SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): SEPTEMBER 5, 2002
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CENTERPOINT ENERGY, INC.
(Exact name of registrant as specified in its charter)
D/B/A/ RELIANT ENERGY, INCORPORATED
TEXAS 1-31447 74-0694415
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
1111 LOUISIANA
HOUSTON, TEXAS 77002
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 207-3000
ITEM 5. OTHER EVENTS
On September 5, 2002, CenterPoint Energy, Inc. (d/b/a Reliant Energy,
Incorporated) announced that its Board of Directors had declared a distribution
of all of the shares of Reliant Resources, Inc. (Reliant Resources) common stock
owned by CenterPoint Energy to its common shareholders on a pro rata basis (the
Distribution). The Distribution will be made on September 30, 2002 to
shareholders of record of CenterPoint Energy, Inc. common stock as of the close
of business on September 20, 2002, the record date for the Distribution.
On September 10, 2002, CenterPoint Energy, Inc. mailed a letter and a
set of questions and answers regarding the restructuring and business separation
of Reliant Energy to its shareholders. A copy of the letter and set of questions
and answers is filed with this Form 8-K as Exhibit 99.2.
Set forth below is a description of the businesses of CenterPoint
Energy, which is referred to as "we", "our" or "CenterPoint Energy," after
giving effect to the disposition of Reliant Resources pursuant to the
Distribution. Also described are certain risk factors which should be considered
in connection with an investment in our securities. Additionally, we have
included pro forma financial information giving effect to the Distribution as
Exhibit 99.1, which pro forma financial information is incorporated by reference
herein.
OUR BUSINESS
OVERVIEW
We are a utility holding company, created on August 31, 2002 as part of
a corporate restructuring of Reliant Energy, Incorporated (Reliant Energy) that
implemented certain requirements of the Texas electric restructuring law
described below. We are the successor to Reliant Energy for financial reporting
purposes under the Securities Exchange Act of 1934. Our wholly owned operating
subsidiaries own and operate electric generation plants, electric transmission
and distribution facilities, natural gas distribution facilities and natural gas
pipelines. We are subject to regulation as a "registered" holding company under
the Public Utility Holding Company Act of 1935. Our wholly owned subsidiaries
include:
o CenterPoint Energy Houston Electric, LLC (CenterPoint Houston),
which engages in Reliant Energy's former electric transmission and
distribution business in a 5,000-square mile area of the Texas Gulf
Coast that includes Houston.
o Texas Genco Holdings, Inc. (Texas Genco), which owns and operates
the Texas generating plants formerly belonging to the integrated
electric utility that was a part of Reliant Energy. As described
under "Our Business-Electric Generation-Texas Genco Distribution,"
we intend to distribute approximately 19% of the outstanding common
stock of Texas Genco to our shareholders in late 2002 or early
2003.
o Reliant Energy Resources Corp. (RERC), which owns gas distribution
systems that together form one of the United States' largest
natural gas distribution operations in terms of customers served.
Through wholly owned subsidiaries, RERC owns two interstate natural
gas pipelines and provides various ancillary services.
In June 1999, the Texas legislature enacted a law that substantially
amended the regulatory structure governing electric utilities in Texas in order
to encourage retail electric competition. We refer to this legislation as the
"Texas electric restructuring law." Under this law, we and other power
generators in Texas ceased to be subject to traditional cost-based regulation.
Since January 1, 2002, generation and retail sales are no longer subject to cost
of service regulation, and we have been selling generation capacity, energy and
ancillary services to wholesale purchasers at prices determined by the market.
Our transmission and distribution services remain subject to rate regulation.
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Retail electric sales involve the sale of electricity and related
services to end users of electricity and were included as part of bundled
regulated service prior to 2002. Since January 1, 2002, retail electric sales
formerly conducted by Reliant Energy have been conducted by Reliant Resources.
As a result of deregulation, CenterPoint Houston, as a regulated
transmission and distribution utility, recovers the cost of its service through
an energy delivery charge and not as a component of the prior bundled rate,
while Texas Genco, which is not regulated, sells its generation capacity in
capacity auctions at prices determined by the market. Accordingly, there are no
meaningful comparisons for these business segments against prior periods.
THE TEXAS ELECTRIC RESTRUCTURING LAW
The Texas electric restructuring law substantially amended the
regulatory structure governing electric utilities in Texas in order to allow
retail electric competition for all customers. Retail pilot projects, allowing
competition for up to 5% of each utility's energy demand, or "load" in all
customer classes, began in August 2001 and retail electric competition for all
other customers began in January 2002. Under the Texas electric restructuring
law:
o integrated electric utilities in Texas have restructured their
businesses in order to separate power generation, transmission and
distribution and retail electric provider activities into separate
units;
o since January 1, 2002, most retail customers of investor-owned
electric utilities in Texas have been entitled to purchase their
electricity from any of several "retail electric providers" that
have been certified by the Public Utility Commission of Texas
(Texas Utility Commission);
o retail electric providers, who may not themselves own any
generation assets, obtain their electricity from power generation
companies, exempt wholesale generators and other generating
entities and provide services at generally unregulated rates,
except that the prices that may be charged to residential and small
commercial customers by retail electric providers affiliated with a
utility within their affiliated electric utility's service area are
set by the Texas Utility Commission (price to beat) until certain
conditions in the Texas electric restructuring law are met;
o the transmission and distribution of power are performed by
transmission and distribution utilities, such as CenterPoint
Houston, at rates that continue to be regulated by the Texas
Utility Commission; and
o transmission and distribution utilities in Texas whose generation
assets were "unbundled" pursuant to the Texas electric
restructuring law, may recover generation-related
(i) "regulatory assets," which consist of the Texas
jurisdictional amount reported by the electric utilities
as regulatory assets and liabilities (offset by specified
amounts) in their audited financial statements for 1998;
and
(ii) "stranded costs," which consist of the positive excess of
the net regulatory book value of generation assets over
the market value of the assets, taking specified factors
into account.
The Texas electric restructuring law permits utilities to recover
regulatory assets and stranded costs through non-bypassable charges authorized
by the Texas Utility Commission, to the extent that such assets and costs are
established in certain regulatory proceedings. The law also authorizes the Texas
Utility Commission to permit utilities to issue securitization bonds based on
the securitization of the revenue associated with that charge. For more
information, please read "Our Business-Electric Transmission and
Distribution--Stranded Costs and Regulatory Assets Recovery."
For additional information regarding the Texas electric restructuring
law, retail competition in Texas and its application to our operations and
structure, please read "Regulation-State and Local Regulations-Texas-Electric
Operations-The Texas Electric Restructuring Law" below.
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ERCOT MARKET FRAMEWORK
CenterPoint Houston is a member of the Electric Reliability Council of
Texas, Inc. ("ERCOT") and is interconnected to a grid covering the ERCOT market.
Texas Genco sells electric generation capacity, energy and ancillary services in
the ERCOT market. The ERCOT market consists of the State of Texas, other than a
portion of the Texas panhandle and a portion of the eastern part of the state
bordering on Louisiana. The ERCOT market represents approximately 85% of the
demand for power in Texas and is one of the nation's largest power markets. The
ERCOT market includes an aggregate net generating capacity of approximately
70,000 MW. There are only limited interconnections between the ERCOT market and
other power markets in the United States.
The ERCOT market operates under the reliability standards set by the
North American Electric Reliability Council. Members of ERCOT include retail
customers, investor and municipally owned electric utilities, rural electric
co-operatives, river authorities, independent generators, power marketers and
retail electric providers. The Texas Utility Commission has primary jurisdiction
over the ERCOT market to ensure the adequacy and reliability of electricity
supply across the state's main interconnected power transmission grid. In July
2001, as part of the transition to deregulation in Texas, ERCOT changed its
operations from multiple control areas, each managed by one of the utilities in
the state, to a single control area managed by the ERCOT independent system
operator (ERCOT ISO). The ERCOT ISO is responsible for maintaining reliable
operations of the bulk electric power supply system in the ERCOT market. Its
responsibilities include ensuring that information relating to a customer's
choice of retail electric provider is conveyed in a timely manner to anyone
needing the information. It is also responsible for ensuring that electricity
production and delivery are accurately accounted for among the generation
resources and wholesale buyers and sellers in the ERCOT market. Unlike
independent system operators in other regions of the country, ERCOT is not a
centrally dispatched power pool and the ERCOT ISO does not procure energy on
behalf of its members other than to maintain the reliable operations of the
transmission system. Members are responsible for contracting their energy
requirements bilaterally. ERCOT also serves as agent for procuring ancillary
services for those who elect not to provide their own ancillary service
requirement.
As part of the change to a single control area, ERCOT initially
established three congestion zones: north, west and south. These congestion
zones are determined by physical constraints on the ERCOT transmission system
that make it difficult or impossible at times to move power from a zone on one
side of the constraint to the zone on the other side of the constraint. ERCOT
will perform an annual analysis of the transmission capability and constraints
in ERCOT to determine if changes to the congestion zones are required. Any
required changes will take effect January 1 of the following year. Such an
analysis was performed in the fall of 2001 and as a result, ERCOT was
reorganized into four congestion zones on January 1, 2002. The current zones are
north, south, west and Houston. In addition, ERCOT conducts annual and monthly
auctions of transmission congestion rights (TCRs) which provide the entity
owning TCRs the ability to financially hedge price differences between zones
(basis risk). Entities are currently limited to owning a maximum of 25% of the
available TCRs. The transmission and distribution, generation and retail load
that were formerly conducted under or served by Reliant Energy are predominately
in the Houston zone.
ELECTRIC TRANSMISSION AND DISTRIBUTION
Service Area. CenterPoint Houston's service area consists of a
5,000-square-mile area located along the Texas Gulf Coast, with a population in
the year 2000 of approximately 4,670,000 people. Electric service is provided to
approximately 1.7 million customers in this area, which includes the City of
Houston and surrounding cities such as Galveston, Pasadena, Baytown, Bellaire,
Freeport and Sugar Land. With the exception of Texas City, CenterPoint Houston
serves nearly all of the Houston/Galveston consolidated metropolitan statistical
area. Effective January 2002, all former electricity customers of Reliant Energy
whose service was regulated became free to choose from retail electric providers
who compete for their business. The competing retail electric providers are now
CenterPoint Houston's primary customers. See "-- Customers" below.
Electric Transmission. CenterPoint Houston's electric transmission
business transports electricity from power plants to substations and from one
substation to another. Transmission services are provided under tariffs approved
by the Texas Utility Commission. Transmission service offers the use of the
transmission system for delivery of power over facilities operating at 69 kV and
above. Other services offered by the transmission business
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include system impact studies, facilities studies and maintenance of substations
and transmission lines owned by other parties.
Electric Distribution. CenterPoint Houston's electric distribution
business distributes electricity for retail electric providers in its
certificated service area. CenterPoint Houston's distribution network consists
of primary distribution lines, transformers, secondary distribution lines and
service wires. Operations include metering services, outage response services
and other call center operations. As part of the restructuring of the Texas
electric utility market, metering services will be provided on a competitive
basis for commercial and industrial electric customers beginning in January 2004
and for residential retail electric customers in each service area on the later
of September 1, 2005, or the date when 40% of those residential retail electric
customers in that service area are taking service from unaffiliated retail
electric providers.
CenterPoint Houston's distribution network receives electricity from
the transmission grid through power distribution substations and distributes
electricity to end users and wholesale customers through CenterPoint Houston's
distribution feeders.
Distribution services are provided under tariffs approved by the Texas
Utility Commission. New Texas Utility Commission rules and market protocols
govern the commercial retail operations of distribution companies and other
market participants.
Most of CenterPoint Houston's transmission and distribution lines have
been constructed over lands of others pursuant to easements or along public
highways and streets as permitted by law. The transmission and distribution
networks are currently subject to the liens of a Mortgage and Deed of Trust, as
supplemented, that secure CenterPoint Houston's obligations under approximately
$1.16 billion aggregate principal amount of outstanding first mortgage bonds
(including approximately $547 million aggregate principal amount issued as
collateral to secure certain long-term debt obligations of CenterPoint Energy).
STRANDED COSTS AND REGULATORY ASSETS RECOVERY
The Texas electric restructuring law provides us an opportunity to
recover our "regulatory assets" and "stranded costs" resulting from the
unbundling of the transmission and distribution utility from the generation
facilities and the related onset of retail electric competition. "Stranded
costs" include the positive excess of the regulatory net book value of
generation assets over the market value of the assets. The Texas electric
restructuring law allows alternative methods of third party valuation of the
fair market value of generation assets, including outright sale, full and
partial stock valuation and asset exchanges. We have agreed in the business
separation plan approved by the Texas Utility Commission that the fair market
value of Texas Genco's generating assets will be determined using the partial
stock valuation method. We expect to distribute to our shareholders
approximately 19% of the common stock of Texas Genco in late 2002 or early 2003.
The publicly traded common stock will then be used to determine the market value
of Texas Genco. For more information regarding the fair market value
determination, please read "--Final True-Up--Stranded Cost Component" and "Our
Business-Electric Generation--Texas Genco Distribution." The Texas electric
restructuring law also provides specific regulatory remedies to reduce or
mitigate a utility's stranded cost exposure. For example, during a base rate
freeze period from 1999 through 2001, earnings above the utility's authorized
rate of return formula were required to be applied in a manner to accelerate
depreciation of generation-related plant assets for regulatory purposes if the
utility was expected to have stranded costs. In addition, depreciation expense
for transmission and distribution related assets could be redirected to
generation assets for regulatory purposes during that period if the utility was
expected to have stranded costs. Reliant Energy undertook both of these remedies
provided in the Texas electric restructuring law.
"Regulatory assets" consist of the Texas jurisdictional amount reported
by an electric utility as regulatory assets and liabilities (offset by specified
amounts) in their audited financial statements for 1998. The Texas electric
restructuring law permits utilities to recover regulatory assets through
non-bypassable transition charges on retail electric customers' bills, to the
extent that such assets and costs are established in certain regulatory
proceedings.
The Texas electric restructuring law also permits CenterPoint Houston,
or a special purpose entity, to issue securitization bonds for the recovery of
generation-related regulatory assets and stranded costs. See
5
"--Securitization Financing" below for a more complete discussion of the
issuance of securitization bonds. Any stranded costs not recovered through the
sale of securitization bonds may be recovered through a separate non-bypassable
charge to transmission and distribution customers.
Mitigation. In the Wires Case described below under "Regulation-State
and Local Regulations--Texas--Transmission and Distribution Rates," the Texas
Utility Commission found that Reliant Energy had overmitigated its stranded
costs by redirecting transmission and distribution depreciation and by
accelerating depreciation of generation assets as provided under its transition
plan and the Texas electric restructuring law. In December 2001, Reliant Energy
recorded a regulatory liability of $1.1 billion to reflect the prospective
refund of accelerated depreciation, removed its previously recorded embedded
regulatory asset of $841 million that had resulted from redirected depreciation
and recorded a regulatory asset of $2.0 billion based upon then current
projections of market value of Reliant Energy's Texas generation assets to be
covered by the 2004 true-up proceeding described below. Recovery of this asset
is dependent upon action by the Texas Utility Commission. Reliant Energy began
refunding the excess mitigation credits in January 2002, and CenterPoint Houston
will continue to do so over a seven year period. If events occur that make the
recovery of all or a portion of the regulatory assets no longer probable, we
will write off the corresponding balance of these assets as a charge against
earnings.
Final True-Up. Beginning in January 2004, the Texas Utility Commission
will conduct true-up proceedings for each investor-owned utility. The purpose of
the true-up proceeding is to quantify and reconcile the amount of stranded
costs, the capacity auction true-up, unreconciled fuel costs and other
regulatory assets associated with the generating assets that were not previously
securitized as described below under "-Securitization Financing." The true-up
proceeding will result in either additional charges or credits being assessed on
certain retail electric providers.
Stranded Cost Component. The regulatory net book value of generating
assets will be compared to the market value based on the partial stock valuation
method. The resulting difference, if positive, is stranded cost that will be
recovered through a transition charge, which is a non-bypassable charge assessed
to customers taking delivery service from CenterPoint Houston, that may be
securitized. If the difference is negative, the amount of over-mitigation not
returned to customers by that time (redirected depreciation and excess earnings
directed to depreciation) will be returned to customers through lower
transmission and distribution charges.
The publicly traded common stock of Texas Genco will be used to
determine the market value of the generating assets of Texas Genco pursuant to
the partial stock valuation method for determining stranded costs. The market
value will be equal to the average daily closing price on a national exchange
for publicly held shares of common stock in Texas Genco for the 30 consecutive
trading days chosen by the Texas Utility Commission out of the 120 trading days
immediately preceding the true-up filing, plus a control premium, up to a
maximum of 10%, to the extent included in the valuation determination made by
the Texas Utility Commission. The regulatory net book value is the balance as of
December 31, 2001 plus certain costs incurred for reductions in emissions of
oxides of nitrogen and any above-market purchase power costs. The regulatory net
book value will also include any mitigation returned to ratepayers through
return of "excess earnings depreciation" or reversal of redirected depreciation.
ECOM True-Up Component. The Texas Utility Commission used a computer
model or projection, called an excess-cost-over-market model or "ECOM model," to
estimate stranded costs related to generation plant assets. In connection with
using the ECOM model to calculate the stranded cost estimate, the Texas Utility
Commission estimated the market power prices that will be received in the
generation capacity auctions mandated by the Texas electric restructuring law
during the period January 1, 2002 through December 31, 2003. Any difference
between the actual market power prices received in those auctions and the Texas
Utility Commission's earlier estimates of those market prices will be a
component of the 2004 true-up to which CenterPoint Houston will be a party.
Fuel Over/Under Recovery Component. The fuel component will be
determined in a final fuel reconciliation. In that proceeding, the amount of any
over- or under-recovery of fuel costs from the period August 1, 1997 through
January 30, 2002 will be determined. Reliant Energy's filing related to this
proceeding covers $8.5 billion in fuel revenues and $8.6 billion in fuel
expenses during that period, resulting in an undercollection, including
interest, of $144 million as of June 30, 2002. Current substantive rules require
that the Texas Utility Commission rule on this case by March 2003. A procedural
schedule has been set with a hearing scheduled to begin
6
in November 2002. Any over- or under-recovery, plus interest thereon, will
either be returned to or recovered from our customers, as appropriate, as a
component of the 2004 true-up.
"Price To Beat" Clawback Component. In connection with the
implementation of the Texas electric restructuring law, the Texas Utility
Commission has set a "price to beat" that retail electric providers affiliated
with a former integrated utility charge residential and small commercial
customers within their affiliated electric utility's service area. The true-up
provides for a clawback of "price to beat" in excess of the market price of
electricity if 40% of the "price to beat" load is not served by a non-affiliated
retail electric provider by January 1, 2004. Pursuant to the master separation
agreement between Reliant Energy and Reliant Resources, Reliant Resources is
obligated to reimburse CenterPoint Houston for the clawback component of the
true-up. The clawback will not exceed $150 times the number of customers served
by the affiliated retail electric provider in the transmission and distribution
utility's service territory less the number of customers served by the
affiliated retail electric provider outside the transmission and distribution
utility's service territory on January 1, 2004.
Securitization Financing. The Texas electric restructuring law provides
for the use of special purpose entities to issue securitization bonds for the
economic value of generation-related regulatory assets and stranded costs. These
bonds will be amortized through non-bypassable charges to CenterPoint Houston's
customers that are authorized by the Texas Utility Commission. Any stranded
costs not recovered through the securitization bonds will be recovered through a
non-bypassable charge assessed to customers taking delivery service from
CenterPoint Houston.
In October 2001, one of our subsidiaries issued $749 million of
transition bonds to securitize generation-related regulatory assets. The bonds
have a final maturity date of September 15, 2015 and are non-recourse to us or
our subsidiaries other than to the special purpose issuer. Payments on the
securitization bonds are made out of funds from non-bypassable transition
charges assessed to customers taking delivery service from CenterPoint Houston.
We expect that CenterPoint Houston will seek to securitize the true-up
balance upon completion of the 2004 true-up proceeding. The bonds may have a
maximum maturity of 15 years. Payments on these securitization bonds would also
be made out of funds from non-bypassable transition charges assessed to
customers taking delivery service from CenterPoint Houston.
PROPERTIES
All of CenterPoint Houston's properties are located in the State of
Texas. CenterPoint Houston's substations serve to connect power plants, the high
voltage transmission lines and the lower voltage distribution lines. Unlike the
transmission system, which carries high voltage electricity over long distances,
distribution lines carry lower voltage power from the substation to the retail
electric customers. The distribution system consists primarily of distribution
lines, transformers, secondary distribution lines and service wires.
Electric Lines--Overhead. As of December 31, 2001, CenterPoint Houston
owned 25,998 pole miles of overhead distribution lines and 3,606 circuit miles
of overhead transmission lines, including 452 circuit miles operated at 69,000
volts, 2,095 circuit miles operated at 138,000 volts and 1,059 circuit miles
operated at 345,000 volts.
Electric Lines--Underground. As of December 31, 2001, CenterPoint
Houston owned 12,701 circuit miles of underground distribution lines and 15.6
circuit miles of underground transmission lines, including 4.5 circuit miles
operated at 69,000 volts and 11.1 circuit miles operated at 138,000 volts.
Substations. As of December 31, 2001, CenterPoint Houston owned 223
major substation sites (252 substations) having total installed rated
transformer capacity of 64,783 megavolt amperes.
CUSTOMERS
CenterPoint Houston's customers consist of municipalities, electric
cooperatives, other distribution companies and approximately 27 retail electric
providers in its certificated service area. Two of these retail electric
7
providers are subsidiaries of Reliant Resources. CenterPoint Houston anticipates
that more than half of its revenues from retail electric providers for 2002 will
come from subsidiaries of Reliant Resources. Each retail electric provider is
licensed by the Texas Utility Commission and must meet creditworthiness criteria
established by the Texas Utility Commission. CenterPoint Houston operates on a
continuous billing cycle, with meter readings being conducted and invoices being
distributed to the retail electric providers each business day.
COMPETITION
CenterPoint Houston's operations are regulated by the Texas Utility
Commission and are conducted within its service territory pursuant to a
certificate of convenience and necessity issued by the Texas Utility Commission.
In order for another provider of transmission and distribution services to
provide such services in CenterPoint Houston's territory, it would be required
to obtain a certificate of convenience and necessity in proceedings before the
Texas Utility Commission.
ELECTRIC GENERATION
Our wholly owned subsidiary, Texas Genco, acquired Reliant Energy's
portfolio of electric generation facilities located in Texas and related
business effective August 31, 2002. From January 31, 2002 until August 31, 2002,
however, the electric generation facilities were operated as a separate division
within Reliant Energy. For convenience, we describe Texas Genco's business in
this Current Report on Form 8-K as if Texas Genco had owned and operated its
generation facilities prior to the date they were actually conveyed to Texas
Genco.
Texas Genco is one of the largest wholesale electric power generating
companies in the United States. As of June 30, 2002, Texas Genco owned and
operated 11 power generating stations (60 generating units) with a net
generating capacity of 14,175 megawatts (MW), including a 30.8% interest in the
South Texas Project Electric Generating Station (South Texas Project). The South
Texas Project is a nuclear generating station with two 1,250 MW nuclear
generating units. Texas Genco sells electric generation capacity, energy and
ancillary services in the ERCOT market, which is the largest power market in the
State of Texas.
Since January 1, 2002, Texas Genco's generation business has been
operated as an independent power producer, with output sold at market prices to
a variety of purchasers, which include Reliant Resources and its subsidiaries.
Because of this change, historical operating data, such as demand and fuel data,
may not accurately reflect the operation of this business subsequent to December
31, 2001.
As a result of requirements under the Texas electric restructuring law,
as well as an agreement with Reliant Resources, Texas Genco is obligated to sell
substantially all of its capacity and related ancillary services through 2003
pursuant to capacity auctions. In these auctions, Texas Genco sells firm
entitlements to capacity and ancillary services on a forward basis dispatched
within specified operational constraints. For more information regarding these
auctions, please read "-- Operations and Capacity Auctions Generally, "--State
Mandated Capacity Auctions," --Contractually Mandated Capacity Auctions" and
"--Auction Results."
The Texas market currently has a surplus of generating capacity, which
helps to facilitate a competitive wholesale market. Generators in ERCOT added
6,925 MW of new capacity in 2001. Due to the large quantity of generation built
recently, it is anticipated that the wholesale market in Texas will be extremely
competitive for the next three to five years.
Facilities. Texas Genco's generation facilities as of June 30, 2002 are
described in the table below.
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NET
GENERATING NUMBER
CAPACITY OF
GENERATION FACILITIES (IN MW)(1) UNITS DISPATCH TYPE FUEL
--------------------- ---------- ------ ------------- ----
W. A. Parish......................... 3,661 9 Base-load, Intermediate, Coal/Gas
Cyclic, Peaking
Limestone............................ 1,612 2 Base-load Lignite
South Texas Project(2)............... 770 2 Base-load Nuclear
Cedar Bayou.......................... 2,260 3 Intermediate Gas/Oil
P. H. Robinson....................... 2,213 4 Intermediate Gas
San Jacinto(3)....................... 162 2 Intermediate Gas
T. H. Wharton........................ 1,254 18 Cyclic, Peaking Gas/Oil
S. R. Bertron........................ 844 6 Cyclic, Peaking Gas/Oil
Greens Bayou......................... 760 7 Cyclic, Peaking Gas/Oil
Webster.............................. 387 2 Cyclic, Peaking Gas
Deepwater............................ 174 1 Cyclic Gas
H. O. Clarke......................... 78 6 Peaking Gas
------- ---
Total........................... 14,175 62
======= ===
-------------
(1) Net generating capacity equals gross nameplate capacity less the electric
energy consumed at the facility.
(2) Texas Genco owns a 30.8% interest in the South Texas Project.
(3) This facility is a cogeneration facility. Cogeneration is the combined
production of steam and electricity in a generation facility.
Market Framework. Since January 1, 2002, any wholesale producer of
electricity that qualifies as a "power generation company" under the Texas
electric restructuring law and that can access the ERCOT electric grid is
allowed to sell power in the Texas market at unregulated rates. Transmission
capacity, which may be limited, is needed to effect power sales. In the Texas
market, buyers and sellers may negotiate bilateral wholesale capacity, energy
and ancillary services contracts or may participate in the spot market.
Operations and Capacity Auctions Generally. Since January 1, 2002,
Texas Genco has operated its generation business solely in the wholesale market.
It is required by the Texas electric restructuring law to auction 15% of the
capacity of its generation business (state mandated auctions) and by an
agreement between Reliant Energy and Reliant Resources to auction the remainder
of its capacity (contractually mandated auctions). Texas Genco's auction
products are only entitlements to capacity dispatched from base, intermediate,
cyclic or peaking units and do not convey a right to receive power from a
particular unit. This enables Texas Genco to dispatch its commitments in the
most cost-effective manner, but also exposes it to the risk that, depending upon
the availability of its units, it could be required to supply energy from a
higher cost unit, such as an intermediate unit, to meet an obligation for lower
cost generation, such as base-load generation, or to obtain the energy on the
open market. In addition, from time to time, Texas Genco may be required to
purchase power from qualifying facilities under the Public Utility Regulatory
Policies Act of 1978.
Revenues from capacity auctions come from two sources: capacity
payments and fuel payments. Capacity payments are based on the final clearing
prices, in dollars per kilowatt-month, determined during the auctions. Texas
Genco bills for these payments on a monthly basis just prior to the month of the
entitlement. Fuel payments consist of a variety of charges related to the fuel
and ancillary services scheduled through the auctioned products. Texas Genco
invoices for these fuel payments on a monthly basis in arrears.
State Mandated Capacity Auctions. The obligation to conduct state
mandated auctions of 15% of Texas Genco's generation capacity will continue
until January 1, 2007, unless before that date the Texas Utility Commission
determines that at least 40% of the electric power consumed before the onset of
competition by residential and small commercial customers in CenterPoint
Houston's service area is being served by retail electric providers not
affiliated with us or formerly affiliated with Reliant Energy. Reliant Resources
currently is not permitted under the Texas electric restructuring law to
purchase capacity sold by Texas Genco in the state mandated auctions.
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Contractually Mandated Capacity Auctions. Texas Genco is obligated to
conduct contractually mandated auctions of the remainder of its capacity until
the date on which the Texas Genco Option, described below, either is exercised
or expires. Texas Genco is permitted to reduce the amount of capacity sold in
the contractually mandated auctions by the amount required to satisfy:
o its operational requirements associated with the capacity sold
pursuant to the Texas Utility Commission rules, including the rules
associated with state mandated auctions and the price to beat; or
o its obligations to another party under an existing spinning reserve
service agreement.
Reliant Resources is entitled to purchase, prior to Texas Genco's submission of
capacity to auction, 50% (but not less than 50%) of the capacity Texas Genco has
available to auction in the contractually mandated auctions at the prices bid by
third parties in the contractually mandated auctions. Whether or not Reliant
Resources exercises this right, Reliant Resources may submit bids to purchase in
the contractually mandated auctions as well.
Auction Results. Texas Genco conducted its initial state mandated
auctions and contractually mandated auctions from September 2001 through July
2002. Thirty-one companies, including Reliant Resources, registered and
qualified to participate in these auctions. As a result, Texas Genco has sold
98% of its available capacity through August 2002, 77% of its available capacity
for September through December 2002, and 11% of its available capacity for the
year 2003. Texas Genco's available capacity equals its total net generating
capacity less capacity withheld as backup operating reserves and capacity that
is subject to planned outages at its facilities. Texas Genco intends to hold
auctions to sell its remaining available capacity for 2003 during October and
November 2002, and March, July and September 2003. Reliant Resources has
purchased 45% of the 2002 capacity sold in the contractually mandated auctions
held to date. To date, its capacity auctions have been consummated at
market-based prices that have resulted in returns substantially below the
historical regulated return on its facilities.
TEXAS GENCO DISTRIBUTION
In order to establish a public market value for the Texas Genco shares
that will be used to calculate how much CenterPoint Houston will be able to
recover as stranded costs, we expect to distribute to our shareholders shares of
Texas Genco common stock that will constitute approximately 19% of the total
number of shares of Texas Genco common stock outstanding immediately after the
distribution (the Texas Genco Distribution). We anticipate that the Texas Genco
Distribution will occur in late 2002 or early 2003.
Following the Texas Genco Distribution, Texas Genco will be a company
with common stock registered under Section 12 of the Securities Exchange Act of
1934. We expect we will continue to indirectly own approximately 81% of the
outstanding shares of Texas Genco common stock until at least 2004 when the
Texas Genco Option, described below, will either be exercised or will expire.
The Texas Genco Distribution will not affect the number of outstanding shares of
our common stock or the rights of our shareholders.
TEXAS GENCO OPTION
Reliant Resources has an option that may be exercised between January
10, 2004 and January 24, 2004 to purchase all of the shares of Texas Genco
common stock that will be owned by us after the Distribution. The exercise price
under the option will equal:
o the average daily closing price per share of Texas Genco common
stock on The New York Stock Exchange for the 30 consecutive trading
days with the highest average closing price for any 30 day trading
period during the 120 trading days immediately preceding January
10, 2004, multiplied by the number of shares of Texas Genco common
stock then owned by us, plus
o a control premium, up to a maximum of 10%, to the extent a control
premium is included in the valuation determination made by the
Texas Utility Commission relating to the market value of Texas
Genco's common stock equity.
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The exercise price formula is based upon the generation asset valuation
methodology in the Texas electric restructuring law that we will use to
calculate the market value of Texas Genco. The exercise price is also subject to
adjustment based on the difference between the per share dividends Texas Genco
paid to us during the period from the distribution date through the option
closing date and Texas Genco's actual per share earnings during that period. To
the extent Texas Genco's per share dividends are less than its actual per share
earnings during that period, the per share option price will be increased. To
the extent its per share dividends exceed its actual per share earnings, the per
share option price will be reduced.
Reliant Resources has agreed that if it exercises its option, Reliant
Resources will purchase from us all notes and other payables owed by Texas Genco
to us as of the option closing date, at their principal amount plus accrued
interest. Similarly, if there are notes or payables owed to Texas Genco by us as
of the option closing date, Reliant Resources will assume those obligations in
exchange for a payment from us of an amount equal to the principal plus accrued
interest.
If the option is exercised and certain regulatory conditions have not
yet been satisfied, the option agreement provides for payment of the exercise
price into escrow and execution of a power sales agreement under which Texas
Genco will sell to Reliant Resources or its designee all of its capacity at
market-based rates until the earlier of the option closing date or May 31, 2005.
If the option closing has not occurred by May 31, 2005, rights under the option
agreement will terminate. On the option closing date, the exercise price plus
accrued interest will be delivered from escrow, net of dividends paid by Texas
Genco to us during the period the escrow is in effect. During the period the
power sales agreement is in effect, Reliant Resources will be required to
advance amounts required by Texas Genco for capital expenditures, subject to
reimbursement if the option closing does not take place before May 31, 2005.
In connection with the Texas Genco Option, Texas Genco is obligated to
operate and maintain its assets and otherwise conduct its business in the
ordinary course in a manner consistent with past practice and to make
expenditures for operations, maintenance, repair and capital expenditures
necessary to keep its assets in good condition and in compliance with applicable
laws, in a manner consistent with good electric generation industry practice.
Texas Genco is also required to maintain customary levels of insurance, comply
with laws and contractual obligations and pay taxes when due. Texas Genco may
not permanently retire generation units, but may "mothball" units if
economically warranted.
Exercise of the option will be subject to various regulatory approvals,
including Hart-Scott-Rodino antitrust clearance and NRC license transfer
approval. In certain circumstances involving a change in control of us, the time
at which the Texas Genco Option may be exercised and the period over which the
exercise price is determined are accelerated, with corresponding changes to the
time and manner of payment of the exercise price.
FUEL AND PURCHASED POWER
Texas Genco relies primarily on natural gas, coal, lignite and uranium
to fuel its generation facilities. The fuel mix of Texas Genco's generating
portfolio, based on actual fuel usage during 2001, was approximately 49% coal
and lignite, 39% natural gas and 12% nuclear for the year 2001. As of June 30,
2002, the fuel mix of its generating portfolio based on the capacity of its
facilities was approximately 66% natural gas, 29% coal and lignite and 5%
nuclear. The actual mix of fuel used by Texas Genco's facilities reflects a
higher percentage of solid fuels than the overall fuel mix of its generating
capacity because its base-load plants are generally powered by solid fuels.
Based on Texas Genco's current assumptions regarding the cost and availability
of fuel, plant operation schedules, load growth, load management and the impact
of environmental regulations, it does not expect the mix of fuel used by its
generating portfolio will vary materially during 2002 from prior levels. As a
result of new air emissions standards imposed by federal and state law, Texas
Genco anticipates having longer plant outages in 2002 and higher levels of plant
maintenance in 2003 and subsequent years associated with the installation of
environmental equipment. These factors could affect the mix of its future fuel
usage. Texas Genco anticipates that the capital investment incurred through May
2003 to comply with these air emissions requirements will be recoverable through
the Texas Utility Commission's determination of stranded costs.
Through December 31, 2001, the Texas Utility Commission provided for
the recovery of most fuel and purchased power costs from customers through a
fixed fuel factor included in electric rates. As a result of the Texas
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energy restructuring law, most of Texas Genco's energy sales are now based on
the generation capacity entitlement auctions described above. Power generated
from the intermediate, cyclic or peaking entitlements in the capacity auctions
includes a fuel cost component that is tied to the indexed cost of gas, reducing
the risk associated with the price of gas for Texas Genco's generation business.
Successful bidders in these auctions are able to dispatch energy from their
entitlements within the operational constraints of the generating units
supporting the capacity entitlement product they purchased. Under the terms of
the capacity auctions, successful bidders are required to absorb the
corresponding fuel cost for the energy dispatched so that, in effect, Texas
Genco will recover its dispatch-based fuel costs from these bidders.
Natural Gas Supply. Texas Genco obtains its long-term natural gas
supply contracts with several suppliers. Substantially all of its long-term
natural gas supply contracts contain pricing provisions based on fluctuating
spot market prices. In 2001, 61% of the natural gas requirements was purchased
under these long-term contracts. Texas Genco purchased the remaining 39% its of
natural gas requirements in 2001 on the spot market. Based on current market
conditions, Texas Genco believes it will be able to replace the supplies of
natural gas covered under its long-term contracts when they expire with gas
purchased on the spot market or under new long-term or short-term contracts.
Texas Genco's natural gas requirements are generally more volatile than
its other fuel requirements because it uses natural gas to fuel intermediate,
cyclic and peaking facilities and other more economical fuels to fuel base-load
facilities. Although natural gas supplies have been sufficient in recent years,
available supplies are subject to potential disruption due to weather
conditions, transportation constraints and other events. As a result of these
factors, supplies of natural gas may become unavailable from time to time or
prices may increase rapidly in response to temporary supply constraints or other
factors.
Coal and Lignite Supply. Texas Genco purchases approximately 80% of the
fuel requirements for its four coal-fired generating units at its W.A. Parish
facility under two fixed-quantity, long-term supply contracts scheduled to
expire in 2010 and 2011. The price for coal is fixed under the first contract
through the end of 2002, after which the price will be tied to spot market
prices. The price for coal under the second contract was approximately three
times greater than the spot market prices for coal as of December 31, 2001. The
fuel payments Texas Genco collects for capacity entitlements with underlying
coal-fired capacity are based on a pre-established price based on the Texas
Utility Commission's forecasted fuel costs, which incorporate Texas Genco's
expected fuel costs under these long-term coal supply contracts. Texas Genco
purchases its remaining coal requirements for the W.A. Parish facility under
short-term contracts. It has long-term rail contracts to transport coal to the
W.A. Parish facility.
Texas Genco obtains the lignite used to fuel the two generating units
of the Limestone facility from a surface mine adjacent to the facility. It owns
the mining equipment and facilities and a portion of the lignite reserves
located at the mine. Mining operations are conducted by the owner of the
remaining lignite reserves. In the past, Texas Genco has obtained its lignite
requirements under a long-term contract on a cost-plus basis. Since July 2002,
Texas Genco has obtained its lignite requirements under an amended long-term
contract with the owner/operator of the mine at a fixed price determined
annually that is expected to result in a cost of generation at the Limestone
facility equivalent to the cost of generating with Wyoming coal. Texas Genco
expects the lignite reserves will be sufficient to provide all of the lignite
requirements of this facility through 2015.
Texas Genco began using a blend of lignite and Wyoming coal to fuel the
Limestone facility in July 2002 as a component of its nitrogen oxides (NOx)
control strategy. A fuel unloading and handling system is being installed at the
Limestone facility to accommodate the delivery of Wyoming coal. Texas Genco
expects to obtain Wyoming coal and rail transportation services through spot and
long-term market-priced contracts.
Nuclear Fuel Supply. The South Texas Project satisfies its fuel supply
requirements by acquiring uranium concentrates, converting uranium concentrates
into uranium hexafluoride, enriching uranium hexafluoride and fabricating
nuclear fuel assemblies. There are numerous contracts covering nuclear fuel
needs of the South Texas Project for uranium, conversion services, enrichment
services and fuel fabrication. Other than a fuel fabrication agreement that
extends for the life of the South Texas Project, these contracts have varying
expiration dates, and most are short to medium term (less than seven years).
Management believes that sufficient capacity for nuclear fuel supplies and
processing exists to permit normal operations of the South Texas Project nuclear
generating units.
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CUSTOMERS
Since January 1, 2002, Texas Genco has sold power to wholesale
purchasers, including retail electric providers, at unregulated rates through
its capacity auctions. In addition to retail electric providers, Texas Genco's
customers in the ERCOT market include municipal utilities, electric
co-operatives, power trading organizations and other power generating companies.
Texas Genco is also a significant provider to the ancillary services market
operated by the ERCOT ISO. Texas Genco expects its mix of customers and the mix
of participants will change significantly as the ERCOT market evolves from one
dominated by vertically integrated electric utilities to one with
utility-affiliated retail electric providers, new entrant retail electric
providers, a higher participation of unregulated energy merchants, and more
generation capacity from independent generation companies.
COMPETITION
The ERCOT market is highly competitive. Texas Genco's competitors
include affiliated generation companies of Texas based utilities, independent
power producers, municipal or co-operative generators and wholesale power
marketers. These competitors will compete with Texas Genco and each other by
buying and selling wholesale power in the ERCOT market, entering into bilateral
contracts and/or selling to aggregated retail customers. A number of Texas
Genco's competitors are building efficient, combined cycle power plants that are
generally not able to provide the operational flexibility, ancillary services
and fuel risk mitigation that Texas Genco's large diversified portfolio of
generating facilities can provide. In addition, we believe that there may be
significant excess generating capacity constructed in the ERCOT market over the
next several years. This overbuilding could result in lower prices for wholesale
power in the ERCOT market. For more information on competition in the ERCOT
market, please read "Risk Factors--Risks Related to Our Electric Generation
Business--There is currently a surplus of generating capacity in the ERCOT
market, and we expect the market for wholesale power to be highly competitive."
NATURAL GAS DISTRIBUTION
Through RERC, we engage in intrastate natural gas sales to, and natural
gas transportation for, residential, commercial and industrial customers in
Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas and some
non-rate regulated retail gas marketing operations. RERC conducts intrastate
natural gas sales to, and natural gas transportation for, residential,
commercial and industrial customers through three unincorporated divisions:
Arkla, Entex and Minnegasco. These operations are regulated as gas utility
operations in the jurisdictions served by these divisions.
o Arkla. Arkla provides natural gas distribution services in over 245
communities in Arkansas, Louisiana, Oklahoma and Texas. The largest
metropolitan areas served by Arkla are Little Rock, Arkansas and
Shreveport, Louisiana. In 2001, approximately 65% of Arkla's total
throughput was attributable to retail sales of gas and
approximately 35% was attributable to transportation services.
o Entex. Entex provides natural gas distribution services in over 500
communities in Louisiana, Mississippi and Texas. The largest
metropolitan area served by Entex is Houston. In 2001,
approximately 97% of Entex's total throughput was attributable to
retail sales of gas and approximately 3% was attributable to
transportation services.
o Minnegasco. Minnegasco provides natural gas distribution services
in over 240 communities in Minnesota. The largest metropolitan area
served by Minnegasco is Minneapolis. In 2001, approximately 97% of
Minnegasco's total throughput was attributable to retail sales of
gas and approximately 3% was attributable to transportation
services.
The demand for intrastate natural gas sales to, and natural gas
transportation for, residential, commercial and industrial customers is
seasonal. In 2001, approximately 62% of RERC's natural gas distribution
business's total throughput occurred in the first and fourth quarters. These
patterns reflect the higher demand for natural gas for heating purposes during
those periods.
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COMMERCIAL AND INDUSTRIAL MARKETING SALES
RERC's commercial and industrial marketing sales group provides
comprehensive natural gas products and services to commercial and industrial
customers in the region from Southern Texas to the panhandle of Florida, as well
as in the Midwestern United States. In 2001, approximately 96% of total
throughput was attributable to the sale of natural gas and approximately 4% was
attributable to transportation services. Typical customer contract terms for
natural gas sales range from one day to three years. RERC's commercial and
industrial marketing sales groups' operations may be affected by seasonal
weather changes and the relative price of natural gas.
SUPPLY AND TRANSPORTATION
Arkla. In 2001, Arkla purchased approximately 53% of its natural gas
supply from Reliant Energy Services, a subsidiary of Reliant Resources, 29%
pursuant to third-party contracts, with terms varying from three months to one
year, and 18% on the spot market. Arkla's major third-party natural gas
suppliers in 2001 included Oneok Gas Marketing Company, Tenaska Marketing
Ventures, Marathon Oil Company and BP Energy Company. Arkla transports
substantially all of its natural gas supplies under contracts with our pipeline
subsidiaries.
Entex. In 2001, Entex purchased virtually all of its natural gas supply
pursuant to term contracts, with terms varying from one to five years. Entex's
major third-party natural gas suppliers in 2001 included AEP Houston Pipeline,
Kinder Morgan Texas Pipeline, L.P., Gulf Energy Marketing, Island Fuel Trading
and Koch Energy Trading. Entex transports its natural gas supplies on both
interstate and intrastate pipelines under long-term contracts with terms varying
from one to five years.
Minnegasco. In 2001, Minnegasco purchased approximately 74% of its
natural gas supply pursuant to term contracts, with terms varying from one to
ten years, with more than 20 different suppliers. Minnegasco purchased the
remaining 26% on the daily or spot market. Most of the natural gas volumes under
long-term contracts are committed under terms providing for delivery during the
winter heating season, which extends from November through March. Minnegasco
purchased approximately 67% of its natural gas requirements from four suppliers
in 2001: Tenaska Marketing Ventures, Reliant Energy Services, Pan-Alberta Gas
Ltd. and TransCanada Gas Services Inc. Minnegasco transports its natural gas
supplies on various interstate pipelines under long-term contracts with terms
varying from one to five years.
Generally, the regulations of the states in which RERC's natural gas
distribution business operates allow it to pass through changes in the costs of
natural gas to its customers through purchased gas adjustment provisions in
rates. There is, however, a timing difference between RERC's purchases of
natural gas and the ultimate recovery of these costs. Consequently, RERC may
incur additional "carrying" costs as a result of this timing difference and the
resulting, temporary under-recovery of its purchased gas costs. To a large
extent, these additional carrying costs are not recovered from RERC's customers.
Arkla and Minnegasco use various leased or owned natural gas storage
facilities to meet peak-day requirements and to manage the daily changes in
demand due to changes in weather. Minnegasco also supplements contracted
supplies and storage from time to time with stored liquefied natural gas and
propane-air plant production.
Minnegasco owns and operates a 7.0 billion cubic feet (Bcf) underground
storage facility, having a working capacity of 2.1 Bcf available for use during
a normal heating season and a maximum daily withdrawal rate of 50 million cubic
feet (MMcf) per day. Minnegasco also owns ten propane-air plants with a total
capacity of 191 MMcf per day and on-site storage facilities for 11 million
gallons of propane (1.0 Bcf gas equivalent). Minnegasco owns a liquefied natural
gas facility with a 12 million-gallon liquefied natural gas storage tank (1.0
Bcf gas equivalent) with a send-out capability of 72 MMcf per day.
Although available natural gas supplies have exceeded demand for
several years, currently supply and demand appear to be more balanced. RERC has
sufficient supplies and pipeline capacity under contract to meet its firm
customer requirements. However, from time to time, it is possible for limited
service disruptions to occur due to weather conditions, transportation
constraints and other events. As a result of these factors, supplies of natural
14
gas may become unavailable from time to time or prices may increase rapidly in
response to temporary supply constraints or other factors.
ASSETS
As of December 31, 2001, RERC owned approximately 61,000 linear miles
of gas distribution mains, varying in size from one-half inch to 24 inches in
diameter. Generally, in each of the cities, towns and rural areas served by
RERC, it owns the underground gas mains and service lines, metering and
regulating equipment located on customers' premises and the district regulating
equipment necessary for pressure maintenance. With a few exceptions, the
measuring stations at which RERC receives gas are owned, operated and maintained
by others, and its distribution facilities begin at the outlet of the measuring
equipment. These facilities, including odorizing equipment, are usually located
on the land owned by suppliers.
COMPETITION
RERC competes primarily with alternate energy sources such as
electricity and other fuel sources. In some areas, intrastate pipelines, other
gas distributors and marketers also compete directly for gas sales to end-users.
In addition, as a result of federal regulatory changes affecting interstate
pipelines, natural gas marketers operating on these pipelines may be able to
bypass RERC's facilities and markets, and sell and/or transport natural gas
directly to commercial and industrial customers.
PIPELINES AND GATHERING
Our pipeline and gathering operations are primarily conducted by wholly
owned subsidiaries of RERC. Our pipeline operations are primarily conducted by
two wholly owned interstate pipeline subsidiaries. Our gathering and pipeline
services operations are conducted by a wholly owned gas gathering subsidiary and
a wholly owned pipeline services subsidiary.
In 2001, approximately 25% of our total operating revenues from
pipelines and gathering was attributable to services provided to Arkla, and
approximately 10% was attributable to services to Laclede Gas Company (Laclede),
an unaffiliated distribution company that provides natural gas utility service
to the greater St. Louis metropolitan area in Illinois and Missouri. An
additional 20% of our operating revenues from pipelines and gathering was
attributable to the transportation of gas marketed by Reliant Energy Services, a
subsidiary of Reliant Resources. Services to Arkla and Laclede are provided
under several long-term firm storage and transportation agreements. Contracts
for firm transportation in Arkla's major service areas are currently scheduled
to expire in 2005. An agreement to extend the existing service relationship with
Laclede for a five-year period was entered into in February 2002.
Our pipelines and gathering business may be affected by seasonal
changes in the demand for natural gas, the relative price of natural gas in the
Midcontinent and Gulf Coast natural gas supply regions and, to a lesser extent,
general economic conditions.
ASSETS
We own and operate approximately 8,100 miles of gas transmission lines.
We also own and operate six natural gas storage fields with a combined daily
deliverability of approximately 1.2 Bcf per day and a combined working gas
capacity of approximately 55.8 Bcf. We also own a 10% interest in the Bistineau
storage facility with 68.8 Bcf of working gas capacity and 1.1 Bcf per day of
deliverability. Our storage capacity in the Bistineau facility is 8 Bcf of
working gas with 100 MMcf per day of deliverability. Most of our storage
operations are in north Louisiana and Oklahoma. We also own and operate
approximately 4,300 miles of gathering pipelines that collect gas from more than
300 separate systems located in major producing fields in Arkansas, Louisiana,
Oklahoma and Texas.
15
COMPETITION
Our pipelines and gathering business competes with other interstate and
intrastate pipelines in the transportation and storage of natural gas. The
principal elements of competition among pipelines are rates, terms of service,
and flexibility and reliability of service. Our pipelines and gathering business
competes indirectly with other forms of energy available to its customers,
including electricity, coal and fuel oils. The primary competitive factor is
price. Changes in the availability of energy and pipeline capacity, the level of
business activity, conservation and governmental regulations, the capability to
convert to alternative fuels, and other factors, including weather, affect the
demand for natural gas in areas we serve and the level of competition for
transportation and storage services. In addition, competition for our gathering
operations is impacted by commodity pricing levels because of their influence on
the level of drilling activity.
REGULATION
We are subject to regulation by various federal, state, local and
foreign governmental agencies, including the regulations described below.
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
We have registered and become subject, with our subsidiaries, to
regulation as a registered holding company system under the 1935 Act. The 1935
Act directs the SEC to regulate, among other things, financings, sales or
acquisitions of assets and intra-system transactions. In order to enable us
ultimately to satisfy the requirements for an exemption from regulation as a
registered holding company under the 1935 Act, we expect to divide the gas
distribution businesses conducted by RERC's three unincorporated gas
distribution divisions, Entex, Arkla and Minnegasco, among three separate
entities. The entity that will hold the Entex assets will also hold ownership of
our natural gas pipelines and gathering business. We have obtained approval of
these transactions from all of the public service commissions that regulate
RERC's operations. Although we expect this business restructuring of RERC can be
completed, we can provide no assurance that this will, in fact, occur, or that
we will ultimately be exempt from regulation under the 1935 Act.
FEDERAL ENERGY REGULATORY COMMISSION
The transportation and sale or resale of natural gas in interstate
commerce is subject to regulation by the FERC under the Natural Gas Act and the
Natural Gas Policy Act of 1978, as amended. The FERC has jurisdiction over,
among other things, the construction of pipeline and related facilities used in
the transportation and storage of natural gas in interstate commerce, including
the extension, expansion or abandonment of these facilities. The rates charged
by interstate pipelines for interstate transportation and storage services are
also regulated by the FERC.
Our natural gas pipeline subsidiaries periodically file applications
with the FERC for changes in their generally available maximum rates and charges
designed to allow them to recover their costs of providing service to customers
(to the extent allowed by prevailing market conditions), including a reasonable
rate of return. These rates are normally allowed to become effective after a
suspension period, and in some cases are subject to refund under applicable law,
until such time as the FERC issues an order on the allowable level of rates.
In February 2000, the FERC issued Order No. 637, which introduces
several measures to increase competition for interstate pipeline transportation
services. Order No. 637 authorizes interstate pipelines to propose
term-differentiated and peak/off-peak rates, and requires pipelines to make
tariff filings to expand pipeline service options for customers. Our natural gas
pipeline subsidiaries made Order No. 637 compliance filings in 2000, one of
which was accepted by the FERC, subject to certain modifications, in March 2002.
The other was accepted by an order appraising a settlement issued by FERC in
June 2002. We have sought clarification of the June order.
STATE AND LOCAL REGULATION
Electric Operations-The Texas Electric Restructuring Law. In June 1999,
the Texas legislature adopted the Texas electric restructuring law, which
substantially amended the regulatory structure governing electric utilities
16
in Texas in order to allow and encourage retail competition. Retail pilot
projects allowing competition for up to 5% of each utility's load in all
customer classes began in August 2001, and retail electric competition for all
other customers began in January 2002.
Municipally-owned utilities and electric cooperatives have the option
to open their markets to retail competition any time after January 1, 2002.
However, until a municipally-owned utility or electric cooperative adopts a
resolution opting to open its market to retail competition, it may not offer
electric energy at unregulated prices to retail customers outside its service
area. Some large Texas cities, including San Antonio and Austin, are served by
municipally-owned utilities that have not announced when or if they will open
their markets to competition.
In addition, CenterPoint Houston holds non-exclusive franchises from
the incorporated municipalities in its service territory. These franchises give
CenterPoint Houston the right to operate its transmission and distribution
system within the streets and public ways of these municipalities for the
purpose of delivering electric service to the municipality, its residents and
businesses. None of these franchises expires before 2007.
For additional information regarding the Texas electric restructuring
law, retail competition in Texas and its application to our operations and
structure, please read "Our Business-Overview-The Texas Electric Restructuring
Law" and "Our Business-Electric Generation."
Transmission and Distribution Rates. All retail electric providers in
CenterPoint Houston's service area pay the same rates and other charges for
distribution services. The transmission and distribution rates that are in
effect as of January 1, 2002 for CenterPoint Houston are based on an order
issued by the Texas Utility Commission. The order resulted from a March 31, 2000
filing with the Texas Utility Commission required by the Texas electric
restructuring law. This order set the regulated rates for CenterPoint Houston to
be effective when electric competition began. This regulated delivery charge
includes the transmission and distribution charge, a system benefit fund fee, a
nuclear decommissioning fund charge, a municipal franchise fee and a transition
charge associated with securitization of regulatory assets. The design of the
new energy delivery rate, which is based on an 11.25% return on equity, differs
from the prior bundled energy rate. The winter/summer rate differential for
residential customers has been eliminated and large commercial and industrial
rates no longer have an energy-based component, but are demand driven. This new
rate design will tend to lessen some of the pronounced seasonal variation of
revenues experienced prior to January 1, 2002. Transmission rates are based on
amounts of energy transmitted under "postage stamp" rates that do not vary with
the distance the energy is being transmitted. In Reliant Energy's appeal of
certain aspects of the order, the Travis County District Court generally upheld
the Texas Utility Commission's order. We may appeal the district court's
decision to the Texas Court of Appeals but have not yet filed an appeal.
Natural Gas Distribution. In almost all communities in which RERC
provides natural gas distribution services, it operates under franchises,
certificates or licenses obtained from state and local authorities. The terms of
the franchises, with various expiration dates, typically range from 10 to 30
years. None of RERC's material franchises expire before 2005. We expect to be
able to renew expiring franchises. In most cases, franchises to provide natural
gas utility services are not exclusive.
Substantially all of RERC's retail natural gas sales are subject to
traditional cost-of-service regulation at rates regulated by the relevant state
public service commissions and, in Texas, by the Texas Railroad Commission and
municipalities it serves.
NUCLEAR REGULATORY COMMISSION
Texas Genco is subject to regulation by the NRC with respect to the
operation of the South Texas Project. This regulation involves testing,
evaluation and modification of all aspects of plant operation in light of NRC
safety and environmental requirements. Continuous demonstrations to the NRC that
plant operations meet applicable requirements are also required. The NRC has the
ultimate authority to determine whether any nuclear powered generating unit may
operate.
17
Texas Genco and the other owners of the South Texas Project are
required by NRC regulations to estimate from time to time the amounts required
to decommission that nuclear generating facility and are required to maintain
funds to satisfy that obligation when the plant ultimately is decommissioned.
CenterPoint Houston currently collects through its electric rates amounts
calculated to provide sufficient funds at the time of decommissioning to
discharge these obligations through a non-bypassable charge from transmission
and distribution customers. Funds collected will be deposited into a nuclear
decommissioning trust. The beneficial ownership in the nuclear decommissioning
trust is held by Texas Genco, as the licensee of the facility. While current
funding levels exceed NRC minimum requirements, no assurance can be given that
the amounts held in trust will be adequate to cover the actual decommissioning
costs of the South Texas Project. Such costs may vary because of changes in the
assumed date of decommissioning and changes in regulatory requirements,
technology and costs of labor, materials and waste burial.
ENVIRONMENTAL MATTERS
GENERAL ENVIRONMENTAL ISSUES
We are subject to numerous federal, state and local requirements
relating to the protection of the environment and the safety and health of
personnel and the public. These requirements relate to a broad range of our
activities, including the discharge of pollutants into air, water, and soil, the
proper handling of solid, hazardous and toxic materials and waste, noise, and
safety and health standards applicable to the workplace. In order to comply with
these requirements, we will spend substantial amounts from time to time to
construct, modify and retrofit equipment, acquire air emission allowances for
operation of our facilities, and to clean up or decommission disposal or fuel
storage areas and other locations as necessary.
If we do not comply with environmental requirements that apply to our
operations, regulatory agencies could seek to impose on us civil, administrative
and/or criminal liabilities as well as seek to curtail our operations. Under
some statutes, private parties could also seek to impose upon us civil fines or
liabilities for property damage, personal injury and possibly other costs.
Texas Genco currently anticipates investing up to $397 million in
capital and other special project expenditures between 2002 and 2006 for
environmental compliance.
Under the federal Comprehensive Environmental Response, Compensation
and Liability Act of 1980, or CERCLA, owners and operators of facilities from
which there has been a release or threatened release of hazardous substances,
together with those who have transported or arranged for the disposal of those
substances, are liable for:
o The costs of responding to that release or threatened release; and
o The restoration of natural resources damaged by any such release.
We are not aware of any liabilities under CERCLA that would have a
material adverse effect on us, our financial position, results of operations or
cash flows.
AIR EMISSIONS
As part of the 1990 amendments to the Federal Clean Air Act,
requirements and schedules for compliance were developed for attainment of
health-based standards. As part of this process, standards for the emission of
NOx, a product of the combustion process associated with power generation and
natural gas compression, are being developed or have been finalized. The
standards require reduction of emissions from Texas Genco's power generating
units and some of our natural gas compression facilities. Through 2001, Texas
Genco invested $331 million for NOx emission controls, and it is planning to
make expenditures of approximately $343 million in the years 2002 through 2004,
with possible additional expenditures after that under Texas law. The Texas
electric restructuring law provides for stranded cost recovery of costs incurred
before May 1, 2003 to achieve the NOx reduction requirements. The post-2004
requirements in Texas are currently being litigated, and the outcome of the
litigation cannot be predicted at this time.
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The Environmental Protection Agency (EPA) has announced its
determination to regulate hazardous air pollutants (HAPs), including mercury,
from coal-fired and oil-fired steam electric generating units under Section 112
of the Clean Air Act. The EPA plans to develop maximum achievable control
technology (MACT) standards for these types of units. The rulemaking for coal
and oil-fired steam electric generating units must be completed by December
2004. Compliance with the rules will be required within three years thereafter.
The MACT standards that will be applicable to the Texas Genco units cannot be
predicted at this time and may adversely impact our results of operations. In
addition, a request for reconsideration of the EPA's decision to impose MACT
standards has been filed with the EPA. We cannot predict the outcome of that
request.
In 1998, the United States became a signatory to the United Nations
Framework Convention on Climate Change (Kyoto Protocol). The Kyoto Protocol
calls for developed nations to reduce their emissions of greenhouse gases.
Carbon dioxide, which is a major byproduct of the combustion of fossil fuel, is
considered to be a greenhouse gas. If the United States Senate ultimately
ratifies the Kyoto Protocol, any resulting limitations on power plant carbon
dioxide emissions could have a material adverse impact on all fossil fuel fired
electric generating facilities, including those belonging to Texas Genco.
The EPA is conducting a nationwide investigation regarding the
historical compliance of coal-fueled electric generating stations with various
permitting requirements of the Clean Air Act. Specifically, the EPA and the
United States Department of Justice have initiated formal enforcement actions
and litigation against several other utility companies that operate these
stations, alleging that these companies modified their facilities without proper
pre-construction permit authority.
In February 2001, the United States Supreme Court upheld a previously
adopted EPA ambient air quality standards for fine particulate matter and ozone.
While attaining these new standards may ultimately require expenditures for air
quality control system upgrades for our facilities, regulations addressing
affected sources and required controls are not expected until after 2005.
Consequently, it is not possible to determine the impact on our operations at
this time.
Multi-pollutant air emission initiative. In February 2002, the White
House announced its "Clear Skies Initiative." The proposal is aimed at long term
reductions of multiple pollutants produced from fossil fuel-fired power plants.
Reductions averaging 70% are targeted for sulfur dioxide (SO2), NOx and mercury.
In addition, a voluntary program for greenhouse gas emissions is proposed as an
alternative to the Kyoto Protocol discussed above. The implementation of the
initiative, if approved by the United States Congress, would be a market-based
program beginning in 2008 with full compliance phased in by 2018. Fossil
fuel-fired power plants owned by Texas Genco would be affected by the adoption
of this program, or other legislation currently pending in the United States
Congress addressing similar issues. Such programs would require compliance to be
achieved by the installation of pollution controls, the purchase of emission
allowances or curtailment of operations.
WATER ISSUES
In July 2000, the EPA issued final rules for the implementation of the
Total Maximum Daily Load program of the Clean Water Act (TMDL). The goal of the
TMDL rules is to establish, over the next 15 years, the maximum amounts of
various pollutants that can be discharged into waterways while keeping those
waterways in compliance with water quality standards. The establishment of TMDL
values may eventually result in more stringent discharge limits in each
facility's discharge permit. Such limits may require our facilities to install
additional water treatment, modify operational practices or implement other
wastewater control measures. Certain members of the United States Congress have
expressed concern to the EPA about the TMDL program and the EPA, in October
2001, extended the effective date of the regulation until April 2003.
In November 2001, the EPA promulgated rules that impose additional
technology based requirements on new cooling water intake structures. Proposed
rules for existing intake structures have also been issued. It is not known at
this time what requirements the final rules for existing intake structures will
impose and whether our existing intake structures will require modification as a
result of such requirements. The process by which the intake structure rules
were written was contentious and litigation is expected. Court action in
response to this expected litigation could result in unforeseen changes in the
requirements.
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A number of efforts are under way within the EPA to evaluate water
quality criteria for parameters associated with the by-products of fossil fuel
combustion. These parameters include arsenic, mercury and selenium. Significant
changes in these criteria could impact generating station discharge limits and
could require Texas Genco's facilities to install additional water treatment
equipment. The impact on Texas Genco as a result of these initiatives is unknown
at this time.
LIABILITY FOR PREEXISTING CONDITIONS AND REMEDIATION
Asbestos and Other. As a result of their age, many of our facilities
contain significant amounts of asbestos insulation, other asbestos-containing
materials and lead-based paint. Existing state and federal rules require the
proper management and disposal of these potentially toxic materials. We have
developed a management plan that includes proper maintenance of existing
non-friable asbestos installations, and removal and abatement of asbestos
containing materials where necessary because of maintenance, repairs,
replacement or damage to the asbestos itself. We have planned for the proper
management, abatement and disposal of asbestos and lead-based paint at our
facilities in our financial planning.
We have been named, along with numerous others, as a defendant in a
number of lawsuits filed by a large number of individuals who claim injury due
to exposure to asbestos while working at sites along the Texas Gulf Coast. Most
of these claimants have been workers who participated in construction of various
industrial facilities, including power plants, and some of the claimants have
worked at locations owned by us. We anticipate that additional claims like those
received may be asserted in the future, and we intend to continue our practice
of vigorously contesting claims that we do not consider to have merit. Although
their ultimate outcome cannot be predicted at this time, we do not believe,
based on our experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on our financial position,
results of operations or cash flows.
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant until 1960 adjacent to the Mississippi River in Minnesota
formerly known as Minneapolis Gas Works. RERC has substantially completed
remediation of the main site other than ongoing water monitoring and treatment.
The manufactured gas was stored in separate holders. RERC is negotiating cleanup
of one such holder. There are six other former manufactured gas plant sites in
the Minnesota service territory. Remediation has been completed on one site. Of
the remaining five sites, RERC believes that two were neither owned nor operated
by RERC. RERC believes it has no liability with respect to the sites we neither
owned nor operated.
At June 30, 2002, RERC had accrued $23 million for remediation of the
Minnesota sites. At June 30, 2002, the estimated range of possible remediation
costs was $11 million to $49 million. The cost estimates of the Minneapolis Gas
Works site are based on studies of that site. The remediation costs for the
other sites are based on industry average costs for remediation of sites of
similar size. The actual remediation costs will be dependent upon the number of
sites remediated, the participation of other potentially responsible parties, if
any, and the remediation methods used.
Issues relating to the identification and remediation of manufactured
gas plants are common in the natural gas distribution industry. RERC has
received notices from the EPA and others regarding its status as a potentially
responsible party for other sites. Based on current information, RERC has not
been able to quantify a range of environmental expenditures for potential
remediation expenditures with respect to other manufactured gas plant sites.
Other Minnesota Matters. At June 30, 2002, RERC had recorded accruals
of $5 million for other environmental matters in Minnesota for which remediation
may be required. At June 30, 2002, the estimated range of possible remediation
costs was $4 million to $8 million.
Hydrocarbon Contamination. In August 2001, a number of Louisiana
residents who live near the Wilcox Aquifer filed suit against RERC and others in
the 1st Judicial District Court, Caddo Parish, Louisiana. The suit alleges that
RERC and the other defendants allowed or caused hydrocarbon or chemical
contamination of the Wilcox Aquifer, which lies beneath property owned or leased
by the defendants and is the sole or primary drinking water aquifer in the area.
The quantity of monetary damages sought is unspecified.
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MERCURY CONTAMINATION
Like similar companies, our pipeline and natural gas distribution
operations have in the past employed elemental mercury in measuring and
regulating equipment. It is possible that small amounts of mercury may have been
spilled in the course of normal maintenance and replacement operations and that
these spills may have contaminated the immediate area around the meters with
elemental mercury. We have found this type of contamination in the past, and we
have conducted remediation at sites found to be contaminated. Although we are
not aware of additional specific sites, it is possible that other contaminated
sites may exist and that remediation costs may be incurred for these sites.
Although the total amount of these costs cannot be known at this time, based on
our experience and that of others in the natural gas industry to date and on the
current regulations regarding remediation of these sites, we believe that the
cost of any remediation of these sites will not be material to our financial
position, results of operations or cash flows.
LEGAL PROCEEDINGS
Reliant Energy, RERC, Reliant Resources and certain subsidiaries of
these entities are named as defendants in several lawsuits described below.
Under a master separation agreement between Reliant Energy and Reliant
Resources, we and our subsidiaries are entitled to be indemnified by Reliant
Resources for any losses arising out of the lawsuits described under
"-California Litigation" and "-Trading and Marketing Activities," including
attorneys' fees and other costs.
Municipal Franchise Fee Lawsuits. In February 1996, the cities of
Wharton, Galveston and Pasadena filed suit, for themselves and a proposed class
of all similarly situated cities in Reliant Energy's electric service area,
against Reliant Energy and Houston Industries Finance, Inc. (now a wholly owned
subsidiary of CenterPoint Houston) alleging underpayment of municipal franchise
fees. Plaintiffs claim that they are entitled to 4% of all receipts of any kind
for business conducted within these cities over the previous four decades. A
jury trial of the original claimant cities (but not the class of cities) in the
269th Judicial District Court for Harris County ended in April 2000 (the Three
Cities case). Although the jury found for Reliant Energy on many issues, they
found in favor of the original claimant cities on three issues, and assessed a
total of $4 million in actual and $30 million in punitive damages. However, the
jury also found in favor of Reliant Energy on the affirmative defense of laches,
a defense similar to a statute of limitations defense, due to the original
claimant cities having unreasonably delayed bringing their claims during the 43
years since the alleged wrongs began. The trial court in the Three Cities case
granted most of Reliant Energy's motions to disregard the jury's findings. The
trial court's rulings reduced the judgment to $1.7 million, including interest,
plus an award of $13.7 million in legal fees. In addition, the trial court
granted Reliant Energy's motion to decertify the class. Following this ruling,
45 cities filed individual suits against Reliant Energy in the District Court of
Harris County.
The Three Cities case has been appealed. We believe that the damage
award resulted from serious errors of law and that it will be set aside by the
Texas appellate courts. In addition, we believe that because of an agreement
between the parties limiting fees to a percentage of the damages, reversal of
the award of attorneys' fees is probable.
The extent to which issues in the Three Cities case may affect the
claims of the other cities served by Reliant Energy cannot be assessed until
judgments are final and no longer subject to appeal. However, the trial court's
rulings disregarding most of the jury's findings are consistent with Texas
Supreme Court opinions. We estimate the range of possible outcomes for recovery
by the plaintiffs in the Three Cities case to be between zero and $18 million,
inclusive of interest and attorneys' fees.
Natural Gas Measurement Lawsuits. In 1997, a suit was filed under the
Federal False Claim Act against RERC and certain of its subsidiaries alleging
mismeasurement of natural gas produced from federal and Indian lands. The suit
seeks undisclosed damages, along with statutory penalties, interest, costs and
fees. The complaint is part of a larger series of complaints filed against 77
natural gas pipelines and their subsidiaries and affiliates. An earlier single
action making substantially similar allegations against the pipelines was
dismissed by the federal district court for the District of Columbia on grounds
of improper joinder and lack of jurisdiction. As a result, the various
individual complaints were filed in numerous courts throughout the country. This
case was consolidated, together with the other similar False Claim Act cases
filed and transferred to the District of Wyoming. Motions to dismiss were
denied. The defendants intend to vigorously contest this case.
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In addition, RERC and certain of its subsidiaries have been named as
defendants in a class action filed in May 1999 against approximately 245
pipeline companies and their affiliates. The plaintiffs in the case purport to
represent a class of natural gas producers and fee royalty owners who allege
that they have been subject to systematic gas mismeasurement by the defendants,
including certain Reliant Energy entities, for more than 25 years. The
plaintiffs seek compensatory damages, along with statutory penalties, treble
damages, interest, costs and fees. The action is currently pending in state
court in Stevens County, Kansas. All of the RERC subsidiaries have joined in
motions to dismiss. The defendants plan to raise significant affirmative
defenses based on the terms of the applicable contracts, as well as on the broad
waivers and releases in take or pay settlements that were granted by the
producer-sellers of natural gas who are putative class members.
California Litigation. Reliant Energy has been named as a defendant in
class action lawsuits and other lawsuits filed against subsidiaries of Reliant
Resources and other companies that own generation plants in California and other
sellers of electricity in California markets. The lawsuits were originally filed
in state courts in San Diego County, San Francisco County and Los Angeles
County, but have been consolidated and removed to the federal district court for
the Southern District of California in San Diego where they are now pending.
While the plaintiffs allege various violations by the defendants of state
antitrust laws and state laws against unfair and unlawful business practices,
each of the lawsuits is grounded on the central allegation that defendants
conspired to drive up the wholesale price of electricity. In addition to
injunctive relief, the plaintiffs in these lawsuits seek treble the amount of
damages alleged, restitution of alleged overpayments, disgorgement of alleged
unlawful profits for sales of electricity, costs of suit and attorneys' fees.
Based on the pleadings filed to date, we are unable to determine the extent of
monetary damages the plaintiffs are seeking from Reliant Resources and its
affiliates.
In March 2002, the California Attorney General filed a civil lawsuit in
a state court in San Francisco county naming Reliant Energy, Reliant Resources
and several subsidiaries of Reliant Resources as defendants. The Attorney
General alleges various violations by the defendants of state laws against
unfair and unlawful business practices arising out of transactions in the
markets for ancillary services run by the California independent system
operator. In addition to injunctive relief, the Attorney General seeks
restitution and disgorgement of alleged unlawful profits from sales of
electricity, and civil penalties. Reliant Resources removed this lawsuit to the
federal district court for the Northern District of California in San Francisco.
In April 2002, the California Attorney General filed a second lawsuit
in San Francisco county against Reliant Energy, Reliant Resources and several
subsidiaries of Reliant Resources alleging that Reliant Resources consistently
charged unjust and unreasonable prices for electricity, and that each instance
of overcharge violated California law. The lawsuit seeks fines of up to $2,500
for each alleged violation, and "other equitable relief as appropriate." Reliant
Resources has also removed this case to the federal district court for the
Northern District of California in San Francisco, where it is currently the
subject of an emergency appeal by the California Attorney General.
Also in April 2002, the California Attorney General and the California
Department of Water Resources filed a complaint in the federal district court
for the Northern District of California in San Francisco against Reliant Energy,
Reliant Resources and a number of Reliant Resources' subsidiaries. In this
lawsuit, the Attorney General alleges that Reliant Resources' acquisition of
electric generating facilities from Southern California Edison in 1998 violated
Section 7 of the Clayton Act, which prohibits mergers or acquisitions that
substantially lessen competition. The lawsuit claims that the acquisitions gave
Reliant Resources market power which it then exercised to overcharge California
consumers for electricity. The lawsuit seeks injunctive relief against alleged
unfair competition, divestiture of Reliant Resources' California facilities,
disgorgement of alleged illegal profits, damages, and civil penalties for each
alleged exercise of market power.
Reliant Resources has filed motions to dismiss all of the pending
lawsuits filed by the California Attorney General.
After the filing of the Attorney General cases, seven new class action
cases were filed in state courts in Northern California. Each of these purports
to represent the same class of California ratepayers, assert the same claims as
asserted in the original class action cases, and in some instances repeat the
allegations in the Attorney General cases. All of these cases have been removed
to the federal district court for the Southern District of California in San
Diego. Certain plaintiffs have opposed this transfer and a hearing on the matter
is expected during
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September 2002. An additional class action lawsuit was filed in federal district
court for the Southern District of California on behalf of electric power
customers in the State of Washington.
Reliant Resources is defending us in the California litigation pursuant
to its indemnification obligations under the master separation agreement between
Reliant Resources and Reliant Energy.
Trading and Marketing Activities. Reliant Energy has been named as a
party in several lawsuits and regulatory proceedings relating to the trading and
marketing activities of its former subsidiary Reliant Resources. Their ultimate
outcome and their effect on us cannot be predicted at this time. Additional
information regarding certain of these matters is set forth below.
In June 2002, the SEC advised us and Reliant Resources that it had
issued a formal order in connection with its investigation of Reliant Resources'
financial reporting, internal controls and related matters. We understand that
the investigation is focused on its same-day commodity trading transactions
involving purchases and sales with the same counterparty for the same volume at
substantially the same price ("round trip trades") and structured transactions.
These matters were previously the subject of an informal inquiry by the SEC. The
SEC's formal order is also addressed to Reliant Energy. We and Reliant Resources
are cooperating with the SEC staff.
In connection with the Texas Utility Commission's industry-wide
investigation into potential manipulation of the ERCOT market on and after July
31, 2001, Reliant Energy and Reliant Resources have provided information to the
Texas Utility Commission concerning their scheduling and trading activities.
In May, June and July 2002, ten class action lawsuits were filed in
federal district court for the Southern District of Texas in Houston and one
class action lawsuit was filed in the federal district court for the Eastern
District of Texas in Texarkana on behalf of purchasers of securities of Reliant
Resources and/or Reliant Energy. Reliant Resources and certain of its executive
officers are named as defendants. Reliant Energy is also named as a defendant in
three of the lawsuits. One lawsuit names Reliant Resources' and Reliant Energy's
independent auditors as a defendant. The complaints allege that the defendants
overstated the revenues of Reliant Energy and Reliant Resources by including
transactions involving the purchase and sale of commodities with the same
counterparty at the same price and that Reliant Energy and Reliant Resources
improperly accounted for certain other transactions, among other things. The
complaints seek monetary damages, and in one of the lawsuits rescission, on
behalf of a supposed class. In eight of the lawsuits, the supposed class is
composed of persons who purchased or otherwise acquired Reliant Resources and/or
Reliant Energy securities during specified class periods. The three lawsuits
that include Reliant Energy as a named defendant were also filed on behalf of
purchasers of securities of Reliant Resources and/or Reliant Energy during
specified class periods.
Additionally, in May and June 2002, four class action lawsuits were
filed on behalf of purchasers of securities of Reliant Energy. Reliant Energy
and several of its executive officers are named as defendants. The lawsuits were
filed in federal district court for the Southern District of Texas in Houston.
The plaintiffs allege that the defendants made false and misleading statements
as part of an alleged scheme to artificially inflate trading volumes and
revenues by including transactions involving the purchase and sale of
commodities with the same counterparty at the same price, to spin-off Reliant
Resources to avoid exposure to Reliant Resources' liabilities and to cause the
price of Reliant Resources' stock to rise artificially, among other things. The
complaints seek monetary damages on behalf of persons who purchased Reliant
Energy securities during specified class periods.
In May 2002, three class action lawsuits were filed in federal district
court for the Southern District of Texas in Houston on behalf of participants in
various employee benefits plans sponsored by Reliant Energy. Reliant Energy and
its directors are named as defendants in all of the lawsuits. One of the
lawsuits has been dismissed without prejudice. The two remaining lawsuits allege
that the defendants breached their fiduciary duties to various employee benefits
plans sponsored by Reliant Energy, in violation of the Employee Retirement
Income Security Act. The plaintiffs allege that the defendants permitted the
plans to purchase or hold securities issued by Reliant Energy when it was
imprudent to do so, including after the prices for such securities became
artificially inflated because of alleged securities fraud engaged in by the
defendants. The complaints seek monetary damages for losses suffered by a
putative class of plan participants whose accounts held Reliant Energy or
Reliant Resources securities, as well as equitable relief in the form of
restitution.
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Reliant Resources is defending us in these class action suits relating
to its trading and marketing activities pursuant to its indemnification
obligations under the master separation agreement between Reliant Resources and
Reliant Energy.
We are involved in other proceedings before various courts, regulatory
commissions and governmental agencies regarding matters arising in the ordinary
course of business. Our management currently believes that the disposition of
these matters will not have a material adverse effect on our financial
condition, results of operations or cash flows.
EMPLOYEES
As of June 30, 2002, we had approximately 11,643 full-time employees,
including approximately 4,252 covered by collective bargaining agreements.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
(AS OF SEPTEMBER 30, 2002)
NAME AGE TITLE
---- --- -----
Milton Carroll................... 51 Chairman of the Board
David M. McClanahan.............. 53 Director, President and Chief Executive Officer
John T. Cater.................... 66 Director
O. Holcombe Crosswell............ 61 Director
Robert J. Cruikshank............. 71 Director
T. Milton Honea.................. 69 Director
Scott E. Rozzell................. 53 Executive Vice President, General Counsel and Corporate Secretary
Stephen C. Schaeffer............. 54 Executive Vice President-Government and Regulatory Affairs
Gary L. Whitlock................. 53 Executive Vice President and Chief Financial Officer
James S. Brian................... 55 Senior Vice President and Chief Accounting Officer
Thomas R. Standish............... 52 President and Chief Operating Officer of CenterPoint Houston
MILTON CARROLL has been a director of Reliant Energy since 1992. Mr.
Carroll is Chairman, President and Chief Executive Officer of Instrument
Products, Inc., an oil-tool manufacturing company in Houston that he founded in
1977. He also serves as a director of Ocean Energy Inc., Texas Eastern Products
Pipeline Company, Blue Cross Blue Shield of Texas and the Houston Endowment
Foundation. He is a former port commissioner of the Port of Houston Authority
and a former director of Pan Energy Corp. and the Federal Reserve Bank of
Dallas. He is currently serving as a director of Reliant Resources.
DAVID M. MCCLANAHAN has served as Vice Chairman of Reliant Energy and
President and Chief Operating Officer-Regulated Operations, which was
responsible for regulated electricity and natural gas distribution and natural
gas pipeline operations, since 1999. Prior to being named President of Regulated
Operations, Mr. McClanahan served as President of the electric utility division
of Reliant Energy. He has served in various executive officer capacities with
Reliant Energy, its predecessors and subsidiaries since 1986.
JOHN T. CATER has been a director of Reliant Energy since 1983. Mr. Cater
is primarily engaged in managing his personal investments in Houston, Texas.
Prior to his retirement in 2000, he was Chairman of Compass Bank--Houston,
Texas. He previously served as President of Compass Bank--Houston, Texas, as
Chairman and a director of River Oaks Trust Company, and as President, Chief
Operating Officer and a director of MCorp, a Texas bank holding company.
O. HOLCOMBE CROSSWELL has been a director of Reliant Energy since 1997. Mr.
Crosswell is President of Griggs Corporation, a real estate and investment
company in Houston, Texas.
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ROBERT J. CRUIKSHANK has been a director of Reliant Energy since 1993. Mr.
Cruikshank is primarily engaged in managing his personal investments in Houston,
Texas. Prior to his retirement in 1993, he was a Senior Partner in the
accounting firm of Deloitte & Touche LLP. Mr. Cruikshank serves as a director of
Kaiser Aluminum Corporation, MAXXAM Inc., Texas Biotechnology Corporation and
Weingarten Realty Investors, and as an advisory director of Compass
Bank--Houston.
T. MILTON HONEA has been a director of Reliant Energy since 1997. Mr. Honea
was Chairman of the Board, President and Chief Executive Officer of NorAm Energy
Corp. until its acquisition by Reliant Energy in 1997, having served in that
capacity since December 1992.
STEPHEN C. SCHAEFFER has served as Senior Vice President-Regulatory of
Reliant Energy since 1999. From 1997 to 1998, he served as Executive Vice
President- Retail Energy Regulation of Reliant Energy's Retail Energy Group. He
has served in various executive officer capacities with Reliant Energy, its
predecessors and subsidiaries since 1989.
GARY L. WHITLOCK has served as Executive Vice President and Chief Financial
Officer-Regulated Operations of Reliant Energy since July 2001. Prior to July
2001, Mr. Whitlock was Vice President, Finance and Chief Financial Officer of
Dow AgroSciences, a subsidiary of The Dow Chemical Company.
SCOTT E. ROZZELL has served as Executive Vice President and General Counsel
- Regulated Operations of Reliant Energy since March 2001. Before joining
Reliant Energy in 2001, Mr. Rozzell served as chair of the Energy Department of
the Houston office of Baker Botts L.L.P.
JAMES S. BRIAN has served as Senior Vice President and Chief Accounting
Officer of Reliant Energy since August 2002. Mr. Brian has served in various
executive officer positions with Reliant Energy, its predecessors and
subsidiaries since 1983.
THOMAS R. STANDISH has served as President and Chief Operating Officer for
both electricity and natural gas in Reliant Energy's Houston service area since
1999. He has served in various executive officer positions with Reliant Energy,
its predecessors and subsidiaries since 1993.
RISK FACTORS
Investors in our securities should consider carefully the risks
described below as well as the other risks described in this Current Report on
Form 8-K. There may be risks that others view in a different way than we do, and
we may omit a risk that we consider immaterial but that others would consider
important. If any of the following risks occurs, our business, financial
condition or results of operations could be materially harmed.
FINANCIAL AND OTHER RISKS
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
TO FUND FUTURE CAPITAL EXPENDITURES AND REFINANCE EXISTING INDEBTEDNESS COULD BE
LIMITED.
As a result of several recent events, including the September 11, 2001
terrorist attacks, the bankruptcy of Enron Corp., the downgrading of the credit
ratings of several energy companies and the unusual volatility in the U.S.
financial markets, the availability and cost of capital for our business have
been adversely affected. If we are unable to obtain external financing to meet
our future capital requirements on terms that are acceptable to us, our
financial condition and future results of operations could be materially
adversely affected. As of August 31, 2002, we had $10.9 billion of outstanding
indebtedness, including $4.3 billion under credit facilities that will expire
during October 2002. To the extent that we continue to need access to this
amount of committed credit, we expect to extend or replace these facilities. If
we are unable to maintain appropriately sized credit facilities on terms that
are acceptable to us, our financial condition could be materially and adversely
affected. In addition, the capital constraints currently impacting our
businesses may require our future indebtedness to include terms that are more
restrictive or burdensome than those of our current indebtedness. These terms
may negatively impact our ability to
25
operate our business or severely restrict or prohibit distributions from our
subsidiaries. The success of our future financing efforts may depend, at least
in part, on:
o general economic and capital market conditions;
o credit availability from banks and other financial institutions;
o investor confidence in us and the market in which we operate;
o maintenance of acceptable credit ratings;
o market expectations regarding our future earnings and probable cash
flows;
o market perceptions of our ability to access capital markets on
reasonable terms;
o our exposure to Reliant Resources as our customer and in connection
with its indemnification obligations arising in connection with its
separation from us;
o provisions of relevant tax and securities laws; and
o our ability to obtain approval of specific financing transactions
under the 1935 Act.
AS A HOLDING COMPANY WITH NO OPERATIONS OF ITS OWN, WE WILL DEPEND ON
DISTRIBUTIONS FROM OUR SUBSIDIARIES TO MAKE PAYMENTS ON ANY OF OUR DEBT
SECURITIES, AND PROVISIONS OF APPLICABLE LAW OR CONTRACTUAL RESTRICTIONS COULD
LIMIT THE AMOUNT OF THOSE DISTRIBUTIONS.
We derive substantially all our operating income from, and hold
substantially all our assets through, our subsidiaries. As a result, we will
depend on distributions of cash flow and earnings of our subsidiaries in order
to meet our payment obligations under any debt securities and our other
obligations. These subsidiaries are separate and distinct legal entities and
will have no obligation to pay any amounts due on our debt securities or to
provide us with funds for our payment obligations, whether by dividends,
distributions, loans or otherwise. In addition, provisions of applicable law,
such as those limiting the legal sources of dividends and those under the 1935
Act, could limit their ability to make payments or other distributions to us,
and they could agree to contractual restrictions on their ability to make
distributions.
Our right to receive any assets of any subsidiary, and therefore the
right of our creditors to participate in those assets, will be effectively
subordinated to the claims of that subsidiary's creditors, including trade
creditors. In addition, even if we are a creditor of any subsidiary, our rights
as a creditor would be subordinated to any security interest in the assets of
that subsidiary and any indebtedness of the subsidiary senior to that held by
us.
WE COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESSES AND ASSETS OF RELIANT
RESOURCES.
In connection with the organization and capitalization of Reliant
Resources, Reliant Resources and its subsidiaries assumed liabilities associated
with various assets and businesses Reliant Energy transferred to them. Reliant
Resources also agreed to indemnify, and cause the applicable transferee
subsidiaries to indemnify, Reliant Energy with respect to liabilities associated
with the transferred assets and businesses. The indemnity provisions were
intended to place sole financial responsibility on Reliant Resources and its
subsidiaries for all liabilities associated with the current and historical
business and operations of Reliant Resources, regardless of the time those
liabilities arise. If Reliant Resources is unable to satisfy a liability that
has been so assumed and in circumstances in which Reliant Energy was not
released from the liability in connection with the transfer, we could be
responsible for satisfying the liability.
As described in "Legal Proceedings," Reliant Energy and Reliant
Resources are named as defendants in a number of lawsuits arising out of power
sales in California and other West Coast markets and financial reporting
26
matters. Although these matters relate to the business and operations of Reliant
Resources, claims against Reliant Energy have been made on grounds that include
the effect of Reliant Resources' financial results on Reliant Energy's
historical financial statements and Reliant Energy's liability as a controlling
shareholder of Reliant Resources. We could incur liability if claims in one or
more of these lawsuits were successfully asserted against us and indemnification
from Reliant Resources were determined to be unavailable or if Reliant Resources
were unable to satisfy indemnification obligations owed to us with respect to
those claims.
OUR HISTORICAL FINANCIAL RESULTS ARE NOT NECESSARILY REPRESENTATIVE OF OUR
EXPECTED FUTURE RESULTS.
We have limited experience operating in a deregulated electricity
market in which our transmission and distribution business is subject to rate
regulation while our generation business is not. The pro forma financial
information we have included in this Current Report on Form 8-K does not
necessarily reflect what our financial position, results of operations and cash
flows would have been had we conducted those businesses separately rather than
as an integrated electric utility during the periods presented.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT.
We have insurance covering our facilities, including property damage
insurance and commercial general public liability insurance in amounts that we
consider appropriate. However, our insurance policies are subject to certain
limits and deductibles and do not include business interruption coverage. We
cannot assure you that insurance coverage will be available in the future on
commercially reasonable terms or that the insurance proceeds received for any
loss of or any damage to any of our facilities will be sufficient to restore the
loss or damage without negative impact on our financial condition and results of
operations. The costs of our insurance coverage have increased significantly in
recent months and may continue to increase in the future.
Texas Genco and the other owners of the South Texas Project maintain
nuclear property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
Under the Price Anderson Act, the maximum liability to the public of owners of
nuclear power plants was $9.3 billion as of June 30, 2002. Owners are required
under the Price Anderson Act to insure their liability for nuclear incidents and
protective evacuations. Texas Genco and the other owners of the South Texas
Project currently maintain the required nuclear liability insurance and
participate in the industry retrospective rating plan. In addition, the security
procedures at this facility have recently been enhanced to provide additional
protection against terrorist attacks. All potential losses or liabilities
associated with the South Texas Project may not be insurable, and the amount of
insurance may not be sufficient to cover them.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND OUR
CONTROL.
The cost of repairing damage to our operating subsidiaries' facilities
due to storms, natural disasters, wars, terrorist acts and other catastrophic
events, in excess of reserves established for such repairs, may adversely impact
our results of operations, financial condition and cash flows.
OUR RESULTS OF OPERATIONS, OUR ABILITY TO ACCESS CAPITAL AND INSURANCE AND OUR
FUTURE GROWTH PROSPECTS COULD BE ADVERSELY AFFECTED BY THE OCCURRENCE OR RISK OF
OCCURRENCE OF FUTURE TERRORIST ATTACKS OR RELATED ACTS OF WAR.
We are currently unable to measure the ultimate impact of the terrorist
attacks of September 11, 2001 on our businesses and the United States economy as
a whole. The risk of future terrorist activity may impact our results of
operations and financial condition in unpredictable ways. These actions could
also result in adverse changes in the insurance markets and disruptions of power
and fuel markets. In addition, our electric transmission and distribution,
electric generation, natural gas distribution and pipeline and gathering
facilities could be directly or indirectly harmed by future terrorist activity.
The occurrence or risk of occurrence of future terrorist attacks or related acts
of war could also adversely affect the United States economy. A lower level of
economic activity could result in a decline in energy consumption, which could
adversely affect our revenues and margins and limit our future growth prospects.
The occurrence or risk of occurrence could also increase pressure to regulate or
otherwise
27
limit the prices charged for electricity. Also, these risks could cause
instability in the financial markets and adversely affect our ability to access
capital.
RISKS RELATED TO OUR ELECTRIC TRANSMISSION AND DISTRIBUTION BUSINESSES
CENTERPOINT HOUSTON IS OPERATING IN A NEW MARKET ENVIRONMENT IN WHICH IT AND
OTHERS HAVE LITTLE OPERATING EXPERIENCE.
The competitive electric market in Texas is new. Neither CenterPoint
Houston nor any of the Texas Utility Commission, ERCOT or other market
participants has any significant operating history under the market framework
created by the Texas electric restructuring law. Some operational difficulties
were encountered in the pilot program conducted last year and are being
experienced now. These difficulties include delays in the switching of some
customers from one retail electric provider to another. These difficulties
create uncertainty as to the amount of transmission and distribution charges
owed by each retail electric provider, which may cause payment of those amounts
to be delayed. While to date these difficulties have not been material, these
operating difficulties could become material or structural changes adopted to
address these difficulties could materially adversely affect CenterPoint
Houston's revenues and results of operations.
MORE THAN HALF OF CENTERPOINT HOUSTON'S REVENUES FROM RETAIL ELECTRIC PROVIDERS
IS DERIVED FROM OUR FORMER AFFILIATE, RELIANT RESOURCES.
CenterPoint Houston's revenues from the distribution of electricity are
collected from retail electric providers that supply the electricity CenterPoint
Houston distributes to their customers. Currently, CenterPoint Houston does
business with approximately 27 retail electric providers. However, we anticipate
that more than half of CenterPoint Houston's revenues from retail electric
providers for 2002 will come from subsidiaries of Reliant Resources. Adverse
economic conditions or structural problems in the new Texas market could impair
the ability of these retail providers to pay for CenterPoint Houston's services
or could cause them to delay such payments. CenterPoint Houston depends on these
retail electric providers to timely remit payments to it. Any delay or default
in payment could adversely affect CenterPoint Houston's results of operations,
financial condition and cash flows.
PROBLEMS WITH METERING THE ELECTRICITY CENTERPOINT HOUSTON DISTRIBUTES MAY
MATERIALLY AFFECT CENTERPOINT HOUSTON'S REVENUES AND RESULTS OF OPERATIONS.
Currently, CenterPoint Houston provides all metering services to retail
electric providers for customers in its service territory. Pursuant to the Texas
electric restructuring law, metering services will be provided on a competitive
basis beginning in January 2004 for commercial and industrial customers and by
at least September 2005 for residential customers. After January 2004, third
parties will be permitted to perform metering services for customers and provide
metering data to CenterPoint Houston. The Texas Utility Commission has not yet
established certification or performance standards for third party metering
entities. Because third parties will not have previously performed metering
services in CenterPoint Houston's service territory, there may be unforeseen
problems in converting to the third party's metering system, in taking accurate
meter readings and in collecting and processing accurate metering data following
the conversion to competitive metering. Any failure by CenterPoint Houston or
these third parties to meter accurately the electricity sold by the retail
electric providers could adversely impact the revenues CenterPoint Houston
receives from retail electric providers.
RATE REGULATION OF CENTERPOINT HOUSTON'S BUSINESS MAY DELAY OR DENY CENTERPOINT
HOUSTON'S FULL RECOVERY OF ITS COSTS.
CenterPoint Houston's rates are regulated by certain municipalities and
the Texas Utility Commission based on an analysis of its expenses incurred in a
test year. Thus, the rates CenterPoint Houston is allowed to charge may not
match its expenses at any given time. While rate regulation in Texas is premised
on providing a reasonable opportunity to recover reasonable and necessary
operating expenses and to earn a reasonable return on its invested capital,
there can be no assurance that the Texas Utility Commission will judge all of
CenterPoint Houston's costs to be reasonable or necessary or that the regulatory
process in which rates are determined will always result in rates that will
produce full recovery of CenterPoint Houston's costs.
28
CENTERPOINT HOUSTON MAY NOT BE SUCCESSFUL IN RECOVERING THE FULL VALUE OF ITS
STRANDED COSTS AND REGULATORY ASSETS RELATED TO GENERATION.
CenterPoint Houston is entitled to recover its stranded costs (i.e.,
the excess of regulatory net book value of generation assets, as defined by the
Texas electric restructuring law, over the market value of those assets) and its
regulatory assets related to generation. CenterPoint Houston expects to make a
filing in January 2004 in a true-up proceeding provided for by the Texas
electric restructuring law. The purpose of this proceeding will be to quantify
and reconcile: the amount of stranded costs; differences in the prices achieved
in the state mandated auctions of Texas Genco's generation capacity and Texas
Utility Commission estimates; unreconciled fuel costs; and other regulatory
assets associated with Reliant Energy's former generation business for which
Reliant Energy was not previously reimbursed through the issuance of
"securitization" bonds by a subsidiary. CenterPoint Houston will be required to
establish and support the amounts of these costs in order to recover them. We
cannot assure you that CenterPoint Houston will be able to successfully
establish and support its estimates of the value of these costs. For more
information about the true-up proceeding, please read "Our Business--Electric
Transmission and Distribution--Stranded Costs and Regulatory Assets Recovery."
DISRUPTIONS IN POWER GENERATION FACILITIES OWNED BY THIRD PARTIES COULD
INTERRUPT CENTERPOINT HOUSTON'S SALES OF TRANSMISSION AND DISTRIBUTION SERVICES.
CenterPoint Houston depends on power generation facilities owned by
third parties to provide retail electric providers with electric power which it
transmits and distributes to their customers. CenterPoint Houston does not own
or operate any power generation facilities. If power generation is disrupted or
if power generation capacity is inadequate, CenterPoint Houston's transmission
and distribution services may be interrupted, adversely affecting CenterPoint
Houston's revenues.
CENTERPOINT HOUSTON'S REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.
A portion of CenterPoint Houston's revenues is derived from rates that
it collects from each retail electric provider based on the amount of
electricity it distributes on behalf of each retail electric provider. Thus,
CenterPoint Houston's revenues and results of operations are subject to
seasonality, weather conditions and other changes in electricity usage.
TECHNOLOGICAL CHANGE MAY MAKE ALTERNATIVE ENERGY SOURCES MORE ATTRACTIVE AND MAY
ADVERSELY AFFECT CENTERPOINT HOUSTON'S REVENUES AND RESULTS OF OPERATIONS.
The continuous process of technological development may result in the
introduction to retail customers of economically attractive alternatives to
purchasing electricity through CenterPoint Houston's distribution facilities.
Manufacturers of self-generation facilities continue to develop smaller-scale,
more-fuel-efficient generating units that can be cost-effective options for some
retail customers with smaller electric energy requirements. Any reduction in the
amount of electric energy CenterPoint Houston distributes as a result of these
technologies may have an adverse impact on its revenues and results of
operations in the future.
RISKS RELATED TO OUR ELECTRIC GENERATION BUSINESSES
TEXAS GENCO'S REVENUES AND RESULTS OF OPERATIONS ARE IMPACTED BY MARKET RISKS
THAT ARE BEYOND ITS CONTROL.
Texas Genco sells electric generation capacity, energy and ancillary
services in the ERCOT market. The ERCOT market consists of the majority of the
population centers in the State of Texas and represents approximately 85% of the
demand for power in the state. Under the Texas electric restructuring law, Texas
Genco and other power generators in Texas are not subject to traditional
cost-based regulation and therefore may sell electric generation capacity,
energy and ancillary services to wholesale purchasers at prices determined by
the market. As a result, Texas Genco is not guaranteed any rate of return on its
capital investments through mandated rates, and its revenues and results of
operations depend, in large part, upon prevailing market prices for electricity
in the ERCOT market. Texas Genco's gross margins are primarily derived from the
sale of capacity entitlements associated with its large, solid fuel base-load
generating units, including its Limestone and W. A. Parish facilities and its
interest in the South
29
Texas Project. The gross margins generated from payments associated with the
capacity of these units are directly impacted by natural gas prices. Since the
fuel costs for Texas Genco's base-load units are largely fixed under long-term
contracts, they are generally not subject to significant daily and monthly
fluctuations. However, the market price for power in the ERCOT market is
directly affected by the price of natural gas. Because natural gas is the
marginal fuel for facilities serving the ERCOT market during most hours, its
price has a significant influence on the price of electric power. As a result,
the price customers are willing to pay for entitlements to Texas Genco's solid
fuel-fired base-load capacity generally rises and falls with natural gas prices.
Market prices in the ERCOT market may also fluctuate substantially due
to other factors. Such fluctuations may occur over relatively short periods of
time. Volatility in market prices may result from:
o oversupply or undersupply of generation capacity,
o power transmission or fuel transportation constraints or
inefficiencies,
o weather conditions,
o seasonality,
o availability and market prices for natural gas, crude oil and
refined products, coal, enriched uranium and uranium fuels,
o changes in electricity usage,
o additional supplies of electricity from existing competitors or new
market entrants as a result of the development of new generation
facilities or additional transmission capacity,
o illiquidity in the ERCOT market,
o availability of competitively priced alternative energy sources,
o natural disasters, wars, embargoes, terrorist attacks and other
catastrophic events, and
o federal and state energy and environmental regulation and
legislation.
THERE IS CURRENTLY A SURPLUS OF GENERATING CAPACITY IN THE ERCOT MARKET AND WE
EXPECT THE MARKET FOR WHOLESALE POWER TO BE HIGHLY COMPETITIVE.
The ERCOT market currently has a surplus of generating capacity. From
January 1995 through April 2002, approximately 14,342 MW of new generating
capacity were added to the ERCOT market. As a result, the average amount by
which power generating capacity exceeded peak demand, or "reserve margin," in
the ERCOT market increased to approximately 30.4% in 2001 compared to 16.6% in
2000 and 16.1% in 1999. In addition, 15 projects with an aggregate net
generating capacity of 11,434 MW are under construction and scheduled to
commence commercial operation prior to December 31, 2004. Another 5,197 MW of
capacity projects for which construction has not yet commenced have been
announced to begin commercial operation between 2002 and 2007. A major market
consulting firm specializing in the power industry, has published a report that
predicts there will be a surplus of generating capacity in the ERCOT market for
the next several years. The rate of construction of new electric generation
facilities may exceed increases in demand. The commencement of commercial
operation of new facilities in the ERCOT market will increase the
competitiveness of the wholesale power market, which could have a material
adverse effect on Texas Genco's business prospects, financial condition, results
of operations and cash flows.
Texas Genco's competitors include affiliated generation companies of
Texas-based utilities, independent power producers, municipal and co-operative
generators, aggregators and wholesale power marketers. The unbundling of
vertically integrated utilities into separate generation, transmission and
distribution and retail
30
businesses pursuant to the Texas electric restructuring law could result in a
significant number of additional competitors participating in the ERCOT market.
Some of Texas Genco's competitors may have more operating experience, larger
staffs, greater financial resources, lower cost structures, more effective risk
management policies and procedures, greater ability to incur losses, greater
potential for profitability from ancillary services, and greater flexibility in
the timing of their sale of generating capacity and ancillary services than
Texas Genco does.
TEXAS GENCO IS SUBJECT TO OPERATIONAL AND MARKET RISKS ASSOCIATED WITH ITS
CAPACITY AUCTIONS.
Texas Genco is obligated to sell substantially all of its capacity and
related ancillary services through 2003 pursuant to the capacity auctions more
fully described under "Our Business-Electric Generation." In these auctions,
Texas Genco sells firm entitlements on a forward basis to capacity and ancillary
services dispatched within specified operational constraints. Although Texas
Genco has reserved a portion of its aggregate net generation capacity from its
capacity auctions for planned or forced outages at its facilities, unanticipated
plant outages or other problems with its generation facilities could result in
its firm capacity and ancillary services commitments exceeding its available
generation capacity. As a result, Texas Genco could be required to obtain
replacement power from third parties in the open market to satisfy its firm
commitments which could result in significant additional costs. In addition, an
unexpected outage at one of Texas Genco's lower cost facilities could require it
to run one of its higher cost plants in order to satisfy its obligations.
The mechanics, regulations and agreements governing Texas Genco's
capacity auctions are complex, and the auction process in which Texas Genco
sells entitlements to its capacity is relatively new. Texas Genco sells capacity
entitlements in state mandated auctions and in its other contractually mandated
auctions. The state mandated auctions require, among other things, Texas Genco's
capacity entitlements to be sold in pre-determined amounts. The characteristics
of the capacity entitlements Texas Genco sells in state mandated auctions are
defined by rules adopted by the Texas Utility Commission and therefore cannot be
changed to respond to market demands or operational requirements without
approval by the Texas Utility Commission. Since the ERCOT market has only
recently been restructured and Texas Genco's customers have relatively little
experience with the capacity auction process, the price that Texas Genco is able
to obtain for its capacity entitlements may be lower than could otherwise be
obtained in a fully developed market. In addition, the term under which Texas
Genco sells entitlements in the auctions create operational complexities that
could cause it to dispatch its facilities in a suboptimal manner.
IF THE ERCOT MARKET DOES NOT FUNCTION IN THE MANNER CONTEMPLATED BY THE TEXAS
ELECTRIC RESTRUCTURING LAW, TEXAS GENCO'S BUSINESS PROSPECTS, FINANCIAL
CONDITION, RESULTS OF OPERATIONS AND CASH FLOWS COULD BE ADVERSELY IMPACTED.
The initiatives under the Texas electric restructuring law have had a
significant impact on the nature of the electric power industry in Texas and the
manner in which participants in the ERCOT market conduct their business. These
changes are ongoing, and we cannot predict the future development of the ERCOT
market or the ultimate effect that this changing regulatory environment will
have on Texas Genco's business. Some restructured markets in other states have
recently experienced supply problems and extreme price volatility. If the ERCOT
market does not function as planned once the deregulation initiatives called for
by the Texas electric restructuring law have taken their full effect, Texas
Genco's results of operations and financial condition could be adversely
affected. In addition, any market failures could lead to revisions or
reinterpretations of the Texas electric restructuring law, the adoption of new
laws and regulations applicable to Texas Genco or its facilities and other
future changes in laws and regulations that may have a detrimental effect on
Texas Genco's business.
As part of the transition to retail competition in Texas, the ERCOT
market has changed from operating with multiple control areas, each managed by
one of the utilities in the state, to a single control area managed by the
independent system operator for the ERCOT market, or "ISO". The ERCOT ISO is
responsible for maintaining reliable operations of the bulk electric power
supply system in the new combined control area. If the ERCOT ISO is unable to
successfully manage these functions, the ERCOT market may not operate properly
and Texas Genco's results of operations could be adversely affected. In
addition, the ERCOT ISO may impose or the Texas Utility Commission may require
price limitations, bidding rules and other mechanisms that could impact
wholesale prices in the ERCOT market and the outcomes of Texas Genco's capacity
auctions.
31
THE OPERATION OF TEXAS GENCO'S POWER GENERATION FACILITIES INVOLVES RISKS THAT
COULD ADVERSELY AFFECT ITS REVENUES, COSTS, RESULTS OF OPERATIONS AND CASH
FLOWS.
Texas Genco is subject to various risks associated with operating its
power generation facilities, any of which could adversely affect its revenues,
costs, results of operations and cash flows. These risks include:
o operating performance below expected levels of output or
efficiency,
o breakdown or failure of equipment or processes,
o disruptions in the transmission of electricity,
o shortages of equipment, material or labor,
o labor disputes,
o fuel supply interruptions,
o limitations that may be imposed by regulatory requirements,
o limitations imposed by the ERCOT ISO,
o violations of permit limitations,
o operator error, and
o catastrophic events such as fires, hurricanes, explosions, floods,
terrorist attacks or other similar occurrences.
A significant portion of Texas Genco's facilities were constructed many
years ago. Older generation equipment, even if maintained in accordance with
good engineering practices, may require significant capital expenditures to keep
it operating at high efficiency and to meet regulatory requirements. This
equipment is also likely to require periodic upgrading and improvement. Any
unexpected failure to produce power, including failure caused by breakdown or
forced outage, could result in reduced earnings.
Texas Genco employs experienced personnel to maintain and operate its
facilities and carry insurance to mitigate the effects of some of the operating
risks described above. Texas Genco's insurance policies, however, are subject to
certain limits and deductibles and do not include business interruption
coverage. Should one or more of the events described above occur, revenues from
Texas Genco's operations may be significantly reduced or its costs of operations
may significantly increase.
TEXAS GENCO RELIES ON POWER TRANSMISSION FACILITIES THAT IT DOES NOT OWN OR
CONTROL AND ARE SUBJECT TO TRANSMISSION CONSTRAINTS WITHIN THE ERCOT MARKET. IF
THESE FACILITIES FAIL TO PROVIDE TEXAS GENCO WITH ADEQUATE TRANSMISSION
CAPACITY, IT MAY NOT BE ABLE TO DELIVER WHOLESALE ELECTRIC POWER TO ITS
CUSTOMERS AND IT MAY INCUR ADDITIONAL COSTS.
Texas Genco depends on transmission and distribution facilities owned
and operated by our wholly owned subsidiary, CenterPoint Houston, and on
transmission and distribution systems owned by others to deliver the wholesale
electric power it sells from its power generation facilities to its customers,
who in turn deliver power to the end users. If transmission is disrupted, or if
transmission capacity infrastructure is inadequate, Texas Genco's ability to
sell and deliver wholesale electric energy may be adversely impacted.
The single control area of the ERCOT market is currently organized into
four congestion zones, referred to as the North, South, West and Houston zones.
These congestion zones are determined by physical constraints on the
32
ERCOT transmission system that make it difficult or impossible at times to move
power from a zone on one side of the constraint to the zone on the other side of
the constraint. All but two of Texas Genco's facilities are located in the
Houston congestion zone. Texas Genco's Limestone facility is located in the
North congestion zone and the South Texas Project is located in the South
congestion zone. Texas Genco sells a portion of the entitlements offered in its
state mandated auctions to customers located in congestion zones other than the
Houston zone. Transmission congestion between these zones could impair Texas
Genco's ability to schedule power for transmission across zonal boundaries,
which are defined by the ERCOT ISO, thereby inhibiting its efforts to match its
facility scheduled outputs with its customer scheduled requirements.
The ERCOT ISO has instituted rules that directly assign congestion
costs to the parties causing the congestion. Therefore, power generators
participating in the ERCOT market could be liable for the congestion costs
associated with transferring power between zones. Texas Genco schedules its
anticipated requirements based on its own forecasted needs, which rely in part
on demand forecasts made by its customers. These forecasts may prove to be
inaccurate. Texas Genco could be deemed responsible for congestion costs if it
schedules delivery of power between congestion zones during times when the ERCOT
ISO expects congestion to occur between the zones. If Texas Genco is liable for
congestion costs, its financial results could be adversely affected. For more
information about the ERCOT market, please read "Our Business-Overview-ERCOT
Market Framework."
TEXAS GENCO'S RESULTS OF OPERATIONS COULD BE ADVERSELY IMPACTED BY A DISRUPTION
OF ITS FUEL SUPPLIES OR BY CHANGES IN FUEL PRICES.
Texas Genco relies primarily on natural gas, coal, lignite and uranium
to fuel its generation facilities. Texas Genco purchases its fuel from a number
of different suppliers under long-term contracts and on the spot market. Under
Texas Genco's capacity auctions, it sells firm entitlements to capacity and
ancillary services. Therefore, any disruption in the delivery of fuel could
prevent Texas Genco from operating its facilities to meet its auction
commitments, which could adversely affect its results of operations.
Delivery of natural gas to each of Texas Genco's natural gas-fired
facilities typically depends on the natural gas pipelines or distributors for
that location. As a result, Texas Genco is subject to the risk that a natural
gas pipeline or distributor may suffer disruptions or curtailments in its
ability to deliver natural gas to it or that the amounts of natural gas Texas
Genco requests are curtailed. These disruptions or curtailments could adversely
affect Texas Genco's ability to operate its natural gas-fired generating
facilities. Texas Genco leases gas storage facilities capable of storing
approximately 6.3 billion cubic feet of natural gas. Generally, Texas Genco
seeks to maintain average reserve gas supplies sufficient to operate its
gas-fired facilities for 16 days which may not be adequate to protect against a
prolonged supply disruption.
Texas Genco purchases coal from a limited number of suppliers.
Generally, Texas Genco seeks to maintain average coal reserves sufficient to
operate its coal-fired facilities for 30 days. Texas Genco also has long-term
rail contracts with two rail transportation companies to transport coal to its
coal-fired facilities. Any extended disruption in Texas Genco's coal supply,
including those caused by transportation disruptions, adverse weather
conditions, labor relations or environmental regulations affecting Texas Genco's
coal suppliers, could adversely affect its ability to operate its coal-fired
facilities.
Texas Genco is also exposed to the risk that suppliers that have agreed
to provide it with fuel could breach their obligations. Should these suppliers
fail to perform, Texas Genco may be forced to enter into alternative
arrangements at then-current market prices. As a result, Texas Genco's results
of operations, financial condition and cash flows could be adversely affected.
Revenues derived from Texas Genco's capacity auctions come from two
sources: capacity payments and fuel payments. Fuel payments consist of a variety
of charges related to the fuel and ancillary services scheduled by Texas Genco's
customers in accordance with the terms of its auctioned capacity entitlements.
The fuel payments Texas Genco collects for capacity entitlements with underlying
coal-fired, lignite-fired or nuclear capacity are based on a preestablished
price based on the Texas Utility Commission's forecasted fuel costs. The
forecasts incorporate Texas Genco's expected fuel costs under its two long-term
coal supply contracts. The fuel payments Texas Genco collects for capacity
entitlements with underlying gas-fired capacity are calculated using specified
published indexes for the price of natural gas. Since the prices Texas Genco
pays for fuel under its long-term contracts or on the spot
33
market may differ from the indexes used to calculate the fuel payments Texas
Genco collects, its fuel costs could exceed its collected fuel payments. As a
result, Texas Genco's results of operations could be adversely affected.
TO DATE, TEXAS GENCO HAS SOLD A SUBSTANTIAL PORTION OF ITS AUCTIONED CAPACITY
ENTITLEMENTS TO A SINGLE CUSTOMER, RELIANT RESOURCES. ACCORDINGLY, TEXAS GENCO'S
RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED IF RELIANT RESOURCES DECLINED
TO PARTICIPATE IN TEXAS GENCO'S FUTURE AUCTIONS OR FAILED TO MAKE CAPACITY
PAYMENTS WHEN DUE UNDER RELIANT RESOURCES' PURCHASED ENTITLEMENTS.
By participating in Texas Genco's contractually mandated auctions, Reliant
Resources has purchased entitlements to 45% of the aggregate 2002 capacity and
51% of the aggregate 2003 capacity that Texas Genco has sold to date through its
capacity auctions. Reliant Resources has made these purchases either through the
exercise of its contractual rights to purchase 50% of the entitlements Texas
Genco auctions in its contractually mandated auctions or through the submission
of bids. In the event Reliant Resources declined to participate in Texas Genco's
future auctions or failed to make capacity payments when due in accordance with
the terms of the capacity entitlement it has purchased to date, Texas Genco's
results of operations, financial condition and cash flows could be adversely
affected.
TEXAS GENCO MAY INCUR SUBSTANTIAL COSTS AND LIABILITIES AS A RESULT OF ITS
OWNERSHIP OF NUCLEAR FACILITIES.
Texas Genco owns a 30.8% interest in the South Texas Project, a nuclear
powered generation facility. As a result, Texas Genco is subject to the risks
associated with the ownership and operation of nuclear facilities. These risks
include:
o the potential harmful effects on the environment and human health
resulting from the operation of nuclear facilities and the storage,
handling and disposal of radioactive materials,
o limitations on the amounts and types of insurance commercially
available to cover losses that might arise in connection with
nuclear operations, and
o uncertainties with respect to the technological and financial
aspects of decommissioning nuclear plants at the end of their
licensed lives.
The NRC has broad authority under federal law to impose licensing and
safety-related requirements for the operation of nuclear generation facilities.
In the event of non-compliance, the NRC has the authority to impose fines, shut
down a unit, or both, depending upon its assessment of the severity of the
situation, until compliance is achieved. Revised safety requirements promulgated
by the NRC could necessitate substantial capital expenditures at nuclear plants.
In addition, although we have no reason to anticipate a serious nuclear incident
at the South Texas Project, if an incident did occur, it could have a material
adverse effect on Texas Genco's results of operations, financial condition and
cash flows.
THE FUNDS MAINTAINED IN TRUST TO SATISFY THE DECOMMISSIONING OBLIGATIONS OF THE
SOUTH TEXAS PROJECT MAY BE INADEQUATE TO COVER THE ACTUAL DECOMMISSIONING COSTS.
Texas Genco and the other owners of the South Texas Project are
required by NRC regulations to estimate from time to time the amounts required
to decommission that nuclear generating facility and are required to maintain
funds in trust to satisfy that obligation when the plant ultimately is
decommissioned. CenterPoint Houston currently collects amounts calculated to
provide sufficient funds at the time of decommissioning to discharge these
obligations through a non-bypassable charge from transmission and distribution
customers. Funds collected will be deposited into a nuclear decommissioning
trust. The beneficial ownership in the nuclear decommissioning trust is held by
Texas Genco, as the licensee of the facility. While current funding levels
exceed NRC minimum requirements, no assurance can be given that the amounts held
in trust will be adequate to cover the actual decommissioning costs of the South
Texas Project. Such costs may vary because of changes in the assumed date of
decommissioning and changes in regulatory requirements, technology and costs of
labor, materials and waste burial. CenterPoint Energy is contractually obligated
to indemnify Texas Genco from and against any obligations relating to the
decommissioning not otherwise satisfied through amounts held in the nuclear
decommissioning trust. Following the
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completion of the decommissioning, if surplus funds remain in the
decommissioning trust, the excess will be refunded to customers of CenterPoint
Houston through reductions in the rates applicable to transmission and
distribution services. If the funds maintained in trust are inadequate to cover
the actual decommissioning costs, it could have a material adverse effect on
our results of operations, financial condition and cash flows.
CONTRACTUAL RESTRICTIONS ON THE OPERATION OF TEXAS GENCO'S BUSINESS MAY
ADVERSELY AFFECT ITS ABILITY TO COMPETE WITH COMPANIES WHO ARE NOT SUBJECT TO
SIMILAR RESTRICTIONS.
Effective December 31, 2000, Reliant Resources and Reliant Energy
entered into a master separation agreement, which now governs the rights and
obligations of us and Reliant Resources in connection with the business
separation plan of Reliant Energy adopted in response to the Texas electric
restructuring law. Reliant Resources also has an option to purchase the shares
of Texas Genco stock owned by us that is exercisable in January 2004. Texas
Genco has agreed to comply with certain restrictions governing its operations as
contemplated by the master separation agreement and option agreement. These
restrictions limit Texas Genco's ability to:
o construct or acquire new generation plants or capacity,
o merge or consolidate with another entity,
o sell assets outside the ordinary course of business,
o enter into long-term agreements and commitments for the purchase of
fuel or the purchase or sale of power outside the ordinary course
of business,
o engage in other businesses,
o engage in hedging transactions,
o encumber Texas Genco's assets,
o issue additional equity securities,
o pay dividends, and
o make certain loans, investments or advances to, or engage in
certain transactions with, Texas Genco's affiliates.
TEXAS GENCO'S OPERATIONS ARE SUBJECT TO EXTENSIVE REGULATION. IF TEXAS GENCO
FAILS TO COMPLY WITH APPLICABLE REGULATIONS OR OBTAIN OR MAINTAIN ANY NECESSARY
GOVERNMENTAL PERMIT OR APPROVAL, ITS RESULTS OF OPERATIONS MAY BE ADVERSELY
AFFECTED.
Texas Genco's operations are subject to complex and stringent energy,
environmental and other governmental laws and regulations. The acquisition,
ownership and operation of power generation facilities require numerous permits,
approvals and certificates from federal, state and local governmental agencies.
These facilities are subject to regulation by the Texas Utility Commission
regarding non-rate matters. Existing regulations may be revised or
reinterpreted, new laws and regulations may be adopted or become applicable to
Texas Genco or any of its generation facilities or future changes in laws and
regulations may have a detrimental effect on its business.
Texas Genco is subject to regulation by the NRC with respect to the
operation of the South Texas Project. This regulation involves testing,
evaluation and modification of all aspects of plant operation in light of NRC
safety and environmental requirements. Continuous demonstrations to the NRC that
plant operations meet applicable requirements are also required. The NRC has the
ultimate authority to determine whether any nuclear powered generating unit may
operate.
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TEXAS GENCO'S COSTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS ARE SIGNIFICANT AND
THE COST OF COMPLIANCE WITH NEW ENVIRONMENTAL LAWS COULD ADVERSELY AFFECT ITS
PROFITABILITY.
Texas Genco's business is subject to extensive environmental regulation
by federal, state and local authorities. Texas Genco is required to comply with
numerous environmental laws and regulations, and to obtain numerous governmental
permits, in operating its facilities. Texas Genco may incur significant
additional costs to comply with these requirements. If Texas Genco fails to
comply with these requirements, it could be subject to civil or criminal
liability and fines. Existing environmental regulations could be revised or
reinterpreted, new laws and regulations could be adopted or become applicable to
Texas Genco or its facilities, and future changes in environmental laws and
regulations could occur, including potential regulatory and enforcement
developments related to air emissions. If any of these events occur, Texas
Genco's business, results of operations, financial condition and cash flows
could be adversely affected.
Texas Genco may not be able to obtain or maintain from time to time all
required environmental regulatory approvals. If there is a delay in obtaining
any required environmental regulatory approvals or if Texas Genco fails to
obtain and comply with them, it may not be able to operate its facilities or it
may be required to incur additional costs.
Texas Genco is generally responsible for all on-site liabilities
associated with the environmental condition of its power generation facilities,
regardless of when the liabilities arose and whether the liabilities are known
or unknown. These liabilities may be substantial.
CHANGES IN TECHNOLOGY MAY MAKE TEXAS GENCO'S POWER GENERATION FACILITIES LESS
COMPETITIVE.
A significant portion of Texas Genco's generation facilities were
constructed many years ago and rely on older technologies. Some of Texas Genco's
competitors may have newer generation facilities and technologies that allow
them to produce and sell power more efficiently, which could adversely affect
Texas Genco's revenues and results of operations. In addition, research and
development activities are ongoing to improve alternate technologies to produce
electricity, including fuel cells, microturbines, windmills and photovoltaic
(solar) cells. It is possible that advances in these or other technologies will
reduce the current costs of electricity production to a level that is below that
of Texas Genco's generation facilities. If this occurs, Texas Genco's generation
facilities will be less competitive and the value of its power plants could be
significantly impaired. Also, electricity demand could be reduced by increased
conservation efforts and advances in technology, which could likewise
significantly reduce the value of Texas Genco's power generation facilities.
RISKS RELATED TO OUR NATURAL GAS BUSINESSES
OUR NATURAL GAS DISTRIBUTION BUSINESS MUST COMPETE WITH ALTERNATIVE ENERGY
SOURCES.
RERC competes primarily with alternate energy sources such as
electricity and other fuel sources. In some areas, intrastate pipelines, other
gas distributors and marketers also compete directly with RERC for gas sales to
end-users. In addition, as a result of federal regulatory changes affecting
interstate pipelines, natural gas marketers operating on these pipelines may be
able to bypass RERC's facilities and market, sell and/or transport natural gas
directly to commercial and industrial customers.
RERC MAY INCUR CARRYING COSTS ASSOCIATED WITH PASSING THROUGH CHANGES IN THE
COSTS OF NATURAL GAS.
Generally, the regulations of the states in which RERC operates allow
it to pass through changes in the costs of natural gas to its customers through
purchased gas adjustment provisions in rates. There is, however, a timing
difference between its purchases of natural gas and the ultimate recovery of
these costs. Consequently, RERC may incur additional "carrying" costs as a
result of this timing difference. To a large extent, these additional carrying
costs are not recovered from RERC's customers.
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OUR PIPELINES AND GATHERING BUSINESSES MUST COMPETE DIRECTLY WITH OTHERS IN THE
TRANSPORTATION AND STORAGE OF NATURAL GAS AND INDIRECTLY WITH ALTERNATIVE FORMS
OF ENERGY.
Our two interstate pipelines and our gathering systems compete with
other interstate and intrastate pipelines and gathering systems in the
transportation and storage of natural gas. The principal elements of competition
are rates, terms of service, and flexibility and reliability of service. They
also compete indirectly with other forms of energy, including electricity, coal
and fuel oils. The primary competitive factor is price.
FORWARD-LOOKING STATEMENTS
Some of the statements in this report and the exhibits hereto are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Actual results may differ materially from those
expressed or implied by these statements. In some cases, you can identify our
forward-looking statements by the words "anticipates," "believes," "continue,"
"could," "estimates," "expects," "forecast," "goal," "intends," "may,"
"objective," "plans," "potential," "predicts," "projection," "should," "will,"
or other similar words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available at the time the statements are
made. We caution you that assumptions, beliefs, expectations, intentions and
projections about future events may and often do vary materially from actual
results. Therefore, actual results may differ materially from those expressed or
implied by our forward-looking statements. You should not place undue reliance
on forward-looking statements. Each forward-looking statement speaks only as of
the date of the particular statement, and we undertake no obligation to update
or revise publicly any forward-looking statements.
In addition to the matters described in this report and the exhibits
hereto, the following list identifies some of the factors that could cause
actual results to differ from those expressed or implied by our forward-looking
statements:
o state, federal and international legislative and regulatory actions or
developments, including deregulation, re-regulation and restructuring of
the electric utility industry, changes in or application of laws or
regulations applicable to other aspects of our business and actions with
respect to, among other things:
o approval of stranded costs;
o allowed rates of return;
o rate structures;
o recovery of investments; and
o operation and construction of facilities;
o non-payment for our services due to financial distress of our
customers;
o the successful and timely completion of our capital projects;
o industrial, commercial and residential growth in our service
territory and changes in market demand and demographic patterns;
o changes in business strategy or development plans;
o unanticipated changes in interest rates or rates of inflation;
o unanticipated changes in operating expenses and capital
expenditures;
37
o weather variations and other natural phenomena;
o commercial bank and financial market conditions, our access to
capital, receipt of certain approvals under the 1935 Act and the
results of our financing and refinancing efforts, including
availability of funds in the debt capital markets;
o actions by rating agencies;
o legal and administrative proceedings and settlements;
o changes in tax laws;
o significant changes in our relationship with our employees,
including the availability of qualified personnel and the
potential adverse effects if labor disputes or grievances were to
occur;
o significant changes in critical accounting policies material to
us;
o acts of terrorism or war, including any direct or indirect effect
on our business resulting from terrorist attacks such as occurred
on September 11, 2001 or any similar incidents or responses to
those incidents;
o the availability and price of insurance;
o the outcome of the pending securities lawsuits against Reliant
Energy, Incorporated and Reliant Resources, Inc.;
o the outcome of the SEC investigation relating to the treatment in
our consolidated financial statements of certain activities of
Reliant Resources, Inc.;
o the reliability of the systems, procedures and other
infrastructure necessary to operate the retail electric business
in our service territory, including the systems owned and
operated by the independent system operator in the Electric
Reliability Council of Texas, Inc.; and
o political, legal, regulatory and economic conditions and
developments in the United States.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(b) Pro Forma Financial Information.
99.1 Unaudited Pro Forma Condensed Consolidated Financial
Statements
99.2 Letter and Questions and Answers Provided to
Shareholders
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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 hereunto duly authorized.
CENTERPOINT ENERGY, INC.
Date: September 13, 2002 By: /s/ James S. Brian
----------------------------------
James S. Brian
Senior Vice President and
Chief Accounting Officer
EXHIBIT INDEX
Exhibit
Number Exhibit Description
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99.1 Unaudited Pro Forma Condensed Consolidated Financial Statements
99.2 Letter and Questions and Answers Provided to Shareholders