PG&E 2010 Annual Report Download - page 75

FAIR VALUE MEASUREMENTS
PG&E Corporation and the Utility determine the fair value
of certain assets and liabilities based on assumptions that
market participants would use in pricing the assets or
liabilities. Fair value is defined as the price that would be
received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the
measurement date, or the “exit price.” PG&E Corporation
and the Utility utilize a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair
value and give precedence to observable inputs in
determining fair value. An instrument’s level within the
hierarchy is based on the lowest level of any significant
input to the fair value measurement. The hierarchy gives
the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1
measurements) and the lowest priority to unobservable
inputs (Level 3 measurements). (See Note 11 below.)
ADOPTION OF NEW ACCOUNTING
PRONOUNCEMENTS
Improvements to Financial ReportingbyEnterprises
Involved with Variable Interest Entities
On January 1, 2010, PG&E Corporation and the Utility
adopted an accounting standards update that changes when
and how to determine, or re-determine, whether an entity
is a variable interest entity (“VIE”), which could require
consolidation. In addition, the accounting standards
update replaces the quantitative approach for determining
who has a controlling financial interest in a VIE with a
qualitative approach and requires ongoing assessments of
whether an entity is the primary beneficiary of a VIE. The
adoption of the accounting standards update did not have
a material impact on PG&E Corporation’s or the Utility’s
Consolidated Financial Statements.
PG&E Corporation and the Utility are required to
consolidate any entities that they control. In most cases,
control can be determined based on majority ownership or
voting interests. However, for certain entities, control is
difficult to discern based on ownership or voting interests
alone. These entities are referred to as VIEs. A VIE is an
entity that does not have sufficient equity at risk to finance
its activities without additional subordinated financial
support from other parties, or whose equity investors lack
any characteristics of a controlling financial interest. An
enterprise has a controlling financial interest if it has the
obligation to absorb expected losses or receive expected
gains that could potentially be significant to a VIE and the
power to direct the activities that are most significant to a
VIE’s economic performance. An enterprise that has a
controlling financial interest is known as the VIE’s primary
beneficiary and is required to consolidate the VIE.
Some of the counterparties to the Utility’s power
purchase agreements are considered VIEs. In determining
whether the Utility has a controlling financial interest in a
VIE, the Utility must first assess whether it absorbs any of
the VIE’s expected losses or receives any portion of the
VIE’s expected residual returns, as a result of power
purchase agreements. This assessment includes an
evaluation of how the risks and rewards associated with the
power plant’s activities are absorbed by variable interest
holders. These VIEs are typically exposed to credit risk,
production risk, commodity price risk, and any applicable
tax incentive risks, among others. The Utility analyzes the
variability in the VIE’s gross margin and the impact of
power purchase agreements on the gross margin to
determine whether the Utility absorbs variability, resulting
in a variable interest. Factors that may be considered when
assessing the impact of a power purchase agreement on the
VIE’s gross margin include the pricing structure of the
power purchase agreement and the cost of inputs and
production, which depend on the technology of the power
plant.
For each variable interest, the Utility must also assess
whether it has the power to direct the activities of the
power plant that most directly impact the VIE’s economic
performance. This assessment considers any decision-
making rights associated with designing the VIE, any
dispatch rights, any operating and maintenance activities,
and any re-marketing activities of the power plant after the
end of the power purchase agreement with the Utility.
The Utility held a variable interest in several entities that
own power plants that generate electricity for sale to the
Utility under power purchase agreements. Each of these
VIEs was designed to own a power plant that would
generate electricity for sale to the Utility utilizing various
technologies such as natural gas, wind, solar photovoltaic,
solar thermal, and hydroelectric. Under each of these
power purchase agreements, the Utility is obligated to
purchase electricity or capacity, or both, from the VIE. The
Utility did not provide any other support to these VIEs,
and the Utility’s financial exposure is limited to the
amount it pays for delivered electricity and capacity. (See
Note 15 below.) The Utility does not have the power to
direct the activities that are most significant to these VIE’s
economic performance. As a result, the Utility does not
have a controlling financial interest in any of these VIEs.
Therefore, at December 31, 2010, the Utility was not the
primary beneficiary of, and did not consolidate, any of
these VIEs.
The Utility continued to consolidate PG&E Energy
Recovery Funding LLC (“PERF”) at December 31, 2010, as
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