UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

 

 

 

Commission file number 1-16455

 

Reliant Energy, Inc.
(Exact Name of Registrant as Specified in Its Charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $9,169,562,460 (computed by reference to the closing sale price of the registrant’s common stock on the New York Stock Exchange on June 30, 2007, the last business day of the registrant’s most recently completed second fiscal quarter).

 

As of February 15, 2008, the registrant had 345,358,284 shares of common stock outstanding and no shares of common stock were held by the registrant as treasury stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for its 2008 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2007, are incorporated by reference into Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

 

This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements that contain projections, assumptions or estimates about our revenues, income, capital structure and other financial items, our plans and objectives for future operations or about our future economic performance, transactions and dispositions and financings and approvals related thereto. In many cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “believe,” “continue,” “could,” “intend,” “may,” “plan,” “potential,” “predict,” “should,” “will,” “expect,” “objective,” “projection,” “forecast,” “goal,” “guidance,” “outlook,” “effort,” “target” and other similar words. However, the absence of these words does not mean that the statements are not forward-looking.

 

Actual results may differ materially from those expressed or implied by the forward-looking statements as a result of many factors or events, including, but not limited to, the following:

 

 

Other factors that could cause our actual results to differ from our projected results are discussed or referred to in Item 1A of this report. Each forward-looking statement speaks only as of the date of the particular statement and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

 

 

 

We provide electricity and energy services to retail and wholesale customers through two business segments.

 

 

For information about our corporate history, business segments and disposition activities, see notes 1, 18, 20, 21 and 22 to our consolidated financial statements and “Selected Financial Data” in Item 6 of this Form 10-K.

 

As a retail electricity provider, we arrange for the transmission and delivery of electricity to our customers, bill customers and collect payment for electricity sold, and maintain call centers to provide customer service. We purchase the electricity we sell to customers from generation companies, utilities, power marketers and other retail energy companies in the wholesale market. We obtain our transmission and distribution services in Texas from entities regulated by the PUCT.

 

Our retail business for residential and small business customers is primarily concentrated in Texas. Based on metered locations, as of December 31, 2007, we had approximately 1.6 million residential and 147,000 small business customers, making us the second largest mass market electricity provider in Texas. Approximately 65% of our Texas customers are in the Houston area. We also have customers in other Texas cities, including Dallas, Ft. Worth and Corpus Christi.

 

In Texas and the PJM Market, we market electricity and energy services to commercial, industrial and governmental/institutional customers. These customers include refineries, chemical plants, manufacturing facilities, hospitals, universities, governmental agencies, restaurants and other facilities. Based on metered locations, as of December 31, 2007, we had approximately 93,000 commercial, industrial and governmental/institutional customers.

 

During 2007, we began to pilot residential and small business products and services in Texas that use advanced technology to help reduce customer consumption during peak usage periods. “Smart Energy” products are expected to lower our supply and operating costs, moderate consumer bills, reduce emissions and enhance our position as a retail market leader.

 

Under our supply strategy for our retail business, we structure our supply portfolio to match our load demands by procuring sufficient power prior to or concurrent with entering into retail sales commitments. Because of our credit-enhanced retail structure with a third party credit provider, we are not required to post collateral for our retail supply purchases.

Operations Data

 

See discussion of our retail energy strategy in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Overview” in Item 7 of this Form 10-K. See discussion of “—Competition and Seasonality” below and in “Risk Factors” in Item 1A of this Form 10-K.

 

 

 

 

 

 

 

 

 

 

As of December 31, 2007, we owned, had an interest in or leased 38 operating electric power generation facilities with an aggregate net generating capacity of 16,337 MW in five regions of the United States. The net generating capacity of these facilities consists of approximately 42% base-load, 34% intermediate and 24% peaking capacity.

 

We sell electricity and energy services from our generation portfolio in hour-ahead, day-ahead and forward markets in bilateral and ISO markets. We sell these products to investor-owned utilities, municipalities, cooperatives and other companies that serve end users or purchase power at wholesale for resale. We obtain transmission and distribution services for our power generation from ERCOT, various RTOs, utilities and municipalities. Because our facilities are not subject to traditional cost-based regulation, we can generally sell electricity at market-determined prices. The following table identifies the principal markets where we own, lease or have under contract wholesale generation assets:

 

 

Through the PJM Market’s reliability pricing model auctions, we have committed approximately 6,400 MW of capacity through the planning year ending May 2011. We expect that a substantial portion of our capacity that clears a PJM auction will continue to be committed to the PJM Market up to three years in advance. Revenue from these capacity sales is determined by market rules designed to ensure regional reliability, encourage competition and reduce price volatility. The California Public Utility Commission and Cal ISO are considering possible enhancements to existing resource adequacy requirements, including alternatives similar to capacity markets designed in New England and PJM.

To ensure adequate fuel supplies, we contract for natural gas, coal and fuel oil for our generation facilities. For our natural gas-fired plants, we also arrange for, schedule and balance natural gas from our suppliers and through transporting pipelines. To perform these functions, we lease natural gas transportation and storage capacity.

 

In February 2006, we completed an evaluation of our wholesale energy segment’s hedging strategy and use of capital. As a result of our evaluation, we substantially reduced hedging activity.

 

The following table describes our electric power generation facilities as of December 31, 2007:

 

 

 

 

Operations Data

 

See discussion of our wholesale energy strategy in “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Business Overview” in Item 7 of this Form 10-K.

 

 

 

 

 

Texas

 

We are certified by the PUCT to provide retail electric service in Texas. We sell electricity in the competitive areas of ERCOT to customers at unregulated prices. Our activities in Texas are subject to standards and regulations adopted by ERCOT. See “Risk Factors” in Item 1A of this Form 10-K.

 

Until January 1, 2007, we were required to make electricity available to Houston area residential and small business customers at the PUCT-approved “price-to-beat.” Any residential “price-to-beat” customers who did not select an alternative product by December 31, 2006 continued being served under our residential services plan.

 

Other States

 

We are certified in Delaware and Illinois to supply retail electric service to commercial and industrial customers in those states. Our retail activities in Delaware and Illinois are subject to standards and regulations adopted by PJM and each state’s utility commission.

 

We operate electric generation facilities in regions administered by PJM, Cal ISO and MISO. These ISOs operate under FERC-approved market rules. The market rules include price limits or caps applicable to all

generators and numerous other FERC-approved requirements relative to the manner in which we must operate our generating facilities.

 

Federal Energy Regulatory Commission

 

A number of our subsidiaries are public utilities under the Federal Power Act and are subject to FERC rules and oversight regulations. As public utilities, these subsidiaries sell power at either market-based rates (if FERC has granted market-based rate authority) or cost-based rates. Each of these subsidiaries has been granted market-based rate authority, although a limited number of services sold by some of them are sold at cost-based rates.

 

The retail and wholesale energy industries are intensely competitive. Our competitors include merchant energy companies, utilities, retail electric service providers and other companies, including in recent years companies owned by investment banking firms, hedge funds and private equity funds. Our principal competitors in the retail electricity markets outside of Houston are typically incumbent retail electric providers, which have the advantage of long-standing relationships with customers. In general, competition in the retail and wholesale energy markets is on the basis of price, service, brand image and product offerings, as well as market perceptions of creditworthiness. For additional information on the effect of competition and for a discussion of how seasonality impacts our business, see “Risk Factors” in Item 1A of this Form 10-K and note 17 to our consolidated financial statements.

 

We are subject to numerous federal, state and local requirements relating to the protection of the environment and the safety and health of personnel and the public. These requirements relate to a broad range of our activities, including the discharge of compounds into the air, water and soil; the proper handling of solid, hazardous and toxic materials and waste; noise and safety and health standards applicable to the workplace.

 

Based on existing regulations, our market outlook, and our current assessment of the costs of labor and materials and the state of evolving technologies, we estimate that we will invest approximately $261 million in 2008, $115 million in 2009 and $33 million to $338 million in 2010 through 2014 on projects to reduce our emission levels and lessen the environmental impact of our operations. These amounts include $39 million for future ash landfill expansions from 2008 through 2014. As described below, a significant amount of these expenditures relate to our election to upgrade the SO₂ emissions controls at some of our facilities.

 

In some cases, which are described below, environmental laws and regulations are pending, are under consideration, are in dispute or could be revised. Unless otherwise noted, we cannot predict the ultimate effect of these matters on our business. For additional information on how environmental matters may impact our business, see “Risk Factors” in Item 1A of this Form 10-K and note 13(b) to our consolidated financial statements.

 

Air Quality

 

Under the Clean Air Act, the EPA has implemented a number of emission control programs that affect industrial sources, including power plants, by limiting emissions of NOx and SO₂. NOx and SO₂ are precursors to the formation of acid rain, fine particulate matter and regional haze. NOx is also a precursor to the formation of ozone.

 

NO_x and SO₂ Emissions

 

In March 2005, the EPA finalized a regulation, referred to as the Clean Air Interstate Rule, to further reduce emissions of NOx and SO₂ in the Eastern United States in two phases. The first phase, which takes

effect in 2009 for NOx and 2010 for SO₂, requires overall reductions within the area of approximately 50% in NOx and SO₂ emissions on an annual basis. The second phase, which takes effect in 2015, requires additional reductions of approximately 10% for a 60% total reduction in NOx and approximately 15% for a 65% reduction in SO₂. The EPA regulations include the use of cap-and-trade programs to achieve these reductions.

 

These regulations require us to provide an allowance for each ton of NOx and SO₂ that we emit under a cap-and-trade program. We maintain emission allowances that at a minimum correspond with forward power sales. In general, we do not have emission allowances for all of our generation. We purchase emission allowances, as needed, to correspond with our generation of electricity.

 

We have undertaken studies to evaluate possible impacts of the Clean Air Interstate Rule and similar legislative and regulatory proposals, which will primarily affect our coal-fired facilities in the Eastern United States. Based on an economic analysis that includes plant operability, changes in the emission allowances market, potential impact of state-imposed regulations and our estimates at this time of capital expenditures, we have elected to invest $217 million in 2008, $51 million in 2009 and an estimated $26 million to $304 million in 2010 through 2013 to principally reduce our emissions of SO₂.

 

Mercury Emissions

 

In March 2005, the EPA finalized the Clean Air Mercury Rule (CAMR), a national rule designed to reduce mercury emissions from coal plants in two phases through a cap-and-trade system. CAMR targets phase I reductions of approximately 30% in 2010 and phase II reductions of approximately 70% in 2018.

 

States are permitted to adopt regulations that conform to CAMR or adopt their own mercury regulations that are stricter than CAMR. Ohio has adopted regulations implementing CAMR. Pennsylvania has finalized stricter regulations for mercury emissions. Pennsylvania’s program generally requires mercury reductions on a facility basis in two phases, with 80% reductions in 2010 and 90% reductions in 2015.

 

Several states initiated litigation targeting CAMR, in particular to require mercury control on a facility basis, instead of through a cap-and-trade system. In February 2008, a federal appeals court struck down CAMR as unlawful. The outcome of this ruling on Ohio and some other state regulations is uncertain, but it may impact our ultimate requirements to control mercury. Pennsylvania is expected to continue implementation of its program.

 

Our preliminary estimate of capital expenditures to comply primarily with the first phase of Pennsylvania’s mercury control program is $88 million to $103 million for 2008 through 2010. Our analysis and evaluation of alternatives for compliance with the second phase of Pennsylvania’s program, including potential capital expenditures for controls, is underway.

 

Air Particulates

 

In September 2006, the EPA issued revised national ambient air quality standards for fine particulate matter with an aerodynamic diameter less than or equal to 2.5 microns, or PM2.5. Individual states must identify the sources of emissions in noncompliant areas and develop emission reduction plans. These plans may be state-specific or regional in scope. If our generating assets are located in areas that are not in compliance, we could be required to take additional or accelerated steps to reduce our NOx and SO₂ emissions.

 

Greenhouse Gas Emissions

 

There is increasing focus within the United States over the direction of domestic climate change policy. Several states in the northeastern, midwestern and western United States, are increasingly active in developing state-specific or regional regulatory initiatives to stimulate CO₂ emission reductions in the electric power generation industry and other industries. The United States Congress is considering numerous bills that would impose mandatory limitation of CO₂ and other greenhouse gas emissions for the domestic power generation sector. The specific impact on our business will depend upon the form of emissions-related legislation or regulations ultimately adopted by the federal government or states in which our facilities are located. Ten

northeastern states, including New Jersey and Maryland, have formed the Regional Greenhouse Gas Initiative, or RGGI, which requires power generators to reduce CO₂ emissions by ten percent by 2019, beginning in 2009. California adopted legislation designed to reduce greenhouse gas emissions to 25% below 1990 levels by 2020, beginning in 2012.

 

In addition, the EPA has announced plans to consider regulations to address CO₂ emissions as part of the Clean Air Act’s New Source Review program. Individual states may also begin to take into account CO₂ emissions when considering permits to construct or modify significant sources of emissions.

 

In September 2007, we joined the Chicago Climate Exchange, a voluntary greenhouse gas registry, reduction and trading system. By joining the exchange, we have committed to reduce our greenhouse gas emissions to six percent below the average of our 1998-2001 levels by 2010. We expect to satisfy our reduction targets through previously implemented unit retirements and capacity factor reductions and ongoing heat rate improvement efforts and transacting on the exchange.

 

Water Quality

 

In July 2007, the EPA suspended its 2004 regulations relating to cooling water intake structures at large existing power plants pending further rulemaking. This action was in response to the Second Circuit Court of Appeals’ January 2007 remand of the 2004 regulations. The EPA retained interim requirements that associated intakes employ best technology available controls as determined on a plant-by-plant, best professional judgment basis.

 

Other

 

As a result of their age, many of our facilities contain significant amounts of asbestos insulation, other asbestos containing materials, as well as lead-based paint. Existing state and federal rules require the proper management and disposal of these potentially toxic materials. We believe we properly manage and dispose of such materials in compliance with these state and federal rules. See note 13(b) to our consolidated financial statements.

 

We do not believe we have any material liabilities or obligations under the Comprehensive Environmental Response Corporation and Liability Act of 1980 or similar state laws. These laws impose clean up and restoration liability on owners and operators of facilities from or at which there has been a release or threatened release of hazardous substances, together with those who have transported or arranged for the disposal of those substances.

 

As of December 31, 2007, we had 3,698 full-time and part-time employees. Of these employees, 1,085 are covered by collective bargaining agreements, which expire on various dates from April 30, 2008 through April 30, 2012. The following table sets forth the number of our employees as of December 31, 2007:

 

 

 

 

 

Mark M. Jacobs has served as our President and Chief Executive Officer since May 2007. Prior to that, he served as our Executive Vice President and Chief Financial Officer from July 2002 to October 2007.

 

Brian Landrum has served as our Executive Vice President and Chief Operating Officer since May 2007. Prior to that, he served as our Executive Vice President, Operations from February 2006 to May 2007. He was Senior Vice President, Commercial and Retail Operations, IT from February 2005 to February 2006; Senior Vice President, Customer Operations and Information Technology from January 2004 to February 2005; President, Reliant Energy Retail Services from June 2003 to January 2004 and Senior Vice President, Retail Operations from August 2001 to May 2003.

 

Rick J. Dobson has served as our Executive Vice President and Chief Financial Officer since October 2007. Prior to that, he served as Senior Vice President and Chief Financial Officer of Novelis Inc., an international aluminum rolling and recycling company, from July 2006 to August 2007 and Senior Vice President and Chief Financial Officer of Aquila, Inc., an electric and natural gas distribution company that also owns and operates generation assets, from October 2002 to July 2006.

 

Charles S. Griffey has served as our Senior Vice President, Market Design and Regulatory Affairs since December 2007. Prior to that, he was Senior Vice President, Regulatory Affairs from February 2003 to December 2007 and Vice President, Regulatory Planning and Analysis from December 1998 to February 2003.

 

D. Rogers Herndon has served as our Senior Vice President, Strategic Planning and Business Development since November 2007. He was Senior Vice President, Commercial Operations and Origination from May 2006 to November 2007. Prior to that, he was a Managing Director for PSEG Energy Resources and Trade and from March 2002 to March 2003, he was Managing Director—Global Derivatives for Bank of America.

 

Michael L. Jines has served as our Senior Vice President, General Counsel and Corporate Secretary since May 2003. He was our Deputy General Counsel and Senior Vice President and General Counsel, Wholesale Group from March 2002 to May 2003.

 

Suzanne L. Kupiec has served as our Senior Vice President, Risk and Structuring since January 2004. In July 2007, she also began serving as our Corporate Compliance Officer. She was our Vice President and Chief Risk and Corporate Compliance Officer from June 2003 to January 2004. From 2000 until the time she joined

us, she was a partner at Ernst & Young LLP, where she led its Energy Trading and Risk Management Practice serving both audit and advisory service clients.

 

Thomas C. Livengood has served as our Senior Vice President and Controller since May 2005. Prior to that, he served as our Vice President and Controller from August 2002 to May 2005.

 

Albert H. Myres has served as our Senior Vice President, Government and Public Affairs since December 2007. He served as Shell Oil Corporation’s Chief of Staff and Senior Advisor to the President and Country Chairman from August 2005 to December 2007 and Senior Advisor, Government Affairs from June 2002 to August 2005.

 

Karen D. Taylor has served as our Senior Vice President, Human Resources since December 2003. In November 2005, she was appointed as our Chief Diversity Officer. Ms. Taylor was Vice President, Human Resources from February 2003 to December 2003 and Vice President, Administration, Wholesale Group from October 1998 to February 2003.

 

Our principal offices are at 1000 Main, Houston, Texas 77002 (713-497-7000). The following information is available free of charge on our website (http://www.reliant.com):

 

 

You can request a free copy of these documents by contacting our investor relations department. It is our intention to disclose amendments to, or waivers from, our business ethics policy on our website. No information on our website is incorporated by reference into this Form 10-K. In addition, certain of these materials are available on the SEC’s website at (http://www.sec.gov) or at its public reference room: 100 F Street, NE, Room 1580, Washington, D.C. 20549 (1-800-SEC-0330).

 

We will timely provide the annual certification of our Chief Executive Officer to the New York Stock Exchange. We filed last year’s certification in June 2007. In addition, our Chief Executive Officer and Chief Financial Officer each have signed and filed the certifications under Section 302 of the Sarbanes-Oxley Act of 2002 with this Form 10-K.

 

 

The financial results of our wholesale and retail energy segments are subject to market risks beyond our control.

 

Our results of operations, financial condition and cash flows are significantly impacted by the prevailing demand and market prices for electricity, purchased power, fuel and emission allowances over which we have no control. Market prices can fluctuate dramatically in response to many factors, including weather conditions; changes in the prices of related commodities; changes in law and regulation; regulatory intervention (including the imposition of price limitations, bidding rules or similar mechanisms); market illiquidity; transmission constraints; environmental limitations; generation unit outages; fuel supply issues; national and world-wide economic activity; and other events.

 

The markets in which we operate are relatively immature markets that are characterized by elements of both deregulated and regulated markets. Changes in the regulatory environment in which we operate could adversely affect our ability to set rates, or the cost, manner or feasibility of conducting our business.

 

We operate in a regulatory environment that is undergoing varying restructuring initiatives. In many instances, the regulatory structures governing the electricity markets are still evolving, creating gaps in the regulatory framework and associated uncertainty. In addition, existing regulations may be revised or reinterpreted and new laws and regulations may be adopted or become applicable to our facilities or our commercial activities. We cannot predict the future direction of these initiatives or the ultimate effect that this changing regulatory environment will have on our business. Consequently, future regulatory restrictions, regulatory or political intervention or changes in laws and regulations, may constrain our ability to set rates at market prices or otherwise have an adverse effect on our business. See “Business—Regulation” in Item 1 of this Form 10-K.

 

The tightening of the supply and demand balance for electricity may result in significant long- and short-term price volatility in both our wholesale and retail businesses. Price volatility may result in legislative, regulatory or judicial initiatives intended to mitigate the impact of such volatility.

 

The permitting and construction of new generation facilities is a lengthy process. Additionally, the progressive tightening of environmental regulatory requirements and their reflection in permits and regulations may result in generation facilities being removed from service prior to their end of useful life or derated permanently or temporarily. As a result, there may be periods when the supply of electricity is reduced or constrained relative to the demand for electricity. During these periods the wholesale price and retail price of electricity may increase significantly. In response to this, legislators, regulators, consumers and others may seek legislative, regulatory or judicial relief in an attempt to control or limit the wholesale price and/or the retail price of electricity.

We depend on sources, facilities and systems that we do not own or control for our fuel and fuel supply and to deliver electricity to and bill our customers. Any disruption in these sources, facilities or systems could have an adverse effect on our business.

 

We depend on fuel sources and fuel supply facilities owned and operated by third parties to supply our generation plants. We depend on power transmission and distribution facilities and metering systems owned and operated by third parties to deliver electricity to our customers and provide energy usage data. If these sources, facilities or systems fail, are disrupted or become unavailable to us, we may be unable to generate and/or provide electricity, our cost of doing so may significantly increase and/or we may be subject to contractual or other penalties. In addition, inaccurate or untimely information from third parties could hinder our ability to bill customers and collect amounts owed. We also participate in regional power pools, reliability councils and transmission organizations and changes in the rules governing such groups and/or in the composition of such groups may have an adverse effect on our business. Participation in RTOs is voluntary, and transmission owning companies may exit an RTO so long as they do so in compliance with the applicable FERC tariffs and agreements and FERC approval.

 

The operation of generation facilities involves significant risks that could interrupt operations and increase our costs.

 

Ownership of generation assets exposes us to risks relating to the breakdown of equipment or processes; fuel supply or transportation interruptions; construction delays or cost overruns; shortages of or delays in obtaining equipment, material and labor; operational restrictions resulting from environmental limitations and governmental interventions; as well as other risks. In addition, many of our facilities are old and require significant maintenance expenditures. We are party to collective bargaining agreements with labor unions at several of our plants. If our workers were to engage in a strike, work stoppage or other slowdown, other employees were to become unionized or the terms and conditions in future labor agreements were renegotiated, we could experience a significant disruption in our operations and higher ongoing labor costs. Similarly, we have an aging workforce at a number of our plants creating potential knowledge and expertise gaps as those workers retire. If we are unable to secure fuel, we will not be able to run our generation units. Construction delays could cause extended and/or unplanned outages of our generation facilities. If a generation unit fails or is unavailable, we may have to purchase replacement power from third parties at higher prices. We have insurance, subject to limits and deductibles, covering some types of physical damage and business interruption related to our generation units. However, this insurance may not always be available on commercially reasonable terms. In addition, there is no assurance that insurance proceeds will be sufficient to cover all losses, insurance payments will be timely made or the policies themselves will be free of substantial deductibles.

 

Our business operations expose us to the risk of loss if third parties fail to perform their contractual obligations.

 

We may incur losses if third parties default on their contractual obligations, such as obligations to pay us money; buy or sell electricity, fuel, emission allowances and other commodities; or provide us with fuel transportation services, power transmission or distribution services. For additional information about third party default risk, including our efforts to mitigate against this risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Risk” in Item 7 of this Form 10-K and note 2(e) to our consolidated financial statements.

 

Our costs of compliance with environmental laws are significant and can affect our future financial results.

 

Our wholesale energy business is subject to extensive and evolving environmental regulations, particularly our coal- and oil-fired generation facilities. We incur significant costs in complying with these regulations and, if we fail to comply, could incur significant penalties. Our cost estimates for compliance with environmental regulations are based on our current assessment of the cost of labor and materials and the state of evolving technologies. Changes to the preceding factors, revisions of environmental regulations, litigation and new

legislation and/or regulations (including new climate change legislation and regulations), as well as other factors, could cause our actual costs to vary outside the range of our estimates. In addition, failure to comply with environmental requirements could require us to shut down or reduce production on our generation facilities or create liability exposure. New environmental laws or regulations may be adopted that would further constrain our operations or increase our environmental compliance costs. We also may be responsible for the environmental liabilities associated with generation facilities even if a prior owner caused the liabilities. We are required to purchase emission allowances to operate some of our facilities. Such allowances may be unavailable or only available at costs that would make it uneconomical to operate our generating assets. See “Business—Environmental Matters” in Item 1 of this Form 10-K and note 13(b) to our consolidated financial statements.

 

Failure to obtain or maintain any required permits or approvals could prevent or limit us from operating our business.

 

To operate our generating facilities and retail electric business, we must obtain and maintain various permits, licenses, approvals and certificates from governmental agencies. In some jurisdictions, we must also meet minimum requirements for customer service and comply with local consumer protection and other laws. Our failure to obtain or maintain any necessary governmental permits or licenses or to satisfy these legal requirements, including environmental compliance provisions, could limit our ability to operate our business or create liability exposure.

 

We could be liable for a share of the payment defaults of other market participants.

 

If a market participant defaults on its payment obligations to an ISO, we, together with other market participants, are liable for a portion of the default obligation that is not otherwise covered by the defaulting market participant. Each ISO establishes credit requirements applicable to market participants and the basis for allocating payment default amounts to market participants. In ERCOT, the allocation is based on share of the total load. As of December 31, 2007, we would have been liable for approximately 20% of any defaulted amount in ERCOT. In PJM, MISO and Cal ISO, the methods of allocating the share of defaults differ, and our exposure from these markets is currently relatively small.

 

Significant events beyond our control, such as hurricanes and other weather-related problems or acts of terrorism, could have a material adverse effect on our business.

 

The uncertainty associated with events beyond our control, such as significant weather events and the risk of future terrorist activity, may affect our results of operations and financial condition in unpredictable ways. These events could result in adverse changes in the insurance markets and disruptions of power and fuel markets. In addition, terrorist actions could damage or shut down our generation facilities or the fuel and fuel supply facilities or the power transmission and distribution facilities upon which our generation and retail businesses are dependent. These events could also adversely affect the United States economy, create instability in the financial markets and, as a result, have an adverse effect on our ability to access capital on terms and conditions acceptable to us.

 

Merrill Lynch provides credit support for our retail business.

 

Under the terms of our credit-enhanced retail structure, Merrill Lynch & Co., Inc. and an affiliate (Merrill Lynch) provide guarantees and post collateral for the supply purchases and related transactions of our Texas and PJM retail energy business. If we do not comply with the material terms of our agreement, Merrill Lynch could terminate its future obligations to provide guarantees and collateral postings on our behalf. There are a number of events, including non-payments of obligations and a non-investment-grade credit rating that could cause Merrill Lynch to default. If Merrill Lynch experiences downgrades in its credit rating or credit outlook, our suppliers may require other credit support or cease doing business with us pursuant to the credit-enhanced

retail structure. In these events, our ability to operate our Texas and PJM retail business could be impaired, which would adversely affect our liquidity, cash flows and results of operations.

 

We depend on third parties to provide electricity to supply our retail customers.

 

We purchase substantially all of our supply requirements from third parties. As a result, our financial performance depends on our ability to obtain adequate supplies of electric generation from third parties at prices below the prices we charge our customers.

 

Rising power supply costs could adversely affect the financial performance of our retail electric operations.

 

Our earnings and cash flows could be adversely affected in any period in which our power supply costs rise at a greater rate than our rates charged to customers. The price of our power supply purchases associated with our energy commitments can be different than that reflected in the rates charged to customers due to, among other factors:

 

 

We may lose further market share in the Houston retail electricity market, which is a significant contributor of income to our consolidated results.

 

In recent years, we have experienced declines in our share of the Houston retail electricity market, which represents approximately 65% of our residential customer base. This trend could continue. The new competitive market has attracted a number of new participants. Competitors are putting downward pressure on our Houston sales volumes and may put downward pressure on our margins over time. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Overview” in Item 7 of this Form 10-K.

 

Violations of market power standards may negatively impact the wholesale cost of power.

 

In 2006, the PUCT implemented a new rule on resource adequacy and market power in the ERCOT Region. In this rule, the PUCT increased the current price cap applicable to generation offers into the ERCOT energy market, eliminated current market power mitigation measures and adopted new market power standards. If a market participant violates the market power standards and it is not adequately mitigated, such violation could have the impact of increasing the wholesale cost of power, which could adversely impact our gross margins in the Texas retail market.

 

We depend on the ISOs to communicate operating and system information in a timely and accurate manner. Information that is not accurate or timely can have an impact on our future reported financial results.

 

Each ISO communicates information relating to a customer’s choice of retail electric provider and other data needed for servicing of customer accounts to utilities and retail electric providers. Any failure to perform these tasks will result in delays and other problems in enrolling, switching and billing customers. Some of the ISOs are also responsible for settling all electricity supply volumes in their region. Information that is not accurate or timely may result in incorrect estimates of our settled volumes and supply costs that would need to be corrected when such information is received. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—New Accounting Pronouncements, Significant Accounting Policies and Critical Accounting Estimates—Critical Accounting Estimates” in Item 7 of this Form 10-K.

 

Our borrowing levels, debt service obligations and restrictive covenants may adversely affect our business. We may be vulnerable to reductions in our cash flow.

 

As of December 31, 2007, we had total gross debt of $3.0 billion:

 

 

If we were unable to generate sufficient cash flows, access funds from operations or raise cash from other sources, we would not be able to meet our debt service and other obligations. These situations could result from adverse developments in the energy, fuel or capital markets, a disruption in our operations or those of third parties or other events adversely affecting our cash flows and financial performance.

 

Our hedging and other risk management activities may not work as planned.

 

Our hedges may not be effective as a result of basis price differences, transmission issues, price correlation, volume variations or other factors. See “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of this Form 10-K.

 

Changes in the wholesale energy market or changes in our evaluation of generation assets could result in impairments.

 

If our outlook for the wholesale energy market changes negatively, or if our ongoing evaluation of our wholesale energy segment results in decisions to mothball, retire or dispose of generation assets, we could have impairment charges related to goodwill or our fixed assets. See notes 2(g) and 2(h) to our consolidated financial statements.

 

Lawsuits, regulatory proceedings and tax proceedings could adversely affect our future financial results.

 

From time to time, we are named as a party to, or our property is the subject of, lawsuits, regulatory proceedings or tax proceedings. These proceedings involve highly subjective matters with complex factual and legal questions. Their outcome is uncertain. Any claim that is successfully asserted against us could result in significant damage claims and other losses. Even if we prevail, any proceedings could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations, which could adversely affect our financial condition, results of operations or cash flows. See notes 11, 13 and 14 to our consolidated financial statements.

 

We have entered into outsourcing arrangements with third party service providers. In addition, our operations are highly dependent on computer and other operating systems, including telecommunications systems. Any interruptions in these arrangements or systems could significantly disrupt our business operations.

 

In recent years, we have entered into outsourcing arrangements, such as information technology production software, infrastructure and development and certain functions within customer operations, with

third party service providers. If these service providers do not perform their obligations, we may incur significant costs and experience interruptions in our business operations in connection with switching to other service providers or assuming these obligations ourselves. We are also highly dependent on our specialized computer and communications systems, the operation of which could be interrupted by fire, flood, power loss, computer viruses or similar disruptions. There is no guarantee that our backup systems and disaster recovery plans will be effective.

 

If we acquire or develop additional generation assets, or dispose of existing generation assets, we may incur additional costs and risks.

 

We may seek to purchase or develop additional generation facilities or dispose of existing generation facilities. There is no assurance that these efforts will be successful. In any sale, we may be required to indemnify a purchaser against liabilities. To finance future acquisitions, we may be required to issue additional equity securities or incur additional debt.

 

For other Company risks, see “Business” in Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Form 10-K.

 

 

None.

 

 

Our principal executive offices are leased through 2018, subject to two five-year renewal options. Our principal generation facilities are described under “Business—Wholesale Energy” in Item 1 of this Form 10-K. We believe that our properties are adequate for our present needs. We have satisfactory title, rights and possession to our owned facilities, subject to exceptions, which, in our opinion, would not have a material adverse effect on the use or value of the facilities.

 

 

For a description of our material pending legal and regulatory proceedings and settlements, see notes 13 and 14 to our consolidated financial statements.

 

 

None.

 

 

Our common stock trades on the New York Stock Exchange under the ticker symbol “RRI.” On February 15, 2008, we had 36,142 stockholders of record.

 

The closing price of our common stock on December 31, 2007 was $26.24.

 

 

We have never paid dividends. Some of our debt agreements restrict the payment of dividends. See note 6 to our consolidated financial statements.

 

Sales of Unregistered Securities.  In the fourth quarter of 2007, we issued 42,818 shares of unregistered common stock pursuant to cashless warrant exercises under an exemption pursuant to Section 4(2) of the Securities Act of 1933, as amended.

 

Stock Price Performance Graph.  The following line graph compares the yearly percentage change in our cumulative total stockholder return on common stock with the cumulative total return of a broad equity market index (Standard & Poor’s 500 Stock Index) and the cumulative total return of a group of our peer companies comprised of Calpine Corporation, Constellation Energy Group, Inc., Dominion Resources, Inc., Dynegy Inc., Exelon Corporation, Mirant Corporation, NRG Energy, Inc., Sempra Energy and TXU Corp. TXU Corp. has been excluded from the graph for 2007 because it was acquired and is no longer a publicly-traded company.

 

This stock price performance graph is furnished in this Form 10-K and is not filed, as permitted by 17 CFR 229.201(e).

 

 

 

 

 

 

 

 

 

Our objective is to be a leader in delivering the benefits of competitive electricity markets to customers. Our business focuses on the competitive retail and wholesale electricity markets.

 

Our strategy is based on our core beliefs about the power industry and the retail and wholesale electricity markets. We are committed to delivering superior returns from competitive markets through insights into the fundamentals of our core markets and a commitment to risk-weighted investments whose return on invested capital exceeds our weighted-average cost of capital.

 

Retail Energy.  The retail energy segment is a low capital investment electricity resale business with relatively stable earnings (excluding unrealized gains/losses on energy derivatives). The key earnings drivers in the retail energy segment are the volume of electricity we sell to customers, the unit margins received on those sales and the cost of acquiring and serving those customers. We earn a margin by selling electricity to end-use customers and simultaneously acquiring supply. While short-term earnings in this business are impacted by local weather patterns and the competitive tactics of other retailers in the market, the longer-term earnings drivers of the business are delivering a superior customer experience, retaining and growing market share in our existing markets through innovative product offerings and expanding into new competitive markets.

 

Our core beliefs about the retail market are:

 

 

 

These core beliefs set the stage for our strategic direction. We will focus on the following value-creation levers:

 

 

Wholesale Energy.  The wholesale energy segment is a capital-intensive, cyclical business. Earnings are significantly impacted by spark spreads and capacity prices. Spark spreads are driven by a number of factors, including the prices of natural gas, coal and fuel oil, the cost of emissions, transmission, weather and global macro-economic factors, none of which we control. The key earnings drivers are the amount of electricity we generate, the margin we earn for each unit of electricity sold and the availability of our generating assets to meet demand. The factor that we have the most control over is the percentage of time that our generating assets are available to run when it is economical for them to do so. Longer-term earnings are driven by regional supply and demand fundamentals, the level of commodity prices and capacity markets.

 

Our core beliefs about the wholesale market are:

 

 

These core beliefs set the stage for our strategic direction. We will focus on the following value-creation levers:

 

 

Company-wide.  We will focus on the following value-creation levers:

 

 

We also believe that stockholder value is enhanced through the development of a highly motivated and customer-focused work force. We continue to focus on:

 

 

Our ability to achieve these strategic objectives and execute these actions is subject to a number of factors, some of which we may not be able to control. See “Cautionary Statement Regarding Forward-Looking Information” and “Risk Factors” in Item 1A of this Form 10-K.

 

Recent Events.  In February 2008, we entered into an agreement to sell our interests in Channelview, subject to approval of the court overseeing Channelview’s bankruptcy proceedings and other closing conditions. Sale proceeds will be used to settle creditors’ claims and a cash sharing agreement. Residual proceeds will be retained by us and will affect the amount of any gain or loss on the sale. It is possible an impairment could be recognized if the net proceeds and remaining assets (including cash and working capital) do not exceed our net investment in and receivables from Channelview. See note 21 to our consolidated financial statements.

 

The following discussion includes non-GAAP financial measures, which are not standardized; therefore it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. We strongly encourage investors to review our consolidated financial statements and publicly filed reports in their entirety and not rely on any single financial measure.

 

2007 Compared to 2006 and 2006 Compared to 2005

 

We reported $365 million consolidated net income, or $1.04 diluted income per share, for 2007 compared to $328 million consolidated net loss, or $1.07 loss per share, for 2006 and $331 million consolidated net loss, or $1.09 loss per share, for 2005.

 

 

Retail Energy Segment

 

In analyzing the results of our retail energy segment, we use the non-GAAP financial measures “retail gross margin” and “retail contribution margin,” which exclude the item described below, as well as our retail energy segment profit and loss measure, “contribution margin, including unrealized gains/losses on energy derivatives.” Retail gross margin and retail contribution margin should not be relied upon without considering the GAAP financial measures. The item that is excluded from these non-GAAP financial measures has a recurring effect on our earnings and reflects aspects of our business that are not taken into account by this measure.

 

Unrealized Gains/Losses on Energy Derivatives.  We use derivative instruments to manage operational or market constraints and to execute our retail energy segment’s supply procurement strategy. We are required to record in our consolidated statement of operations non-cash gains/losses related to future periods based on current changes in forward commodity prices for derivative instruments receiving mark-to-market accounting treatment. We refer to these gains and losses prior to settlement, as well as ineffectiveness on cash flow hedges, as “unrealized gains/losses on energy derivatives.” In substantially all cases, the underlying transactions being hedged receive accrual accounting treatment, resulting in a mismatch of accounting treatments. Since the application of mark-to-market accounting has the effect of pulling forward into current periods non-cash gains/losses relating to and reversing in future delivery periods, analysis of results of operations from one period to another can be difficult. We believe that excluding these unrealized gains/losses on energy derivatives provides a more meaningful representation of our economic performance in the reporting period and is therefore useful to us, investors, analysts and others in facilitating the analysis of our results of operations from one period to another.

Our retail energy segment’s contribution margin, including unrealized gains/losses on energy derivatives was $942 million in 2007 compared to $250 million in 2006. The $692 million increase was primarily due to the net change in unrealized gains/losses on energy derivatives of $725 million, partially offset by a $32 million decrease in retail gross margin. Our retail energy segment’s contribution margin, including unrealized gains/losses on energy derivatives was $250 million in 2006 compared to $342 million in 2005. The $92 million decrease was primarily due to the increase in unrealized losses on energy derivatives of $218 million. In addition, contribution margin was impacted by a $232 million increase in retail gross margin and a $106 million increase in operation and maintenance, selling and marketing and bad debt expense. See “—Retail Energy Margins” below for explanations.

 

Retail Energy Revenues.

 

 

 

 

Retail Energy Cost of Sales.

 

 

 

 

Retail Energy Margins.

 

 

 

 

Wholesale Energy Segment

 

In analyzing the results of our wholesale energy segment, we use the non-GAAP financial measures “open energy gross margin,” “open wholesale gross margin” and “open wholesale contribution margin,” which exclude the items described below, as well as our wholesale energy segment profit and loss measure, “contribution margin, including historical and operational wholesale hedges and unrealized gains/losses on energy derivatives.” Open energy gross margin, open wholesale gross margin and open wholesale contribution margin should not be relied upon without considering the GAAP financial measures. The items that are excluded from these non-GAAP financial measures have or have had a recurring effect on our earnings and reflect aspects of our business that are not taken into account by these measures.

 

Historical and Operational Wholesale Hedges.  We exclude the effect of certain historical, although recurring until the contracts terminate, wholesale hedges that were entered into in order to hedge the economics of a portion of our wholesale operations. These amounts primarily relate to settlements of forward power hedges, long-term tolling purchases, long-term natural gas transportation contracts not serving our generation assets and our legacy energy trading. We also exclude the effect of certain on-going operational wholesale hedges that were entered into primarily to mitigate certain operational risks at our generation assets. These amounts primarily relate to settlements of fuel hedges, long-term natural gas transportation contracts and storage contracts. Operational wholesale hedges are derived based on methodology consistent with the calculation of open energy gross margin. We believe that it is useful to us, investors, analysts and others to show our results in the absence of both historical and operational hedges. The impact of these hedges on our financial results is not a function of the operating performance of our generation assets, and excluding the impact better reflects the operating performance of our generation assets based on prevailing market conditions.

 

Unrealized Gains/Losses on Energy Derivatives.  We use derivative instruments to manage operational or market constraints and to increase the return on our generation assets. We are required to record in our consolidated statement of operations non-cash gains/losses related to future periods based on current changes in forward commodity prices for derivative instruments receiving mark-to-market accounting treatment. We refer to these gains and losses prior to settlement, as well as ineffectiveness on cash flow hedges, as “unrealized gains/losses on energy derivatives.” In some cases, the underlying transactions being hedged receive accrual accounting treatment, resulting in a mismatch of accounting treatments. Since the application of mark-to-market accounting has the effect of pulling forward into current periods non-cash gains/losses relating to and reversing in future delivery periods, analysis of results of operations from one period to another can be difficult. We believe that excluding these unrealized gains/losses on energy derivatives provides a more meaningful representation of our economic performance in the reporting period and is therefore useful to us, investors, analysts and others in facilitating the analysis of our results of operations from one period to another. These gains/losses are also not a function of the operating performance of our generation assets, and excluding their impact helps isolate the operating performance of our generation assets under prevailing market conditions.

 

Changes in California-Related Receivables and Reserves.  In 2005, we excluded the impact of changes in receivables and reserves relating to energy sales in California from October 2000 through June 2001. We reached a settlement concerning these receivables during the third quarter of 2005. Because of the market conditions and regulatory events that underlie the changes in these receivables and reserves, we believe that excluding this item provides a more meaningful representation of our results of operations on an ongoing basis and is therefore useful to us, investors, analysts and others in facilitating the analysis of our results of operations from one period to another. For additional information, see note 14(a) to our consolidated financial statements.

 

Our wholesale energy segment’s contribution margin, including historical and operational wholesale hedges and unrealized gains/losses on energy derivatives was $524 million in 2007 compared to $146 million in 2006. The $378 million increase was primarily due to (a) reduced negative effect of historical and operational wholesale hedges of $284 million and (b) $184 million increase in open wholesale gross margin. These increases were partially offset by (a) net change in unrealized gains/losses on energy derivatives of

$49 million and (b) $40 million increase in operation and maintenance expense. Our wholesale energy segment’s contribution margin, including historical and operational wholesale hedges and unrealized gains/losses on energy derivatives was $146 million in 2006 compared to $110 million in 2005. The $36 million increase was primarily due to (a) net change in unrealized gains/losses on energy derivatives of $179 million and (b) reduced negative effect of historical and operational wholesale hedges of $108 million. These increases were partially offset by (a) $199 million decrease in open wholesale gross margin and (b) $55 million increase in operation and maintenance expense. See “—Wholesale Energy Margins” below for explanations.

 

Wholesale Energy Revenues.