File No. 70-8725
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Amendment No. 6
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 Thomas G. Boren, 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 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
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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 letters1 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.
o Since the passage of the Energy Policy Act and the April 24, 1996
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1 Correspondence of Jim Sullivan, President, Alabama Public Service
Commission, January 16, 1996; Susan F. Clark, Chairman, Florida Public Service
Commission, January 16, 1996; Bob Durden, Chairman of the Georgia Public Service
Commission, December 27, 1995; and Curt Hebert, Chairman Mississippi Public
Service Commission, January 16, 1996.
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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.
o The additional authority sought herein will enable Southern to pursue
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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.2 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 five 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,
and by issuing notes evidencing short-term and term loan borrowings and/or
commercial paper. 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").
o File No. 70-8733 (Holding Co. Act Rel. No. 26468, dated February 2,
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2 See Holding Co. Act Rel. No. 26212, dated December 30, 1994. See also
HCAR No. 26468, dated February 2, 1996.
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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 extend its authority to make
Financial Guarantees to December 31, 2005, 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 March 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.
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
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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.3 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 at September 30, 1998, was approximately $3.935
billion.
In addition to these Financing Orders, Southern is further authorized
by the terms of HCAR No. 26468 (December 30, 1994) to issue Performance
Guarantees4 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).
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
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3 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.
4 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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aggregate of approximately $2.972 billion at September 30, 1998, in Exempt
Projects, or about 76 percent of Southern's consolidated retained earnings as
defined by Rule 53 for the four quarters ended September 30, 1998.5 Southern's
current holdings of Exempt Projects are reported pursuant to Southern's
Certificates of Notification filed pursuant to Rule 24 in this file. The most
significant Exempt Project holdings are as follows:
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
intermediate subsidiary that invests in FUCOs) is the largest independent power
producer in Asia. CEPA is engaged in Exempt Project development throughout Asia.
CEPA has installed capacity of approximately 3,310 megawatts of power generation
of which it owns 1,807 megawatts.
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
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5 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.
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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.
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.
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.
o Empresa Electrica del Norte Grande S.A. ("EDELNOR") - Southern
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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.
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
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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
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.
Southern is presently refurbishing the units.
o New England: As a result of successful bidding in a competitive
auction implemented as part of regional restructuring efforts Southern Energy
agreed to purchase electric generating assets in New England from subsidiaries
of Commonwealth Energy System and Eastern Utilities Associates for $537 million.
The power plants, with a combined generating capacity of 1,872 MW, were sold as
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part of the companies' divestiture of generating assets resulting from the
restructuring of the electric utility industry in New England. Southern closed
this acquisition at the end of 1998. Southern Energy will own and operate the
plants while SCEM will sell the output to the divesting utilities and in the
wholesale market.
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
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practices will support long-term investment of private capital. Both boards must
approve the relevant foreign country as acceptable for investment.
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
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in revenues and other contingencies. Southern Energy's success in arranging
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
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"off-take" commitment of a single power purchaser, usually but not always the
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
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include the amount of any limited guaranty Southern may agree to provide) and
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.6 To
date, Southern has never been called upon to fund its obligation under any such
guarantee.7
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
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6 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.
7 At September 30, 1998, Southern's "aggregate investment" in Exempt
Projects included approximately $244 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 $800
million, the exact amount of the proceeds of securities the subsidiaries have
issued to pay down short term debt incurred by Southern to fund investments in
FUCOs. This investment is reflected in Southern's calculation of aggregate
investment in Exempt Projects.
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host country. Where appropriate, part or all of the revenue from a project is
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
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experienced in doing business in the host country in order to provide local
experience, risk diversification, and mitigation of the risk of future
expropriation or unfair regulatory treatment. Where appropriate, an additional
mitigating factor is the participation of official or multilateral agencies in a
project.8
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
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8 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.
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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 $2.97 billion currently invested in Exempt
Projects, $761 million is invested in FUCOs that provide distribution service to
mass markets of consumers (Bewag, CEMIG, SWEB). Most of the remaining projects
have firm off-take agreements that are sufficient to support project financing.
<PAGE>
-21-
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 will take 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 modest but important contributions to earnings. For
example, for the year ended December 31, 1997, excluding the effect of the
windfall profits tax assessed on SWEB, Southern's investments in EWGs and FUCOs
have increased consolidated net income by approximately $119 million. Despite
the imposition of the $111 million windfall profits tax on Southern's interest
in SWEB, Southern's 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. For the twelve months ending September 30, 1998, Southern's investment
in EWGs and FUCOs yielded $279 million in net income.
<PAGE>
-22-
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
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
<PAGE>
-23-
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>
-24-
[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
<PAGE>
-25-
(approximately 150 percent of consolidated retained earnings), Texas Utilities
(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).9
o Effect of Trading and Marketing on Mitigating North American Risk.
The significant participation of Southern Company Energy Marketing,
L.P. ("SCEM")10 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
- -------------------------------
9 Goldman Sachs Research, October 29, 1998.
10 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>
-26-
suppliers unable to meet demand. SCEM's participation also minimizes the
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.11 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
- ---------------------------------
11 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>
-27-
requirements are commodity procurement, management and trading skills."12 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.13 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., "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).
Southern recently entered into agreements to invest in the following
Exempt Projects:
- -------------------------
12 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.
13 See, e. g., Southern Company, 1997 Annual Report, at 3.
<PAGE>
-28-
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.
China: Southern Energy and Johnston Development Company LLC have
entered into a preliminary agreement with Shanxi Enhava Energy Company Ltd. to
develop a $500 million power project in China. The June 1998 agreement provides
for the development of two 300 megawatt coal-fired units located 280 miles
southwest of Beijing in the Shanxi Province coal mining region. The project is
to be developed with the Xishan Coal Mining Bureau and the Shanxi Provincial
Power Company, which has formed a joint venture company called Shanxi Enhua
Energy Company Ltd.
Cajun Electric Power Cooperative: Southern Energy has joined NRG Energy
Inc. and Zeigler Coal Holding Company in an offer to purchase the non-nuclear
assets of Cajun Electric Power Cooperative. The offer is currently pending
before the U.S. Bankruptcy Court of the Middle District of Louisiana. The
combined plan offers $932 million in cash for the assets. Cajun generates and
sells electricity to a group of 12 distribution cooperatives which deliver power
to residences and businesses. The cooperatives that buy electricity from Cajun
serve more than 1 million people in Louisiana.
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.
<PAGE>
-29-
Wisconsin: Southern Energy is undertaking to construct a 340 MW
gas-fired generating plant near Neenah, Wisconsin. Wisconsin Electric has
reached an agreement with Southern Energy to purchase the output for eight
years. The planned in-service date is June 1, 2000.
New York: As a result of a successful bid in a competitive auction,
Southern Energy has agreed to purchase for $480 million 1,776 MW of generating
capacity from Orange and Rockland Utilities and Consolidated Edison. Five of the
plants are fossil-fueled.
Eight of the units are hydro-electric.
Texas: Southern Energy has contracted to purchase an 80 MW gas-fired
generating unit from the Wichita Falls Energy Company on October 1, 1999.
California: As a result of a successful bid in a competitive auction,
Southern Energy has agreed to purchase approximately 3,065 MW of fossil-fueled
(primarily natural gas) generating capacity from Pacific Gas & Electric for $801
million.
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.
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
<PAGE>
-30-
territorial load.14 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. Within the United States, there are currently fifteen major U.S.
domestic electric utility generation divestitures pending, including utilities
in Maine, New York, Illinois, New Jersey, Pennsylvania, Maryland, Montana,
Oregon, Washington, California, Connecticut and Massachusetts. There are
currently seven major electric utility mergers pending approval by FERC, each of
which will entail some measure of restructuring and several of which will
involve divestitures of generation. Twelve states have 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, California, Connecticut, Delaware, Illinois, Maine, Massachusetts,
Pennsylvania, Nevada, Rhode Island, 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. Approximately
- -----------------------------------
14 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>
-31-
42,000 megawatts of generation is currently pending divestiture in the United
States.15
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.
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
oversubscription 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.
The Commission has approved several applications granting expanded
investment authority in FUCOs and EWGs. See, e. g. Central and Southwest, HCAR
- ----------------------------
15 Goldman Sachs Research: October 29, 1998.
<PAGE>
-32-
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 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
<PAGE>
-33-
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,
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, 2005.16
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 $5,000.
- ------------------------------
16 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>
-34-
Item 3. Applicable Statutory Provisions.
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 is proposing herein that
Southern's "aggregate investment" 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>
-35-
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 Aggregate investments in amounts above Southern's consolidated
retained earnings for Exempt Projects, if Southern invested $4 billion in
addition to the currently authorized 100 percent of consolidated retained
earnings, or 175 percent of consolidated retained earnings, respectively, would
still represent a relatively small commitment of capital for a company the size
of Southern, based on various key financial ratios at September 30, 1998. For
example, investments in these amounts would be equal to only 20.80 percent or
19.38 percent, respectively of Southern's total capitalization ($38 billion),
<PAGE>
-36-
22.54 percent or 21 percent, respectively of consolidated net utility plant ($35
billion), 14.89 percent or 13.88 percent respectively of total consolidated
assets ($53 billion), and 31.11 percent or 28.16 percent, respectively of the
market value of Southern's outstanding common stock ($25.5 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.17
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.
- ----------------------------
17 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>
-37-
o Southern's consolidated retained earnings have grown on average
approximately 7.2 percent per year over the last five years. Excluding the $111
million one-time windfall profits tax imposed on SWEB, the average growth would
be 7.8 percent.
o Southern's consolidated capitalization ratios at September 30, 1998
are 49.4 percent equity, 50.6 percent debt including all non-recourse debt, and
are 61.45 percent equity, 38.55 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) 9/30/1998 1997 1996
--------- ---- ----
<S> <C> <C> <C>
Proceeds from sale of stock $168 $360 $171
Proceeds from preferred securities guaranteed by holding company $200 $600
</TABLE>
(in millions)
Projected proceeds available from internal plans:
DRIP $220
ESP $97
Other $57
-----------
Total $374
o The market's assessment of Southern's future growth and earnings also
compared favorably to other electric utility issuers in the 1994 - 1997 time
<PAGE>
-38-
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.
<TABLE>
<CAPTION>
P/E Ratio 1994 1995 1996 1997 Current
<S> <C> <C> <C> <C> <C>
Southern 13.2 14.8 13.5 18.2 16.7 (as of 9/30/98)
Electric Industry* 11.8 12.5 11.5 14.2 15.0 (as of 9/30/98)
Market-to-Book Ratio:
Southern 160 % 188% 166.2 % 186 % 203.6 % (as of 9/30/98)
Electric Industry* 133 % 154 % 145 % 171 % 186 % (as of 9/30/98)
</TABLE>
*Source: StockVal covering 85 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:
Payout Ratio ( percent): 1994 1995 1996 1997 Current
- ----------------------- ---- ---- ---- ---- -------
Southern 77.5 73.5 75.1 82.118 75.5 (as of 9/30/98)
Electric Industry* 81.4 76.1 74.9 76.3 74.7 (as of 9/30/98)
*Source: StockVal covering 85 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
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 September 30, 1998,
- ----------------
18 Excluding the windfall profits tax. Including the effect of that tax
Southern's payout ratio is 91.5 percent.
<PAGE>
-39-
non-recourse debt for all Exempt Projects (including debt of intermediate
subsidiaries) totaled $4.8 billion, or approximately 58 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.19
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'
financial integrity (including ability of the Operating Companies to issue
senior securities), lack of current and anticipated need for any significant
- -----------------------
19 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, 1997.
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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,20 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 50.6 percent.*
- ----------------------------
20 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.
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Debt as percent Sept.
of Capitalization 1993 1994 1995 1996 1997 1998
- -------------- ---- ---- ---- ---- ---- ----
Alabama 45.9 46 48 45.7 46.4 45.9
Georgia 49 47 43 42.5 42.3 39.6
Gulf 45 45 45 43.1 45.2 40.4
Mississippi 44 44 44 41.6 41.8 42.3
Savannah 46 45 44 44.7 43.9 43.3
*Source: "A" industry average - Moody's Electric Utility Sourcebook, October
1997.
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.21 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 coal-fired and nuclear
power construction cycles.
- ------------------------------
21 Southern contributed $25 million to Mississippi Power Company in 1994
and $30 million in 1993. Southern anticipates increased capital contributions by
it to the Operating Companies to fund the acquisition of combustion turbine
generating plants. The authority conferred herein will not impair Southern's
ability to make such contributions.
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Operating Companies - Construction Expenditures:
Actual and projected expenditures ($million)*:
1993 1994 1995 1996 1997 1998 1999
- ---- ---- ---- ---- ---- ---- ----
1402 1388 1189 1005 1056 1278 1461
*Source: Historical - Southern Company 1997 Form 10-K; Projections - Southern
Company Financial Projections - For the Three Years 1998-2000)
Percent internally generated:
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
99% 79% 112% 119% 102%
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.22
o The senior securities of each of the Operating Companies are
currently rated `A+' by Standard & Poor's and have all experienced upgrades in
the last 5 years. The Operating Companies' coverages have generally been within
- ------------------------------
22 Indenture earnings coverages for the Operating Companies have recently
ranged from about 5.2x to 8.3x, and charter earnings coverages have ranged from
about 2.98x to 5.2x, in each case well above the required coverages of 2x and
1.5x, respectively.
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the `A' and `AA' ranges set by the major rating agencies in recent years. The
Operating Companies continue to show strong financial statistics as 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: 1993 1994 1995 1996 1997 1998 (Current)
------------ ---- ---- ---- ---- ---- --------------
Alabama A A A+ A+ A+ A+
Georgia A- A A+ A+ A+ A+
Gulf A A A+ A+ AA- AA-
Mississippi A+ A+* A+ A+ AA- AA-
Savannah A A A+ A+ AA- AA-
*Mississippi Power was upgraded by Moody's to Aa3 from A1 in 1994.
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
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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
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. 23
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, 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 application should be granted
because Southern has shown that it is carrying out a balanced and successful
- ----------------------------
23 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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program of investing in EWGs and FUCOS consistent with the Energy Policy Act and
the energy markets the Energy Policy Act and related state and federal
regulatory action have engendered, and because 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.
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 $4 billion in addition to the amount previously authorized by the Commission,
or 175 percent of consolidated retained earnings, whichever is greater, in
Exempt Projects, 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:
(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;
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(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.
G - Form of Federal Register Notice.
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.).
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(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 and 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.)
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.
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: January 15, 1999 THE SOUTHERN COMPANY
By: /s/Tommy Chisholm
Tommy Chisholm, Secretary
EXHIBIT "F"
Troutman Sanders LLP
600 Peachtree Street
Atlanta, GA 30308
January 15, 1999
Securities and Exchange Commission
Washington, D.C. 20549
RE: The Southern Company Application or
Declaration on Form U-1 (File No. 70-8725)
Ladies and Gentlemen:
We are familiar with the statement on Form U-1 filed by The Southern
Company ("Southern"), a registered holding company, in the above-referenced
proceeding and are furnishing this opinion with respect to the actions requested
therein, which, if granted, would authorize Southern to invest the proceeds of
securities issued by it in activities defined by the above-referenced
application ( the "Application") and to make guarantees of obligations
pertaining to investments identified in the Application.
We are of the opinion that Southern is a validly organized and duly
existing corporation under the laws of its state of incorporation and that, upon
the issuance of your order herein and the effectiveness of the Application, and
in the event the proposed transaction is carried out in accordance with the
terms of the Application and your order:
(a) all state laws applicable to the proposed transaction will have
been complied with; and
(b) the consummation of the proposed transactions will not violate the
legal rights of the holders of any securities issued by Southern or any
subsidiary or associate company of Southern.
We hereby consent to the use of this opinion in connection with the
filing of such Application.
Very truly yours,
/s/Troutman Sanders LLP
Troutman Sanders LLP
Exhibit "G"
Form of Federal Register Notice
The Southern Company (70-8725)
The Southern Company ("Southern"), 270 Peachtree Street, N.W., Atlanta,
Georgia 30303, a registered holding company, has filed an
application-declaration under sections 6(a), 7, 12(b), 32 and 33 of the Act and
rules 45, 53, 54 and 100(a) thereunder.
Southern is currently authorized under the terms of five separate orders to
finance the operations of its subsidiaries: (1) by issuing and selling
approximately 25 million additional authorized shares of its common stock, par
value $5 per share, from time to time through December 31, 1999; (2) by issuing
additional shares of Southern's authorized common stock pursuant to Southern's
dividend reinvestment, employee savings and stock ownership plans; (3) by
issuing guaranties of the securities of one or more exempt wholesale generators
("EWGs") or foreign utility companies ("FUCOs"), as defined in sections 32 and
33 of the Act, in an aggregate amount not to exceed $1.2 billion at any one time
outstanding, from time to time through December 31, 2000; (4) by issuing notes
evidencing short-term and term loan borrowings and/or commercial paper, in an
aggregate principal amount not to exceed $2 billion at any one time outstanding,
from time to time through March 31, 2001; (5) and by using the proceeds of
authorized financings of Southern to invest in EWGs and FUCOs, provided that
Southern's "aggregate investment" in EWGs and FUCOs does not exceed 100% of
Southern's "consolidated retained earnings", all as defined in 17 CFR ss. 250.53
(Holding Co. Act Release Nos. 26349 (Aug. 3, 1995), 26347 (Aug. 5, 1995), 26468
(February 2, 1996), 26489 (March 13,1996), and 26501 (April 1, 1996) (the
"Orders").
Under the terms of the Orders, Southern may use the proceeds of common stock
sales and borrowings to finance the acquisition of the securities of one or more
EWGs or FUCOs, and may issue guaranties in respect of the securities of such
entities, provided that the sum of the net proceeds of common stock sales and
borrowings used by Southern for these purposes and the guaranties at any time
outstanding shall not, when added to Southern's "aggregate investment" (as
defined in rule 53(a) under the Act) in all EWGs and FUCOs, exceed 100% of
Southern's "consolidated retained earnings" (as defined in rule 53(a)).
Southern requests the Commission to modify this limitation, and exempt
Southern from the requirements of rule 53(a)(1), to permit Southern to use the
net proceeds of common stock sales and borrowings authorized by the Orders to
acquire the securities of EWGs and FUCOs, and to issue guaranties pursuant to
the Orders, in an aggregate amount that, when added to Southern's direct and
indirect "aggregate investment", as defined, in all EWGs and FUCOs, would not at
any time exceed an amount equal to $4 billion in excess of amounts previously
authorized or 175% of consolidated retained earnings, as defined by Rule 53,
whichever is greater, through December 25, 2005. Southern requests that its
guarantee authority pursuant to the Orders be modified so that it may issue
financial guarantees or performance guarantees of EWGs and FUCOs in any amount
or combination of amounts through December 31, 2005, provided that the amount of
such guarantees shall be included within and subject to the restrictions on the
"aggregate investment" authorized herein. The current amount of Southern's
"aggregate investment" in EWGs and FUCOs is $2.972 billion and its "consolidated
retained earnings" for the four quarters ending September 30, 1998, calculated
in accordance with Rule 53, is $3.935 billion. The requested authority would
authorize Southern to invest an additional $4.953 billion in EWG and FUCO
projects, based upon Southern's consolidated retained earnings for the four
quarters ending September 30, 1998.
Southern states that it expects to invest the majority of the additional
authority requested herein in EWGs located in the United States because such
domestic 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 Energy Policy Act of 1992, state
legislatures, and state regulatory authorities. Southern also describes
comprehensive procedures that it has established to identify and address risks
involved in EWG and FUCO investments.
Southern states that the use of financing proceeds and guarantees to make
investments in EWGs and FUCOs to the proposed increased level will not have a
substantial adverse impact on the financial integrity of the Southern system or
an adverse impact on any utility subsidiary of Southern or its customers, or on
the ability of the affected state commissions to protect such customers.
Southern further represents, as it has previously in this file, that it will not
seek recovery through higher rates to its utility subsidiaries' customers in
order to compensate Southern for any possible losses that it may sustain on
investments in EWGs and FUCOs or for any inadequate returns on such investments
and notes that each state commission has previously reserved its right to take
appropriate action in order to assure ratepayer protection.
