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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-K

     (Mark One)

For the Fiscal Year Ended December 31, 2002

OR

For the transition period from                      to

COMMISSION FILE NO. 333-66032

PG&E National Energy Group, Inc.

(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant’s Principal Executive Offices)

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  None

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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

As of February 28, 2003, there were 1,000 shares of common stock, $1 par value outstanding.

Aggregate market value of voting and non-voting common equity held by non-affiliates at February 28, 2003: 0

PG&E National Energy Group, Inc.

Form 10-K

Table of Contents

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GLOSSARY OF TERMS

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PART I.

ITEM 1. BUSINESS

PG&E National Energy Group Inc. (PG&E NEG), an integrated energy company, was incorporated on December 18, 1998, as a wholly owned subsidiary of PG&E Corporation. Shortly thereafter, PG&E Corporation contributed various subsidiaries to PG&E NEG. At the end of 2002, PG&E NEG’s principal subsidiaries included:

	•		PG&E Generating Company, LLC and its subsidiaries, collectively referred to as PG&E Gen;
	•		PG&E Energy Trading Holdings Corporation and its subsidiaries, collectively referred to as PG&E ET;
	•		PG&E Gas Transmission Corporation and its subsidiaries, collectively referred to as PG&E GTC, which includes PG&E Gas Transmission, Northwest Corporation and its subsidiaries (collectively referred to as PG&E GTN), including North Baja Pipeline, LLC.

As result of the sustained downturn in the power industry, PG&E NEG and its affiliates have experienced a financial downturn which caused the major credit rating agencies to downgrade PG&E NEG’s and its affiliates’ credit ratings to below investment grade. PG&E NEG is currently in default under various recourse debt agreements and guaranteed equity commitments totaling approximately $2.9 billion. In addition, other PG&E NEG subsidiaries are in default under various debt agreements totaling approximately $2.5 billion, but this debt is nonrecourse to PG&E NEG. PG&E NEG, its subsidiaries and their lenders are engaged in discussions to restructure PG&E NEG’s debt obligations and such other commitments. PG&E NEG and its subsidiaries are continuing to review opportunities to abandon, sell, or transfer certain assets, and have significantly reduced their energy trading operations in an ongoing effort to raise cash and reduce debt, whether through negotiation with lenders or otherwise. PG&E NEG’s objective is to limit its trading and risk management activities to only what is necessary for energy management services to facilitate the transition of PG&E NEG’s merchant generation facilities through their sale, transfer or abandonment process. PG&E NEG will then further reduce and transition to only retain limited capabilities to ensure fuel procurement and power logistics for PG&E NEG’s retained independent power plant operations. Impairment due to future asset transfers, sales, and abandonments have caused substantial charges to earnings in 2002 of approximately $3.9 billion and will cause additional charges during 2003. If the lenders exercise their default remedies or if the financial commitments are not restructured, PG&E NEG and certain of its subsidiaries may be compelled to seek protection under or be forced involuntarily into proceedings under the U.S. Bankruptcy Code.

PG&E NEG is currently focused on power generation and natural gas transmission in the United States. PG&E NEG reports its business segments as follows: interstate pipeline operations (or “Pipeline Business”) and power generation also referenced as Integrated Energy and Marketing (or “Generation Business”). Financial information for each reportable segment is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation”, and in Note 14 of the “Notes to Consolidated Financial Statements.”

The consolidated financial statements of PG&E NEG included herein include the accounts of PG&E NEG and its wholly owned and controlled subsidiaries. The principal executive offices are located at 7600 Wisconsin Avenue (mailing address: 7500 Old Georgetown Road), Bethesda, Maryland 20814. PG&E NEG’s telephone number is (301) 280-6800. PG&E NEG’s quarterly and other reports filed with the Securities and Exchange Commission are available on PG&E Corporation’s website, www.pge-corp.com.

Generation Business

In the Generation Business segment, PG&E NEG engages in the generation of electricity in the continental United States. As of December 31, 2002, PG&E NEG had ownership or leasehold interests in 16 operating generating facilities with a net generating capacity of 1,476 megawatts (MW), as follows:

PG&E NEG provides operating and/or management services for 14 of these 16 owned and leased generating facilities. Plant operations are focused on maximizing power generation ability during peak energy price hours, improving operating efficiencies and minimizing operating costs while placing a heavy emphasis on safety standards, environmental compliance and plant flexibility.

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These generating facilities sell all or a majority of their electrical capacity and output to one or more third parties under long-term power purchase agreements tied directly to the output of that plant.

PG&E NEG holds interests in these projects through wholly owned indirect subsidiaries and typically manages and operates these facilities through an operation and maintenance agreement and/or a management services agreement. These agreements generally provide for management, operations, maintenance and administration for day-to-day activities, including financial management, billing, accounting, public relations, contracts, reporting and budgets. In order to provide fuel for PG&E NEG’s independent power projects (IPPs), natural gas and coal supply commitments are typically purchased from third parties under long-term supply agreements.

The revenues generated from long-term power sales agreements usually consist of two components: energy payments and capacity payments. Energy payments are typically based on the facility’s actual electrical output and capacity payments are based on the facility’s total available capacity. Energy payments are made for each kilowatt-hour of energy delivered, while capacity payments, under most circumstances, are made whether or not any electricity is delivered. However, capacity payments may be reduced if the facility does not attain an agreed availability level. The average life of a power sales agreement is 15 years.

Description of Generating Facilities

The following table provides information regarding each of PG&E NEG’s owned or leased generating facilities, as of December 31, 2002:

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The following section describes each of PG&E NEG’s generating facilities.

New England Region Generating Facilities

MASSPOWER. PG&E NEG indirectly owns a 13% interest in MASSPOWER, a 267 MW gas-fired combined cycle cogeneration facility located in Springfield, Massachusetts. This facility, which commenced commercial operations in 1993, consists of two gas turbine generators, each feeding exhaust gases to a heat recovery steam generator. Steam from the two heat recovery steam generators is fed to a steam turbine for generating additional electricity.

MASSPOWER sells approximately 75% of its electrical capacity and output to Boston Edison Company, Commonwealth Electric Co. and Massachusetts Municipal Wholesale Electric Co. under separate power purchase agreements with initial terms of either 15 or 20 years, the earliest of which expires in 2008. Each of these power purchase agreements provides for capacity and energy payments and has fuel escalation clauses. MASSPOWER sells the balance of its electrical capacity and output to the market. MASSPOWER also sells an annual average of 50,000 pounds of steam per hour to Solutia under a steam sales agreement with an initial term of 20 years that expires in 2013.

Pittsfield. PG&E NEG indirectly owns a 89% interest in Pittsfield Generating Company L.P., which leases a 173 MW gas-fired combined cycle cogeneration facility located in Pittsfield, Massachusetts. This facility, which commenced commercial operations in 1990, consists of three gas turbine generators, each feeding exhaust gases to a heat recovery steam generator. Steam from the three heat recovery steam generators is fed to a steam turbine for generating additional electricity.

Pittsfield sells its electrical capacity and output to USGen New England, Commonwealth Electric, and Cambridge Electric under separate power purchase agreements that expire in, 2010, 2011 and 2011 respectively. Each of these power purchase agreements provides for capacity and energy payments and has fuel escalation clauses. Pittsfield has a steam sales agreement with General Electric (GE) that expires in 2008. GE is contractually obligated to purchase a minimum of 700 million pounds of steam per year up to a maximum of 840 million pounds per year.

Pittsfield failed to meet the efficiency standard required to maintain qualified facility (QF) status in 1999 through 2002. FERC granted the project a waiver for 1999 and 2000. In November 2002, FERC denied Pittsfield’s request for a waiver for 2001. Pittsfield has filed a request for a rehearing and, in January 2003, FERC responded that they would consider the request for rehearing. Failure to maintain QF status is a default under the partnership’s participation agreement, lease agreement, term loan agreement and working capital agreement. The lessor had granted a waiver to any default under these agreements for failure to maintain QF status through January 1, 2003. The lessor has not extended the term of its waiver.

Mid-Atlantic and New York Region Generating Facilities

Selkirk. PG&E NEG indirectly owns a 42% interest in the Selkirk Cogeneration Facility, a 345 MW natural gas-fired combined-cycle cogeneration facility located near Albany, New York. This facility commenced commercial operations in 1992 and is capable of producing a maximum average steam output of 400,000 pounds per hour.

Selkirk sells up to 265 MW of its electric capacity and output to Consolidated Edison under a power purchase agreement with an initial term of 20 years that expires in 2014 and is renewable for another ten years at Consolidated Edison’s option. Under an amended and restated power purchase agreement with a term that expires in 2008, Niagara Mohawk Power Corporation has contracted for approximately 52 MW of Selkirk’s electric capacity and the remaining 28 MW of electric capacity is available to be sold in the competitive market. Selkirk also sells up to 400,000 pounds per hour of steam to General Electric under a steam sale agreement with an initial term of 20 years that expires in 2014. Under this agreement, General Electric must purchase and use the minimum amount of steam required to maintain Selkirk’s status as a qualifying facility, or QF, under the Public Utility Regulatory Policies Act of 1978, or PURPA, which is currently 80,000 pounds per hour of steam. However, General Electric’s obligation to purchase and use steam is subject to reduction or termination in the event its steam requirements are reduced or cease. PG&E NEG has no reason to believe that General Electric will reduce or cease its steam purchases.

Carneys Point. PG&E NEG indirectly owns a 50% interest in Carneys Point Generating Facility, a 245 MW pulverized coal cogeneration facility. This facility is located in Carneys Point, New Jersey and commenced commercial operations in 1994.

Carneys Point sells up to 188 MW to Atlantic City Electric Company during the summer and up to 173 MW during the winter under a power sale agreement with an initial term of 30 years that expires in 2024. Under this agreement, Atlantic City Electric Company must purchase a minimum of 637,700 MWh per year or pay for an equivalent amount of energy reduced by variable operating costs.

Carneys Point sells up to 650,000 pounds per hour of steam in the summer and 1,000,000 pounds per hour of steam in the winter to DuPont under a steam and electricity purchase contract. This agreement has an initial term of 30 years that expires in 2024. As long as DuPont has not closed down or abandoned its manufacturing facility powered by Carneys Point, DuPont must take the minimum amount of steam required for Carneys Point to maintain its status as a QF under PURPA, which is currently approximately 60,000 pounds per hour. The price paid by DuPont for steam under this agreement is adjusted for changes in Carneys Point’s weighted average coal price.

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Logan. PG&E NEG indirectly owns a 50% interest in Logan Generating Facility, a 225 MW pulverized coal cogeneration facility. This facility is located in Logan Township, New Jersey and commenced commercial operations in 1994. The plant provides up to 203 MW of dispatchable energy to Atlantic City Electric Company. Logan also provides 30,000-50,000 pounds per hour of steam to Ferro (formerly Monsanto/Solutia).

In 1999, Logan and Atlantic City Electric Company (Atlantic) entered into arbitration regarding determination of the project heat rate as it relates to the sale of energy to Atlantic. The arbitration prescribed a test procedure to establish the project heat rate under the power sale agreement with Atlantic. The project expects to complete the determination of the heat rate in accordance with the test procedure during 2003.

On October 29, 2002, the long-term coal supplier, Anker Energy Corporation, filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Under the terms of Logan’s non-recourse project financing, this filing constitutes a default, which Logan had sixty days to cure. Logan obtained a waiver from its lenders based on either the coal supply contract being assumed by Anker in bankruptcy or, if it is rejected by Anker, replaced by a similar agreement with another supplier. Anker assumed the Logan coal supply contract and the assumption has been granted by the bankruptcy court. The unsecured creditors filed a motion for reconsideration of the assumption and after completing a review of the contract have submitted a motion to withdraw the request for reconsideration. The motion to withdraw has been accepted by the bankruptcy court.

Northampton. PG&E NEG indirectly owns a 50% interest in Northampton Generating Facility, an anthracite waste coal-fired electric generating facility located in Northampton County, Pennsylvania that commenced commercial operation in 1995. The facility provides approximately 110 MW of net electrical energy under a contract with Metropolitan Edison Company that extends to 2020. Northampton also provides 14,000-80,000 pounds of steam per hour to an adjacent paper recycling and processing facility owned by Newstech PA, L.P.

Panther Creek. PG&E NEG indirectly owns a 55% equity interest in Panther Creek Generating (economic interest is less than 50%), an 80-MW waste coal electric generating facility that uses circulating fluidized bed technology. The facility is located in Nesquehoning (Carbon County), Pennsylvania and has been providing electricity to Metropolitan Edison under a 20-year contract since 1992.

Scrubgrass. PG&E NEG indirectly owns a 50% interest in Scrubgrass Generating Plant, an 87-MW bituminous waste coal facility. This facility is located in Scrubgrass Township, Venango County, Pennsylvania and commenced commercial operations in 1993. It provides electricity to Pennsylvania Electric Company under a contract that extends to 2017. Scrubgrass has the capability to produce low-pressure steam for industrial use, however, currently it has no steam contracts.

Madison: PG&E NEG indirectly owns a 100% interest in Madison Wind an 11.55 MW wind generation facility located in Madison, New York. Madison generates electricity from seven Vestas V-66 wind turbines and sells the output as a merchant facility in the New York Independent System Operator system.

Midwest Region Generating Facilities

Ohio Peakers. PG&E NEG Indirectly owns a 100% interest in three natural gas-fueled gas turbine peaking facilities in Bowling Green, Napolean and Galion, Ohio. Each unit is approximately 49.5 MW. The Bowling Green unit is under contract to American Municipal Power of Ohio until 2005.

Southern Region Generating Facilities

Indiantown. PG&E NEG indirectly owns a 35% interest in the Indiantown Cogeneration Facility, a 330 MW pulverized coal cogeneration facility located on an approximately 240-acre site in Martin County, Florida. Indiantown, which commenced commercial operations in 1995, utilizes pulverized coal technology consisting of a single pulverized coal boiler, a steam turbine generator, air pollution control equipment and a selective catalytic reduction system to reduce nitrogen oxides.

Indiantown sells all of its capacity and electrical output to Florida Power & Light Company under a power purchase agreement that expires in 2025. Indiantown also supplies up to 745 million pounds of steam per year to a citrus processing plant owned by Louis Dreyfus Citrus, Inc. (LDC) under an energy services agreement with an initial term of 15 years. Under the energy services agreement, LDC must purchase the lesser of 525 million pounds of steam per year or the minimum quantity of steam per year necessary for Indiantown to maintain its status as a QF under PURPA.

The coal supplier to Indiantown, Lodestar, is currently in bankruptcy. Indiantown has negotiated changes to the coal contract with Lodestar, which has been approved by the bankruptcy court. Separately, Lodestar’s bankruptcy proceedings has been modified so that the business and assets of Lodestar, including Indiantown’s coal contract, will be sold and it is currently anticipated that Lodestar will not emerge from its bankruptcy proceeding as a going concern. Lodestar has failed to perform certain of its obligations under the contract as it pertains to ash disposal and Indiantown has delivered a notice of default to Lodestar. In the event the contract is terminated as a result of such default, by Lodestar or otherwise, Indiantown has arranged for replacement coal supply and ash disposal agreements. Lodestar has contested the notice of default.

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Cedar Bay. PG&E NEG indirectly owns a 64% equity interest in the Cedar Bay Generating Facility (economic interest is less than 50%), a 258 MW coal-fired cogeneration facility located in Jacksonville, Florida. Cedar Bay, which commenced commercial operations in 1994 and consists of three circulating fluidized bed boilers, a steam turbine generator, air pollution control equipment and selective non-catalytic reduction to reduce nitrogen oxides.

Cedar Bay sells its electric capacity and output to Florida Power & Light Company under a power purchase agreement with an initial term of 31 years that expires in 2024. Cedar Bay also sells up to 380,000 pounds per hour of steam to Smurfit Stone Container Corporation under an energy services agreement with an initial term of 19 years that expires in 2013. Under this agreement, Smurfit Stone Container Corporation pays Cedar Bay a capacity payment according to a fixed schedule and a variable payment based on Cedar Bay’s cost of coal. Cedar Bay is currently in litigation with Smurfit Stone regarding payment of liquidated damages under the energy services agreement.

The former coal supplier to Cedar Bay, Lodestar, is currently in bankruptcy. Lodestar has rejected the coal supply contract and Cedar Bay is purchasing coal from a new supplier at prices in excess of those that were charged under the Lodestar contract.

The financial statements of Cedar Bay at December 31, 2002, have been prepared on a going concern basis. Failure to make timely payments on senior project debt is an event of default. The lenders have rights and remedies if such events of default are not cured. Cedar Bay's 2003 and 2004 current cash flow projections indicate that payments due under the senior project debt will not be made on their required dates, but will be paid in full at a later date to cure any event of default.

Western Region Generating Facilities

Hermiston. PG&E NEG indirectly owns a 50.1% interest in Hermiston Generating Company L.P. (HGC). HGC, in turn, owns a 50% interest in the Hermiston Generating Facility, a 474 MW natural gas-fired cogeneration facility located in Hermiston, Oregon. This facility, which commenced commercial operations in 1996, is a combined-cycle cogeneration facility that utilizes two GE 7FA turbines and associated systems and facilities.

HGC sells its share of electric capacity and output generated by Hermiston to PacifiCorp under a power sale agreement with an initial term that expires in 2016. PacifiCorp has an option to extend the term of this agreement for an additional ten years. Hermiston also sells steam to a nearby food processing facility owned by Lamb-Weston, Inc. under a retail energy services agreement with a term of 20 years that expires in 2016.

Plains End. PG&E NEG indirectly owns a 100% interest in the 111-MW Plains End Generating Station. This peaking facility, which is located in Arvada, Colorado and commenced operating in 2002, consists of 20 reciprocating engine generators. Plains End is under contract to Public Service of Colorado to 2012.

San Diego Peakers. PG&E NEG indirectly owns a 100% interest in two natural gas-fueled gas turbine peaking facilities in Escondido and Chula Vista, California. Each unit is approximately 42 MW. Both facilities are under contract to the California Independent System Operator until November 2003.

Colstrip. PG&E NEG indirectly owns a 17% interest in Colstrip Energy, LP, which owns the Rosebud Power Plant, a 40-MW fluidized bed, waste coal electric generating facility located in Colstrip, Montana. The plant has been providing electricity to Montana Power under a 35-year contract since 1990.

Natural Gas Transmission Business

In its Pipeline Business segment, PG&E NEG owns, operates and develops natural gas pipeline facilities, including the pipelines owned by PG&E GTN (the Gas Transmission Northwest pipeline, or GTN, and the North Baja pipeline, or NBP) and, an interest in the Iroquois pipeline.

The following table summarizes PG&E NEG’s gas transmission pipelines:

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GTN Pipeline System

GTN consists of over 1,350 miles of natural gas transmission pipeline in the Pacific Northwest with a capacity of approximately 2.9 billion cubic feet of natural gas per day. GTN begins at the British Columbia-Idaho border, extends for approximately 612 miles through northern Idaho, southeastern Washington and central Oregon, and ends at the Oregon-California border, where it connects with other pipelines. GTN,