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FAIR VALUE MEASUREMENTS
 3 Months Ended
Sep. 30, 2012
Notes to Consolidated Financial Statements [Abstract]  
Fair Value Measurements

NOTE 8. FAIR VALUE MEASUREMENTS

We discuss the valuation techniques and inputs we use to measure fair value and the definition of the three levels of the fair value hierarchy in Notes 1 and 2 of the Notes to Consolidated Financial Statements in the Updated Annual Report. We have not changed the valuation techniques or inputs we use to measure fair value during the nine months ended September 30, 2012.

Recurring Fair Value Measures

The three tables below, by level within the fair value hierarchy, set forth our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2012 and December 31, 2011. We classify financial assets and liabilities in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities, and their placement within the fair value hierarchy levels.

The fair value of commodity derivative assets and liabilities is determined in accordance with our netting policy, as discussed below under “Derivative Positions Net of Cash Collateral.”

The determination of fair values, shown in the tables below, incorporates various factors, including but not limited to, the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits, letters of credit and priority interests).

Our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 in the tables below include the following:

  • Nuclear decommissioning trusts reflect the assets of SDG&E's nuclear decommissioning trusts, excluding cash balances. A third party trustee values the trust assets using prices from a pricing service based on a market approach. We validate these prices by comparison to prices from other independent data sources. Equity and certain debt securities are valued using quoted prices listed on nationally recognized securities exchanges or based on closing prices reported in the active market in which the identical security is traded (Level 1). Other debt securities are valued based on yields that are currently available for comparable securities of issuers with similar credit ratings (Level 2).
  • We enter into commodity contracts and interest rate derivatives primarily as a means to manage price exposures. We primarily use a market approach with market participant assumptions to value these derivatives. Market participant assumptions include those about risk, and the risk inherent in the inputs to the valuation techniques. These inputs can be readily observable, market corroborated, or generally unobservable. We have exchange-traded derivatives that are valued based on quoted prices in active markets for the identical instruments (Level 1). We also may have other commodity derivatives that are valued using industry standard models that consider quoted forward prices for commodities, time value, current market and contractual prices for the underlying instruments, volatility factors, and other relevant economic measures (Level 2). All Level 3 recurring items are related to CRRs at SDG&E, as discussed below under “Level 3 Information.” Commodity derivative contracts that are subject to rate recovery are recorded as commodity costs that are offset by regulatory account balances and are recovered in rates.

  • Investments include marketable securities that we value using a market approach based on closing prices reported in the active market in which the identical security is traded (Level 1).

There were no transfers into or out of Level 1, Level 2, or Level 3 for Sempra Energy Consolidated, SDG&E or SoCalGas during the periods presented.

RECURRING FAIR VALUE MEASURES – SEMPRA ENERGY CONSOLIDATED
(Dollars in millions)
 At fair value as of September 30, 2012
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Nuclear decommissioning trusts:          
Equity securities$ 529$ ―$ ―$ ―$ 529
Debt securities:          
Debt securities issued by the U.S. Treasury and other           
U.S. government corporations and agencies  72  74  ―  ―  146
Municipal bonds  ―  66  ―  ―  66
Other securities  ―  123  ―  ―  123
Total debt securities  72  263  ―  ―  335
Total nuclear decommissioning trusts(1)  601  263  ―  ―  864
Interest rate instruments  ―  73  ―  ―  73
Commodity contracts subject to rate recovery  21  ―  23  ―  44
Commodity contracts not subject to rate recovery  19  19  ―  ―  38
Investments  1  ―  ―  ―  1
Total$ 642$ 355$ 23$ ―$ 1,020
Liabilities:          
Interest rate and foreign exchange instruments$ ―$ 136$ ―$ ―$ 136
Commodity contracts subject to rate recovery  32  8  ―  (32)  8
Commodity contracts not subject to rate recovery  9  30  ―  (13)  26
Total$ 41$ 174$ ―$ (45)$ 170
           
 At fair value as of December 31, 2011
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Nuclear decommissioning trusts:          
Equity securities$ 468$ ―$ ―$ ―$ 468
Debt securities:          
Debt securities issued by the U.S. Treasury and other           
U.S. government corporations and agencies  92  78  ―  ―  170
Municipal bonds  ―  77  ―  ―  77
Other securities  ―  78  ―  ―  78
Total debt securities  92  233  ―  ―  325
Total nuclear decommissioning trusts(1)  560  233  ―  ―  793
Interest rate instruments  ―  66  ―  ―  66
Commodity contracts subject to rate recovery  10  1  23  ―  34
Commodity contracts not subject to rate recovery  15  35  ―  (2)  48
Investments  5  ―  ―  ―  5
Total$ 590$ 335$ 23$ (2)$ 946
Liabilities:          
Interest rate instruments$ 1$ 124$ ―$ ―$ 125
Commodity contracts subject to rate recovery  61  13  ―  (61)  13
Commodity contracts not subject to rate recovery  1  52  ―  (4)  49
Total$ 63$ 189$ ―$ (65)$ 187
(1)Excludes cash balances and cash equivalents.          

RECURRING FAIR VALUE MEASURES – SDG&E
(Dollars in millions)
 At fair value as of September 30, 2012
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Nuclear decommissioning trusts:          
Equity securities$ 529$ ―$ ―$ ―$ 529
Debt securities:          
Debt securities issued by the U.S. Treasury and other          
U.S. government corporations and agencies  72  74  ―  ―  146
Municipal bonds   ―  66  ―  ―  66
Other securities   ―  123  ―  ―  123
Total debt securities  72  263  ―  ―  335
Total nuclear decommissioning trusts(1)  601  263  ―  ―  864
Commodity contracts subject to rate recovery  19  ―  23  ―  42
Commodity contracts not subject to rate recovery  2  ―  ―  ―  2
Total$ 622$ 263$ 23$ ―$ 908
           
Liabilities:          
Interest rate instruments$ ―$ 85$ ―$ ―$ 85
Commodity contracts subject to rate recovery  32  7  ―  (32)  7
Total$ 32$ 92$ ―$ (32)$ 92
           
 At fair value as of December 31, 2011
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Nuclear decommissioning trusts:          
Equity securities$ 468$ ―$ ―$ ―$ 468
Debt securities:          
Debt securities issued by the U.S. Treasury and other          
U.S. government corporations and agencies  92  78  ―  ―  170
Municipal bonds   ―  77  ―  ―  77
Other securities   ―  78  ―  ―  78
Total debt securities  92  233  ―  ―  325
Total nuclear decommissioning trusts(1)  560  233  ―  ―  793
Commodity contracts subject to rate recovery  9  ―  23  ―  32
Commodity contracts not subject to rate recovery  1  ―  ―  ―  1
Total$ 570$ 233$ 23$ ―$ 826
           
Liabilities:          
Interest rate instruments$ ―$ 81$ ―$ ―$ 81
Commodity contracts subject to rate recovery  61  12  ―  (61)  12
Total$ 61$ 93$ ―$ (61)$ 93
(1)Excludes cash balances and cash equivalents.          

RECURRING FAIR VALUE MEASURES – SOCALGAS
(Dollars in millions)
 At fair value as of September 30, 2012
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Commodity contracts subject to rate recovery$ 2$ ―$ ―$ ―$ 2
Commodity contracts not subject to rate recovery  2  ―  ―  ―  2
Total$ 4$ ―$ ―$ ―$ 4
           
Liabilities:          
Commodity contracts subject to rate recovery$ ―$ 1$ ―$ ―$ 1
Total$ ―$ 1$ ―$ ―$ 1
           
 At fair value as of December 31, 2011
        Collateral  
  Level 1 Level 2 Level 3 netted Total
Assets:          
Commodity contracts subject to rate recovery$ 1$ 1$ ―$ ―$ 2
Commodity contracts not subject to rate recovery  2  ―  ―  ―  2
Total$ 3$ 1$ ―$ ―$ 4
           
Liabilities:          
Commodity contracts subject to rate recovery$ ―$ 1$ ―$ ―$ 1
Total$ ―$ 1$ ―$ ―$ 1

 

Level 3 Information

The following table sets forth reconciliations of changes in the fair value of CRRs classified as Level 3 in the fair value hierarchy for Sempra Energy Consolidated and SDG&E:

 

 Three months ended September 30,
(Dollars in millions)20122011
Balance as of July 1$ 13$ 3
Realized and unrealized gains  16  5
Allocated transmission instruments  17  ―
Settlements  (23)  (5)
Balance as of September 30$ 23$ 3
Change in unrealized gains or losses relating to     
instruments still held at September 30$ ―$ ―

 Nine months ended September 30,
(Dollars in millions)20122011
Balance as of January 1$ 23$ 2
Realized and unrealized gains  23  17
Allocated transmission instruments  18  2
Settlements  (41)  (18)
Balance as of September 30$ 23$ 3
Change in unrealized gains or losses relating to     
instruments still held at September 30$ ―$ ―

CRRs are recorded at fair value based almost entirely on the most current auction prices published by the California Independent System Operator (ISO), an objective source. The impact associated with discounting is negligible. Because auction prices are a less observable input, these instruments are classified as Level 3. Auction prices range from $(3) per MWh to $5 per MWh at a given location, and the fair value of these instruments is derived from auction price differences between two locations. Positive values between two locations represent expected future reductions in congestion costs, whereas negative values between two locations represent expected future charges. Valuation of our CRRs is sensitive to a change in auction price. If auction prices at one location increase (decrease) relative to another location, this could result in a higher (lower) fair value measurement. We summarize CRR volumes in Note 7. The earnings impacts of CRRs are deferred and recorded in regulatory accounts to the extent they are recoverable or refundable through rates. Upon settlement, CRRs are included in Cost of Electric Fuel and Purchased Power on the Condensed Consolidated Statements of Operations.

Derivative Positions Net of Cash Collateral

Each Condensed Consolidated Balance Sheet reflects the offsetting of net derivative positions with fair value amounts for cash collateral with the same counterparty when management believes a legal right of offset exists.

The following table provides the amount of fair value of cash collateral receivables that were not offset in the Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011:

 September 30,December 31,
(Dollars in millions)20122011
Sempra Energy Consolidated$ 46$ 20
SDG&E  20  10
SoCalGas  4  2

Fair Value of Financial Instruments

The fair values of certain of our financial instruments (cash, temporary investments, accounts and notes receivable, dividends and accounts payable, short-term debt and customer deposits) approximate their carrying amounts. The following table provides the carrying amounts and fair values of certain other financial instruments at September 30, 2012 and December 31, 2011:

 

FAIR VALUE OF FINANCIAL INSTRUMENTS
(Dollars in millions)
  September 30, 2012
  Carrying Fair Value
  Amount Level 1Level 2Level 3Total
Sempra Energy Consolidated:           
Investments in affordable housing partnerships(1)$ 16 $ ―$ ―$ 46$ 46
Total long-term debt(2)  11,727   ―  12,556  755  13,311
Preferred stock of subsidiaries  99   ―  108  ―  108
SDG&E:           
Total long-term debt(3)$ 4,137 $ ―$ 4,308$ 347$ 4,655
Contingently redeemable preferred stock  79   ―  86  ―  86
SoCalGas:           
Total long-term debt(4)$ 1,662 $ ―$ 1,872$ ―$ 1,872
Preferred stock  22   ―  24  ―  24
             
  December 31, 2011
  Carrying Fair Value
  Amount Level 1Level 2Level 3Total
Sempra Energy Consolidated:           
Investments in affordable housing partnerships(1)$ 21 $ ―$ ―$ 48$ 48
Total long-term debt(2)  9,826   ―  10,447  600  11,047
Preferred stock of subsidiaries  99   ―  106  ―  106
SDG&E:           
Total long-term debt(3)$ 3,895 $ ―$ 3,933$ 355$ 4,288
Contingently redeemable preferred stock  79   ―  86  ―  86
SoCalGas:           
Total long-term debt(4)$ 1,313 $ ―$ 1,506$ ―$ 1,506
Preferred stock  22   ―  23  ―  23
(1)We discuss our investments in affordable housing partnerships in Note 4 of the Notes to Consolidated Financial Statements in the Updated Annual Report.
(2)Before reductions for unamortized discount (net of premium) of $17 million at September 30, 2012 and $16 million at December 31, 2011, and excluding capital leases of $192 million at September 30, 2012 and $204 million at December 31, 2011, and commercial paper classified as long-term debt of $400 million at December 31, 2011. We discuss our long-term debt in Note 6 above and in Note 5 of the Notes to Consolidated Financial Statements in the Updated Annual Report.
(3)Before reductions for unamortized discount of $12 million at September 30, 2012 and $11 million at December 31, 2011, and excluding capital leases of $187 million at September 30, 2012 and $193 million at December 31, 2011.
(4)Before reductions for unamortized discount of $4 million at September 30, 2012 and $3 million at December 31, 2011, and excluding capital leases of $5 million at September 30, 2012 and $11 million at December 31, 2011.

We calculate the fair value of our investments in affordable housing partnerships using an income approach based on the present value of estimated future cash flows discounted at rates available for similar investments (Level 3).

We base the fair value of certain of our long-term debt and preferred stock on a market approach using quoted market prices for identical or similar securities in thinly-traded markets (Level 2). We value other long-term debt using an income approach based on the present value of estimated future cash flows discounted at rates available for similar securities (Level 3).

Nuclear Decommissioning Trusts

We discuss SDG&E's investments in nuclear decommissioning trust funds in Note 6 of the Notes to Consolidated Financial Statements in the Updated Annual Report. The following table shows the fair values and gross unrealized gains and losses for the securities held in the trust funds:

NUCLEAR DECOMMISSIONING TRUSTS
(Dollars in millions)
     Gross Gross Estimated
     Unrealized Unrealized Fair
   Cost Gains Losses Value
As of September 30, 2012:        
Debt securities:        
Debt securities issued by the U.S. Treasury and other         
U.S. government corporations and agencies(1)$ 134$ 12$ ―$ 146
Municipal bonds(2)  60  6  ―  66
Other securities(3)  114  9  ―  123
Total debt securities  308  27  ―  335
Equity securities  249  284  (4)  529
Cash and cash equivalents  28  ―  ―  28
Total $ 585$ 311$ (4)$ 892
As of December 31, 2011:        
Debt securities:        
Debt securities issued by the U.S. Treasury and other         
U.S. government corporations and agencies$ 157$ 13$ ―$ 170
Municipal bonds  72  5  ―  77
Other securities  76  3  (1)  78
Total debt securities  305  21  (1)  325
Equity securities  246  227  (5)  468
Cash and cash equivalents  11  ―  ―  11
Total $ 562$ 248$ (6)$ 804
(1)Maturity dates are 2013-2042
(2)Maturity dates are 2012-2057
(3)Maturity dates are 2013-2111

The following table shows the proceeds from sales of securities in the trusts and gross realized gains and losses on those sales:

SALES OF SECURITIES
(Dollars in millions)
 Three months ended September 30,Nine months ended September 30,
 2012201120122011
Proceeds from sales$ 204$ 294$ 524$ 384
Gross realized gains  3  27  12  29
Gross realized losses  (1)  (8)  (6)  (10)

Net unrealized gains (losses) are included in Regulatory Liabilities Arising from Removal Obligations on the Condensed Consolidated Balance Sheets. We determine the cost of securities in the trusts on the basis of specific identification.

Non-Recurring Fair Value Measures – Sempra Energy Consolidated

We discuss non-recurring fair value measures and the associated accounting impact on our investments in RBS Sempra Commodities and Argentina in Note 4 of the Notes to Consolidated Financial Statements in the Updated Annual Report and, with regard to RBS Sempra Commodities, in Note 4 above. We also discuss non-recurring fair value measures and the associated accounting impact on our investment in Rockies Express in Note 4 above.

Rockies Express

In the second quarter of 2012, the noncash impairment charge of $300 million ($179 million after-tax) primarily resulted from the continuing decline in basis differential on REX associated with shale gas production zones coming on line, assumptions related to the re-contracting of the long-term transportation agreements, and the refinancing of the existing project level debt, discussed further below. The fair value measurement was significantly impacted by unobservable inputs (Level 3) as defined by the accounting guidance for fair value measurements, which we discuss in Note 11 of the Notes to Consolidated Financial Statements in the Updated Annual Report. We considered a market participant's view of the total value for Rockies Express, based on an estimation of the future cash distributions it would be able to generate, adjusted for our 25-percent ownership interest. To estimate future cash distributions, we considered factors impacting Rockies Express' ability to pay future distributions including:

  • the extent to which future cash flows are hedged by capacity sales contracts and their duration (generally through 2019), as well as the creditworthiness of the various counterparties;
  • Rockies Express' future financing needs, including the ability to secure borrowings at reasonable rates as well as potentially using operating cash to retire principal;
  • prospects for generating attractive revenues and cash flows beyond 2019, including natural gas' future basis differentials (driven by the location and extent of future supply and demand) and alternative strategies potentially available to utilize the assets; and

  • discount rates commensurate with the risks inherent in the cash flows.

In the third quarter of 2012, KMI reached an agreement, expected to close in the fourth quarter of 2012, to sell the FTC-mandated asset group, which includes its interest in Rockies Express. Events in the third quarter of 2012 related to this agreement have provided us with additional market participant data. We therefore updated our analysis of the fair value of our investment in Rockies Express as of September 30, 2012 to reflect these additional inputs and recorded an additional impairment charge of $100 million ($60 million after-tax). This fair value measurement in the third quarter was based primarily on the Level 2 input. We believe this is useful and reliable information, but we considered that it may be impacted by the FTC's requirement for KMI to sell its interest in Rockies Express. To reflect this uncertainty, our updated analysis included the less subjective Level 2 market participant input as the primary indicator of fair value, with less weight ascribed to value based on estimated discounted cash flows as discussed above and in the table below. The updates to the cash flow analyses used in determining fair value in the second quarter reflected discussions with Tallgrass as to the strategic direction they are planning to take with their equity partners for Rockies Express, as well as additional discussions with other market participants. Tallgrass is expected to be the operator of Rockies Express.

We believe our analysis forms a reasonable estimate of the fair value of Rockies Express. This estimate includes the material input described above, which was generally observable during the period most relevant to our analysis. Regarding the unobservable inputs, significant uncertainties exist with regard to REX's ability to secure attractive revenues beyond 2019. Accordingly, our analysis suggests that the fair value of our investment in Rockies Express could be materially different from the value we have estimated at this time. For example, if REX is able to sustain the level of revenues currently generated beyond 2019, the value of our investment in Rockies Express would be materially enhanced and the indicated value of our investment in Rockies Express could be significantly higher. Conversely, if REX is unable to sell its transport capacity at sufficient rates or in sufficient volumes beyond 2019, the fair value of our investment in Rockies Express could be materially lower than our carrying amount. Separately, future events involving REX equity could occur and may also provide additional information regarding the fair value of our investment in REX.

Sempra Natural Gas developed the models and scenarios used to measure the fair value of our investment in REX. This modeling used inputs from external sources as described above and in the table below, as well as internally available data, such as operating and maintenance budgets used for financial planning purposes. External experts that forecast the future price of natural gas at various physical locations were also engaged to help validate certain scenarios and modeling assumptions. The fair value measurements were reviewed in detail by Sempra Natural Gas' financial management, as well as Sempra Energy's financial management team.

RBS Sempra Commodities

In both the three months and nine months ended September 30, 2011, we reduced our investment in RBS Sempra Commodities to reflect the latest estimates of our expected future cash distributions from the partnership. This fair value measurement was significantly impacted by unobservable inputs (i.e. Level 3 inputs) as described in the table below.

The following table summarizes significant inputs impacting non-recurring fair value measures related to our investments in REX and RBS Sempra Commodities:

NON-RECURRING FAIR VALUE MEASURES – SEMPRA ENERGY CONSOLIDATED
(Dollars in millions)
 Estimated Fair   
 Fair Value% of Fair Value Range of
 ValueValuation TechniqueHierarchyMeasurementInputs Used to Develop MeasurementInputs
Investment in      
Rockies Express$ 369Market approachLevel 267%Equity sale offer price100%
       
       
  Probability weightedLevel 333%Combined transportation rate assumption(1)6% - 78%
  discounted cash flow  Counterparty credit risk on existing contractsLow
     Operation and maintenance escalation rate0% - 1%
     Forecasted interest rate on debt to be refinanced5% - 10%
     Discount rate8% - 10%
Investment in       
RBS Sempra      
Commodities$ 126Discounted cash flowLevel 3100%Future cash distributions90% - 110%
(1)Transportation rate beyond existing contract terms as a percentage of current mean REX rates.