File No. 70-8725
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Amendment No. 7
(Post-Effective Amendment No. 2)
APPLICATION OR DECLARATION
on
FORM U-1
under
The Public Utility Holding Company Act of 1935
THE SOUTHERN COMPANY
270 Peachtree Street, N.W.
Atlanta, Georgia 30303
(Name of company or companies filing this statement
and addresses of principal executive offices)
THE SOUTHERN COMPANY
(Name of top registered holding company parent
of each applicant or declarant)
Tommy Chisholm, Secretary
The Southern Company
270 Peachtree Street, N.W.
Atlanta, Georgia 30303
(Names and addresses of agents for service)
The Commission is requested to mail signed copies of all
orders, notices and communications to:
W. L. Westbrook Marce Fuller, President
Financial Vice President Southern Energy, Inc.
The Southern Company 900 Ashwood Parkway
270 Peachtree Street, N.W. Suite 500
Atlanta, Georgia 30303 Atlanta, Georgia 30338
John D. McLanahan, Esq.
Troutman Sanders LLP
600 Peachtree Street, N.E.
Suite 5200
Atlanta, Georgia 30308-2216
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INFORMATION REQUIRED
The Application or Declaration in this proceeding, as heretofore
amended, is restated in its entirety to read as follows:
Item 1. Description of Proposed Transaction.
The Southern Company ("Southern") is seeking authority to utilize the
proceeds of authorized Southern financings to invest in Exempt Wholesale
Generators ("EWGs") and Foreign Utility Companies ("FUCOs") through December 31,
2005 in an amount equal to $4 billion in excess of amounts previously
authorized, or 175 percent of consolidated retained earnings as defined by Rule
53, whichever is greater. Southern further proposes that it be authorized to
issue Financial Guarantees or Performance Guarantees (as hereinafter defined) of
EWGs and FUCOs in any amount or combination of amounts through December 31,
2005, provided that the amounts of such Financial Guarantees and Performance
Guarantees outstanding shall be included as "aggregate investment" for the
purposes of Rule 53. Southern anticipates using the majority of this additional
authority to invest in U.S. domestic projects. These projects have become
increasingly attractive and important to Southern's operations as a result of
industry restructuring encouraged by the Federal Energy Regulatory Commission,
the implementation of the Energy Policy Act of 1992, state legislatures, and
state regulatory authorities. Southern requests that the Commission issue an
order authorizing the authority sought herein in an amount equal to 150% of
consolidated retained earnings as defined by Rule 53 and reserve jurisdiction
over the remaining amount pending future supplementation of the record in this
file.
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Southern renews, without qualification or modification, its commitment
not to seek recovery through the rates of its regulated public-utility
subsidiaries, including Alabama Power Company, Georgia Power Company, Gulf Power
Company, Mississippi Power Company and Savannah Electric and Power Company (the
"Operating Company" subsidiaries of Southern), of any costs associated with
Southern's investments in EWGs or FUCOs authorized herein. All of Southern's
investments in EWGs and FUCOs are segregated from the Operating Companies. No
Operating Company has extended credit or sold or pledged its assets directly or
indirectly to any EWG or FUCO, and the indebtedness of the EWG and FUCO projects
is not otherwise recourse to any Operating Company. Southern will not seek
recovery through higher rates to the Operating Companies' utility customers in
order to compensate Southern for any possible losses that it may sustain on
investments in EWGs or FUCOs or for any inadequate returns on such investments.
Each state commission has reserved its right to take appropriate action in order
to assure ratepayer protection, as is documented in the letters in this file.
Southern seeks no authority pertaining to its public-utility subsidiaries in
this filing. In support of its application Southern shows the following:
o With the passage of the Energy Policy Act of 1992, Congress
recognized that investment in generation projects apart from those owned or
operated by vertically-integrated public utilities, is consistent with the
efficient operation of a registered public-utility holding company system such
as Southern's and created the EWG mechanism to promote such investment.
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o Since the passage of the Energy Policy Act and the April 24, 1996
adoption of FERC Order 888, which provides for electric power transmission
service on a nondiscriminatory basis "functionally unbundled" from power
generation, there has emerged a vigorous United States (and North American)
energy market where all domestic operating generating plants have transmission
access to wholesale and retail markets.
o Since the passage of the Energy Policy Act, Southern has developed a
robust energy trading and marketing business apart from its traditional
pubic-utility operations, which greatly lessens the risk of investment in EWGs.
o Since the passage of the Energy Policy Act, several states have
effectively restructured electric power service so as to provide for the
generation and sale of electric power through market competition rather than
exclusively through vertically integrated electric power public-utility
companies. This restructuring has resulted in new opportunities for marketing
electric power generated by EWGs.
o A substantial demand exists for ownership and operation of generation
divested from public-utility systems in the United States.
o A substantial demand exists for new generating capacity both within
the United States and globally.
o Since the enactment of the exemption of FUCOs from the Act by the
Energy Policy Act, a substantial international energy market has emerged.
Effective participation within this market requires substantial portfolio
diversification among types of projects and among countries and investment at
levels sufficient to secure the advantages of economies of scale.
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o The additional authority sought herein will enable Southern to pursue
growth opportunities consistent with the Energy Policy Act and Southern's goal
of growing shareholder value at a faster growth rate than would occur solely as
a result of Southern's regulated public-utility operations. Southern seeks
thereby to minimize its overall cost of capital.
o Southern's investments to date in EWGs and FUCOs have been on a
diversified basis, have contributed to the growth of earnings, and have given
Southern experience in operating in deregulated energy markets.
o Utilization of the authority sought herein will not result in a
change in Southern's risk profile that is detrimental to investors or consumers,
particularly in light of the continuing commitment by Southern to insulate its
regulated public-utility operations from any costs pertaining to EWG and FUCO
investments.
1.1 Background.
Southern Company is a registered holding company under the Public
Utility Holding Company Act of 1935, as amended (the "Act"). Acting through the
subsidiaries now consolidated under its wholly-owned subsidiary, Southern
Energy, Inc. ("Southern Energy"), Southern has engaged in preliminary
development activities related to potential investments by Southern in
qualifying facilities ("QFs"), as defined under the Public Utility Regulatory
Policies Act of 1978, as amended, EWGs and FUCOs, as defined in Sections 32 and
33 of the Act, respectively, certain non-exempt power projects which constitute
a part of Southern's integrated electric utility system, energy-related
companies as defined by Rule 58, and in providing project management, operations
and maintenance, construction, fuel management, and other similar kinds of
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services to associate project companies and to non-associates.1 Southern now has
more than a decade's experience with projects of this nature. See, e.g., HCAR
No. 26212 (December 30, 1994); HCAR No. 24476 (October 20, 1987); HCAR No.
22315A (December 18, 1981); HCAR No. 22132 (July 17, 1981).
Southern is currently authorized under the terms of six separate orders
(the "Financing Orders") to finance the operations of its subsidiaries by
issuing and selling additional authorized shares of its common stock, par value
$5 per share, by issuing guarantees of the securities of certain subsidiaries,
by issuing notes evidencing short-term and term loan borrowings and/or
commercial paper, and by issuance of stock purchase contracts and stock purchase
units, Southern's authorization under the Financing Orders may be summarized as
follows:
o File No. 70-8277 (Holding Co. Act Rel. No. 26349, dated August 3,
1995). -- Southern may issue and sell in one or more transactions from time to
time through December 31, 1999, up to 25 million additional shares of its
authorized common stock (as such number may be adjusted for any subsequent share
split).
o File No. 70-8435 (Holding Co. Act Rel. No. 26347, dated August 5,
1995). -- Southern may issue and sell in one or more transactions from time to
time through December 31, 1999, additional shares of its authorized common stock
pursuant to Southern's dividend reinvestment, employee savings, and stock
ownership plans (collectively the "Plans").
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1 See Holding Co. Act Rel. No. 26212, dated December 30, 1994. See also
HCAR No. 26468, dated February 2, 1996.
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o File No. 70-8733 (Holding Co. Act Rel. No. 26468, dated February 2,
1996). -- Southern may guarantee from time to time through December 31, 2000,
the securities of one or more Exempt Projects or of certain other subsidiaries
which directly or indirectly hold interests in Exempt Projects in an aggregate
amount at any one time outstanding not to exceed $1.2 billion (hereafter
referred to as the "Financial Guarantees"). Southern proposes to increase and to
extend its authority to make Financial Guarantees to December 31, 2005, as set
forth herein, with the aggregate amount at any one time outstanding to be
included within the calculation of "aggregate investment" pursuant to Rule 53.
o File No. 70-8789 (Holding Co. Act Rel. No. 26489, dated March 13,
1996). -- Southern may issue and sell in one or more transactions from time to
time through December 31, 2001, notes evidencing short-term and term loan
borrowings and/or commercial paper in an aggregate principal amount at any one
time outstanding not to exceed $2 billion.
o File No. 70-8725 (Holding Co. Act Rel. No. 26501, dated April 1,
1996). -- Amending prior orders limiting the use of financing proceeds for
investment in EWGs and FUCOs to 50 percent of Southern's consolidated retained
earnings by increasing the percentage limitation to 100 percent of consolidated
retained earnings.
o File No. 70-9335 (Holding Co. Act Rel. No. 27061, dated August 18,
1999). -- Southern may issue and sell in one or more transactions from time to
time through September 20, 2003 up to $1 billion in stock purchase units
consisting of stock purchase contracts and preferred securities, notes and/or
debt obligations of third parties.
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Under the terms of each of the Financing Orders, Southern may use the
proceeds of common stock sales and borrowings to, among other things, finance
the acquisition of the securities of or other interest in one or more Exempt
Projects (or of certain intermediate subsidiaries organized to facilitate such
acquisitions), and may issue Financial Guarantees in respect of the securities
of such Exempt Projects (or such intermediate subsidiaries), provided that the
sum of the Financial Guarantees at any time outstanding and the net proceeds of
common stock sales and borrowings by Southern that may at any time be used by
Southern to fund investments in Exempt Projects (or in such intermediate
subsidiaries) shall not, when added to Southern's "aggregate investment," as
defined in Rule 53(a), in all such entities, exceed 100 percent of Southern's
consolidated retained earnings.2 The term "consolidated retained earnings," also
defined in Rule 53(a), is the average of consolidated retained earnings for the
previous four quarters, as reported on Form 10-K and Form 10-Q. For Southern,
consolidated retained earnings for the four quarters ending June 30, 1999, was
approximately $3.965 billion.
In addition to these Financing Orders, Southern is further authorized
by the terms of HCAR No. 26468 (December 30, 1994) to issue Performance
Guarantees3 on behalf of Exempt Projects in an amount not to exceed $250
million, provided that any such Performance Guarantees shall be included within
Southern's calculation of aggregate investment as defined in Rule 53(a).
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2 See File No. 70-8725 (Holding Co. Act Rel. No. 26501, dated April 1,
1996) amending prior orders to expand Southern's financing authority from 50
percent of consolidated retained earnings to 100 percent of consolidated
retained earnings.
3 Guarantees of performance of subsidiaries of Southern developing,
investing in or operating Exempt Projects and indemnification of persons acting
as surety on bonds or other obligations involved in the development, financing,
or operation of Exempt Projects.
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Southern proposes to extend this authority through 2005, to be exercised in any
amount consistent with the overall limitations upon investment in Exempt
Projects effective hereunder.
1.2 Description of Exempt Projects Currently Owned by Southern.
Since passage of the Energy Policy Act of 1992, which added Sections 32
and 33 to the Act, Southern has invested or committed to invest directly (or
indirectly through intermediate subsidiaries within the meaning of Rule 53) an
aggregate of approximately $3.892 billion at June 30, 1999, in Exempt Projects,
or in excess of 98 percent of Southern's consolidated retained earnings as
defined by Rule 53 for the four quarters ended June 30, 1999.4 Southern's
current holdings of Exempt Projects are reported in Southern's Certificates of
Notification filed pursuant to Rule 24 in this file. The most significant Exempt
Project holdings are as follows:
o SE California - In April, 1999, Southern Energy California L.L.C.
("SE California") acquired 3065 MW of generating capacity located near San
Francisco, California, for $801 million plus additional consideration for fuel
inventory, capital expenditures and property taxes. Purchased from Pacific Gas &
Electric Company, the capacity principally consists of peaking and intermediate
natural gas-fired generation. Southern Energy is undertaking to expand the
generating capacity owned by SE California.
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4 The calculation of aggregate investment does not include investment
which is non-recourse to Southern. Proprietary data concerning Exempt Project
financing and performance is filed with the Commission pursuant to Certificate
of Notification filed pursuant to Rule 24 and subject to Rule 104. 17 C.F.R. ss.
250.104. Southern Energy has undertaken debt financing without recourse to
Southern and has repaid certain amounts loaned to it by Southern. Accordingly,
as of August 1, 1999, aggregate investment was reduced to $3,605,175.
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o SE New York - Various subsidiaries of Southern Energy ("SE New York")
purchased 1776 MW of generation from Orange & Rockland Utilities, Inc. and
Consolidated Edison Company of New York for a net purchase price of $476.2
million. The generating capacity includes hydro-electric facilities and natural
gas, oil, and coal-fired plants. SE New York anticipates expanding its
generating capacity.
o SE Wisconsin - SEI Wisconsin, L.L.C. ("SE Wisconsin") is constructing
the Neenah Power Plant, a 300 MW natural gas-fired generating plant located in
the Town of Neenah, Wisconsin, and has entered into an eight year agreement to
sell the entire output of the plant to Wisconsin Electric Power Company. The
Neenah Power Plant is expected to cost $100 million and to be operational in
June 2000.
o SE Texas - SEI Texas, L.P. ("SE Texas") plans to develop, construct
and operate a 450 MW natural gas-fired generating plant in Whitney, Texas, near
the Dallas-Fort Worth metropolitan area. The output will initially be available
to SCEM under a tolling agreement and is likely to be used to satisfy a portion
of SCEM's wholesale power supply obligations to Brazos Electric Cooperative
which has contracted with SCEM for its requirements.
Initially the plant will operate as a peaking facility, with units
coming on line in June 2000 and January 2001, costing approximately $150
million. Southern Energy may in the future add heat recovery equipment and a
steam turbine, increasing total capacity to 675 MW and converting the plant to
an intermediate to base load plant.
o Consolidated Electric Power Asia Limited ("CEPA") -- Southern
acquired an 80 percent interest in CEPA in January of 1997, an additional 19.99
percent in August of 1997, and the final .01 percent in December, 1997. CEPA (an
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intermediate subsidiary that invests in FUCOs) is the largest independent power
producer in Asia. CEPA is engaged in Exempt Project development throughout Asia.
CEPA owns 1,807 megawatts of installed generating capacity.
o Shandong International Power Development Company -- Southern, through
its intermediate subsidiary, SE China Investments, Inc., acquired in June of
1999 a 9.9% interest in Shandong International Power Development Company Limited
("SIPD"), which owns 13 coal-fueled units for a total installed capacity of 3625
MW in China's Shandong province.
o Berliner Kraft und Licht AGA ("Bewag") -- Southern indirectly
acquired a 26 percent interest in Bewag, an integrated utility in Berlin,
Germany, through its participation in a consortium formed with two leading
German utilities, PreussenElektra and Bayernwerk, which together purchased 75
percent of Bewag in September, 1997. Bewag, a FUCO, serves approximately 2.1
million people in the city and suburbs of Berlin. Bewag's assets include nearly
26,000 miles of transmission and distribution lines and 3,116 megawatts of
generating capacity.
o Companhia Energetica de Minas Gerais ("CEMIG") -- In January 1998,
Southern acquired 8.24 percent of the voting shares of CEMIG. The state of Minas
Gerais in Brazil owns 51 percent, while AES owns a 21.1 percent share. Other
investors own the remaining 19.3 percent. The ownership structure results in
Southern holding a 3.6 percent economic interest. CEMIG operates the largest
distribution network in South America, and serves 4.6 million customers. This
FUCO is a fully integrated utility with a generating capacity of 5,068 megawatts
and nearly 165,000 miles of transmission and distribution lines. Southern Energy
provides technical and operational support for CEMIG.
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o South Western Electricity plc ("SWEB") -- Southern purchased
substantially all of the ordinary share capital of SWEB in October of 1995,
acquired all of the remaining shares prior to year end 1995, and sold 25 percent
in July of 1996. In June 1998, Southern sold an additional 26 percent interest,
decreasing Southern's economic interest to 49 percent. Southern retains
operational and management control of SWEB. SWEB, which is a FUCO, serves
approximately 1.3 million customers in the southwestern part of England. It was
one of the 12 regional electricity companies created in 1990 by the British
government as a part of the privatization of the electric utility industry in
England and Wales. SWEB is primarily a distribution company, purchasing most of
its electricity requirements from third-party generators. Southern anticipates
SWEB selling its energy supply business, but retaining its power delivery
operations.
o Hidroelectrica Alicura, S.A. ("Alicura") -- Southern indirectly owns
a 55 percent interest in Alicura, a FUCO which, in 1993, acquired from the
Argentine government a 30-year concession to a four-unit 1000 MW hydroelectric
generating facility located on the Limay River. Southern Energy manages the
concession company and oversees the operations and maintenance of the
facilities.
Southern Energy intends to sell its interest in Alicura.
o Empresa Electrica del Norte Grande S.A. ("EDELNOR") -- Southern
indirectly owns an 82 percent interest in EDELNOR, a FUCO which serves most of
Northern Chile and owns and is constructing new generating capacity. EDELNOR
also operates the transmission grid for northern Chile, serving a rapidly
expanding copper mining industry. Half of EDELNOR's electricity is sold to
mining companies under contract, and half is sold to electric distribution
companies. Southern Energy intends to sell its interest in EDELNOR.
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o Freeport Power Company ("Freeport Power") -- In early 1993, Southern
indirectly purchased 50 percent of the common stock of Freeport Power, a
privately-held company which provides electric service to about 15,000 customers
on the Island of Grand Bahama in the Bahamas. The other 50 percent is owned by
Intercontinental Diversified Utilities (ICDU). In October 1996, Southern
purchased 25 percent of ICDU, so that Southern's effective ownership is 62.5
percent. Freeport Power's facilities include five oil and distillate-fired
generating plants with a combined installed capacity of about 126 MW, as well as
a transmission and distribution network that serves the entire island of Grand
Bahama. In addition to overall management control of the utility, Southern
manages the transmission and distribution network.
o Power Generation Company of Trinidad and Tobago Ltd. ("PowerGen") --
Southern indirectly owns a 39 percent interest in PowerGen, a joint-venture
company formed in 1994 to purchase and operate the existing electrical
generation facilities on the island of Trinidad and Tobago. The remaining stock
of PowerGen is owned by Amoco (10 percent) and the Government of Trinidad and
Tobago (51 percent). The PowerGen facilities consist of three gas-fired
generating stations having a combined generating capacity of 1,178 MW. The
electrical output of these facilities is purchased by the Trinidad and Tobago
Electricity Commission ("T&TEC"), the state-owned electric utility that owns and
operates the island's transmission and distribution system. T&TEC serves
approximately 300,000 customers on the island.
o Birchwood Power Partners, L.P. ("Birchwood") -- Southern indirectly
owns 50 percent of the general and limited partnership interests in Birchwood,
an EWG that operates a 222 MW coal-fired cogeneration facility in King George
County, Virginia. Cogentrix owns the other fifty percent. The Birchwood
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facility, which is also a QF, began commercial operation in November 1996.
Southern Energy developed this project, arranged for construction financing, and
constructed the facility under a fixed-price turn-key contract. Southern Energy
also operates the plant under a cost reimbursement/incentive-based operations
and maintenance agreement. All of the electrical output of the Birchwood
facility is sold to a Dominion Resources subsidiary, Virginia Power, under a
long-term power purchase agreement, and approximately 35,000 pounds of steam per
hour is supplied to a 45 acre greenhouse complex operated by Village Farms of
Virginia, Inc.
o State Line Energy, L.L.C. ("State Line") -- Southern acquired 100
percent ownership of this EWG in 1997. State Line consists of two coal-fired
units located in Hammond, Indiana, which deliver 490 MW of capacity to
Commonwealth Edison under the terms of a 15-year power purchase agreement.
o New England -- As a result of successful bidding in a competitive
auction implemented as part of regional restructuring efforts Southern Energy
purchased electric generating assets in New England from subsidiaries of
Commonwealth Energy System and Eastern Utilities Associates for $537 million on
December 30, 1998. The power plants, with a combined generating capacity of
1,267 MW. The generating plants consist of natural gas and oil-fired capacity.
Southern Energy is planning to add generating capacity at the two sites nearest
to Boston, Massachusetts. Southern Energy will own and operate the plants while
SCEM will sell the output to the divesting utilities and in the wholesale NEPOOL
market. The output of Canal Unit 1, a 566 MW oil-fired plant, is committed by
contract to various wholesale power customers. Southern Energy anticipates
expanding the generating capacity operated by its New England subsidiaries.
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1.3 Risk Management. Southern Energy has established comprehensive
procedures to identify and eliminate or mitigate risks associated with
investment in FUCOs and EWGs.
As is described more fully below, the development of energy markets in
the past several years has augmented Southern's ability to manage risk. The risk
management process, however, begins with the project review process, which is
not materially different from that described previously in this file.
The Project Review Process. Every potential project investment
opportunity developed by Southern Energy is subjected to a series of formal
reviews to ensure the project's soundness. The process begins with an annual
strategic plan which surveys FUCO and EWG opportunities throughout the United
States and abroad. This review leads to the identification of projects and
countries where Southern Energy intends to pursue project development efforts
and results in budgeted levels of expenditure on those activities. Before
Southern makes any investment in a FUCO or EWG in a foreign country, an analysis
of that country is presented to the board of directors of Southern Energy and
subsequently to the Finance Committee of Southern's board of directors. The
analysis focuses on political and economic stability of a particular country,
the government's commitment to private power, the legal and regulatory framework
for private investment in electricity facilities, and whether local business
practices will support long-term investment of private capital. Both boards must
approve the relevant foreign country as acceptable for investment.
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Once development of a project is undertaken, milestones are established
to ensure that continuing expenditures on development are producing acceptable
results. In addition, project teams are required to identify the major
technical, financial, commercial and legal risks associated with their
particular project and whether and how those risks can or will be mitigated. In
addition, the members of the project team are responsible for the due diligence
investigation of risks that have been identified and must secure the concurrence
of an officer of Southern Energy with functional oversight over the relevant
subject matter for their conclusion.
Every project is subjected to several levels of management review.
Depending on the amount of Southern's anticipated financial exposure to a
particular project, the proposed investment must be approved successively by the
board of directors of Southern Energy, the Finance Committee of Southern's board
of directors (which is currently comprised entirely of outside directors), and
finally, by the full board of directors of Southern.
The final project review process is to a large extent replicated by the
lenders who agree to provide construction or permanent debt financing on a
non-recourse basis, because repayment of that debt will depend solely upon the
success of the project. Project debt maturities are often long-term (e.g., 15 or
more years), meaning that the lenders' exposure to the risks of a project
extends for many years after closing or completion of construction. Typically,
project debt documents require the establishment of major maintenance, debt
service and other funded reserves, all of which are designed to preserve the
asset and protect the financial performance of the project against interruptions
in revenues and other contingencies. Southern Energy's success in arranging
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appropriate levels of non-recourse financing for its exempt and non-exempt
projects in effect serves as a validation of the project review process
described above.
Southern Energy carefully evaluates the potential risks of EWGs and
FUCOs, as described below.
o Operating risks are typically addressed in a number of ways. Southern
Energy has generally limited its project development efforts to technologies
with which it has existing competencies in coal, natural gas, oil, or
hydroelectric generation. Due diligence of operating assumptions is carried out
by Southern Energy's engineers with experience in the technology being evaluated
and by outside technical consultants. Operating risks are addressed by equipment
warranties and by casualty, business interruption and other forms of insurance.
North American operational risks are also mitigated by Southern Energy's
substantial energy commodities trading and marketing operations, which are
discussed below.
o Construction risks are typically addressed under fixed-price
contracts with milestones and performance guarantees (e.g., guaranteed heat
rates, availability factors), backed by appropriate levels of liquidated
damages. The credit-worthiness and "track record" of the construction contractor
is a very important consideration in this regard. In those cases in which
Southern Energy serves as its own general construction contractor, as was the
case in the Birchwood project, it looks to pre-negotiated damage provisions from
sub-contractors to protect against cost over-runs and schedule delays.
o Commercial risks. Some independent power projects rely on the
"off-take" commitment of a single power purchaser, usually but not always the
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local utility company, to eliminate all or most of the risk of variation in
revenues. In such cases, Southern Energy makes an assessment of the
credit-worthiness of the power purchaser over the life of the project and
undertakes to have a fall-back plan in place in case the off-taker defaults.
With other projects, particularly in emerging competitive power
markets, both inside and outside the U.S., long-term off-take contracts may not
be available. Electricity prices are determined by supply and demand. Southern
Energy conducts extensive investigations of the electricity markets in these
environments to ensure the availability of a viable market. Further, Southern
Energy seeks to ensure that a project will be capable of producing electricity
at or below long-run marginal costs in the region, thus assuring that the
project will be a competitive supplier. As is discussed below, Southern Energy's
trading and marketing operations substantially reduce the commercial risks
associated with domestic EWG projects.
o Financial risks. Southern Energy addresses the financial risks of its
projects in a variety of ways. First and foremost, the permanent debt financing
for Southern Energy's projects is, by its express terms, non-recourse to
Southern or any associate company (other than other Southern Energy Exempt
Projects or intermediate subsidiaries organized to acquire and hold Southern's
interests in Exempt Projects), except to the extent that project debt may be
expressly guaranteed by Southern. This means that the debt of each project or
foreign utility system is secured solely by its assets and revenues, and
creditors have no ability to seek repayment upon default from Southern. This
method of financing ensures that Southern's financial exposure with respect to
any EWG or FUCO is limited to the amount of its equity commitment (which would
include the amount of any limited guaranty Southern may agree to provide) and
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that Southern's Operating Companies and their customers bear no risk of a
project's failure or financial distress.
As indicated above, from time-to-time, Southern may agree to provide
limited guarantees (i.e., limited in amount or duration, or both) or other forms
of credit support in connection with non-recourse financings, but these
financial supports are carefully monitored and treated as a part of Southern's
equity commitment for regulatory reporting and internal control purposes.5 To
date, Southern has never been called upon to fund its obligation under any such
guarantee.6
In addition to the essentially non-recourse nature of project debt
financing, project debt is carefully structured to match the characteristics of
the particular project. For example, when the value of a project depends on a
long-term, fixed price, off-take contract (i.e., a purchase power contract), the
project debt is typically designed to be of a similar term, with scheduled debt
payments usually covered by fixed charges (usually the capacity payment
component in the contract). On the other hand, where there is no long-term,
fixed source of revenue, the percentage of non-recourse debt financing is
typically smaller.
o Foreign currency exchange risk. There are several ways in which
Southern Energy has addressed this risk element, depending on the status of the
host country. Where appropriate, part or all of the revenue from a project is
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5 The purposes of such limited guarantees and the inclusion thereof as
a part of Southern's committed equity has previously been considered by the
Commission. See The Southern Company, et al., Holding Co. Act Rel. No. 26468,
dated February 2, 1996.
6 At June 30, 1999, Southern's "aggregate investment" in Exempt
Projects included approximately $206 million of financial guarantees. Southern
has also provided guarantees of debt obligations of Southern Company Capital
Funds, Inc. to its Southern Company Capital Trust subsidiaries, totaling $950
million, the exact amount of the proceeds of securities the Capital Trust
subsidiaries have issued to pay down short term debt incurred by Southern to
fund investments in Exempt Projects. This investment is reflected in Southern's
calculation of aggregate investment in Exempt Projects.
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payable in or indexed to hard currency (usually U.S. Dollars). In addition,
Southern Energy has negotiated back-up guarantees or other undertakings by the
central government in the country in which the project is located to ensure
payment of the U.S. dollar payments due under an off-take contract. Contractual
arrangements are used to express payment in units of account or payments tied to
U.S. dollar costs of new capacity. In other cases (e.g., SWEB), the non-recourse
project debt is borrowed in the same currency as the project's revenues, thereby
ensuring a match between debt service obligations and operating income. In
addition, in more developed countries, long-term currency swaps are available to
provide further hedging for the equity component of the investment.
o Legal risks. Legal risks are addressed by careful review of any
investment by legal counsel, including local and international counsel where
foreign projects are concerned. Such legal reviews address regulatory and
permitting risks, environmental risks, the adequacy and enforceability of
guarantees or other contractual undertakings of third parties, the status of
title to utility property, and the obligations inherent in the financing
arrangements.
In addition to the mitigation of the specific risks mentioned above,
the country review process described above ensures that the political and
economic stability of any country has been reviewed at several decisional levels
up to and including Southern's board of directors before any investment occurs.
In addition to a general review, the country analysis focuses specifically on
the country's electric sector and on the government's support for private
ownership in that sector. Southern Energy seeks local partners who are
experienced in doing business in the host country in order to provide local
experience, risk diversification, and mitigation of the risk of future
<PAGE>
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expropriation or unfair regulatory treatment. Where appropriate, an additional
mitigating factor is the participation of official or multilateral agencies in a
project.7
o Ongoing Investment Review. Southern reviews the performance of its
investments in EWGs and FUCOs on an ongoing basis in order to enhance the
overall performance of its portfolio. No single return benchmark is utilized
because risk and expected return varies among projects. The portfolio method
applied by Southern to Exempt Project management is described more fully below.
o Portfolio Diversification. Apart from the detailed and comprehensive
approach to the specific risks described above, Southern's fundamental view is
that the best long-term approach to managing the risk of investing in power
generation of any form, including EWGs and FUCOs, is through diversifying both
the type and the location of projects. In this regard, Southern recognizes that
the risk inherent in any investment cannot be eliminated entirely, even by the
most careful approach to project development. Consequently, Southern is
committed to diversifying its investments across countries and regions of the
world. Southern Energy's strategy has been to invest in North America (outside
the core regulated business of Southern), South America, the Caribbean, Europe,
and Asia. Substantial investments have been made in all regions.
Regional diversification is important because history indicates that
economic and political instability tend to involve multiple countries in a
________________________
7 When funds for the project are supplied by government-sponsored
export credit agencies or other governments or institutions (such as the World
Bank through its International Finance Corporation affiliate) or the obligation
of the power purchaser is otherwise contractually supported by the host country,
the host country has strong incentives not to take actions which would harm a
project's viability.
<PAGE>
-22-
region. Accordingly, Southern's board of directors may set limits on investment
in specific countries which vary according to an assessment of the country's
stability.
Another element of Southern and Southern Energy's diversification
policy is to achieve a balance between so-called "greenfield" projects and
acquisitions of existing facilities and power systems. Greenfield projects are
those that involve completely new development and construction of electric
facilities, principally generating stations. Greenfield projects involve a
higher degree of risk because they entail a lengthy process of development and
construction. Funds are expended during the early years of such projects; and
return on investment is not earned until the project is in operation.
Nevertheless, while these projects have higher levels of risk and deferred
returns, they are important to Southern Energy because they generally produce
higher rates of return on investment than investments in existing assets and lay
the foundation for continued earnings growth.
To balance these greenfield project development efforts, Southern
Energy has also purchased assets that are already in operation, consisting of
generation projects with established power markets and market access. These
acquisitions of existing systems and assets reduce the risk of Southern's
overall business by producing near-term earnings without significant development
or construction risk. Of the $3.892 billion invested in Exempt Projects as of
June 30, 1999, $730 million is invested in FUCOs that provide distribution
service to mass markets of consumers (BEWAG, CEMIG, SWEB). A significant and
growing amount of Exempt Project investment represents U.S. domestic investment
in generation projects which are dispatched into state and FERC sponsored bid
<PAGE>
-23-
power pools that serve established regional bulk power markets. Most of the
remaining projects have firm off-take agreements that are sufficient to support
project financing.
The result of this balanced portfolio strategy is that Southern is not
dependent on any single country, regulatory environment, or type of asset for
its earnings from EWGs and FUCOs. In addition, while Southern Energy has
successfully developed significant investments in projects which are expected to
produce long-term favorable returns, it has also ensured that Southern's
portfolio of projects will add cash flow and earnings for Southern shareholders
in the immediate future, thereby supporting share value and earnings. Southern
reviews project performance on an ongoing basis, conducts net present value
reviews of its projects based upon expected cash flows, and adjusts its holdings
in order best to enhance and preserve shareholder value. For example, Southern
recently evaluated Alicura and EDELNOR. As a result of that reevaluation,
Southern has decided to sell these projects and has taken appropriate charges
against earnings to reflect the current reduced market value of these assets.
o Earnings From Exempt Projects. Southern's investments in EWGs and
FUCOs have generated important contributions to earnings. For example, for the
year ended December 31, 1997, excluding the effect of the $111 million windfall
profits tax assessed on SWEB, Southern's investments in EWGs and FUCOs increased
consolidated net income by approximately $119 million. For the twelve months
ending December 31, 1998, despite the reduction in net income resulting from
revaluing the assets associated with the Alicura and Edelnor projects,
Southern's investments in EWGs and FUCOs yielded $40 million in net income.
Thus, despite the imposition of the windfall profits tax on Southern's interest
in SWEB in 1997 and the writedown of South American assets in 1998, Southern's
<PAGE>
-24-
interests in Exempt Projects have made a positive contribution to earnings in
the two calendar years ending after the Rule 53(c) order. Southern expects that
its investments in Exempt Projects will continue to generate positive earnings
and contribute to consolidated earnings growth in the future.
o Effect of Regulatory Change. Regulatory change in the United States
has served both to mitigate the risk of investing in EWGs, and to increase the
opportunities for investment in EWGs. Global regulatory changes and
privatization have increased the opportunities to invest in FUCOs. In this
environment, Southern can best enhance its future earnings growth, and thereby
lower its overall cost of capital, through a broadly diversified program of
developing and investing in Exempt Projects.
In the past several years, the United States (and North American)
energy market has evolved into a competitive and liquid market, with open
transmission access in the United States and substantial markets available
through federal and state sponsored restructuring. This market has evolved since
the passage of the Energy Policy Act and particularly in the wake of the
transmission access required by FERC Order 888.
In addition, partially as a result of the Energy Policy Act, partially
as a result of foreign nations opening government utility systems to private
investment activity, and partially through utility restructuring such as
experienced in the United Kingdom, the global energy market has evolved to allow
a much greater level of competition and outside investment. Participants in this
market who seek to own or operate power generation must utilize a portfolio
approach to investment and maintain investment levels sufficient to achieve the
<PAGE>
-25-
benefits of scale economies. Southern has successfully participated in this
global market through investments in EWGs and FUCOs. Continued success will
require continued investment and growth. The Commission recognized the
transfiguration of the market in the United States in its Order adopting Rule
58:
As a result of Congressional action [i.e. the Energy Policy Act],
combined with initiatives of the Federal Energy Regulatory Commission
("FERC") and the state and local ratemaking authorities, the pace of
change in the gas and electric utility industry is accelerating. Today,
the gas industry is largely deregulated and the electric industry is
undergoing a similar process. In addition to increasing competition at
the wholesale level, retail electric competition is developing more
rapidly than anticipated, due to state efforts. Utilities and the
suppliers of energy appear poised to compete in retail markets. As a
result of these developments the contemporary gas and electric
industries no longer focus solely on the traditional production and
distribution function of a regulated utility, but are instead evolving
toward broadly based, competitive energy services business.
Holding Company Act Release No. 26687 (February 14, 1997), text at footnotes
19-21. These findings are consistent with the findings of "The Regulation of
Public Utility Holding Companies" Report of the Division of Investment
Management, Securities and Exchange Commission (June 1995), at 19-22, 26-27.
The United States Congress recognized the linkage between the domestic
energy market and the global energy market when it passed the EWG and FUCO
amendments to the Act in tandem. The emergence of a global energy market driven
by the search to achieve efficient production and risk management through
portfolio diversification was recently chronicled in E.G. Flowers, U.S. Utility
Mergers And The Restructuring Of The New Global Power Industry (Quorem Books,
Westport, Conn. 1998). Dr. Flowers notes:
<PAGE>
-26-
[T]he new production technologies of energy convergence, and
the new market technologies of energy trading and arbitrage,
meant that [utility] mergers were not limited to contiguous
utilities, domestic utilities, or utilities producing the same
form of power. ... Current foreign investment in the
internationalizing utilities industry can be explained by ...
traditional theories of financial market capitalism. In the
utilities industry, corporations appear to be striving for the
rate of return that markets expect on their capital investment
.... With these forces at work, the assumption that all large
utilities are now operating under the scrutiny of global
capital markets is a very reasonable one, and the global
utilities drive for high return on investment satisfactorily
explains most of their foreign direct investment and mergers
and acquisition activity in a very straightforward way.
U.S. Utility Mergers And The Restructuring Of The New Global Power Industry, at
202-203 (emphasis added).
Southern is not alone in seeking earnings growth greater than that
which is possible through franchised public utility operations within its
traditional service area in the United States. Over the past five years exempt
holding companies and non-holding company generation companies have made
substantial investments in foreign utilities and domestic generation. In
1995-1998, UtiliCorp., General Public Utilities, Texas Utilities, Central and
Southwest, Pacificorp, Entergy, Edison International, AES Corp., Dominion
Resources, CMS Energy, Cal Energy, Northern States Power, Public Service of
Colorado, PacfiCorp and Enron, in addition to Southern, closed foreign utility
investments totaling in excess of $53 billion.
In the absence of a regulatory constraint, the optimal level of
investment in EWGs and FUCOs bears no relationship to consolidated retained
earnings, as is illustrated by the past five years' investment by AES
(approximately 150 percent of consolidated retained earnings), Texas Utilities
<PAGE>
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(approximately 175 percent of consolidated retained earnings), UtiliCorp
(approximately 205 percent of consolidated retained earnings), and Edison
International (approximately 100 percent of consolidated retained earnings).8
o Effect of Trading and Marketing on Mitigating North American Risk.
The significant participation of Southern Company Energy Marketing,
L.P. ("SCEM")9 in the rapidly developing energy trading business provides an
additional protection against potential risk associated with investment in North
American Exempt Projects. There are numerous reasons this arm of Southern Energy
enhances Southern's investment in domestic Exempt Projects.
When Southern invests in an Exempt Project, it arranges with SCEM for
the provision of fuel and power marketing. Through these arrangements Southern
Energy is able to optimize the value of these assets. SCEM has contract rights
to natural gas supplies and is able to remarket fuel that is not needed at the
generating plants. SCEM also typically commits to acquire some or all of the
power output of the EWG for a number of years. SCEM's participation in fuel
procurement allows it to efficiently and cost effectively procure fuel for these
generating plants. SCEM's market presence, the use of long term fuel contracts
and its purchasing in the spot market help reduce the cost and volatility of
fuel procurement.
SCEM's presence in regional markets as a trader allows for quick
responses to market conditions, including sale of excess capacity to neighboring
suppliers unable to meet demand. SCEM's participation also minimizes the
__________________________
8 Goldman Sachs Research, October 29, 1998.
9 Southern Company Energy Marketing, L.P., jointly owned by Southern
Energy and Vastar Resources, Inc., engages in energy trading and marketing,
providing such products and services to customers in North America.
<PAGE>
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economic risk associated with outages because it usually is able to arrange for
deliveries from alternative sources in the market. Additionally, presence in the
local market develops understanding of local market dynamics that can reduce
long term risk. SCEM's presence in regional markets allows efficient trading of
such capacity with an understanding of the risks that may be unique to that
region (e.g., financial stability of purchasers; transmission limitations).
SCEM is able to procure fuel, market production and assist Southern in
dispatching generation assets to optimize such assets in the deregulated
wholesale energy market. Investment in operational EWGs by Southern is thereby
complemented with the experience of SCEM and SCEM's ability to provide
flexibility in fuel supplies while providing opportunities for marketing excess
capacity and minimizing operational risk. The synergies between a national
trading and marketing business and the ownership of EWGs were highlighted by
U.S. Generating Company's explanation of its strategy for its purchase of
eighteen fossil and hydroelectric plants from the New England Electric System
for $1.59 billion, an amount substantially above book value.10 Their management
noted that "[t]he ability to manage fuel and power supply risks simultaneously
will be the linchpin to operating in a competitive power market. Key
______________________
10 As this purchase and other purchases resulting from divestiture
programs are part of a transition to a competitive market, the economic value of
the asset is determined by its prospective market value, which bears no
necessary relationship to depreciated book value. Thus, it is not surprising
that the result of competitive auctions at times yield prices over book value.
Effective participation in competitive divestitures requires the ability to bid
competitively, both as to price and terms and conditions. A condition of project
specific regulatory approval in addition to requirements imposed by a sponsoring
state which apply to all purchasers, would make effective participation by the
bidder burdened by such a requirement commercially impracticable.
<PAGE>
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requirements are commodity procurement, management and trading skills."11 Thus,
although energy marketing at times has been treated for regulatory purposes as a
separate line of business, Southern Energy's energy marketing operations are an
integral part of the risk management and economic optimization of North American
EWG projects. The ability to mitigate market risk reduces the risk differential
between North American EWG projects and traditional public utility generation
investment.
1.4 Future Investments in Additional Exempt Projects. Southern Energy
is currently investigating, alone and in conjunction with others, investment
opportunities in several additional domestic and foreign power projects and
existing foreign utility systems. Shortly after passage of the Energy Policy
Act, Southern adopted a business plan to achieve an earnings growth rate
exceeding that which would result from simply maintaining its then existing
public-utility subsidiary operations.12 Southern has successfully executed this
plan to date, as is reflected in the performance of its investment in EWGs and
FUCOs, which is rapidly approaching 100 percent of consolidated retained
earnings.
Southern expects that domestic and international project development
will increase significantly. See, e.g., Southern Company 1998 Annual Report at
3-4, 18; "Price-Driven Merchant Market In U.S.", March 20, 1998 Global Power
Report, at 5 (global projection of 340,000 MW of new generation and 120,000 MW
of generation privatization between 2003 and 2007).
______________________
11 Haarmeyer, "The New England Auction; Regional Strategy For
Competitive Generation; Why U.S. Generating's bid for the NEES Power Plants
Could Prove A Bargain", February 15, 1998, Public Utilities Fortnightly, at 34.
12 See, e. g., Southern Company, 1998 Annual Report at 3-4, 18;
Southern Company, 1997 Annual Report, at 3.
<PAGE>
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Southern recently entered into agreements to invest in the following
Exempt Projects:
Thailand: Southern Energy has obtained the opportunity to acquire a 28
percent voting interest in Union Power Development, Ltd., which is developing a
1,400 MW coal-fired station with a potential equity investment of $300 million.
Cajun Electric Power Cooperative: Southern Energy, in partnership with
NRG Energy, Inc., a wholly owned subsidiary of Minneapolis-based Northern States
Power Company, was awarded the bid for Cajun Electric Power Cooperative's 1,708
megawatts of fossil-fueled generation on August 26, 1999. The Louisiana
Generating LLC partnership, held 50 percent by NRG Energy and 50 percent by
Southern Energy, offered $1.026 billion for the Cajun assets.
Southern Energy and NRG signed an agreement that gave Southern Energy
the option to sell its ownership interest in Louisiana Generating to NRG upon
confirmation. The agreement also gave NRG the option to require Southern Energy
to sell its interest in Louisiana Generating. NRG decided to exercise its option
in September, 1999 which resulted in Southern Energy, Inc. selling its 50
percent interest in Louisiana Generating LLC to NRG Energy, Inc.
Australia: Southern is seeking Queensland governmental approval to
develop a 500 MW coal-fired plant near Brisbane. The plant would be located near
the Kogan Creek coal mine, which is owned by Southern through CEPA.
Texas: Southern Energy has contracted to purchase an 80 MW gas-fired
generating unit from the Wichita Falls Energy Company on October 1, 1999.
<PAGE>
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Southern is actively bidding on additional projects, as are Southern's
competitors, including exempt holding companies, traditional public utilities,
domestic and foreign industrial and energy firms and conglomerates, and other
registered holding companies. Timely enhancement of Southern's authority is
essential if Southern is to compete effectively for potential projects.
o Overview of Future Projects
Southern cannot predict with certainty whether or when any of the
states within which the Operating Companies function will change the traditional
public-utility service model for electric power service to consumers. Unlike
many other public utility systems, Southern is making incremental investments in
electric power generation to serve its traditional public utility service
territorial load.13 Because incremental additions of generating capacity consist
primarily of combined-cycle natural gas-fired combustion turbines, the overall
investment on a per megawatt basis is substantially lower that coal-fired or
nuclear generating capacity. The lower relative cost of new generation additions
reduces the equity contributions by Southern needed to support economical debt
financing by the Operating Company subsidiaries.
Southern's prospects for significant earnings growth, however, depend
upon its ability to participate in emerging energy markets, both domestic and
foreign, and Southern intends therefore to continue its program of investing in
Exempt Projects. Authority equal to 150% of consolidated retained earnings is
necessary at this time in order for Southern to continue its investment program
_________________________
13 The Energy Information Administration of the Department of Energy
identified the increased reliance on independent power generation to meet
utility system load growth in "The Changing Structure of the Electric Power
Industry: An Update", at 8 (July 30, 1998) ("EIA Update").
<PAGE>
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and to compete for project opportunities. Southern expects that the full
requested amount of authority will be needed during the requested authorization
period.
Within the United States, numerous major U.S. domestic electric utility
generation divestitures are pending. As of June, 1998, twelve states had passed
restructuring legislation that will provide access to retail customers for power
marketers. EIA Update, at 4. A majority of the states are actively considering
such proposals. Retail access is being implemented pursuant to state legislation
in Arizona, Arkansas, California, Connecticut, Delaware, Illinois, Maine,
Maryland, Massachusetts, Ohio, Oregon, Pennsylvania, Nevada, New Hampshire,
Rhode Island, Texas and Virginia. In addition to state restructuring under
legislative mandate, the demand for power in many areas of the country is
requiring the construction of new generation. As of October, 1998, approximately
42,000 megawatts of generation was pending divestiture in the United States.14
By July, 1999, Central Hudson Gas & Electric Company, Consumers Energy Duquesne
Light Company, EUA Service Corporation, GPU, Inc., Pennsylvania Power & Light
Company, Portland General Electric, Potamac Edison Co., and Tucson Electric Co.
all have active divestiture proposals pending.
FERC open access initiatives and state restructuring efforts have
created expanding markets that support investment in Exempt Projects through
guaranteed access to markets. The result of these developments is a power
industry dramatically different from that which existed in 1993 when Rule 53 was
promulgated. At that time, EWGs were "novel entities" (HCAR No. 25886, 58 Fed.
________________________________
14 Goldman Sachs Research: October 29, 1998.
<PAGE>
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Reg. 51488, 51493 (Oct. 1, 1993)) all but requiring independent power developers
to rely upon plant off-take agreements in order to service debt and provide an
assurance of a reasonable return on investment. The market-making initiatives
that followed passage of the Energy Policy Act of 1992, including FERC Order
888, the enactment of numerous state restructuring laws, and state restructuring
initiatives, substantially enhance the opportunity to market generation
associated with Exempt Projects by guaranteeing market access by independent or
merchant power plants on a playing field level with that of utility-owned
generation. The result is that merchant plants are now able to obtain investment
grade financing. See, e.g., "Dominion Financing Coal Merchant Plant with
Investment-Grade Bonds", May 11, 1998, Power Markets Week, at 10 (300 percent
over subscription to $265 million offering rated Baa3 or BBB-). See also
"Calpine Debt Rated Ba3 by Moody's," April 3, 1998, Global Power Report at 5.
FERC (and similarly-minded state commissions) has reduced the riskiness of
merchant plants by guaranteeing access to markets.
Substantial Commission precedent supports authorizing increased
investment authority in Exempt Projects by a factor equal to 50% of consolidated
retained earnings. The Commission has approved several such applications
granting expanded investment authority in FUCOs and EWGs. See, e. g. New Century
Energies, Inc., HCAR No. 26982 (February 26, 1999) (delegated authority); GPU,
Inc., HCAR No. 16501 (March 23, 1998); Central and Southwest, HCAR No. 26653
(July 24, 1997); American Electric Power, HCAR No. 26864 (April 27, 1998);
Cinergy Corp., HCAR No. 26848 (March 23, 1998). See also Campaign For Prosperous
Georgia v. SEC, 149 F.3d 1282 (11th Cir. 1998). Southern's own experience has
<PAGE>
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indicated that these projects contribute to present and future earnings and
improve the economic diversity of Southern's operations.
In addition to the effects of guarantees of market access, to
transmission and to equal treatment in emerging retail markets, rising power
demand in the United States is creating opportunities to invest in new plants
and the necessity for new investment, as is highlighted by market clearing
prices paid in 1998 to power marketers during shortages in the Midwest. See,
"Price Driven Merchant Market In U.S.," March 20, 1998, Global Power Report, at
5 (150,000 MW of new capacity for North America projected between 2007-2010).
This increased demand and the availability of assets due to divestiture,
increases the need for financial flexibility to meet these new opportunities.
o Investment Community Looks Favorably Upon Southern's EWG and FUCO
Investments. On April 1, 1996 the Commission entered its Order allowing Southern
to increase its use of financing proceeds for investment in EWGs and FUCOs to
100 percent of consolidated retained earnings. Following this development, and
Southern's investment in major EWG and FUCO projects, the investment community
has continued to look favorably upon Southern and its investment in EWGs and
FUCOs, as is shown by the January 1997 assignment by Standard & Poor's of an "A"
corporate rating to Southern, which was consistent with the implied corporate
rating previously held by Southern.
1.5 Proposed Increase in Financing of Exempt Projects. For the reasons
stated above, Southern hereby requests that the Commission modify Southern's
financing authority to allow Southern to invest up to $4 billion in addition to
amounts previously authorized, or 175 percent of consolidated retained earnings,
<PAGE>
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whichever is greater, through December 31, 2005. Southern also requests
authority to issue Financial Guarantees of the obligations of Exempt Projects
and Performance Guarantees pertaining to Exempt Projects until December 31,
2005, in any combination not to exceed, in combination with Southern's other
aggregate investment in Exempt Projects under Rule 53, the authority sought
herein. As noted by the Commission in HCAR 26687 (February 14, 1997), the
authorization to enter into a line of business inherently carries with it the
authority to engage in development activities. Id. text at fn. 83. Southern
accordingly proposes to continue to engage in project development activities of
a nature consistent with that previously authorized in HCAR No. 26468 (February
2, 1996) through December 31, 2005.15 Southern requests that the Commission
reserve jurisdiction over the requested authority to the extent it exceeds 150%
of consolidated retained earnings as defined by Rule 53.
Southern is not herein requesting any further authority to issue and
sell any additional common stock, notes evidencing borrowings, or any other
modification to any other terms or conditions of the Financing Orders.
Item 2. Fees, Commissions and Expenses.
The fees, commissions, and expenses paid or to be paid or incurred in
connection with the filing of this Application or Declaration are estimated not
to exceed $15,000.
Item 3. Applicable Statutory Provisions.
____________________________
15 At the time Southern Energy Resources, Inc. (formerly Southern
Electric International) obtained its Exempt Project development authority in
File No. 70-7932, the Commission had not yet amended Rules 52 and 45 to
authorize capital contributions to non-utility subsidiaries for authorized lines
of business. When Southern Energy's authority was augmented and extended to
"energy-related" companies by HCAR 26468, the Commission had not yet promulgated
Rule 58, which authorizes investment in "energy-related companies."
<PAGE>
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3.1 General Provisions. The proposal herein is subject to Sections
6(a), 7, 12(b), 32 and 33 of the Act and Rules 45, 53, 54, and 100(a)
thereunder. Rule 53 provides that, if each of the conditions of paragraph (a)
thereof is met, and none of the conditions of paragraph (b) thereof is
applicable, then the Commission may not make certain adverse findings under
Sections 7 and 12 of the Act in determining whether to approve a proposal by a
registered holding company to issue securities in order to finance an investment
in any EWG or to guaranty the securities of any EWG. Giving effect to the
proposals contained herein, Southern will satisfy all of the conditions of Rule
53(a) except for clause (1) thereof, since Southern's "aggregate investment"
will continue to exceed 50 percent of Southern's "consolidated retained
earnings." None of the conditions specified in Rule 53(b) is or will be
applicable.
3.2 Analysis of Rule 53(c) Issues. Rule 53(c) states that, in
connection with a proposal to issue and sell securities to finance an investment
in any EWG, or to guarantee the securities of any EWG, a registered holding
company that is unable to satisfy the requirements of paragraph (a) or (b) of
Rule 53 must "affirmatively demonstrate" that such proposal:
(i) will not have a substantial adverse impact upon the financial
integrity of the registered holding company system; and
(ii) will not have an adverse impact on any utility subsidiary of the
registered holding company, or its customers, or on the ability of
state commissions to protect such subsidiary or customers.
Southern addresses each of these requirements as follows:
<PAGE>
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1. The use of common stock proceeds, borrowings, and guarantees to make
investments in EWGs and FUCOs will not have a "substantial adverse impact" on
the financial integrity of the Southern System.
The lack of any "substantial adverse impact" on Southern's financial
integrity as a result of increased levels of investment in Exempt Projects can
be demonstrated in several ways, including by analyses of historic trends in
Southern's consolidated capitalization ratios and retained earnings, the market
view of Southern's securities, and Southern's proven success in obtaining
appropriate levels of non-recourse debt financing and third-party equity for its
associate Exempt Projects. Consideration of these and other relevant factors
supports the conclusion that the issuance of securities by Southern to finance
investments in Exempt Projects exceeding the 50 percent consolidated retained
earnings safe harbor in Rule 53(a)(1) and the 100 percent authorization
established in File No. 70-8725 (Holding Co. Act Rel. No. 26501, dated April 1,
1996) will not have any "substantial adverse impact" on the financial integrity
of the Southern System.
o If Southern invested an amount equal to 50% of its consolidated
retained earnings, in addition to the currently authorized 100 percent of
consolidated retained earnings, aggregate investment in Exempt Projects would
still represent a relatively small commitment of capital for a company the size
of Southern, based on various financial ratios at June 30, 1999. For example,
investment in this amount --150% of consolidated retained earnings -- would be
equal to only 18.1 percent of Southern's total capitalization ($33 billion),
22.3 percent of consolidated net utility plant ($27 billion) , 13.4 percent of
total consolidated assets ($45 billion), and 29.3 percent of the market value of
<PAGE>
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Southern's outstanding common stock ($20 billion). These ratios compare
favorably to those of other holding companies that presently have authority to
invest up to 100 percent of consolidated retained earnings in Exempt Projects.16
o In foreign markets, where investment in foreign EWGs and FUCOs can be
subject to unique risks, Southern has diversified its investment among FUCOs
with existing mass markets and projects with firm off-take agreements, including
existing plants and new plants. The balanced portfolio approach, coupled with
country specific and project specific risk management, minimizes any risk
differential between domestic and foreign projects and global energy market
participation by Southern and ultimately diversifies the general economic and
energy market risk faced by shareholders.
o In the domestic market, Southern's investment in EWGs continues to
benefit from the assurance of access to transmission and bulk power markets.
Where retail access has been implemented, EWGs may provide electric generation
on an equal footing with traditional (and re-regulated) public utility
generation. As the nation progressively relies on market-based generation
instead of generation added as a part of a public utility's network service
obligations, Southern will have the ability to compete effectively in this
arena, thus enhancing any EWG investment.
o Southern's consolidated retained earnings have grown on average
approximately 5.5 percent per year over the last five years. Excluding the $111
million one-time windfall profits tax imposed on SWEB and the write down of
__________________________
16 By way of example, at the time application for authority up to 100
percent was made, investments in that amount were equal to 25 percent of Central
and South West's (CSW) total capitalization and 29 percent of GPU's total
capitalization, 21 percent and 32 percent of CSW's and GPU's respective
consolidated net utility plant, and 13 percent and 19 percent of their
respective total consolidated assets.
<PAGE>
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assets in 1998, the average growth would be 7.2 percent.
o Southern's consolidated capitalization ratios at June 30, 1999 are
44.4 percent equity, 55.6 percent debt including all non-recourse debt, and are
56.0 percent equity, 44.0 percent debt excluding all non-recourse debt. Both are
within accepted industry ranges and within the limits set by the independent
rating agencies (such as Standard & Poor's) for "A" rated utilities.
o Southern's ability to raise common equity has not been adversely
affected by investments in Exempt Projects. In fact, just the opposite is true.
Southern has maintained its ability to access the capital markets as investments
in EWGs and FUCOs have increased.
<TABLE>
<CAPTION>
(in millions) 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Proceeds from sale of stock $234 $360 $171
Proceeds from preferred securities guaranteed by holding company $350 $600 $ 0
</TABLE>
Beginning in April 1999, Southern began a program to repurchase up to
50 million shares of its common stock. Through August 31, 1999, $574 million or
21.2 million shares had been repurchased. Southern has continued to access
capital markets through its short-term borrowing facilities. At August 31, 1999,
Southern had approximately $1.6 billion of short-term borrowings, including
commercial paper and short-term notes payable.
o The market's assessment of Southern's future growth and earnings also
compared favorably to other electric utility issuers in the 1994 - 1999 time
frame. This can be shown by comparison of price/earnings and market-to-book
ratios, both of which were above the electric utility industry average in that
period.
<PAGE>
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<TABLE>
<CAPTION>
P/E Ratio 1994 1995 1996 1997 1998 6/30/99
<S> <C> <C> <C> <C> <C> <C>
Southern 13.2 14.8 13.5 18.2 20.8 18.4
Electric Industry* 11.8 12.5 11.5 14.2 14.9 14.2
Market-to-Book Ratio:
Southern 160 % 188% 166 % 186 % 207% 192%
Electric Industry* 133 % 154 % 145 % 171 % 187% 177%
</TABLE>
*Source: StockVal covering approximately 80 electric utilities
o Southern's dividend payout ratio (percentage of earnings paid out in
dividends) over the past several years as compared with the electric industry
average is set forth below:
<TABLE>
<CAPTION>
Payout Ratio ( percent): 1994 1995 1996 1997 1998 6/30/99
- ----------------------- ---- ---- ---- ---- ---- -------
<S> <C> <C> <C> <C> <C> <C>
Southern 77.5 73.5 75.1 82.117 77.918 76.319
Electric Industry* 81.4 76.1 74.9 76.3 74.4 69.5
</TABLE>
*Source: StockVal covering approximately 80 electric utilities
o The market's favorable assessment of the overall quality of Southern
Energy's portfolio of Exempt Projects is demonstrated by the success that
_____________________
17 Excluding the windfall profits tax. Including the effect of that tax
Southern's payout ratio is 91.5 percent.
18 Excluding the write-down of assets in 1998. Including the write down
of assets in 1998 the payout ratio is 95.6 percent.
19 Excluding the writedown of assets in 1998. Including the writedown
of assets in 1998, the payout ratio is 93.2 percent at June 30, 1999.
<PAGE>
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Southern Energy has had in obtaining appropriate levels of non-recourse debt to
finance and refinance the operations of these entities, and in selling down
portions of its equity investments in such projects. At June 30, 1999,
non-recourse debt for all Exempt Projects (including debt of intermediate
subsidiaries) totaled $5.8 billion, or approximately 53 percent of
capitalization of those entities. Included as Exhibit H, and filed separately
pursuant to Rule 104(b), is a table showing the breakdown in Exempt Project
non-recourse debt.
o As previously described, Southern's portfolio of Exempt Projects is
well diversified, by country, project type, and stage of development (i.e., most
are in operation or nearing completion).
o Revenues and income from Exempt Projects have made a modest but
important contribution to Southern's consolidated revenues and consolidated
earnings.20
None of the negative conditions described in paragraph (b) of Rule 53
is applicable to Southern. Further, it is reasonable to expect continued growth
of the operating income and return contribution of Southern's Exempt Projects as
a group.
2. The proposed increased use of financing proceeds to invest in Exempt
Projects will not have an "adverse impact" on any public-utility subsidiary of
Southern, or its customers, or on the ability of the four State commissions to
protect such customers.
The conclusion that the Operating Companies and their customers will
not be adversely impacted by increased levels of investment by Southern in
Exempt Projects is well supported by analyses of the Operating Companies'
_____________________________
20 The financial statements filed in response to Item 6(b), infra, which
are separately filed pursuant to Rule 104(b), include a table showing the
breakdown in revenues and earnings of each of the Exempt Projects for the 12
months ended December 31, 1996 and December 31, 1998.
<PAGE>
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financial integrity (including ability of the Operating Companies to issue
senior securities), lack of current and anticipated need for any significant
amount of equity capital from Southern, and the existing structural and other
safeguards against adverse effects of Southern's investments in Exempt Projects,
including the proven effectiveness of state commission oversight and continuing
compliance with other applicable requirements of Rule 53(a). Moreover, Southern
effectively is seeking authority no greater than that which it has successfully
exercised to date.
o All of Southern's investments in EWGs (as well as in FUCOs) are
segregated from the Operating Companies. No Operating Company has extended
credit or sold or pledged its assets directly or indirectly to any Exempt
Project,21 and the indebtedness of the Exempt Projects is not otherwise recourse
to any Operating Company. Southern will not seek recovery through higher rates
to the Operating Companies' utility customers in order to compensate Southern
for any possible losses that it may sustain on investments in Exempt Projects or
for any inadequate returns on such investments.
o Debt ratios (including short-term debt) of the Operating Companies
are generally below (i.e., better than) industry averages for "A"-rated electric
utilities. Debt levels of the Operating Companies are projected to remain stable
through the year 2000, at approximately 45 percent. The current industry average
for "A"-rated electric utilities is 50.4 percent.*
_________________________
21 It should be noted that Section 33(f), with a minor exception,
prohibits State regulated public-utilities from financing investments in FUCOs,
and Section 33(g) prohibits outright any pledge or encumbrance of utility assets
by a State regulated public utility for the benefit of any associate FUCO.
<PAGE>
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<TABLE>
<CAPTION>
Debt as percent of June
Capitalization 1994 1995 1996 1997 1998 1999
<S> <C> <C> <C> <C> <C> <C>
Alabama 46.3 47.6 45.7 46.4 47.5 49.9
Georgia 46.9 43.2 42.5 42.3 43.6 44.4
Gulf 45.2 45.3 43.1 45.2 42.1 46.0
Mississippi 44.4 43.5 41.6 41.8 43.7 47.6
Savannah 45.0 44.0 44.7 43.9 43.2 46.6
</TABLE>
* Source: "A" industry average at December 31, 1998-- Standard & Poor's "Utility
Financial Statistics" published June 1999.
o Additional investments in Exempt Projects will not have any negative
impact on the Operating Companies' ability to fund operations and growth because
the Operating Companies do not depend unduly upon Southern's capital. Over the
past five years, the Operating Companies have funded substantially all of their
construction expenditures from internal sources of cash and from sales of senior
securities and other borrowings.22 As noted above, the relative low cost of new
generating capacity permits such additions to be made by the Operating Companies
without requiring the equity contribution required by higher cost coal-fired and
nuclear power construction cycles.
_______________________
22 Southern contributed $25 million to Mississippi Power Company in
1994, $30 million to Alabama Power Company in 1998, and $130 million to Georgia
Power Company in July, 1999. Southern anticipates increased capital
contributions by it to the Operating Companies to fund the acquisition of
combustion turbine generating plants. The authority conferred herein will not
impair Southern's ability to make such contributions.
<PAGE>
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Operating Companies - Construction Expenditures:
Actual and projected expenditures ($million)*:
1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ----
1,388 1,189 1,005 1,056 1,265 1,798 1,571 1,835
*Source: Southern Company 1998 Form 10-K
Percent internally generated:
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
79% 112% 144% 122% 100%
o The Operating Companies' ability to issue first mortgage bonds and
preferred stock in the future depends upon earnings coverages at the time such
securities are issued; that is, the Operating Companies must comply with certain
coverage requirements designated in their respective mortgage bond indentures
and corporate charters. Currently, the Operating Companies anticipate having
more than adequate earnings coverages for financing requirements in the
foreseeable future.23
o The senior securities of each of the Operating Companies are
currently rated `A+' or better by Standard & Poor's and have all experienced
upgrades in the last 5 years. The Operating Companies' coverages have generally
been within the `A' and `AA' ranges set by the major rating agencies in recent
years. The Operating Companies continue to show strong financial statistics as
___________________________
23 Indenture earnings coverages for the Operating Companies have
recently ranged from about 4.2x to 9.5x, and charter earnings coverages have
ranged from about 2.3x to 3.2x, in each case well above the required coverages
of 2x and 1.5x, respectively.
<PAGE>
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measured by the rating agencies (pre-tax interest coverage, debt ratio, funds
from operations to debt, funds from operations interest coverage, and net cash
flow to capital expenditures).
S&P Senior
Bond Rating: 1994 1995 1996 1997 1998 -1999
------------ ---- ---- ---- ---- ----------
Alabama A A+ A+ A+ A+
Georgia A A+ A+ A+ A+
Gulf A A+ A+ AA- AA-
Mississippi A+ A+ A+ AA- AA-
Savannah A A+ A+ AA- AA-
o Southern has complied and will continue to comply with the
requirements of Rule 53(a)(2) regarding preparation and making available of
books and records and financial reports regarding Exempt Projects.
o Southern has complied and will continue to comply with the
requirements of Rule 53(a)(3) regarding limitation on use of Operating Company
employees in connection with providing services to Exempt Projects. Increased
levels of investment in Exempt Projects are not expected to have any impact on
utilization of Operating Company employees. The Operating Companies have not and
will not increase staffing levels or acquire other resources to support the
operations of Exempt Projects. In this regard, the vast majority of the
operational employees of the Exempt Projects are hired or contracted locally.
This is true even where Southern Energy is the operator. Project development,
management, and home office support functions for the Exempt Projects are
largely performed by Southern Energy, and by outside consultants (e.g.,
engineers, investment advisors, accountants and attorneys) engaged by Southern
<PAGE>
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Energy. Accordingly, Southern Energy's need for the support of personnel
provided by the Operating Companies has been and is projected to remain
relatively modest.
o There is no evidence that the four state commissions have been or
will be unable to protect utility customers. Each state commission reserved the
right to insulate the retail cost of service from the costs associated with
investment in EWGs and FUCOs and has reserved the right to address such issues
with the Commission should the need arise. 24
o Southern has complied and will continue to comply with the
requirements of Rule 53(a)(4) regarding filing copies of applications and
reports with other regulatory commissions.
o None of the circumstances described in Rule 53(b) has occurred.
Southern undertakes to notify the Commission by filing a post-effective
amendment in this proceeding in the event that any of the circumstances
described in Rule 53(b) should occur during the authorization period.
In conclusion, Southern's application for immediate authority to invest
up to 150% of consolidated earnings retained in Exempt Projects should be
granted because Southern has shown that it is carrying out a balanced and
successful program of investing in EWGs and FUCOs consistent with the Energy
Policy Act. Wholly apart from the Rule 53 "safe harbor," Southern has
demonstrated herein that the authority it seeks is consistent with the
applicable standards of the Act, including the interests of investors and
consumers and the general public. Southern's ongoing Exempt Project development
and investment program is consistent with continued participation in the energy
___________________________
24 Section 33(c)(2) provides that the State commissions may make
recommendations to the SEC regarding a registered holding company's relationship
to FUCOs, and that the SEC shall "reasonably and fully consider" such
recommendations.
<PAGE>
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markets the Energy Policy Act and related state and federal regulatory action
have sponsored. Further, Southern has shown that it maintains appropriate risk
mitigation measures, internal controls, and separation of the obligations and
risks arising from investment in EWGs and FUCOs from the provision of
public-utility service by Southern's Operating Company subsidiaries. For these
reasons, the Commission should grant the immediate increase in authority to 150%
of consolidated retained earnings requested herein and reserve jurisdiction over
the balance. Item 4. Regulatory Approval.
The issuance and sale of securities by Southern and the use of the
proceeds thereof to acquire or guarantee the securities of any Exempt Project
are not subject to the jurisdiction of any state commission or of any federal
commission other than this Commission. Southern has complied with the
requirements of Rule 53(a)(4) by submitting a copy of this Application or
Declaration to the public utility commissions in Alabama, Florida, Georgia, and
Mississippi. Item 5. Procedure.
For the reasons stated above, Southern hereby requests that the
Commission modify Southern's financing authority to allow Southern to invest up
to 150% of consolidated retained earnings in Exempt Projects and reserve
jurisdiction over the balance of the authority sought in this file, such
authorized aggregate investment to include the outstanding amounts of
Performance Guarantees and Financial Guarantees.
Southern will continue to file a quarterly report pursuant to Rule 24
which contains the following information:
<PAGE>
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(i) A computation in accordance with Rule 53(a) (as modified by
the Commission's order in this proceeding) of Southern's
"aggregate investment" in all Exempt Projects;
(ii) Southern's cumulative "aggregate investment" in all Exempt
Projects expressed as a percentage of: total capitalization,
net utility plant, total consolidated assets, and market value
of common equity, all as of the end of such quarter;
(iii) Consolidated capitalization ratios as of the end of such
quarter, with consolidated debt to be inclusive of all
short-term debt and non-recourse Exempt Project Debt to the
extent normally consolidated under applicable financial
reporting rules;
(iv) The market-to-book ratio of Southern's common stock at the end
of such quarter;
(v) An analysis of the growth in consolidated retained earnings,
which segregates earnings growth attributable to Exempt
Projects as a whole versus all other subsidiaries of Southern;
and
(vi) A breakdown in revenues and net income of each of the Exempt
Projects for the 12-months then ended.
Southern proposes to continue to file a single report under Rule 24
which combines the foregoing information with the information required pursuant
to Rule 24 in File No. 70-8733 (Holding Co. Act Rel. No. 26468, dated February
2, 1996).
Item 6. Exhibits and Financial Statements.
(a) Exhibits:
F - Opinion of Counsel. (previously filed)
<PAGE>
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H - Non-Recourse Debt of Exempt Projects and certain
intermediate subsidiaries at December 31, 1997 (filed
separately pursuant to Rule 104(b) as part of
Southern's current Certificate of Notification filed
pursuant to Rule 24 in this file.).
I - The Southern Company's opposition to the "Motion of
the Campaign For A Prosperous Georgia To Intervene,
And Request For Denial of Application Or, In The
Alternative, Request For A Public Hearing And Other
Action" (previously filed).
(b) Financial Statements.
Breakdown of revenues and net income of each of
Southern's Exempt Projects for the 12-month periods
ended December 31, 1996, December 31, 1997, and
December 31, 1998. (Filed separately pursuant to Rule
104(b) as part of Southern's current Certificate of
Notification filed pursuant to Rule 24 in this file.)
Item 7. Information as to Environmental Effects.
(a) In light of the nature of the proposed transactions, as described
in Item 1 hereof, the Commission's action in this matter will not
constitute any major federal action significantly affecting the quality
of the human environment. (b) No other federal agency has prepared or
is preparing an environmental impact statement with regard to the
proposed transactions.
<PAGE>
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SIGNATURE
Pursuant to the requirements of the Public Utility Holding Company Act
of 1935, the undersigned company has duly caused this statement to be signed on
its behalf by the undersigned authorized officer and agent.
Dated: October 6, 1999 THE SOUTHERN COMPANY
By__/s/Tommy Chisholm
Tommy Chisholm, Secretary
