Executive Summary / Key Takeaways

• Southern California Gas Company (SOCGM), a regulated natural gas distribution utility and subsidiary of Sempra (SRE), reported a significant 23% increase in earnings for Q1 2025, primarily driven by favorable regulatory outcomes from the 2024 General Rate Case (GRC) Final Decision and higher income tax benefits from flow-through items.
• The company is heavily focused on substantial infrastructure investment, particularly in pipeline safety (Pipeline Safety Enhancement Plan - PSEP) and system modernization, with cost recovery for these programs being a key element of ongoing regulatory proceedings like the Track 3 request in the 2024 GRC.
• SOCGM operates within a competitive landscape defined by other regulated utilities and increasing pressure from renewable energy alternatives, leveraging its established infrastructure and regulatory licenses as core competitive advantages while managing vulnerabilities related to its gas dependency.
• Significant risks persist, including the financial and operational uncertainties surrounding the ongoing Aliso Canyon natural gas storage facility litigation and potential liabilities and cost recovery challenges related to wildfires in its service territory.
• Near-term outlook is shaped by pending regulatory decisions on cost recovery for specific events and the biennial assessment of the Aliso Canyon facility, while long-term performance hinges on successful execution of capital plans and favorable regulatory treatment amidst evolving energy policies.

The Foundation: Delivering Energy in a Complex Landscape

Southern California Gas Company (SOCGM) serves as a critical component of the energy infrastructure across Southern and central California, operating as a regulated public natural gas distribution utility under the Sempra umbrella. Its core mission revolves around providing safe, reliable, and increasingly clean natural gas service to a vast customer base. The company's history is intrinsically linked to the regulatory cycles and significant operational events that have shaped the California utility landscape, from managing large-scale infrastructure like the Aliso Canyon natural gas storage facility – the largest in its system, authorized to operate at a maximum working gas level of 68.60 bcf – to responding to the challenges posed by wildfires and evolving environmental mandates.

Operating within a regulated framework means SOCGM's financial health and strategic direction are heavily influenced by decisions from the California Public Utilities Commission (CPUC). This structure allows for the pass-through of certain costs, such as the cost of natural gas purchased for core customers, and provides mechanisms for recovering investments and operating expenses through authorized rates. This regulatory dynamic forms the bedrock of SOCGM's business model, providing a degree of revenue stability but also introducing complexity and dependence on favorable regulatory outcomes.

In this environment, SOCGM competes not in a traditional sense for customers within its service territory due to its regulated monopoly status for distribution, but rather against other large investor-owned utilities in terms of operational efficiency, capital allocation effectiveness, and the ability to secure favorable regulatory treatment. Peers like PG&E Corp (PCG), The Southern Company (SO), Xcel Energy Inc (XEL), and Exelon Corporation (EXC) operate similar regulated models, albeit with different geographic footprints and energy mixes. Furthermore, the broader energy market presents increasing indirect competition from renewable energy providers, which offer alternatives to natural gas and influence long-term energy policy.

SOCGM's operational capabilities are underpinned by its extensive network of pipelines and storage facilities. The company places a strong emphasis on infrastructure integrity and safety, exemplified by its Pipeline Safety Enhancement Plan (PSEP). While the company's filings do not detail specific proprietary technological differentiators with quantifiable metrics compared to peers, its operational focus on safety and reliability implies the application of modern utility technologies for pipeline inspection, maintenance, and storage management. Market analysis suggests that SOCGM's established infrastructure and operational focus contribute to efficiencies, potentially leading to lower operating costs per unit compared to some peers, and that its regulatory licenses provide a significant competitive moat by ensuring a stable customer base and revenue stream.

The Regulatory Engine and Q1 Performance

The CPUC's General Rate Case (GRC) process is fundamental to determining SOCGM's authorized revenue requirements and the opportunity to earn a return on its investments. The recent Final Decision in the 2024 GRC, approved in December 2024 and made effective retroactive to January 1, 2024, has had a tangible impact on the company's financial results. This decision authorized SoCalGas's revenue requirements for 2024 and included attrition year adjustments through 2027, providing a clearer path for base revenues over the next few years. The incremental revenue requirements for the period from January 1, 2024, through January 31, 2025, are being recovered over an 18-month period that commenced on February 1, 2025.

This regulatory clarity, coupled with other factors, contributed to a strong start to 2025. For the three months ended March 31, 2025, SoCalGas reported earnings attributable to common shares of $443 million, a significant increase of $84 million, or 23%, compared to $359 million in the same period of 2024. This earnings growth was primarily driven by a $54 million increase in income tax benefits, largely stemming from flow-through items including gas repairs tax benefits, and a $38 million increase in CPUC base operating margin, net of operating expenses, reflecting the impact of the 2024 GRC. A lower authorized cost of capital also contributed $8 million to the earnings improvement. These gains were partially offset by a $9 million increase in net interest expense.

Total revenues for the first quarter of 2025 increased by $215 million, or 12%, reaching $2,020 million compared to $1,805 million in Q1 2024. This increase was primarily attributable to $147 million higher CPUC-authorized revenues, reflecting the impact of the 2024 GRC Final Decision which incorporated certain incremental and balanced capital projects into base revenues. Additionally, $146 million in higher revenues associated with refundable programs contributed to the top-line growth, though these costs are offset in operation and maintenance expenses. Higher regulatory revenues, including gas repairs tax benefits, also played a role, offset by income tax expense. The increase in revenues occurred despite a $50 million decrease in the cost of natural gas sold, driven by lower average natural gas prices and lower volumes due to weather. Operation and maintenance expenses saw a corresponding increase of $144 million, or 23%, to $757 million, largely reflecting the higher expenses associated with these refundable programs.

Investing in the Future: Capital Plans and Cost Recovery

A key aspect of SOCGM's strategy and future financial performance is its significant capital investment program, focused on enhancing the safety, reliability, and modernization of its natural gas system. Capital expenditures for property, plant, and equipment totaled $555 million in the first quarter of 2025, an increase from $519 million in Q1 2024. These investments are directed towards critical areas such as the PSEP, compressor station projects (including Moreno and Honor Rancho), and customer information system replacements.

The GRC process provides the mechanisms for SOCGM to seek cost recovery for these substantial investments. The company has submitted specific requests, including a Track 3 request in April 2025 seeking review and recovery of $499 million of PSEP costs incurred from 2015 through 2020. While proposed decisions for these Track 3 requests are expected in the first half of 2026, SOCGM is authorized interim rate recovery of up to 50% of the recorded PSEP regulatory account balance at the end of each year, subject to refund. The ability to recover these costs is crucial for the company to earn a return on its growing rate base and fund future capital needs.

Furthermore, SOCGM's authorized cost of capital, which impacts its allowed return on rate base, is determined through CPUC proceedings. The authorized return on rate base for 2025 is 7.49%. The company filed an application in March 2025 to update its cost of capital for the 2026-2028 period, with a final decision anticipated by the end of 2025. These proceedings are vital as changes in authorized return directly impact earnings potential.

Competitive Dynamics and Strategic Positioning

Within the regulated utility sector, SOCGM's competitive positioning is shaped by its specific service territory and operational focus. Compared to diversified peers like Southern Company or Xcel Energy, SOCGM is primarily a natural gas distribution utility. Market analysis suggests that SOCGM benefits from operational efficiencies in its gas-specific infrastructure, such as advanced pipeline technology and optimized storage systems, which may contribute to lower operating costs per unit than some competitors with broader asset portfolios. Its regulatory licenses in a high-demand region like Southern California provide a stable market position and customer base, offering a degree of resilience.

However, this specialization also presents vulnerabilities. The increasing societal and regulatory focus on decarbonization and the transition to cleaner energy sources pose a long-term challenge to a business centered on natural gas. While SOCGM is investing in modernizing its gas infrastructure, competitors with significant renewable energy generation or transmission assets may be better positioned for future growth in a rapidly evolving energy landscape. The competitive analysis highlights that while SOCGM may have advantages in gas-specific operational metrics, it may lag peers in overall revenue growth rates and diversification into non-gas areas. The rise of indirect competitors offering renewable energy solutions could potentially impact future demand for natural gas distribution services.

Liquidity and Navigating Risks

SOCGM's liquidity is supported by cash flows from operations, access to credit facilities, and the ability to incur debt. At March 31, 2025, the company had $40 million in cash and cash equivalents and $1,053 million in available unused credit under its committed line expiring in 2029. The company also had a $700 million term loan facility outstanding. Management expects these resources to be adequate to fund current operations and planned capital expenditures. However, access to capital markets and borrowing costs can be influenced by economic conditions and credit rating actions, such as the negative outlook revision by S&P for Sempra and the downgrade for SoCalGas in January 2025.

The company faces several significant risks that could impact its financial condition and future performance. The ongoing litigation related to the 2015-2016 Aliso Canyon natural gas leak remains a material uncertainty. As of May 5, 2025, approximately 505 plaintiffs continue to pursue claims. SoCalGas's loss contingency accruals do not cover amounts beyond what has been reasonably estimated, and the company is unable to estimate the possible loss or range of losses in excess of accrued amounts, which could be significant and materially adverse.

Wildfire risk in California also presents a substantial challenge. While SDGE, another Sempra subsidiary, is more directly exposed through its electric transmission and distribution assets, wildfires in SoCalGas's service territory, such as the recent LA Fires, can result in significant costs related to facility repairs and potential liabilities. The ability to recover these costs through regulatory mechanisms or insurance is crucial, and any failure to do so could have a material adverse effect.

Regulatory risk extends beyond GRC outcomes to specific cost recovery requests. A proposed CPUC decision in April 2025 authorized only partial recovery ($19 million out of $58 million requested) for costs recorded in memorandum accounts related to catastrophic events and COVID-19 pandemic protections. SoCalGas is pursuing full recovery, with a final decision expected in June 2025. This highlights the uncertainty inherent in the regulatory recovery process for specific events. Furthermore, the operational status of the Aliso Canyon facility is subject to future CPUC biennial reviews, with the first assessment due in June 2025, which could potentially impact authorized storage levels and operations. Inflationary pressures on costs, if not fully recoverable in rates or subject to recovery lags, also pose a risk to margins.

Conclusion

Southern California Gas Company's performance in the first quarter of 2025 demonstrates the positive financial impact of favorable regulatory decisions, particularly the retroactive effect of the 2024 GRC Final Decision and associated tax benefits. The company's core investment thesis is centered on its role as a critical regulated natural gas utility, underpinned by ongoing significant capital investments in infrastructure safety and reliability. These investments, and the ability to recover their costs and earn a return through the regulatory process, are fundamental drivers of future value.

However, investors must weigh these positive regulatory tailwinds and investment opportunities against the substantial risks inherent in SOCGM's operations. The potential financial impact of the unresolved Aliso Canyon litigation, the ongoing threat of wildfires and associated recovery challenges, and the uncertainties within the regulatory process regarding specific cost recovery requests and the future of the Aliso Canyon facility are material considerations. While SOCGM benefits from its established market position and operational focus within the regulated gas distribution sector, the broader energy transition and increasing competition from renewable alternatives present long-term strategic challenges that will require careful management and potential adaptation of its business model. The company's ability to successfully navigate these complex regulatory, operational, and market dynamics will ultimately determine its long-term financial trajectory.