DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Sep. 30, 2011

Notes to Consolidated Financial Statements [Abstract]

Derivative Financial Instruments

NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS

We use derivative instruments primarily to manage exposures arising in the normal course of business. Our principal exposures are commodity market risk and benchmark interest rate risk. We may also manage foreign exchange rate exposures using derivatives. Our use of derivatives for these risks is integrated into the economic management of our anticipated revenues, anticipated expenses, assets and liabilities. Derivatives may be effective in mitigating these risks (1) thatcould lead to declines in anticipated revenues or increases in anticipated expenses, or (2) that our asset values may fall or our liabilities increase. Accordingly,our derivative activity summarized below generally represents an impact that is intended to offset associated revenues, expenses, assets or liabilities that are not presented below.

We record all derivatives at fair value on the Condensed Consolidated Balance Sheets. We designate each derivative as (1) a cash flow hedge, (2) a fair value hedge, or (3) undesignated. Depending on the applicability of hedge accounting and, for the Sempra Utilities and other operations subject to regulatory accounting, the requirement to pass impacts through to customers, the impact of derivative instruments may be offset in other comprehensive income (cash flow hedge), on the balance sheet (fair value hedges and regulatory offsets), or recognized in earnings. We classify cash flows from the settlements of derivative instruments as operating activities on the Condensed Consolidated Statements of Cash Flows.

In certain cases, we apply the normal purchase or sale exception to derivative accounting and have other commodity contracts that are not derivatives. These contracts are not recorded at fair value and are therefore excluded from the disclosures below.

HEDGE ACCOUNTING

We may designate a derivative as a cash flow hedging instrument if it effectively converts anticipated revenues or expenses to a fixed dollar amount. We may utilize cash flow hedge accounting for derivative commodity instruments and interest rate instruments. Designating cash flow hedges is dependent on the business context in which the instrument is being used, the effectiveness of the instrument in offsetting the risk that a given future revenue or expense item may vary, and other criteria.

We may designate an interest rate derivative as a fair value hedging instrument if it effectively converts our own debt from a fixed interest rate to a variable rate. The combination of the derivative and debt instruments results in fixing that portion of the fair value of the debt that is related to benchmark interest rates. Designating fair value hedges is dependent on the instrument being used, the effectiveness of the instrument in offsetting changes in the fair value of our debt instruments, and other criteria.

ENERGY DERIVATIVES

Our market risk is primarily related to natural gas and electricity price volatility and the specific physical locations where we transact. We use energy derivatives to manage these risks. The use of energy derivatives in our various businesses depends on the particular energy market, and the operating and regulatory environments applicable to the business.

• The Sempra Utilities use natural gas energy derivatives, on their customers' behalf, with the objective of managing price risk and basis risks, and lowering natural gas costs. These derivatives include fixed price natural gas positions, options, and basis risk instruments, which are either exchange-traded or over-the-counter financial instruments. This activity is governed by risk management and transacting activity plans that have been filed with and approved by the California Public Utilities Commission(CPUC). Natural gas derivative activities are recorded as commodity costs that are offset by regulatory account balances and are recovered in rates. Net commodity cost impacts on the Condensed Consolidated Statements of Operations are reflected in Cost of Electric Fuel and Purchased Power or in Cost of Natural Gas.
• SDG&E is allocated and may purchase congestion revenue rights (CRRs), which serve to reduce the regional electricity price volatility risk that may result from local transmission capacity constraints. Unrealized gains and losses do not impact earnings, as they are offset by regulatory account balances. Realized gains and losses associated with CRRs are recorded in Cost of Electric Fuel and Purchased Power, which is recoverable in rates, on the Condensed Consolidated Statements of Operations.
• Sempra Generation uses natural gas and electricity instruments to market energy products and optimize the earnings of its natural gas power plants. Gains and losses associated with these undesignated derivatives are recognized in Energy-Related Businesses Revenues or in Cost of Natural Gas, Electric Fuel and Purchased Power on the Condensed Consolidated Statements of Operations.
• Sempra LNG and Sempra Pipelines & Storage use natural gas derivatives to market energy products and optimize the earnings of our liquefied natural gas business and Sempra Pipelines & Storage's natural gas storage and transportation assets. Sempra Pipelines & Storage also uses natural gas energy derivatives with the objective of managing price risk and lowering natural gas prices at its Mexican distribution operations. These derivatives, which are recorded as commodity costs that are offset by regulatory account balances and recovered in rates, are recognized in Cost of Natural Gas on the Condensed Consolidated Statements of Operations. At Sempra Pipelines & Storage's non-utility businesses, derivatives are undesignated, and their impact on earnings is recorded in Energy-Related Businesses Revenues or in Cost of Natural Gas, Electric Fuel and Purchased Power on the Condensed Consolidated Statements of Operations. Sempra LNG's derivatives are undesignated, and their impact on earnings is recorded in Energy-Related Businesses Revenues on the Condensed Consolidated Statements of Operations.

• From time to time, our various businesses, including the Sempra Utilities, may use other energy derivatives to hedge exposures such as the price of vehicle fuel.

We summarize net energy derivative volumes as of September 30, 2011 and December 31, 2010 as follows:

Business Unit and Commodity		September 30, 2011	December 31, 2010
Sempra Utilities:
SDG&E:
Natural gas		42 million MMBtu	51 million MMBtu	(1)
Congestion revenue rights		16 million MWh	21 million MWh	(2)
Energy-Related Businesses:
Sempra Generation - electric power		7 million MWh	1 million MWh
Sempra Pipelines & Storage - natural gas		8 million MMBtu	8 million MMBtu
Sempra LNG - natural gas		5 million MMBtu	7 million MMBtu
(1)	Million British thermal units
(2)	Megawatt hours

In addition to the amounts noted above, we frequently use commodity derivatives to manage risks associated with the physical locations of our customers, assets and other contractual obligations, such as natural gas purchases and sales.

INTEREST RATE DERIVATIVES

We are exposed to interest rates primarily as a result of our current and expected use of financing. We periodically enter into interest rate derivative agreements intended to moderate our exposure to interest rates and to lower our overall costs of borrowing. We utilize interest rate swaps typically designated as fair value hedges, as a means to achieve our targeted level of variable rate debt as a percent of total debt. In addition, we may utilize interest rate swaps, which are typically designated as cash flow hedges, to lock in interest rates on outstanding debt or in anticipation of future financings.

Interest rate derivatives are utilized by the Sempra Utilities as well as by other Sempra Energy subsidiaries. Although the Sempra Utilities generally recover borrowing costs in rates over time, the use of interest rate derivatives is subject to certain regulatory constraints, and the impact of interest rate derivatives may not be recovered from customers as timely as described above with regard to natural gas derivatives. Accordingly, interest rate derivatives are generally accounted for as hedges at the Sempra Utilities, as well as at the rest of Sempra Energy's subsidiaries. Separately, Otay Mesa VIE has entered into interest rate swap agreements to moderate its exposure to interest rate changes. This activity was designated as a cash flow hedge as of April 1, 2011.

The net notional amounts of our interest rate derivatives as of September 30, 2011 and December 31, 2010 were:

		September 30, 2011			December 31, 2010
(Dollars in millions)		Notional Debt		Maturities	Notional Debt		Maturities
Sempra Energy Consolidated(1)		$	15-305	2013-2019	$	215-355	2011-2019
SDG&E(1)			285-358	2019		285-365	2019
SoCalGas			―	―		150	2011
(1)	Includes Otay Mesa VIE. All of SDG&E's interest rate derivatives relate to Otay Mesa VIE.

FINANCIAL STATEMENT PRESENTATION

The following tables provide the fair values of derivative instruments, without consideration of margin deposits held or posted,on the Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010:

DERIVATIVE INSTRUMENTS ON THE CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in millions)
		September 30, 2011
									Deferred
									credits
			Current				Current		and other
			assets:				liabilities:		liabilities:
			Fixed-price		Investments		Fixed-price		Fixed-price
			contracts		and other		contracts		contracts
			and other		assets:		and other		and other
Derivatives designated as hedging instruments			derivatives(1)		Sundry		derivatives(2)		derivatives
Sempra Energy Consolidated:
Interest rate instruments(3)		$	7	$	13	$	(16)	$	(63)
SDG&E:
Interest rate instruments(3)		$	―	$	―	$	(16)	$	(63)
Derivatives not designated as hedging instruments
Sempra Energy Consolidated:
Interest rate instruments		$	9	$	41	$	(8)	$	(35)
Commodity contracts not subject to rate recovery			104		36		(89)		(57)
Associated offsetting commodity contracts			(60)		(27)		60		27
Commodity contracts subject to rate recovery			10		2		(43)		(24)
Associated offsetting commodity contracts			(8)		(1)		8		1
Total		$	55	$	51	$	(72)	$	(88)
SDG&E:
Commodity contracts subject to rate recovery		$	6	$	2	$	(37)	$	(24)
Associated offsetting commodity contracts			(4)		(1)		4		1
Total		$	2	$	1	$	(33)	$	(23)
SoCalGas:
Commodity contracts subject to rate recovery		$	5	$	―	$	(7)	$	―
Associated offsetting commodity contracts			(4)		―		4		―
Total		$	1	$	―	$	(3)	$	―
(1)	Included in Current Assets: Other for SoCalGas.
(2)	Included in Current Liabilities: Other for SoCalGas.
(3)	Includes Otay Mesa VIE. All of SDG&E's amounts relate to Otay Mesa VIE.
DERIVATIVE INSTRUMENTS ON THE CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in millions)
		December 31, 2010
									Deferred
									credits
			Current				Current		and other
			assets:				liabilities:		liabilities:
			Fixed-price		Investments		Fixed-price		Fixed-price
			contracts		and other		contracts		contracts
			and other		assets:		and other		and other
Derivatives designated as hedging instruments			derivatives(1)		Sundry		derivatives(2)		derivatives
Sempra Energy Consolidated:
Interest rate instrument		$	3	$	―	$	―	$	―
SoCalGas:
Interest rate instrument		$	3	$	―	$	―	$	―
Derivatives not designated as hedging instruments
Sempra Energy Consolidated:
Interest rate instruments(3)		$	9	$	22	$	(25)	$	(57)
Commodity contracts not subject to rate recovery			59		20		(44)		(34)
Associated offsetting commodity contracts			(2)		(8)		2		8
Commodity contracts subject to rate recovery			5		―		(43)		(27)
Associated offsetting commodity contracts			(37)		(26)		37		26
Total		$	34	$	8	$	(73)	$	(84)
SDG&E:
Interest rate instruments(3)		$	―	$	―	$	(17)	$	(41)
Commodity contracts not subject to rate recovery			1		―		―		―
Commodity contracts subject to rate recovery			2		―		(35)		(27)
Associated offsetting commodity contracts			(34)		(26)		34		26
Total		$	(31)	$	(26)	$	(18)	$	(42)
SoCalGas:
Commodity contracts not subject to rate recovery		$	1	$	―	$	―	$	―
Commodity contracts subject to rate recovery			3		―		(3)		―
Associated offsetting commodity contracts			(3)		―		3		―
Total		$	1	$	―	$	―	$	―
(1)	Included in Current Assets: Other for SoCalGas.
(2)	Included in Current Liabilities: Other for SoCalGas.
(3)	Includes Otay Mesa VIE. All of SDG&E's amounts relate to Otay Mesa VIE.

The effects of derivative instruments designated as hedges on theCondensed Consolidated Statements of Operations and on Other Comprehensive Income (OCI) and Accumulated Other Comprehensive Income (AOCI) for the three months and nine months ended September 30, 2011 and 2010 were:

FAIR VALUE HEDGE IMPACT ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
			Gain (loss) on derivatives recognized in earnings
			Three months ended September 30,				Nine months ended September 30,
		Location	2011		2010		2011		2010
Sempra Energy Consolidated:
Interest rate instruments		Interest Expense	$	2	$	2	$	7	$	9
Interest rate instruments		Other Income, Net		13		(2)		16		(11)
Total(1)			$	15	$	―	$	23	$	(2)
SoCalGas:
Interest rate instrument		Interest Expense	$	―	$	2	$	1	$	5
Interest rate instrument		Other Income, Net		―		(2)		(3)		(4)
Total(1)			$	―	$	―	$	(2)	$	1
(1)	There has been no hedge ineffectiveness on these swaps. Changes in the fair values of the interest rate swap agreements are exactly offset by changes in the fair value of the underlying long-term debt.

CASH FLOW HEDGE IMPACT ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
		Pretax gain (loss) recognized					Gain (loss) reclassified from AOCI
		in OCI (effective portion)					into earnings (effective portion)
		Three months ended September 30,					Three months ended September 30,
		2011		2010		Location	2011		2010
Sempra Energy Consolidated:
Interest rate instruments(1)		$	(21)	$	―	Interest Expense	$	4	$	(2)
Interest rate instruments			(27)		―	Equity Losses, Before Income Tax		(2)		―
Commodity contracts not subject
to rate recovery			―		1	Equity Losses, Before Income Tax		―		7
Total		$	(48)	$	1		$	2	$	5
SDG&E:
Interest rate instruments(1)		$	(21)	$	―	Interest Expense	$	4	$	(1)
SoCalGas:
Interest rate instruments		$	―	$	―	Interest Expense	$	(1)	$	(1)
		Nine months ended September 30,					Nine months ended September 30,
		2011		2010		Location	2011		2010
Sempra Energy Consolidated:
Interest rate instruments(1)		$	(32)	$	―	Interest Expense	$	―	$	(9)
Interest rate instruments			―		―	Other Income, Net(2)		―		10
Interest rate instruments			(34)		―	Equity Losses, Before Income Tax		(3)		―
Commodity contracts not subject
to rate recovery			―		1	Equity Losses, Before Income Tax		―		14
Total		$	(66)	$	1		$	(3)	$	15
SDG&E:
Interest rate instruments(1)		$	(32)	$	―	Interest Expense	$	2	$	(5)
SoCalGas:
Interest rate instruments		$	―	$	―	Interest Expense	$	(3)	$	(4)
(1)	Amounts include Otay Mesa VIE. All of SDG&E's interest rate derivative activity relates to Otay Mesa VIE. There has been a negligible amount of ineffectiveness related to these swaps.
(2)	Gains reclassified into earnings due to changes in cash requirements and associated impacts on forecasted interest payments, primarily related to proceeds received from RBS Sempra Commodities. See Note 4.

Sempra Energy expects that losses of $8 million, which are net of income tax benefit, that are currently recorded in Accumulated Other Comprehensive Income (Loss) related to cash flow hedges will be reclassified into earnings during the next twelve months as the hedged items affect earnings. Actual amounts ultimately reclassified into earnings depends on the interest rates in effect when derivative contracts that are currently outstanding mature. For all forecasted transactions, the maximum term over which we are hedging exposure to the variability of cash flows is 91 months at September 30, 2011.

SDG&E and SoCalGas expect that losses of $4million and $1 million, respectively, which are net of income tax benefit, that are currently recorded in Accumulated Other Comprehensive Income (Loss) related to these cash flow hedges will be reclassified into earnings during the next twelve months as the hedged items affect earnings.

The effects of derivative instruments not designated as hedging instruments on the Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2011 and 2010 were:

UNDESIGNATED DERIVATIVE IMPACT ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
			Gain (loss) on derivatives recognized in earnings
			Three months ended September 30,				Nine months ended September 30,
		Location	2011		2010		2011		2010
Sempra Energy Consolidated:
Interest rate and foreign exchange
instruments(1)		Other Income, Net	$	(26)	$	(17)	$	(14)	$	(50)
Commodity contracts not subject		Revenues: Energy-Related
to rate recovery		Businesses		3		15		17		45
Commodity contracts not subject		Cost of Natural Gas, Electric
to rate recovery		Fuel and Purchased Power		―		(7)		1		(22)
Commodity contracts not subject
to rate recovery		Other Operation and Maintenance		―		―		1		―
Commodity contracts subject		Cost of Electric Fuel
to rate recovery		and Purchased Power		(15)		(39)		(6)		(100)
Commodity contracts subject
to rate recovery		Cost of Natural Gas		(2)		(5)		(1)		(9)
Total			$	(40)	$	(53)	$	(2)	$	(136)
SDG&E:
Interest rate instruments(1)		Other Income (Expense), Net	$	―	$	(17)	$	―	$	(51)
Commodity contracts not subject
to rate recovery		Operation and Maintenance		(1)		―		―		―
Commodity contracts subject		Cost of Electric Fuel
to rate recovery		and Purchased Power		(15)		(39)		(6)		(100)
Total			$	(16)	$	(56)	$	(6)	$	(151)
SoCalGas:
Commodity contracts not subject
to rate recovery		Operation and Maintenance	$	(1)	$	―	$	―	$	―
Commodity contracts subject
to rate recovery		Cost of Natural Gas		(2)		(4)		(1)		(5)
Total			$	(3)	$	(4)	$	(1)	$	(5)
(1)	Amount for 2010 is related to Otay Mesa VIE. Sempra Energy Consolidated also includes additional instruments.

CONTINGENT FEATURES

For Sempra Energy and SDG&E, certain of our derivative instruments contain credit limits which vary depending upon our credit ratings. Generally, these provisions, if applicable, may reduce our credit limit if a specified credit rating agency reduces our ratings. In certain cases, if our credit ratings were to fall below investment grade, the counterparty to these derivative liability instruments could request immediate payment or demand immediate and ongoing full collateralization. 

For Sempra Energy and SDG&E, the total fair value of this group of derivative instruments in a net liability position at September 30, 2011 is $10 million and $1 million, respectively. As of September 30, 2011, if the credit ratings of Sempra Energy and SDG&E were reduced below investment grade, $10 million and $1 million, respectively, of additional assets could be required to be posted as collateral for these derivative contracts.

For Sempra Energy, SDG&E, and SoCalGas, some of our derivative contracts contain a provision that would permit the counterparty, in certain circumstances, to request adequate assurance of our performance under the contracts. Such additional assurance, if needed, is not material and is not included in the amounts above.