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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-16455
RELIANT RESOURCES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0655566
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-3000
(Address and zip code of principal executive offices) (Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, par value $.001 per share, and associated New York Stock Exchange
rights to purchase Series A Preferred Stock
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
Reliant Resources, Inc. (Reliant Resources) was $833,436,412 as of April 1,
2002, using the definition of beneficial ownership contained in Rule 13d-3
promulgated pursuant to the Securities Exchange Act of 1934 and excluding shares
held by directors and executive officers. As of April 1, 2002, Reliant Resources
had 289,354,781 shares of Common Stock outstanding including 240,000,000 shares
which were held by Reliant Energy, Incorporated. Excluded from the number of
shares of Common Stock outstanding are 10,449,219 shares held by Reliant
Resources as treasury stock.
Portions of the definitive proxy statement relating to the 2002 Annual
Meeting of Stockholders of Reliant Resources, which will be filed with the
Securities and Exchange Commission within 120 days of December 31, 2001, are
incorporated by reference in Item 10, Item 11, Item 12 and Item 13 of Part III
of this Form 10-K.
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TABLE OF CONTENTS
PART I
Item 1. Business...................................................................................... 4
Item 2. Properties.................................................................................... 31
Item 3. Legal Proceedings............................................................................. 31
Item 4. Submission of Matters to a Vote of Security Holders........................................... 32
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters.................................. 33
Item 6. Selected Financial Data....................................................................... 34
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 36
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................... 80
Item 8. Financial Statements and Supplementary Data................................................... F-1
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... III-1
PART III
Item 10. Directors and Executive Officers.............................................................. III-1
Item 11. Executive Compensation........................................................................ III-1
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ III-1
Item 13. Certain Relationships and Related Transactions................................................ III-1
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................... IV-1
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements 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.
For a list of factors that could cause actual results to differ materially
from those expressed or implied in our forward-looking statements, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings" in Item 7 of this
Form 10-K.
We have based our forward-looking statements on 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 publicly update or revise any
forward-looking statements.
The following sections of this Form 10-K contain forward-looking
statements:
- Our Business --
- General
- Formation, Initial Public Offering and Anticipated
Distribution
- Wholesale Energy --
- Northeast Region --
- Facilities
- Midwest Region --
- Facilities
- Florida and Other Southeastern Markets --
- Facilities
- West Region --
- Facilities
- ERCOT Region
- Facilities
- Development Activities
- Domestic Trading, Marketing, Power Origination and Risk
Management Services Operations --
- Natural Gas Trading and Marketing
- European Energy --
- European Trading, and Power Origination
Operations
- Retail Energy --
- Market Framework
- Retail Energy Supply
- Regulation --
- Federal Energy Regulatory Commission --
- Electricity
- Texas -- Retail Energy
1
- Environmental Matters --
- General
- Air Emissions
- Water Issues
- Liability for Preexisting Conditions and Remediation
- European Energy
- Management's Discussion and Analysis of Financial Condition and
Results of Operations --
- Our Separation from Reliant Energy, Incorporated
- Consolidated Results of Operations --
- 2001 Compared to 2000 --
- Income Tax Expense
- Results of Operations by Business Segment --
- Retail Energy
- Other Operations --
- 2001 Compared to 2000
- Related-Party Transactions --
- Agreements Between Reliant Energy and Reliant
Resources --
- Service Agreements
- Payment to Reliant Energy
- Common Directors on Reliant Resources' and Reliant
Energy's Board of Directors
- Certain Factors Affecting Out Future Earnings --
- Factors Affecting the Results of Our Wholesale Energy
Operations --
- Price Volatility
- Risk Associated with Our Hedging and Risk
Management Activities
- Uncertainty in the California Market
- Industry Restructuring, the Risk or Re-regulation
and the Impact of Current Regulations
- Uncertainty Related to the New York Regulatory
Environment
- Integration and Other Risks Associated with Our
Orion Power Assets
- Operating Risks
- Factors Affecting Our Acquisition and Project
Development Activities
- Increasing Competition in Our Industry
- Hydroelectric Facilities Licensing
- Factors Affecting the Results of Our European Energy
Operations --
- General
- Competition in the European Market
- Deregulation of the Dutch Market
- Plant Outages
- Other Factors
- Factors Affecting the Results of Our Retail Energy
Operations --
- General
- Competition in the Texas Market
- Obligations as a Provider of Last Resort
- "Clawback" Payment to Reliant Energy
- Operational Risks
- Factors Related to our Separation from Reliant Energy --
- Distribution
- Reliant Energy as a 80+% Stockholder
- Possible Conflicts of Interest
- Adverse Tax Consequences
- Deconsolidation from the Reliant Energy
Consolidated Tax Group
- Other Factors --
- Terrorist Attacks and Acts of War
- Environmental Regulation
- Holding Company Organizational Structure
- Liquidity Concerns
2
- Liquidity and Capital Resources --
- Consolidated Capital Requirements and Uses of Cash --
- Environmental Expenditures
- Mid-Atlantic Assets Lease Obligation
- Naming Rights to Houston Sports Complex
- Payment to Reliant Energy
- Treasury Stock Purchases
- Downgrade in Our Credit Rating
- Counterparty Credit Risk
- Consolidated Sources or Cash --
- Reliant Resources Restricted Cash
- Credit Facilities
- Reliant Resources Credit Facilities Covenants
- Orion Power Credit Facilities
- Potential Future Liquidity Sources --
- Commercial Paper Program
- Debt Securities in the Capital Markets
- Settlement of Indemnification of REPGB Stranded
Costs
- Factors Affecting Our Sources of Cash and Liquidity --
- Credit Ratings
- Off-Balance Sheet Transactions --
- Construction Agency Agreements
- Equipment Financing Structure
- New Accounting Pronouncements and Critical Accounting
Policies --
- New Accounting Pronouncements
- Critical Accounting Policies
- Quantitative and Qualitative Disclosures About Market Risk --
- Market Risk
- Trading Market Risk
- Non-trading Market Risk
- Risk Management Structure
- Credit Risk
3
ITEM 1. BUSINESS.
OUR BUSINESS
GENERAL
Reliant Resources, Inc., a Delaware corporation, was incorporated in
August 2000. In this Form 10-K, we refer to Reliant Resources, Inc. as "Reliant
Resources," and to Reliant Resources and its subsidiaries collectively, as "we"
or "us," unless the context clearly indicates otherwise. The executive offices
of Reliant Resources are located at 1111 Louisiana, Houston, TX 77002 (telephone
number 713-207-3000).
We provide electricity and energy services with a focus on the competitive
wholesale and retail segments of the electric power industry in the United
States. We acquire, develop and operate electric power generation facilities
that are not subject to traditional cost-based regulation and therefore can
generally sell power at prices determined by the market. We also trade and
market power, natural gas and other energy-related commodities and provide
related risk management services.
As of December 31, 2001, we owned or leased electric power generation
facilities with an aggregate net generating capacity of 14,585 megawatts (MW),
including 11,109 MW in the United States and 3,476 MW in the Netherlands. Of the
11,109 MW in the United States, 1,179 MW represent our entitlement to capacity
of facilities that we lease under operating leases. For additional information
regarding these operating leases, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Consolidated Capital Requirements and Uses of Cash" in Item
7 of this Form 10-K, and Note 13(c) to our consolidated financial statements,
which, together with the notes related to these statements, we refer to in this
Form 10-K as our "consolidated financial statements." We acquired our first
power generation facilities in 1998 and have increased our net generating
capacity since then through a combination of acquisitions and development of new
generation projects. Since December 31, 2001, we have added 5,644 MW of
additional net generating capacity to our asset portfolio through our
acquisition of Orion Power Holdings, Inc. According to Resource Data
International, Inc., we are the second largest independent electric power
producer in the United States based on total MW of wholesale generation capacity
in operation as of February 28, 2002.
As of December 31, 2001, we had 3,587 MW (3,391 MW, net of 196 MW to be
retired upon completion of one facility) of additional net generating capacity
under construction, including 2,120 MW of facilities owned by off-balance sheet
special purpose entities that are being constructed under construction agency
agreements pursuant to synthetic leasing arrangements. Upon the completion of
construction, we expect that we will lease these facilities from their owners.
For additional information regarding the construction agency agreements, please
read "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Off-Balance Sheet Transactions"
in Item 7 of this Form 10-K and Note 13(h) to our consolidated financial
statements. We consider a project to be "under construction" once we have
acquired the necessary permits to begin construction, broken ground on the
project site and contracted to purchase machinery for the project, including the
combustion turbines.
Additionally, we became a retail electric provider (i.e., a seller of
electricity to retail customers) in Texas when that market began opening to
retail electric competition in late 2001 and fully opened to retail competition
in January 2002. Since then, all classes of customers of most investor-owned
Texas utilities, as well as those of any municipal utility or electric
cooperative that opted to participate in the competitive marketplace, have been
able to choose their retail electric provider. Under Texas regulation, retail
electric providers procure or buy electricity from wholesale generators at
unregulated rates, sell electricity at generally unregulated rates to their
retail customers and pay the local transmission and distribution regulated
utilities a regulated tariff rate for delivering the electricity to their
customers. In January 2002, we became the retail electric provider for all of
Reliant Energy HL&P's (formerly the integrated electric utility serving the
Houston, Texas metropolitan area) (Reliant Energy's electric utility)
approximately 1.7 million customers in the Houston area who did not take action
to select another retail electric provider. At that time, we were also able to
acquire and serve new retail electric customers in other Texas competitive
markets.
4
We conduct our operations through the following business segments:
- Wholesale Energy -- provides electricity and energy services in the
competitive segments of the United States wholesale energy
industries,
- European Energy -- includes power generation assets in the
Netherlands and a related trading and power origination business,
- Retail Energy -- provides electricity and related services to retail
customers primarily in Texas, and
- Other Operations -- includes the operations of our venture capital
and Communications businesses, and unallocated corporate costs.
For information about the revenues, operating income, assets and other
financial information relating to our business segments, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations by Business Segment" in Item 7 of this Form
10-K and Note 18 to our consolidated financial statements. For information
regarding the decision to exit our Communications business, please read Note 16
to our consolidated financial statements.
FORMATION, INITIAL PUBLIC OFFERING AND ANTICIPATED DISTRIBUTION
Reliant Energy, Incorporated (Reliant Energy) owns more than 80% of our
outstanding common stock. Reliant Energy has adopted a business separation plan
in response to the Texas Electric Choice Plan (Texas electric restructuring law)
adopted by the Texas legislature in June 1999. The Texas electric restructuring
law substantially amended the regulatory structure governing electric utilities
in Texas in order to allow retail electric competition with respect to all
customer classes beginning in January 2002. Under its business separation plan
filed with the Public Utility Commission of Texas (Texas Utility Commission),
Reliant Energy has transferred substantially all of its unregulated businesses
to us in order to separate its regulated and unregulated operations. In
accordance with the plan, we completed our initial public offering (IPO) of
nearly 20% of our common stock in May 2001 and received net proceeds from the
IPO of $1.7 billion. Pursuant to the terms of the master separation agreement
between Reliant Energy and us, we used $147 million of the net proceeds to repay
certain indebtedness owed to Reliant Energy. We used the remainder of the net
proceeds of the IPO for repayment of third party borrowings, capital
expenditures, repurchases of our common stock and to increase our working
capital. For additional information regarding the IPO, please read Notes 1 and
9(a) to our consolidated financial statements. For additional information
regarding agreements and transactions between Reliant Resources and Reliant
Energy, please read "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Related-Party Transactions" in Item 7 of this Form
10-K and Notes 3 and 4 to our consolidated financial statements.
As part of its business separation plan, Reliant Energy has publicly
disclosed that it intends to restructure its corporate organization into a
public utility holding company structure (Reorganization) and to distribute,
subject to further governmental and corporate approvals, market and other
conditions, its remaining equity interest in our common stock to its or its
successor's shareholders (Distribution). In December 2001, Reliant Energy's
shareholders voted to approve the merger required for the holding company
reorganization. As a result of the Reorganization and the Distribution, Reliant
Energy's successor holding company will be named "CenterPoint Energy, Inc." and
will own essentially all of Reliant Energy's regulated businesses (CenterPoint
Energy), and we will become a separate company unaffiliated with CenterPoint
Energy. Reliant Energy has publicly disclosed its goal to complete the
Reorganization and subsequent Distribution as quickly as possible after all the
necessary conditions are fulfilled, including receipt of an order from the
Securities and Exchange Commission (SEC) granting the required approvals under
the Public Utility Holding Company Act of 1935 (1935 Act) and an extension from
the IRS for a private letter ruling obtained by Reliant Energy regarding
tax-free treatment of the Distribution. Reliant Energy has filed an application
with the SEC requesting the required approvals. The IRS private letter ruling is
predicated on the completion of the Distribution by April 30, 2002. Reliant
Energy is in the process of requesting an extension of this deadline. Reliant
Energy currently expects to complete the Reorganization and Distribution in the
summer of 2002. We cannot assure you that the Distribution will be completed as
described or within the time period outlined above.
5
ORION POWER ACQUISITION
On February 19, 2002, we acquired all of the outstanding shares of common
stock of Orion Power Holdings, Inc. (Orion Power) for $26.80 per share in cash
pursuant to a definitive merger agreement for an aggregate purchase price of
$2.9 billion. At the time of closing, Orion Power had approximately $2.4 billion
of debt obligations ($2.1 billion net of cash acquired, some of which is
restricted pursuant to debt covenants). Orion Power is an independent electric
power generating company that was formed in March 1998 to acquire, develop, own
and operate power-generating facilities in certain deregulated wholesale markets
in North America. Orion Power has a diversified portfolio of generating assets,
both geographically across the states of New York, Pennsylvania, Ohio and West
Virginia, and by fuel type, including gas, oil, coal and hydropower. As of
February 28, 2002, Orion Power owned 81 power plants with an aggregate net
generating capacity of 5,644 MW and had two development projects with an
additional 804 MW of capacity under construction. We consider most of the Orion
Power facilities to be part of our Northeast regional portfolio and the
remainder to be part of our Midwest regional portfolio. For additional
information regarding our acquisition of Orion Power and its operations, please
read "-- Wholesale Energy -- Northeast Region," and "-- Midwest Region," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of Our Wholesale Energy Operations -- Integration and Other Risks
Associated with Our Orion Power Assets" and "-- Uncertainty Related to the New
York Regulatory Environment" in Item 7 of this Form 10-K, and Note 19 to our
consolidated financial statements.
WHOLESALE ENERGY
Our Wholesale Energy business segment provides energy and energy services
with a focus on the competitive wholesale segment of the United States energy
industry. We acquire, develop and operate electric power generation facilities
that are not subject to traditional cost-based regulation and therefore can
generally sell power at prices determined by the market, subject to regulatory
limitations in certain regions. We also trade and market power, natural gas,
natural gas transportation capacity and other energy-related commodities and
provide related risk management services.
POWER GENERATION OPERATIONS
As of December 31, 2001, our Wholesale Energy business segment owned or
leased electric power generation facilities with an aggregate net generating
capacity of 11,109 MW located in five regions of the United States. We also had
3,587 MW (3,391 MW, net of 196 MW to be retired upon completion of one facility)
of net generating capacity under construction as of that date. In addition, by
acquiring Orion Power in February 2002, we added 81 power plants with an
aggregate net generating capacity of 5,644 MW and two development projects with
an additional 804 MW of capacity under construction to our regional portfolios.
6
The following table describes our Wholesale Energy business segment's
electric power generation facilities by region as of December 31, 2001.
REGIONAL SUMMARY OF OUR GENERATION FACILITIES
(AS OF DECEMBER 31, 2001)
NUMBER OF TOTAL NET
GENERATION GENERATING CAPACITY
REGION FACILITIES(1) (MW) DISPATCH TYPE(2) FUEL TYPE
------ ------------- ------------------- ----------------- ---------
NORTHEAST
Operating(3).............................. 21 4,262 Base, Inter, Peak Gas/Coal/Oil/Hydro
Under Construction(4)(5)(6)............... 1 1,120 Base, Inter, Peak Gas/Oil/Coal
------ ------
Combined.................................. 22 5,382
MIDWEST
Operating................................. 2 1,063 Peak Gas
Under Construction(7)..................... -- 154 Peak Gas
------ ------
Combined.................................. 2 1,217
SOUTHEAST
Operating(8).............................. 3 979 Inter, Peak, Cogen Gas/Oil
Under Construction(5)(9).................. 1 958 Base, Inter, Peak Gas/Oil
------ ------
Combined.................................. 4 1,937
WEST
Operating(7).............................. 7 4,635 Base, Inter, Peak Gas
Under Construction........................ 1 548 Base, Peak Gas
------ ------
Combined.................................. 8 5,183
ERCOT(10)
Operating................................. 1 170 Base, CoGen Gas
Under Construction(4)..................... -- 611 Base, CoGen Gas
------ ------
Combined.................................. 1 781
TOTAL
Operating................................. 34 11,109
Under Construction........................ 3 3,391
------ ------
Combined.................................. 37 14,500
====== ======
- ----------
(1) Unless otherwise indicated, we own a 100% interest in each facility
listed.
(2) We use the designations "Base," "Inter," "Peak" and "CoGen" to indicate
whether the facilities described are base-load, intermediate, peaking or
cogeneration facilities, respectively.
(3) We lease a 100%, 16.67% and 16.45% interest in three Pennsylvania
facilities having 613 MW, 285 MW and 281 MW, respectively, through
facility lease agreements having terms of 26.5 years, 33.75 years and
33.75 years, respectively.
(4) One of our two construction projects in this region will replace one of
our existing facilities upon completion. Therefore, this project is not
included in the facility count for the "Under Construction" group of this
region.
(5) Our two construction projects in the Northeast region and one of our
projects in the Southeast region are owned by off-balance sheet special
purpose entities and are being constructed under construction agency
agreements pursuant to synthetic leasing arrangements. We expect that we
will lease these facilities from their owners upon completion.
(6) The 1,120 MW of net capacity under construction is based on 1,316 MW of
capacity currently under construction less 196 MW of operating capacity
that will be retired upon completion of one of the projects.
(7) Five of the six generating units of one of the facilities in this region
are operational while the sixth unit is under construction. This partially
operational facility is included in the facility count for the "Operating"
group of this region.
(8) We own a 50% interest in one of these facilities. An independent third
party owns the other 50%.
(9) Two of the three generating units of one of the facilities in this region
are operational while the third unit is under construction. This partially
operational facility is included in the facility count for the "Operating"
group of this region.
7
(10) We also have an option, which is exercisable in January 2004, subject to
completion of the Distribution, to acquire Reliant Energy's approximate
80% interest in a company that is currently expected to own approximately
13,900 MW of net generating capacity in the Electric Reliability Council
of Texas (ERCOT) in January 2004. For additional information regarding
this option, please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Related-Party
Transactions -- Agreements between Reliant Energy and Reliant Resources --
Genco Option Agreement" in Item 7 of this Form 10-K and Note 4(b) to our
consolidated financial statements.
The following table describes our Orion Power electric power generation
facilities by region as of February 28, 2002.
REGIONAL SUMMARY OF OUR ORION POWER FACILITIES
(AS OF FEBRUARY 28, 2002)
NUMBER OF TOTAL NET
GENERATION GENERATING
REGION FACILITIES CAPACITY (MW) DISPATCH TYPE(1) FUEL TYPE
------ ---------- ------------- ---------------- ---------
NORTHEAST
Operating(2).............................. 78 4,174 Base, Inter, Peak Gas/Oil/Coal/Hydro
Under Construction........................ 2 804 Base, Inter Gas
------ ------
Combined.................................. 80 4,978
MIDWEST
Operating................................. 3 1,470 Base, Inter, Peak Coal/Gas
TOTAL
Operating(2).............................. 81 5,644
Under Construction........................ 2 804
------ ------
Combined(2)............................... 83 6,448
====== ======
- ----------
(1) We use the designations "Base," "Inter" and "Peak" to indicate whether the
facilities described are base-load, intermediate or peaking, respectively.
(2) Two hydro plants with a net generating capacity of approximately 5 MW are
not currently operational.
NORTHEAST REGION
Facilities. As of December 31, 2001, we owned or leased 21 electric power
generation facilities with an aggregate net generating capacity of 4,262 MW
located in the control area of PJM Interconnection, L.L.C. (PJM ISO), the
independent system operator in the Pennsylvania-New Jersey-Maryland market (PJM
market). These facilities are owned or leased by subsidiaries of one of our
wholly owned subsidiaries, Reliant Energy Mid-Atlantic Power Holdings, LLC
(REMA). The generating capacity of these facilities consists of approximately
40% of base-load, 40% of intermediate and 20% of peaking capacity, and
represents approximately 7% of the total generation capacity located in the PJM
ISO's control area. For additional information regarding our acquisition of
these facilities, please read Note 5(a) to our consolidated financial
statements.
By acquiring Orion Power in February 2002, we added 78 power generation
facilities, of which 75 are currently operational, with an aggregate net
generating capacity of 4,174 MW to our Northeast regional portfolio. These
facilities include 70 hydroelectric facilities, of which 68 are currently
operational, located in central and northern New York State, three facilities
located in New York City, one facility located in East Syracuse, New York, and
four facilities, three of which are currently fully operational, located in
Pennsylvania. The generating capacity of these facilities consists of
approximately 45% of base-load, 35% of intermediate and 20% of peaking capacity.
For a discussion of factors that may affect the future earnings generated by
these Orion Power facilities, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Certain Factors Affecting
Our Future Earnings -- Factors Affecting the Results of Our Wholesale Energy
Operations -- Integration and Other Risks Associated With Our Orion Power
Assets" and "-- Uncertainty Related to the New York Regulatory Environment" in
Item 7 of this Form 10-K.
8
We have begun construction on a 795 MW gas-fired base-load and
intermediate facility located in Pennsylvania. We expect this facility will
begin commercial operation in the second quarter of 2003. We have also begun
construction on a 521 MW coal-fired base-load facility, also located in
Pennsylvania, that will replace one of our existing facilities. This facility
will add 325 MW of additional capacity to our Northeast regional portfolio, net
of the 196 MW of capacity of the currently existing facility that will be
retired upon commencement of commercial operations of the new facility. We
expect this facility will begin commercial operation near the end of 2004. These
facilities are owned by off-balance sheet special purpose entities and are being
constructed under the terms of separate construction agency agreements pursuant
to synthetic leasing arrangements. Upon completion of the construction of these
facilities, we expect that we will lease these facilities from their owners,
purchase or remarket each facility. For additional information regarding the
construction agency agreements, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Off-Balance Sheet Transactions -- Construction Agency
Agreements" in Item 7 of this Form 10-K and Note 13(h) to our consolidated
financial statements.
By acquiring Orion Power in February 2002, we added two additional
development projects with an additional 804 MW of capacity under construction.
The first project is the construction of a 550 MW gas-fired base-load facility
located south of Philadelphia, Pennsylvania. We expect this facility will begin
commercial operation in the second quarter of 2002. The second project is the
conversion and upgrade of a peaking facility located near downtown Pittsburgh,
Pennsylvania. We expect this project will be completed by the third quarter of
2002 and will increase the aggregate generating capacity of this facility by 254
MW to a total capacity of 308 MW.
Market Framework. We currently sell the power generated by our Northeast
regional facilities in the PJM market, the wholesale energy market of the State
of New York (New York wholesale market) operated by the New York Independent
System Operator (NYISO) and to buyers in adjacent power markets, such as the
region covered by the East Central Area Reliability Coordinating Counsel (ECAR
market). We also expect to sell power in a newly created extension of the PJM
market in western Pennsylvania (PJM West market). Each of the PJM Market, the
New York wholesale market and the PJM West market operate as centralized power
pools with open-access, non-discriminatory transmission systems administered by
independent system operators approved by the Federal Energy Regulatory
Commission (FERC). Although the transmission infrastructure within these markets
is generally well developed and independently operated, transmission constraints
exist between, and to a certain extent within, these markets. In particular,
transmission of power from eastern Pennsylvania to western Pennsylvania and into
New York City may be constrained from time to time. Depending on the timing and
nature of transmission constraints, market prices may vary from market to
market, or between sub-regions of a particular market. For example, as a result
of transmission constraints into New York City, power prices are generally
higher there than in other parts of the state.
In addition to managing the transmission system for each market, the
respective independent system operator for each of the PJM market, the New York
wholesale market and the PJM West market is responsible for maintaining
competitive wholesale markets, operating the spot wholesale energy market and
determining the market clearing price based on bids submitted by participating
generators in each market. Each independent system operator generally matches
sellers with buyers within a particular market that meet specified minimum
credit standards. We sell capacity, energy and ancillary services into the
markets maintained by the applicable independent system operator for each of
these types of products for both real-time sales and forward-sales for periods
of up to one year. Our customers include the members of each market, consisting
of municipalities, electric cooperatives, integrated utilities, transmission and
distribution utilities, retail electric providers and power marketers. We also
sell capacity, energy and ancillary services to customers in the Northeast
region under negotiated bilateral contracts. Bilateral contracts, in addition to
other physical and financial transactions enable us to hedge a portion of our
generation portfolio. For a more complete description of our hedging strategy
and a summary of the consolidated hedge position of our United States generating
assets, please read "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Certain Factors Affecting Our Future Earnings --
Factors Affecting the Results of Our Wholesale Energy Operations -- Risks
Associated with Our Hedging and Risk Management Activities" in Item 7 of this
Form 10-K.
Our markets in the Northeast region are subject to constant and
significant regulatory oversight and control and the results of our operations
in the region may be adversely affected by any changes or additions to the
current regulatory structure. Our sales into markets administered by the PJM ISO
are governed by the PJM ISO's operating
9
agreements, tariffs and protocols (PJM Protocols). The PJM Protocols provide the
structure, rules and pricing mechanisms for the PJM ISO's energy, capacity and
ancillary services markets, and establish rates, terms and conditions for
transmission service in the PJM ISO's control area and the PJM West market,
including transmission congestion pricing. Wholesale energy prices in the
markets administered by the PJM ISO are currently capped at $1,000 per
megawatt-hour. Lower caps are utilized in other regions and it is possible that
this price cap might be lowered in the future.
Our sales into markets administered by the NYISO are governed by the
NYISO's tariff and protocols (NYISO Protocols). The NYISO Protocols provide the
structure, rules and pricing mechanisms for the NYISO's energy, capacity and
ancillary services markets, and establish rates, terms and conditions for
transmission service in the NYISO's control area. The NYISO Protocols allow
energy demand, commonly referred to as "load," to respond to high prices in
emergency and non-emergency situations. The lack of programs, however, to
implement load response to prices has been cited as one of the primary reasons
for retaining wholesale energy bid caps, which are currently set at $1,000 per
megawatt-hour. Lower price caps are utilized in other regions and it is possible
that this price cap might be lowered in the future.
A capacity market has been established by the NYISO that ensures that
there is enough generation capacity to meet retail energy demand and ancillary
services requirements. All power retailers are required to demonstrate
commitments for capacity sufficient to meet their peak forecasted load plus a
reserve requirement, currently set at 18%. As an extra reliability measure,
power retailers located in New York City are required to procure the majority of
this capacity, currently 80% of their peak forecasted load, from generating
units located in New York City. Because New York City is currently short of this
capacity requirement and the existing capacity is owned by only a few entities,
a price cap has been instituted for in-city generators.
For additional discussion of the impact of current regulations on the
markets in the Northeast region and the related risks of re-regulation, please
read "-- Regulation -- Federal Energy Regulatory Commission" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Factors Affecting Our Future Earnings -- Factors Affecting the Results
of Our Wholesale Energy Operations -- Industry Restructuring, the Risk of
Re-regulation and the Impact of Current Regulations" and "-- Uncertainty Related
to the New York Regulatory Environment" in Item 7 of this Form 10-K.
MIDWEST REGION
Facilities. As of December 31, 2001, we owned two electric power
generation facilities located in the State of Illinois with an aggregate net
generating capacity of 1,063 MW in operation. One of these facilities is a 344
MW gas-fired peaking generation facility located in Shelby County, Illinois. The
first phase of this facility was initially placed in commercial operation in
June 2000 and the second phase was placed in commercial operation in May 2001.
We also have an 873 MW gas-fired peaking generation facility under construction
in Aurora, Illinois. As of December 31, 2001, five of the six generating units
at this facility with an aggregate net generating capacity of 719 MW had been
placed in commercial operation. We expect the remaining unit at this facility
will begin commercial operation in the second quarter of 2002.
By acquiring Orion Power in February 2002, we added three power generation
facilities with an aggregate net generating capacity of 1,470 MW to our Midwest
regional portfolio. Two of these facilities are located in Ohio and one is
located in West Virginia. The generating capacity of these facilities consists
of approximately 50% of base-load, 15% of intermediate and 35% of peaking
capacity. For a discussion of the factors that may affect the future earnings
generated by these Orion Power assets, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Certain Factors
Affecting Our Future Earnings -- Factors Affecting the Results of Our Wholesale
Energy Operations -- Integration and Other Risks Associated With Our Orion Power
Assets" in Item 7 of this Form 10-K.
Market Framework. We sell the power generated by our Midwest regional
facilities into the ECAR market and the region covered by the Mid-America
Interconnected Network Reliability Council (MAIN market). These markets include
all or portions of the states of Illinois, Wisconsin, Missouri, Indiana, Ohio,
Michigan, Virginia, West Virginia, Tennessee, Maryland and Pennsylvania. These
markets are currently in a state of transition and are in the process of
establishing regional transmission organizations (RTO) that would define the
rules and
10
requirements around which competitive wholesale markets in the region would
develop. The FERC has approved proposals by the Midwest Independent System
Operator (Midwest ISO) to administer a substantial portion of the transmission
facilities in the Midwest region. The FERC also has ordered the Alliance RTO,
which had a separate proposal to be the RTO for parts of the Midwest region, to
explore joining the Midwest ISO. As a result, the final market structure for the
Midwest region remains unsettled. The timing of the development of a RTO and the
extent to which the Midwest ISO and the Alliance RTO would combine is currently
unknown. In addition, some states within these markets have restructured their
electric power markets to competitive markets from traditional utility monopoly
markets, while others have not. Currently the transmission infrastructure in
these markets is generally owned by non-independent market participants, some of
which are our competitors, which has the potential to create market anomalies.
Transmission constraints exist in these markets and have been managed by the
owners of the transmission infrastructure, subject to transmission tariffs and
protocols regulated by the FERC.
We currently sell power from our facilities in the Midwest region to
customers under bilateral contracts that are generally non-standard with highly
negotiated terms and conditions. Our customers include municipalities, electric
cooperatives, integrated utilities, transmission and distribution utilities and
power marketers. Direct customer sales, in addition to other physical and
financial transactions enable us to hedge a portion of our generation portfolio.
For a more complete description of our hedging strategy and a summary of the
consolidated hedge position of our United States generating assets, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of Our Wholesale Energy Operations -- Risks Associated with Our
Hedging and Risk Management Activities" in Item 7 of this Form 10-K.
FLORIDA AND OTHER SOUTHEASTERN MARKETS
Facilities. As of December 31, 2001, we owned, or owned interests in,
three power generation facilities with an aggregate net generating capacity of
979 MW located in the states of Florida and Texas. These facilities include one
gas and oil-fired generation facility with an aggregate net generating capacity
of 619 MW located near Titusville, Florida. This facility can be operated as
either an intermediate or a peaking facility. We also own a 464 MW gas and
oil-fired peaking generation facility in Osceola County, Florida. Two of the
three generating units of this plant with an aggregate net generating capacity
of 310 MW commenced commercial operation in December 2001. We expect the
remaining generating unit at this facility will begin commercial operation in
the second quarter of 2002. In addition, we own a 50% interest in a 100 MW
gas-fired base-load/cogeneration facility located in Orange, Texas. Air Liquide
owns the other 50% interest in this plant which has been in commercial operation
since December 1999.
We have begun construction on an 804 MW gas-fired intermediate/peaking
facility in Choctaw County, Mississippi. We expect this facility will begin
commercial operation in the second quarter of 2003. This facility is being
constructed under the terms of a construction agency agreement under a synthetic
leasing arrangement. Upon completion of the construction of this facility, we
will have the right to lease, purchase or remarket the facility. For additional
information regarding the construction agency agreement, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Off-Balance Sheet Transactions
- -- Construction Agency Agreements" in Item 7 of this Form 10-K, and Note 13(h)
to our consolidated financial statements.
Market Framework. We currently conduct the majority of our Southeast
regional operations in the state of Florida. The state of Florida, other than a
portion of the western panhandle, constitutes a single reliability council and
contains approximately 5% of the United States population. The
transmission-owning utilities in Florida have proposed establishing an
independent system operator to assume control of the transmission system and
undertake to define the rules and requirements for a competitive wholesale
market. The timing of the development of an independent system operator for the
Florida market is currently unknown. Under its present structure, the Florida
market is dominated by incumbent utilities. There are a number of statutory and
regulatory restrictions that negatively impact the development of additional
power generation facilities in the region.
We currently sell power from our facilities in the Florida market under
bilateral contracts that are non-standard and highly negotiated for terms and
conditions. Until the rules for system operations are established, we expect
limited trading opportunities will exist in the Florida market. The customers
who participate in power transactions
11
in this region include municipalities, electric cooperatives and integrated
utilities. We sell capacity and energy to customers in the Florida market,
however a market for ancillary services has not developed. Forward hedging of a
portion of our Florida portfolio is generally accomplished through
customer-tailored, multi-year sale agreements as no liquid, over-the-counter or
auction markets currently exists in Florida. For a more complete description of
our hedging strategy and a summary of the consolidated hedge position of our
United States generation assets, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Certain Factors
Affecting Our Future Earnings -- Factors Affecting the Results of Our Wholesale
Energy Operations -- Risks Associated with Our Hedging and Risk Management
Activities" in Item 7 of this Form 10-K.
With respect to our facilities in East Texas and Mississippi, several of
the transmission-owning utilities in the Southeast region have formed the
SETrans Grid Company (SETrans RTO) that they are proposing to serve as the
region's RTO. The proposed SETrans RTO would manage, but not own, the
transmission grid in the region and operate forward and spot markets for energy.
The SETrans RTO has filed a status report with the FERC, but has not filed
tariffs or protocols and has not been approved as the region's RTO.
WEST REGION
Facilities. As of December 31, 2001, we owned, or owned interests in,
seven electric power generation facilities with an aggregate net generating
capacity of 4,635 MW located in the states of California, Nevada and Arizona.
These facilities include approximately 20% of base-load, 75% of intermediate and
5% of peaking capacity. Our facilities in the West region include five
facilities with an aggregate net generating capacity of 3,800 MW located in
California. We also own a 50% interest in a 490 MW gas-fired, base-load, peaking
facility located near Las Vegas, Nevada. Sempra Energy owns the other 50%
interest in this plant. In addition, we own a 590 MW gas-fired, base-load,
peaking generation facility in Casa Grande, Arizona. This facility was placed in
commercial operation in the fourth quarter of 2001. We also have a 548 MW
gas-fired, base-load, peaking generation facility under construction in
Nevada. We expect this facility will begin commercial operation in the fourth
quarter of 2003.
Market Framework. Our West regional market includes the states of Arizona,
California, Oregon, Nevada, New Mexico, Utah and Washington. Generally we sell
the power generated by our California and Nevada facilities to customers located
in the Los Angeles basin of southern California. We also sell power generated by
our Nevada facility to customers located in southern Nevada. Our customers in
these states include power marketers, investor-owned utilities, electric
cooperatives, municipal utilities and the California Independent System Operator
(Cal ISO) acting on behalf of load-serving entities. We sell power and ancillary
services to these customers through a combination of bilateral contracts and
sales made in the Cal ISO's day-ahead and hour-ahead ancillary services markets
and its real-time energy market. The Cal ISO does not currently maintain a
market for capacity; however, a capacity market has recently been proposed by
the Cal ISO under its market mitigation plan for the California market.
We have agreed to sell up to 100% of the power generated by our Arizona
facility to the Salt River Project Agricultural Improvement and Power District
of the State of Arizona under a long-term power purchase agreement. Bilateral
contracts, in addition to other physical and financial transactions enable us to
hedge a portion of our generation portfolio. For a more complete description of
our hedging strategy and a summary of the consolidated hedge position of our
United States generating assets, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Certain Factors
Affecting Our Future Earnings -- Factors Affecting the Results of Our Wholesale
Energy Operations -- Risks Associated with Our Hedging and Risk Management
Activities" in Item 7 of this Form 10-K. In addition, although we do not own
generation facilities in the states of Oregon, New Mexico, Utah and Washington,
our trading and marketing operations purchase and deliver energy commodities in
these states.
Our operations in the California market are subject to numerous
environmental and other regulatory restrictions. Permits issued by local air
districts restrict the output of some of our generating facilities. In addition,
certain air districts require us to purchase emission credits to offset Nitrogen
Oxides (NOx) emissions from our facilities.
In response to California's electricity market restructuring initiative,
the FERC issued a series of orders in 1996 and 1997 approving a wholesale market
structure administered by two independent non-profit corporations: the Cal
12
ISO, responsible for operational control of the transmission system and the
purchase or sale of electricity in "real-time" to balance actual supply and
demand, and the California Power Exchange (Cal PX), responsible for conducting
auctions for the purchase or sale of electricity on a day-ahead or day-of basis.
As part of this market restructuring, California's distribution utilities sold
essentially all of their gas-fired plants to third-party generators. The
utilities were required to sell their remaining generation into the Cal PX
markets and purchase all of their power requirements from the Cal PX markets at
market-based rates approved by the FERC. California's regulatory system
initially prohibited the utilities from entering into forward contracts to cover
the bulk of their customers' requirements. Retail electricity rates were
initially frozen at levels in effect on June 10, 1996, with a 10% rate reduction
for residential and smaller commercial customers. When wholesale power costs
began to rise dramatically in 2000, driven by a combination of factors,
including higher natural gas prices and emission allowance costs, reduction in
available hydroelectric generation resources, increased demand and decreases in
net imports, some of the California utilities were unable to recover their
purchased power costs through the retail rates they were allowed to charge. As a
result, the utilities accumulated huge debts to wholesale power suppliers,
including us. The Cal ISO currently is conducting a major market redesign
process that, if approved by the FERC, could change the structure of the markets
operated by the Cal ISO, including changes to market monitoring and mitigation,
congestion management and capacity obligations. For a discussion of litigation
and other legal proceedings related to energy sales in California, the impact of
current regulations on our West region and related uncertainty associated with
the California wholesale market, please read "-- Regulation -- Federal Energy
Regulatory Commission," "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Factors Affecting the Results of Our Wholesale Energy Operations --
Uncertainty in the California Market" and Notes 13(e) and 13(i) to our
consolidated financial statements.
In Nevada and Arizona, there is presently no RTO in place to manage the
transmission systems or to operate energy markets, although one RTO working
group is evaluating the establishment of an organization that would assume
control, subject to FERC approval, over the transmission systems of the
utilities operating in this region. The FERC has recently expressed its
intention to pursue the establishment of an RTO in the West region.
Additionally, in Nevada and Arizona, state-level regulatory initiatives
may impact competition in the electric sector. In Nevada, the state legislature
has passed legislation prohibiting the state's investor-owned utilities from
divesting generation. Similarly, in Arizona, proceedings are pending before the
Arizona Corporation Commission that would allow the Arizona Public Service
Company to avoid a requirement to seek competitive bids for 50% of the Arizona
Public Service Company's generation needs.
ERCOT REGION
Facilities. We currently own a partially operational 781 MW gas-fired,
combined cycle, cogeneration facility in Channelview, Texas. 170 MW of this
facility's capacity is currently operational and 611 MW are under construction.
We expect the remaining generating units for this facility will begin commercial
operations in the third quarter of 2002.
In addition to our Channelview facility, we have an option exercisable in
January 2004, subject to completion of the Distribution, to acquire Reliant
Energy's ownership interest in a company (Texas Genco) that is currently
expected to own approximately 13,900 MW of aggregate net generation capacity in
Texas in January 2004 (Texas Genco Option). Reliant Energy has agreed to
publicly offer or distribute to its shareholders approximately 20% of the common
stock of Texas Genco before December 31, 2002. The generating capacity of these
facilities consists of approximately 60% of base-load, 35% of intermediate and
5% of peaking capacity, and represents approximately 20% of the total capacity
in ERCOT. As part of Reliant Energy's business separation plan, Reliant Energy's
electric utility will convey its generating assets to Texas Genco. The
conveyance is part of the anticipated restructuring of Reliant Energy's
businesses into a holding company structure. For additional information
regarding the Texas Genco Option, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Related Party
Transactions -- Agreements between Reliant Energy and Reliant Resources -- Genco
Option Agreement" in Item 7 of this Form 10-K, and Note 4(b) to our consolidated
financial statements.
Market Framework. The state of Texas, other than a portion of the
panhandle and a portion of the east bordering on Louisiana, constitutes a single
reliability council (ERCOT market). As part of the transition to deregulation in
Texas, ERCOT changed its operations from 10 control areas, managed by utilities
in the state, to a
13
single control area on July 31, 2001. The ERCOT independent system operator
(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 systems operators in other
regions of the country, ERCOT is not a centrally dispatched pool and the ERCOT
ISO does not procure energy on behalf of its members other than to maintain the
reliable operation 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 services requirement.
Members of ERCOT include retail customers, investor and municipal owned
electric utilities, rural electric co-operatives, river authorities, independent
generators, power marketers and retail electric providers. The ERCOT market
operates under the reliability standards set by the North American Electric
Reliability Council. The Texas Utility Commission has primary jurisdictional
authority over the ERCOT market to ensure the adequacy and reliability of
electricity across the state's main interconnected power grid. For information
regarding ERCOT systems issues and delays, please read "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Certain Factors
Affecting Our Future Earnings -- Factors Affecting the Results of Our Retail
Energy Operations -- Operational Risks" in Item 7 of this Form 10-K.
As part of the change to a single control area, ERCOT initially
established three congestion zones; north, west and south. ERCOT will perform an
annual analysis of the transmission capability in ERCOT to determine if changes
to the congestions zones is 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 divided 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 (TCR)
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 retail load obligation of our Retail
Energy segment that was acquired as part of full retail deregulation on January
1, 2002 is predominately in the Houston zone. For additional information
regarding the retail load obligations of our Retail Energy segment, please read
"-- Retail Energy -- Retail Energy Supply."
LONG-TERM PURCHASE AND SALE AGREEMENTS
In the ordinary course of business, and as part of our hedging strategy,
we enter into long-term sales arrangements for power, as well as long-term
purchase arrangements. For information regarding our long-term fuel supply
contracts, purchase power and electric capacity contracts and commitments,
electric energy and electric sale contracts and tolling arrangements, please
read Notes 6, 13(a) and 13(c) to our consolidated financial statements. For
information regarding our hedging strategy relating to such long-term
commitments, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Factors Affecting the Results of Our Wholesale Energy Operations --
Risks Associated with Our Hedging and Risk Management Activities" in Item 7 of
this Form 10-K.
DEVELOPMENT ACTIVITIES
As of December 31, 2001, we had 3,587 MW (3,391 MW, net of 196 MW to be
retired upon completion of one facility) of additional net generating capacity
under construction, including 2,120 MW of facilities owned by off-balance sheet
special purpose entities, that are being constructed under construction agency
agreements pursuant to synthetic leasing arrangements. Upon the completion of
the construction of these facilities, we expect that we will lease these
facilities from their owners. For additional information regarding the
construction agency agreements, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Off-Balance Sheet Transactions -- Construction Agency
Agreements" in Item 7 of this Form 10-K, Note 13(h) to our consolidated
financial statements.
In addition, Orion Power had three projects totaling 1,054 MW under
construction as of December 31, 2001. However, at this time, we have decided to
postpone a 250 MW project in Florida because of capital market and
14
economic considerations. With improved capital market conditions and required
approvals from Florida authorities on a newly configured 500 MW design, we would
plan to proceed with construction in the future. Also, Orion Power had two
projects under advanced development as of December 31, 2001, which have been
deferred. A 1,088 MW project in Maryland has been postponed due to capital
market considerations and because we believe that the PJM market will be
sufficiently supplied for the next few years. A repowering project in New York
City with a total capacity of 1,608 MW has been postponed until we see an
improvement in the capital markets.
As a result of several recent events, including the United States economic
recession, the price decline of our industry sector in the equity capital
markets and the downgrading of the credit ratings of several of our significant
competitors, the availability and cost of capital for our business and the
businesses of our competitors has been adversely affected. In response to these
events and the intensified scrutiny of companies in our industry sector by the
rating agencies, we have reduced our planned capital expenditures by $2.7
billion over the 2002 -- 2006 time frame.
DOMESTIC TRADING, MARKETING, POWER ORIGINATION AND RISK MANAGEMENT SERVICES
OPERATIONS
In addition to our power generation operations, we trade and market power,
natural gas and other energy-related commodities and provide related risk
management services to our customers. According to Platt's Power Markets Week
and Natural Gas Intelligence Group, we were the third largest power trader and
ninth largest natural gas trader in the United States in 2001. Our domestic
trading, marketing, power origination and risk management operations complement
our domestic power generation operations by providing a full range of energy
management services. These services include management of the sales and
marketing of energy, capacity and ancillary services from these facilities, and
also management of the purchase and sale of fuels and emission allowances needed
to operate these facilities. Generally, we seek to sell a portion of the
capacity of our domestic facilities under fixed-price sale contracts,
fixed-capacity payments or contracts to sell power at a predetermined multiple
of either gas or oil prices. This provides us with certainty as to a portion of
our margins while allowing us to maintain flexibility with respect to the
remainder of our generation output. We evaluate the regional forward power
market versus our own fundamental analysis of projected future prices in the
region to determine the amount of our capacity we would like to sell and the
terms of sale pursuant to longer-term contracts. We also take operational
constraints and operating risk into consideration in making these
determinations. Generally, we seek to hedge a portion of our fuel costs, which
are usually linked to a percentage of our power sales. We also market
energy-related commodities and offer physical and financial wholesale energy
marketing and price risk management products and services to a variety of
customers. These customers include natural gas distribution companies, electric
utilities, municipalities, cooperatives, power generators, marketers or other
retail energy providers, aggregators and large volume industrial customers.
The following table illustrates the growth of our physical power and gas
trading volumes since 1999.
TRADING VOLUMES
FOR THE YEAR ENDED DECEMBER 31
---------------------------------------------
1999 2000 2001
----------- ----------- -----------
Total Power (MWh(1)) ...... 112,133,103 201,938,485 380,404,604
Total Gas (Bcf(2)) ........ 1,746 2,423 3,695
- ----------
(1) Megawatt hours.
(2) Billion cubic feet.
Electric Power Trading and Marketing. We purchase electric power from
other generators and marketers and sell power primarily to electric utilities,
municipalities and cooperatives and other marketing companies. Our trading and
marketing group is also responsible for the marketing of power produced from the
power plants we own. We also provide risk management, physical and financial
fuel purchase and power sales and optimization services to our customers.
Power Origination. Some of our employees focus on developing and providing
customers with long-term customized products (power origination products). These
products are designed and negotiated on a case-by-case
15
basis to meet the specific energy requirements of our customers. Our power
origination teams work closely with our trading and marketing group and our
power generation group to sell long-term products from our power generation
assets. They also work to leverage our market knowledge to capture attractive
opportunities available through selling products that combine or repackage
energy products purchased from third parties with other third-party products or
with products from our power generation assets. Our efforts to sell power
origination products from our power generation assets have been focused on
longer-term forward sales to municipalities, cooperatives and other companies
that serve end users, as well as sales of near-term products that are not widely
traded. Our power origination products that combine or repackage third-party
products are generally highly structured and therefore require the application
of our commercial capabilities (e.g., power trading and asset positions).
Natural Gas Trading and Marketing. We purchase natural gas from a variety
of suppliers under daily, monthly and term, variable-load and base-load
contracts that include either market sensitive or fixed pricing provisions. We
sell natural gas under sales agreements that have varying terms and conditions,
most of which are intended to match seasonal and other changes in demand. We
sold an average of 10.1 Bcf per day of natural gas in 2001, an average of 6.6
Bcf per day in 2000 and an average of 4.8 Bcf per day in 1999, some of which was
sold to the natural gas distribution company subsidiaries of Reliant Energy. We
plan to continue to purchase natural gas to supply to our power plants.
Our natural gas marketing activities include contracting to buy natural
gas from suppliers at various points of receipt, aggregating natural gas
supplies and arranging for their transportation, negotiating the sale of natural
gas and matching natural gas receipts and deliveries based on volumes required
by customers.
We arrange for, schedule and balance the transportation of the natural gas
we market from the supply receipt point to the purchaser's delivery point. We
generally obtain pipeline transportation to serve our customers. Accordingly, we
use a variety of transportation arrangements for our customers, including
short-term and long-term firm and interruptible agreements with intrastate and
interstate pipelines. We also utilize brokered firm transportation agreements
when dealing on the interstate pipeline system. As of December 31, 2001, we held
over two bcf per day of firm transportation in the United States. In the normal
course of business it is common for us to hedge the risk of pipeline
transportation expenses through "basis swaps." To the extent we have
contractually secured pipeline transportation rights in order to fulfill our
obligations to sell gas at specific delivery points, or to acquire gas for our
own requirements at generation facilities as part of our hedging strategy for
power sales, and a pipeline experiences a force majeure event, our ability to
transport gas on a contracted capacity basis could become impaired, which could
affect the integrity of our hedged position.
We also enter into various short-term and long-term firm and interruptible
agreements for natural gas storage in order to offer peak delivery services to
satisfy winter heating and summer electric generating demands. Natural gas
storage capacity allows us to better manage the unpredictable daily or seasonal
imbalances between supply volumes and demand levels. In addition to entering
into contracts of natural gas storage capacity in strategic locations throughout
the country, we are actively pursuing a natural gas storage development plan.
These services are also intended to provide an additional level of performance
security and backup services to our customers.
Other Commodities and Derivatives. We trade and market other
energy-related commodities. We use derivative instruments to manage and hedge
our fixed-price purchase and sale commitments and to provide fixed-price or
floating-price commitments as a service to our customers and suppliers. We also
use derivative instruments to reduce our exposure relative to the volatility of
the cash and forward market prices and to protect our investment in storage
inventories. For additional information regarding our financial exposure to
derivative instruments, please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Factors Affecting Our
Future Earnings -- Factors Affecting the Results of Our Wholesale Energy
Operations -- Risks Associated with Our Hedging and Risk Management Activities"
in Item 7 of this Form 10-K and "Quantitative and Qualitative Disclosures About
Market Risk" in Item 7A of this Form 10-K.
Intercontinental Exchange. In July 2000, we, along with five other natural
gas and power companies, American Electric Power, Aquila Energy, Duke Energy, El
Paso Corporation and Mirant Corporation, made an investment in
Intercontinental-Exchange, a new, web-based, on-line trading platform
(www.intcx.com) for trading various commodities including precious metals, crude
oil and refined products, natural gas and electricity. The other five natural
gas and power companies, along with us, own less than 50% of Intercontinental --
Exchange. In June 2001, Intercontinental-Exchange acquired the International
Petroleum Exchange. With this acquisition, Intercontinental-Exchange became the
first company to offer both an exchange trading over-the-counter commodity
contracts and an
16
exchange trading commodity futures contracts. At the same time,
Intercontinental-Exchange announced plans to integrate the two types of
exchanges into a single electronic trading platform. Our decision to invest, as
one of a group of natural gas and power companies, in Intercontinental-Exchange
was based on a desire to support the development of a neutral, anonymous,
electronic trading platform for bi-lateral energy transactions. We believe the
commercial success of such an exchange model will benefit us by contributing to
improved price transparency and transaction liquidity in the wholesale energy
markets. The principal online competitors of Intercontinental-Exchange are
currently TradeSpark.com and the NYMEX, a traditional futures exchange that has
announced an online initiative.
Risk Management Controls. For information regarding our risk management
structure and accounting policies, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Trading and
Marketing Operations" in Item 7 of this Form 10-K and "Quantitative and
Qualitative Disclosures About Market Risk" in Item 7A of this Form 10-K.
COMPETITION
For a discussion of competitive factors affecting our Wholesale Energy
segment, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Factors Affecting the Results of Our Wholesale Energy Operations --
Increasing Competition in Our Industry" in Item 7 of this Form 10-K, which
section is incorporated herein by reference.
EUROPEAN ENERGY
Our European Energy business segment includes 3,476 MW of power generation
assets located in the Netherlands and a related trading and power origination
operations. This segment includes the operations of Reliant Energy Power
Generation Benelux N.V. (formerly UNA N.V.) (REPGB) and Reliant Energy Trading &
Marketing B.V. and its affiliates.
In 2001, we evaluated strategic alternatives for our European Energy
segment, including a possible sale. We completed our evaluation and have
determined that given current market conditions and prices, it is not advisable
to sell our European Energy operations. Consequently, we decided to continue to
own and operate our European Energy segment and expand our trading and
origination activities in Northwest Europe.
EUROPEAN POWER GENERATION OPERATIONS
Facilities. As of December 31, 2001 we owned five electric power
generation facilities in the Netherlands with an aggregate net generating
capacity of 3,476 MW and include approximately 39% of base-load, 36% of
intermediate and 25% of peaking capacity. Our facilities are grouped in three
clusters adjacent to the cities of Amsterdam, Utrecht and Velsen. In 2001, our
generation facilities produced 14 million MWh, an amount which represented
approximately 13% of the electricity production of the Netherlands (excluding
electricity generated by cogeneration or other industrial processes). In
addition to electricity, our generating stations sell heated water produced as a
byproduct of the generation process for use in providing heating (district
heating) to the cities of Amsterdam, Nieuwegein, Utrecht and Purmerend.
In 2001, approximately 51% of our European Energy segment's generation
output was natural gas-fired, 30% was coal-fired, 18% was blast furnace
gas-fired and less than 1% was oil-fired. Our European Energy segment purchases
substantially all of its gas fuel requirements under medium to long-term gas
purchase contracts with N.V. Nederlandse Gasunie, the primary supplier and
transporter of natural gas in the Netherlands. The purchase price and
transportation costs for natural gas under these contracts are calculated on the
basis of regulated tariffs.
Our European Energy segment historically purchased all of its coal
requirements under short-term contracts with a coal trading and supply company
now owned by two of the Dutch generation companies. In December 2001, REPGB and
the other shareholder of the coal trading and supply company agreed to terminate
future coal purchases through this entity effective in mid-2002. Our European
Energy segment intends to obtain its future coal requirements through short to
medium-term forward purchase contracts on the open market through a variety of
suppliers and brokers.
17
One of our European Energy generation stations, which has a production
capacity of 144 MW, uses blast furnace gas, an industrial waste gas generated by
a steel plant adjacent to the generation station, as its fuel. Two of our other
European Energy segment's generation plants have the flexibility to operate
using blast furnace gas. We purchase the blast furnace gas from the adjacent
steel plant under a medium-term and a long-term contract. We purchase our fuel
oil requirements on the open market.
We acquired REPGB in October 1999 for approximately $1.9 billion (based on
the then applicable exchange rate of 2.06 Dutch Guilders (NLG) per U.S. dollar).
For information regarding the acquisition, please read note 5(b) to our
consolidated financial statements.
Market Framework. Our European Energy segment produces, buys and sells
electricity, gas and other energy-related commodities in the Northern European
wholesale market. Its generation production activities are centered in the
Netherlands, where it is one of the four large-scale generation companies. It
operates five generation facilities with an installed capacity of 3,476 MW. Its
energy trading and origination operations concentrate their activities primarily
in the Netherlands, Germany and the Scandinavian regions. In the fourth quarter
of 2001, our European Energy segment expanded its electricity trading operations
to the United Kingdom.
The primary customers of our European Energy segment are electric
distribution companies, large industrial consumers and energy trading companies.
We sell electricity and other energy-related commodities primarily in the form
of forward purchase contracts transacted in the over the counter markets, on
various European energy exchanges and in individually negotiated transactions
with individual counterparties. To a lesser extent, we also engage in
transactions involving financial energy-related derivative products.
The most significant factor affecting the markets in which our European
Energy segment operates has been the recent deregulation of the Dutch and
certain other European wholesale energy markets, including access on a
non-discriminatory basis to high voltage transmission grid systems, the
establishment of new energy exchanges and other events. Notwithstanding these
factors, the scope and pace of the future liberalization of the European energy
markets is uncertain. For example, access to some European markets continues to
be subject to transmission and other constraints. In some cases, fuel suppliers
continue to operate in largely regulated markets not yet open to full
competition.
EUROPEAN TRADING AND POWER ORIGINATION OPERATIONS
Our European Energy segment's trading and power origination operations are
centered in Amsterdam, Netherlands, with additional offices in London and
Frankfurt. Our European Energy segment trades electricity and fuel products in
the Netherlands, Germany, Austria, Switzerland, the United Kingdom and the
Scandinavian countries. Our marketing operations focus on distribution companies
and large industrial and commercial customers in the Benelux and German markets.
As of December 31, 2001, our European Energy segment had entered into forward
purchase and sale contracts, and associated hedging transactions, covering
approximately 18.6 million MWh for delivery in 2002.
Our European Energy segment's trading and power origination operations
seek to utilize a business model, including risk management and related control
policies, similar to that utilized in our Wholesale Energy operations in the
United States. There are, however, significant differences in the United States
and European markets. Among other things, European energy markets involve
increased currency hedging requirements (the Euro and non-Euro currencies), and
more complicated cross-border tax and transmission tariff systems than in the
United States. In addition, European energy markets are significantly less
mature than United States energy markets in terms of liquidity, the scope and
complexity of trading and marketing products, the use of standardized
market-based trading contracts and other aspects.
In addition, there exist greater uncertainties in some European
jurisdictions as to the enforceability of certain contract-based mechanisms to
hedge risks, such as the enforceability of automatic termination rights and
rights of set--off upon bankruptcy, limitations on liquidated damages and the
rules by which European courts construct contracts. In many civil law
jurisdictions, courts reserve the right to interpret contracts based upon
principles of good faith and fairness as opposed to a literal construction of
the contract
18
As of December 31, 2001, we had provided an aggregate of $831 million in
guarantees with respect to contract obligations of the European Energy segment.
COMPETITION
For a discussion of competitive factors affecting our European Energy
segment, please read "Management's Discussion and Analysis of Financial
Condition and Operations -- Certain Factors Affecting Our Future Earnings --
Factors Affecting the Results of Our European Energy Operations -- Competition
in the European Market" in Item 7 of this Form 10-K, which section is
incorporated herein by reference.
RETAIL ENERGY
We provide electricity and related services to retail customers primarily
in Texas through our wholly owned subsidiaries Reliant Energy Retail Services,
LLC (Residential Services), Reliant Energy Solutions, LLC (Solutions) and StarEn
Power, LLC (StarEn Power). As a retail electric provider, generally we procure
or buy electricity from wholesale generators at unregulated rates, sell
electricity at generally unregulated rates to our retail customers and pay the
local transmission and distribution regulated utilities a regulated tariff rate
for delivering the electricity to our customers. We became a provider of retail
electricity in Texas when that market began opening to retail competition in
late 2001 and fully opened to retail competition in January 2002. In January
2002, we began to provide retail electricity services to all of the
approximately 1.7 million customers of Reliant Energy's electric utility located
in its service area who did not take action to select another retail electric
provider. We provide electricity and related products and services to
residential and small commercial (i.e., small and medium-sized business
customers with a peak demand for power at or below one MW) customers through
Residential Services, and offer customized, integrated electric commodity and
energy management services to large commercial, industrial and institutional
(e.g., hospitals, universities, school systems and government agencies)
customers through Solutions for customers with a peak demand for power of
greater than one MW. Residential Services, Solutions and StarEn Power have been
certified as retail electric providers by the Texas Utility Commission. StarEn
Power has been appointed by the Texas Utility Commission to be the provider of
last resort (POLR) in certain areas of the State of Texas. Under the Texas
electric restructuring law, a POLR is required to offer a standard retail
electric service package to requesting customers of a class designated by the
Texas Utility Commission within the POLR's territory at a fixed, nondiscountable
rate.
In preparation for retail electric competition in Texas, we expanded our
infrastructure of information technology systems, business processes and
staffing levels to meet the needs of our retail businesses. These include a
customer care system module and wholesale/retail energy supply, risk management,
e-commerce, scheduling/settlement, customer relationship management and sales
force automation systems. As of December 31, 2001, we had invested $153 million
in retail infrastructure development. For additional information regarding the
Texas retail electric market, please read "-- Market Framework," "-- Regulation
- -- Texas -- Retail Energy" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Factors Affecting Our
Future Earnings -- Factors Affecting the Results of Our Retail Energy Operations
- -- Competition in the Texas Market" in Item 7 of this Form 10-K.
RESIDENTIAL SERVICES
Residential Services provides electricity to residential retail and small
commercial customers in Texas. As of January 1, 2002, Residential Services was
the retail electric provider for approximately 1.5 million residential customers
located in the Houston metropolitan area, making us the second largest retail
electric provider in Texas as of that date. Residential Services' marketing
strategy for residential customers emphasizes reliability and trust with our
customers, and focuses on savings, value and customer service. We launched an
advertising campaign to reposition our brand in the Houston and Dallas/Fort
Worth metropolitan areas in the second half of 2001.
As the affiliated retail electric provider, or successor in interest, to
Reliant Energy's electric utility, Residential Services was also the retail
electric provider for approximately 200,000 small commercial customers in the
Houston metropolitan area as of January 1, 2002. Residential Services' marketing
strategy for small commercial customers
19
uses a combination of direct marketing and individual sales calls to establish
our brand and to attract additional customers.
As the affiliated retail electric provider, Residential Services will not
be permitted to sell electricity to residential and small commercial customers
in Reliant Energy's electric utility service territory at a price other than a
fixed, specified price (price to beat) until January 1, 2005, unless before that
date the Texas Utility Commission determines that 40% or more of the amount of
electric power that was consumed in 2000 by the relevant class of customers in
the service territory is committed to be served by other retail electric
providers. In addition, the Texas electric restructuring law requires us, as the
affiliated retail electric provider, to make the price to beat available to
residential and small commercial customers in Reliant Energy's electric utility
service territory through January 1, 2007, if requested by such customers. For
more information about the price to beat, please read "-- Regulation -- Texas --
Retail Energy."
SOLUTIONS
Solutions provides electricity and energy services to large commercial,
industrial and institutional customers with whom it has signed contracts. In
addition, it provides electricity at previously established default rates to
those large commercial, industrial and institutional customers in the service
territory of Reliant Energy's electric utility who have not entered into a
contract with another retail electric provider. The majority of Solutions'
revenues will come from the sale of electricity to its customers. In order to be
classified as a large commercial customer, an electricity customer may aggregate
the purchase of electricity for its own use at multiple locations such that the
total peak demand exceeds one MW.
In addition to providing electricity, Solutions provides customized,
integrated energy solutions, including risk management and energy services
products, and demand side and energy information services to large commercial,
industrial and institutional customers. Since its formation in April 1996,
Solutions has completed over 220 energy services projects for large commercial,
industrial and institutional clients. The services that Solutions provides its
customers include the replacement or upgrade of energy-intensive capital
equipment, the financing of energy-intensive equipment, infrastructure
optimization, substation development and maintenance and power quality
assurance.
Solutions is recognized as the affiliated retail electric provider, or
successor in interest, to Reliant Energy's electric utility for large
commercial, industrial and institutional customers. Solutions targets
institutional, manufacturing, industrial and other large commercial customers,
including multisite retailers and restaurants, petroleum refineries, chemical
companies, real estate management firms, educational institutions and healthcare
providers. As of December 31, 2001, this customer segment in Texas included
approximately 1,750 buying organizations consuming an aggregate of approximately
16,000 MW of electricity at peak demand. As of December 31, 2001, Solutions had
signed contracts with customers representing a peak demand of approximately
3,700 MW and serving approximately 12,000 meter locations.
STAREN POWER
StarEn Power serves as the POLR in portions of the state of Texas, as
designated by the Texas Utility Commission. For 2002, StarEn Power has been
appointed to serve as the POLR for residential and small commercial customers in
the western portion of the Dallas/Fort Worth metropolitan area formally served
by TXU Electric Company. In addition, StarEn Power has been appointed as the
POLR in the service territory of Reliant Energy's electric utility for large
commercial, industrial and institutional customers. The rates and terms under
which StarEn Power provides service are governed by the terms of a settlement
agreement between StarEn Power and various interested parties approved by the
Texas Utility Commission. For additional information regarding our POLR
obligations, rates and terms of service, please read "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Certain Factors
Affecting Our Future Earnings -- Factors Affecting the Results of Our Retail
Energy Operations -- Obligations as a Provider of Last Resort" in Item 7 of this
Form 10-K.
20
MARKET FRAMEWORK
The Texas electric restructuring law substantially amended the regulatory
structure governing electric utilities in Texas in order to allow retail
competition, which fully began in January 2002. In order to prepare for the
opening of the retail market, a retail pilot project for up to 5% of each
utility's load in all customer classes began in August 2001. For information
regarding the retail market framework in Texas, please read "-- Regulation --
Texas -- Retail Energy" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Factors Affecting the Results of Our Retail Energy Operations" in
Item 7 of this Form 10-K. Generally, under the Texas electric restructuring law,
the retail electric provider procures or buys electricity from wholesale
generators, sells electricity at retail to its customers and pays the
transmission and distribution utility a regulated tariffed rate for delivering
electricity to its customers. All retail electric providers in an area pay the
same rates and other charges for transmission and distribution, whether or not
they are affiliated with the transmission and distribution utility for that
area. The transmission and distribution rates in effect as of January 1, 2002
for each utility were set through rate cases before the Texas Utility
Commission.
RETAIL ENERGY SUPPLY
In Texas, our Wholesale Energy group and our Retail Energy group work
together in order to determine the price, demand and supply of energy required
to meet the needs of our Retail Energy segment's customers. Our Wholesale Energy
trading and marketing operations are responsible for commodity pricing, risk
assessment and supply procurement for our Retail Energy segment. Our Retail
Energy segment manages retail pricing decisions and forecasts the demand for the
procurement of electricity by the Wholesale Energy segment. The costs of our
trading, marketing and risk management services associated with obtaining the
electricity supply for our retail customers in Texas are borne by our Retail
Energy segment. Our Wholesale Energy group acquires supply for our Retail Energy
segment by several means. We may purchase capacity from non-affiliated parties
in the capacity auctions mandated by the Texas Utility Commission. Please read
"-- Regulation -- Texas -- Retail Energy" for more information about these
auctions. Under the terms of the Master Separation Agreement between Reliant
Resources and Reliant Energy, we may also participate in and purchase up to
approximately 50% of the remaining capacity of the generation facilities to be
owned by Texas Genco sold in auctions substantially similar to, but separate
from, the capacity auctions mandated by the Texas Utility Commission in which
15% of the total capacity of these facilities is required to be auctioned. In
addition, we have the right to purchase 50% (but not less than 50%) of the
remaining capacity of Texas Genco following the state mandated capacity auctions
at prices to be established in the aforementioned Texas Genco auctions. Please
read Notes 3 and 4(b) to our consolidated financial statements for a discussion
of our participation in these auctions. We also enter into bilateral contracts
with third parties for capacity, energy and ancillary services. We continuously
monitor and update these positions based on retail sales forecasts and market
conditions.
COMPETITION
For a discussion of competitive factors affecting our Retail Energy
segment, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Factors Affecting the Results of Our Retail Energy Operations --
Competition in the Texas Market" in Item 7 of this Form 10-K, which section is
incorporated herein by reference.
OTHER OPERATIONS
For 2001, our Other Operations business segment included:
- the operations of our venture capital division (New Ventures),
- the operations of our communications business (Communications), and
- unallocated corporate costs.
21
NEW VENTURES
Our New Ventures division manages our existing new technology investments
and identifies and invests in promising new technologies and businesses that
relate to our energy services operations. Focus areas for investment include
distributed generation, clean energy and energy industry software and systems.
Generally, we make our investments either directly or indirectly as
limited partners in venture capital funds. As of December 31, 2001, we have
invested approximately $35 million in five venture capital funds with an energy
and utility focus and have made commitments to invest an additional $11 million
in these funds. As of December 31, 2001, these funds held investments in 43
companies. Excluding our investment in Grande Communications, Inc. discussed
below, New Ventures' direct investment portfolio consists of eight companies
with a total of $7 million invested as of December 31, 2001.
In September 2000, we committed to make a $25 million investment in Grande
Communications, Inc., which was completed in August 2001. Grande Communications
is a Texas-based communications company building a deep fiber broadband network
that will offer bundled services, including high-speed Internet, all-distance
telephone and advanced cable entertainment to homes and businesses. We invested
a further $1 million in Grande Communications in October 2001 as part of a
larger debt and equity financing for the company. Grande Communications has
announced its intention to build a broadband network in the Houston area and has
secured a cable franchise from the City of Houston. The Houston build out will
be in addition to the Central Texas cities of Austin, San Marcos, and San
Antonio which are already under development.
COMMUNICATIONS
During the third quarter of 2001, we decided to exit our Communications
business. The business served as a facility-based competitive local exchange
carrier and Internet services provider and owned network operations centers and
managed data centers in Houston and Austin. Our exit plan was substantially
completed in the first quarter of 2002. For more information regarding the
exiting of our Communication business, please read Note 16 to our consolidated
financial statements.
REGULATION
OVERVIEW
We are subject to regulation by various federal, state, local and foreign
governmental agencies, including the regulations described below.
FEDERAL ENERGY REGULATORY COMMISSION
Electricity. Under the Federal Power Act, the FERC has exclusive
rate-making jurisdiction over wholesale sales of electricity and the
transmission of electricity in interstate commerce by "public utilities." Public
utilities that are subject to the FERC's jurisdiction must file rates with the
FERC applicable to their wholesale sales or transmission of electricity in
interstate commerce. All of our generation subsidiaries sell power at wholesale
and are public utilities under the Federal Power Act with the exception of two
facilities in Texas, which are qualifying facilities and not regulated as public
utilities. The FERC has authorized these subsidiaries to sell electricity and
related services at wholesale at market-based rates. In its orders authorizing
market-based rates, the FERC also has granted these subsidiaries waivers of many
of the accounting, record keeping and reporting requirements that are imposed on
public utilities with cost-based rate schedules.
The FERC's orders accepting the market-based rate schedules filed by our
subsidiaries or their predecessors, as is customary with such orders, reserve
the right to revoke or limit our market-based rate authority if the FERC
subsequently determines that any of our affiliates possess excessive market
power. If the FERC were to revoke or limit our market-based rate authority, we
would have to file, and obtain the FERC's acceptance of, cost-based rate
schedules for all or some of our sales. In addition, the loss of market-based
rate authority could subject us to the accounting, record keeping and reporting
requirements that the FERC imposes on public utilities with cost-based rate
schedules.
22
The FERC issued Order No. 2000 in December 1999. Order No. 2000, which
applies to all FERC jurisdictional transmission providers, describes the FERC's
intention to promote the establishment of large RTOs and sets forth the minimum
characteristics and functions of RTOs. Among the basic minimum characteristics
are that the RTOs must be independent of market participants and must be of
sufficient scope and geographical configuration. Order No. 2000 also encourages
RTOs to work with each other to minimize or eliminate "seams" issues between
RTOs that operate as barriers to inter-regional transactions. The FERC's goal is
to encourage the growth of a robust competitive wholesale market for
electricity. Although jurisdictional transmission providers are not required to
join RTOs, they are encouraged to do so. Under Order No. 2000, RTOs were to be
operational by December 15, 2001. However, because RTO development was in
different stages in different regions of the country, the FERC issued an order
on November 7, 2001 extending the deadline until it resolves issues relating to
geographic scope and governance of qualifying RTOs across the country and issues
relating to business and procedural needs. For organizations to accomplish the
functions of Order No. 2000, the FERC is taking steps to create business
standards and protocols to facilitate RTO formation. However, there can be no
assurance that the FERC's goals will be achieved. Also there is considerable
state-level resistance in some regions, including regions in which we operate,
to the formation of RTOs. At least 14 separate organizations, covering the
substantial majority of all the FERC jurisdictional transmission providers, are
in various stages of organization and have made at least preliminary filings
with the FERC.
Trading and Marketing. Our domestic trading and marketing operations are
also subject to the FERC's jurisdiction under the Federal Power Act. As a gas
marketer, we make sales of natural gas in interstate commerce at wholesale
pursuant to a blanket certificate issued by the FERC, but the FERC does not
otherwise regulate the rates, terms or conditions of these gas sales. We are
also a "public utility" under the Federal Power Act, and our wholesale sales of
electricity in interstate commerce are subject to a FERC-filed rate schedule
that authorizes us to make sales at negotiated, market-based rates.
In authorizing market-based rates for various of our subsidiaries, the
FERC has imposed some restrictions on these entities' transactions with Reliant
Energy's electric utility, including a prohibition on the receipt of goods or
services on a preferential basis. The FERC also has imposed restrictions on
natural gas transactions between us and Reliant Energy's natural gas pipeline
subsidiaries to preclude any preferential treatment. Similar restrictions apply
to transactions between us and Reliant Energy's electric utility under Texas
utility regulatory laws.
Hydroelectric Facilities. The majority of our generating facilities
located in the state of New York are hydroelectric facilities, many of which are
subject to the FERC's exclusive authority under the Federal Power Act to license
non-federal hydroelectric projects located on navigable waterways and federal
lands. These FERC licenses must be renewed periodically and can include
conditions on operation of the project at issue.
TEXAS -- RETAIL ENERGY
In June 1999, Texas adopted the Texas electric restructuring law. The
Texas electric restructuring law substantially amended the regulatory structure
governing electric utilities in Texas. Full retail competition in the service
territories of some investor-owned electric utilities began in January 2002, and
in the territories of any municipally-owned utility and electric cooperative
that opts to open its market to retail competition. Under the Texas electric
restructuring law, the traditional, vertically-integrated utility is required to
separate its generation, transmission and distribution, and retail activities.
Unlike the vertically-integrated utility, which was subject to cost-of-service
rate regulation, the profit earned by retail electric providers will not be
subject to regulation, except for the price to beat requirement described below.
The transmission and distribution business will continue to be subject to
cost-of-service rate regulation and will be responsible for the delivery of
electricity to retail customers through retail electric providers. Wholesale
power generators will continue to sell electric energy to purchasers, including
retail electric providers, at unregulated rates. To facilitate a competitive
market, each power generator affiliated with a transmission and distribution
utility is required to sell at auction 15% of the output of its installed
generating capacity. This auction obligation continues until January 1, 2007,
unless the Texas Utility Commission determines before that date that at least
40% of the quantity of electric power consumed in 2000 by residential and small
commercial customers in the affiliated transmission and distribution utility's
service area is being served by retail electric providers not affiliated with
the incumbent utility. An affiliated retail electric provider may not purchase
capacity sold by its affiliated power generation company in the state mandated
capacity auctions.
23
The Texas electric restructuring law allows most retail electric customers
of Texas investor-owned electric utilities, and those of any municipally-owned
utility or electric cooperative that opts to open its market to retail
competition, to take action to select their retail electric provider for service
as of January 1, 2002. Retail electric providers which are affiliates of, or
successors in interest to, electric utilities may compete substantially
statewide for these sales, but prices they may charge to residential and small
commercial customers within the affiliated electric utility's traditional
service territory are subject to a fixed, specified price (price to beat) at the
outset of retail competition. The price to beat is subject to potential
adjustments up to two times per year, as described below. In December 2001, the
Texas Utility Commission established the price to beat we are required to charge
our residential and small commercial customers for electricity sales in the
Houston metropolitan area. Our price to beat was set at a level resulting in an
estimated 17% reduction to pre-existing rates for our residential customers and
an estimated 22% reduction to pre-existing rates for our small commercial
customers.
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. In November 2001, Nueces Electric Cooperative and San Patricio Electric
Cooperative received Texas Utility Commission approval of required filings
necessary to open their markets to retail competition. 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.
New, unaffiliated retail electric providers that enter a particular market
may sell electricity to residential and small commercial customers at any price,
including a price below the price to beat. By allowing non-affiliated retail
electric providers to provide retail electric service to customers in an
electric utility's traditional service territory at any price, including a price
below the price to beat, the Texas electric restructuring law is designed to
encourage competition among retail electric providers. Affiliated retail
electric providers will not be permitted to sell electricity to residential and
small commercial customers in the transmission and distribution utility's
traditional service territory at a price other than the price to beat until
January 1, 2005, unless before that date the Texas Utility Commission determines
that 40% or more of the amount of electric power that was consumed in 2000 by
the relevant class of customers in the certificated service area of the
affiliated transmission and distribution utility is committed to be served by
other retail electric providers. In addition, the Texas electric restructuring
law requires the affiliated retail electric provider to make the price to beat
available to residential and small commercial customers in the traditional
service area of the related incumbent utility through January 1, 2007. The price
to beat only applies to electric services provided to residential and small
commercial customers (i.e., customers with an aggregate peak demand at or below
one MW). Electric services provided to large commercial, industrial and
institutional customers (i.e., customers with an aggregate peak demand of
greater than one MW), whether by the affiliated retail electric provider or a
non-affiliated retail electric provider, may be provided at any negotiated
price.
The Texas Utility Commission's regulations allow an affiliated retail
electric provider to adjust the wholesale energy supply cost component or "fuel
factor," included in its price to beat based on a percentage change in the price
of natural gas. The fuel factor included in our price to beat was initially set
by the Texas Utility Commission at the then average forward 12 month gas price
strip of approximately $3.11/mmbtu. In addition, the affiliated retail electric
provider may also request an adjustment as a result of changes in its price of
purchased energy. In such a request, the affiliated retail electric provider may
adjust the fuel factor to the extent necessary to restore the amount of headroom
that existed at the time the initial price to beat fuel factor was set by the
Texas Utility Commission. An affiliated retail electric provider may request
that its price to beat be adjusted twice a year. Currently, we cannot estimate
with any certainty the magnitude and timing of the adjustments required, if any,
and the eventual impact of such adjustments on headroom. To the extent that the
adjustments are not received on a timely basis, our results of operations may be
adversely affected. Based on forward gas prices at the end of March 2002, we
estimate that we would be able to increase our price to beat by between
approximately 4% and 5%.
The Texas electric restructuring law requires the affiliated retail
electric provider to reconcile and credit to the affiliated transmission and
distribution utility in early 2004 any positive difference between the price to
beat, reduced by a specified delivery charge, and the prevailing market price of
electricity unless the Texas Utility Commission determines that, on or prior to
January 1, 2004, 40% or more of the amount of electric power that was consumed
in 2000 by residential or small commercial customers, as applicable, within the
affiliated transmission
24
and distribution utility's traditional service territory is committed to be
served by other non-affiliated retail electric providers. If the 40% test is not
met, the reconciliation and credit will be in the form of a payment to Reliant
Energy, not to exceed $150 per customer. For additional information regarding
this payment, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources --
Consolidated Capital Requirements and Uses of Cash -- Payment to Reliant Energy"
in Item 7 of this Form 10-K and Note 13(g) to our consolidated financial
statements.
The Texas electric restructuring law requires the Texas Utility Commission
to designate retail electric providers as POLR in areas of the state in which
retail competition is in effect. A POLR is required to offer a standard retail
electric service package for each class of customers designated by the Texas
Utility Commission at a fixed, nondiscountable rate approved by the Texas
Utility Commission, and is required to provide the service package to any
requesting retail customer in the territory for which it is the POLR. In the
event that another retail electric provider fails to serve any or all of its
customers, the POLR is required to offer that customer the standard retail
service package for that customer class with no interruption of service to the
customer. For additional information regarding our obligation as a POLR, and
regarding the Texas retail market framework in general, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of Our Retail Energy Operations" in Item 7 of this Form 10-K.
SECURITIES AND EXCHANGE COMMISSION -