Now, am I understanding the Area of Effect rules correctly with this power that if he targets and hits 1 figure with EE and there's an adjacent figure that gets hit with the "splash damage" that it's no longer "only one character" for this power? So it's effectively EE *or* PB if it's just one targeted/hit character?

pretty sure the AOE is in fact made up of all adjacent non-targeted characters.

No, if he targets one character, it could have 7 adjacent. All 7 would be hit with splash damage and penetrating damage. He only targeted one, then rolls and compares to all defenses in the aoe.

This.

I'm more confused by why the power is called Frag Grenade. Frag Grenade is already a thing...

Okay, thanks. The AoE thing is one of the newer terms that they made while I was out of the game and it's been one of the harder concepts as I've heard different answers from different places/people. I've had some say that figures in the AoE are also targeted and some that say they are not targets, but they are hit... and it doesn't help that it's a small blurb in the rulebook that I can never find at the event.

They're not targeted, and as such Shape Change won't kick in. However, they do get to roll Super Senses, and they also get ES/D.

A basic rule of targeting is when you draw a lof to something for a game effect. You're not drawing lof to the aoe characters (in Energy Explosion), so they were not targeted.
That's not to say all aoe's don't target though. Pulse Wave is an aoe, but you draw lof for it, so the characters are targeted.

And I think that's what confuses so many people (which gives different answers on it). I'm going to look through the rulebook tonight or when I get a chance to see if I can find the section that someone showed me in a game that caused some confusion on this, too.