DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Jun. 30, 2013

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) 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 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 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 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, foreign currency 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 California 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 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 Mexico and Sempra Natural Gas may use natural gas and electricity derivatives, as appropriate, to optimize the earnings of their assets which support the following businesses: liquefied natural gas (LNG), natural gas transportation, power generation, and Sempra Natural Gas' storage. Gains and losses associated with 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. Certain of these derivatives may also be designated as cash flow hedges. Sempra Mexico 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.

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

We summarize net energy derivative volumes as of June 30, 2013 and December 31, 2012 as follows:

NET ENERGY DERIVATIVE VOLUMES
Segment and Commodity		June 30, 2013	December 31, 2012
California Utilities:
SDG&E:
Natural gas		23 million MMBtu	25 million MMBtu	(1)
Congestion revenue rights		24 million MWh	30 million MWh	(2)
SoCalGas - natural gas		1 million MMBtu	―
Energy-Related Businesses:
Sempra Natural Gas:
Electric power		1 million MWh	1 million MWh
Natural gas		43 million MMBtu	36 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 assets and other contractual obligations, such as natural gas and electric power 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 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, excluding the cross-currency swaps discussed below, as of June 30, 2013 and December 31, 2012 were:

INTEREST RATE DERIVATIVES
(Dollars in millions)
		June 30, 2013			December 31, 2012
		Notional Debt		Maturities	Notional Debt		Maturities
Sempra Energy Consolidated:
Cash flow hedges(1)		$	422	2013-2028	$	439	2013-2028
Fair value hedges			500	2013-2016		500	2013-2016
Undesignated contracts			216	2015-2035		―	―
SDG&E:
Cash flow hedge(1)			340	2019		345	2019
(1)	Includes Otay Mesa VIE. All of SDG&E’s interest rate derivatives relate to Otay Mesa VIE.

FOREIGN CURRENCY DERIVATIVES

We are exposed to exchange rate movements at our Mexican subsidiaries, which have U.S. dollar denominated cash balances, 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. We may also utilize cross-currency swaps to hedge exposure related to Mexican peso-denominated debt at our Mexican subsidiaries.On February 14, 2013, Sempra Mexico entered intocross-currency swap agreements, which were designated as cash flow hedges. We discuss the notional amount of the cross-currency swaps in Note 6.

In addition, Sempra South American Utilities may utilize foreign currency derivatives at its subsidiaries and joint ventures as a means to manage foreign currency rate risk. We discuss such a swap at ChilquintaEnergía'sEletrans joint venture investment in Note 4.

FINANCIAL STATEMENT PRESENTATION

Each Condensed Consolidated Balance Sheet reflects the offsetting of net derivative positions and cash collateral with the same counterparty when management believes a legal right of offset exists.The following tables provide the fair values of derivative instruments on the Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012, including the amount of cash collateral receivables that were not offset, as the cash collateral is in excess of liability positions.

DERIVATIVE INSTRUMENTS ON THE CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in millions)
		June 30, 2013
									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(1)		Sundry		derivatives(2)		derivatives
Sempra Energy Consolidated:
Derivatives designated as hedging instruments:
Interest rate and foreign exchange instruments(3)		$	17	$	11	$	(18)	$	(74)
Commodity contracts not subject to rate recovery			4		―		―		―
Derivatives not designated as hedging instruments:
Interest rate and foreign exchange instruments			9		36		(10)		(22)
Commodity contracts not subject to rate recovery:			82		14		(75)		(13)
Associated offsetting commodity contracts			(62)		(11)		62		11
Associated offsetting cash collateral			(3)		―		1		―
Commodity contracts subject to rate recovery:			13		34		(26)		(2)
Associated offsetting commodity contracts			(2)		―		2		―
Associated offsetting cash collateral			―		―		15		2
Net amounts presented on the balance sheet			58		84		(49)		(98)
Additional margin posted for commodity contracts
not subject to rate recovery			9		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			14		―		―		―
Total		$	81	$	84	$	(49)	$	(98)
SDG&E:
Derivatives designated as hedging instruments:
Interest rate instruments(3)		$	―	$	―	$	(16)	$	(44)
Derivatives not designated as hedging instruments:
Commodity contracts subject to rate recovery:			12		34		(24)		(2)
Associated offsetting commodity contracts			(1)		―		1		―
Associated offsetting cash collateral			―		―		15		2
Net amounts presented on the balance sheet			11		34		(24)		(44)
Additional margin posted for commodity contracts
not subject to rate recovery(4)			2		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			12		―		―		―
Total		$	25	$	34	$	(24)	$	(44)
SoCalGas:
Derivatives not designated as hedging instruments:
Commodity contracts subject to rate recovery:		$	1	$	―	$	(2)	$	―
Associated offsetting commodity contracts			(1)		―		1		―
Net amounts presented on the balance sheet			―		―		(1)		―
Additional margin posted for commodity contracts
not subject to rate recovery(4)			3		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			2		―		―		―
Total		$	5	$	―	$	(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.
(4)	Includes cash collateral not offset related to a negligible amount of commodity contracts not subject to rate recovery.
DERIVATIVE INSTRUMENTS ON THE CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in millions)
		December 31, 2012
									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(1)		Sundry		derivatives(2)		derivatives
Sempra Energy Consolidated:
Derivatives designated as hedging instruments:
Interest rate instruments(3)		$	7	$	12	$	(19)	$	(64)
Commodity contracts not subject to rate recovery			1		―		―		―
Derivatives not designated as hedging instruments:
Interest rate instruments			8		40		(8)		(35)
Commodity contracts not subject to rate recovery:			117		15		(116)		(27)
Associated offsetting commodity contracts			(102)		(12)		102		12
Associated offsetting cash collateral			―		―		4		7
Commodity contracts subject to rate recovery:			30		35		(35)		(1)
Associated offsetting commodity contracts			(4)		―		4		―
Associated offsetting cash collateral			―		―		22		1
Net amounts presented on the balance sheet			57		90		(46)		(107)
Additional margin posted for commodity contracts
not subject to rate recovery			22		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			13		―		―		―
Total		$	92	$	90	$	(46)	$	(107)
SDG&E:
Derivatives designated as hedging instruments:
Interest rate instruments(3)		$	―	$	―	$	(17)	$	(64)
Derivatives not designated as hedging instruments:
Commodity contracts subject to rate recovery:			28		35		(33)		(1)
Associated offsetting commodity contracts			(3)		―		3		―
Associated offsetting cash collateral			―		―		22		1
Net amounts presented on the balance sheet			25		35		(25)		(64)
Additional margin posted for commodity contracts
not subject to rate recovery(4)			1		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			12		―		―		―
Total		$	38	$	35	$	(25)	$	(64)
SoCalGas:
Derivatives not designated as hedging instruments:
Commodity contracts subject to rate recovery:		$	2	$	―	$	(2)	$	―
Associated offsetting commodity contracts			(1)		―		1		―
Net amounts presented on the balance sheet			1		―		(1)		―
Additional margin posted for commodity contracts
not subject to rate recovery(4)			2		―		―		―
Additional margin posted for commodity contracts
subject to rate recovery			1		―		―		―
Total		$	4	$	―	$	(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.
(4)	Includes cash collateral not offset related to a negligible amount of commodity contracts not subject to rate recovery.

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 six months endedJune 30were:

FAIR VALUE HEDGE IMPACT ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
			Gain (loss) on derivatives recognized in earnings				Gain (loss) on derivatives recognized in earnings
			Three months ended June 30,				Six months ended June 30,
		Location	2013		2012		2013		2012
Sempra Energy Consolidated:
Interest rate instruments		Interest Expense	$	2	$	2	$	4	$	4
Interest rate instruments		Other Income, Net		(5)		―		(5)		2
Total(1)			$	(3)	$	2	$	(1)	$	6
(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 June 30,					Three months ended June 30,
		2013		2012		Location	2013		2012
Sempra Energy Consolidated:
Interest rate and foreign
exchange instruments(1)		$	33	$	(18)	Interest Expense	$	(3)	$	(1)
						Equity Earnings (Losses),
Interest rate instruments			13		(7)	Before Income Tax		(2)		2
Commodity contracts not subject						Cost of Natural Gas, Electric
to rate recovery			4		―	Fuel and Purchased Power		5		―
Total		$	50	$	(25)		$	―	$	1
SDG&E:
Interest rate instruments(1)		$	10	$	(10)	Interest Expense	$	(2)	$	(1)
SoCalGas:
Interest rate instruments		$	―	$	―	Interest Expense	$	(1)	$	―
		Six months ended June 30,					Six months ended June 30,
		2013		2012		Location	2013		2012
Sempra Energy Consolidated:
Interest rate and foreign
exchange instruments(1)		$	5	$	(15)	Interest Expense	$	(6)	$	(2)
						Equity Earnings (Losses),
Interest rate instruments			14		(6)	Before Income Tax		(4)		―
Commodity contracts not subject						Cost of Natural Gas, Electric
to rate recovery			4		―	Fuel and Purchased Power		5		―
Total		$	23	$	(21)		$	(5)	$	(2)
SDG&E:
Interest rate instruments(1)		$	11	$	(10)	Interest Expense	$	(4)	$	(1)
SoCalGas:
Interest rate instruments		$	―	$	―	Interest Expense	$	(1)	$	(1)
(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.

Sempra Energy Consolidated expects that losses of $22 million, which are net of income tax benefit, that are currently recorded in AOCI (including losses of $11 million in noncontrolling interests) 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 and certain commodity prices in effect when derivative contracts that are currently outstanding mature. The Sempra Energy Consolidated amount includes losses of $10 million at SDG&E in noncontrolling interest related to Otay Mesa VIE.

SoCalGas expects that losses of $1 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.

For all forecasted transactions, the maximum term over which we are hedging exposure to the variability of cash flows at June 30, 2013 is approximately 16 years and 6 years for Sempra Energy and SDG&E, respectively. The maximum term of hedged interest rate variability related to debt at Sempra Renewables' equity method investees is 18 years.

We recorded $1 million of hedge ineffectiveness in the three-month and six-month periods ended June 30, 2013 and negligible hedge ineffectiveness in the three-month and six-month periods ended June 30, 2012.

The effects of derivative instruments not designated as hedging instruments on the Condensed Consolidated Statements of Operations for the three months and six monthsended June 30were:

UNDESIGNATED DERIVATIVE IMPACT ON THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions)
		Gain (loss) on derivatives recognized in earnings
		Three months ended June 30,				Six months ended June 30,
	Location	2013		2012		2013		2012
Sempra Energy Consolidated:
Interest rate and foreign exchange
instruments	Other Income, Net	$	6	$	(1)	$	13	$	10
Foreign exchange instruments	Equity Earnings,
	Net of Income Tax		4		―		4		―
Commodity contracts not subject	Revenues: Energy-Related
to rate recovery	Businesses		21		(9)		1		2
Commodity contracts not subject
to rate recovery	Operation and Maintenance		―		(1)		―		―
Commodity contracts subject	Cost of Electric Fuel
to rate recovery	and Purchased Power		(18)		12		(9)		(9)
Commodity contracts subject
to rate recovery	Cost of Natural Gas		(1)		(1)		(1)		(1)
Total		$	12	$	―	$	8	$	2
SDG&E:
Commodity contracts subject	Cost of Electric Fuel
to rate recovery	and Purchased Power	$	(18)	$	12	$	(9)	$	(9)
SoCalGas:
Commodity contracts not subject
to rate recovery	Operation and Maintenance	$	―	$	(1)	$	―	$	―
Commodity contracts subject
to rate recovery	Cost of Natural Gas		(1)		(1)		(1)		(1)
Total		$	(1)	$	(2)	$	(1)	$	(1)

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, the total fair value of this group of derivative instruments in a net liability position at June 30, 2013 and December 31, 2012 is $6 million and $8 million, respectively. As of June 30, 2013, if the credit ratings of Sempra Energy were reduced below investment grade, $6 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 June 30, 2013 and December 31, 2012 is $4 million and $6 million, respectively. As of June 30, 2013, if the credit ratings of SDG&E were reduced below investment grade, $4 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.