers will receive the legislated io-percent electric rate cut, which began January I, 1998. To finance the rate cut, a trust established by the California Infrastructure and Economic Development Bank issued approximately

$6 billion of special rate-reduction bonds that allow California's electric utilities to refinance a portion of their debt at a lower interest rate. The interest savings, in turn, are being used to finance the rate cut.

No matter whom customers buy electricity from, they will still be SDG&E customers as the utility con tinues to deliver energy over its existing power lines.

In this new competitive environment, there is little profit for SDG&E and the other California investor owned utilities in actually generating electricity. Future earnings will be tied to the efficiency with which

6.

ENOVA CORPORATION 1 9 9 7Annua/Report In California's restructured energy industry, SDG&E is focused on providing 3 million consumers with safe, reliable electric and gas delivery service. SDG&E has more than 3,500 employees serving a territory of 4,100 square miles in San Diego and southern Orange counties.

PA, 1NV1O PO A

I N7 qLI

8.

E NOVA CO R

P0 RATI 0 N 1997Annual

/Report delivery services are performed to meet customer needs.

Fortunately, SDG&E is well prepared to meet the challenge.

SDG&E will continue to maintain the electric and gas distribution and transmission grid, so that all cus tomers will enjoy reliable delivery of electricity and natural gas. And, as in the past, SDG&E will respond quickly to power outages to restore power.

Service will be enhanced as well, using technology to accelerate response to customer requests and to improve efficiency. Two examples of these technological improvements are installation of a state-of-the-art sys tem for dispatching service professionals, as well as a new customer information system that handles up to 8 million transactions each month.

Sempra Energy RATHER THAN WAIT for completion of the merger, Solutions -

Enova Corporation and Pacific Enterprises are position Building a Retail ing the companies to take advantage of unregulated Energy Business business opportunities in the emerging competitive marketplace.

In March 1997, Enova Corporation and Pacific Enterprises launched Sempra Energy Solutions (for merly Energy Pacific), a joint venture, to provide inte grated energy products and services to a broad range of customers in California and nationally. The joint ven ture incorporated several existing unregulated busi nesses of both companies, including Enova Technologies and the retail operations of Enova Energy.

Sempra Energy Solutions has focused on becoming a strong multi-regional residential and commercial energy service provider. In addition, the company offers

ENOVA CORPORATION

9.

comprehensive turnkey energy management services targeting government, large institutions and national accounts.

While still a relatively young company, Sempra Energy Solutions already has established an impressive cus tomer list. The company was named by the U.S.

Department of Energy as one of a handful of contractors prequalified to pursue $750 million in energy-effi ciency retrofitting work for federal buildings in the western United States.

Bangor Hydro and Sempra Energy Solutions have formed Bangor Gas, LLC, to build, own and operate a

$40 million natural gas distribution system to serve the greater Bangor, Maine, area. Sempra Energy Solutions also has signed an agreement with Frontier Utilities to build a new $55 million natural gas delivery system that eventually will serve 150,000 customers in a seven-county region of North Carolina.

Sempra Energy Solutions was awarded the California Department of Public Services' contract to supply nat ural gas to state and local government facilities in the service territory of SDG&E. The company also signed a contract with the San Diego Unified School District for Encharge TM services -

including utility bill auditing and verification, tariff review, and energy-use and cost analysis for 165 schools and three district offices.

In December 1997, Sempra Energy Solutions increased its market presence by announcing the acquisition of CES/Way International, Inc., the largest U.S. indepen dent energy service company. Headquartered in Houston, CES/Way is a market leader in energy-service performance contracting, including energy audits, engi neering design, project management, construction and financing, and contract maintenance.

10.

ENO VA CORPORATION 1 9 9 7 Annual Report For Hill Air Force Base in Salt Lake City. Sempra Energy Solutions subsidiary CES/Way has undertaken one of the most comprehensive energy-conservation projects at any U.S. military base. Since the project began in 1994. energy-efficiency savings at the base have totaled $1.-7 million annually.

ENOVA CORPORATION I.

12.

E NO VA CORPORATION 1997 Annual Repon CES/Way has special expertise in the governmental and institutional sectors, including healthcare, colleges, universities and schools -

giving Sempra Energy Solutions an immediate, strong national position in these market segments. CES/Way is one of a select number of companies contracting with the U.S. Department of Defense to provide $r.i billion in energy-efficiency ser vices to federal facilities in 46 states.

In addition, Sempra Energy Solutions already has launched three successful new consumer products and services in Southern California: a seismic automatic gas shut-off valve, an appliance-protection plan and an appliance-repair service.

Enova International -

ENOVA INTERNATIONAL PURSUES the develop Building New Markets ment and acquisition of energy infrastructure to provide Worldwide energy services to customers outside the United States.

The company targets foreign energy projects that have higher earnings potential than those available through investments in regulated utilities in the United States.

In 1997, Enova International and its partners, includ ing Pacific Enterprises International, delivered natural gas to its first Mexican customers -

manufacturing plants in the cities of Mexicali and Chihuahua. The Mexicali and Chihuahua distribution systems represent the first two natural gas privatization licenses ever awarded by the Mexican government. Historic deliver ies to these two cities mark the initial successful steps in Enova Corporation's strategy to increase its revenue base by expanding into countries with rapidly growing energy demands.

The Mexicali distribution system now serves 20 indus trial customers and will be expanded to reach 25,000

ENOVA CORPORATION 13 businesses and households within the next four years. In Chihuahua, Enova International and partners assumed control of an existing pipeline network serving 24 industrial customers and have initiated service to resi dential customers, as well. By the fifth year of opera tion, the system will serve 50,000 customers. The Chihuahua project also is significant in that it marks the first time that Pemex, Mexico's state-run oil monopoly, has transferred natural gas assets to a private company.

These two projects are part of an integrated and focused strategy that is designed to achieve the same market presence and leadership position in northern Mexico that SDG&E has in California. These projects have allowed Enova International to develop local engineer ing, operating and development capabilities.

Enova International will continue to bid on several gas distribution, pipeline and power-supply projects in Mexico. The Mexican government estimates that Mexico will experience a 35-percent increase in power demand by the year 2005. In addition, new environ mental regulations and the phase-out of propane subsi dies will increase substantially natural gas consumption in Mexico over the next io years.

Building on its success in Mexico, Enova International is now pursuing energy projects in other parts of Latin America.

Sempra Energy Trading-IN THE E V OLVING WOR LD of energy competi Building Competitive tion, Enova Corporation believes that success as an Strength energy retailer requires having access to reliable, low cost electricity and natural gas -

and a portfolio of risk management services.

14.

ENO VA CORPORATION 199 7 AnnualReport In 1997, Enova International and its partners initiated a brand-new natural gas distribution system in Mexicali, a city in northern Baja California with a population of 700,000 and a thriving industrial sector. Clean-burning natural gas is help ing glass-bottle manufacturer Vidriera Mexicali reduce its emissions by 70 percent.

ENOVA CORPORATION 15.

16.

ENO VA CORPORATION 1997 Annual Report With the energy commodity trading and risk management capabilities of Sempra Energy Trading, Enova Corporation can pro vide a full portfolio of energy products and services for customers nationwide and internationally. Based in Greenwich, Connecticut, Sempra Energy Trading has marketing offices in Calgary. Toronto and Houston.

E NO VA CORPORATION

17.

8.

ENO VA CORPORAT ON 1997 Annual Report To meet these wholesale needs, Enova Corporation and Pacific Enterprises acquired a leading natural gas and power marketing firm, Sempra Energy Trading (for merly AIG Trading Corp.), in December 1997. The company is headquartered in Greenwich, Connecticut, and has marketing offices in Calgary, Toronto and Houston. It is one of the largest participants in marketing physical and financial energy products, including natural gas, power, crude oil and associated commodities. The company has been profitable since inception. In 1997, Sempra Energy Trading transac tions averaged over 3.5 billion cubic feet of gas per day.

By adding the trading and risk management capabilities of Sempra Energy Trading, Enova Corporation can pro vide a full portfolio of energy products and services for customers, including gas and power trading, marketing and risk management. This acquisition immediately establishes Enova Corporation as one of the nation's premier energy trading organizations and develops the wholesale commodity trading business necessary to support the company's retail marketing.

To support the trading business, Enova Corporation plans to acquire additional assets in generation, gas pro duction, gas and electric transmission, and gas storage.

Additional benefits of the Sempra Energy Trading acquisition include: enhanced commodity-purchasing capability, an opportunity to participate in the expected growth of commodity and retail energy services, and the ability to reach customers throughout the United States and Canada through strategic alliances with other utilities and energy retailers.

E NOVA C

ORPORATION

19.

Enova Financial ENO VA FINANCIAL HELPs Enova Corporation Building Earnings by enhance earnings by investing in affordable housing.

Helping People In severe shortage nationwide, affordable housing bene fits moderate-and low-income families and individuals by offering them attractive housing at affordable rents.

The federal government reduces income tax payments as an incentive to individuals and businesses to support financially the development and construction of these projects.

Transactions usually involve a pool of properties, each of which has between a dozen and several hundred housing units. In 1997, Enova Financial further expanded its portfolio to now include more than 1,200 affordable housing properties in 50 states and Puerto Rico.

One such example is the Windcrest Apartments com plex in Houston. Built in 1996, Windcrest houses 228 families in garden-style apartments and includes a com munity center and recreational facilities. In Modesto, California, Enova Financial invested in Sherwood Manor, a 38-unit special apartment complex for the elderly. At Sherwood Manor, residents can take advan tage of planned activities and convenient shuttle service to local shopping centers.

Enova Financial's investments are limited strictly to successful development companies that are experienced in the art of assembling properties into a fund and have a proven track record in affordable housing.

Enova Financial invests as a limited partner, restricting participation by acquiring less than 5o percent of any given investment. The company was responsible for 7 percent of Enova Corporation's earnings in 1997.

20,.

LNOV A

COR POR A TIO N

1997 AnnualRepor Enova Financial's portfolio includes 1,200 affordable-housing properties in 50 states and Puerto Rico (pictured here: the Park Village development in Houston). These investments, which provide attractive housing at affordable rents to moderate and low-income families, generated 7 percent of Enova Corporation's earnings in 1997.

ENOVA CORPORATION

21.

Sempra Energy IN OCTOBER I 9 96, Enova Corporation and Pacific Enterprises announced an agreement to merge. The merger will create a company with the size, scope and resources to compete in deregulated energy markets nationwide and internationally.

Upon completion of the merger, which is expected in the summer of 1998, the new combined company will be called Sempra Energy.

Sempra is derived from the Latin word "semper," which means "always." The name suggests that customers can always depend upon the company to provide innovative energy solutions. The name also reflects the combined company's commitment to be a total energy provider that delivers on its promises.

Sempra Energy will have the largest customer base of any energy utility in the United States, serving 20 million consumers through 6 million gas and electric meters, with nearly i1,000 employees and an asset base of $io billion.

Pacific Enterprises is a Los Angeles-based energy company whose principal subsidiary is Southern California Gas Company, the nation's largest natural gas distributor.

Southern California Gas Company's service territory is spread over 23,000 square miles:

from the U.S.-Mexico border at El Centro in the south to Fresno in the north, and from California's state border in the east to the Pacific Ocean.

SDG&E's 4,1 oo-square-mile service territory covers all of San Diego County and southern Orange County, The only overlap in customers between SDG&E and Southern California Gas Company is in Orange County, where SDG&E provides electric service and Southern California Gas Company, gas service.

I Pacific Enterprises' other subsidiaries include Pacific Enterprises International, which has partnered with Enova International on two Mexican gas-distribution projects.

Separately, Pacific Enterprises International has interests in gas-utility operations in Argentina.

Corporate headquarters for Sempra Energy will be in San Diego, as will SDG&E's headquarters. Southern California Gas Company will maintain its Los Angeles headquar ters. Sempra Energy Solutions (formerly Energy Pacific), the retail services joint venture formed by Enova Corporation and Pacific Enterprises, also will be based in Los Angeles.

Sempra Energy Trading (formerly AIG Trading Corp.), which was acquired jointly by Enova Corporation and Pacific Enterprises in December 1997, remains headquartered in Greenwich, Connecticut.

Upon completion of the merger, Richard D. Farman, president and chief operating officer of Pacific Enterprises, will become chairman and chief executive officer of Sempra Energy. Stephen L. Baum, chairman and chief executive officer of Enova Corporation, will become Sempra Energy's vice chairman, president and chief operating officer. Baum will become chief executive officer of Sempra Energy two years after the effective date of the merger and chairman by September 2000, when Farman retires.

Donald E. Felsinger, president and chief operating officer of Enova Corporation, will become president and principal executive officer of Sempra Energy's unregulated busi nesses. Warren I. Mitchell, president of Southern California Gas Company, will be presi dent and principal executive officer of the new company's regulated operations. Both Felsinger and Mitchell will report to the new Office of the Chairman, which will consist of Farman and Baum.

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ENOVA CORPORATION

23.

Enova Corporation Financial Statements Ten-Year Summary

24.

Management's Discussion and Analysis of Financial Condition and Results of Operations

26.

Responsibility Reportfor the Consolidated Financial Statements

40.

Independent Auditors' Report

40.

Consolidated Financial Statements

40.

Notes to Consolidated Financial Statements

48.

Quarterly Financial Data 59.

24.

END VA C ORPORATON 1997 Answas Report Ten-Year Summary Por th years ended December35 1997 1996 1995 1994 Dollars in millions except per share amounts Operating revenues Electric

$ 1,769.4

$ 1,59o.

$ 1,503.9

$ 1,510.3 Gas 398.1 348.o 310.2 346.2 Other 49-5 54.6 56.6 55.7 Total

$ 2,217.0

$ 1,993-5

$ 1,870.7

$-1,912.2 Operating income 344.2 335.0 345.7' 317.2 Earnings applicable to common shares 251.6 230.9 225.8 135.8 Earnings per common share from continuing operations 2.20 1.98 1.94 1.71 Earnings per common share (basic and diluted) $

2.20 1.98 1.94 1.17 Dividends declared per common share 1.56 1.56 1.56 1.52 Pretax income/revenue 18.I x9.0%

x9.3%

17.5%

Return on common equity 16.3 %

14.9%

15.1%

9.1%

Effective income tax rate 37.4 %

39.1%

37.4%

40.6 Dividend payout ratio (declared) 70.9 %

78.8%

80.4%

129.9 Price range of common shares 27V/8-213/8 243/4-203/8 237/8-19 18 25-17'/2 At December 31 Total assets

$ 5,233.9

$ 4,649.2

$ 4,748.6

$ 4,662.9 Long-term debt and preferred stock subject to mandatory redemption (excludes current portion)

$ 2,082.0

$ 1,504.3

$ 1,490.1

$.1,479.2 Current assets

$ 1,040.0 503.7 400.0 327.0 Current liabilities 558.6 507.8 663.0 670.1 Common shareholders' equity

$ 1,570.4

$ 1,569.7

$ 1,520.0

$ 1,474.4 Common shares outstanding a 113,635 116,629 116,583 116,537 Book value per common share 13.82 13-46 13.04 12.65 Price/earnings ratio 12.2 a1.5 12.2 I6.5(c Number of electric utility customers (,178.1 M,

x63.9 i,x5o.8 1,138.9 Number of gas utility customers (E 720.8 710.9 701.8 694.1 Number of utility employees 3,576 3,688 3,880 3,998 (A Including ($o.07) in 1989 for cmulatinv efta of changers ansWing pris.

fro continuing operations.

c Higher in 1994 due to oe-time witedowns at SDG&E and noetility sabridiard.

Indluds long-term debt redeemable within one year E In thousands.

(f) Estimated (6jDor not incud transportation customers.

This snmmary should be rud in conjunction wit the consolidatedfiancial statements and notes to consolidated financial statements contained elsewhere in this report.

ENOVA CORPORATION

5.

1993 1992 1991 1990 1989 1988

$ 1,514.6

$ 1,447.1

$ 1,357.5

$ 1,356.4

$ 1,324.9

$ 1,300.0 346.7 337.0 338.2 355.1 300.4 285.4 36.2 4.9 4.5 2.8 3.6 3-8

$ 1,897.5

$ I,789.o

$ 1,700.2

$ 1,714.3

$ 1,628.9

$ 1,589.2 303-9 308.9 304-9 305.7 274.7 267.6 210.2 201.1 197-5 197.0 168.2 177.7 1.89 1.86 1.68 1.58 1.4'^A) 1.55 x.81 1.77 1.76 r.76

.50A 1.59 1.48 1.44

$ 1.3875 1.35 1.35 1.30 19.7%

20.6%

i8.6%

8.8%,

18.7%

18.i%

14.2%

14.4%

14.9%

15.5%

13.7%

14.6%

41.3%

42.5%

40.5%

45.4%

46.9%

39.7%

81.8%

81.4%

78.6%

76.7%

85.7%

81.8%

27'/4-23'/4 253/8-21'/8 23-18 4 2 3'/8-19/2 22314-18/4 193/4-15

$ 4,694.7

$ 4,472-8

$,3,979.4

$ 3,897.4

$ 3,826.9

$ 3,510.7

$ 1,523.6

$ 1,647.3

$ 1,323.2

$ 1,333.1

$ 1,278.8

$ 1,349.0 304.2 282.3 274.6 296.8 266.8 297.4 655.6 550.3 574.4 558.o 576.2 501.4

$ 1,516.2

$ 1,441.4

$ 1,350.0

$ 1,295.6

$ 1,248.4

$ 1,229.9 116,515 115,034 112,496 111,898 111,843 111,797 13.01 12.53 12.00 11.58 1I.16 1I.00 13-7 13.6 12.8 12.7.

14.3 12.0 1,129.3 1,122.0 1,111.3 1,095.2 1,069.6 1,032.6 688.6 684.7 68o.6 673.5 661.5 642.8 4,166 4,249 4,215 4,175 4,209 4,420

26.

1 N O VA CORPORAT ION i997 Anaal Rport Management's Discussion and Analysis of Financial Condition and Results of Operations General Enova Corporation (referred to herein as Enova, which includes the parent and its wholly owned sub sidiaries) was formed in January 1996 to become the parent company of San Diego Gas & Electric (SDG&E). At that time SDG&E's outstanding common stock was converted on a share-for-share basis into Enova Corporation common stock. SDG&E's debt securities, preferred stock and preference stock were unaffected and remained with SDG&E.

SDG&E is an operating public utility engaged in the electric and gas businesses. It generates and pur chases electric energy and distributes it to I.2 million customers in San Diego County and an adjacent por tion of Orange County, California. It also purchases and distributes natural gas to 721,ooo customers in San Diego County and transports electricity and gas for others. California has enacted an electric restructuring law that affects the operations of SDG&E and the other California investor-owned electric utilities. This information is discussed below under "Electric Industry Restructuring." Enova has several other subsidiaries (referred to herein as nonutility subsidiaries). Enova Financial invests in limited partnerships representing approximately 1,200 affordable-housing properties located throughout the United States. Califia leases com puter equipment. These two subsidiaries are expected to provide income tax benefits over the next several years. Enova International is involved in energy projects outside the United States. Pacific Diversified Capital is the parent company of Phase One Development, which has been involved in real estate development.

Enova Energy is an energy management and consulting firm offering services to utilities and large con sumers. In December 1997, subsidiaries of Enova and Houston Industries formed a joint venture, El Dorado Energy, to build, own and operate a natural gas-fired power plant in Boulder City, Nevada. Enova Technologies is in the business of developing new technologies generally related to utilities and energy. In January 1997, Enova Energy, Enova Technologies and certain subsidiaries of Pacific Enterprises (discussed below) formed Energy Pacific, a joint venture to market integrated energy and energy-related products and services. Energy Pacific has recently changed its name to Sempra EnergySolutions. In January 1998, Sempra Energy Solutions completed the acquisition of CES/Way International, a leading national energy service provider. In December 1997, Enova and Pacific Enterprises completed the joint acquisition of AIG Trading Corporation (AIG), a leading natural gas and power marketing firm based in Greenwich, Connecticut. AIG has subsequently changed its name to Sempra Energy Trading. Additional information regarding Enova's nonutility subsidiaries is described herein under "Electric Generatiop" and "Liquidity and Capital Resources

- Investing Activities," and in Notes I, 2 and 3 of the notes to consolidated financial statements.

Business Combination In October 1996, Enova and Pacific Enterprises (PE), parent company of Southern California Gas Company (SoCalGas), announced that they have agreed to combine the two companies. Enova and PE have selected Sempra Energy as the name of the new company formed by the business combination. As a result of the combination, which was unanimously approved by the boards of directors of both companies, (i) each out standing share of common stock of Enova will be converted into one share of common stock of Sempra Energy, (ii) each outstanding share of common stock of PE will be converted into I.5038 shares of Sempra Energy's common stock and (iii) the preferred stock and preference stock of SDG&E, PE and SoCalGas will remain outstanding. In March 1997, the shareholders of Enova and PE approved the combination.

Consummation of the combination is conditional upon the approvals of the California Public Utilities Commission (CPUC) and various other regulatory bodies (see below).

In June 1997, the CPUC revised its procedural schedule for the business combination after delaying until July 1997 its final decision on the Performance-Based Ratemaking (PBR) proceeding for SoCalGas. (The CPUC's decision on SoCalGas's PBR proceeding adopted a rate-setting mechapism for SoCalGas that pro vides incentives for cost control and efficiency improvement, including comparisons of productivity and other factors against benchmarks based on industry performance. SoCalGas had been operating under tradi tional "cost of service" regulation. The decision provides for, among other things, a net rate reduction of

$i6o million.) In accordance with the CPUC's revised schedule, the administrative law judge handling the proceeding issued a draft decision on February 23, 1998. That draft decision proposed approval of the com bination. Among other things, the draft decision proposed 5o/o sharing of the net cost savings resulting from the combination between shareholders and customers, but only for five years rather than the zo years sought. The draft decision would reduce the net shareable savings from $t.' billion to $340 million. The CPUC decision is scheduled for the end of March 1998.

In November 1997, the California attorney general issued an advisory opinion concluding that the busi ness combination would not adversely affect competition within either the wholesale electricity or inter state gas markets. The opinion included a recommendation that the CPUC consider requiring SoCalGas to

BNOVA CORPO-RATION

27.

auction offsetting volumes of natural gas transportation rights equal to the load with SDG&E that will be withdrawn if the CPUC concludes that SDG&EVwould be eliminated as a potential competitor in the par tially regulated intrastate gas transmission market.

In September 1997, the CPUC staff issued a final Negative Declaration, toncluding that the business combination will not result in any activities or operational changes that may cause a significant adverse effect on the environment.

In June 1997, the Federal Energy Regulatory Commission (FERC) approved the business combination, subject to the conditions that the combined company will not unfairly use any potential market power regarding natural gas transportation to gas-fired electric-generation plants. The FERC acknowledged that Opeating Revees this issue is clearly within the jurisdiction of the CPUC and the conditions will be considered during the in amnsew okldh CPUC review process. Therefore, the FERC's final decision is not expected to be issued before the CPUCs approval.

In August 1997, the Nuclear Regulatory Commissiotv approved the business combination, ruling GMs that the creation of the new company will not affect SDG&E's qualifications to hold the license for its W or 20-percent interest in the San Onofre Nuclear Generating Station (SONGS).

Remaining regulatory reviews, which are not expected to be concluded prior to the CPUC decision, include clearance by the U.S. Department of'Justice, under the Hart-Scott-Rodino Antitrust Act, and approval by the Securities and Exchange Commission. Both agencies will review the business combination for its impacts on competition.

The commencement of combined operations is expected in the summer of 1998. Earnings of the com bined company could be negatively impacted in 1998, and to a lesser extent in subsequent years, by delays in achieving cost savings from the combination caused by the later-than-expected effective combination date, CPUC limitations on transactions between SDG&E and SoCalGas, which may be modified by the CPUC combination proceedings (discussed below), the possibility that the CPUC might not permit recov ery of certain costs of the combination and might reduce the period or percentage for shareholder participa tion in the related cost savings, and slower-than-anticipated growth in revenues from Sempra Energy Solutions. Additional information regarding the proposed business combination is described in Note x of the notes to consolidated financial statements.

91 94 95 96 SP Results of Operations Operating Results Electric revenues increased Ii percent in 1997, primarily due to an increase in sales for resale to other utilities and increased retail sales volume due to weather. Electric revenues increased 6 percent in 1996, primarily due to the accelerated recovery of SONGS Units 2 and 3 which commenced in April 1996. Gas revenues increased 14 percent in 1997, primarily due to weather-related higher sales volume and higher purchased-gas prices, offset by an increase in customer purchases of gas directly from other suppliers (for whom SDG&E provides transportation). Gas revenues increased 12 percent in 1996, reflecting higher purchased-gas prices.

Operating Expenses Electric fuel expense increased 22 percent in 1997, primarily due to increased natural gas prices and increased natural gas-fired generation resulting fron SONGS Units 2 and 3 refuelings.

Electric fuel expense increased 34 percent in 1996, primarily due to increased generation and increases in natural gas prices.

Purchased-power expenses increased 42 percent in 1997, primarily due to increased volume, which result ed from lower nuclear-generation availability from the SONGS refuelings and increased use of purchased power due to decreased purchased-power prices. Purchased-power expenses decreased 9 percent in 1996, reflecting the availability of lower-cost nuclear generation and decreases in purchased-power capacity charges.

Gas purchased for resale increased 20 percent in 1997 and 34 percent in 1996, primarily due to increases in sales volume and in natural gas prices.

The changes in maintenance expenses reflect the nuclear refuelings in 1997 and 1995.

General and administrative expenses decreased 15 percent in 1997, primarily due to higher 1996 costs for customer service, partially offset by the expenses relating to the proposed business combination with Pacific Enterprises.

Earnings 1997 earnings per common share were $2.2o compared to $1.98 in 1996 and $1.94 in 1995.

The increase in earnings in 1997 is primarily due to incentive rewards for Performance-Based Ratemaking (PBR) and Demand-Side Management (DSM) programs, retirements of debt and common shares, and improved earnings of Enova Financial, partially offset by expenses relating to the proposed business combi nation with Pacific Enterprises. Other events that improved 1997 earnings included income tax benefits from the 1995 sale of Wahlco Environmental Systems and capital gains from the sale of property held by Pacific Diversified Capital. The increase in earnings in 1996 is primarily due to DSM rewards, partially offset by SDG&E's lower authorized return on equity.

Earnings per share for the quarter ended December 31, 1997, were $0.72, compared to $0.47 for the same period in 1996. The increase in earnings for the quarter was due to numerous offsetting factors, including PBR and DSM rewards, rtirement of common shares, higher off-system electric sales, previously announced seasortal variability related to the elimination of electric-balancing accounts, and expenses relat ing to the proposed business combination with Pacific Enterprises. Although the elimination of the

28.

E NO VA CO ORATION 1997 AsaI Rport balancing accounts did not have any effect on 1997 full-year earnings, quarterly earnings now fluctuate sig nificantly, depending on monthly or seasonal changes in electric sales and fuel prices. In general, earnings are expected to be higher in high sales-volume months and lower in others. In 1998 and future years, full year earnings also will be affected by sales volumes.

Some of the PBR rewards recorded in 1997 had been pending with the CPUC for several years. During 1998, SDG&E will not have a multiple-year backlog of these PBR rewards to record. In addition, because of the elimination of the Generation and Dispatch PBR mechanism and the San Onofre Nuclear Generating Station Target Capacity Factor mechanism, the impact of performance rewards on future earn ings will be reduced.

Dividend Payout Ratio Califia and Enova Financial's contributions to earnings for the year were $0.21 in 1997, $0.19 in 1996 dwrlqed, J pmvt and $0.17 in 1995. Contributions to earnings by Enova Energy and Enova Technologies were negatively impacted in 1997 by the slower-thari-anticipated growth in revenues from Sempra Energy Solutions.

Liquidity and Capital Resources SDG&E's operations continue to be a major source of liquidity. In addition, financing needs are met pri marily through issuances of short-term and long-term debt. These capital resources are expected to remain available. Cash requirements include utility capital expenditures, nonutility subsidiaries' investments, and repayments and retirements of long-term debt. Nonutility cash requirements include capital expenditures 90 associated with subsidiary activities related to the plans to distribute natural gas in Mexico and the eastern United States; new products; investments in Sempra Energy Trading, CES/Way International and El Dorado Energy; and affordable-housing, leasing and other investments. Additional information on these 6o activities is discussed under "Cash Flows from Investing Activities" below. In addition to changes described elsewhere, major changes in cash flows are described below.

30 Cash Flows from Operating Activities The major changes in cash flows from operations among the three years result from changes in income taxes, accounts receivable, other current assets, accounts payable, and regulatory balancing accounts. The changes in cash flows related to income taxes were primarily due to the 0

timing of certain deductions in 1997 and higher 1996 income tax payments in connection with settle 93 94 95 96 97 ments with the Internal Revenue Service. The changes in cash flows related to accounts and notes receiv able were primarily due to increases in sales in December 1997. The changes in cash flows related to other current assets were primarily due to advances made to unconsolidated subsidiaries during late 1997. The changes in cash flows related to accounts payable were primarily due to fluctuations in natural gas purchas es and prices from year to year. The changes in cash flows related to regulatory balancing accounts were primarily due to overcollections in the Electric Revenue Adjustment Mechanism (ERAM) account as a result of higher-than-authorized sales volumes in 1997 and changes in prices for natural gas in 1996.

Quarterly cash dividends of $0.39 per share were declared for the year ended December 31, 1997. The dividend payout ratios for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 were 71 per cent, 79 percent, 80 percent, 130 percent, and 82 percent, respectively. The increase in the payout ratio for the year ended December 3 1, 1994, was due to writedowns recorded during 1994. For additional informa tion regarding the writedowns, see Enova Corporation's 1996 Annual Report. The payment of future divi dends is within the discretion of the Enova board of directors and is dependent upon future business con ditions, earnings and other factors. Net cash flows provided by operating activities currently are sufficient to maintain the payment of dividends at the present level.

Enova has initiated an enterprise-wide program to prepare the company's computer systems and applica tions for the year 2000 and beyond. A comprehensive review has been conducted to identify the systems that could be affected by the year 2000 issue and an implementation plan has been developed. The year 2000 issue results from time-sensitive software applications that recognize a date usihg only two digits. For example, "oo" may be recognized as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations. This year 2000 problem creates risk for the company from unforeseen problems in its own computer systems and from third parties with whom the company deals on financial transac tions. Management has not yet assessed whether the company's date-conversion project will be completed on a timely basis nor the impact of third-party computer system failures. The company expects to incur internal staff costs as well as consulting and other expenses related to infrastructure and facilities enhance ments necessary to prepare the systems for the year 2ooo. Expenditures for the testing and conversion of system applications were $4 million in 1997 and are expected to be between $20 million and $25 million over the next two years. These costs are expensed as incurred.

Cash Flows from Financing Activities Enova did not issue additional stock or long-term debt in 1997, except for SDG&E-related refinancings and electric industry restructuring-related rate-reduction bonds.

Additional information concerning the rate-reduction bonds is discussed below and under "Electric Industry Restructuring." Enova and SDG&E do not plan any issuances in 1998.

In October 1997, SDG&E issued $25 million of tax-exempt Industrial Development Bonds (IDBs) through the City of Chula Vista. The variable-rate bonds were issued at an initial rate of 3.5 percent. The proceeds from the bonds, which will mature in 2023, were used to redeem $25 million of 8.75 percent IDBs with the City of San Diego. Also during 1997, SDG&E purchased and retired $62 million of 9.625 percent and 8.5 percent first mortgage bonds.

BNOVA CORPORATION

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In December 1997, $658 million of rate-reduction bonds were issued on SDG&E's behalf at an average interest rate of 6.26 percent. A portion of the bond proceeds was used to retire $14.9 million of variable rate, taxable IDBs in December 1997 and $15.7 million of variable-rate, taxable IDBs in January 1998.

Additional retirements are planned. Additional information concerning the rate-reduction bonds is provid ed below under "Electric Industry Restructuring."

SDG&E currently has approximately $83 million of temporary investments that will be maintained into the future. The purpose of maintaining such a level of investments is to offset a like amount of long-term debt. The specific debt series being offset consists of variable-rate IDBs. The CPUC has approved specific ratemaking treatment which allows SDG&E to offset IDBs as long as there is at least a like amount of tem Cash and Temponay porary investments. If and when SDG&E requires all or a portion of the $83 million of IDBs to meet Investments future needs for long-term debt, such as to finance new construction, the amount of investments which is Ionsofidola" being maintained will be reduced below $83 million and the level of IDBs being offset will be reduced by "640 the same amount.

During 1997, Enova Corporation repurchased three million shares of its outstanding common stock.

During 1998, the $1.82-series preferred stock becomes callable at $26 per share.

SDG&E maintains its capital structure so as to obtain long-term financing at the lowest possible rates.

The following table shows the percentages of capital represented by the various components. In 1993 the capital structure is net of the construction funds held by a trustee.

400 1993 1994 1995 z996 1997 Goal 320(A()

()

Common equity 47%

48%

49%

5o%

5z%

41%

4649%

240 Preferred stock 4

4 4

4 4

3 3-5 do Debt and leases 49 48 47 46 45 56 4649 Total Ioo%

oo%

1oo%

oo%

loo%

ioo%

100%

(A) Exdades rate redsction bonds ($658 million at December 31, 1997).

(B)

Indmdes rate rduction bonds

($658 million at Damber 31, 1997).

(0ae 93 94 9i 96 97 The CPUC regulates SDG&E's capital structure, limiting the dividends it may pay Enova. At December 31, 1997, $152 million of common equity was available for future dividends. In addition, at December 31, 1997, approximately one half of the $658 million of rare-reduction bonds was also available for future divi dends. Of this available amount, $'oo million in dividends were paid by SDG&E to Enova on January 2, 1998, in conjunction with the acquisition of Sempra Energy Trading. This restriction is not expected to affect Enova's ability to meet its cash obligations.

In December 1997, Moody's Investors Service upgraded SDG&E's long-term-bond rating from an Ax/sta ble outlook to an Ai/positive outlook, reflecting SDG&E's business mix, which is heavily weighted toward distribution and transmission. The outlook upgrade also reflects the probability of recovery of stranded costs and the expected proceeds from the sale of generating assets (see discussion under "Electric Generation").

Standard & Poor's Ratings Group affirmed SDG&E's long-term-bond rating of A+/positive outlook.

Cash Flows from Investing Activities Cash used in investing activities in 1997 included SDG&E's con struction expenditures and payments to its nuclear decommissioning trusts. SDG&E's capital expenditures were $197 million in 1997 and are estimated to be $242 million in 1998. Actual capital expenditures in 1997 were lower than anticipated due to changes in the scope and timing of several major capital projects.

Estimated 1998 capital expenditures are closer to normal levels, with increases to meet industry restructur ing needs and improvements to the electric distribution system. SDG&E continuously reviews its construc tion, investment and financing programs and revises them in response to changes in competition, customer growth, inflation, customer rates, the cost of capital, andenvironmental and regulatory requirements.

Among other things, the level of expenditures in the next few years will depend heavily on the impacts of industry restructuring and the sale of SDG&E's Encina and South Bay power plants and other electric-gen erating assets, as well as the timing and extent of expenditures to comply with air-emission reduction and other environmental requirements. Additional information concerning the proposed sale of SDG&E's elec tric-generating assets is provided below under "Electric Generation."

Payments to the nuclear-decommissioning trusts are expected to continue until SONGS is decommis sioned, which is not expected to occur before 2013. Although Unit i was permanently shut down in 1992, it is scheduled to be decommissioned concurrently with Units 2 and 3. However, this will depend on the outcome of the proposed sale of SDG&E's electric-generating assets, including its interest in SONGS.

Enova's level of nonutility expenditures in the next few years will depend primarily on the activities of its subsidiaries other than SDG&E, including Sempra Energy Solutions and the natural gas distribution projects in Mexico and the eastern United States. Nonutility expenditures were $ 18 inillion in 1997 and are estimated to be $ i oo million in 1998, not including special projects. The decrease in expected expend tures in 1998 is primarily attributable to a decrease in expected investments by Enova Financial.

As discussed previously, in January 1997, certain subsidiaries of Enova and Pacific Enterprises formed Sempra Energy Solutions, a joint venture to market integrated energy and energy-related products and ser vices. During 1997, Enova invested $21 million in Sempra Energy Solutions. In addition, in January 1998,

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ENo VA CoRPORAT ON 1997 Annual Report Sempra Energy Solutions completed the acquisition of CS/Way International, a leading national energy service provider.

In September 1997, Sempra Energy Solutions formed a joint venture with Bangor Hydro to build, own and operate a $40 million natural gas distribution system in Bangor, Maine. In addition, in December 1997 Sempra Energy Solutions signed a partnership agreement with Frontier Utilities to build and operate a $55 million natural gas distribution system in North Carolina.

In December 1997, Enova and Pacific Enterprises completed the joint acquisition of C

/G Trading Corporation, a leading natural gas and power marketing firm. Enova contributed $i o.6 million to that acquisition, which was subsequently renamed Sempra Energy Trading.

Utility Construction, In July 1997, Enova International and its partners, Pacific Enterprises International and Proxima S.A. de Expenditures (txclude A)Q C., delivered their first supply of natural gas to Baja California. The Mexican company formed by the three partners, Distribuidora de Gas Natural de Mexicali, will invest up to $25 million during the first five years of the 30-year license period to supply natural gas to the region. The partnership is expected to serve 25,000 b

GScustomers over the next four years. In March 1997, the Mexican Energy Regulatory Commission awarded the partners their second natural gas privatization license in Mexico, allowing DGN de Chihuahua to build and operate a natural gas distribution system in Chihuahua. That partnership plans to invest approximately

$5o million in the project and is expected to serve 5o,oo customers over the next five years. In January 1998, Enova International and its partner, Union Fenosa ACEX of Spain, submitted a bid to build, own and operate a natural gas distribution system in Monterrey, Mexico. The project will consist of an initial invest

.40 ment of $19o million for a system that will serve 320,000 customers, with an additional $6o million invested over five years to serve a total of 400,000 customers. Two other international consortia have submit ted bids on the project. The Mexican Energy Regulatory Commission is expected to announce the winning bidder in March 1998.

In December 1997, Enova Power Corporation, a subsidiary of Enova, and Houston Industries Power Generation formed El Dorado Energy, a joint venture to build, own and operate a natural gas power plant in Boulder City, Nevada. Enova invested $2.3 million in El Dorado Energy in 1997 and expects to invest an additional $37 million in 1998 and $17 million in 1999.

Additional information about these acquisitions and joint ventures is discussed in Note 3 of the notes to 93 94 95 96 97 consolidated financial statements.

Derivative Financial Instruments The policy of Enova is to use derivative financial instruments to reduce exposure to fluctuations in interest rates, foreign currency exchange rat-s and natural gas prices.

These financial instruments are with major investment firms and expose Enova to market and credit riski.

At times, these risks may be concentrated with certain counterparcies, although counterparty nonperfor mance is not anticipated.

SDG&E periodically enters into interest-rate swap and cap agreements to moderate its exposure to inter est-rate changes and to lower its overall cost of borrowing. These swap and cap agreements generally remain off the balance sheet as they involve the exchange of fixed-and variable-rate interest payments without the exchange of the underlying principal amounts. The related gains or losses are reflected in the income statement as part of interest expense. SDG&E would be exposed to interest-rate fluctuations on the underlying debt should other parties to the agreement not perform. Such nonperformance is not anticipat ed. At December 31, 1997, SDG&E had an agreement for a floating-to-fixed-rate swap associated with

$45 million of variable-rate bonds maturing in 2002.

SDG&E's pension fund periodically uses foreign-currency forward contracts to reduce its exposure to exchange-rate fluctuations associated with certain investments in foreign equity securities. These contracts generally have maturities ranging from three to six months. At December 31, 1997, and 1996, there were no foreign-currency forward contracts outstanding.

In November 1996, SDG&E commenced price risk management activities, on a limited basis, in the area of hedging price volatility of natural gas requirements. SDG&E uses energy derivatives for both hedg ing and trading purposes within certain limitations imposed by company policies. These derivative finan cial instruments include forward contracts, swaps, options and other contracts which have maturities rang ing from 30 days to nine months. Additional information on derivative financial instruments of SDG&E is provided in Note 8 of the notes to consolidated financial statements and under "Market Risk" below.

Sempra Energy Trading Corp. derives a substantial portion of its revenue from trading ac'tivities in natural gas, petroleum and electricity. Trading profits are earned as Sempra Energy Trading acts as a deal er in structuring and executing transactions that permit its counterparties to manage their risk profiles.

In addition, Sempra Energy Trading takes positions in energy markets based on the expectations of future market conditions. These positions may be offset with similar positions or may be offset in the exchange traded markets. These positions include options, forwards, futures and swaps. Additional information on derivative financial instruments of Sempra Energy Trading is provided in Note 3 of the notes to consoli dated financial statements and under "Market Risk" below.

Market Risk Market risk arises from the potential change in the value of financial instruments and physical commodities based on fluctuations in natural gas, petroleum and electricity commodity exchange prices and basis. Market risk is also affected by changes in volatility and liquidity in markets in which these instruments are traded. SDG&E utilizes a variety of financial structures, products and terms which

ENOVA CORPORATION

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require the company to manage, on a portfolio basis, the resulting market risks inherent in these transac tions, subject to parameters established by company policies. Market risks are monitored separately from the groups that create or actively manage these risk exposures to ensure compliance with the company's stated risk management policies at both the Enova and subsidiary levels.

SDG&E measures the risk in its portfolio on a daily basis in accordance with value-at-risk methodolo gies, which simulate forward price curves in the energy markets to estimate the size and probability of future potential losses. The quantification of market risk using value-at-risk provides a consistent measure of risk across diverse energy markets and products. The use of this methodology requires a number of key assumptions, including the selection of a confidence level for losses and the holding period chosen for the value-at-risk calculation.

SDG&E expresses value-at-risk as the amount of SDG&E's earnings at risk based on a 95 percent confi dence level using a time horizon of the average life of the portfolio. As of December 31, 1997, SDG&E's value-at-risk for its price-risk management activities was $2.8 million (net of income taxes) of SDG&E's net earnings. Since this is not an absolute measure of risk under all conditions for all products, SDG&E performs alternative scenario analyses to estimate the economic impact of a sudden market movement on the value of the portfolio. This and the professional judgment of experienced business and risk managers is used to supplement the value-at-risk methodology.

Based upon the ongoing policies and controls discussed above, SDG&E does not anticipate a material adverse effect on its financial position or results of operations as a result of market fluctuations.

A Risk Management Committee, composed of Enova and Pacific Enterprises officers, is responsible for monitoring operating performance and compliance with established risk management policies for Sempra Energy Solutions and its subsidiaries. Sempra Energy Trading has established position and stop-loss limits for each line of business to monitor its market risk and traders are required to maintain positions within

-these market-risk limits. The position limits are monitored during the day by Sempra Energy Trading's senior management, which determines whether to adjust its market-risk profile.

All of Sempra Energy Trading's market-risk sensitive instruments are entered into for trading purposes.

The following table provides the potential changes in net principal transaction revenues resulting from hypothetical 1o-percent increases and io-percent decreases in the applicable commodity prices for signifi cant commodity market-price sensitive instruments held on December 3, 1997. This quantitative infor-,

mation about market-risk is limited because it does not take into account potential hedging transactions or changes to the market risk profile of the portfolio by management in reaction to such changes in market conditions. Additionally, it does not take into account anticipated management reaction to breaches of counterparty credit limitations caused by the shocks within a given risk category. Further, inherent limita tions arise from assuming that hypothetical io-percent increases and 1o-percent decreases in commodity prices move in the same direction, and this information does not recognize co-movements in prices.

The following table presents the impact on Sempra Energy Trading's net principal transaction revenues resulting from a 10-percent increase and a io-percent decrease in the respective December 31, 1997, commodity prices:

In thuas of ddlars Commodity 10 Increase xo% Decrease Crude oil and derivatives

$ 3,288

$ (3288)

Natural gas (2,441) 2,441 Emission credits (81)8 Electiiciry (540) 540 SDG&E's payments to the externally managed nuclear decommissioning trust funds expose SDG&E to market risk. Market risk can result from fluctuations in the volatility and liquidity in markets in which these instruments are traded. These fluctuations can also correspondingly affect the level of funding of the decommissioning trust.

Credit Risk Credit risk relates to the risk of loss that would be incurred as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. SDG&E and Sempra Energy Trading avoid concentration of counterparties and maintain credit policies with regard to counterparries that man agement believes significantly minimize overall credit risk. These policies include an evaluation of poten tial counterparties' financial condition (including credit rating), collateral requirements under certain cir cumstances, and the use of standardized agreements which allow for the netting of positive and negative exposures associated with a single counterparty.

The companies monitor credit risk exposure through an approval process and the assignment of credit limits. These credit limits are established based on risk and return considerations under terms customarily available in the industry.

Electric Industry Restructuring Background In September 1996, the state of California enacted a law restructuring California's electric utility industry (AB 1890). The legislation adopts the December 1995 CPUC policy decision that restruc tures the industry to stimulate competition and reduce rates.

32.

E NOV A COR POR1A TIO N 1997 Annmal Report In May D997, the CPUC issued a decision providing for direct access to be available to all California electric customers on January i, j998. The CPUC concluded that there were no-technical or operational barriers to justify limiting direct access availability once electric restructuring commenced. The decision allowed customers to begin choosing electricity providers in November r

In December s997, the CPUC agreed to delay the initiation of electric restructuring until March 3 1, 1998, to allow California's Power Exchange (PX) and Independent System Operator (ISO) to resolve computer software problems and conduct additional user training. Beginning on March 31, 1998, customers wil be given the choice to con tinue to purchase electricity from their local utility under regulated tariffs, to enter into contracts with other energy service providers (i.e., private generators, brokers, etc.) or buy their power from the indepen Depreciation and dent PX that serves as a wholesale power pool allowing all enefgy producers to, participate competitively.

Decmmissionig The PX obtains power from qualifying facilities, nuclear units, and, lastly, from the lowest-bidding suppli in ilhw of dolars ers. The ISO will schedule the power transactions and access to the transmission system. To facilitate this, 2 Electric the utilities will transfer the operational control of their transmission facilities to the ISO. The local utility

• ~

will continue to provide distribution services, regardless of which source the consumer chooses. These cus tomer choices will, in effect, open up the service territories of all California utilities. This will allow Enova, through Sempra Energy Solutions, to pursue customers outside of SDG&E's traditional service territory to provide electricity and other energy-related services. This also allows other energy service providers to enter SDG&E's service territory to compete for generation customers.

Transition Costs Both the CPUC decision and the California legislation allow utilities, within certain limits, the opportunity to recover their stranded costs incurred for certain above-market CPUC-approved facilities, contracts and obligations through the establishment of a nonbypassable competition transition charge (CTC). The CPUC's direction is that traditional cost-of-service regulation will move toward perfor mance-based regulation.

Utilities are allowed a reasonable opportunity to recover their stranded costs through December 31, 2001. Stranded costs such as reasonable employee-related costs directly caused by restructuring and pur chased-power contracts (including those with qualifying facilities) may be recovered beyond 2001, subject to a reasonableness review.

93 94 97 96 97 SDG&E's transition-cost application, filed in October 1996, identified $2 billion of estimated stranded costs, including generation, purchased-power and qualifying facilities' contracts, and regulatory assets. The amount includes sunk costs, as well as ongoing costs the CPUC finds necessary to maintain generation facilities through December 31, 2001. These identified transition costs were determined to be reasonable by independent auditors selected by the CPUC, with $73 million identified as requiring further action before being deemed recoverable transition costs. Through December 31, 1997, SDG&E has recovered transition costs of $0.2 billion for nuclear generation and $o.i billion for nonnuclear generation.

Additionally, overcollections of $o.x billion recorded in the Energy Cost Adjustment Clause (ECAC) and the Electric Revenue Adjustment Mechanism (ERAM) balancing accounts as of December 31, 1997, have been applied to transition cost recovery, leaving approximately $1.6 billion for future CTC recovery.

Included therein is $0.4 billion for post-2001 purchased-power-contract payments that may be recovered after 2001, subject to an annual reasonableness review. Outside of the exceptions discussed above, transi tion costs not recovered by December 31, 2001, will not be collected from customers. Such costs, if any, would be written off as a charge against earnings. AB 1890 clarifies that all existing and future consumers must pay CTC, except for a segment of self-generators and irrigation districts. SDG&E has very few, if any, of these types of customers and does not anticipate a material impact from the exemption. During the 1998 2001 period, the recovery of transition costs is limited by the rate freeze (discussed below). Management believes that the rates within the rate freeze and the proceeds from the sale of electric-generating assets (dis cussed below) will be sufficient to recover all of SDG&E's approved transition costs by December 31, 2001.

In November 1997, the CPUC issued a decision allowing SDG&E the opportunity to recover all of its sunk nonnuclear generation costs, with the exception of $39 million in fixed costs relating to gas trans portation to power plants, which SDGG-E believes will be recovered through contracts with the ISO. The decision does not include generation plant additions made after December 20, 1995. Instead, SDG&E must file an application seeking a CPUC reasonableness review thereof. In October 1997, SDG&E filed an application with the CPUC seeking recovery of $14.5 million in 1996 capital additions for the Encina and South Bay power plants. A final CPUC decision is expected in 1998.

Rate-Reduction Bonds AB 1890 required a zo-percent rate reduction for residential and small-commer cial customers beginning in January 1998. AB 1890 also provided for the issuance of rate-reduttion bonds by an agency of the state of California to enable California's investor-owned electric utilities (IOUs) to use the proceeds to finance this rate reduction. In December 1997, $658 million of rate-reduction bonds were issued on behalf of SDG&E at an average interest rate of 6.26 percent. These bonds are being repaid over

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ro years by SDG&E's residential and small-commercial customers via a nonbypassable charge on their elec tricity bills. In September 1997, SDG&E and the other California IOUs received a favorable ruling by the Internal Revenue Service on the tax treatment of the bond transaction. The ruling states, among other things, that the receipt of the bond proceeds does not result in gross income to SDG&E at the time of issuance, but rather the proceeds are taxable over the life of the bonds. The Securities and Exchange Commission determined that these bonds should be reflected on the utilities' balance sheets as debt, even though the bonds are not secured by, or payable from, utility assets, but rather by the revenue streams col 4ected from customers. SDG&E formed a subsidiary, SDG&E Funding LLC, to facilitate the issuance of the rate-reduction bonds. In exchange for the bond proceeds, SDG&E sold to SDG&E Funding all of its rights to the revenue streams. Consequently, the revenue streams are not the property of SDG&E nor are they available to satisfy any claims of SDG&E's creditors. There was no gain or loss recorded from the issuance of the bonds or the receipt of the proceeds. SDG&E has begun to use a portion of the proceeds to redeem its higher cost debt, described herein under "Liquidity and Capital Resources - Financing Activities." In December 1997, the California Supreme Court dismissed a petition submitted by a coalition of consumer groups to overturn the CPUC's Rate-Reduction Bond financing orders. A related coalition of consumer groups has also put together a California ballot initiative that, among other things, would possibly result in an additional i0-percent rate reduction, require that this rate reduction be achieved through the elimi nation or reduction of CTC payments and prohibit the collection of the charge on customer bills that would finance the rate reduction. SDG&E cannot predict the final outcome of the initiative. If the initiative were to be voted into law and upheld by the courts, the financial impact on SDG&E could be substantial.

Electric Rates AB 1890 included a rate freeze for all customers. Until the earlier of March 31, 2oo2, or when transition cost recovery is complete, SDG&E's average system rate will be frozen at 9.64 cents per kilowatt-hour, except for the impacts of natural gas price changes and the mandatory 1o-percent rate reduction. As a result of significant increases in natural gas prices during the first quarter of 1997, SDG&E received CPUC authority to increase rates, but rates could not be increased above 9.985 cents per kwh.

With the 1o-percent rate reduction beginning on January 1, 1998, the maximum system-average rate became 9.43 cents per kwh. SDG&E's ability to recover its transition costs is dependent on its total rev enues under the rate freeze exceeding normal cost-of-service revenues during the transition period by at least the amount of the CTC less any proceeds from the sale of electric-generating assets (discussed below).

During the transition period, SDG&E will not earn awards from special programs, such as DSM, unless total revenues are also adequate to cover the awards. Fuel-price volatility is the most significant variable in the ability of SDG&E to recover its transition costs and program awards.

Balancing Accounts In October 1997, the CPUC issued a decision eliminating the ECAC and the ERAM balancing accounts, effective December 31, 1997. As of December 31, 1997, net overcollections for these accounts of $130 million have been transferred to the interim transition-cost-balancing account to be applied to CTC recovery, subject to a reasonableness review. The decision eliminates further ECAC pro ceedings for generation costs incurred beginning in January 1998. Additionally, the decision eliminates all other electric-balancing accounts, except for those associated with the administration of DSM, low-income assistance, and research and development (R&D) programs, which will be used to assist in the administra tion of public-purpose funds (discussed below). In addition, SDG&E has requested the retention of the Electric Vehicle balancing account through December 31, 1998. The elimination of ERAM and ECAC resulted in earnings volatility that began in the first quarter of 1997. Although no effect in 1997 was seen for the full year, quarterly earnings fluctuated significantly, as was the case for the other California IOUs.

The largest impacts were reduced first-quarter earnings and increased third-quarter earnings. This quarterly volatility pattern is expected to continue in the future. Beginning in 1998, annual earnings also will be affected by sales volumes.

Regulatory Accounting Standards SDG&E had been accounting for the economic effects of regulation on all of its utility operations in accordance with Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." Under SFAS No. 71, a regulated entity records a regulatory asset if it is probable that, through the ratemaking process, the utility will recover that asset from customers. Regulatory liabilities represent future reductions in revenues for amounts due to customers.

The SEC indicated a concern that the California IOUs may not meet the criteria of SFAS No. 7 1 with respect to their electric-generation net regulatory assets. SDG&E has ceased the application of SFAS No. 7 1 to its generation business, in accordance with the conclusion by the Emerging Issues Task Force of the Financial Accounting Standards Board that the application of SFAS No. 71 should be discontinued when deregulatory legislation is issued that determines that a portion of an entity's business will no longer be regulated. SDG&E's discontinuance of SFAS No. 71 applied to its generation business will not result in a write-off of its net regulatory assets, since the CPUC has approved the recovery of these assets by the distri bution portion of its business, subject to the rate freeze.

34-NO VA Co PO AT10N 1997 Asmnat Report Consumer Education In August 1997, the CPUC authorized $89 million in rate recovery to fund California's Customer Education Program (CEP). SDG&E's share of this amount is approximately $9 mil lion. The CEP's objective is to provide information to California electric customers to help them compare and choose among electric products and services in a competitive environment. The CEP began in September 1997 and is expected to end by May 31, 1998.

Public-Purpose Programs The CPUC has established a new administrative structure and initial funding levels to manage DSM, renewable-energy, low-income assistance and R&D programs beginning in January 1998. The CPUC has formed independent boards to oversee a competitive bidding process to administer DSM and low-income programs. On an interim basis, the CPUC has required that the California IOUs transfer their administration of DSM and low-income programs to these boards by October 1998, and January 1999, respectively. Until the transition to a fully competitive energy service market is complete, customers will be required to provide the funding. For 1998, SDG&E will be funded $32 million and $12 million for DSM and renewables programs, respectively. Low-income assistance funding will remain at 1996 authorized levels. The California Energy Commission will be allocated most of the $63 million authorized to administer the R&D programs, of which SDG&E will be funded $4 million. SDG&E's earnings potential from DSM programs will be reduced when the transition to the competitive market is complete.

Federal Restructuring Activities In October 1997, the FERC approved key elements of the California IOUs' restructuring proposal effective January x, 1998. This includes the transfer by the IOUs of the oper ational control of their transmission facilities to the ISO, which is under FERC jurisdiction. The FERC also approved, on an interim basis, the establishment of the California PX to operate as an independent whole sale power pool. The California IOUs will pay to the PX a restructuring charge (in four annual install ments) and an administrative-usage charge for each megawatt-hour of volume transacted. SDG&E's share of the restructuring charge is approximately $0 million, which is eligible for transition-cost recovery. The IOUs have jointly guaranteed $300 million of commercial loans to the PX and ISO for their development and initial start-up. SDG&E's share of the guarantee is $30 million.

Electric Generation In November 1997, SDG&E's board of directors approved a plan to auction the company's power plants and other electric-generating assets, enabling SDG&E to continue to concentrate its business on the trans mission and distribution of electricity and natural gas as California opens its electric utility industry to competition in 1998. The plan includes the divestiture of SDG&E's fossil power plants -

the Encina (Carlsbad, California) and South Bay (Chula Vista, California) plants -

and its combustion turbines, as well as its 20-percent interest in the San Onofre Nuclear Generating Station (SONGS) and its portfolio of long-term purchased-power contracts, including those with qualifying facilities. The power plants, includ ing the interest in SONGS, have a net book value as of December 31, 1997, of $8oo million ($200 million for fossil and $6o million for SONGS) and a combined generating capacity of 2,400 megawatts. The pro ceeds from the auction will be applied directly to SDG&E's transition costs. In December 1997, SDG&E filed with the CPUC for its approval of the auction plan. The sale of the nonnuclear generating assets is expected to be completed by the end of the first quarter of 1999.

Although the other California IOUs are required by the CPUC to divest themselves of at least 5o per cent of their fossil power plants as a part of industry restructuring, SDG&E is not under the same mandate.

Other companies in the free market, not bound by the rules that apply to tlhe state's regulated utilities, are expected to have a greater opportunity to provide competitive generation services with SDG&E's plants.

The FERC has ruled that it has jurisdiction over all electricity sales into the California PX, meaning that the buyers of divested California power plants.would qualify as wholesale power generators. The FERCs ruling has increased the interest in the nonnuclear plants owned by the other California IOUs, and is expected to have the same impact on SDG&E's fossil plants.

As previously discussed, subsidiaries of Enova and Houston Industries have formed a joint venture to build, own and operate a 48o-megawatt natural gas-fired power plant in Boulder City, Nevada, 40 miles southeast of Las Vegas. The joint venture, called El Dorado Energy, plans to sell the plant's electricity into the wholesale market to utilities throughout the western United States. The new plant will employ an advanced combined-cycle gas-turbine technology, enabling it to become one of the more efficient and environmentally friendly power plants in the nation. Its proximity to existing natural gas pipelines and electric transmission lines will allow El Dorado to actively compete in the deregulated electric-generation market. Construction on the $280 million project, which will be funded 5o percent each by Enova and Houston Industries, began in the first quarter of 1998, with an expected operational date set for the fourth quarter of 1999.

Affiliate Transaction Guidelines In December 1997, the CPUC issued a decision on the rules governing transactions between a regulated utility and its affiliates that are not regulated by the CPUC. The decision adopts guidelines that are more favorable to consumers and lessrestrictive to utilities and their affiliates than the conditions that were rec ommended in October 1oo7 by a CPUC administrative law judge's proposed decision and an alternate

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decision by two CPUC commissioners. Key elements of the decision include: allowing the unregulated affiliates to operate within the utility's service territory without limitation; permitting utilities to share logos with their parent company and unregulated affiliates as long as proper disclaimers to California cus tomers clearly communicate the utility-affiliate relationship; and allowing officers or board of directors of the parent company to also hold positions with the utility or unregulated affiliate, but not both. The rules adopted require separating functions between the utility and the affiliates with the exception of sharing certain corporate support services. These guidelines include transactions between affiliated utilities.

However, these transactions have been addressed by the CPUC in the Enova/Pacific Enterprises business combination proceedings and the draft decision arising from that proceeding would exclude transactions between SDG&E and SoCalGas from the guidelines.

Performance-Based Ratemaking (PBR)

Background The CPUC has affirmed its belief that the new competitive environment should be based on policies that encourage efficient operation and improved productivity rather than on reasonableness reviews and disallowances. SDG&E has been participating in a PBR process for base rates, gas procurement, and electric generation and dispatch. SDG&E has applied to extend the Gas Procurement mechanism. The Generation and Dispatch mechanism has been terminated. SDG&E has filed a proposal for a new Distribution PBR mechanism to replace the current experimental Base-Rate PBR when it terminates at the end of 1998.

Base Rates In December 1997, the CPUC approved $6.5 million in performance rewards for SDG&E's 1996 PBR. The CPUC has eliminated the price-performance benchmark indicator, which compares SDG&E's average electric-system rate to a national average, from SDG&E's Base-Rate PBR effective in 1997 due to the electric-rate freeze. For the 1998 PBR, all customer sharing amounts will be credited to the transition-cost-balancing account rather than refunded to customers.

In December 1997, the CPUC eliminated SDG&E's 1999 General Rate Case filing requirement, and replaced it with a 1999 Cost of Service study in its new Distribution PBR application for electric distribu tion and gas operations (filed in January 1998 to begin in 1999). The Distribution PBR, which includes six categories of performance indicators, will measure SDG&E's ability to provide efficient, safe and reliable utility transmission (gas only) and distribution services. The application requests a $6o million increase in SDG&E's revenue requirements ($35 million for electric distribution and $25 million for gas). The electric distribution increase does not affect rates and, therefore, reduces the amount available to recover transition costs. Under the new mechanism, all customer-sharing amounts will be reflected as reductions to future rates rather than refunded directly to customers. SDG&E's ability to control its costs within the limits of the revenues authorized by the study will impact future earnings.

1998 Revenues In December 1997, the CPUC approved a $67 million increase in SDG&E's authorized electric distribution revenue requirements and a $7 million increase in gas base rates, effective on January x, 1998. The electric distribution increase, which reflects 1998 PBR escalations, does not affect rates and, therefore, reduces the amount available to recover transition costs.

Natural Gas In September 1997, SDG&E filed with the CPUC its application for a permanent Gas Procurement PBR mechanism. The filing proposes a mechaxism structured around a commodity price cap plus an incremental adjustment, designed to recover transportation costs to the California border. SDG&E is holding settlement discussions with the CPUC's Office of Ratepayer Advocates over the proposed new mechanism.

Natural Gas Operations The ongoing restructuring of the natural gas utility industry has allowed customers to bypass utilities as suppliers and, to a lesser extent, as transporters of natural gas. Currently, nonutility electricity producers and other large customers may use a natural gas utility's facilities to transport gas purchased from other suppliers. Also, smaller customers may form groups to buy natural gas from another supplier.

In January 1998, the CPUC opened a rulemaking proceeding designed 'to open the natural gas industry to all customers, expanding the opportunities oftresidential and small commercial customers to have access to competing natural gas suppliers. The rulemaking will allow smaller customers to receive the price and service benefits already realized by larger customers. A potential benefit from future natural gas reform, benefiting both customers and industry participants, would be the opportunity for energy providers to offer integrated retail electric and natural gas service to develop synergies between the two energy markets. In developing a natural gas retail restructuring proposal, the CPUC hs provided several guiding principles:

replace traditional regulation with competition in those markets where competition or the potential for competition exists, thereby allowing market forces to dictate Prices; reform regulation for those utility functions that are not fully competitive; maintain a standard of consumer protection in both competitive and noncompetitive markets; and maintain supply reliability and ensure the safety of consumers' natural gas service. Hearings on the proposed restructuring are scheduled to begin in April 1998, with a final CPUC decision expected to be issued before the end of r998.

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RPOR A T 1 ON 1997 Annual Report Enova's nonutility subsidiaries are involved in several projects to develop natural gas systems in the United States and in Mexico. Discussion on these activities is included herein under "Liquidity and Capital Resources - Investing Activities."

Cost of Capital In October 1997, SDG&E filed with the CPUC its 1998 Market Indexed Capital Adjustment MechanismW (MICAM). MICAM, approved by the CPUC in 1996, adjusts SDG&E's authorized cost of capital based on changes in interest rates. For the current MICAM review, interest-rate movements over the corresponding 12 months did'not trigger the mechanism to change, resulting in SDG&E's 1998 cost of capital remaining at 1997 authorized levels of i1.6o percent for the rate of return on equity and 9.35 percent for the rate of return on rate base. Beginning in x998, MICAM only applies to electric distribution and gas rate base, and excludes the rates of return on nuclear and nonnuclear generating assets (recovered as transition costs),

which are authorized at rates of 7.14 percent and 6.75 percent, respectively. During 1998, the CPUC will conduct proceedings to establish separate rates for the electric and gas components. SDG&E's authorized capital structure, which excludes the rate-reduction bonds, remains 49.75 percent common equity, 44.5 percent long-term debt and 5.75 percent preferred stock.

Electric trmsmission rates are regulated by the FERC. SDG&E's 1998 rate of return for transmission is 9.54 percent.

Resource Planning Sources of Fuel and Energy SDG&E's primary sources of fuel and purchased power include natural gas from Canada and the Southwest, surplus power from other utilities in the Southwest and the Northwest, and uranium from Canada. Although short-term natural gas supplies are volatile due to weather and other conditions, these sources should provide SDG&E with an adequate supply of competitively priced natural gas. SDG&E has been involved in litigation concerning its long-term contracts for natural gas with four Canadian suppliers. SDG&E has settled with one supplier, with gas being delivered under the terms of the settlement agreement. The remaining suppliers have ceased deliveries pending legal resolution. A U.S.

Court of Appeals has upheld a U.S. District Court's decision to invalidate the contracts with two of the suppliers, although the value of the gas delivered has not yet been determined by the court. SDG&E has long-term pipeline capacity commitments related to these contracts for natural gas supplies. If the supply of Canadian natural gas to SDG&E is not resumed, SDG&E intends to use the capacity in other ways, including the release of a portion of this capacity to third parties. SDG&E cannot predict the final outcome of the litigation, but does not expect that an unfavorable outcome would have a material effect on its finan cial condition, results of operations or liquidity. Additional information on Canadian gas litigation is discussed in Note 9 of the notes to consolidated financial statements.

San Onofre Nuclear Generating Station In January 1996, the CPUC approved the accelerated recovery of the existing capital costs of Units 2 and 3. The decision allowed SDG&E to recover its remaining invest ment in the units at a lower rate of return (7.14 percent) over an eight-year period beginning in 1996, rather than over the life of the units' license, which extends to 2013. The accelerated recovery began in April 1996. At December 31, 1997, approximately $6oo million was not yet recovered. California electric industry restructuring legislation requires that all generation-related stranded assets, which includes the uneconomic sunk costs of Units 2 and 3, be recovered by 2001. The 1996 decision also includes a perfor mance incentive plan that encourages continued, efficient operation of the plant. Under this plan, cus tomers will pay about $0.04 per kilowatt-hour through December 31, 2003. This pricing structure replaces the traditional method of recovering the units' operating expenses and capital improvements. This is intended to make the units more competitive with other sources.

The California Coastal Commission (CCC) approved the SONGS owners' preliminary plan to provide I5o acres of wetlands restoration, i50 acres of kelp reef and other mitigation that was ordered by the CCC in April 1997. SDG&E's share of the cost is estimated to be $23 million. Additional information is included under "Water Quality" below.

While conducting routine inspections of Unit 3 during its scheduled refueling in the second quarter of 1997, it was noted that, in several areas, the thickness of the heat transfer tubes' structural supports was significantly reduced, apparently due to erosion. In June 1997, the Nuclear Regulatory Commission approved the removal of the affected tubes from service as a corrective action and the unit's return to ser vice. Unit 2, which also had this inspection during its scheduled refueling in the first quarter of 1997, showed no signs of this type of erosion. As a precautionary measure, Unit 2 was shut down in January 1998 for a 30-day mid-cycle outage for an inspection of its steam generators. The SONGS owners have scheduled a 3o-day outage for Unit 3 in March 1998, for this inspection. The discovery of such problems in the future could increase the possibility that the units would be removed from service prior to 2013.

Environmental Matters SDG&E's operations are conducted in accordance with federal, state and local environmental laws and regu lations governing hazardous wastes, air and water quality, land use and solid-waste disposal. SDG&E incurs significant costs to operate its facilities in compliance with these laws and regulations, and to clean up the environment as a result of prior operations of SDG&E or of others.

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The costs of compliance with environmental laws and regulations are normally recovered in customer rates. However, restructuring of the California electric utility industry (see "Electric Industry Restructuring" above) will change the way utility rates are set and costs are recovered. SDG&E has pro posed a change in the hazardous waste memorandum account to exclude cleanup costs related to electric generation activities, as described below. Capital costs related to environmental regulatory compliance for electric generation are intended to be included in transition costs for recovery through 2001. However, depending on the final outcome of industry restructuring and the impact of competition, the costs of com pliance with future environmental regulations may not be fully recoverable.

Capital expenditures to comply with environmental laws and regulations were $4 million in 1997,

$6 million in 1996 and $4 million in 1995, and are expected to be $38 million in the aggregate over the next five years. These expenditures primarily include the estimated cost of retrofitting SDG&E's power plants to reduce air emissions. However, in November 1997 SDG&E announced a plan to auction its power plants and other electric-generating resources. Additional information on SDG&E's plan to divest its elec tric-generating assets is discussed in Note io of the notes to consolidated financial statements.

Hazardous Wastes In 1994, the CPUC approved the Hazardous Waste Collaborative, which allows utili ties to recover cleanup costs of hazardous waste contamination at sites where the utility may have responsi bility or liability under the law to conduct or participate in any required cleanup. In general, utilities are allowed to recover 90 percent of their cleanup costs and any related costs of litigation with responsible par ties. SDG&E has asked the CPUC that beginning on January i, 1998, the hazardous waste memorandum account be modified to exclude cleanup costs related to electric-generation activities. Electric-generation related cleanup costs are intended to be eligible for transition cost recovery. A CPUC decision is still pending.

SDG&E lawfully disposed of hazardous wastes at facilities owned and operated by other entities.

Operations at these facilities may result in actual or threatened risks to the environment or public health.

Where the owner or operator of such a facility fails to complete any corrective action required by regulatory agencies to abate such risks, applicable environmental laws may impose an obligation to undertake correc tive actions on SDG&E and others who disposed of hazardous wastes at the facility.

During the early 19oos, SDG&E and its predecessors manufactured gas from coal and oil at its Station A facility and at two small facilities in Escondido and Oceanside. Certain amounts of residual by-products from the gas manufacturing process and subsurface hydrocarbon contamination were discovered on portions of the Station A site during an environmental assessment which was completed in 1996. A risk assessment has been completed for Station A and demolition was performed during 1997 at a cost of $i million.

Cleanup will commence in 1998, to be completed in 1999, and is estimated to cost $5 million for subsur face remediation. SDG&E also may be required to assess certain off-site contamination which, in part, may have originated from the gas manufacturing process or other operations at Station A. Not included in this estimate are potential costs related to a previously removed shallow underground tank-like structure found under a public street immediately west of Station A. Any potential costs related to this tank would be immaterial. SDG&E is completing negotiations for an appropriate site-remediation work plan for Station A with the County of San Diego Department of Environmental Health.

The Escondido facility was remediated during 1990 through 1993 at a cost of $3 million and a site closure letter from the Department of Environmental Health has been received. However, contaminants similar to those on the Escondido site have been observed on adjacent property. In 1997, SDG&E assessed the nature and extent of these off-site contaminants at a cost of $75,000. Hazardous contaminants were found on property to the east of the site and are believed to have originated from SDG&E operations.

Remediaion of these contaminants was initiated in 1997 and completed in 1998 at a total cost of

$250,000. A site-closure letter has been requested from the Department of Environmental Health.

Nonhazardous contaminants were determined to be present on property to the north, but may not require further action subject to future land-use decisions. Finally, potential contaminants resulting from the gas manufacturing process by-products were assessed at the Oceanside facility, as well as on adjacent property.

The cost to remediate the hazardous contaminants discovered in the assessment at the property adjacent to the Oceanside facility and at the facility itself is estimated to be $150,000.

Asbestos was used in the construction of SDG&E's Station B power plant, which closed in 1993 Activities to dismantle and decommission the facility require the removal of the asbestos in a manner com plying with all applicable environmental, health and safety laws. Thik work also includes the removal or cleanup of paints containing heavy metals and small amounts of PCBs, fuel oil and other substances. These activities commenced in 1997 at a cost of $3 million. This work effort is expected to be completed in 1998 at an estimated additional cost of $3 million.

Electric and Magnetic Fields (EMFs) In property-damage litigation in 1996, the California Supreme Court agreed with SDG&E and unanimously affirmed the 1995 California Court of Appeal decision that the CPUC has exclusive jurisdiction over EMF health and safety issues. The California Supreme Court also stated that scientific evidence is insufficient to conclude that EMFs pose a health hazard. In addition, in a December 1997 case involving Pacific Gas & Electric, the California Court of Appeal held that the CPUC has exclusive jurisdiction over EMF personal injury, as well as EMF property-damage cases. Plaintiffs have sought review of this case at the California Supreme Court, which request is still pending.

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0 N 1997 AnnualI Report Although scientists continue to research the possibility that exposure to EMFs causes adverse health effects, to date, science has demonstrated no cause-and-effect relationship between adverse health effects and exposure to the type of EMFs emitted by utilities' power lines and other electrical facilities. Some labo ratory studies suggest that such exposure creates biological effects, but those effects have not been shown to be harmful. The studies that have most concerned the public are certain epidemiological studies, some of which have reported a weak correlation between childhood leukemia and the proximity of homes to certain power lines and equipment. Other epidemiological studies found no correlation between estimated expo sure and any disease. Scientists cannot explain why some studies using estimates of past exposure report correlations between estimated EMF levels and disease, while others do not.

To respond to public concerns, the CPUC has directed California utilities to adopt a low-cost EMF reduction policy that requires reasonable design changes to achieve noticeable reduction of EMF levels that are anticipated from new projects. However, consistent with the major scientific reviews of the available research literature, the CPUC has indicated that no health risk has been identified.

Air Quality The San Diego Air Pollution Control District (APCD) regulates air quality in San Diego County in conformance with the California and Federal Clean Air Acts. California's standards are more restrictive than federal standards.

During 1996 and 1997, SDG&E installed equipment on South Bay Unit i in order to comply with the nitrogen oxide emission limits that the APCD imposed on electric-generating boilers through its Rule 69.

Under this rule, SDG&E must maintain the total nitrogen oxide emissions from its entire system below a prescribed emissions cap, which decreases periodically through 2005. The estimated capital costs for compliance with the rule through 2005 are $6o million. The California Air Resources Board has expressed concern that Rule 69 does not meet the requirements of the California Clean Air Act and may advocate or propose more restrictive emissions limitations which will likely cause SDG&E's Rule 69 compliance costs to increase.

Under a South Coast Air Quality Management District program called RECLAIM, SDG&E is required to reduce its nitrogen oxide emission levels of the natural gas compressor engines at its Moreno gas compression facility by to percent a year through 2003. This will be accomplished through the installation of new emission-monitoring equipment, operational changes to take advantage of low-emission engines and engine retrofits. The cost of complying with RECLAIM may be as much as $3 million.

Water Quality Wastewater discharge permits issued by the Regional Water Quality Control Board (RWQCB) for SDG&E's Encina and South Bay power plants are required to enable SDG&E to discharge its cooling water and certain other wastewaters into the Pacific Ocean and into San Diego Bay. Wastewater discharge permits are prerequisite to the continued cooling-water and other wastewater discharges and, therefore, the continued operation of the power plants as they are curre'ntly configured. Increasingly strin gent cooling-water and wastewater discharge limitations may be imposed in the future and SDG&E may be required to build additional facilities or modify existing facilities to comply with these requirements. Such facilities could include wastewater treatment facilities, cooling towers or offshore-discharge pipelines. Any required construction could involve substantial expenditures, and certain plants or units may be unavailable for electric generation during construction.

In 1981, SDG&E submitted a demonstration'study in support of its request for two exceptions to certain thermal discharge requirements imposed by the California Thermal Plan for Encina power plant Unit 5. In November 1994, the RWQCB issued a new discharge permit, subject to the results of certain additional thermal discharge and cooling-water-related studies, to be used in considering SDG&E's earlier thermal dis charge exception requests. The results of these additional studies were submitted to the RWQCB and the United States Environmental Protection Agency in 1997. If SDG&E's exception requests are denied, SDG&E could be required to construct off-shore discharge facilities at a cost of $75 million to $o million or to per form mitigation, the costs of which may be significant.

In November 1996, the RWQCB issued a new discharge permit to SDG&E for the South Bay power plant. SDG&E filed an appeal to the State Water Resources Control Board (SWRCB) of 'various provisions which SDG&E considers unduly stringent. The SWRCB has not yet formally acted on the appeal.

However, the SWRCB sponsored workshops with the RWQCB and the Environmental Health Coalition in November and December 1997, as a result of which several important issues may be resolved in 1998. As with the Encina power plant, increasingly stringent cooling-water and wastewater discharge limitations may require SDG&E to build additional facilities to comply with these requirements. To comply with its current permit, in 1997 SDG&E diverted its in-plant wastewater discharges from San Diego Bay to the sanitary sewer at a cost of $2 million.

During 1997, in conjunction with its permit requirements to treat wastewater at its Encina and South Bay power plants, SDG&E evaluated whether any remediation activities may be required at the power plants based on currently available records and other information. In addition, SDG&E evaluated whether remediation is required at its Silvergate plant, which was shut down in 1984. As a result of these evalua tions, only minor and localized remediation efforts were required. However, these evaluations did not

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include an extensive sampling and analysis of the property at such sites. Extensive sampling and analysis may identify additional contamination or other environmental conditions requiring remediation.

As previously discussed, in December 1997, SDG&E filed an application with the CPUC to divest its electric-generating assets, including its Encina and South Bay power plants, gas combustion turbines and its interest in the San Onofre Nuclear Generating Station. As a part of the sale of any such facilities, SDG&E will complete an environmental baseline analysis of such sites, which may identify significant con tamination or other environmental conditions requiring abatement or remediation.

The California Coastal Commission (CCC) required a study of the offshore impact on the marine envi ronment from the cooling-water discharge by SONGS Units 2 and 3 as a condition of granting a construc tion permit. The study concluded that some environmental damage is caused by the discharge. To mitigate the damage, the CCC ordered Southern California Edison, SDG&E and the cities of Anaheim and Riverside to improve the plant's fish-protection system, build a 300-acre artificial reef to help restore kelp beds and restore I50 acres of coastal wetlands. SDG&E and Edison asked the CCC to reconsider and modify this mitigation plan to reduce the size of the artificial reef and shorten the monitoring period based on new studies that show that the environmental damage is much less than anticipated. During 1997 the CCC ordered that the plant owners proceed with a mitigation program that includes the enhanced fish protection system, a 150-acre artificial reef and restoration of Io acres of coastal wetlands. In addition, plant owners must deposit $3.6 million with the state for the enhancement of miarine fish hatchery pro grams and pay for state monitoring and oversight of the mitigation projects. SDG&E's share of the cost is estimated to be $23 million. The pricing structure contained in the CPUC's decision regarding accelerated recovery of SONGS Units 2 and 3 (see "San Onofre Nuclear Generating Station" above) likely will accom modate most of these added mitigation costs.

New Accounting Standards In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement, which is effective for 1998 financial statements, requires reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. The term "com prehensive income" describes all changes in equity of a business enterprise during a period from transac tions and other events including, as applicable, foreign-currency items, minimum pension liability adjust ments and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption, financial statements for earlier periods provided for comparative purposes must be restated. The impact on Enova and SDG&E of the adoption of this new accounting standard is considered immaterial to the companies' financial statements.

Also in June 1997, the FASB issued SIAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement, which is effective for 1998 financial statements, requires that public companies report certain information about operating segments in complete sets of financial statements of the enterprise and in condensed financial statements of interim periods. It also requires certain information about the company's products and services, geographic areas in which they operate, and their major cus tomers. Under SIAS No. 131, operating segments are to be determined consistent with the way that man agement organizes and evaluates financial information internally for making operating decisions and assess ing performance. Upon adoption, statements for earlier periods provided for comparative purposes must reflect this information. The impact of the adoption of this new accounting standard is the potential redefi nition of the company's segments. The company estimates that the primary segments upon adoption of SFAS No. 131 will be electric operations, gas operations, energy services and other.

Information Regarding Forward-Looking Statements This Annual Report to Shareholders includes forward-looking statements within the definition of Section 27A of the Securities Act of,t933 and Section 21E of the Securities Exchange Act of 1934. When used in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," the words "estimates," "expects," "anticipates," "plans" and "intends," variations of such words, and similar expres sions are intended to identify forward-looking statements that involve risks and uncertainties.

Although Enova and SDG&E believe that their expectations are based on reasonable assumptions, they can give no assurance that thosd expectations will be realized. Important factors that could cause actual results to differ materially from those in the forward-looking statements herein include political develop ments affecting state and federal regulatory agencies, the pace and substance of electric industry deregulation in California and in the United States, the ability to effect a coordinated and orderly implementation of both state legislation and the CPUC's restructuring regulations, the consummation and timing of the proposed business combination of Enova and Pacific Enterprises, the timing and level of proceeds of sales of SDG&E's electric-generating assets, the level of sales of electricity, the rate of growth of nonutility subsidiary revenues, international political developments, environmental regulations, and the timing and extent of changes in interest rates and prices for natural gas and electricity.

40.

E NOVA CORP0RATION 1997 Anual Report Responsibility Report for the Consolidated Financial Statements Enova Corporation and SDG&E (collectively referred to as "Enova") are responsible for the consolidated financial statements and other data in this annual report. Enova's management believes the consolidated financial statements, which include amounts based on estimates and judgments of management, have been prepared in conformity with generally accepted accounting principles.

Management maintains the system of internal controls, which it believes is adequate to provide reasonable, but not absolute, assurance that its assets are safeguarded, that transactions are executed in accordance with its objectives, and that the financial records and reports are reliable for preparing the consolidated financial statements in accordance with generally accepted accounting principles.

The concept of reasonable assurance recognizes that the cost of a system of internal controls should not exceed the benefits derived and that management makes estimates and judgments of these cost/benefit factors. The system of intemal controls is supported by an extensive program of internal audits, selection and training of qualified personnel, and written policies and procedures.

Enova assesses its internal control system in relation to criteria for effective internal control as described in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on these assessments, Enova believes that as of December 31, 1997, its system of internal controls over financial reporting and safeguarding of assets meets those criteria.

Enova's independent auditors, Deloitte & Touche LLP, are engaged to audit Enova's consolidated financial statements in accordance with gen erally accepted auditing standards for the purpose of expressing their opinion as to whether Enova's consolidated financial statements are present ed fairly, in all material respects, in accordance with generally accepted accounting principles.

The audit committee, composed of directors who are not officers or employees of Enova, discusses with Enova's internal auditors and the inde pendent auditors the overall scope and specific plans for their respective audits. The committee also discusses Enova's consolidated financial state ments and the adequacy of Enova's internal controls. The committee met twice during the fiscal year with the intenal auditors, the independent auditors and management to discuss the results of their examinations, their evaluations of Enova's internal controls, and the overall quality of Enova's financial reporting. The internal auditors and the independent auditors have full and free access to the committee throughout the year.

David R. Kuzma Frank H. Ault Enova Corporation, San Diego Gas & Electric Senior Vice President, Chief Financial Officer and Treasurer Vice President, Chief Financial Officer, Treasurer and Controller Independent Auditors' Report To the Shareholders and Board of Directors of Enova Corporation:

We have audited the accompanying consolidated balance sheets and the statements of consolidated capital stock and of consolidated long-term debt of Enova Corporation and subsidiaries as of December 31, 1997 and 1996, and the related statements of consolidated income, consolidated changes in capital stock and retained earnings, consolidated cash flows, and consolidated financial information by segments of business for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's manage ment. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examing, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Enova Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.

DELOITTE & TOUCHE LLP San Diego, California February 23, 1998

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42 ENO VA CORPORATION 1997 Anua Report Consolidated Balance Sheets Balance at December 31 I thousands ofdolan 1997 1996 Assets Utility plant-at original cost

$ 5,888,539

$ 5,704,464 Accumulated depreciation and decommissioning (2,952,455)

(2,630,093)

Utility plant-net 2,936,084 3,074,371 Investments in partnerships and unconsolidated subsidiaries 5 16,1 13 271,035 Nuclear decommissioning trusts 399,143 328,042 Current assets Cash and temporary investments M

624,375 173,079 Accounts receivable 231,678 186,529 Notes receivable 27,083 33,564 Inventories 67,074 63,437 Other (D) 89,826 47,094 Total current assets 1,040,036 503,703 beferred taxes recoverable in rates 184,837 189,193 Deferred charges and other assets 157,711 282,893 Total

$ 5,233,924

$ 4,649,237 Capitalization and Liabilities Capitalization (see Statements of Consolidated 4 apital Stock and of Long-Term Debt)

Common equity

$ 1,570.383

$ 1,569,670 Preferred stock not subject to mandatory redemption 78,475 78,475 Preferred stock subject to mandatory redemption 25,000 25,000 Long-tern debt

(

2,057,033 1,479,338 Total capitalization 3,730,891 3,152,483 Current liabilities Current portion of long-term debt 121,700 69,902 Accounts payable 163,395 175,815 Dividends payable 46,050 47,213 Interest accrued 23,160 21,259 Regulatory balancing acounts overcollected-net 58,063 35,338 Other 146,267 158,317 Total current liabilities 558,635 507,844 Cistomer advances for construction 37,661 34,666 Accumulated deferred income taxes-net 501,030 497,400 Accumulated deferred investment tax credits 62,332 64,410 Deferred credits and other liabilities 343,375 392,434 Contingencies and commitments (Notes 9 and to)

Total

$ 5,233,924

$ 4,649,237 Excepts from Managements Discussion and Analysis (unaudited).

(A) The incrase in investments is primarily 4w to 1997 investments made in Enova Financial, Sempra Energy Trading and Sempra Energy Soltions.

M $658 million of rate-reduction bonds were issued in December 1997.

(c> The inmase in accounts receivable reflects inmmAes in ales in December 1997.

(D The increase in other current assets is primarily due to advances made to unconsolidated subihdaries during late 1997.

See nowter to consolidated financial statents.

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44.

EN 0 VA co Po oRAT1N 997 Annual Report Statements of Consolidated Changes in Capital Stock and Retained Earnings Preferred Stock For the years ended Nor Subject Subject to Premium on

cb31, 1999,W96, 1997 to 1andatory Mandatory Common Capital Retained In thousand ofdollars Redemption Redemption Stock Stock Earnings Balance, January 1, 1995

$ 93,493

$25,000

$291,341

$564,508

$ 618,581 Earnings applicable to common shares 225,794 Long-term incentive plan activity-net 117 1,530 Preferred stock retired (88o shares)

(18) 8 Common stock dividends declared (181 809)

Balance, December 31, 1995 93475 25,000 291,458 566,046 662,566 Earnings applicable to common shares 230,927 Long-term incentive plan activity-net 113 582 Preferred stock retired (150,000 shares)

(5,ooo)

15)

Common stock dividends declared (181,867)

Balance, December 31, 1996 78475 25,000 291,571 566473 7 11,626 Earnings applicable to common shares 251,607 Long-term incentive plan activity-net 172 1,158 Common stock retired (3,062,490 shares)

(7,656)

(66,145)

Common stock.dividends declared (178,423)

Balance, Decpmber 3 1, 1997

$ 78,475

$25,000

$284,087

$501,486 784,81o Si notes to consolidatad fiwancial statensets.

ENOVA CORPORATION

45.

Statements of Consolidated Capital Stock Balance at December x!

In shoaads of dllars ewt cal primr 1997 1996 Common Equity Common stock, without par value, authorized 300,000,000 shares, outstanding: 1997, I13,634,744 shares; i996, 116,628,735 shares 284,087

$ 291,571 Premium on capital stock 501,486 566,473 Retained earnings 784,810 711,626 Total common equity

$1,570,383

$1,569,670 Preferred Stock ^

Trading Call Not subject to mandatory redemption Symbolm)

Price

$20 par value, authorized 1,375,000 shares 5% Series, 375,000 shares outstanding SDOPrA

$ 2400 7,500 7,500 4.50% Series, 300,000 shares outstanding SDOPrB

$ 21.20 6,oo 6,ooo 4.40% Series, 325,000 shares outstanding SDOPrC

$ 21.00 6,5oo 6,500 4.60% Series, 373,770 shares outstanding

$ 20.25 7,475 7,475 Without par values0

$.o70 Series, I,4oo,ooo shares outstanding

$ 25.850) 35,000 35,obo

$1.82 Series, 64o,ooo shares outstanding SDOPrH

$ 26.oo )

16,ooo 16,oo Total not subject to mandatory redemption 78,475 78,475 Subject to mandatory redemption "Without par values0

$1.7625 Series, 1,ooo,000 shares outstanding

$ 25.00o) 25,000 25,000 (A) All seria of pford stock hA_ caudatiw pefmce as to diidmnd. The $20 par Vale prefemd steck has to Mt per sha, wrWWs the no par dwe prBferred stock is snsating. The $ao par u e

ptrrred stock has a liqpidation swine at par The wpar or s

prefemd stock has a liquidation Vue Of$25 per shar All listed shares are traded on the American Stock Exthange (C) SDG&E is aathorized to issue zooooooo sham total (kth subjec to and not ssbjk to MandatoY *dmption). Enon is authorized to isae 30,000,000 shares tWol, of which no shares awr issuedand outstanding at D*rk 31, 1997.

(D)The $1.70 and $r.7625 series are not callahe intil 2oo3; the $1.82 series is sttallable Autil Nowsher r998. AU other seris are cuwrntly callable (E> The $1.7625 si has a sinking find requirent to redeem 50,000 sham Per yrfm 2003 to 2007. The naining 750,000 share nusest redeemed in 2008.

Se nos to coasdidated financial statements.

46.

ENO VA C AD, RPORATIO N

1997 ANnual Report Statements of Consolidated Long-Term Debt Balance at December 31 First Call In thousands of dollars Date 1997 1996 SDG&E First mortgage bonds 5.5% Series I, due March 1, 1997 4/15/67 25,000 8.75% Series II, due March 1, 2o23(A) 9/1/97 25,000 9.625% Series JJ, due April 15, 2020 4/15/00 54,260 100,000 6.8% Series KK, due June 1, 2015"'

Non-callable 14,400 14400 8.5% Series LL, due April 1, 2022 4/1/0 43,725 60,000 7.62 5% Series MM, due June 15, 2002 Non-callable 80,000 80,000 6.i% and 6.4% Series NN, due September 1, lo18 and 2 0 1 9 " )

9/102 118,615 118,615 Various % Series 00, due December I, 2 0 2 7()

250,000 250,000 5.9% Series PP, due June i, 2018^

611/03 70,795 70,795 Variable % Series QQ, due June 1, 20 18( ^)

14,915 5.85% Series RR, due June 1, 202 1 6/1/03 6oooo 6oooo 5.9% Series SS, due September 1, 2018' 91/03 92,945 92,945 Variable 6 Series TT, due September 1, 2020(

57,650 57,650 Variable % Series UU, due September 1, 2020' 16,700 16,700 Total 859,09 986,020 Unsecured bonds 590%0 Series CPCFA96A, due June 1, 2014(

Non-callable 129,820 129,820 Variable %7 Series CV96A, due July 1, 2 02 1("

8 38,900 38,900 Variable 7% Series CV96B, due December 1, 2021 (c (9) 6o,ooo 6o,ooo Variable % Series CV97A, due March 1, 20234 7

25,000 Total 253,720 228,720 Rate-reduction bonds (N a

658,000

,Capitalized lease/

95,301 105,315 Other long-term debt 465 528 Unamortized discount on long-term debt (6,178)

(2,128)

Current portion of long-term debt (72,575)

(33,639)

Total SDG&E 1,787,823 1,284,816 Other Subsidiaries Debt incurred to acquire limited partnerships, various rates, payable annually through 2008 3 12,862 219,051 Other long-term debt 5,473 11,734 Current portion of long-term debt (49,125)

(36,263)

Total Other Subsidiaries 269,210 194,522 Total Enova

$ 2,057,033

$1,479,338 A)Issued to sece SDG&Es obligation under a series of loan agreements with the City of San Diego under which the city loaned the proceeds from the sale of ondatrial-devlopment revenue bonds to the company to finance certain quaifiedfacilities. All sertes are tax-exempt "xet QQ and U U.

SIssused to secure SDG6&Es obligation under a ser of loan agreements with the California Polluttion Control Financing Authority under which the Authority loaned posceeds from the sale of tax-exemrpt pollmnion-control revenue bonds to the company to finance certain qualified facilities.

(C) Issaed tow SDG&EFs obligation under a series of loan agreements with the City of Chula Vista under which the city loaned the prcedsfrom the sale of tax-exmt indrial development revenue bonds to the c ompany to finance cerain qualifled facilities.I I

(D) The first call date for $ 7 million is December 1, 2 02. The remaining $1Z75 million of the bond is curenty variable rate and is calable at twrious dates within one Year Of this, $45 million is subject to a floating-to-fixed rate swcp, which expires December 15, 2002 (See Nose 8).

Cal/able at various date within one year, Lsued to facilate so p ratroe reduction mnaebyCalifornia's eetic restruecturing law Issued in December 1997 at an anerage interet rtwe of 6.26 perent, Bonds are securd by the' revenue stroams collatd from customers over so years etan arent secured by utility assets.

See note to consoidad financial statement.

48.

N0VA CoRr PO AT ON 1997 Annual Report Notes to Consolidated Financial Statements Note t: Business Combination In October 1996 Enova Corporation and Pacific Enterprises (PE), parent company of Southern California Gas Company (SoCalGas), announced an agreement to combine the two companies. As a result of the combination, (i) each outstanding share of common stock of Enova will be converted into one share of common stock of the new company, (ii) each outstanding share of common stock of PE will be converted into 1.5038 shares of common stock of the new company and (iii) the preferred stock and preference stock of SDG&E, PE and SoCalGas will remain outstanding.

The combination was unanimously approved by the boards of directors of both companies and subsequent ly was approved by the shareholders of both companies. The combination will be a tax-free transaction and is expected to be accounted for as a pooling of interests. Enova and PE have selected Sempra Energy as the name of the new combined company, with the corporate headquarters to be located in San Diego, California.

Headquarters for SDG&E and SoCalGas, whose names will be retained, will remain in San Diego and Los Angeles, California, respectively. Consummation of the combination is conditional upon the approvals of the California Public Utilities Commission and various other regulatory bodies, with completion expected in the summer of 1998. On February 23, 1998, the CPUC's administrative law judge handling the proceeding issued a draft decision that proposed approval of the combination. Among other things, the draft decision proposed 50/50 sharing of the net cost savings resulting from the combination between shareholders and customers, but only for five years rather than the to years sought. The draft decision would reduce the net shareable savings from $i.x billion to $340 million. The CPUC decision is scheduled for the end of March 1998. Additional information concerning Enova/PE joint activities is discussed in Note 3 Note 2: Significant Accounting Policies Nature of Operations On January x, 1996, Enova Corporation (referred to herein as Enova, which includes the parent and its wholly owned subsidiaries) became the parent of SDG&E and its unregulated subsidiaries (referred to herein as nonutility subsidiaries). SDG&E's outstanding common stock was con verted on a share-for-share basis into Enova common stock. SDG&E's debt securities, preferred and prefer ence stock were unaffected and remain with SDG&E.

The consolidated financial statements include Enova and its wholly owned subsidiaries. The sub sidiaries include SDG&E, Califia, Enova Financial, Enova Energy, Enova Technologies, Enova International and Pacific Diversified Capital. In 1997, nonutility subsidiaries contributed 8 percent to operating income (8 percent in 1996 and 9 percent in 1995).

Utility Plant and Depreciation Utility plant represents the buildings, equipment and other facilities used by SDG&E to provide electric and gas service. The cost of utility plant includes labor, materials, contract services and related items, and an allowance for funds used during construction. The cost of retired depreciable utility plant, plus removal costs minus salvage value is charged to accumulated depreci ation. Information regarding industry restructuring and its effect on utility plant is included in Note ro.

Utility plant in service by major functional categories at December 31, 1997, are: electric generation

$x.8 billion, electric distribution $2.3 billion, electric transmission $0.7 billion, other electric $0.3 billion and gas operations $o.8 billion. The corresponding amounts at December 31, 1996, were essentially the same as 1997. Accumulated depreciation and decommissioning of electric and gas utility plant in service at December 31, 1997, are $2.6 billion and $0.4 billion, respectively, and at December 31, 1996, were

$2.2 billion and $0.4 billion, respectively.

Depreciation expense is based on the straight-line method over the useful lives of the assets or a short er period prescribed by the California Public Utilities Commission (CPUC) (for SONGS, see below). The provisions for depreciation as a percentage of average depreciable utility plant (by major functional cate gories) in 1997 and (in 1996, 1995, respectively) are: electric generation 8.$3 (7-57, 4.04), electric distri bution 4.39 (4.38, 4.36), electric transmission 3.28 (3.25, 3.21), other electric 6.02 (5.95, 5.89) and gas operations 4.03 (4.07, 4.06). The increases for electric generation in 1997 and 1996 reflect the accelerated recovery of San Onofte Nuclear Generating Station (SONGS) Units 2 and 3 approved by the CPUC in April 1996.

Inventories Included in inventories at December 31, 1997, are SDG&E's $43 million of materials and supplies ($46 million in 1996), and $22 million of fuel oil and natural gas ($23 million in 1996).

Materials and supplies are valued at average cost; fuel oil and natural gas are valued by the last-in first out (LIFO) method.

E NOV A

COR POR A TIO N

47, Statements of Consolidated Financial Information by Segments of Business At December 31 or for the years then ended In thousands of doars 1997 1996 199 Operating Revenue?

$2,217,oo7 1993474

$io,676 Operating Income Electric operations

$ 257,706

$ 269,038

$ 263,346 Gas operations 59,382 39,724 51,654 Other 27,082 26,201 30,650 Tbtal 344,170

$ 334,963

$ 345,650 Depreciation and Decommisioning Electric operations 286,804 279,251 227,6x6 Gas operations 37,078 35,027 33,225 Other 23,556 18,212 17,398 Total

$ 347,438

$ 332,490 278,239 Utility Plant Addition?

Electric operations

$ 160,689

$ 167,166

$ 171,151 Gas operations 36,495 41,684 49,597 Total 197,184 208,85o

$ 220,748 Identifiable Assets Utility plant-net Electric operations

$2,487,472

$2,625,620

$2,737,201 Gas operations 448,612 448,751 441,140 Total 2,936,084 3,074,371 3,178,341 Inventories Electric operations 50,354 47,445 53,828 Gas operations 15,036 15,633 14,131 Other 1,684 359 Total 67,074 63,437 67,959 Other identifiable assets Electric operations 770,885 697,145 802,172 Gas operations 128,525 161,252 148,714 Other 69 9,19 1(c 488,102 434,940 Total 1,598,601 I,346,499 1,385,826 Other Utility Assets 632,J65 164,930 116,498 Total Assets

$5,233,924

$4,649,237

$4,748,624

( The detail to operating renues is prwided in the Statements of Consolidated Income The gas operating revenes shown theeni incdde $14 million in 19 9 7,

$9 million in 1996 and $9 million in t995, representing the gross margin on sales to the electric segment. These margins arse from interdepartmental transfers of $544 millio in 1997, $1 "z million in 1996 and $85 million in 1995, based on tranrfer pricing appromd by the California Public Utilities Commission in tariff rates.

Exclueding alloreanefer equityfundr used during constractical l

$378 million in real state inwstments.

Utility income tax and awporae expeses an allocated beduan elti and gas operatson in aaw e with tegrlatory acanting reqsaireWets.

Ste notes to consolidoatedfinancial statements.

ENOVA CORPORATION

49.

Other Current Assets Included in other current assets at December 3P, 1997, is $44 million for Enova's current and deferred income taxes ($47 million in 1996). Included therein is SDG&E's portion of

$26 milliotf ($33 million in 1996).

Short-term Borrowings There were no short-term borrowings At December 31, 1997, and 1996. At December 31, 1997, SDG&E had $5o million of bank lines available to support commercial paper.

Commitment fees are paid on the unused portion of the lines and there are no requirements for compen sating balances.

Other Current Liabilities Included in other current liabilities at December 31, 1997, is Califia's

$21 million current portion of deferred lease revenue ($33 million in 1996) and $35 million for SDG&E's accrued vacation and sick leave ($33 million in 1996). In 1996 the $21 million noncurrent portion of Califia's deferred lease revenue is included in "Deferred Credits and Other Liabilities." The deferred rev enue is amortized over the lease terms that end in 1998.

Allowance for Funds Used During Construction (A FUDC) The allowance represents the cost of funds used to finance the construction of utility plant and is added to the cost of utility plant. AFUDC also increases income, as an offset to interest charges shown in the Statements of Consolidated Income, although it is not a current source of cash. The average rate used to compute AFUDC was 9.35 percent in 1997, 9.36 percent in 1996 and 9.74 percent in 1995.

Effects of Regulation SDG&E's accounting policies conform with generally accepted accounting princi ples for regulated enterprises and reflect the policies of the CPUC and the Federal Energy Regulatory Commission. SDG&E has been preparing its financial statements in accordance with the provisions of Statement of Financial Accounting Standards (SPAS) No. 71, "Accounting for the Effects of Certain Types of Regulation," under which a regulated utility may record a regulatory asset if it is probable that, through the ratemaking process, the utility will recover that asset from customers. Regulatory liabilities represent future reductions in revenues for amounts due to customers. To the extent that a portion of SDG&E's operations is no longer subject to SFAS No. 71, or recovery is no longer probable as a result of changes in regulation or SDG&E's competitive position, the related regulatory assets and liabilities would be written off. In addition, SFAS No.121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of," affects utility plant and regulatory assets such that a loss must be recognized whenever a regulator excludes all or part of an asset's cost from rate base. As discussed in Note to, California enacted a law restructuring the electric utility industry. The law adopts the December 1995 CPUC policy deci sion, and allows California utilities the opportunity to recover existing utility plant and regulatory assets over a transition period that ends in 2001. SDG&E has ceased the application of SPAS No. 71 with respect to its electric-generation business. SDG&E continues to evaluate the applicability of SPAS No.

121 as industry restructuring progresses. Additional information concerning regulatory assets and liabili ties is described below in "Revenues and Regulatory Balancing Accounts" and in Note io.

Revenues and Regulatory Balancing Accounts Revenues from utility customers have consisted of deliveries to customers and the changes in regulatory balancing accounts. Earnings fluctuations from changes in the costs of fuel oil, purchased energy and natural gas, and consumption levels for electricity and the majority of natural gas previously were eliminated by balancing accounts authorized by the CPUC. This is still the case for natural gas sales. However, as a result of California's electric restructuring law, beginning in 1997 overcollections recorded in the Energy Cost Adjustment Clause (ECAC) and Electric Revenue Adjustment Mechanism (ERAM) balancing accounts were transferred to the interim transition cost-balancing account, which is being applied to transition cost recovery (see Note 10). At December 31, 1997, overcollections of

$130 million were included in this account. Of this amount, $98 million of overcollections were recorded at December 31, t996. The elimination of ECAC and ERAM resulted in quarter-to-quarter earnings volatility in 1997. This earnings volatility will continue in future years. Additional information on indus try restructuring is included in Note 10.

DQeferred Charges and Other Assets Deferred charges include SDG&E's unrecovered premium on early retirement of debt and other regulatory-related expenditures that SDG&E expects to recover in future rates, excluding generation operations (discussed above). These items are amortized as recovered in rates.

The net regulatory assets associated with SDG&E's generation operations at December 31, 1997, were credited to the interim transition cost-balancing account.

Deferred Credits and-Other Liabilities Other liabilities at December 31, 1997, include $rr7 million of accumulated decommissioning costs associated with SONGS Unit 1 ($96 million in 1996), which was permanently shut down in 1992. Additional information on SONGS Unit i decommissioning costs is included in Note 5.

50.

No VA CORPORAT1ON 1997 Annual Report Discontinued Operations Enova's financial statements for periods prior to 1996 reflect the June 1995 sale of Wahico Environmental Systems, Inc. as discontinued operations, in accordance with Accounting Principles Board Opinion No.

30, "Reporting the Effects of a Disposal of a Sekment of Business." Discontinued operations are summarized in the table below:

In millions of dollars t995 Revenues

$ 24 Loss from operations before income taxes Ioss on disposal before income taxes (12)

Income tax benefits 12 The loss on disposal of Wahico reflects the sale of Wahico and Wahlco's 1995 net operating losses prior to the sale.

Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Statements of Consolidated Cash Flows Temporary investments are highly liquid investments with orig inal maturities of three months or less, or investments that are readily convertible to cash.

Basis of Presentation Certain prior-year amounts have been reclassified to conform to the current year's format.

Note 3: Significant Acquisitions and Joint Ventures Sempra Energy Trading On December 31, 1997, Enova and Pacific Enterprises completed their acquisi tion (5o% interest each) of Sempra Energy Trading (formerly AIG Trading Corporation), a leading natural gas and power marketing firm headquartered in Greenwich, Connecticut, for a total cost of $225 million.

Sempra Energy Trading's primary business focus is wholesale trading and marketing of natural gas, power and oil to customers primarily in North America. Sempra Energy Trading had net assets Of $30 million at December 3 p1, i997o An allocation of the purchase price has not yet been completed. The difference between the cost and underlying equity in the net assets will be amortized over a period of not more than 15 years.

As of December 31, 1997, Sempra Energy Trading's trading assets and trading liabilities approximate the following:

In millions of dollars Trading Assets Unrealized gains on swaps and forwards

$ 497 Due from commodity clearing organization and clearing brokers 41 OTC commodity options purchased 33 Due from trading counterparties 16 Total

$587 Trading Liabilities Unrealized losses on swaps and forwards

$487 Due to trading counterparties 41 OTC commodity options written 29 Total

$557 The notional amounts of Sempra Energy Trading's financial instruments are provided below and include a maturity profile as of December 31, 1997 based upon the expected timing of the future cash flows. The notional amounts do not necessarily represent the amounts exchanged by parties to the finan cial instruments and do not measure Sempra Energy Trading's exposure to credit or market risks. The notional or contractual amounts are used to summarize the volume of financial instruments, but do not reflect the extent to which positions may offset one another. Accordingly, Sempra Energy Trading is exposed to much smaller amounts potentially subject to risk.

ENOVA CORPORATION

51.

Within One to Five Five to Ten After in millions of dollas One Year Years Years Ten Years Total Forwards and commodity swaps

$3,175

$458

$ 90

$ 74

$3,797 Futures 856 189 1,045 Options purchased 704 52 756 Options written 592 62 654 Total

$5,327

$761

$ 90 74

$6,252 Enova and Pacific Enterprises have jointly and severally guaranteed certain trading obligations of Sempra Energy Trading with credit worthy counterparties in connection with authorized transactions and in connection with funding. The total obligations guaranteed by the companies as of December 31, 1997, are $ 1 90 million.

Sempra Energy Solutions In January 1998 Sempra Energy Solutions completed the acquisition of CES/Way International, a leading national energy service provider. In September 1997 Sempra Energy Solutions formed a joint venture with Bangor Hydro to build, own and operate a $40 million natural gas distribution system in Bangor, Maine. In December 1997, Sempra Energy Solutions signed a partnership agreement with Frontier Utilities to build and operate a $5s million natural gas distribution system in North Carolina.

Enova International Gas Distribution Projects Enova International, Pacific Enterprises International and Proxima S.A. de C.V., partners in the Mexican companies Distribuidora de Gas Natural de Mexicali and Distribuidora de Gas Natural de Chihuahua, are the licensees to build and operate natural gas distrib ution systems in Mexicali and Chihuahua. DGN - Mexicali will invest up to $25 million during the first five years of the 30-year license period. DGN - Chihuahua plans to invest $50 million in the gas distribu tion project in Chihuahua over the next five years.

El Dorado Power Project In December 1997, Enova Power Corporation, a subsidiary of Enova, and Houston Industries Power Generation (HIPG) formed a joint venture, El Dorado Energy, to build, own and operate a 480-megawatt natural gas-fired plant in Boulder City, Nevada. Total cost of construction is expected to be $280 million, with each company providing 5o percent of the funding. Enova Power and HIPG each will be responsible for 5o percent of the plant's fuel procurement and output marketing.

Construction on the plant is expected to begin in the first quarter of 1998 and be completed in the fourth quarter of 1999.

Note 4: Long-Term Debt Amounts and due dates of long-term debt are shown on the Statements of Consolidated Long-Term Debt.

Excluding capital leases, which are described in Note 9, maturities of long-term debt for SDG&E are

$66 million due in 1998, $65 million due in 1999, 2oo and 2001, and $145 million due in 2002. Total maturities of long-term debt for nonutility subsidiaries are $49 million for 1998j $53 million for 1999,

$44 million for 2000, $35 million for 200r and $34 million for 2002. SDG&E has CPUC authorization to issue an additional $185 million in long-term debt.

First Mortgage Bonds First mortgage bonds are secured by a lien on substantially all of SDG&E's utility plant. Additional first mortgage bonds may be issued upin compliance with the provisions of the bond indenture, which provides for, among other things, the issuance of an additional $1.3 billion of first mort gage bonds at December 31, 1997. Certain first mortgage bonds may be called at SDG&E's option.

First mortgage bonds totaling $249 million have variable-interest-rate provisions. During 1997, SDG&E retired $127 million of first mortgage bonds of which $102 million were retired prior to sched uled maturity.

Unsecured Bonds During, 1997, SDGrE issued $25 million of unsecured bonds. Unsecured bonds total ing $124 million have variable-interest-rate provisions.

Rate-Reduction Bonds In December 1997, $658 million of rate-reduction bonds were issued on behalf of SDG&E at an average interest rate of 6.26 percent. These bonds were issued to facilitate the 1o-percent rate reduction mandated by California's electric restructuring law. These bonds are being repaid over io years by SDG&E's residential and small-commercial customers via a charge on their electricity bills. These bonds are secured by the revenue streams collected from customers and are not secured by, or payable from, utility assets. Additional information on rate-reduction bonds and electric industry restructuring is discussed in Note o.

52.

E NOV A C 0 RPOZRA T 1O 0 J.19 nulRpr Other At December 31, 1997, SDG&E had $340 million of bank lines, providing a committed source of long-term borrowings, with no debt outstanding. Bank lines, unless renewed by SDG&E, expire in 1998

($6o million) and in 2ooo ($28o million). Commitment fees are paid on the unused portion of the lines and there are no requirements for compensating balances.

Nonutility loans (Enova Financial and Califia) Of$318 million and $231 million at December 30, 1997, and 1996, respectively, are secured by real estate and equipment.

SDG&E's interest payments, including those applicable to short-term borrowings, amounted to

$89 million in 1997, $93 million in 1996 and $ioo million in 1995. Nonutility interest payments amounted to $12 million in 1997, $12 million in 1§96 and $14 million in 19c5.

SIDG&E periodically enters into interest-rate swap and cap agreements to moderate its exposure to interest-rate changes and to lower its overall cost of borrowings. At December 31, 1997, SDG&E had such an agreement, maturing in 2002, with underlying debt of $45 million. See additional information in Note 8.

Although holders of variable-rate bonds may elect to redeem them prior to scheduled maturity, for purposes of determining the maturities listed above, it is assumed the bonds will be held to maturity.

Note 5: Facilities Under joint Ownership SONGS and the Southwest Powerlink transmission line are owned jointly with other utilities. SDG&E's interests at December 31, 1997, are:

I millions ofdollars Southwest Project SONGS Powerlink Percentage ownership 20 89 Utility plant in service

$ 1,143

$217 Accumulated depreciation

$, 593

$ 96 Construction work in progress 9

SDG&E's share of operating expenses is included in the Statements of Consolidated Income. Each partic ipant in the projects must provide its own financing. The amounts specified above for SONGS include nuclear production, transmission and other facilities.

SONGS Decommissioning Objectives, work scope and procedures for the future dismantling and decon tamination of the SONGS units must meet the requirements of the Nuclear Regulatory Commission, the Environmental Protection Agency, the California Public Ttilities Code and other regulatory bodies.

SDG&E's share of decommissioning costs for the SONGS units is estimated to be $401 million in cur rent dollars and is based on studies performed and updated periodically by outside consultants. The most recent study was performed in 1993. A new study is planned for 1998. A new escalation methodology was utilized to estimate the liability in 1997. This methodology was authorized by the CPUC izt its 1996 Performance-Based Ratemaking decision for Southern California Edison (principal owner of SONGS), and incorporates an internal rate of return calculation that results in higher escalation amounts. Although electric industry restructuring legislation requires that stranded costs, which include SONGS plant costs, be amortized in rates by 2001, the recovery of decommissioning costs is allowed until the time as the costs are fully recovered.

The amount accrued each year is based on the amount allowed by regulators and is currently being collected in rates. This amount is considered sufficient to cover SDG&E's share of future decommissioning costs. The depreciation and decommissioning expense reflected on the Statements of Consolidated Income includes $22 million of decommissioning expense for each of the years 1997, 1996 and 1995.

The amounts collected in rates are invested in externally managed trust funds. In accordance with SFAS No. I15, "Accounting for Certain Investments in Debt and Equity Securities," the securities held by the tiust are considered available for sale and are adjusted to market value ($399 million at December 31, 1997, and $328 million at December 31, 1996) and shown on the Consolidated Balance Sheets. The fair values reflect unrealized gains of $89 million and $5o million at December 31, 1997, and 1996, respectively. The corresponding accumulated accrual is included on the Consolidated Balance Sheets in "Accumulated Depreciation and Decommissioning" for SONGS Units 2 and 3 and in "Deferred Credits and Other Liabilities" for Unit i. SONGS Unit i was permanently shut down in 1992.

The Financial Accounting Standards Board is reviewing the accounting for liabilities related to closure and removal of long-lived assets, such as nuclear power plants, including the recognition, measurement and classification of such costs. The Board could require, among other things, that SDG&E's future bal ance sheets include a liability for the estimated decommissioning costs, and a related increase in the cost of utility plant.

Additional information regarding SONGS is included in Notes 9 and io.

ENOVA CORPORATION

53.

Note 6: Employee Benefit Plans Pension Plan SDG&E has a defined-benefit pension plan, which covers substantially all of its employees.

Benefits are related to the employees' compensation. Plan assets consist primarily of common stocks and bonds. SDG&E funds the pln based on the projected unit credit actuarial cost method. Net pension cost consisted of the following for the years ended December 31:

In thouands ofdar 1997 1996 1995 Cost related to current service

$ 16,756

$ 18,547

$ 14,598 Interest on projected benefit obligation 39,089 37,253 30,760 Return on plan assets (119,554)

(72,829)

(132,674)

Net amortization and deferral 63,500 25,315 93,708 Cost pursuant to general accounting standards (209) 8,286 6,392 Regulatory adjustment (15,286) 6o8 Net cost (benefit)

(209)

$ (7,000) 7,000 The plan's status was as follows at December 31:

In thousands of dollar 1997 1996 Accumulated benefit obligation Vested

$ 495,278

$ 435,029 Non-vested 11,637 12,321 Total

$ 506,915

$ 447,350 Plan assets at fair value

$ 699,000

$ 598,61o Projected benefit obligation 589,911 539,391 Plan assets less projected benefit obligation 109,089 59,219 Unrecognized effect of accounting change (761)

(950)

Unrecognized prior service cost 28,444 31,315 Unrecognized actuarial gains (204,o61)

(157,082)

Net liability

$ (67,289)

$ (67,498)

The projected benefit obligation assumes a 7.25-percent actuarial discount rate in 1997 (7.50 percent in 1996) and a 5.0-percent average annual compensation increase. The expected long-term rate of return on plan assets is 8.5 percent. The increase in the total accumulated benefit obligation and projected benefit obligation at December 31, 1997, is due primarily to a decrease in the actuarial discount rate. SDG&E's annual cost for a supplemental retirement plan for a limited number of key employees was approximately

$3 million in 1997, 1996 and x995.

Post-Retirement Health Benefits SDG&E provides certain health and life insurance benefits to retired employees. These benefits are accrued during the employee's years of service, up to the year of benefit eli gibility. SDG&E is recovering the cost of these benefits based upon actuarial calculations and funding limitations. The costs for the benefits were $4 million in 1997, $5 million in 1996 and $5 million in 1995. These costs include $2 million of amortization per year for the unamortized transition obligation (arising from the initial implementation of this accounting policy) of approximately $31 million, which is being amortized through 2012.

Savings Plan Essentially all employees are eligible to participate in SDG&E's savings plan. Eligible employees may make a contribution of i percent to I5 percent of their base pay to the savings plan for investment in mutual funds or in Enova common stock. SDG&E contributes amounts equal to up to 3 percent of participants' compensation for investment in Enova common stock. SDG&E's annual compensa tion expense for this plan was $3 million in 1997, $2 million in 1996 and $2 million in 1995.

Stock-Based Compensation Enova has a long-term incentive stock compensation plan that provides for aggregate awards of up to 2,700,000 shares of Enova common stock. The plan terminates in April 2005. In each of the last 10 years, 49,000 shares to 75,000 shares of stock were issued to officers and key employees, subject to forfeiture over four years if certain corporate goals are not met. The long-term incentive stock compensation plan also provides for the granting of stock options. In October 1997, Enova rescinded all options granted in October 1996. There were no stock options outstanding at December 31, 1997. As per mitted by SFAS No. 123, "Accounting for Stock-Based Compensation," SDG&E has adopted the disclo sure-only requirements of SFAS No. 123 and continues to account for stock-based compensation by apply ing the provisions of Accounting principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The differences between compensation cost included in net income and the related cost mea sured by the fair-value-based method defined in SFAS No. 123 are immaterial. SDG&E's compensation expense for this plan was approximately $x million in 1997, $1 million in 1996 and $2 million in 1995..

54-E N 0V A

CO0R P 0RA TIO 1

-t 1997 AnnutalRep,?rt Note 7: Income Taxes Income tax payments totaled $162 million in 1997, $176 million in 1996 and $148 million in 1995.

The components of accumulated deferred income taxes at December 3 1 are as follows:

In thoeand ofdollars 1997 1996 Deferred tax liabilities Differences in financial and tax bases of utility plant

$ 567,804

$ 628,617 Loss on reacquired debt 30,535 26,399 Other 91,708 80,033 Total deferred tax liabilities 69o,047 735,049 Deferred tax assets Unamortized investment tax credits 62,r44 66,729 Equipment leasing activities 8,494 22,333 Regulatory balancing accounts 27,903 37,010 Unbilled revenue 22,365 21,923 Other' 89,856 123,158 Total deferred tax assets 2 0,762 27II53 Net deferred income tax liability 479,28 5 463,896 Current portion (net asset) 21,745 33,504 Non-current portion (net liability)

$ 501,030

$ 497,400 The components of income tax expense are as follows:

In thousands of dollars T997 1996 1995 Current Federal

$ 93,040

$ 1154ro

$ 134,212 State 38413 39,939 42,630 Total current taxes 131453 155,349 176,842 Deferred Federal 23,222 434 (23,914)

State 1,600 (1,518)

(13,464)

Total deferred taxes 24,822 (1,084)

(37,378)

Deferred investment tax credits - net (6,073)

(5,791)

(4,859)

Total income tax expense

$ 150,202

$ 148,474

$ 134,605 Federal and state income taxes are allocated between operating income and other income.

The reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:

1997 1996 1995 Statutory federal income tax rate 35.0%

35.0%

35.0%

Depreciation 8.1 6.3 5.5 State income taxes - net of federal income tax benefit 7.0 6.9 5.5 Tax credits (00.8)

(9.5)

(7.6)

Equipment leasing activities (2.3)

(2.8)

(2.8)

Repair allowance (1.9)

(1.2)

(3.0)

Other - net 2.3 4-4 4.8 Effective income tax rate 37-4%

39.1%

37.4%

Note 8: Financial Instruments Fair Value The fair values of financial instruments (cash, temporary investments, funds held in trust, notes receivable, vestments in limited partnerships, dividends payable, short-and long-term debt, deposits from customers, and preferred stock subject to mandatory redemption) are not materially different from the carrying amounts, except for long-term debt. The carrying amounts and fair value of long-term debt are $2.1 billion and $2.2 billion, respectively, at December 31, 1997, and $1.5 billion and $1.5 bil lion, respectively, at December 31, 1996. The fair values of SDG&E's first mortgage bonds are estimated based on quoted market prices for them or for similar issues. The fair values of long-term notes payable are based on the present values of the future cash flows, discounted at rates available for similar notes with comparable maturities. The fair values of the rate-reduction bonds issued in December 1997 are estimated to approximate carrying value due to the relatively short period of time between the issuance date and the valuation date, and the relative market stability during those periods.

Off-Balance-Sheet Financial Instruments Enova's policy is to use derivative financial instruments to reduce its exposure to fluctuations in interest rates, foreign-currency exchange rates and natural gas prices.

sNoVA CoRePORATO 55 These financial instruments expose Enova to market and credit risks which may at times be concentrated with certain counterparties, although counterparty nonperformance is not anticipated.

Interest-Rate-Swap Agreements SDG&E periodically enters into interest-rate-swap agreements to moder ate its exposure to interest-rate changes and to lower its overall cost of borrowing. These swap agreements generally remain off the balance sheet as they involve the exchange of fixed-and variable-rate interest pay ments without the exchange of the underlying principal amounts. The related gains or losses are reflected in the income statement as part of interest expense. At December 31, 1997, SDG&E had one interest-rate swap agreement: a floating-to-fixed-rate swap associated with $45 million of variable-rate bonds maturing in 2002. SDG&E expects to hold this derivative financial instrument to its maturity. This swap agreement has effectively fixed the interest rate on the underlying variable-rate debt at 5.4 percent. SDG&E would be exposed to interest-rate fluctuations on the underlying debt should the counterparty to the agreement not perform. Such nonperformance is not anticipated. This agreement, if terminated, would result in an obliga tion of $2 million at December 31, 1997, and at December 31, 1996.

Foreign-Currency Forward Exchange Contracts SDG&E's pension fund periodically uses foreign currency forward contracts to reduce its exposure to exchange-rate fluctuations associated with certain investments in foreign equity securities. These contracts generally have maturities ranging from three to six months. At December 31, 1997, there were no fbreign-currency forward contracts outstanding.

Energy Derivatives SDG&E uses energy derivatives for both hedging and trading purposes within certain limitations imposed by company policies. These derivative financial instruments include fbrward contracts, swaps, options and other contracts which have maturities ranging from*3o days to nine months. SDG&Eks accounting policy is to adjust the book value of these derivatives to market each month with gains and losses recognized in earnings. These instruments are included in other current assets on the Consolidated Balance Sheet. Certain instruments such as swaps are entered into and closed out within the same month and, therefore, do not have any balance sheet impact. Gains and losses are included in electric or gas rev enue or expense, whichever is appropriate, on the Consolidated Income Statement.

As of December 31, 1997, the net fair value of open positions was $5.9 million. The net unrealized profit of these open positions was $0.3 million. These positions hedge approximately 6 percent of SDG&E's annual total purchased-gas volumes. The average fair value of derivative financial instruments during 1997 was an obligation of $O.2 million. The net gains arising from these activities during 1997 were $2.5 mil lion. Infbrmation on derivative financial instruments of Sempra Energy Trading is provided in Note 3.

Market and Credit Risk SDG&E and Sempra Energy Trading utilize a variety of financial structures, products and terms which require the company to manage, on a portfolio basis, the resulting market risks inherent in these transactions, subject to parameters established by company policies. Market risks are monitored separately from the groups that create or actively manage these risk exposures to ensure compli ance with the company's stated risk management policies.

Credit risk relates to the risk of loss that would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. SDG&E and Sempra Energy Trading avoid concen tration of counterparties and maintain credit policies with regard to counterparties that management believes significantly minimize overall credit risk.

A Risk Management Committee, composed of Enova and Pacific Enterprises officers, is responsible for monitoring operating performance and compliance with established risk management policies for Sempra Energy Solutions and its subsidiaries.

Note 9: Contingencies and Commitments Purchased-Power Contracts SDG&E buys electric power under several short-term and long-term con tracts. Purchases are for up to 7 percent of plant capacity under contracts with other utilities and up to oo percent of plant capacity under contracts with nonutility suppliers. No one supplier provides more than 3 percent of SDG&E's total system requirements. The contracts expire on various dates between 1998 and 2025.

At December 31, 1997, the estimated future minimum payments under the contracts were:

14 wiliom of ddlars 1998 234 1999 232 2000 200 2001 183 2002 134 Thereafter 2,462 Total minimum paymentsA

56.

E N 0VA C 0oPoRAT 11997Anal Rpert These payments represent capacity charges and minimum energy purchases. SDG&E is required to pay additional amounts for actual purchases of energy that exceed the minimum energy commitments. TQtal payments, including energy payments, under the contracts were $421 million in 1997, $296 million in 1996 and $329 million in 1995. Payments under purchased-power contracts increased in 1997 due to increased sales volume and lower nuclear gineration availability.

In November 1997, SDG&E announced a plan to auction its power plants and other electric-generat ing resources, which include its long-term purchased-power contracts. Additional information on SDG&E's plan to divest its electric-generating assets is discussed in Note zo.

Natural Gas Contracts SDG&B has a contract with Southern California Gas Company (SoCalGas) that provides SDG&E with intrastate transportation capacity on SoCalGas' pipelines. This contract is currently being renegotiated and continues on a month-to-month basis under the original terms until a new agree ment is reached. The commitment presumes a contract renewal for one year. SDG&E's long-term con tracts with interstate pipelines for transportation capacity expire on various dates between 2007 and 2023. SDG&E's contract with SoCalGas for 8 billion cubic feet of natural gas storage capacity expires in March 1998. A new agreement has been reached for 6 billion cubic feet of natural gas storage capacity from April z998 through March 1999. SDG&E has long-term natural gas supply contracts (included in the table below) with four Canadian suppliers that expire between 200 and 20o4. SDG&E has been involved in negotiations and litigation with the suppliers concerning the contracts' terms and prices.

SDG&E has settled with one supplier, with gas being delivered under the terms of the settlement agree ment. The remaining suppliers have ceased deliveries pending legal resolution. A U.S. Court of Appeals has upheld a U.S. District Court's invalidation of the contracts with two of these suppliers, although the value of the gas delivered has not yet been determined by the court.

At December 31, 1997, the future minimum payments under natural gas contracts were:

Transportation Natural In mliaws ofddlars and Storage Gas 1998

$ 65

$ 19 p999 15 17 2000 14 19 2001 14 21 2002 14 24 Thereafter 234 25 Total minimum payments

$ 356

$125 Total payments under the contracts were $125 million in 1997, $ioo million in 1996 and

$95 million in 1995.

Leases SDG&E has nuclear fuel, office buildings, a generating facility and other properties that are financed by long-term capital leases. Utility plant includes $198 million at December 31, 1997, and

$2oo million at December 3 z, z996, related to these leases. The associated accumulated amortization is

$1o2 million and $95 million, respectively. SDG&E and nonutility subsidiaries also lease office facilities, computer equipment and vehicles under operating leases. Certain leases on office facilities contain escala tion clauses requiring annual increases in rent ranging from 2 percent to 7 percent.

The minimum rental commitments payable in future years under all noncancellable leases are:

Operating Capitalized In rilion efdlrs Enova SDG&E SDG&E 1998 35

$ 1$

26 1999 12 12 26 2000 12 12 20 2oot 8

8 12 2oo2 8

8 12 Thereafter 36 36 Total future rental commitment II86 Imputed interest (6% to 9%)

(21)

Net commitment

$95 Enova's rental payments totaled $8x million in 1997, $88 million in 1996 and $85 million in 1995.

Included in these amounts are SDG&E payments of $43 million, $46 million and $

million, respectively.

SNOVA CORPORATION

57.

Environmental Issues SDG6E's operations are conducted in accordance with federal, state and local envi ronmental laws and regulations governing hazardous wastes, air and water quality, land use, and solid waste disposal. SDG&E incurs significant costs to operate its facilities in compliance with these laws and regulations. The costs of compliance with environmental laws and regulations have been recovered in cus tomer rates. Capital expenditures to comply with environmental laws and regulations were $4 million in 1997, $6 million in 1996 and $4 million in 1995, and are expected to be $38 millioi-over the next five years.

These expenditures primarily include the estimated cost of retrofitting SDG&E's power plants to reduce air emissions.

SDG&E has been associated with various sites which may require remediation under federal, state or local environmental laws. SDG&E is unable to determine the extent of its responsibility for remediation of these sites until assessments are completed. Furthermore, the number of others that also may be responsi ble, and their ability to share in the cost of the cleanup, is not known. Environmental liabilities that may arise from these assessments are recorded when remedial efforts are probable, and the costs can be estimat ed. In 1994 the CPUC approved the Hazardous Waste Collaborative Memorandum account allowing util ities to recover their hazardous waste costs, including those related to Superfund sites or similar sites requiring cleanup. The decision allows recovery of 9o percent of cleanup costs and related third-party liti gation costs and 70 percent of the related insurance-litigation expenses. As discussed in Note 1o, restruc turing of the California electric utility industry will change the way utility rates are set and costs are recovered. Both the CPUC and state legislation have indicated that the California utilities will be allowed an opportunity to recover existing utility plant and regulatory assets over a transition period that ends in 2001. SDG&E has asked the CPUC that beginning on January 1, 1998, the collaborative account be mod ified, and that electric-generation-related cleanup costs be eligible for transition cost recovery. A CPUC decision is still pending. Depending on the final outcome of industry restructuring and the impact of competition, the costs of compliance with environmental regulations may not be fully recoverable.

Nuclear Insurance SDG&E and the co-owners of SONGS have purchased primary insurance of $2oo mil lion, the maximum amount available, for public-liability claims. An additional $8.7 billion of coverage is provided by secondary financial protection required by the Nuclear Regulatory Commission and provides for loss sharing among utilities owning nuclear reactors if a costly accident occurs. SDG&E could be assessed retrospective premium adjustments of up to $32 million in the event of a nuclear incident involv ing any of the licensed, commercial reactors in the United States, if the amount of the loss exceeds

$2oo million. In the event the public-liability limit stated above is insufficient, the Price-Anderson Act provides for Congress to enact further revenue-raising measures to pay claims, which could include an additional assessment on all licensed reactor operators.

Insurance coverage is provided for up to $2.8 billion of property damage and decontamination liability.

Coverage is also provided for the cost of replacement power, which includes indemnity payments for up to three years, after a waiting period of 17 weeks. Coverage is provided primarily through mutual insurance companies owned by utilities with nuclear facilities. If losses at any of the nuclear facilities covered by the risk-sharing arrangements were to exceed the accumulated funds available from these insurance programs, SDG&E could be assessed retrospective premium adjustments of up to $6 million.

Department of Energy Decommissioning The Energy Policy Act of x992 established a fund for the decon tamination and decommissioning of the Department of Energy niclear-fuel-enrichment facilities. Utilities using the DOE services are contributing a total of $2.3 billion, subject to adjustment for inflation, over a 15-year period ending in 2oo6. Each utility's share is based on its share of enrichment services purchased from the DOE. SDG6E's annual contribution is $i million, and will be recovered as part of decommis sioning costs (see Note to).

Litigation Enova and its subsidiaries, including SDG&E, are involved in various legal matters, including those arising out of the ordinary course of business. Management believes that these matters will not have a material adverse effect on Enova's results of operations, financial condition or liquidity.

Distribution System Cotversion Under a CPUC-mandated program and through franchise agreements with various cities, SDG&E is committed, in varying amounts, to convert overhead distribution facilities io underground. As of December 31, 1997, the aggregate unexpended amount of this commitment was approximately $zoo million. Capital expenditures for underground conversions were $17 million in 1997,

$15 million in 1996 and $12 million in 1995.

Concentration of Credit Risk SDG&E grants credit to its utility customers, substantially all of whom are located in its service territory, which covers all of San Diego County and an adjacent portion of Orange County.

58 3 NaVA CoR PRT N

997 Asnsat Report Note io: Industry Restructuring In September 1996, the state of California enacted a law restructuring California's electric utility industry (AB 1890). The legislation adopts the December r995 CPUC policy decision restructuring the industry to stimulate competition and reduce rates. The new law supersedes the CPUC policy decision when in conflict.

Beginning on March 31, 1998, customers will be able to buy their electricity through a power exchange that will obtain power from qualifying facilities, nuclear units, and, lastly, from the lowest-bid ding suppliers. The power exchange will serve as a wholesale power pool allowing all energy producers to participate competitively. An Independent System Operator (ISO) will schedule power transactions and access to the transmission system. Consumers also may choose either to continue to purchase from their local ntility under regulated tariffs or to enter into private contracts with generators, brokers or others. The local utility will continue to provide distribution service regardless of which source the consumer chooses.

Utilities are allowed a reasonable opportunity to recover their stranded costs through December 3 1, 2001. Stranded costs, such as those related to reasonable employee-related costs directly caused by restruc turing and purchased-power contracts (including those with qualifying facilities), may be recovered beyond December 31, 200. Outside of those exceptions, stranded costs not recovered through 200 will not be collected from customers. Such costs, if any, would be written off as a charge against earnings.

SDG&B's transition-cost application filed in October 1996 identifles costs totaling $2 billion (net pre sent value in 1998 dollars). These identified transition costs were determined to be reasonable by indepen dent auditors selected by the CPUC, with $73 million requiring further action before being deemed recov erable transition costs. Of this amount, the CPUC has excluded from transition cost recovery $39 million in fixed costs relating to gas transportation to power plants, which SDG&E believes will be recovered through contracts with the ISO. Total transition costs include sunk costs, as well as ongoing costs the CPUC finds reasonable and necessary to maintain generation facilities through December 31, 2001. Both the CPUC policy decision and AB i89o provide that above-market costs for existing purchased-power con tracts may be recovered over the terms of the contracts or sooner. Qualifying facilities purchases include approximately too existing contracts, which extend as ft as 2025. Other power purchases consist of two long-term contracts expiring in 200 and 2013. Transition costs also include other items SDG&E has accrued under cost-of-service regulation. Nuclear-decommissioning costs are nonbypassable until fully recovered, but are not included as part of transition costs.

Through December 31, 19 97, SDG&E has recovered transition costs of $o.2 billion for nuclear genera tion and $o.! billion for nonnuclear generation. Additionally, overcollections of $o.1 billion recorded in the ECAC and ERAM balancing accounts as of December 3 z, 1997, have been applied to transition cost recov ery, leaving approximately $1.6 billion for future recovery. Included therein is $0.4 billion for post-200 purchased-power-contract payments that may be recovered after 2oo1, subject to an annual reasonableness review. SDG&E has announced a plan to auction its power plants and other electric-generating assets. This plan includes the divestiture of SDG&E's fbssil power plants and combustion turbines, its 2o-percent inter est in SONGS and its portfolio of long-term purchased-power contracts. The power plants, including the interest in SONGS, have a net book value as of December 31, 1997, of $8o million ($2oo million for fossil and $6oo million for SONGS). The proceeds from the auction will be applied directly to SDG&E's transi tion costs. In December 1997, SDG&E filed with the CPUC for its approval of the auction plan. The sale of the nonnuclear-generating assets is expected to be completed by the end of the first quarter of 1999. During the z998-2oor period, recovery of transition costs is limited by the rate freeze (discussed below).

Management believes that the rates within the rate cap and the proceeds from the sale of electric-generating assets will be sufficient to recover all of SDG&E's approved transition costs by December 31, 200.

The California legislation provides for a zo-percent reduction of residential and small-commercial cus tomers' rates, which began in January 1998, as a result of the utilities' receiving the proceeds of rare-reduc tion bonds issued by an agency of the state of California. In December 1997, $658 million of rate-reduc tion bonds were issued on behalf of SDG&E at an average interest rate of 6.26 percent. These bonds are being repaid over zo years by SDG&E's residential and small-commercial customers via a nonbypassable charge on their electric bills.

In addition, the California legislation includes a rate freeze for all customers. Until the earlier of March 31, 2002, or when transition cost recovery is complete, SDG&E's system-average rate will be frbzen at June 1996 levels (9.64 cents per kwh), except for the impact of fuel cost changes and the 1o-percent rate reduc tion described above. Beginning in 1998 system-average rates cannot be increased above 9.43 cents per kwh, which includes the mandatory rate reduction and any impact of fuel cost changes.

As discussed in Note 2, SDG&E has been accounting for the economic effects of regulation in accor dance with SPAS No. 71. The SEC indicated a concern that the California investor-owned utilities may not meet the criteria of SFAS No. 71 with respect to their electric-generation net-regulatory assets. SDG&E has ceased the application of SFAS No. 71 to its generation business, in accordance with the conclusion by the Emerging Issues Task Force of the Financial Accounting Standards Board that the application of SPAS 71 should be discontinued when deregulatory legislation is issued that determines that a portion of an entity 's business will no longer be regulated. The discontinuance of SFAS No. 7 1 applied to the utilities' genera tion business did not result in a write-off of their net regulatory assets, since the CPUC has approved the recovery of these assets by the distribution portion of their business, subject to the rate cap.

sNoVA CoAPOSAToN

59.

Quarterly Financial Data (Unaudited)

Quaer ended Ia thrnk aop pn r shae aments Match 31 June3 September 30 December 31

'997 Operating revenues

$ 507,930

$501,481

$ 581,058

$ 626,538 Operating expenses 438,535 46,241 485,699 534,362 Operating income 69,395 85,240 95,359 94,176 Other income and (deductions) 6,o86 (124)

(3425) 14,267 Net interest charges and preferred dividends 26,615 28,738 26,868 27,146 Earnings applicable to common shares

$ 48,866

$ 56,378

$ 65,o66

$ 81,297 Average common shares outstanding 116,452 113,616 113,616 113,643 Earnings per common share (basic and diluted)* $

0.42 0.50 0.57 0.72 1996 Operating revenues

$ 465,897

$ 470,967

$ 507,593

$ 549,017 Operating expenses 372,905 396,442 420,307 468,857 Operating income 92,992 74,525 87,286 8o,x6o Other income t,i68 1x 4,373 420 Net interest charges and preferred dividends 28,1o8 27,186 28,914 25,8oo Earnings applicable to common shares

$ 66,o52

$ 47,350 62,745

$ 54,780 Average common shares outstanding 116,570 116,565 116,566 116,587 Earnings per common share (basic and diluted)* $

0.57 0.41 0.54 0.47 Thee amuonut, are ianit ta *ioh epaes qfIaEow 4ft anadjaMueMs ama-Yr afairpUneaWd...

• The saw of qauerly eagpers ra sase d t qw k an#nal sal dto

mdin, Quarterly Common Stock Data (Unaudited) 1997 1996 First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarker Quarter Quarter Quarter Market price High 23 243/8 25/4 27'/8 243/4 23'/8 23

3 Low-21I/8 21Is/

233/8 23'5/16 21/8 20/8 20/2 205/8 Dividends declared

$ 0.39 $ 0.39 $ 0.39

$ 0.39

$ 0.39

$ 0.39

$ 0.39

$ 039

60.

E N VA 0

PORAT1 0 997 Aunsal Report Shareholder Reference Guide Where to Call for Information Transfer Agent Shareholders with questions concerning account information, stock certificates, dividend payments or stock transfers should contact the company's transfer agent:

First Chicago Trust Company Telephone: 800/307-7343 P.O. Box 2500 Hearing Impaired (TTY): 201/222-4955 Jersey City, NJ 07303-2500 Fax: 201/222-4861 E-mail: fctc@em.fcnbd.com Internet: http://www.fctc.com Shareholder Services Investors with general questions regarding Enova Corporation or San Diego Gas & Electric should contact the company at:

Enova Corporation Shareholder Services Post Office Box 129400 Telephone: 800/826-5942 San Diego, CA 92112-9400 Fax: 619/233-6875 E-mail: investoreenova.com Internet: http://www.enova.com, News Update To hear a tape-recorded corporate news report and stock update, call 800/443-7343.

Investor Relations Security analysts, portfblio managers or other members of the financial community should contact:

Mark A. Fisher Telephone: 619/696-290I Investor & Shareholder Relations Manager Fax: 619/696-2374 Stock Exchange Listing Common Stock:

Preferred Stock:

New York Stock Exchange American Stock Exchange Pacific Stock Exchange Ticker Symbol: SDO Ticker Symbol: ENA Direct Common Stock Investment Plan The company offers the Direct Common Stock Investment Plan as a simple, convenient and affordable way to invest in Enova Corporation. Cash dividends from a participant's account can be automatically reinvested in full or in part to purchase additional shares, or participants may choose to receive all or a portion of their cash dividends electronically or by check. The Plan allows optional cash investments of as little as $25 up to a maximum of $z 5o,ooo per calendar year. Non-shareholders may join the Plan with a minimum investment of $25o. Brokerage commissions incurred in the purchase of shares will be paid by Enova. Purchases are made at least every five business days. The Plan is offered only by the means of a prospectus, which can be obtained by calling the Plan Administrator, First Chicago Trust Company, at 800/821-2550 or through the Internet at http://www.netstockdirect.com.

Direct Deposit of Dividends This program allows Enova common shareholders and holders of SDG&E's preferred and preference shares to have dividends deposited directly into any bank account free of charge. To enroll, call the First Chicago Trust Company Direct Deposit Line at 80o/870-2340.

How to Eliminate Duplicate Mailings If you wish to eliminate duplicate mailings of Enova Corporation reports please send your written permission, including the associated account numbers, to the transfer agent.

BNOVA CORPORATION

61.

Replacement of Dividend Checks If you hold stock in your name and do not receive your dividend check within to business days after the payment date, or if a check is lost or destroyed, you should notify the transfer agent so that payment of the check can be stopped and a replacement issued.

Lost or Stolen Stock Certificates If your stock certificate has been lost, stolen or in some way destroyed, you should notify the transfer agent immediately.

1998 Dividend Payment Dates Ex-Dividend Date Record Date Payment Date March 6, 1998 March zo, 1998 April r5, r998 June 8, 1998 June io, 1998 July 15, 1998 September 8, 1998 September so, 1998 October x5,1998 December 8, 1998 December 3o, 1998 January z5, 1999 Shareholder Profile As of December 31, 1997, there were 72,639 common stock shareholders of record and approximate ly 70,000 common stock shareholders whose shares are held in street name by securities brokers and nominees. There were also 1,352 preference and preferred stock shareholders of record at December 31, 1997.

Common Stock Shareholders By geographic area:

SDG,&E service area 24,351 California, except SDG&tE service area 17,629 United States, except California 30,465 Foreign countries 194 By shares owned:

1-99 22,307 10-300 21,014 3o1-500 9,009 501-1000 10,814 1oo or more 9,495 Credit Ratings at December 31, 1997 Issue Standad & Poors Moody's Bonds A+

Az Commercial paper A-i P-I Preferred stock A

The Pretation of de wis is not a,womwodatiog to ey sdl or hold thes swia.

Publications Available to Shareholders The following publications are available to shareholders at no charge by writing to Enova Corporation Shareholder Services:

Form io-K The annual report filed with the Securities and Exchange Commission.

Shareholder Handbook Answers to frequently asked questions from shareholders.

Report to Investors Periodic reports of current activities and recent financial results.

62.

ENo VA Co Po ATION 9pp7 Annual Report Boards of Directors of Enova Corporation and San Diego Gas & Electric Enova Coporation San Diego Gas & Electric Richard C. Atkinson, Ph.D.

Richard C. Atkinson, Ph.D.

President, University of California; Audit Committee Audit Committee Stephen L. Baum Ann Burr Chairman and Chief Executive Officer of Enova; Audit Committee; Nominating Committee Executive Committee (Chair); Nominating Committee (Chair)

Richard A. Collato Audit Committee (Chair); Executive Committee; Ann Burr Nominating Committee President of Time Warner Communications in Rochester, New York; Audit Committee; Nominating Daniel W. Derbes Committee Chairman of the Board of Directors; Executive Committee (Chair); Executive Compensation Richard A. Collato Committee; Nominating Committee (Chair)

President and Chief Executive Offcer, YMCA of San Diego County; Audit Committee (Chair); Executive Robert H. Goldsmith Committee; Nominating Committee Executive Committee; Finance Committee Daniel W. Derbes Edwin A. Guiles President, Signal Ventures; Executive Committee; President of SDG&E; Executive Vice President of Executive Compensation Committee; Technology Enova; Executive Committee; Nominating Committee (Chair)

Committee Robert H. Goldsmith William D. Jones Management Consultant; Executive Committee; Finance Committee (Chair); Nominating Finance Committee; Technology Committee Committee William D. Jones Ralph R. Ocampo, M.D.

President, Chief Executive Offieer and Director, Executive Compensation Committee CiryLink Investment Corporation; Finance Committee (Chair); Nominating Committee Thomas A. Page Finance Committee; Nominating Committee Ralph R. Ocampo, M.D.

Physician and Surgeon; Executive Compensation Thomas C. Stickel Committee; Technology Committee Executive Compensation Committee (Chair);

Finance Committee Thomas A. Page Director of Enova and SDG&E; Finance Committee; Nominating Committee Thomas C. Stickel Chairman, Chief Executive Officer/Founder of University Venture Network; Executive Compensation Committee (Chair); Finance Committee; Technology Committee Committees of the Boards Audit Fiance This committee selects an independent auditor and reviews the This committee counsels management, helps plan the overall plan of the audit, financial statements, audit results, company's capital requrements, pa pro scope of internal audit procedures and the auditors' evaluation of grams and capital risk exposure analyi, reviews the gen internal controls.

oral investment policy performance frthe pension plan and savings plan, and sets dividend policy.

Exawtii This committee is empowered to act in place of the full board, Noating required by the bylaws.

the board, and sots criteria for board and committee c-0 ezco~ in crtai circmstaces were ull bard ctlpnisoTits o

mm bcniersadreomedpnmnest Exeawrit Compensation This committee reviews the salaries and other forms of compen.

Thnology (Ena only) sation of company offices and makes compensation recommen-This committee provides advice and counsel to the board dations to the board.

and to management on certain technology-related projects

NIIatre'Cll n ITe lam

ic 1

A 11i1-1(1or