SEMPRA ENERGY - 10-Q Quarterly Report

Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005
-------------------------------------

Commission file number 1-14201
---------------------------------------------

Sempra Energy
----------------------------------------------------------
(Exact name of registrant as specified in its charter)

California 33-0732627
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

101 Ash Street, San Diego, California 92101
- -------------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)

(619) 696-2034
----------------------------------------------------------
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
----- -----

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----

Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.

Common stock outstanding on April 30, 2005: 239,265,771
---------------------

2

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report contains statements that are not historical fact
and constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The words
"estimates," "believes," "expects," "anticipates," "plans," "intends,"
"may," "could," "would" and "should" or similar expressions, or
discussions of strategy or of plans are intended to identify forward-
looking statements. Forward-looking statements are not guarantees of
performance. They involve risks, uncertainties and assumptions. Future
results may differ materially from those expressed in these forward-
looking statements.

Forward-looking statements are necessarily based upon various
assumptions involving judgments with respect to the future and other
risks, including, among others, local, regional, national and
international economic, competitive, political, legislative and
regulatory conditions and developments; actions by the California
Public Utilities Commission, the California State Legislature, the
California Department of Water Resources, and the Federal Energy
Regulatory Commission and other regulatory bodies in the United States
and other countries; capital markets conditions, inflation rates,
interest rates and exchange rates; energy and trading markets,
including the timing and extent of changes in commodity prices; the
availability of natural gas; weather conditions and conservation
efforts; war and terrorist attacks; business, regulatory, environmental
and legal decisions and requirements; the status of deregulation of
retail natural gas and electricity delivery; the timing and success of
business development efforts; the outcome of litigation; and other
uncertainties, all of which are difficult to predict and many of which
are beyond the control of the company. Readers are cautioned not to
rely unduly on any forward-looking statements and are urged to review
and consider carefully the risks, uncertainties and other factors which
affect the company's business described in this report and other
reports filed by the company from time to time with the Securities and
Exchange Commission.

3

PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

SEMPRA ENERGY
STATEMENTS OF CONSOLIDATED INCOME
(Dollars in millions, except per share amounts)

4

SEMPRA ENERGY
CONSOLIDATED BALANCE SHEETS
(Dollars in millions)

5

SEMPRA ENERGY
CONSOLIDATED BALANCE SHEETS
(Dollars in millions)

6

SEMPRA ENERGY
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in millions)

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. GENERAL

This Quarterly Report on Form 10-Q is that of Sempra Energy (the
company), a California-based Fortune 500 holding company. Sempra
Energy's subsidiaries include San Diego Gas & Electric Company (SDG&E)
and Southern California Gas Company (SoCalGas) (collectively referred
to herein as the California Utilities); Sempra Global, which is the
holding company for Sempra Commodities, Sempra Generation, Sempra
Pipelines & Storage, Sempra LNG and other, smaller businesses; and
Sempra Financial and additional smaller businesses. The financial
statements herein are the Consolidated Financial Statements of Sempra
Energy and its consolidated subsidiaries.

The accompanying Consolidated Financial Statements have been prepared
in accordance with the interim-period-reporting requirements of Form
10-Q. Results of operations for interim periods are not necessarily
indicative of results for the entire year. In the opinion of
management, the accompanying statements reflect all adjustments
necessary for a fair presentation. These adjustments are only of a
normal recurring nature. On December 1, 2004, Sempra Energy Solutions'
commodities business was absorbed into Sempra Commodities, while its
other businesses, energy services and facilities management, are now
part of Sempra Generation. As a result, certain amounts for the quarter
ended March 31, 2004 have been revised to conform to the current year's
presentation.

Information in this Quarterly Report is unaudited and should be read in
conjunction with the Annual Report on Form 10-K for the year ended
December 31, 2004 (the Annual Report).

The company's significant accounting policies are described in Note 1
of the notes to Consolidated Financial Statements in the Annual Report.
The same accounting policies are followed for interim reporting
purposes.

The company follows the guidance of Statement of Financial Accounting
Standards (SFAS) 142, Goodwill and Other Intangible Assets. The
carrying amount of goodwill (included in Noncurrent Sundry Assets on
the Consolidated Balance Sheets) was $188 million as of March 31, 2005
and December 31, 2004.

The California Utilities account for the economic effects of regulation
on utility operations in accordance with SFAS 71, Accounting for the
Effects of Certain Types of Regulation.

In accordance with SFAS 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits, the following table provides
the components of benefit costs for the quarters ended March 31:

8

Note 9 of the notes to Consolidated Financial Statements in the Annual
Report discusses the company's expected contribution to its pension and
other postretirement benefit plans in 2005. For the quarter ended March
31, 2005, $2 million and $12 million of contributions have been made to
its pension and other postretirement benefit plans, respectively.

In accordance with Financial Accounting Standards Board (FASB) Staff
Position 106-2, the net periodic postretirement benefit costs for the
quarter ended March 31, 2005 were reduced by $3 million, before
regulatory adjustments, to reflect the expected subsidy as a result of
the Medicare Prescription Drug, Improvement and Modernization Act of
2003.

Changes in asset-retirement obligations, as defined in SFAS 143,
Accounting for Asset Retirement Obligations, for the quarter ended
March 31, 2005 and 2004 are as follows (dollars in millions):

2005 2004
- ------------------------------------------------------------------
Balance as of January 1 $ 348* $ 337*
Accretion expense 6 6
Payments (2) (3)
------ ------
Balance as of March 31 $ 352* $ 340*
- ------------------------------------------------------------------

* The current portion of the obligation is included in Other Current
Liabilities on the Consolidated Balance Sheets.

At March 31, 2005 and December 31, 2004, the estimated removal costs
recorded as a regulatory liability were $1.5 billion and $1.4 billion,
respectively, for SoCalGas, and $926 million and $913 million,
respectively, for SDG&E.

9

NOTE 2. NEW ACCOUNTING STANDARDS

Stock-Based Compensation: In December 2004, the FASB issued SFAS 123
(revised), a revision of SFAS 123, Accounting for Stock-Based
Compensation, which establishes the accounting for transactions in
which an entity exchanges its equity instruments for goods or services
received. This statement requires companies to measure and record the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award and gives
companies three alternative transition methods. The company has not
determined the transition method it will use. The effective date of
this statement is January 1, 2006 for the company.

The following table provides the pro forma effects that would have
resulted if stock options had been expensed.

FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51" (FIN 46): Contracts under
which SDG&E acquires power from generation facilities otherwise
unrelated to SDG&E could result in a requirement for SDG&E to
consolidate the entity that owns the facility. As permitted by the
interpretation, SDG&E is continuing the process of determining whether
it has any such situations and, if so, gathering the information that
would be needed to perform the consolidation. The effects of this, if
any, are not expected to significantly affect the financial position of
SDG&E and there would be no effect on results of operations or
liquidity.

FIN 47, "Accounting for Conditional Asset Retirement Obligations, an
interpretation of FASB Statement No. 143": Issued in March 2005, FIN 47
clarifies that the term conditional asset-retirement obligation as used
in SFAS 143, Accounting for Asset Retirement Obligations, refers to a

10

legal obligation to perform an asset-retirement activity in which the
timing and/or method of settlement are conditional on a future event
that may or may not be within the control of the entity. FIN 47
requires companies to recognize a liability for the fair value of a
conditional asset-retirement obligation if the fair value of the
obligation can be reasonably estimated. FIN 47 is effective for the
company's 2005 annual report. The company has not determined the effect
of FIN 47 on its financial position or results of operations.

FASB Staff Position 109-2, "Accounting and Disclosure Guidance for the
Foreign Earnings Repatriation Provision within the American Jobs
Creation Act of 2004": As discussed in the 2004 Annual Report, the
company has not completed its evaluation of the repatriation provision
and does not expect to make a decision on the amount of such
repatriations, if any, until the fourth quarter of 2005. Among other
things, the decision will depend on the level of earnings outside the
U.S., the debt level between the company's U.S. and non-U.S.
affiliates, and administrative guidance from the Internal Revenue
Service.

NOTE 3. OTHER FINANCIAL DATA

Earnings per Share (EPS)

The following tables provide the per share computations of income from
continuing operations.

Quarter ended March 31, 2005
--------------------------------------
Income Shares Per
(millions) (thousands) Share
(numerator) (denominator) Amounts
----------- ------------- -------
Basic EPS:
Income from continuing
operations $ 223 232,939 $ 0.96
=======
Effect of dilutive
securities:
Stock options and
restricted stock
awards -- 4,083 *
Equity Units -- 4,083 *
--------- ---------
Diluted EPS:
Income from continuing
operations $ 223 241,105 $ 0.92
========= ========= =======

* That these amounts are the same is coincidental.

11

Quarter ended March 31, 2004
--------------------------------------
Income Shares Per
(millions) (thousands) Share
(numerator) (denominator) Amounts
----------- ------------- -------
Basic EPS:
Income from continuing
operations $ 221 228,055 $ 0.97
=======
Effect of dilutive
securities:
Stock options and
restricted stock
awards -- 2,574
Equity Units -- 507
--------- ---------
Diluted EPS:
Income from continuing
operations $ 221 231,136 $ 0.96
========= ========= =======

Additional information regarding the Equity Units is provided in Note
13 of the notes to Consolidated Financial Statements in the Annual
Report.

Comprehensive Income

The following is a reconciliation of net income to comprehensive
income.
Quarters ended
March 31,
--------------
(Dollars in millions) 2005 2004
- ---------------------------------------------------------------

Net income $ 223 $ 197

Foreign currency adjustments (15) 4

Financial instruments, net of income tax
(benefit) of $2 and $(1), respectively (Note 5) 8 (5)

Available-for-sale securities,
net of income tax of $1 (2) --
--------------
Comprehensive income $ 214 $ 196
- ----------------------------------------------------------------

Available-for-Sale Securities

Sempra Commodities had $8 million and $14 million of available-for-sale
securities included in Investments at March 31, 2005 and December 31,
2004, respectively. Additionally, Sempra Commodities recorded $1
million in purchases and $6 million in sales of available-for-sale
securities for the quarter ended March 31, 2005. The cost basis of the
sales was determined by the specific identification method and a gain
of $2 million, net of income tax, was realized as a result of the
sales. There were $2 million and $4 million in unrealized gains, net of
income tax, in Accumulated Other Comprehensive Income (Loss) at March

12

31, 2005 and December 31, 2004, respectively, related to these
securities.

Company Repurchases of Common Stock

On April 5, 2005, the board of directors authorized the expenditure of
up to $250 million for the purchase of shares of common stock, at any
time and from time to time, in the open market, in negotiated
transactions and otherwise. Such authorization supersedes a prior
authorization to expend up to $100 million to purchase shares that was
adopted on March 7, 2000 and of which $82.8 million remained
unutilized.

NOTE 4. DISCONTINUED OPERATIONS

In the first quarter of 2004, Sempra Energy's board of directors
approved management's plan to dispose of its interest in Atlantic
Electric & Gas Limited (AEG), a marketer of power and natural gas
commodities to commercial and residential customers in the United
Kingdom. In April 2004, AEG went into administrative receivership and
substantially all of the assets were sold. This transaction resulted in
an after-tax loss of $2 million in the second quarter of 2004, which
was reported separately on the Statements of Consolidated Income.

AEG's balance sheet data are summarized below:

NOTE 5. FINANCIAL INSTRUMENTS

Accounting for Derivative Instruments and Hedging Activities

In accordance with SFAS 133 and related amendments SFAS 138 and 149
(collectively SFAS 133), derivative instruments and related hedges are
recognized as assets or liabilities on the balance sheet (measured at
fair value) and changes in their fair values are recognized in earnings
unless the derivative qualifies as an accounting hedge.

SFAS 133 provides for hedge accounting treatment when certain criteria
are met. For derivative instruments designated as fair value hedges,
the gain or loss is recognized in earnings in the period of change
together with the offsetting gain or loss on the item to which the risk
being hedged is related; therefore, there is no effect on net income.

13

For derivative instruments designated as cash flow hedges, the
effective portion of the derivative gain or loss is included in other
comprehensive income, but not in net income until the corresponding
hedged transaction is similarly reflected. Any ineffective portion is
reported in earnings immediately. For the quarter ended March 31, 2005,
pre-tax income arising from the ineffective portion of interest-rate
swaps included $4 million recorded in Other Income on the Statements of
Consolidated Income. There was no effect on net income for the quarter
ended March 31, 2004.

The effect of cash flow hedges on other comprehensive income (loss) for
the quarters ended March 31, 2005 and 2004 was $8 million and $(5)
million, respectively. The balances in Accumulated Other Comprehensive
Income (Loss) at March 31, 2005 and December 31, 2004 related to cash
flow hedges were $(31) million and $(39) million, respectively.

The company utilizes derivative instruments to reduce its exposure to
unfavorable changes in commodity prices, which are subject to
significant and often volatile fluctuation. Derivative instruments
include futures, forwards, swaps, options and long-term delivery
contracts. These contracts allow the company to predict with greater
certainty the effective prices to be received by the company and, in
the case of the California Utilities, the prices to be charged to their
customers. At the California Utilities, the use of derivative financial
instruments is subject to certain limitations imposed by company policy
and regulatory requirements.

The company classifies its forward contracts as follows:

Contracts that meet the definition of normal purchases and sales,
i.e., those that rarely settle by means other than physical delivery
of the commodities involved in the transaction, are eligible for the
normal purchases and sales exception of SFAS 133, whereby they are
accounted for under accrual accounting and recorded in Revenues or
Cost of Sales on the Statements of Consolidated Income at the time
of delivery.

Electric and Natural Gas Purchases and Sales:

As they relate to the California Utilities, the unrealized gains and
losses related to forward contracts are offset by regulatory assets
and liabilities on the Consolidated Balance Sheets to the extent
derivative gains and losses will be recoverable or payable in future
rates. If gains and losses at the California Utilities are not
recoverable or payable through future rates, the California
Utilities apply hedge accounting if certain criteria are met. When a
contract no longer meets the hedging requirements of SFAS 133, the
unrealized gains and losses and the related regulatory asset or
liability will be amortized over the remaining contract life.

The transactions associated with fixed-price contracts and other
derivatives had no material impact on the Statements of Consolidated
Income for the quarter ended March 31, 2005. For the quarter ended
March 31, 2004, pre-tax income from transactions associated with fixed-
price contracts and other derivatives included $13 million recorded in
Other Income on the Statements of Consolidated Income.

14

Market Risk

The company's policy is to use derivative physical and financial
instruments to reduce its exposure to fluctuations in interest rates,
foreign currency exchange rates and commodity prices. The company also
uses and trades derivative instruments in its trading and marketing of
energy and other commodities. Transactions involving these instruments
are with major exchanges and other firms believed to be credit-worthy.
The use of these instruments exposes the company to market and credit
risk, which may at times be concentrated with certain counterparties,
although counterparty nonperformance is not anticipated.

Interest-Rate Risk Management

As described in Note 6 of the notes to Consolidated Financial
Statements in the Annual Report, the company periodically enters into
interest-rate swap agreements to moderate its exposure to interest-rate
changes and to lower the overall cost of borrowing.

Energy Derivatives

The company utilizes derivative instruments to reduce its exposure to
unfavorable changes in energy prices, which are subject to significant
and often volatile fluctuation. Derivative instruments are comprised of
futures, forwards, swaps, options and long-term delivery contracts.
These contracts allow the company to predict with greater certainty the
effective prices to be received.

Energy Contracts

The California Utilities record transactions for natural gas and
electric energy contracts in Cost of Natural Gas and Cost of Electric
Fuel and Purchased Power, respectively, in the Statements of
Consolidated Income. For open contracts not expected to result in
physical delivery, changes in the market value of the contracts are
recorded in these accounts during the period the contracts are open,
with an offsetting entry to a regulatory asset or liability. The
majority of the California Utilities' contracts result in physical
delivery.

Sempra Commodities

Sempra Commodities derives revenue from market making and trading
activities, as a principal, in natural gas, electricity, petroleum
products, metals and other commodities, for which it quotes bid and
asked prices to other market makers and end users. It also earns
trading profits as a dealer by structuring and executing transactions
that permit its counterparties to manage their risk profiles. Sempra
Commodities utilizes derivative instruments to reduce its exposure to
unfavorable changes in market prices, which are subject to significant
and often volatile fluctuation. These instruments include futures,
forwards, swaps and options, and represent contracts with
counterparties under which payments are linked to or derived from
energy market indices or on terms predetermined by the contract, which
may or may not be financially settled by Sempra Commodities. Sempra
Energy guarantees many of Sempra Commodities' transactions.

15

Sempra Commodities also derives a portion of its revenue from
delivering electric and natural gas supplies to its commercial and
industrial customers. Such contracts are hedged to preserve margin and
reduce market risk. The derivative instruments used to hedge the
transactions include swaps, forwards, futures, options or combinations
thereof.

Trading instruments for all activities are recorded by Sempra
Commodities on a trade-date basis and the majority of such derivative
instruments are adjusted daily to current market value with gains and
losses recognized in Other Operating Revenues on the Statements of
Consolidated Income. These instruments are included on the Consolidated
Balance Sheets as trading assets or trading liabilities and include
amounts due from commodity clearing organizations, amounts due to or
from trading counterparties, unrealized gains and losses from exchange-
traded futures and options, derivative over-the-counter (OTC) swaps,
forwards and options. Unrealized gains and losses on OTC transactions
reflect amounts that would be received from or paid to a third party
upon settlement of the contracts. Unrealized gains and losses on OTC
transactions are reported separately as assets and liabilities unless a
legal right of setoff exists under an enforceable netting arrangement.
Other derivatives that qualify as hedges are accordingly recorded under
hedge accounting.

As a result of the rescission of Emerging Issues Task Force (EITF) 98-
10 (discussed in Note 1 of the notes to Consolidated Financial
Statements in the Annual Report) energy commodity inventory is being
recorded at the lower of cost or market; however metals inventories
continue to be recorded at fair value in accordance with Accounting
Research Bulletin No. 43, Restatement and Revision of Accounting
Research Bulletins.

Futures and exchange-traded option transactions are recorded as
contractual commitments on a trade-date basis and are carried at fair
value based on closing exchange quotations. Commodity swaps and forward
transactions are accounted for as contractual commitments on a trade-
date basis and are carried at fair value derived from dealer quotations
and underlying commodity exchange quotations. OTC options purchased and
written are recorded on a trade-date basis. OTC options are carried at
fair value based on the use of valuation models that utilize, among
other things, current interest, commodity and volatility rates, as
applicable.

16

The carrying values of trading assets and trading liabilities, primarily at
Sempra Commodities, approximate the following:

March 31, December 31,
(Dollars in millions) 2005 2004
- -----------------------------------------------------------------------
TRADING ASSETS

Trading-related receivables and deposits, net:
Due from trading counterparties $ 2,164 $ 2,371
Due from commodity clearing organizations
and clearing brokers 278 235
-------------------
2,442 2,606
-------------------
Derivative trading instruments:
Unrealized gains on swaps and forwards 1,889 1,607
OTC commodity options purchased 1,134 732
-------------------
3,023 2,339
-------------------
Commodities owned 1,201 1,547
---------------------
Total trading assets $ 6,666 $ 6,492
- ----------------------------------------------------------------------
TRADING LIABILITIES

Trading-related payables $ 2,795 $ 3,182
-------------------
Derivative trading instruments sold,
not yet purchased:
Unrealized losses on swaps and forwards 1,789 1,232
OTC commodity options written 625 252
-------------------
2,414 1,484
-------------------
Commodities and securities sold with agreement
to repurchase 291 513
---------------------

Total trading liabilities $ 5,500 $ 5,179
- -----------------------------------------------------------------------

At Sempra Commodities, market risk from market-making and trading
activities arises from the potential for changes in the value of
physical and financial instruments resulting from fluctuations in
prices and basis for natural gas, electricity, petroleum, petroleum
products, metals and other commodities. Market risk is also affected by
changes in volatility and liquidity in markets in which these
instruments are traded. Market risk for electric and natural gas
delivery contract activity from fluctuations in natural gas or
electricity prices is reduced by Sempra Commodities' hedging strategy
as described above.

Sempra Commodities' credit risk from physical and financial instruments
as of March 31, 2005 is represented by their positive fair value after

17

consideration of collateral. Options written do not expose Sempra
Commodities to credit risk. Exchange-traded futures and options are not
deemed to have significant credit exposure since the exchanges
guarantee that every contract will be properly settled on a daily
basis. Credit risk is also associated with its retail customers.

The following table summarizes the counterparty credit quality and
exposure for Sempra Commodities at March 31, 2005 and December 31,
2004, expressed in terms of net replacement value. These exposures are
net of collateral in the form of customer margin and/or letters of
credit of $1.4 billion and $1.1 billion at March 31, 2005 and December
31, 2004, respectively.

March 31, December 31,
(Dollars in millions) 2005 2004
- ------------------------------------------------------------------
Counterparty credit quality*

Commodity exchanges $ 278 $ 235
AAA 20 7
AA 404 259
A 635 562
BBB 967 680
Below investment grade and not rated 571 532
--------------------------
Total $ 2,875 $ 2,275
--------------------------

* As determined by rating agencies or internal models intended to
approximate rating-agency determinations.

NOTE 6. CALIFORNIA UTILITIES' REGULATORY MATTERS

COST OF SERVICE FILINGS

There has been no resolution of SDG&E's Petition for Modification or
Application for Rehearing filed in December 2004 and January 2005,
respectively, to increase revenues for each of 2004 and 2005 by $10
million to correct what SDG&E believes was a computational error by the
California Public Utilities Commission (CPUC) concerning SDG&E's
nuclear electric rate revenues.

In July 2004, the California Utilities filed with the CPUC a proposed
settlement of Phase II of their cost of service proceedings, addressing
attrition allowances and performance-based incentive mechanisms. On
March 17, 2005, the CPUC approved the settlement and adopted related
performance measures and incentives.

The CPUC's decision establishes an indexing methodology for post-test-
year ratemaking which includes inflation adjustments and earnings-
sharing mechanisms. The decision is retroactive to January 1, 2005 and
is applicable to years 2005-2007. It eliminates earnings sharing that
would otherwise have been applicable for 2004 and incentive awards for
2004.

For the years 2005-2007, the California Utilities' authorized base-rate
revenues will be annually increased by the increase in the Consumer

18

Price Index, subject to minimum and maximum percentage increases that
vary with the particular utility and increase yearly. The annual
minimum percentage increases range from 2.0% to 3.8% and the annual
maximum percentage increases range from 3.0% to 4.8%. For these years,
any utility base-rate earnings that exceed the CPUC-authorized rate of
return on ratebase plus 0.5 percentage point will be shared with
customers, in proportions that vary with the amount of the excess,
beginning with customers' receiving 75% of the excess, declining to 25%
as the excess increases. The decision authorizes either utility to file
for a suspension of the indexing and sharing mechanisms if its base-
rate earnings for any year are at least 1.75 percentage points below
its authorized rate of return and authorizes others to file for a
suspension if either utility's base-rate earnings for any year are at
least 1.75 percentage points above its authorized rate of return. The
mechanisms will be automatically suspended for either utility if its
base-rate earnings for either 2005 or 2006 are at least 3 percentage
points above or below its authorized rate of return.

The decision also establishes formula-based performance measures for
customer service, safety and reliability. These provide symmetrical
annual reward and penalty potentials aggregating approximately $22
million.

With the end of the Incremental Cost Incentive Mechanism in 2003,
SDG&E's San Onofre Nuclear Generating Station (SONGS) ratebase
restarted at $0 on January 1, 2004 and, therefore, SDG&E's earnings
from SONGS are now generally limited to a return on new capital
additions.

Southern California Edison (Edison), the operator of SONGS, has applied
for CPUC approval to replace SONGS' steam generators, which Edison
stated would require an estimated capital expenditure of $782 million.
Hearings before the CPUC on Edison's application were completed on
February 11, 2005 and a final decision addressing the cost
effectiveness of the steam generator project is expected during the
second half of 2005. SDG&E had elected not to participate in the
project. SDG&E nonparticipation would result in a reduction in its
ownership in the project and a proportionate reduction in its share of
SONGS' output. On February 18, 2005, an arbitrator issued a decision
that, based upon Edison's cost calculations, would result in SDG&E's
ownership interest in SONGS and its related share of SONGS' output
being reduced to zero if SDG&E continues to decline to participate in
the project. If this were to occur, SDG&E would seek to recover its
investments in SONGS made since January 1, 2004 ($35 million) and any
future SONGS investments until the reduced ownership becomes effective,
and its return on those investments. The arbitration decision is
subject to CPUC review and approval, with a CPUC decision expected in
2006. The CPUC could require SDG&E to participate in the project or, if
the reductions of SDG&E's ownership percentage resulting from the CPUC
final decision were to be unacceptable, SDG&E may elect to participate.

UTILITY RATEMAKING INCENTIVE AWARDS

Performance-Based Regulation (PBR), demand-side management (DSM) and
Gas Cost Incentive Mechanism (GCIM) awards are not included in the
company's earnings before CPUC approval of the award is received. No
incentive awards were approved during the first quarter of 2005.

19

On December 30, 2004, a joint settlement agreement between the
California Utilities and the CPUC's Office of Ratepayers Advocates
(collectively, the joint parties) was filed with the CPUC for
approval. The settlement agreement resolves all outstanding
shareholder earnings claims filed with the CPUC commencing in 2000
associated with DSM, energy efficiency and low-income energy
efficiency programs and those claims that would have been filed
through 2007 (for SDG&E's DSM programs through 1997 and through
various dates for the efficiency programs) and 2009 (for SoCalGas' DSM
programs through 1999 and through various dates for the efficiency
programs). The proposed settlement is for $73 million and $14 million,
respectively, for SDG&E and SoCalGas (including interest, franchise
fees, uncollectible amounts and awards earned in prior years that had
not yet then been requested). The $14 million would be included in
2005 income. Approximately $40 million of the $73 million, depending
on the timing of the CPUC approval, would be included in 2005 income.
The joint parties requested expeditious approval of the settlement
agreement, without modification. A CPUC decision is expected in the
second or third quarter of 2005.

Other performance incentives pending CPUC approval at March 31, 2005
and, therefore, not included in the company's earnings were (dollars
in millions):

Program SoCalGas SDG&E Total
- -----------------------------------------------------------
2003 Distribution PBR $ -- $ 8.2 $ 8.2
GCIM/natural gas PBR 2.4 0.2 2.6
2003 safety 0.5 -- 0.5
- -----------------------------------------------------------
Total $ 2.9 $ 8.4 $ 11.3
- -----------------------------------------------------------

The cumulative amount of awards subject to refund based on the outcome
of the Border Price Investigation discussed in "Litigation" below is
$65.3 million, substantially all of which has been included in net
income.

SDG&E's ELECTRIC RESOURCES

The California Department of Water Resources' (DWR) operating agreement
with SDG&E, approved by the CPUC, provides that SDG&E is acting as a
limited agent on behalf of the DWR in undertaking energy sales and
natural gas procurement functions under the DWR contracts allocated to
SDG&E's customers. Legal and financial responsibility associated with
these activities continues to reside with the DWR. Therefore, the
revenues and costs associated with the contracts are not included in the
Statements of Consolidated Income.

In October 2003, the CPUC initiated a proceeding to consider a
permanent methodology for allocating the DWR's revenue requirement
beginning in 2004 through the remaining life of the DWR contracts
(2013). On December 2, 2004, the CPUC issued a decision that would
shift $790 million of the costs to SDG&E's customers over that period
and subsequently initiated consideration of other methods, one of which
could increase that amount by an additional $450 million. On December

20

20, 2004, SDG&E filed an application for rehearing of the December 2,
2004 decision, arguing that the CPUC reached its decision without the
proper evidentiary review of the method of calculating above-market
costs. On January 13, 2005, the CPUC acted to grant rehearing on that
limited issue.

Such a shift would not affect SDG&E's net income, but would adversely
affect its customers' commodity costs. In the near term, the effect on
SDG&E's cash flows would be minor, but could become significant in
later years unless rate ceilings imposed by Assembly Bill 1X, which
froze total rates for most residential customers at the February 2001
level, are increased to provide more-contemporaneous recovery. Until
January 1, 2016, CPUC Decision 04-12-048 provides SDG&E with a true-up
triggering mechanism when an overcollection or undercollection in
SDG&E's power procurement balancing account exceeds approximately five
percent of the prior year's recorded electric commodity revenue.

SDG&E's long-term resource plan identifies the forecasted needs for
capacity resources within its service territory to support transmission
grid reliability. A 10-year resource plan was approved by the CPUC in
December 2004, in a proceeding to consider utility resource planning,
including energy efficiency, contracted power, demand response,
qualifying facilities, renewable generation and distributed generation.
Further discussion of this plan is included in the Annual Report. In
December 2004, the CPUC also endorsed SDG&E's continued analysis and
planning for a 500-kV transmission line. SDG&E expects to file for a
new transmission line by the end of 2005.

RECOVERY OF CERTAIN DISALLOWED TRANSMISSION COSTS

The Federal Court of Appeals has set oral argument for May 9, 2005 on
SDG&E's appeal of a Federal Energy Regulatory Commission (FERC)
decision that denied SDG&E recovery in its transmission rates of the
differentials between certain payments to SDG&E by its co-owners of the
Southwest Powerlink (SWPL) and charges assessed to SDG&E under the
California Independent System Operator (ISO) FERC tariff. As a result
of the FERC decision, SDG&E has been and is incurring unreimbursed
costs of $5 million to $11 million per year, including $2.7 million in
the first quarter of 2005.

In July 2001, SDG&E filed an arbitration claim against the ISO,
claiming the ISO should not charge SDG&E for the transmission losses
attributable to its SWPL co-owners' energy schedules. In October 2003,
the arbitrator awarded SDG&E all amounts claimed, which totaled $22
million, including interest, as of the time of the award. The ISO
appealed this result to the FERC and a decision on this appeal is
pending.

SDG&E has also challenged at the FERC the ISO's grid management charges
assessed on the subject SWPL schedules. In January 2004, the FERC
denied rehearing of its Opinion No. 463, which upheld such charges on
the subject SWPL schedules for 2001 through 2003, but ordered certain
refunds to SDG&E. The refunds are pending before the FERC. In March
2004, SDG&E petitioned the U.S. Court of Appeals for review of these
FERC orders. The court has held SDG&E's appeal in abeyance pending the
FERC's disposition of other parties' rehearing requests.

21

SDG&E has also commenced a private arbitration to reform the SWPL
Participation Agreements to remove prospectively SDG&E's obligation to
provide to its SWPL co-owners the services that result in unreimbursed
ISO tariff charges. The parties have agreed to hold the arbitration in
abeyance pending resolution of the related FERC proceedings.

SDG&E and the ISO have entered into discussions in an attempt to settle
this matter.

NATURAL GAS MARKET OIR

The CPUC's Natural Gas Market Order Instituting Rulemaking (OIR) was
instituted in January 2004 and is being addressed in two phases. A
decision on Phase I was issued in September 2004; Phase II has had a
prehearing conference and is awaiting CPUC direction on further
proceedings. Further discussion of Phase I and Phase II is included in
the Annual Report.

In Phase I, the CPUC's objective was to develop a process enabling the
CPUC to review and approve new interstate capacity contracts before
they are executed. The Phase I decision directed SoCalGas and SDG&E to
file an application to establish proposals for transmission system
integration, firm access rights and off-system delivery services. In
Phase II, the CPUC will investigate the need for emergency natural gas
storage reserves and the role of utilities in backstopping the noncore
market, and address ratemaking policies. The focus of the OIR is the
period from 2006 to 2016. Since Natural Gas Industry Restructuring
(GIR), as discussed in the Annual Report, would end in August 2006 and
there is overlap between GIR and the OIR issues, a number of parties
(including SoCalGas) have requested the CPUC not to implement GIR.

CPUC INVESTIGATION OF COMPLIANCE WITH AFFILIATE RULES

In February 2003, the CPUC opened an investigation of the business
activities of SDG&E, SoCalGas and Sempra Energy to determine if they
have complied with statutes and CPUC decisions in the management,
oversight and operations of their companies.

Beginning in November 2004, the CPUC initiated an independent audit to
evaluate energy-related holding company systems and affiliate
activities undertaken by Sempra Energy within the service territories
of SDG&E and SoCalGas. A final audit report, covering years 1997
through 2003, is due on August 31, 2005. The scope of the audit will be
broader than the annual affiliate audit.

On May 2, 2005, the California Utilities filed with the CPUC the
results of the annual independent audit of the California Utilities'
transactions with other Sempra Energy affiliates. In response to a
finding of the auditor that utility procurement information was
improperly provided to an affiliated risk management consulting firm
employed by Sempra Energy, the California Utilities will adopt the
auditor's recommendation to perform risk management functions
themselves rather than utilizing Sempra Energy's Risk Management
Department.

22

ELECTRIC METERS

In March 2005, SDG&E submitted a proposal to the CPUC for installing
advanced electric meters with integrated two-way communications. This
advanced metering infrastructure (AMI) has the capability to measure
usage at frequent intervals, and would enable SDG&E to establish rates
that vary by time, thus encouraging customers to conserve and to shift
usage from time periods of high prices or capacity constraints. AMI
could also result in efficiency improvements by eliminating the need
for manual meter reading and by streamlining the handling of outages
and routine services by providing SDG&E with real-time diagnostics of
customers' electric usage. Installing AMI would require spending $420
million over four years, including $13 million in 2005 if CPUC approval
is received on a timely basis. A CPUC decision is expected by the first
quarter of 2006.

SOUTHERN CALIFORNIA FIRES

The company had expected a decision on recovery of its costs during the
first quarter of 2005. The assigned administrative law judge (ALJ)
recently indicated that he now expects to issue a proposed decision
during the second quarter of 2005.

NOTE 7. CONTINGENCIES

NUCLEAR INSURANCE

SDG&E and the other owners of SONGS have insurance to respond to
nuclear liability claims related to SONGS. The insurance provides
coverage of $300 million, the maximum amount available. In addition,
the Price-Anderson Act provides for up to $10.5 billion of secondary
financial protection. Should any of the licensed/commercial reactors in
the United States experience a nuclear liability loss which exceeds the
$300 million insurance limit, all utilities owning nuclear reactors
could be assessed to provide the secondary financial protection.
SDG&E's total share would be $40 million, subject to an annual maximum
assessment of $4 million, unless a default were to occur by any other
SONGS owner. In the event the secondary financial protection limit were
insufficient to cover the liability loss, SDG&E could be subject to an
additional assessment.

SDG&E and the other owners of SONGS have $2.75 billion of nuclear
property, decontamination and debris removal insurance and up to $490
million for outage expenses and replacement power costs incurred
because of accidental property damage. This coverage is limited to $3.5
million per week for the first 52 weeks and $2.8 million per week for
up to 110 additional weeks, after a waiting period of 12 weeks. The
insurance is provided through a mutual insurance company, through which
insured members are subject to retrospective premium assessments (up to
$8.8 million in SDG&E's case).

The nuclear liability and property insurance programs subscribed to by
members of the nuclear power generating industry include industry
aggregate limits for non-certified acts (as defined by the Terrorism
Risk Insurance Act) of terrorism-related SONGS losses, including
replacement power costs. An industry aggregate limit of $300 million
exists for liability claims. An industry aggregate limit of $3.24

23

billion exists for property claims, including replacement power costs,
for non-certified acts of terrorism. These limits are the maximum
amount to be paid to members who sustain losses or damages from these
non-certified terrorist acts. For certified acts of terrorism, the
individual policy limits stated above apply.

Further information is provided in the Annual Report.

ARGENTINE INVESTMENTS

As a result of the devaluation of the Argentine peso at the end of 2001
and subsequent further declines, Sempra Pipelines & Storage reduced the
carrying value of its investment downward by a cumulative total of $196
million as of March 31, 2005 ($198 million as of December 31, 2004).
These non-cash adjustments continue to occur based on fluctuations in
the Argentine peso. They do not affect net income, but increase or
decrease Other Comprehensive Income (Loss) and Accumulated Other
Comprehensive Income (Loss).

A decision is expected in 2006 on Sempra Pipelines & Storage's
arbitration proceedings under the 1994 Bilateral Investment Treaty
between the United States and Argentina for recovery of the diminution
of the value of Sempra Pipelines & Storage's investments that has
resulted from Argentine governmental actions. Sempra Energy also has a
$48.5 million political-risk insurance policy under which it filed a
claim to recover a portion of the investments' diminution in value,
which could be resolved in 2005.

LITIGATION

Except for the matters referred to below, neither the company nor its
subsidiaries are party to, nor is their property the subject of, any
material pending legal proceedings other than routine litigation
incidental to their businesses. Further background on these matters is
provided in the Annual Report. At March 31, 2005, the company had
accrued $249 million to provide for the costs of legal proceedings, of
which $235 million related to cases arising from the 2000-2001
California energy crisis. Management believes that none of these
matters will have material adverse effect on the company's financial
condition.

DWR Contract

In 2003, Sempra Generation was awarded judgment in its favor in a state
civil action between Sempra Generation and the DWR, in which the DWR
sought to void its 10-year contract expiring in 2011 under which the
company sells electricity to the DWR. The DWR filed an appeal of this
ruling in January 2004. Oral argument on the appeal was held in March
2005, with a decision by the appellate court expected during 2005.

In 2003 the FERC issued orders upholding the DWR contract, as well as
contracts between the DWR and other power suppliers, as consistent with
the public interest. In December 2003, appeals of this matter filed by
a number of parties, including the California Energy Oversight Board
and the CPUC, were consolidated and assigned to the Ninth Circuit Court
of Appeals. Oral argument on the appeal was held in December 2004, with
a decision by the appellate court expected in 2005.

24

The DWR continues to accept scheduled power from Sempra Generation and
has paid all amounts billed. However, the DWR has commenced an
arbitration proceeding disputing Sempra Generation's performance on
various operational matters and has disputed a portion of the billings
and the manner of certain deliveries. Sempra Generation believes the
DWR's claims are without merit. In November 2004, the arbitration panel
denied Sempra Generation's motion to dismiss claims. Arbitration is
expected to occur in mid-2005.

California Energy Crisis

Dramatic increases in the prices of electricity and natural gas in
California during 2000 and 2001 have resulted in many, often
duplicative, governmental investigations, regulatory proceedings and
lawsuits involving numerous energy companies seeking recovery of tens
of billions of dollars for allegedly unlawful activities asserted to
have caused or contributed to increased energy prices. The material
proceedings that involve the company are summarized below.

Natural Gas Cases

Class-action and individual antitrust and unfair competition lawsuits
filed in 2000 and thereafter, and currently consolidated in San Diego
Superior Court, allege that Sempra Energy, SoCalGas and SDG&E, along
with El Paso Natural Gas Company (El Paso) and several of its
affiliates, unlawfully sought to control natural gas and electricity
markets. In December 2003, the Court approved a settlement whereby the
applicable El Paso entities will pay approximately $1.6 billion to
resolve these claims (including cases involving unrelated claims not
applicable to Sempra Energy, SoCalGas or SDG&E). The proceeding against
Sempra Energy and the California Utilities has not been resolved and
continues to be litigated. The plaintiffs' damage claims, as revised,
assert damages of approximately $23 billion (after applicable
trebling). Trial is scheduled to commence on September 2, 2005.

Similar lawsuits were filed by the Attorneys General of Arizona and
Nevada, alleging that El Paso and certain Sempra Energy subsidiaries
unlawfully sought to control the natural gas market in their respective
states. The claims against the Sempra Energy defendants in the Arizona
lawsuit were settled in September 2004 for $150,000. The Nevada
Attorney General's lawsuit remains pending.

The company is cooperating with an investigation being conducted by the
California Attorney General into possible anti-competitive behavior in
the natural gas and electricity markets during 2000-2001. Several of
the company's senior officers have testified at investigational
hearings conducted by the California Attorney General's Office, and the
company expects additional hearings to be held.

In April 2003, Sierra Pacific Resources and its utility subsidiary
Nevada Power filed a lawsuit in U.S. District Court in Las Vegas
against major natural gas suppliers, and included Sempra Energy, the
California Utilities and other company subsidiaries, seeking recovery
of damages alleged to aggregate in excess of $150 million (before
trebling). The U.S. District Court dismissed the case in November 2004,
determining that this is a matter for the FERC to resolve. In January

25

2005, plaintiffs filed an appeal with the Ninth Circuit Court of
Appeals.

Between May 2003 and December 2004, 20 antitrust actions were filed
against Sempra Energy, or one or more of its affiliates (the California
Utilities and Sempra Commodities, depending on the lawsuit) and
various, unrelated energy companies, alleging that energy prices were
unlawfully manipulated by defendants' reporting artificially inflated
natural gas prices to trade publications and by entering into wash
trades. On April 8, 2005, one of those lawsuits, filed in the Nevada
U.S. District Court, was dismissed on the merits, on the grounds that
the claims asserted were preempted by federal law and the Filed Rate
Doctrine.

Electricity Cases

Various antitrust lawsuits, which seek class-action certification,
allege that numerous entities, including Sempra Energy and certain
subsidiaries (SDG&E, Sempra Commodities and Sempra Generation,
depending on the lawsuit), that participated in the wholesale
electricity markets unlawfully manipulated those markets. Collectively,
these lawsuits allege damages against all defendants in an aggregate
amount in excess of $16 billion (before trebling). In January 2003, the
federal court granted a motion to dismiss one of these lawsuits, filed
by the Snohomish County, Washington Public Utility District, on the
grounds that the claims contained in the complaint were subject to the
Filed Rate Doctrine and were preempted by the Federal Power Act. That
ruling was appealed to the Ninth Circuit U.S. Court of Appeals. In May
2003, the Port of Seattle filed a similar complaint against a number of
energy companies, including Sempra Energy, Sempra Generation and Sempra
Commodities. That action was dismissed by the San Diego U.S. District
Court in May 2004. Plaintiff has appealed the decision. In May and June
2004, two lawsuits substantially identical to the Port of Seattle case
were filed in Washington and Oregon U.S. District Courts. These cases
were transferred to the San Diego U.S. District Court and motions to
dismiss were granted in both cases on February 11, 2005, and plaintiffs
have appealed. In October 2004, another case was filed in Santa Clara
Superior Court against Sempra Generation, alleging substantively
identical claims to those in the Port of Seattle case. This action was
removed to the U.S. District Court in April 2005.

In September 2004, the Ninth Circuit U.S. Court of Appeals dismissed
the suit against Sempra Energy, Sempra Commodities and Sempra
Generation brought by the Snohomish County, Washington Public Utility
District. The court ruled that the FERC, not civil courts, has
exclusive jurisdiction over the matter. The company believes that this
decision provides a precedent for the dismissal on the basis of federal
preemption and the Filed Rate Doctrine of the other lawsuits against
the Sempra Energy companies claiming manipulation of the electricity
markets. Snohomish County has appealed the Ninth Circuit decision to
the U.S. Supreme Court. On February 22, 2005, the U.S. Supreme Court
issued an order seeking the Solicitor General's views as to whether
review should be granted in the case.

On February 16, 2005, in connection with the California Senate Select
Committee's investigation into Price Manipulation in the Wholesale
Energy Market, Senator Dunn held a press conference and asserted that

26

Sempra Commodities committed perjury in denying that it had engaged in
three types of Enron-like strategies. Senator Dunn stated that he
intends to refer the matter to the Sacramento District Attorney's
Office and to seek contempt charges from the state Senate. The company
denies these charges and will defend the matters vigorously.

CPUC Border Price Investigation

In November 2002, the CPUC instituted an investigation into the
Southern California natural gas market and the price of natural gas
delivered to the California - Arizona border between March 2000 and
May 2001. A CPUC Administrative Law Judge-proposed decision highly
critical of SoCalGas' natural gas purchase, sales, hedging and storage
activities during the period has been rejected by the CPUC.

The portion of this investigation relating to the California Utilities
is still open. If the investigation were to determine that the conduct
of either of the California Utilities contributed to the natural gas
price spikes that occurred during the investigation period, the CPUC
may modify the party's natural gas procurement incentive mechanism,
reduce the amount of any shareholder award for the period involved,
and/or order the party to issue a refund to ratepayers. At March 31,
2005, the cumulative amount of shareholder awards, substantially all
of which has been included in net income, was $65.3 million.

The CPUC may hold additional rounds of hearings to consider whether
other companies, including other California utilities, as well as the
company and its non-utility subsidiaries, contributed to the natural
gas price spikes or issue an order terminating the investigation. No
hearings have yet been scheduled and discovery is ongoing.

FERC Refund Proceedings

In December 2002, a FERC ALJ issued preliminary findings indicating
that the California Power Exchange (PX) and ISO owe power suppliers
$1.2 billion for the October 2, 2000 through June 20, 2001 period (the
$3.0 billion that the California PX and ISO still owe energy companies
less $1.8 billion that the energy companies charged California
customers in excess of the preliminarily determined competitive market
clearing prices). In March 2003, the FERC adopted its ALJ's findings,
but changed the calculation of the refund by basing it on a different
estimate of natural gas prices. The March 26 order estimates that the
replacement formula for estimating natural gas prices will increase the
refund obligations from $1.8 billion to more than $3 billion for the
same time period. Pending in the Ninth Circuit are various parties'
appeals on aspects of the FERC's order. On April 12 and 13, 2005, the
Ninth Circuit heard oral argument on issues relating to the scope of
the refund proceeding and whether the FERC had jurisdiction to order
refunds from governmental entities. Sempra Commodities previously
established reserves for its likely share of the original $1.8 billion
discussed above. During 2004 and in the first quarter of 2005, Sempra
Commodities recorded additional reserves to reflect the estimated
effect of the FERC's revision of the benchmark prices to be used by the
FERC to calculate refunds, and Sempra Generation recorded its share of
the 2004 amounts related to its transactions with Sempra Commodities.

27

In a separate complaint filed with the FERC in 2002, the California
Attorney General challenged the FERC's authority to establish a market-
based rate regime, and further contended that, even if such a regime
were valid, electricity sellers had failed to comply with the FERC's
quarterly reporting requirements. The Attorney General requested that
the FERC order refunds from suppliers. The FERC dismissed the complaint
and instead ordered sellers to restate their reports. After an appeal
by the California Attorney General, the Ninth Circuit Court of Appeals
upheld the FERC's authority to establish a market-based rate regime,
but ordered remand of the case to the FERC for further proceedings,
stating that failure to file transaction-specific quarterly reports
gave the FERC authority to order refunds with respect to jurisdictional
sellers. In October 2004, the FERC announced that it will not appeal
the court's decision. Although a group of sellers has requested the
Ninth Circuit to rehear this matter, the timing and substance of the
FERC's response to the remand is not yet known. However, it is possible
that the FERC could order refunds or disgorgement of profits for
periods in addition to those covered by its prior refund orders and
substantially increase the refunds that ultimately may be required to
be paid by Sempra Commodities and other power suppliers.

At March 31, 2005, Sempra Commodities remains due approximately $100
million from energy sales made in 2000 and 2001 through the ISO and the
PX markets. The collection of these receivables depends on several
factors, including the FERC refund case. The company believes adequate
reserves have been recorded.

FERC Manipulation Investigation

The FERC is separately investigating whether there was manipulation of
short-term energy markets in the western United States that would
constitute violations of applicable tariffs and warrant disgorgement of
associated profits. In this proceeding, the FERC's authority is not
confined to the periods relevant to the refund proceeding. In May 2002,
the FERC ordered all energy companies engaged in electric energy
trading activities to state whether they had engaged in various
specific trading activities in violation of the PX and ISO tariffs.

On June 25, 2003, the FERC issued several orders requiring various
entities to show cause why they should not be found to have violated
California ISO and PX tariffs. First, the FERC directed 43 entities,
including Sempra Commodities and SDG&E, to show cause why they should
not disgorge profits from certain transactions between January 1, 2000
and June 20, 2001 that are asserted to have constituted gaming and/or
anomalous market behavior under the California ISO and/or PX tariffs.
Second, the FERC directed more than 20 entities, including Sempra
Commodities, to show cause why their activities, in partnership or in
alliance with others, during the period between January 1, 2000 and
June 20, 2001 did not constitute gaming and/or anomalous market
behavior in violation of the tariffs. Remedies for confirmed violations
could include disgorgement of profits and revocation of market-based
rate authority. On October 31, 2003, Sempra Commodities agreed to pay
$7.2 million in full resolution of these investigations. That liability
was recorded as of December 31, 2003. The Sempra Commodities settlement
was approved by the FERC on August 2, 2004. Certain California parties
have sought rehearing on this order. SDG&E and the FERC resolved the
matter through a settlement, which documents the ISO's finding that

28

SDG&E did not engage in market activities in violation of the ISO or PX
tariffs, and in which SDG&E agreed to pay $27,792 into a FERC-
established fund.

Settlement of Claims Associated with the FERC's Investigations

On January 13, 2005, SDG&E announced a $23.8 million settlement
(including an unsecured claim in the Mirant bankruptcy proceeding
valued at approximately $2.4 million), which resolves specified claims
against merchant generator Mirant Corp. for the 2000-2001 energy crisis
period. The settlement has received final CPUC, FERC and U.S.
Bankruptcy Court (for Mirant) approval. The majority of the funds is
expected to be received within 20 days of receiving FERC approval (on
or before May 12, 2005) with the remainder contingent on certain
actions by the FERC, the ISO and the PX. Receipt of the remaining
amounts by SDG&E would take place at the conclusion of the FERC refund
proceeding, now expected to be in early 2006. These funds would be
received for the benefit of SDG&E's bundled customers and will
reimburse SDG&E for the costs of litigating this matter. The unsecured
claim in the bankruptcy proceeding is estimated to be paid out at a
rate of 60 cents on the dollar and is not guaranteed. Funds associated
with the unsecured claim will not be disbursed until a final decision
is reached in the bankruptcy proceeding, expected in the third quarter
of 2005.

Other Litigation

In May 2003, a federal judge issued an order finding that the
Department of Energy's (DOE) environmental assessment of the
Termoelectrica de Mexicali (TDM) plant and another, unrelated Mexicali
power plant failed to evaluate the plants' environmental impact
adequately and called into question the U.S. permits they received to
build their cross-border transmission lines. In July 2003, the judge
ordered the DOE to conduct additional environmental studies and denied
the plaintiffs' request for an injunction blocking operation of the
transmission lines, thus allowing the continued operation of the TDM
plant. The DOE undertook to perform an Environmental Impact Study,
which was completed in December 2004. Plaintiff may elect to dismiss
its complaint or to further challenge the agency action. The U.S.
permits were reissued in April 2005. If a stipulation of dismissal is
not filed to terminate the litigation by August 15, 2005, the DOE will
file a motion by August 22, 2005, showing cause why the court should
not set aside the permits. In that event, court hearings may take place
in the fourth quarter of 2005.

The Peruvian tax authorities have continued to claim that affiliate Luz
del Sur owes additional income taxes, interest and penalties related to
a 1996 revaluation of assets. In December 2004, the tax court ordered a
third revaluation study of the asset values, which will be used as a
basis for its decision. After the study is completed, the tax court has
90 business days to issue a verdict.

INCOME TAX MATTERS

Like all public companies of its size, the company's tax returns are
routinely examined by federal and state tax agencies. Within the past
several weeks the company resolved a number of issues in its federal

29

and state income tax examinations that span the 1998-2001 period. Since
not all issues have been resolved, the federal and state income tax
liabilities for these years are not yet finally determined and the
company continues to work with the agencies to answer questions they
have and to resolve a number of unagreed issues.

At March 31, 2005, the company had provided $143 million for income tax
issues not yet resolved with federal, state and foreign tax
authorities.

Section 29 Income Tax Credits

On July 1, 2004, Sempra Financial sold its investment in an enterprise
that earns Section 29 income tax credits. That investment comprised
one-third of Sempra Energy's Section 29 participation and was sold
because the company's alternative minimum tax position defers
utilization of the credits in the determination of income taxes
currently payable. The sale has been accounted for under the cost-
recovery method, whereby future proceeds in excess of the carrying
value of the investment will be recorded as income when received. As a
result of this sale, Sempra Financial is no longer receiving Section 29
income tax credits.

The IRS has conducted various examinations of the partnerships
associated with the Section 29 income tax credits, covering various
years as recent as 2000, depending on the partnership. It has reported
no change in the credits. From acquisition of the facilities in 1998,
the company has generated Section 29 income tax credits of $371 million
through March 31, 2005, of which $22 million was recorded for the
quarter ended March 31, 2005.

If the recent increases in oil prices continue and do not reverse, a
partial or complete phaseout of Section 29 tax credits may occur in
2005 or in subsequent years in accordance with Section 29 regulations.
Sempra Commodities has entered into financial transactions to offset
substantially the 2005 impact of any phaseout.

NOTE 8. SEGMENT INFORMATION

The company is a holding company, whose subsidiaries are primarily
engaged in the energy business. It has four separately managed
reportable segments (SoCalGas, SDG&E, Sempra Commodities and Sempra
Generation), which are described in the Annual Report.

The accounting policies of the segments are described in the notes to
Consolidated Financial Statements in the Annual Report, and segment
performance is evaluated by management based on reported income.
California utility transactions are based on rates set by the CPUC and
the FERC. There were no significant changes in segment assets during
the quarter ended March 31, 2005.

30

- ---------------------------------------------------------------------
Quarters ended
March 31,
------------------------------
(Dollars in millions) 2005 2004
- ---------------------------------------------------------------------
Operating Revenues:
Southern California Gas Company $ 1,241 46% $ 1,148 49%
San Diego Gas & Electric 621 23 580 24
Sempra Commodities 458 17 308 13
Sempra Generation 420 16 300 13
All other 34 1 38 2
Intersegment revenues (82) (3) (14) (1)
------------------------------
Total $ 2,692 100% $ 2,360 100%
- ---------------------------------------------------------------------
Net Income (Loss):
Southern California Gas Company* $ 69 31% $ 56 29%
San Diego Gas & Electric* 59 26 50 25
Sempra Commodities 29 13 57 29
Sempra Generation 46 21 35 18
All other 20 9 (1) (1)
------------------------------
Total $ 223 100% $ 197 100%
- ---------------------------------------------------------------------
* after preferred dividends

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the
financial statements contained in this Form 10-Q, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations" contained in the Annual Report and "Risk Factors" contained
in the Form 10-K.

OVERVIEW

Sempra Energy is a Fortune 500 energy services holding company. Its
business units provide a wide spectrum of value-added electric and
natural gas products and services to a diverse range of customers.
Operations are divided between delivery services, comprised of the
California Utilities, and Sempra Global.

31

RESULTS OF OPERATIONS

Net income was $223 million for the first quarter of 2005, a 13%
increase over 2004, which included a $24 million loss from discontinued
operations. Income from continuing operations increased 1% from $221
million.

Net Income by Business Unit
Quarters ended
March 31,
----------------------------
(Dollars in millions) 2005 2004
- ---------------------------------------------------------------
California Utilities
Southern California Gas Company $ 69 31% $ 56 29%
San Diego Gas & Electric 59 26 50 25
--------------------------
Total Utilities 128 57 106 54
--------------------------

Sempra Global
Sempra Commodities 29 13 57 29
Sempra Generation 46 21 35 18
Sempra Pipelines & Storage 13 6 11 5
Sempra LNG (5) (2) 6 3
--------------------------
Total Sempra Global 83 38 109 55

Sempra Financial 4 1 10 5
Parent and other* 8 4 (4) (2)
--------------------------
Continuing operations 223 100 221 112
Discontinued operations -- -- (24) (12)
--------------------------
Consolidated net income $ 223 100% $ 197 100%
==========================
- ---------------------------------------------------------------
* Includes after-tax interest expense of $25 million and $28
million in 2005 and 2004, respectively; intercompany eliminations
recorded in consolidation; and certain corporate costs incurred at
Sempra Global.

32

Comparison of Earnings

To assist the reader in understanding the trend of earnings, the
following table summarizes the major unusual factors affecting income
in the first quarters of 2005 and 2004.

California Utility Revenues and Cost of Sales

Natural gas revenues increased as a result of higher natural gas costs,
which are passed on to customers.

Under the current regulatory framework, the cost of natural gas
purchased for customers and the variations in that cost are passed
through to the customers on a substantially concurrent basis. However,
SoCalGas' GCIM allows SoCalGas to share in the savings or costs from
buying natural gas for customers below or above market-based monthly
benchmarks. In addition, SDG&E's natural gas procurement PBR mechanism
provides an incentive mechanism by measuring SDG&E's procurement of
natural gas against a benchmark price comprised of monthly natural gas
indices, resulting in shareholder awards for costs achieved below the
benchmark and shareholder penalties when costs exceed the benchmark.
Further discussion is provided in Notes 1 and 15 of the notes to
Consolidated Financial Statements in the Annual Report.

Electric revenues increased as a result of higher costs of electric
fuel and purchased power resulting from increased volumes and electric
commodity costs. Under the current regulatory framework, changes in
commodity costs generally do not affect net income.

33

The tables below summarize the natural gas and electric volumes and
revenues by customer class for the quarters ended March 31, 2005 and
2004.

Gas Sales, Transportation and Exchange
(Volumes in billion cubic feet, dollars in millions)

Electric Distribution and Transmission
(Volumes in millions of kWhs, dollars in millions)

Although revenues and costs associated with long-term contracts
allocated to SDG&E from the DWR are not included in the income
statement, the associated volumes and distribution revenue are included
in the above table.

34

Other Operating Revenues

Other operating revenues, which consist primarily of revenues from
Sempra Global, increased by $219 million (34%) in 2005 to $865 million.
This change was primarily due to higher revenues at Sempra Commodities
and at Sempra Generation.

Other Cost of Sales

Other cost of sales, which consists primarily of cost of sales at
Sempra Global, increased by $257 million (79%) in 2005 to $584 million,
primarily due to the higher sales noted above for Sempra Commodities
and Sempra Generation.

Other Income, Net

Other income, primarily equity earnings from unconsolidated
subsidiaries and interest on regulatory balancing accounts, increased
by $12 million (240%) in 2005 to $17 million. Other income in 2005
included lower equity losses at Sempra Financial (due to the 2004 sale
of its alternative-fuel investment, Carbontronics, and decreased equity
losses from certain affordable-housing investments) and higher equity
earnings at Sempra Generation resulting from the acquisition of the
Coleto Creek coal plant by a joint venture 50% owned by Sempra
Generation in July 2004. Other income in 2004 included a $13 million
before-tax settlement of an unpaid portion of the purchase price of the
proposed Cameron liquefied natural gas (LNG) project for an amount less
than the liability (which had been recorded as a derivative).

Interest Income

Interest income decreased by $12 million (52%) in 2005 to $11 million
due primarily to interest income on income tax issues in 2004.

Income Taxes

Income tax expense was $8 million in 2005 and $57 million in 2004. The
effective income tax rates were 3.6 percent and 20.5 percent,
respectively. The decrease in income tax expense was due to lower pre-
tax income from continuing operations and the lower effective tax rate.
The decrease in the effective rate was due primarily to the favorable
resolution of prior years' income tax issues in 2005, offset by a
lesser amount of resolutions in 2004. Further discussion of the 2005
resolution is provided in Note 7 of the notes to Consolidated Financial
Statements.

Discontinued Operations

In the first quarter of 2004, Sempra Energy's board of directors
approved management's plan to dispose of the company's interest in AEG,
which marketed power and natural gas commodities to commercial and
residential customers in the United Kingdom. AEG's losses were $24
million for the quarter ended March 31, 2004. Note 4 of the notes to
Consolidated Financial Statements provides further details.

35

Net Income

Information concerning changes in net income is provided in the table
shown previously under "Comparison of Earnings" and in the following
discussions for each business unit.

Net Income by Business Unit

Southern California Gas Company

Net income for SoCalGas increased by $13 million (23%) to $69 million
in 2005 due primarily to the CPUC's 2005 cost of service decision
eliminating 2004 revenue sharing, for which $11 million after-tax had
been accrued in 2004 pending the decision, and the favorable resolution
of income-tax issues in 2005.

San Diego Gas & Electric

Net income for SDG&E increased by $9 million (18%) to $59 million in
2005, primarily due to the favorable resolution of income-tax issues in
2005.

Sempra Commodities

Sempra Commodities' net income decreased by $28 million (49%) to $29
million in 2005. Earnings variability will continue in future periods
as a result of certain items', primarily related to storage and
transportation, not being marked to market while the economically
offsetting derivative instruments are marked to market. Other changes
in its margin are generally offsetting as shown in the product-line
table below.

Margin (Dollars in millions) 2005 2004
- ----------------------------------------------------------------
Geographical:
North America $ 125 81% $ 120 59%
Europe and Asia 29 19 84 41
---------------------------
$ 154 100% $ 204 100%
---------------------------
Product Line:
Gas $ (15) (10)% $ 42 21%
Power 42 27 45 22
Oil - crude and products 80 52 42 21
Metals 14 9 58 28
Other 33 22 17 8
---------------------------
$ 154 100% $ 204 100%
- ----------------------------------------------------------------
Margin consists of net trading revenues less related costs (primarily
brokerage, transportation and storage) plus or minus net interest
income/expense.

36

A summary of Sempra Commodities' unrealized revenues for trading
activities for the quarters ended March 31, 2005 and 2004 follows:

(Dollars in millions) 2005 2004
- -----------------------------------------------------------------
Balance at December 31 $ 1,193 $ 347
Additions (60) 647
Realized (544) (464)
------------------------------------
Balance at March 31 $ 589 $ 530
- -----------------------------------------------------------------

The estimated fair values as of March 31, 2005, and the scheduled
maturities are (dollars in millions):

Sempra Commodities' Value at Risk (VaR) amounts are described in Item 3
herein.

Sempra Generation

Sempra Generation's net income increased by $11 million (31%) to $46
million in 2005, primarily due to increased sales from its facilities
in Texas, including the Coleto Creek power plant.

Sempra Pipelines & Storage

Sempra Pipelines & Storage's net income increased by $2 million (18%)
to $13 million in 2005. The increase was due primarily to improved
results at most of its operations.

37

Sempra LNG

Sempra LNG recorded a net loss of $5 million in 2005 compared to net
income of $6 million in 2004. The 2005 loss resulted from increased
development costs. Development costs in 2004 were more than offset by
the $8 million after-tax gain on the settlement of the Cameron
liability.

Sempra Financial

Sempra Financial's net income decreased by $6 million (60%) to $4
million in 2005 due to a decrease in tax credits (resulting primarily
from the sale of Carbontronics) offset by decreased equity losses.

Parent and Other

Net income for Parent and Other was $8 million in 2005 compared to a
net loss of $4 million in 2004. The change was due primarily to lower
income tax expense as discussed above under "Income Taxes", offset by
higher operating costs in 2005 and interest income on income tax issues
in 2004.

CAPITAL RESOURCES AND LIQUIDITY

The company's California Utility operations are a major source of
liquidity. Funding of other business units' capital expenditures is
partly dependent on dividends from the California Utilities and Sempra
Commodities' liquidity requirements, which can fluctuate significantly.

At March 31, 2005, the company had $609 million in unrestricted cash
and $4.6 billion in available unused, committed lines of credit to
provide liquidity and support commercial paper. At March 31, 2005, $31
million of these lines supported variable-rate debt.

Management believes that these amounts and cash flows from operations
and security issuances will be adequate to finance capital expenditures
and meet liquidity requirements and to fund shareholder dividends, any
new business acquisitions or start-ups, and other commitments. If cash
flows from operations were to be significantly reduced or the company
were to be unable to issue new securities under acceptable terms,
neither of which is considered likely, the company would be required to
reduce non-utility capital expenditures, trading operations and
investments in new businesses. Management continues to regularly monitor
the company's ability to finance the needs of its operating, financing
and investing activities in a manner consistent with its intention to
maintain strong, investment-quality credit ratings.

At the California Utilities, cash flows from operations and from
security issuances are expected to continue to be adequate to meet
utility capital expenditure requirements and provide dividends to
Sempra Energy. In June 2004, SDG&E received CPUC approval of its
intended 2006 purchase from Sempra Generation of the 550-megawatt
Palomar generating facility being constructed in Escondido, California.
As a result, the level of SDG&E's dividends to Sempra Energy is
expected to be significantly lower during the construction of the
facility to increase SDG&E's equity in preparation for the purchase of
the completed facility.

38

Sempra Commodities provides or requires cash as the level of its net
trading assets fluctuates with prices, volumes, margin requirements
(which are substantially affected by credit ratings and commodity price
fluctuations) and the length of its various trading positions. Its
status as a source or use of cash also varies with its level of
borrowings from its own sources, including the $1 billion two-year
syndicated revolving line of credit that it obtained in June 2004. At
March 31, 2005, Sempra Commodities' intercompany borrowings were $424
million, up from $421 million at December 31, 2004. Sempra Commodities'
external debt was $226 million and $161 million at March 31, 2005 and
December 31, 2004, respectively. Company management continuously
monitors the level of Sempra Commodities' cash requirements in light of
the company's overall liquidity.

Sempra Generation's projects have been financed through a combination
of project financing, funds from the company and external borrowings.
Existing and future projects are expected to be financed from Sempra
Generation's cash from operations, project financing and funds from the
company.

Sempra Generation's energy contracts typically contain collateral
requirements related to credit lines. The collateral arrangements
provide for Sempra Generation and/or the counterparty to post cash,
guarantees or letters of credit to the other party for exposure in
excess of established thresholds. Sempra Generation may be required to
provide collateral when market price movements adversely affect the
counterparty's cost of replacement energy supplies were Sempra
Generation to fail to deliver the contracted amounts. As of March 31,
2005, Sempra Generation had outstanding collateral requirements under
these contracts of $172 million, of which $163 million had been
remitted at March 31, 2005.

Sempra Pipelines & Storage is expected to require funding from the
company and/or external sources to continue the expansion of its
existing natural gas distribution operations in Mexico and its planned
development of pipelines and storage to serve LNG facilities expected
to be developed in Baja California, Mexico; Louisiana and Texas.

Sempra LNG will require funding for its planned development of LNG
receiving facilities. While Sempra LNG's $1.25 billion credit facility
and other, Sempra Energy sources are expected to be adequate for these
requirements, the company may decide to use project financing if that
is believed to be advantageous.

Recently Sempra Financial has not been a provider of cash through
reductions of consolidated income tax payments from its investments in
affordable housing because the company is in an alternative minimum tax
position. However, it is expected that it will again be a cash provider
in the future when the company is no longer in an alternative minimum
tax position.

CASH FLOWS FROM OPERATING ACTIVITIES

Net cash provided by operating activities decreased by $72 million (9%)
to $719 million for 2005. The change was primarily due to deferred
taxes.

39

For the quarter ended March 31, 2005, the company made pension and other
postretirement benefit plan contributions of $2 million and $12 million,
respectively.

CASH FLOWS FROM INVESTING ACTIVITIES

Net cash provided by (used in) investing activities totaled $(246)
million and $157 million for the first quarters of 2005 and 2004,
respectively. The change was primarily attributable to proceeds from the
2004 sale of U.S. Treasury obligations that previously securitized the
Mesquite synthetic lease for one of Sempra Generation's power plants and
higher capital expenditures.

During the first quarter of 2005, Sempra Pipelines & Storage and Sempra
LNG filed for FERC authorization to construct and operate the Liberty
natural gas storage facility and the Port Arthur pipeline, and the Port
Arthur LNG terminal, respectively.

Sempra LNG has preliminary non-binding agreements with multiple parties
and covering sufficient volumes that, upon finalization, would permit
the company to commence construction of its Cameron terminal.

Sempra Global has a non-binding memorandum of understanding with Gazprom
to explore the marketing of Gazprom's LNG in North America. Securing the
LNG volumes contemplated by Gazprom for the North American market would
be sufficient to commence construction of the Port Arthur terminal,
subject to receiving final permits.

The company expects to make capital expenditures and investments of $1.6
billion in 2005, of which $270 million had been expended as of March 31,
2005. Significant capital expenditures and investments are expected to
include $900 million for the California Utilities' plant improvements,
$150 million for the Palomar plant and $300 million for the development
of LNG regasification terminals. These expenditures and investments are
expected to be financed by cash flows from operations and security
issuances.

CASH FLOWS FROM FINANCING ACTIVITIES

Net cash used in financing activities decreased by $436 million to $283
million for 2005. The change was due to lower payments on long-term
debt, offset by the redemption of $200 million of mandatorily
redeemable preferred securities in 2005 and a net decrease in short-
term borrowings in 2005 compared to a net increase in 2004.

FACTORS INFLUENCING FUTURE PERFORMANCE

The California Utilities' operations and Sempra Generation's long-term
contracts generally provide relatively stable earnings and liquidity,
while Sempra Pipelines & Storage, Sempra LNG and the remaining output
of Sempra Generation provide opportunities for earnings growth. Sempra
Commodities experiences significant volatility in earnings and
liquidity requirements. Notes 6 and 7 of the notes to Consolidated
Financial Statements herein and Notes 14 through 16 of the notes to
Consolidated Financial Statements in the Annual Report describe matters
that could affect future performance.

40

Litigation

Note 7 of the notes to Consolidated Financial Statements herein and
Note 16 of the notes to Consolidated Financial Statements in the Annual
Report describe significant litigation against the company, primarily
cases arising from the California energy crisis and Sempra Generation's
contract with the DWR.

California Utilities

Note 6 of the notes to Consolidated Financial Statements herein and
Notes 14 and 15 of the notes to Consolidated Financial Statements in
the Annual Report describe electric and natural gas restructuring and
rates, the recent cost of service proceedings, and other pending
proceedings and investigations.

Sempra Global

Electric-Generation Assets

As discussed in "Capital Resources and Liquidity," above, and in Notes
2 and 3 of the notes to Consolidated Financial Statements in the Annual
Report, the company is involved in the expansion of its electric-
generation capabilities, which will affect the company's future
performance.

Investments

As discussed in "Cash Flows From Investing Activities," the company's
investments will significantly impact the company's future performance.

Sempra LNG is in the process of developing Energia Costa Azul, an LNG
receiving terminal in Baja California, Mexico; the Cameron LNG
receiving terminal in Louisiana; and the Port Arthur LNG receiving
terminal in Texas. In addition, in December 2004, Sempra LNG entered
into a non-binding development agreement with Alaska Gasline Port
Authority to jointly consider and analyze the feasibility of building a
proposed 800-mile gas pipeline from Alaska's North Slope to Valdez,
where a natural gas liquefaction facility could be developed to export
LNG to the West Coast of North America. The future profitability of
this business unit is dependent upon numerous factors, including the
quantities of and relative prices of natural gas in North America and
from LNG suppliers located elsewhere, negotiating sale and supply
contracts at adequate margins, acquiring all necessary permits, and
completing cost-effective construction of the required facilities.
Additional information regarding these activities is provided in Note 2
of the notes to Consolidated Financial Statements in the Annual Report.

Beginning in 2003, the company started expanding its natural gas
storage capacity by developing Bluewater Gas Storage, LLC, located in
Michigan. In April 2004, the company announced the acquisition of land
and associated rights for the development of a salt-cavern natural gas
storage facility in Evangeline Parish, Louisiana, operating as the Pine
Prairie Energy Center. In July 2004, the company announced that it had
acquired the rights to develop a salt-cavern natural gas storage
facility located in Calcasieu Parish, Louisiana, called "Liberty."

41

Additional information regarding these activities is provided in Note 2
of the notes to Consolidated Financial Statements in the Annual Report.

The Argentine economic decline and government responses (including
Argentina's unilateral, retroactive abrogation of utility agreements
early in 2002) are continuing to adversely affect the company's
investment in two Argentine utilities. Information regarding this
situation is provided in Notes 3 and 16 of the notes to Consolidated
Financial Statements in the Annual Report.

CRITICAL ACCOUNTING POLICIES AND KEY NON-CASH PERFORMANCE INDICATORS

There have been no significant changes to the accounting policies
viewed by management as critical or to key non-cash performance
indicators for the company and its subsidiaries, as set forth in the
Annual Report.

NEW ACCOUNTING STANDARDS

Stock-Based Compensation: In December 2004, the FASB issued SFAS 123
(revised), a revision of SFAS 123, Accounting for Stock-Based
Compensation. This statement requires companies to measure and record
the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. The
effective date of this statement is January 1, 2006 for the company.

FASB Interpretation No. 47, "Accounting for Conditional Asset
Retirement Obligations, an interpretation of FASB Statement No. 143"
(FIN 47): Issued in March 2005, FIN 47 clarifies that the term
conditional asset-retirement obligation as used in SFAS 143, Accounting
for Asset Retirement Obligations, refers to a legal obligation to
perform an asset-retirement activity in which the timing and/or method
of settlement are conditional on a future event that may or may not be
within the control of the entity. FIN 47 requires companies to
recognize a liability for the fair value of a conditional asset-
retirement obligation if the fair value of the obligation can be
reasonably estimated. FIN 47 is effective for the company's 2005 annual
report.

Further discussion is provided in Note 2 of the notes to Consolidated
Financial Statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes in the risk issues affecting the
company subsequent to those discussed in the Annual Report.

42

Following is a summary of Sempra Commodities' trading VaR profile
(using a one-day holding period) in millions of dollars:

95% 99%
- -----------------------------------------------------------
March 31, 2005 $ 9.4 $ 13.2
2005 1st quarter range $ 5.7 to $ 11.6 $ 7.9 to $ 16.2
March 31, 2004 $ 10.0 $ 14.1
2004 1st quarter range $ 2.8 to $ 10.0 $ 3.9 to $ 14.1
- -----------------------------------------------------------

As of March 31, 2005, the total VaR of the California Utilities'
positions was not material.

ITEM 4. CONTROLS AND PROCEDURES

Company management is responsible for establishing and maintaining
adequate internal control over financial reporting, as defined in
Exchange Act Rules 13a-15(f). The company has designed and maintains
disclosure controls and procedures to ensure that information required
to be disclosed in the company's reports is recorded, processed,
summarized and reported within the time periods specified in the rules
and forms of the Securities and Exchange Commission and is accumulated
and communicated to the company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. In designing and
evaluating these controls and procedures, management recognizes that
any system of controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the
desired objectives and necessarily applies judgment in evaluating the
cost-benefit relationship of other possible controls and procedures. In
addition, the company has investments in unconsolidated entities that
it does not control or manage and, consequently, its disclosure
controls and procedures with respect to these entities are necessarily
substantially more limited than those it maintains with respect to its
consolidated subsidiaries.

The company evaluates the effectiveness of its internal control over
financial reporting based on the framework in Internal Control--
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Under the supervision and
with the participation of management, including the Chief Executive
Officer and the Chief Financial Officer, the company evaluated the
effectiveness of the design and operation of the company's disclosure
controls and procedures as of March 31, 2005, the end of the period
covered by this report. Based on that evaluation, the company's Chief
Executive Officer and Chief Financial Officer concluded that the
company's disclosure controls and procedures were effective at the
reasonable assurance level.

There has been no change in the company's internal controls over
financial reporting during the company's most recent fiscal quarter
that has materially affected, or is reasonably likely to materially
affect, the company's internal controls over financial reporting.

43

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

SDG&E and the County of San Diego are continuing to discuss alleged
environmental law violations by SDG&E and its contractors in connection
with the abatement of asbestos-containing materials during the
demolition of a natural gas storage facility in 2001. SDG&E expects
that any settlement with the County would involve payments by SDG&E of
less than $750,000. In January 2005, Sempra Energy and SDG&E received a
grand jury subpoena from the United States Attorney's Office in San
Diego seeking documents related to this matter and are fully
cooperating with the investigation.

Except as described above and in Notes 6 and 7 of the notes to
Consolidated Financial Statements herein, neither the company nor its
subsidiaries are party to, nor is their property the subject of, any
material pending legal proceedings other than routine litigation
incidental to their businesses.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Purchases of Equity Securities:

The following table sets forth information concerning purchases made by
the company of its common stock during the first quarter of 2005:

44

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Sempra Energy's board of directors is divided into three classes whose
terms are staggered so that the term of one class expires at each
Annual Meeting of Shareholders. At the annual meeting of shareholders
on April 5, 2005, the shareholders elected four directors for a three-
year term expiring in 2008. The name of each nominee and the number of
shares voted for and withheld from the election of each director were
as follows:

Nominees Votes For Votes Withheld
Richard A. Collato 140,342,139 59,192,615
Denise K. Fletcher 184,707,096 14,827,658
William C. Rusnack 142,323,821 57,210,933
William P. Rutledge 140,493,159 59,041,595

The results of the voting on the other proposals considered at the
annual meeting were as follows:

(a) management proposal for the ratification of independent auditors.

In favor 194,114,565
Opposed 2,760,425

(b) shareholder proposal regarding stock option expensing.

In favor 98,547,617
Opposed 61,296,207

(c) shareholder proposal regarding annual election of directors.

In favor 107,724,125
Opposed 53,328,296

(d) shareholder proposal regarding performance-based stock options.

In favor 36,663,764
Opposed 123,649,804

(e) shareholder proposal regarding shareholder rights plan.

In favor 115,368,923
Opposed 45,444,221

The three approved shareholder proposals constitute recommendations to
the board of directors and will be considered by the board prior to the
next annual meeting of shareholders.

45

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit 12 - Computation of ratios

12.1 Computation of Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends.

Exhibit 31 -- Section 302 Certifications

31.1 Statement of Registrant's Chief Executive Officer pursuant
to Rules 13a-14 and 15d-14 of the Securities Exchange Act of
1934.

31.2 Statement of Registrant's Chief Financial Officer pursuant
to Rules 13a-14 and 15d-14 of the Securities Exchange Act of
1934.

Exhibit 32 -- Section 906 Certifications

32.1 Statement of Registrant's Chief Executive Officer pursuant
to 18 U.S.C. Sec. 1350.

32.2 Statement of Registrant's Chief Financial Officer pursuant
to 18 U.S.C. Sec. 1350.

(b) Reports on Form 8-K

The following reports on Form 8-K were filed after December 31, 2004:

Current Reports on Form 8-K filed January 11, 2005 and January 18,
2005, discussing the current status of energy crisis litigation.

Current Report on Form 8-K filed February 8, 2005, announcing that
Sempra Energy had raised its earnings-per-share estimate for 2004 to
approximately $3.80, from its previous guidance of $3.15 to $3.25,
filing as an exhibit Sempra Energy's press release of February 8, 2005.

Current Report on Form 8-K filed February 23, 2005, filing as an
exhibit Sempra Energy's press release of February 23, 2005, giving the
financial results for the three months ended December 31, 2004.

Current Report on Form 8-K filed March 17, 2005, announcing the CPUC's
March 17, 2005, decision in Phase II of the California Utilities' cost
of service proceedings.

Current Report on Form 8-K filed May 4, 2005, filing as an exhibit
Sempra Energy's press release of May 4, 2005, giving the financial
results for the three months ended March 31, 2005.

46

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

SEMPRA ENERGY
-------------------
(Registrant)

Date: May 4, 2005 By: /s/ F. H. Ault
----------------------------
F. H. Ault
Sr. Vice President and Controller