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) that could 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 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 California 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 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.

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.

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.

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


		December 31,
Business Unit and Commodity		2011	2010
California Utilities:
SDG&E:
	Natural gas	35 million MMBtu	51 million MMBtu	(1)
	Congestion revenue rights	19 million MWh	21 million MWh	(2)

Energy-Related Businesses:
Sempra Natural Gas:
Electric power		5 million MWh	1 million MWh
Natural gas		20 million MMBtu	15 million MMBtu
Sempra Mexico - natural gas		1 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.

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 California Utilities as well as by other Sempra Energy subsidiaries. Although the California 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 California 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 December 31, 2011 and 2010 were:

We are exposed to exchange rate movements primarily as a result of our Mexican subsidiaries, which have U.S. dollar denominated receivables and payables (monetary assets and liabilities) that give rise to Mexican currency exchange rate movements for Mexican income tax purposes. These subsidiaries also have deferred income tax assets and liabilities that are denominated in the Mexican peso, which must be translated into U.S. dollars for financial reporting purposes. From time to time, we may utilize short-term foreign currency derivatives at our subsidiaries and at the consolidated level as a means to manage the risk of exposure to significant fluctuations in our income tax expense from these impacts.

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

DERIVATIVE INSTRUMENTS ON THE CONSOLIDATED BALANCE SHEETS
(Dollars in millions)
		December 31, 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)	$	5	$	11	$	(17)	$	(65)
SDG&E:
	Interest rate instruments(3)	$	―	$	―	$	(16)	$	(65)

Derivatives not designated as hedging instruments
Sempra Energy Consolidated:
	Interest rate instruments	$	8	$	41	$	(7)	$	(36)
	Commodity contracts not subject to rate recovery		156		72		(148)		(94)
	Associated offsetting commodity contracts		(120)		(68)		120		68
	Commodity contracts subject to rate recovery		28		8		(62)		(24)
	Associated offsetting commodity contracts		(10)		(2)		10		2
	Total	$	62	$	51	$	(87)	$	(84)
SDG&E:
	Commodity contracts subject to rate recovery	$	22	$	8	$	(55)	$	(24)
	Associated offsetting commodity contracts		(5)		(2)		5		2
	Total	$	17	$	6	$	(50)	$	(22)
SoCalGas:
	Commodity contracts subject to rate recovery	$	6	$	―	$	(7)	$	―
	Associated offsetting commodity contracts		(5)		―		5		―
	Total	$	1	$	―	$	(2)	$	―
(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 CONSOLIDATED BALANCE SHEETS (Continued)
(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 the Consolidated Statements of Operations and on Other Comprehensive Income (OCI) and Accumulated Other Comprehensive Income (AOCI) for the years ended December 31 were:

FAIR VALUE HEDGE IMPACT ON THE CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
			Gain (loss) on derivatives recognized in earnings
			Years ended December 31,
		Location	2011		2010		2009
Sempra Energy Consolidated:
	Interest rate instruments	Interest Expense	$	9	$	10	$	19
	Interest rate instruments	Other Income, Net		13		(11)		(11)
	Total(1)		$	22	$	(1)	$	8
SoCalGas:
	Interest rate instrument	Interest Expense	$	1	$	6	$	6
	Interest rate instrument	Other Income, Net		(3)		(4)		(2)
	Total(1)		$	(2)	$	2	$	4
(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 CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
		Pretax gain (loss) recognized in OCI							Gain (loss) reclassified from AOCI into earnings
		(effective portion)							(effective portion)
		Years ended December 31,							Years ended December 31,
			2011		2010		2009	Location		2011		2010		2009
Sempra Energy Consolidated:
	Interest rate instruments(1)	$	(42)	$	―	$	―	Interest Expense	$	(8)	$	(12)	$	(2)
	Interest rate instruments		―		―		13	Other Income, Net(2)		―		10		3
								Equity Earnings, Net of Income
	Interest rate instruments		(32)		2		―	Tax		(5)		(1)		―
	Commodity contracts not subject							Revenues: Energy-Related
	to rate recovery		―		―		17	Businesses		―		―		22
	Commodity contracts not subject							Cost of Natural Gas, Electric
	to rate recovery		―		―		―	Fuel and Purchased Power		―		―		(16)
	Commodity contracts not subject
	to rate recovery		―		―		1	Other Operation and Maintenance		―		―		2
	Commodity contracts not subject							Equity Earnings (Losses): RBS
	to rate recovery		―		1		37	Sempra Commodities LLP		―		21		7
	Total	$	(74)	$	3	$	68		$	(13)	$	18	$	16
SDG&E:
	Interest rate instruments(1)	$	(40)	$	―	$	―	Interest Expense	$	(5)	$	(7)	$	3
	Commodity contracts not subject
	to rate recovery		―		―		―	Operation and Maintenance		―		―		1
	Total	$	(40)	$	―	$	―		$	(5)	$	(7)	$	4
SoCalGas:
	Interest rate instrument	$	―	$	―	$	―	Interest Expense	$	(3)	$	(5)	$	(4)
	Commodity contracts not subject
	to rate recovery		―		―		1	Operation and Maintenance		―		―		1
	Total	$	―	$	―	$	1		$	(3)	$	(5)	$	(3)
(1)	Amounts include Otay Mesa VIE. All of SDG&E’s 2010 and 2011 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 AOCI 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 depend on the interest rates in effect when derivative contracts that are currently outstanding mature.

SDG&E and SoCalGas expect that losses of $3 million and $1 million, respectively, which are net of income tax benefit, that are currently recorded in AOCI related to cash flow hedges will be reclassified into earnings during the next twelve months as the hedged items affect earnings.

For all forecasted transactions, the maximum term over which we are hedging exposure to the variability of cash flows at December 31, 2011 is 88 months for Sempra Energy and SDG&E. The maximum term of exposure related to contracts at Sempra Renewables' equity method investees is 18 years.

The effects of derivative instruments not designated as hedging instruments on the Consolidated Statements of Operations for the years ended December 31 were:

UNDESIGNATED DERIVATIVE IMPACT ON THE CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
			Gain (loss) on derivatives recognized in earnings
			Years ended December 31,
		Location	2011		2010		2009
Sempra Energy Consolidated:
	Interest rate and foreign
	exchange instruments(1)	Other Income, Net	$	(14)	$	(34)	$	30
	Commodity contracts not subject	Revenues: Energy-Related
	to rate recovery	Businesses		30		47		47
	Commodity contracts not subject	Cost of Natural Gas, Electric
	to rate recovery	Fuel and Purchased Power		1		(29)		(39)
	Commodity contracts not subject
	to rate recovery	Other Operation and Maintenance		1		2		―
	Commodity contracts subject	Cost of Electric Fuel
	to rate recovery	and Purchased Power		(14)		(102)		(54)
	Commodity contracts subject
	to rate recovery	Cost of Natural Gas		(2)		(9)		(10)
	Total		$	2	$	(125)	$	(26)
SDG&E:
	Interest rate instruments(1)	Other Income, Net	$	(1)	$	(34)	$	27
	Commodity contracts not subject
	to rate recovery	Operation and Maintenance		―		1		―
	Commodity contracts subject	Cost of Electric Fuel
	to rate recovery	and Purchased Power		(14)		(102)		(54)
	Total		$	(15)	$	(135)	$	(27)
SoCalGas:
	Commodity contracts not subject
	to rate recovery	Operation and Maintenance	$	1	$	1	$	―
	Commodity contracts subject
	to rate recovery	Cost of Natural Gas		(2)		(5)		(5)
	Total		$	(1)	$	(4)	$	(5)
(1)	Amounts are related to Otay Mesa VIE. Sempra Energy Consolidated also includes additional instruments.

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, the total fair value of this group of derivative instruments in a net liability position at December 31, 2011 is $24 million. As of December 31, 2011, if the credit ratings of Sempra Energy were reduced below investment grade, $24 million of additional assets could be required to be posted as collateral for these derivative contracts.

For SDG&E, the total fair value of this group of derivative instruments in a net liability position at December 31, 2011 is $11 million. As of December 31, 2011, if the credit ratings of SDG&E were reduced below investment grade, $11 million 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.