EXHIBIT 99(a)
(8) COMMITMENTS AND CONTINGENCIES
(a) HL&P. HL&P has various commitments for capital expenditures, fuel,
purchased power, cooling water and operating leases. Commitments in
connection with HL&P's capital program are generally revocable by HL&P
subject to reimbursement to manufacturers for expenditures incurred or
other cancellation penalties. HL&P's other commitments have various
quantity requirements and durations. However, if these requirements
could not be met, various alternatives are available to mitigate the
cost associated with the contracts' commitments.
HL&P's capital program (exclusive of AFUDC) is presently estimated to
cost $478 million in 1994, $381 million in 1995 and $418 million in
1996. These amounts do not include expenditures on projects for which
HL&P expects to be reimbursed by customers or other parties.
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HL&P has entered into several long-term coal, lignite and natural gas
contracts which have various quantity requirements and durations.
Minimum obligations for coal and transportation agreements are
approximately $167 million in 1994, and $165 million in 1995 and 1996.
In addition, the minimum obligations under the lignite mining and lease
agreements will be approximately $14 million annually during the
1994-1996 period. HL&P has entered into several gas purchase agreements
containing contract terms in excess of one year which provide for
specified purchase and delivery obligations. Minimum obligations for
natural gas purchase and natural gas storage contracts are approximately
$57.4 million in 1994, $58.9 million in 1995 and $60.5 million in 1996.
Collectively, the gas supply contracts included in these figures could
amount to 11% of HL&P's annual natural gas requirements. The Utility
Commission's rules provide for recovery of the coal, lignite and natural
gas costs described above through the energy component of HL&P's
electric rates. Nuclear fuel costs are also included in the energy
component of HL&P's electric rates based on the cost of nuclear fuel
consumed in the reactor.
HL&P has commitments to purchase firm capacity from cogenerators of
approximately $145 million in 1994, $32 million in 1995 and $22 million
in 1996. The Utility Commission's rules allow recovery of these costs
through HL&P's base rates for electric service and additionally
authorize HL&P to charge or credit customers for any variation in actual
purchased power cost from the cost utilized to determine its base rates.
In the event that the Utility Commission, at some future date, does not
allow recovery through rates of any amount of purchased power payments,
the three principal firm capacity contracts contain provisions allowing
HL&P to suspend or reduce payments and seek repayment for amounts
disallowed.
In November 1990, the Clean Air Act was extensively amended by Congress.
HL&P has already made an investment in pollution control facilities, and
all of its generating facilities currently comply in all material
respects with sulfur dioxide emission standards established by the
legislation. Provisions of the Clean Air Act dealing with urban air
pollution required establishing new emission limitations for nitrogen
oxides from existing sources. The cost of modifications necessary to
reduce nitrogen oxide emissions from existing sources has been estimated
at $29 million in 1994 and $10.5 million in 1995. In addition,
continuous emission monitoring regulations are anticipated to require
expenditures of $12 million in 1994 and $2 million in 1995. Capital
expenditures are expected to total $71 million for the years 1994
through 1996.
The Energy Policy Act of 1992, which became law in October 1992,
includes a provision that assesses a fee upon domestic utilities having
purchased enrichment services from the Department of Energy before
October 22, 1992. This fee is to cover a portion of the cost to
decontaminate and decommission the enrichment facilities. It is
currently estimated that the assessment to the South Texas Project
Electric Generating Station (South Texas Project) will be approximately
$4 million in 1994 and approximately $2 million each year thereafter
(subject to escalation for inflation), of which HL&P's share is 30.8%.
This assessment will continue until the earlier of 15 years or when
$2.25 billion (adjusted for inflation) has been collected from domestic
utilities. Based on HL&P's actual payment of $579,810 in 1993, it
recorded an estimated liability of $8.7 million.
HL&P's service area is heavily dependent on oil, gas, refined products,
petrochemicals and related business. Significant adverse events
affecting these industries would negatively impact the revenues of the
Company and HL&P.
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(9) JOINTLY-OWNED NUCLEAR PLANT
(a) HL&P INVESTMENT. HL&P is project manager and one of four co-owners in
the South Texas Project, which consists of two 1,250 megawatt nuclear
generating units. Unit Nos. 1 and 2 of the South Texas Project achieved
commercial operation in August 1988 and June 1989, respectively. Each
co-owner funds its own share of capital and operating costs associated
with the plant, with HL&P's interest in the project being 30.8%. HL&P's
share of the operation and maintenance expenses is included in electric
operation and maintenance expenses on the Company's Statements of
Consolidated Income and in the corresponding operating expense amounts
on HL&P's Statements of Income.
As of December 31, 1993, HL&P's investments (net of accumulated
depreciation and amortization) in the South Texas Project and in nuclear
fuel, including AFUDC, were $2.1 billion and $119 million, respectively.
(b) CITY OF AUSTIN LITIGATION. In 1983, the City of Austin (Austin), one of
the four co-owners of the South Texas Project, filed a lawsuit against
the Company and HL&P alleging that it was fraudulently induced to
participate in the South Texas Project and that HL&P failed to perform
properly its duties as project manager. After a jury trial in 1989,
judgment was entered in favor of HL&P, and that judgment was affirmed on
appeal. In May 1993, following the expiration of Austin's rights to
appeal to the United States Supreme Court, the judgment in favor of the
Company and HL&P became final.
On February 22, 1994, Austin filed a new suit against HL&P. In that
suit, filed in the 164th District Court for Harris County, Texas, Austin
alleges that the outages at the South Texas Project since February 1993
are due to HL&P's failure to perform obligations it owed to Austin under
the Participation Agreement among the four co-owners of the South Texas
Project (Participation Agreement). Austin asserts that such failures
have caused Austin damages of at least $125 million, which are
continuing, due to the incurrence of increased operating and maintenance
costs, the cost of replacement power and lost profits on wholesale
transactions that did not occur. Austin states that it will file a
"more detailed" petition at a later date. For a discussion of the 1993
outage, see Note 9(f).
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As it did in the litigation filed against HL&P in 1983, Austin asserts
that HL&P breached obligations HL&P owed under the Participation
Agreement to Austin, and Austin seeks a declaration that HL&P had as
duty to exercise reasonable care in the operation and maintenance of the
South Texas Project. In that earlier litigation, however, the courts
concluded that the Participation Agreement did not impose on HL&P a duty
to exercise reasonable skill and care as Project Manager.
Austin also asserts in its new suit that certain terms of a settlement
reached in 1992 among HL&P and Central and South West Corporation (CSW)
and its subsidiary, Central Power and Light Company (CPL), are invalid
and void. The Participation Agreement permits arbitration of certain
disputes among the owners, and the challenged settlement terms provide
that in any future arbitration, HL&P and CPL would each appoint an
arbitrator acceptable to the other. Austin asserts that, as a result of
this agreement, the arbitration provisions of the Participation
Agreement are void and Austin should not be required to participate in
or be bound by arbitration proceedings; alternatively, Austin asserts
that HL&P's rights with respect to CPL's appointment of an arbitrator
should be shared with all the owners or canceled, and Austin seeks
injunctive relief against arbitration of its dispute with HL&P. For a
further discussion of the settlement among HL&P, CSW and CPL, see Note
9(c) below.
HL&P and the Company do not believe there is merit to Austin's claims,
and they intend to defend vigorously against them. However, there can
be no assurance as to the ultimate outcome of this matter.
(c) ARBITRATION WITH CO-OWNERS. During the course of the litigation filed
by Austin in 1983, the City of San Antonio (San Antonio) and CPL, the
other two co-owners in the South Texas Project, asserted claims for
unspecified damages against HL&P as project manager of the South Texas
Project, alleging HL&P breached its duties and obligations. San Antonio
and CPL requested arbitration of their claims under the Participation
Agreement. This matter was severed from the Austin litigation and is
pending before the 101st District Court in Dallas County, Texas.
The 101st District Court ruled that the demand for arbitration is valid
and enforceable under the Participation Agreement, and that ruling has
been upheld by appellate courts. Arbitrators were appointed by HL&P and
each of the other co-owners in connection with the District Court's
ruling. The Participation Agreement provides that the four appointed
arbitrators will select a fifth arbitrator, but that action has not yet
occurred.
In 1992, the Company and HL&P entered into a settlement with CPL and
CSW with respect to various matters including the arbitration and
related legal proceedings. Pursuant to the settlement, CPL withdrew its
demand for arbitration under the Participation Agreement, and the
Company, HL&P, CSW and CPL dismissed litigation associated with the
dispute. The settlement also resolved other disputes between the
parties concerning various transmission agreements and related billing
disputes. In addition, the parties also agreed to support, and to seek
consent of the other owners of the South Texas Project to, certain
amendments to the Participation Agreement, including changes in the
management structure of the South Texas Project through which HL&P would
be replaced as project manager by an independent entity.
Although settlement with CPL does not directly affect San Antonio's
pending demand for arbitration, HL&P and CPL have reached certain other
understandings which contemplate that: (i) CPL's arbitrator previously
appointed for that proceeding would be replaced by CPL; (ii) arbitrators
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approved by CPL and HL&P for any future arbitrations will be mutually
acceptable to HL&P and CPL; and (iii) HL&P and CPL will resolve any
future disputes between them concerning the South Texas Project without
resorting to the arbitration provision of the Participation Agreement.
The settlement with CPL did not have a material adverse effect on the
Company's or HL&P's financial position and results of operations.
In February 1994, San Antonio indicated a desire to move forward with
its demand for arbitration and suggested that San Antonio considers all
allegations of mismanagement against HL&P to be appropriate subjects for
arbitration in that proceeding, not just allegations related to the
planning and construction of the South Texas Project. It is unclear
what additional allegations San Antonio may make, but it is possible
that San Antonio will assert that HL&P has liability for all or some
portion of the additional costs incurred by San Antonio due to the 1993
outage of the South Texas Project. For a discussion of that outage see
Note 9(f).
HL&P and the Company continue to regard San Antonio's claims to be
without merit. From time to time, HL&P and other parties to these
proceedings have held discussions with a view toward settling their
differences on these matters.
While HL&P and the Company cannot give definite assurance regarding the
ultimate resolution of the San Antonio litigation and arbitration, they
presently do not believe such resolutions will have a material adverse
impact on HL&P's or the Company's financial position and results of
operations.
(d) NUCLEAR INSURANCE. HL&P and the other owners of the South Texas Project
maintain nuclear property and nuclear liability insurance coverages as
required by law and periodically review available limits and coverage
for additional protection. The owners of the South Texas Project
currently maintain $500 million in primary property damage insurance
from American Nuclear Insurers (ANI). Effective November 15, 1993, the
maximum amounts of excess property insurance available through the
insurance industry increased from $2.125 billion to $2.2 billion. This
$2.2 billion of excess property insurance coverage includes $800 million
of excess insurance from ANI and $1.4 billion of excess property
insurance coverage through participation in the Nuclear Electric
Insurance Limited (NEIL) II program. The owners of the South Texas
Project have approved the purchase of the additional available excess
property insurance coverage. Additionally, effective January 1, 1994,
ANI will be increasing their excess property insurance limits to $850
million, and the owners of the South Texas Project have also approved
the purchase of the additional limits at the March 1, 1994 renewal for
ANI excess property insurance. Under NEIL II, HL&P and the other owners
of the South Texas Project are subject to a maximum assessment, in the
aggregate, of approximately $15.9 million in any one policy year. The
application of the proceeds of such property insurance is subject to the
priorities established by the United States Nuclear Regulatory
Commission (NRC) regulations relating to the safety of licensed reactors
and decontamination operations.
Pursuant to the Price Anderson Act, the maximum liability to the public
for owners of nuclear power plants, such as the South Texas Project, was
increased from $7.9 billion to $9.3 billion effective February 18, 1994.
Owners are required under the Act to insure their liability for nuclear
incidents and protective evacuations by maintaining the maximum amount
of financial protection available from private sources and by
maintaining secondary financial protection through an industry
retrospective rating plan. Effective August 20, 1993, the assessment of
deferred premiums provided by the plan for each nuclear incident has
increased from $63 million to up to $75.5 million per reactor subject to
indexing for inflation, a possible 5%
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surcharge (but no more than $10 million per reactor per incident in
any one year) and a 3% state premium tax. HL&P and the other owners of
the South Texas Project currently maintain the required nuclear
liability insurance and participate in the industry retrospective rating
plan.
There can be no assurance that all potential losses or liabilities will
be insurable, or that the amount of insurance will be sufficient to
cover them. Any substantial losses not covered by insurance would have
a material effect on HL&P's and the Company's financial condition.
(e) NUCLEAR DECOMMISSIONING. HL&P and the other co-owners of the South
Texas Project are required by the NRC to meet minimum decommissioning
funding requirements to pay the costs of decommissioning the South Texas
Project. Pursuant to the terms of the order of the Utility Commission
in Docket No. 9850, HL&P is currently funding decommissioning costs for
the South Texas Project with an independent trustee at an annual amount
of $6 million.
As of December 31, 1993, the trustee held approximately $18.7 million
for decommissioning, for which the asset and liability are reflected on
the Company's Consolidated and HL&P's Balance Sheets in deferred debits
and deferred credits, respectively. HL&P's funding level is estimated
to provide approximately $146 million in 1989 dollars, an amount which
currently exceeds the NRC minimum. However, the South Texas Project
co-owners have engaged an outside consultant to review the estimated
decommissioning costs of the South Texas Project which review should be
completed by the end of 1994. While changes to present funding levels,
if any, cannot be estimated at this time, a substantial increase in
funding may be necessary. No assurance can be given that the amounts
held in trust will be adequate to cover the decommissioning costs.
(f) NRC INSPECTIONS AND OPERATIONS. Both generating units at the South
Texas Project were out of service from February 1993 to February 1994,
when Unit No. 1 was authorized by the NRC to return to service.
Currently, Unit No. 1 is out of service for repairs to a small steam
generator leak encountered following the unit's shutdown to repair a
feedwater control valve. Those repairs are scheduled for completion by
mid-March 1994, and no formal NRC approval is required to resume
operation of Unit No. 1. Unit No. 2 is currently scheduled to resume
operation after completion of regulatory reviews, in the spring of 1994.
HL&P removed the units from service in February 1993 when a problem was
encountered with certain pumps. At that time HL&P concluded that the
units should not resume operation until HL&P had determined the root
cause of the failure and had briefed the NRC and corrective action had
been taken. The NRC formalized that commitment in a Confirmatory Action
Letter, which confirmed that HL&P would not resume operations until it
had briefed the NRC on its findings and actions. Subsequently, that
Confirmatory Action Letter was supplemented by the NRC to require HL&P,
prior to resuming operations, to address additional matters which were
identified during the course of analyzing the issues associated with the
original pump failure and during various subsequent NRC inspections and
reviews.
In June 1993, the NRC announced that the South Texas Project had been
placed on the NRC's "watch list" of plants with "weaknesses that warrant
increased NRC attention." Plants in this category are authorized to
operate but are subject to close monitoring by the NRC. The NRC reviews
the status of plants on this list semi-annually, but HL&P does not
anticipate that the South Texas Project would be removed from that list
until there has been a period of operation for both units, and the NRC
concludes that the concerns which led the NRC to place the South Texas
Project on that list have been satisfactorily addressed.
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The NRC's decision to place the South Texas Project on its "watch list"
followed the June 1993 issuance of a report by its Diagnostic Evaluation
Team (DET) which conducted a review of the South Texas Project in the
spring of 1993 and identified a number of areas requiring improvement at
the South Texas Project. Conducted infrequently, NRC diagnostic
evaluations do not evaluate compliance with NRC regulations but are
broad-based evaluations of overall plant operations and are intended to
review the strengths and weaknesses of the licensee's performance and to
identify the root cause of performance problems.
The DET report found, among other things, weaknesses in maintenance and
testing, deficiencies in training and in the material condition of some
equipment, strained staffing levels in operations and several weaknesses
in engineering support. The report cited the need to reduce backlogs of
engineering and maintenance work and to simplify work processes which,
the DET found, placed excessive burdens on operating and other plant
personnel. The report also identified the need to strengthen management
communications, oversight and teamwork as well as the capability to
identify and correct the root causes of problems. The DET also
expressed concern with regard to the adequacy of resources committed to
resolving issues at the South Texas Project but noted that many issues
had already been identified and were being addressed by HL&P.
In response to the DET report, HL&P presented its plan to address the
issues raised in that report and began its action program to address
those concerns. While those programs were being implemented, HL&P also
initiated additional activities and modifications that were not
previously scheduled during 1993 but which are designed to eliminate the
need for some future outages and to enhance operations at the South
Texas Project. The NRC conducted additional inspections and reviews of
HL&P's plans and agreed in February 1994 that HL&P's progress in
addressing the NRC's concerns had satisfied the issues raised in the
Confirmatory Action Letter with respect to Unit No. 1. The NRC
concurred in HL&P's determination that Unit No. 1 could resume
operation. Work is now underway to address the NRC's concerns with
respect to Unit No. 2, which HL&P anticipates will not require as
extensive an effort as was required by the NRC for Unit No. 1. However,
difficulties encountered in completing actions required on Unit No. 2
and any additional issues which may be raised in the conduct of those
activities or in the operation of Unit No. 1 could adversely affect the
anticipated schedule for resuming operation of Unit No. 2. During the
outage, HL&P has not had, and does not anticipate having, difficulty in
meeting its energy needs.
During the outage, both fuel and non-fuel expenditures have been higher
for HL&P than levels originally projected for the year. HL&P's non-fuel
expenditures for the South Texas Project during 1993 were approximately
$115 million greater than originally budgeted levels (of which HL&P's
share was $35 million) for work undertaken in connection with the DET
and for other initiatives taken during the year. It is expected that,
subsequent to 1993, operation and maintenance costs will continue to be
higher than previous levels in order to support additional initiatives
developed in 1993. Fuel costs also were necessarily higher due to the
use of higher cost alternative fuels. However, these increased
expenditures are expected to be offset to some extent by savings from
future outages that can now be avoided as a result of activities
accelerated into 1993 and from overall improvement in operations
resulting from implementing the programs developed during the outage.
For a discussion of regulatory treatment related to the outage, see
Notes 10(f) and 10(g).
During 1993, the NRC imposed a total of $500,000 in civil penalties (of
which HL&P's share was $154,000) in connection with violations of NRC
requirements.
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In March 1993, a Houston newspaper reported that the NRC had referred to
the Department of Justice allegations that the employment of three
former employees and an employee of a contractor to HL&P had been
terminated or disrupted in retaliation for their having made
safety-related complaints to the NRC. Such retaliation, if proved,
would be contrary to requirements of the Atomic Energy Act and
regulations promulgated by the NRC. The NRC has confirmed to HL&P that
these matters have been referred to the Department of Justice for
consideration of further action and has notified HL&P that the NRC is
considering enforcement action against HL&P and one or more HL&P
employees in connection with one of those cases. HL&P has been advised
by counsel that most referrals by the NRC to the Department of Justice
do not result in prosecutions. The Company and HL&P strongly believe
that the facts underlying these events would not support action by the
Department of Justice against HL&P or any of its personnel; accordingly,
HL&P intends to defend vigorously against such charges. HL&P also
intends to defend vigorously against civil proceedings filed in the
state court in Matagorda County, Texas, by the complaining employees and
against administrative proceedings before the Department of Labor and
the NRC, which, independently of the Department of Justice, could impose
administrative sanctions if they find violations of the Atomic Energy
Act or the NRC regulations. These administrative sanctions may include
civil penalties in the case of the NRC and, in the case of the
Department of Labor, ordering reinstatement and back pay and/or imposing
civil penalties. Although the Company and HL&P do not believe these
allegations have merit or will have a material adverse effect on the
Company or HL&P, neither the Company nor HL&P can predict at this time
their outcome.
(10) UTILITY COMMISSION PROCEEDINGS
Pursuant to a series of applications filed by HL&P in recent years, the
Utility Commission has granted HL&P rate increases to reflect in
electric rates HL&P's substantial investment in new plant construction,
including the South Texas Project. Although Utility Commission action
on those applications has been completed, judicial review of a number of
the Utility Commission orders is pending. In Texas, Utility Commission
orders may be appealed to a District Court in Travis County, and from
that Court's decision an appeal may be taken to the Court of Appeals for
the 3rd District at Austin (Austin Court of Appeals). Discretionary
review by the Supreme Court of Texas may be sought from decisions of the
Austin Court of Appeals. The pending appeals from the Utility
Commission orders are in various stages. In the event the courts
ultimately reverse actions of the Utility Commission in any of these
proceedings, such matters would be remanded to the Utility Commission
for action in light of the courts' orders. Because of the number of
variables which can affect the ultimate resolution of such matters on
remand, the Company and HL&P generally are not in a position at this
time to predict the outcome of the matters on appeal or the ultimate
effect that adverse action by the courts could have on the Company and
HL&P. On remand, the Utility Commission's action could range from
granting rate relief substantially equal to the rates previously
approved, to a reduction in the revenues to which HL&P was entitled
during the time the applicable rates were in effect, which could require
a refund to customers of amounts collected pursuant to such rates.
Judicial review has been concluded or currently is pending on the
final orders of the Utility Commission described below.
(a) DOCKET NOS. 6765, 6766 AND 5779. In February 1993, the Austin Court of
Appeals granted a motion by the Office of Public Utility Counsel (OPC)
to voluntarily dismiss its appeal of the Utility Commission's order in
HL&P's 1984 rate case (Docket No. 5779). In December 1993, the Supreme
Court of Texas granted a similar motion by OPC to dismiss its appeal of
the Utility
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Commission's order in HL&P's 1986 rate case (Docket Nos. 6765 and 6766).
As a result, appellate review of the Utility Commission's orders in
those dockets has been concluded, and the orders have been affirmed.
(b) DOCKET NO. 8425. In October 1992, a District Court in Travis County,
Texas affirmed the Utility Commission's order in HL&P's 1988 rate case
(Docket No. 8425). An appeal to the Austin Court of Appeals is pending.
In its final order in that docket, the Utility Commission granted HL&P a
$227 million increase in base revenues, allowed a 12.92% return on
common equity, authorized a qualified phase-in plan for Unit No. 1 of
the South Texas Project (including approximately 72% of HL&P's
investment in Unit No. 1 of the South Texas Project in rate base) and
authorized HL&P to use deferred accounting for Unit No. 2 of the South
Texas Project. Rates substantially corresponding to the increase
granted were implemented by HL&P in June 1989 and remained in effect
until May 1991.
In the appeal of the Utility Commission's order, certain parties have
challenged the Utility Commission's decision regarding deferred
accounting, treatment of federal income tax expense and certain other
matters. A recent decision of the Austin Court of Appeals, in an appeal
involving another utility (and to which HL&P was not a party), adopted
some of the arguments being advanced by parties challenging the Utility
Commission's order in Docket No. 8425. In that case, Public Utility
Commission of Texas vs. GTE-SW, the Austin Court of Appeals ruled that
when a utility pays federal income taxes as part of a consolidated
group, the utility's ratepayers are entitled to a fair share of the tax
savings actually realized, which can include savings resulting from
unregulated activities. The Texas Supreme Court has agreed to hear an
appeal of that decision, but on points not involving the federal income
tax issues, though tax issues could be decided in such opinion.
In its final order in Docket No. 8425, the Utility Commission did not
reduce HL&P's tax expense by any of the tax savings resulting from the
Company's filing of a consolidated tax return. Although the GTE
decision was not legally dispositive of the tax issues presented in the
appeal of Docket No. 8425, it is possible that the Austin Court of
Appeals could utilize the reasoning in GTE in addressing similar issues
in the appeal of Docket No. 8425. However, in February 1993 the Austin
Court of Appeals, considering an appeal involving another telephone
utility, upheld Utility Commission findings that the tax expense for the
utility included the utility's fair share of the tax savings resulting
from a consolidated tax return, even though the utility's fair share of
the tax savings was determined to be zero. HL&P believes that the
Utility Commission findings in Docket No. 8425 and in Docket No. 9850
(see Note 10(c)) should be upheld on the same principle (i.e., that the
Utility Commission determined that the fair share of tax savings to be
allocated to ratepayers is determined to be zero). However, no
assurance can be made as to the ultimate outcome of this matter.
The Utility Commission's order in Docket No. 8425 may be affected also
by the ultimate resolution of appeals concerning the Utility
Commission's treatment of deferred accounting. For a discussion of
appeals of the Utility Commission's orders on deferred accounting, see
Notes 10(e) and 11.
(c) DOCKET NO. 9850. In August 1992, a district court in Travis County
affirmed the Utility Commission's final order in HL&P's 1991 rate case
(Docket No. 9850). That decision was appealed by certain parties to the
Austin Court of Appeals, raising issues concerning the Utility
Commission's approval of a non-unanimous settlement in that docket, the
Utility Commission's calculation of federal income tax expense and the
allowance of deferred accounting reflected in the settlement. In August
1993, the Austin Court of Appeals
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affirmed on procedural grounds the ruling by the Travis County District
Court, and applications for writ of error were filed with the Supreme
Court of Texas by one of the other parties to the proceeding. The
Supreme Court has not yet ruled on these applications. In Docket No.
9850, the Utility Commission approved a settlement agreement reached
with most parties. That settlement agreement provided for a $313
million increase in HL&P's base rates, termination of deferrals granted
with respect to Unit No. 2 of the South Texas Project and of the
qualified phase-in plan deferrals granted with respect to Unit No. 1 of
the South Texas Project, and recovery of deferred plant costs. The
settlement authorized a 12.55% return on common equity for HL&P, and
HL&P agreed not to request additional increases in base rates that would
be implemented prior to May 1, 1993. Rates contemplated by that
settlement agreement were implemented in May 1991 and remain in effect.
The Utility Commission's order in Docket No. 9850 found that HL&P would
have been entitled to more rate relief than the $313 million agreed to
in the settlement, but certain recent actions of the Austin Court of
Appeals could, if ultimately upheld and applied to the appeal of Docket
No. 9850, require a remand of that settlement to the Utility Commission.
HL&P believes that the amount which the Utility Commission found HL&P
was entitled to would exceed any disallowance that would have been
required under the Austin Court of Appeals' ruling regarding deferred
accounting (see Notes 10(e) and 11) or any adverse effect on the
calculation of tax expense if the court's ruling in the GTE decision
were applied to that settlement (see Note 10(b) above). However, the
amount of rate relief to which the Utility Commission found HL&P to be
entitled in excess of the $313 million agreed to in the settlement may
not be sufficient if the reasoning in both the GTE decision and the
ruling on deferred accounting were to be applied to the settlement
agreement in Docket No. 9850. Although HL&P believes that it should be
entitled to demonstrate entitlement to rate relief equal to that agreed
to in the stipulation in Docket No. 9850, HL&P cannot rule out the
possibility that a remand and reopening of that settlement would be
required if decisions unfavorable to HL&P are rendered on both the
deferred accounting treatment and the calculation of tax expense for
ratemaking purposes.
(d) DOCKET NO. 6668. In June 1990, the Utility Commission issued the final
order in Docket No. 6668, the Utility Commission's inquiry into the
prudence of the planning, management and construction of the South Texas
Project. The Utility Commission's findings and order in Docket No. 6668
were incorporated in Docket No. 8425, HL&P's 1988 general rate case.
Pursuant to the findings in Docket No. 6668, the Utility Commission
found imprudent $375.5 million out of HL&P's $2.8 billion investment in
the two units of the South Texas Project.
The Utility Commission's findings did not reflect $207 million in
benefits received in a settlement of litigation with the former
architect-engineer of the South Texas Project or the effects of federal
income taxes, investment tax credits or certain deferrals. In addition,
accounting standards require that the equity portion of AFUDC accrued
for regulatory purposes under deferred accounting orders be utilized to
determine the cost disallowance for financial reporting purposes. After
taking all of these items into account, HL&P recorded an after-tax
charge of $15 million in 1990 and continued to reduce such loss with the
equity portion of deferrals in 1991 related to Unit No. 2 of the South
Texas Project. The findings in Docket No. 6668 represent the Utility
Commission's final determination regarding the prudence of expenditures
associated with the planning and construction of the South Texas
Project. Unless the order is modified or reversed on appeal, HL&P will
be precluded from recovering in rate proceedings the amount found
imprudent by the Utility Commission.
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Appeals by HL&P and other parties of the Utility Commission's order in
Docket No. 6668 were dismissed by a District Court in Travis County in
May 1991. However, in December 1992 the Austin Court of Appeals
reversed the District Court's dismissals on procedural grounds. HL&P
and other parties have filed applications for writ of error with the
Supreme Court of Texas concerning the order by the Austin Court of
Appeals, but unless the order is modified on further review, HL&P
anticipates that the appeals of the parties will be reinstated and that
the merits of the issues raised in those appeals of Docket No. 6668 will
be considered by the District Court, with the possibility of subsequent
judicial review once the District Court has acted on those appeals. In
addition, separate appeals are pending from Utility Commission orders in
Dockets Nos. 8425 and 9850, in which the findings of the order in Docket
No. 6668 are reflected in rates. See Notes 10(b) and 10(c).
(e) DOCKET NOS. 8230 AND 9010. Deferred accounting treatment for Unit No. 1
of the South Texas Project was authorized by the Utility Commission in
Docket No. 8230 and was extended in Docket No. 9010. Similar deferred
accounting treatment with respect to Unit No. 2 of the South Texas
Project was authorized in Docket No. 8425. For a discussion of the
deferred accounting treatment granted, see Note 11. In September 1992,
the Austin Court of Appeals, in considering the appeal of the Utility
Commission's final order in Docket Nos. 8230 and 9010, upheld the
Utility Commission's action in granting deferred accounting treatment
for operation and maintenance expenses, but rejected such treatment for
the carrying costs associated with the investment in Unit No. 1 of the
South Texas Project. That ruling followed the Austin Court of Appeals
decision rendered in August 1992, on a motion for rehearing, involving
another utility which had been granted similar deferred accounting
treatment for another nuclear plant. In its August decision, the court
ruled that Texas law did not permit the Utility Commission to allow the
utility to place the carrying costs associated with the investment in
the utility's rate base, though the court observed that the Utility
Commission could allow amortization of such costs.
The Supreme Court of Texas has granted applications for writ of error
with respect to the Austin Court of Appeals decision regarding Docket
Nos. 8230 and 9010. The Supreme Court of Texas has also granted
applications for writ of error on three other decisions by the Austin
Court of Appeals regarding deferred accounting treatment granted to
other utilities by the Utility Commission. The Supreme Court heard oral
arguments on these appeals on September 13, 1993. The court has not yet
ruled.
(f) DOCKET NO. 12065. HL&P is not currently seeking authority to change its
base rates for electric service, but the Utility Commission has
authority to initiate a rate proceeding pursuant to Section 42 of the
Public Utility Regulatory Policy Act (PURA) to determine whether
existing rates are unjust or unreasonable. In 1993, the Utility
Commission referred to an administrative law judge (ALJ) the complaint
of a former employee of HL&P seeking to initiate such a proceeding.
On February 23, 1994, the ALJ concluded that a Section 42 proceeding
should be conducted and that HL&P should file full information,
testimony and schedules justifying its rates. The ALJ acknowledged that
the decision was a close one, and is subject to review by the Utility
Commission. However, he concluded that information concerning HL&P's
financial results as of December 1992 indicated that HL&P's adjusted
revenues could be approximately $62 million (or 2.33% of its adjusted
base revenues) more than might be authorized in a current rate
proceeding. The ALJ's conclusion was based on various accounting
considerations, including use of a different treatment of federal income
tax expense than the method utilized in HL&P's last rate case. The ALJ
also found that there could be a link between the 1993 outage at the
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South Texas Project, the NRC's actions with respect to the South Texas
Project and possible mismanagement by HL&P, which in turn could result
in a reduction of HL&P's authorized rate of return as a penalty for
imprudent management.
HL&P and the Company believe that the examiner's analysis is incorrect,
that the South Texas Project has not been imprudently managed, and that
ordering a Section 42 proceeding at this time is unwarranted and
unnecessarily expensive and burdensome. HL&P has appealed
the ALJ's decision to the Utility Commission.
If HL&P ultimately is required to respond to a Section 42 inquiry, it
will assert that it remains entitled to rates at least at the levels
currently authorized. However, there can be no assurance as to the
outcome of a Section 42 proceeding if it is ultimately authorized, and
HL&P's rates could be reduced following a hearing. HL&P believes that
any reduction in base rates as a result of a Section 42 inquiry would
take effect prospectively.
HL&P is also a defendant in a lawsuit filed in a Fort Bend County,
Texas, district court by the same former HL&P employee who originally
initiated the Utility Commission complaint concerning HL&P's rates. In
that suit, Pace and Scott v. HL&P, the former employee contends that
HL&P is currently charging illegal rates since the rates authorized by
the Utility Commission do not allocate to ratepayers tax benefits
accruing to the Company and to HL&P by virtue of the fact that HL&P's
federal income taxes are paid as part of a consolidated group. HL&P is
seeking dismissal of that suit because in Texas exclusive jurisdiction
to set electric utility rates is vested in municipalities and in the
Utility Commission, and the courts have no jurisdiction to set such
rates or to set aside authorized rates except through judicial appeals
of Utility Commission orders in the manner prescribed in applicable law.
Although substantial damages have been claimed by the plaintiffs in that
litigation, HL&P and the Company consider this litigation to be wholly
without merit, and do not presently believe that it will have a material
adverse effect on the Company's or HL&P's results of operations, though
no assurances can be given as to its ultimate outcome at this time.
(g) FUEL RECONCILIATION. HL&P recovers fuel costs incurred in electric
generation through a fixed fuel factor that is set by the Utility
Commission. The difference between fuel revenues billed pursuant to
such factor and fuel expense incurred is recorded as an addition to or a
reduction of revenues, with a corresponding entry to under- or
over-recovered fuel, as appropriate. Amounts collected pursuant to the
fixed fuel factor must be reconciled periodically by the Utility
Commission against actual, reasonable costs as determined by the Utility
Commission. Any fuel costs which the Utility Commission determines are
unreasonable in a fuel reconciliation proceeding would not be
recoverable from customers, and a charge against earnings would result.
Under Utility Commission rules, HL&P is required to file an application
to reconcile those costs in 1994. Such a filing would also be required
in conjunction with any rate proceeding that may be filed, such as the
Section 42 proceeding described in Note 10(f).
Unless filed earlier in conjunction with a rate proceeding, HL&P
currently anticipates filing its fuel reconciliation application in the
fourth quarter of 1994 in accordance with a schedule proposed by the
Utility Commission staff. If that schedule is approved by the Utility
Commission, HL&P anticipates that fuel costs through some time in 1994
will be submitted for reconciliation. No hearing would be anticipated
in that reconciliation proceeding before 1995.
The schedule for a fuel reconciliation proceeding could be affected by
the institution of a prudence inquiry concerning the outage at the South
Texas Project. The Utility Commission staff has indicated a desire to
conduct an inquiry into the prudence of HL&P's management prior to and
during the outage, but it is currently unknown what action the Utility
Commission will take on that request or what the nature and scope of any
such proceeding
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would be. Such an inquiry could also be conducted in connection with a
rate proceeding under Section 42 of PURA if one is instituted by the
Utility Commission.
Through the end of 1993, HL&P had recovered through the fuel factor
approximately $115 million (including interest) less than the amounts
expended for fuel, a significant portion of which under recovery
occurred in 1993 during the outage at the South Texas Project. In any
review of costs incurred during the period of the 1993 outage at the
South Texas Project, it is anticipated that other parties will contend
that a portion of fuel costs incurred should be attributed to imprudence
on the part of HL&P and thus should be disallowed as unreasonable, with
recovery from rate payers denied. Those amounts could be substantial.
HL&P intends to defend vigorously against any allegation that its
actions have been imprudent or that any portion of its costs incurred
should be judged to be unreasonable, but no prediction can be made as to
the ultimate outcome of such a proceeding.
(11) DEFERRED PLANT COSTS
Deferred plant costs were authorized for the South Texas Project by the
Utility Commission in two contexts. In the first context, or "deferred
accounting," the Utility Commission orders permitted HL&P, for
regulatory purposes, to continue to accrue carrying costs in the form of
AFUDC (at a 10% rate) on its investment in the two units of the South
Texas Project until costs of such units were reflected in rates (which
was July 1990 for approximately 72% of Unit No. 1, and May 1991 for the
remainder of Unit No. 1 and 100% of Unit No. 2) and to defer and
capitalize depreciation, operation and maintenance, insurance and tax
expenses associated with such units during the deferral period.
Accounting standards do not permit the accrual of the equity portion of
AFUDC for financial reporting purposes under these circumstances.
However, in accordance with accounting standards, such amounts were
utilized to determine the amount of plant cost disallowance for
financial reporting purposes.
The deferred expenses and the debt portion of the carrying costs
associated with the South Texas Project are included on the Company's
Statements of Consolidated Income in deferred expenses and deferred
carrying costs, respectively.
Beginning with the June 1990 order in Docket No. 8425, deferrals were
permitted in a second context, a "qualified phase-in plan" for Unit No.
1 of the South Texas Project. Accounting standards require allowable
costs deferred for future recovery under a qualified phase-in plan to be
capitalized as a deferred charge if certain criteria are met. The
qualified phase-in plan as approved by the Utility Commission meets
these criteria.
During the period June 1990 through May 15, 1991, HL&P deferred
depreciation and property taxes related to the 28% of its investment in
Unit No. 1 of the South Texas Project not reflected in the Docket No.
8425 rates and recorded a deferred return on that investment as part of
the qualified phase-in plan. Deferred return represents the financing
costs (equity and debt) associated with the qualified phase-in plan. The
deferred expenses and deferred return related to the qualified phase-in
plan are included on the Company's Statements of Consolidated Income and
HL&P's Statements of Income in deferred expenses and deferred return
under phase-in plan, respectively. Under the phase-in plan, these
accumulated deferrals will be recoverable within ten years of the June
1990 order.
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On May 16, 1991, HL&P implemented under bond, in Docket No. 9850, a
$313 million base rate increase consistent with the terms of the
settlement. Accordingly, HL&P ceased all cost deferrals related to the
South Texas Project and began the recovery of such amounts. These
deferrals are being amortized on a straight-line basis as allowed by the
final order in Docket No. 9850. The amortization of these deferrals
totaled $25.8 million for both 1993 and 1992 and $16.1 million in 1991,
and is included on the Company's Statements of Consolidated Income and
HL&P's Statements of Income in depreciation and amortization expense.
See also Notes 10(b), 10(c) and 10(e).
The following table shows the original balance of the deferrals and the
unamortized balance at December 31, 1993.
Balance at
Original December 31,
Balance 1993
--------- -----------
(Thousands of Dollars)
Deferred Accounting: (a)
Deferred Expenses . . . . . $ 250,151 $ 233,341
Deferred Carrying Costs on
Plant Investment . . . 399,972 373,094
--------- ---------
Total . . . . . . . . . . 650,123 606,435
Qualified Phase-In Plan: (b) . 82,254 58,264
--------- ---------
Total Deferred Plant Cost . . . $ 732,377 $ 664,699
========= =========
__________
(a) Amortized over the estimated depreciable life of the South Texas
Project.
(b) Amortized over nine years beginning in May 1991.
As of December 31, 1993, HL&P has recorded deferred income taxes of
$200.9 million with respect to deferred accounting and $14.5 million
with respect to the deferrals associated with the qualified phase-in
plan.
(12) MALAKOFF ELECTRIC GENERATING STATION
The scheduled in-service dates for the Malakoff Electric Generating
Station (Malakoff) units were postponed during the 1980's as
expectations of continued strong load growth were tempered. These units
have been indefinitely deferred due to the availability of other cost
effective resource options. In 1987, all developmental work was stopped
and AFUDC accruals ceased.
Due to the indefinite postponement of the in-service date for Malakoff,
the engineering design work is no longer considered viable. The costs
associated with this engineering design work are currently included in
rate base and are earning a return per the Utility Commission's final
order in Docket No. 8425. Pursuant to HL&P's determination that such
costs will have no future value, $84.1 million was reclassified from
plant held for future use to recoverable project costs as of December
31, 1992. An additional $7.0 million was reclassified to recoverable
project costs in 1993. Amortization of these amounts began in 1993.
Amortization amounts will correspond to the amounts being earned as a
result of the inclusion of such costs in rate base. The Utility
Commission's action in allowing treatment of those costs as plant held
for future use has been challenged in the pending appeal of the Utility
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Commission's final order in Docket No. 8425. Also, recovery of such
Malakoff costs may be addressed if rate proceedings are initiated such
as that proposed under Section 42 of PURA. See Notes 10(b) and 10(f) for
a discussion of these respective proceedings.
In June 1990, HL&P purchased from its then fuel supply affiliate,
Utility Fuels, all of Utility Fuels' interest in the lignite reserves
and lignite handling facilities for Malakoff. The purchase price was
$138.2 million, which represented the net book value of Utility Fuels'
investment in such reserves and facilities. As part of the June 1990
rate order (Docket No. 8425), the Utility Commission ordered that issues
related to the prudence of the amounts invested in the lignite reserves
be considered in HL&P's next general rate case which was filed in
November 1990 (Docket No. 9850). However, under the October 1991
Utility Commission order in Docket No. 9850, this determination was
postponed to a subsequent docket.
HL&P's remaining investment in Malakoff through December 31, 1993 of
$167 million, consisting primarily of lignite reserves and land, is
included on the Company's Consolidated and HL&P's Balance Sheets in
plant held for future use. For the 1994-1996 period, HL&P anticipates
$14 million of expenditures relating to lignite reserves, primarily to
keep lignite leases and other related agreements in effect.
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