**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                               ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**or**

**o**                                  TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition period from                to                **

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**Commission file number 1-16455**

**ReliantEnergy, Inc.**

(ExactName of Registrant as Specified in Its Charter)

| **Delaware**                                                     |   | **76-0655566**                                              |
|------------------------------------------------------------------|--------|-------------------------------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization) |   | (I.R.S. Employer  Identification No.)                       |
| **1000 Main Street**                                             |   | ** **                                                  |
| **Houston,  Texas 77002**                                        |   | **(713)  497-3000**                                         |
| (Address and Zip  Code  of Principal Executive Offices)          |   | (Registrant’s  Telephone Number,  Including Area Code) |

 

**Securitiesregistered pursuant to Section 12(b) of the Act:**

| Title of each class                                                                                   | ** ** | **Name of each exchange on  which registered** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|
| Common Stock, par  value $.001 per share, and associated  rights to purchase Series A Preferred Stock |       | New York Stock  Exchange                       |

 

**Securities registered pursuant to Section 12(g) ofthe Act:**None

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes x  No o

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

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (check one):
| Large accelerated filer x | Accelerated  filer o | Non-accelerated  filer o |
|--------------------------------|---------------------------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct). Yes o  No x

The aggregate market valueof the voting and non-voting common equity held by non-affiliates of theregistrant was $2,044,846,996 (computed by reference to the closing sale priceof the registrant’s common stock on the New York Stock Exchange on June 30,2006, the last business day of the registrant’s most recently completed secondfiscal quarter).

As of February 15, 2007,the registrant had 339,264,991 shares of common stock outstanding and no sharesof common stock were held by the registrant as treasury stock.

**DOCUMENTS INCORPORATED BYREFERENCE**

Portions of theregistrant’s definitive proxy statement for its 2007 Annual Meeting ofStockholders, which will be filed with the Securities and Exchange Commissionwithin 120 days of December 31, 2006, are incorporated by reference into Part IIIof this Form 10-K.

 

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**TABLEOF CONTENTS**

| Forward-Looking Information  |   | iii                                                                                                                 |   |
|------------------------------|--------|---------------------------------------------------------------------------------------------------------------------|--------|
| Glossary  of Technical Terms |   | iv                                                                                                                  |   |
| **PART I**              |   |                                                                                                                |   |
| Item 1.                      |   | Business                                                                                                            |   | 1 |   |
|                         |   | General                                                                                                             |   | 1 |   |
|                         |   | Retail Energy                                                                                                       |   | 1 |   |
|                         |   | Wholesale Energy                                                                                                    |   | 3 |   |
|                         |   | Regulation                                                                                                          |   | 6 |   |
|                         |   | Seasonality  and Competition                                                                                        |   | 6 |   |
|                         |   | Environmental  Matters                                                                                              |   | 6 |   |
|                         |   | Employees                                                                                                           |   | 9 |   |
|                         |   | Executive  Officers                                                                                                 |   | 9 |   |
|                         |   | Available  Information                                                                                              |   | 10 |   |
|                         |   | Certifications                                                                                                      |   | 11 |   |
| Item 1A.                     |   | Risk Factors                                                                                                        |   | 11 |   |
|                         |   | Risks  Related to the Retail and Wholesale Energy Industries                                                        |   | 11 |   |
|                         |   | Risks  Relating to Our Texas Retail Operations                                                                      |   | 13 |   |
|                         |   | Risks  Related to Our Company                                                                                       |   | 14 |   |
|                         |   | Other Risks                                                                                                         |   | 16 |   |
| Item  1B.                    |   | Unresolved  Staff Comments                                                                                          |   | 16 |   |
| Item 2.                      |   | Properties                                                                                                          |   | 16 |   |
| Item 3.                      |   | Legal  Proceedings                                                                                                  |   | 16 |   |
| Item  4.                     |   | Submission  of Matters to a Vote of Security Holders                                                                |   | 16 |   |
| **PART II**             |   |                                                                                                                |   |
| Item  5.                     |   | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   | 17 |   |
| Item  6.                     |   | Selected Financial Data                                                                                             |   | 18 |   |
| Item 7.                      |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operation                          |   | 20 |   |
|                         |   | Business Overview                                                                                                   |   | 20 |   |
|                         |   | Consolidated Results of  Operations                                                                                 |   | 22 |   |
|                         |   | Liquidity  and Capital Resources                                                                                    |   | 32 |   |
|                         |   | Off-Balance  Sheet Arrangements                                                                                     |   | 34 |   |
|                         |   | Historical Cash Flows                                                                                               |   | 35 |   |
|                         |   | New  Accounting Pronouncements, Significant Accounting Policies and Critical  Accounting Estimates                  |   | 37 |   |
| Item 7A.                     |   | Quantitative and Qualitative  Disclosures About Market Risk                                                         |   | 40 |   |
|                         |   | Market  Risks and Risk Management                                                                                   |   | 40 |   |
|                         |   | Non-trading Market Risks                                                                                            |   | 40 |   |
|                         |   | Trading Market  Risks                                                                                               |   | 42 |   |
| Item  8.                     |   | Financial  Statements and Supplementary Data                                                                        |   | 44 |   |
| Item  9.                     |   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                               |   | 44 |   |
| Item  9A.                    |   | Controls  and Procedures                                                                                            |   | 44 |   |
| Item 9B.                     |   | Other  Information                                                                                                  |   | 44 |   |

i

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| **PART III** |       |                                                                                             |       |
|-------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| Item  10.         |       | Directors,  Executive Officers and Corporate Governance                                          |       | 45 |   |
| Item  11.         |       | Executive  Compensation                                                                          |       | 45 |   |
| Item  12.         |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |       | 45 |   |
| Item  13.         |       | Certain  Relationships and Related Transactions, and Director Independence                       |       | 45 |   |
| Item  14.         |       | Principal  Accountant Fees and Services                                                          |       | 45 |   |
| **PART IV**  | ** ** | ** **                                                                                       | ** ** |
| Item  15.         |       | Exhibits  and Financial Statement Schedules                                                      |       | 46 |   |

 

ii

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**Forward-LookingInformation**

**This report contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. Forward-looking statements are statements that contain projections,assumptions or estimates about our revenues, income and other financial items,our plans and objectives for future operations or about our future economicperformance, transactions and dispositions and financings related thereto. Inmany cases, you can identify forward-looking statements by terminology such as “anticipate,”“estimate,” “believe,” “continue,” “could,” “intend,” “may,” “plan,” “potential,”“predict,” “should,” “will,” “expect,” “objective,” “projection,” “forecast,” “goal,”“guidance,” “outlook,” “effort,” “target” and other similar words. However, theabsence of these words does not mean that the statements are notforward-looking.**

**Actualresults may differ materially from those expressed or implied by the forward-lookingstatements as a result of many factors or events, including, but not limitedto, the following:**

·       Demandand market prices for electricity, purchased power and fuel and emissioncharges;

·       Limitationson our ability to set rates at market prices;

·       Ourability to obtain adequate fuel supply;

·       Interruptionor breakdown of our generating equipment and processes;

·       Failureof third parties to perform contractual obligations;

·       Changesin environmental regulations that constrain our operations or increase ourcompliance costs;

·       Failureby transmission system operators to properly communicate operating and systeminformation;

·       Failureto meet our debt service, collateral postings and obligations related to ourcredit-enhanced retail structure;

·       Ineffectivehedging and other risk management activities;

·       Changesin the wholesale energy market;

·       The outcome of pending or threatened lawsuits,regulatory proceedings and investigations;

·       Weather-relatedevents;

·       Thetiming and extent of changes in commodity prices and interest rates;

·       Ourability to attract and retain customers and to adequately forecast their energyneeds and usage; and

·       Ouraccess to capital.

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

iii

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**GLOSSARYOF TECHNICAL TERMS**

| brownfield site            |   | An existing location which has expansion,  redevelopment or reuse opportunities to improve efficiency, change fuel type,  reduce emissions or increase capacity.                                                                         |
|----------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Cal ISO                    |   | California Independent  System Operator.                                                                                                                                                                                                 |
| capacity                   |   | Energy that could have  been generated at continuous full-power operation during the period.                                                                                                                                             |
| capacity factor            |   | The ratio of actual net  electricity generated to capacity.                                                                                                                                                                              |
| CenterPoint                |   | CenterPoint  Energy, Inc. and its subsidiaries, on and after August 31, 2002,  and Reliant Energy, Incorporated and its subsidiaries, prior to  August 31, 2002.                                                          |
| CO2                        |   | Carbon dioxide.                                                                                                                                                                                                                          |
| commercial capacity factor |   | Generation volume  divided by economic generation volume.                                                                                                                                                                                |
| contribution margin        |   | Revenues less  (a) purchased power, fuel and cost of gas sold, (b) operation and  maintenance, (c) selling and marketing and (d) bad debt expense.                                                                   |
| EBITDA                     |   | Earnings (loss) before  interest expense, interest income, income taxes, depreciation and  amortization expense.                                                                                                                         |
| economic generation volume |   | Estimated generation at  100% plant availability based on an hourly analysis of when it is economical  to generate based on the price of power, fuel, emission allowances and  variable operating costs.                                 |
| EITF                       |   | Emerging Issues Task  Force.                                                                                                                                                                                                             |
| EITF No. 02-03        |   | EITF Issue No. 02-03,  “Issues Involved in Accounting for Derivative Contracts Held for Trading  Purposes and Contracts Involved in Energy Trading and Risk Management  Activities.”                                      |
| EITF No. 03-11        |   | EITF Issue No. 03-11,  “Reporting Realized Gains and Losses on Derivative Instruments that are  Subject to FASB Statement No. 133 and Not ‘Held for Trading Purposes’ as  Defined in EITF No. 02-03.” |
| EPA                        |   | United States  Environmental Protection Agency.                                                                                                                                                                                          |
| ERCOT                      |   | Electric Reliability  Council of Texas.                                                                                                                                                                                                  |
| ERCOT ISO                  |   | ERCOT Independent System  Operator.                                                                                                                                                                                                      |
| ERCOT Region               |   | The electric market  operated by ERCOT.                                                                                                                                                                                                  |
| FASB                       |   | Financial Accounting  Standards Board.                                                                                                                                                                                                   |
| FERC                       |   | Federal Energy  Regulatory Commission.                                                                                                                                                                                                   |
| GAAP                       |   | Accounting principles  generally accepted in the United States of America.                                                                                                                                                               |
| gross margin               |   | Revenues less purchased  power, fuel and cost of gas sold. Gross margin excludes depreciation,  amortization, labor and other product costs.                                                                                             |
| GWh                        |   | Gigawatt hour.                                                                                                                                                                                                                           |
| ISO                        |   | Independent system  operator.                                                                                                                                                                                                            |
| KWh                        |   | Kilowatt hour.                                                                                                                                                                                                                           |
| LIBOR                      |   | London Inter Bank  Offering Rate.                                                                                                                                                                                                        |

iv

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| MISO                    |   | Midwest Independent Transmission System Operator,  which is an RTO.                                                                                                                          |
|-------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| MMbtu                   |   | One million British thermal  units.                                                                                                                                                          |
| MW                      |   | Megawatt.                                                                                                                                                                                    |
| MWh                     |   | Megawatt hour.                                                                                                                                                                               |
| net generating capacity |   | The average of a  facility’s summer and winter generating capacities, net of auxiliary power.                                                                                           |
| NOx                     |   | Nitrogen oxides.                                                                                                                                                                             |
| NYMEX                   |   | New York Mercantile  Exchange.                                                                                                                                                               |
| Orion Power             |   | Orion Power  Holdings, Inc. and its subsidiaries.                                                                                                                                       |
| PEDFA                   |   | Pennsylvania Economic  Development Financing Authority.                                                                                                                                      |
| PJM                     |   | PJM Interconnection,  LLC, which is an RTO.                                                                                                                                                  |
| PJM Market              |   | The wholesale and retail  electric market operated by PJM primarily in Delaware, the District of  Columbia, Illinois, Maryland, New Jersey, Ohio, Pennsylvania, Virginia and  West Virginia. |
| PUCT                    |   | Public Utility  Commission of Texas.                                                                                                                                                         |
| REMA                    |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC and its subsidiaries.                                                                                                                       |
| RERH Holdings           |   | RERH Holdings, LLC and  its subsidiaries.                                                                                                                                                    |
| RTO                     |   | Regional transmission  organization.                                                                                                                                                         |
| SEC                     |   | United States Securities  and Exchange Commission.                                                                                                                                           |
| SO2                     |   | Sulfur dioxide.                                                                                                                                                                              |

 

v

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**PART I**

**Item 1.**                        *Business.*

**General**

We provideelectricity and energy services to retail and wholesale customers through twobusiness segments.

·       *Retail energy—*provides electricity andenergy services to approximately 1.9 million retail electricity customers inTexas, including residential and small business customers and commercial,industrial and governmental/institutional customers. We also serve commercial,industrial and governmental/ institutional customers in the PJM Market, and weregularly evaluate entering other markets.

·       *Wholesale energy*—provides electricity andenergy services in the competitive wholesale energy markets in the UnitedStates through our ownership and operation or contracting for power generationcapacity. As of December 31, 2006, we had approximately 16,000 MW ofowned, leased or contracted for generation capacity in operation.

For information about our corporate history, businesssegments and disposition activities, see notes 1, 18, 20 and 21 to ourconsolidated financial statements and “Selected Financial Data” in Item 6 ofthis Form 10-K.

**Retail Energy**

As a retail electricity provider, we arrange for thetransmission and delivery of electricity to our customers, bill customers andcollect payment for electricity sold, and maintain call centers to providecustomer service. We purchase the electricity we sell to customers fromgeneration companies, utilities, power marketers and other retail energycompanies in the wholesale market. We obtain our transmission and distributionservices in Texas from entities regulated by the PUCT.

Our retail business for residential and small businesscustomers is primarily concentrated in Texas. Based on metered locations, as ofDecember 31, 2006, we had approximately 1.6 million residential and157,000 small business customers, making us the second largest mass marketelectricity provider in Texas. Approximately 68% of our customers are in theHouston area. We also have customers in other Texas cities, including Dallas,Ft. Worth and Corpus Christi.

In Texas and the PJM Market, we market electricity andenergy services to commercial, industrial and governmental/institutionalcustomers. These customers include refineries, chemical plants, manufacturingfacilities, hospitals, universities, governmental agencies, restaurants andother facilities. Based on metered locations, as of December 31, 2006, wehad approximately 76,000 commercial, industrial and governmental/institutionalcustomers.

Under our supply strategyfor our retail business, we structure our supply portfolio to match our loaddemands by procuring sufficient power prior to or concurrent with entering intoretail sales commitments. Following the initiation of our credit-enhancedretail structure, we are no longer required to post collateral for our Texasretail supply purchases.

1

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**Operations Data**

| ** **                                          | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|----------|------------|----------|------------|
| ** **                                          | ** ** | **(gigawatt hours)** | ** ** |
| **Electricity Sales to End-Use  Retail Customers:** |       |                      |       |     |       |     |       |
| Mass:                                               |       |                      |       |     |       |     |       |
| Residential:                                        |       |                      |       |     |       |     |       |
| Houston                                             |       | 15,447                    |       | 18,029   |       | 19,314   |       |
| Non-Houston                                         |       | 7,955                     |       | 6,504    |       | 4,505    |       |
| Small Business:                                     |       |                      |       |     |       |     |       |
| Houston                                             |       | 3,587                     |       | 3,640    |       | 4,474    |       |
| Non-Houston                                         |       | 1,375                     |       | 891      |       | 528      |       |
| Total Mass                                          |       | 28,364                    |       | 29,064   |       | 28,821   |       |
| Commercial and  Industrial:                         |       |                      |       |     |       |     |       |
| ERCOT(1)                                            |       | 33,393                    |       | 32,309   |       | 35,445   |       |
| Non-ERCOT                                           |       | 5,572                     |       | 6,152    |       | 3,619    |       |
| Total Commercial and Industrial                     |       | 38,965                    |       | 38,461   |       | 39,064   |       |
| Market usage  adjustments(2)                        |       | 8                         |       | (250     | )          | (51      | )          |
| Total                                               |       | 67,337                    |       | 67,275   |       | 67,834   |       |

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(1)             Thesevolumes include customers of the Texas General Land Office for whom we provideservices.

(2)             The revenues and therelated energy supply costs in our retail energy segment include our estimatesof customer usage based on initial usage information provided by theindependent system operators and the distribution companies. We revise theseestimates and record any changes in the period as additional settlementinformation becomes available (collectively referred to as “market usageadjustments”). These amounts represent the adjustments to volumes for marketusage adjustments.

| ** **                                   | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                   | ** ** | **(in thousands, metered locations)** | ** ** |
| **Weighted  Average Retail Customer Count:** |       |                                                 |       |     |       |     |       |   |   |   |   |   |   |
| Mass:                                        |       |                                                 |       |     |       |     |       |   |   |   |   |   |   |
| Residential:                                 |       |                                                 |       |     |       |     |       |   |   |   |   |   |   |
| Houston                                      |       |                                                 | 1,164      |     |       |     | 1,256      |   |   |   | 1,360 |   |   |
| Non-Houston                                  |       |                                                 | 504        |     |       |     | 390        |   |   |   | 271 |   |   |
| Small Business:                              |       |                                                 |       |     |       |     |       |   |   |   |   |   |   |
| Houston                                      |       |                                                 | 132        |     |       |     | 139        |   |   |   | 153 |   |   |
| Non-Houston                                  |       |                                                 | 29         |     |       |     | 17         |   |   |   | 10 |   |   |
| Total Mass                                   |       |                                                 | 1,829      |     |       |     | 1,802      |   |   |   | 1,794 |   |   |
| Commercial and Industrial:                   |       |                                                 |       |     |       |     |       |   |   |   |   |   |   |
| ERCOT(1)                                     |       |                                                 | 74         |     |       |     | 70         |   |   |   | 77 |   |   |
| Non-ERCOT                                    |       |                                                 | 1          |     |       |     | 2          |   |   |   | 1 |   |   |
| Total Commercial and Industrial              |       |                                                 | 75         |     |       |     | 72         |   |   |   | 78 |   |   |
| Total                                        |       |                                                 | 1,904      |     |       |     | 1,874      |   |   |   | 1,872 |   |   |

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(1)             Includes customers ofthe Texas General Land Office for whom we provide services.

2

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| ** **                      | ** ** | **December 31,**                                | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **(in thousands, metered locations)** | ** ** |
| **Retail Customers:**           |       |                                                 |       |   |   |   |   |   |   |
| Mass:                           |       |                                                 |       |   |   |   |   |   |   |
| Residential:                    |       |                                                 |       |   |   |   |   |   |   |
| Houston                         |       |                                                 | 1,095      |   |   |   | 1,213 |   |   |
| Non-Houston                     |       |                                                 | 547        |   |   |   | 462 |   |   |
| Small Business:                 |       |                                                 |       |   |   |   |   |   |   |
| Houston                         |       |                                                 | 124        |   |   |   | 137 |   |   |
| Non-Houston                     |       |                                                 | 33         |   |   |   | 29 |   |   |
| Total Mass                      |       |                                                 | 1,799      |   |   |   | 1,841 |   |   |
| Commercial and  Industrial:     |       |                                                 |       |   |   |   |   |   |   |
| ERCOT(1)                        |       |                                                 | 75         |   |   |   | 70 |   |   |
| Non-ERCOT                       |       |                                                 | 1          |   |   |   | 2 |   |   |
| Total Commercial and Industrial |       |                                                 | 76         |   |   |   | 72 |   |   |
| Total                           |       |                                                 | 1,875      |   |   |   | 1,913 |   |   |

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(1)             Includes customers ofthe Texas General Land Office for whom we provide services.

**Wholesale Energy**

As of December 31, 2006, we owned, had aninterest in or leased 37 operating electric power generation facilities with anaggregate net generating capacity of 15,935 MW in five regions of theUnited States. The net generating capacity of these facilities consists ofapproximately 38% base-load, 35% intermediate and 27% peaking capacity. 

Wesell electricity and energy services from our generation portfolio inhour-ahead, day-ahead, forward, bilateral and ISO markets. We sell theseproducts to investor-owned utilities, municipalities, cooperatives and othercompanies that serve end users or purchase power at wholesale for resale. Becauseour facilities are not subject to traditional cost-based regulation, we cangenerally sell electricity at market-determined prices. The following tableidentifies the principal markets where we own, lease or have under contractwholesale generation assets:

| **Region** | ** ** | ** **                                  | ** ** | **Principal Markets** |
|------------|------------|---------------------------------------------|------------|-----------------------|
| PJM        |       | Illinois, New Jersey and  Pennsylvania      |
| MISO       |       | Illinois, western  Pennsylvania and Ohio    |
| Southeast  |       | Florida, Mississippi and  Texas (non-ERCOT) |
| West       |       | California and Nevada                       |
| ERCOT      |       | Texas (ERCOT)                               |

 

Beginning June 1, 2007, we expect that asubstantial portion of our capacity that clears a PJM auction will be committedto the PJM Market up to three years in advance. Revenue from these capacitysales will be determined by new market rules, which are designed to ensure regionalreliability, encourage competition and reduce price volatility. Cal ISO isconsidering similar reforms to its wholesale market rules in California,which are currently expected to be implemented in early 2008.

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

3

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

Thefollowing table describes our electric power generation facilities and netgenerating capacity by region as of December 31, 2006:

| **Region**      | ** ** | ** ** | ** ** | **Number of  Generation  Facilities** | ** ** | **Net Generating  Capacity  (MW)** | ** ** | **Fuel Type** | ** ** | **Dispatch Type** | ** ** |
|-----------------|------------|------------|------------|--------------------------------------------|------------|-----------------------------------------|------------|--------------------|------------|------------------------|------------|
| **PJM**         |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating(1)    |       |       | 21         |                                       |       |                                    | 7,230      |               |       | Coal/Gas/Oil/Dual      |       | Base-load/Intermediate/Peaking |   |
| Mothballed      |       |       | 1          |                                       |       |                                    | 68         |               |       | Dual                   |       | Peaking |   |
| Combined        |       |       | 22         |                                       |       |                                    | 7,298      |               |       |                   |       |   |   |
| **MISO**        |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating       |       |       | 4          |                                       |       |                                    | 1,670      |               |       | Coal/Gas/Oil           |       | Base-load/Intermediate/Peaking |   |
| **Southeast**   |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating(2)(3) |       |       | 5          |                                       |       |                                    | 2,215      |               |       | Gas/Dual               |       | Base-load/Intermediate/Peaking |   |
| Mothballed      |       |       | 1          |                                       |       |                                    | 800        |               |       | Gas                    |       | Intermediate |   |
| Combined        |       |       | 6          |                                       |       |                                    | 3,015      |               |       |                   |       |   |   |
| **West**        |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating       |       |       | 6          |                                       |       |                                    | 3,990      |               |       | Gas/Dual               |       | Base-load/Intermediate/Peaking |   |
| **ERCOT**       |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating       |       |       | 1          |                                       |       |                                    | 830        |               |       | Gas                    |       | Base-load |   |
| **Total**       |       |       |       |                                       |       |                                    |       |               |       |                   |       |   |   |
| Operating       |       |       | 37         |                                       |       |                                    | 15,935     |               |       |                   |       |   |   |
| Mothballed      |       |       | 2          |                                       |       |                                    | 868        |               |       |                   |       |   |   |
| Combined        |       |       | 39         |                                       |       |                                    | 16,803     |               |       |                   |       |   |   |

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(1)             Welease a 100%, 16.67% and 16.45% interest in three Pennsylvania facilities having572 MW, 1,711 MW and 1,712 MW of net generating capacity,respectively, through facility lease agreements expiring in 2026, 2034 and2034, respectively. The table includes our net share of the capacity of thesefacilities.

(2)             Weown a 50% interest in one of these facilities having a net generating capacityof 108 MW. An unaffiliated party owns the other 50%. The table includes our netshare of the capacity of this facility.

(3)             Weare party to tolling agreements entitling us to 100% of the capacity of twoFlorida facilities having 630 MW and 474 MW of net generatingcapacity, respectively. These tolling agreements expire in 2012 and 2007,respectively, and are treated as operating leases for accounting purposes.

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**Operations Data**

| ** **                       | ** ** | **2006** | ** ** | **2005**               | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|------------------------|------------|----------|------------|
| ** **                       | ** ** | **GWh**  | ** ** | **% Economic**(1) | ** ** | **GWh**  | ** ** | **% Economic**(1) | ** ** | **GWh** | ** ** | **% Economic**(1) | ** ** |
| **Economic Generation Volume:**  |       |     |       |                   |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PJM Coal                         |       | 23,541.9 |       |                   | 81         | %        |       | 23,152.2 |   |   | 81 | % |   | 20,249.4 |   |   | 80 | % |   |
| MISO Coal                        |       | 6,525.1  |       |                   | 59         | %        |       | 7,047.2 |   |   | 63 | % |   | 7,675.6 |   |   | 69 | % |   |
| PJM/MISO Gas                     |       | 998.0    |       |                   | 3          | %        |       | 1,562.9 |   |   | 6 | % |   | 672.3 |   |   | 2 | % |   |
| West                             |       | 2,830.0  |       |                   | 11         | %        |       | 2,032.0 |   |   | 9 | % |   | 4,542.9 |   |   | 16 | % |   |
| Other                            |       | 5,731.1  |       |                   | 86         | %        |       | 6,005.9 |   |   | 56 | % |   | 6,627.1 |   |   | 62 | % |   |
| Total                            |       | 39,626.1 |       |                   | 39         | %        |       | 39,800.2 |   |   | 39 | % |   | 39,767.3 |   |   | 38 | % |   |
| **Commercial  Capacity Factor:** |       |     |       |                   |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PJM Coal                         |       | 82.9     | %          |                   |       |     |       | 78.9 | % |   |   |   |   | 79.1 | % |   |   |   |   |
| MISO Coal                        |       | 85.5     | %          |                   |       |     |       | 83.3 | % |   |   |   |   | 68.0 | % |   |   |   |   |
| PJM/MISO Gas                     |       | 91.8     | %          |                   |       |     |       | 77.1 | % |   |   |   |   | 83.0 | % |   |   |   |   |
| West                             |       | 86.1     | %          |                   |       |     |       | 95.9 | % |   |   |   |   | 91.7 | % |   |   |   |   |
| Other                            |       | 91.9     | %          |                   |       |     |       | 91.1 | % |   |   |   |   | 84.1 | % |   |   |   |   |
| Total                            |       | 85.1     | %          |                   |       |     |       | 82.3 | % |   |   |   |   | 79.3 | % |   |   |   |   |
| **Generation  Volume****(2):**   |       |     |       |                   |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PJM Coal                         |       | 19,522.3 |       |                   |       |     |       | 18,259.3 |   |   |   |   |   | 16,010.0 |   |   |   |   |   |
| MISO Coal                        |       | 5,577.7  |       |                   |       |     |       | 5,871.4 |   |   |   |   |   | 5,219.3 |   |   |   |   |   |
| PJM/MISO Gas                     |       | 916.4    |       |                   |       |     |       | 1,205.5 |   |   |   |   |   | 557.7 |   |   |   |   |   |
| West                             |       | 2,435.8  |       |                   |       |     |       | 1,948.5 |   |   |   |   |   | 4,163.9 |   |   |   |   |   |
| Other                            |       | 5,268.8  |       |                   |       |     |       | 5,474.3 |   |   |   |   |   | 5,571.6 |   |   |   |   |   |
| Total                            |       | 33,721.0 |       |                   |       |     |       | 32,759.0 |   |   |   |   |   | 31,522.5 |   |   |   |   |   |
| **Unit  Margin ($/MWh)****(3):** |       |     |       |                   |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PJM Coal                         |       | $        | 27.05      |                   |       |     |       |   | $ | 35.05 |   |   |   |   |   | $ | 19.36 |   |   |   |   |   |
| MISO Coal                        |       | 21.33    |       |                   |       |     |       | 33.38 |   |   |   |   |   | 11.88 |   |   |   |   |   |
| PJM/MISO Gas                     |       | 40.38    |       |                   |       |     |       | 31.52 |   |   |   |   |   | NM | (4) |   |   |   |   |
| West                             |       | 4.93     |       |                   |       |     |       | NM | (4) |   |   |   |   | 5.04 |   |   |   |   |   |
| Other                            |       | 0.76     |       |                   |       |     |       | 4.93 |   |   |   |   |   | 7.36 |   |   |   |   |   |
| Total weighted average           |       | $        | 20.76      |                   |       |     |       |   | $ | 27.20 |   |   |   |   |   | $ | 13.64 |   |   |   |   |   |

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(1)             Represents economicgeneration volume (hours) divided by maximum generation hours (maximum plantcapacity X 8,760 hours).

(2)             Excludes generationvolume related to power purchase agreements, including tolling agreements.

(3)             Represents openenergy gross margin divided by generation volume. Open energy gross margin is anon-GAAP measure as discussed in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in Item 7 of this Form 10-K.

(4)             NM is not meaningful.

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**Regulation**

**Texas**

We are certified by the PUCT to provide retailelectric service in Texas. We sell electricity in the competitive areas ofERCOT to residential and small business customers at unregulated prices. Until January 1,2007, we were required to make electricity available to Houston area residentialand small business customers at the PUCT-approved “price-to-beat.”

During 2006, approximately 528,000 of our residentialcustomers in Houston selected one of our products other than the “price-to-beat.”  Any residential “price-to-beat” customers whodid not select an alternative product by December 31, 2006 are now beingserved under our residential service plan.

In the January 2007 Texas legislative session, anumber of electricity-related bills have been filed that, if passed,could impact the retail electricity market in Texas, including the PUCT’sregulation of our activities.

In addition to the PUCT,our activities in Texas are subject to standards and regulations adopted byERCOT. See “Risk Factors” in Item 1A of this Form 10-K.

**Other States**

We operate electricgeneration facilities in regions administered by PJM, Cal ISO and MISO, whichoperate under FERC-established tariffs and regulations. In each of theseregions, the market rules include price limits or caps applicable to allgenerators. In addition, at the request of the local system operator, we may berequired to operate our plants at fixed prices or subject to temporary pricecaps to maintain reliability. The ISOs also impose numerous other requirementsrelative to the manner in which we must operate our plants.

**Federal EnergyRegulatory Commission**

A number of oursubsidiaries are public utilities under the Federal Power Act and are subjectto FERC rules and oversight regulations. As public utilities, theseentities must sell power at either market-based rates (if market-basedrates authority has been granted by FERC) or cost-based rates. Each ofour FERC-jurisdictional subsidiaries has been granted market-based rateauthority, although a limited number of services sold by some of these entitiesare sold at cost-based rates.

**Seasonality andCompetition**

The retail and wholesaleenergy industries are intensely competitive. Our competitors include merchantenergy companies, utilities, retail electric service providers and othercompanies, including in recent years companies owned by investment bankingfirms, hedge funds and private equity funds. Our principal competitors in theretail electricity markets outside of Houston are typically incumbent retailelectric providers, which have the advantage of long-standing relationshipswith customers. In general, competition in the retail and wholesale energymarkets is on the basis of price, service, brand image and product offerings,as well as market perceptions of creditworthiness. For a discussion of howseasonality impacts our business and for additional information on the effectof competition, see “Risk Factors” in Item 1A of this Form 10-K andnote 17 to our consolidated financial statements.

**EnvironmentalMatters**

We are subject to numerous federal, state and localrequirements relating to the protection of the environment and the safety andhealth of personnel and the public. These requirements relate to a broad rangeof our activities, including the discharge of compounds into the air, water andsoil; the proper 

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handling of solid,hazardous and toxic materials; and waste, noise and safety and health standardsapplicable to the workplace.

Based on existing regulations, our market outlook, andour current assessment of the costs of labor and materials and the state ofevolving technologies, we estimate that we will invest approximately $140million in 2007, $220 million in 2008 and $150 million to $430 million in 2009through 2014 on projects to reduce our emission levels, comply with existingregulations and lessen the environmental impact of our operations. Theseamounts include $35 million for future ash landfill expansions from 2007through 2014. As described below, a significant amount of our expendituresrelate to our election to upgrade the SO2 emissions controls at some of ourfacilities.

In some cases, which aredescribed below, environmental laws and regulations are pending, are underconsideration, are in dispute or could be revised. Unless otherwise noted, wecannot predict the ultimate effect of these matters on our business. For additional information on howenvironmental matters may impact our business, see “Risk Factors” inItem 1A of this Form 10-K and note 13(b) to ourconsolidated financial statements.

**Air Quality**

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

*NO*x and SO2 Emissions

In March 2005, the EPA finalized a regulation,referred to as the Clean Air Interstate Rule, to further reduce emissions of NOx and SO2 in the EasternUnited States in two phases. The first phase, which takes effect in 2009 for NOx and 2010 for SO2, requires overall reductions within thearea of approximately 50% in NOx and SO2 emissions on anannual basis. The second phase, which takes effect in 2015, requires additionalreductions of approximately 10% for a 60% total reduction in NOx and approximately 15% for a 65%reduction in SO2. TheEPA regulations include the use of cap-and-trade programs to achieve thesereductions.

These regulations require us to provide an allowancefor each ton of NOx and SO2 that we emitunder a cap-and-trade program. As part of our effort to operate ourbusiness efficiently, we concluded that since our generating assets dispatchbased on market prices, we should maintain an emission allowances inventorythat corresponds with forward power sales. We may sell excess emissionallowances inventory if the price is equal to or above our fundamental view ofthe value of the allowances.

We have undertaken studiesto evaluate possible impacts of the Clean Air Interstate Rule and similarlegislative and regulatory proposals, which will primarily affect ourcoal-fired facilities in the Eastern United States. Based on an economicanalysis that includes plant operability, changes in the emission allowancesmarket, potential impact of state-imposed regulations and our preliminaryestimates of capital expenditures, we have elected to invest amounts rangingfrom approximately $340 million to $615 million through 2013 to principallyreduce our emissions of SO2. We anticipate that these expenditures would be madeover time, with the majority of the expenditures being incurred in 2007 and2008.

*Mercury Emissions*

In March 2005, the EPA finalized the Clean AirMercury Rule (CAMR), a national rule designed to reduce mercury emissionfrom coal plants in two phases through a cap-and-trade system. CAMR targetsphase I reductions of approximately 30% in 2010 and phase II reductions ofapproximately 70% in 2018. Under CAMR, states are permitted to adoptregulations that conform to CAMR or adopt their own 

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mercury regulations thatare stricter than those provided for in CAMR. Ohio has proposed regulationsthat generally conform to the federal CAMR standard. Several states, includingPennsylvania, initiated litigation of CAMR, in particular to require mercurycontrol on a facility basis, instead of through a cap-and-trade system. Theoutcome of this litigation is uncertain, but may impact our ultimaterequirements to control mercury.

In late 2006, thePennsylvania Department of EnvironmentalProtection finalized stricter regulations for mercury emissions andseveral other states have done so or are considering doing so as well. Pennsylvania’sprogram generally requires mercury reductions on a facility basis in twophases, with 80% reductions in 2010 and 90% reductions in 2015. Our preliminaryestimate of capital expenditures to comply with the first phase of the rules isapproximately $45 million to $55 million for 2007 through 2009. Our analysisand evaluation of alternatives for compliance with the second phase of thismercury control rule, including potential capital expenditures for controls, isunderway.

*Air Particulates*

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

*Greenhouse GasEmissions*

There is an increasedfocus within the United States over the direction of domestic climate changepolicy. Several states, primarily in the northeastern and coastal westernUnited States, are increasingly active in developing state-specific or regionalregulatory initiatives to stimulate CO2 emission reductions in the electric powergeneration industry and other industries. The United States Congress isconsidering numerous bills that would impose mandatory limitation of CO2 and other greenhouse gas emissions for thedomestic power generation sector. The specific impact on our business willdepend upon the form of emissions-related legislation or regulations ultimatelyadopted by the federal government or states in which our facilities are located.In September 2006, California adopted legislation designed to reducegreenhouse gas emissions to 25% below 1990 levels by 2020. This legislationrequires the California Air Resources Board to adopt regulations to becomeeffective by 2012 which will limit emissions of greenhouse gases and providefor gradual reductions in emission levels to the 2020 limit.

**Water Quality**

In July 2004, the EPApromulgated final regulations relating to the design and operation of coolingwater intake structures at existing power plants. In 2004, we initiatedsite-specific evaluations to determine our practicable compliance options andthe associated costs. The EPA developed facility-specific cost assumptions thatprovide an interim means to benchmark our future compliance expenditures. Usingthese assumptions, we anticipate capital expenditures of approximately $50million between 2008 and 2010. However, several environmental organizations andAttorneys General of six northeastern states filed suit against the EPAalleging the regulations are insufficient for protection of the state watersand fisheries. In January 2007, the court responded by remanding the rule tothe EPA for substantial revisions. As a result of the court decision andbecause of ongoing efforts in certain states, including California, to developregulations that are more stringent than the federal regulations, our costestimates and the timing of any expenditures may change.

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**Other**

As a result of their age, many of our facilitiescontain significant amounts of asbestos insulation, other asbestos containingmaterials, as well as lead-based paint. Existing state and federal rules requirethe proper management and disposal of these potentially toxic materials. Webelieve we properly manage and dispose of such materials in compliance withthese state and federal rules. See note 13(b) to our consolidatedfinancial statements.

We do not believe we haveany material liabilities or obligations under the Comprehensive EnvironmentalResponse Corporation and Liability Act of 1980 and similar state laws. Theselaws impose clean up and restoration liability on owners and operators offacilities from or at which there has been a release or threatened release ofhazardous substances, together with those who have transported or arranged forthe disposal of those substances.

**Employees**

As of December 31,2006, we had 3,524 full-time and part-time employees. Of these employees, 1,112are covered by collective bargaining agreements, which expire on various datesfrom April 2007 through October 2011. The following table sets forththe number of our employees by business segment as of December 31, 2006:

| **Segment**      | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|------------|------------|
| Retail energy    |       | 969        |       |
| Wholesale energy |       | 1,910      |       |
| Other operations |       | 645        |       |
| Total            |       | 3,524      |       |

 

**Executive Officers**

**Thefollowing table lists our executive officers:**

| **Name**            | ** ** | ** ** | ** ** | **Age**(1)                                                                                 | ** ** | **Present  Position** |
|---------------------|------------|------------|------------|--------------------------------------------------------------------------------------------|------------|-----------------------|
| Joel  V. Staff      |       | 63         |       | Chairman  and Chief Executive Officer                                                      |
| Mark  M. Jacobs     |       | 44         |       | Executive  Vice President and Chief Financial Officer                                      |
| Brian  Landrum      |       | 44         |       | Executive  Vice President, Operations                                                      |
| Jerry  J. Langdon   |       | 55         |       | Executive  Vice President, Public and Regulatory Affairs and Corporate Compliance  Officer |
| Michael  L. Jines   |       | 48         |       | Senior  Vice President, General Counsel and Corporate Secretary                            |
| Suzanne  L. Kupiec  |       | 40         |       | Senior  Vice President, Risk and Structuring                                               |
| Karen  D. Taylor    |       | 49         |       | Senior  Vice President, Human Resources and Chief Diversity Officer                        |
| Thomas C. Livengood |       | 51         |       | Senior Vice President and  Controller                                                      |

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(1)             Ageis as of February 1, 2007.

**Joel V. Staff**has served as our Chairman and Chief ExecutiveOfficer since April 2003. He was Executive Chairman of National-Oilwell, Inc.(now National Oilwell Varco, Inc.), an international oil and gas servicesand equipment company, from May 2001 to May 2002. He also serves onthe Board of Directors of ENSCO International Incorporated and is a member ofits Nominating, Governance and Compensation Committee.

**Mark M. Jacobs**has served as our Executive Vice President and ChiefFinancial Officer since July 2002. He served as Executive Vice Presidentand Chief Financial Officer of CenterPoint from 

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**July 2002until our separation from it and Managing Director in the Natural ResourcesGroup of Goldman, Sachs & Co., a global investment banking, securitiesand investment management firm, from 1989 to 2002.**

**BrianLandrum**hasserved as our Executive Vice President, Operations since February 2006. Hewas Senior Vice President, Commercial and Retail Operations, IT from February 2005to February 2006; Senior Vice President, Customer Operations andInformation Technology from January 2004 to February 2005; President,Reliant Energy Retail Services from June 2003 to January 2004 andSenior Vice President, Retail Operations from August 2001 to May 2003.

**Jerry J. Langdon**has served as our Executive Vice President,Public and Regulatory Affairs and Corporate Compliance Officer since January 2004.He was our Executive Vice President and Chief Administrative Officer from May 2003to January 2004. Before joining us, Mr. Langdon served as Presidentof EPGT Texas Pipeline, L.P., an El Paso Corporation affiliate that providedgas transportation and storage services, from June 2001 until May 2003.

**Michael L. Jines**has served as our Senior Vice President, GeneralCounsel and Corporate Secretary since May 2003. He was our Deputy GeneralCounsel and Senior Vice President and General Counsel, Wholesale Group from March 2002to May 2003. Previously, Mr. Jines served as Deputy General Counselof CenterPoint and Senior Vice President and General Counsel of its WholesaleGroup from 1999 until our separation from it.

**SuzanneL. Kupiec**has served as ourSenior Vice President, Risk and Structuring since January 2004. She wasour Vice President and Chief Risk and Corporate Compliance Officer from June 2003to January 2004. From 2000 until the time she joined us, Ms. Kupiecwas a partner at Ernst & Young LLP, where she led its Energy Tradingand Risk Management Practice serving both audit and advisory service clients.

**KarenD. Taylor**has served as ourSenior Vice President, Human Resources since December 2003. In November 2005,she was appointed as our Chief Diversity Officer. Ms. Taylor was VicePresident, Human Resources from February 2003 to December 2003 andVice President, Administration, Wholesale Group from October 1998 to February 2003.

**Thomas C. Livengood**hasserved asour Senior Vice President and Controller since May 2005.He was Vice President and Controller from August 2002 to May 2005. From1996 to August 2002, Mr. Livengood served as Executive Vice Presidentand Chief Financial Officer of Carriage Services, Inc., a consumerservices company.

**AvailableInformation**

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

·       Ourcorporate governance guidelines and board committee charters;

·       Ourannual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to these reports; and

·       Ourbusiness ethics policy.

You can request a free copy of these documents bycontacting our investor relations department. It is our intention to discloseamendments to, or waivers from, our business ethics policy on our website. Noinformation on our website is incorporated by reference into this Form 10-K.In addition, certain of these materials are available on the SEC’s website at(http://www.sec.gov) or at its public reference room:  100 F Street, NE, Room 1580, Washington,D.C. 20549 (1-800-SEC-0330).

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**Certifications**

We will timely provide theannual certification of our Chief Executive Officer to the New York StockExchange. We filed last year’s certification in June 2006. In addition,our Chief Executive Officer and Chief Financial Officer each have signed andfiled the certifications under Section 302 of the Sarbanes-Oxley Act of2002 with this Form 10-K.

**Item 1A.**                *Risk Factors.*

**Risks Related tothe Retail and Wholesale Energy Industries**

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

Our results of operations,financial condition and cash flows are significantly impacted by the prevailingdemand and market prices for electricity, purchased power, fuel and emissionallowances over which we have no control. Market prices can fluctuatedramatically in response to many factors, including weather conditions; changesin the prices of related commodities; changes in law and regulation; regulatoryintervention (including the imposition of price limitations, bidding rules orsimilar mechanisms); market illiquidity; transmission constraints;environmental limitations; generation unit outages; fuel supply issues; andother events.

***The markets in which we operate are relativelyimmature markets that are characterized by elements of both deregulated andregulated markets. Changes in the regulatory environment in which we operatecould adversely affect the cost, manner or feasibility of conducting ourbusiness.***

We operate in a regulatoryenvironment that is undergoing varying restructuring initiatives. In manyinstances, the regulatory structures governing the electricity markets arestill evolving, creating gaps in the regulatory framework and associateduncertainty. In addition, existing regulations may be revised or reinterpretedand new laws and regulations may be adopted or become applicable to ourfacilities or our commercial activities. We cannot predict the future directionof these initiatives or the ultimate effect that this changing regulatory environmentwill have on our business.  Consequently,future regulatory restrictions, regulatory or political intervention or changesin laws and regulations, may constrain our ability to set rates at marketprices or otherwise have an adverse effect on our business. See “Business—Regulation”in Item 1 of this Form 10-K.

***We depend on sources, facilities and systems that we do not own orcontrol for our fuel and fuel supply and* to deliverelectricity to and bill our customers. Any disruption in these sources, facilitiesor systems could have an adverse effect on our business.**

We depend on fuel sourcesand fuel supply facilities owned and operated by third parties to supply ourgeneration plants and power transmission, distribution facilities and meteringsystems owned and operated by third parties to deliver electricity to ourcustomers and provide energy usage data. If these sources, facilities orsystems fail, we may be unable to generate and/or deliver electricity. Inaddition, inaccurate or untimely information from third parties could hinderour ability to bill customers and collect amounts owed.

***The operation of generation facilities involvessignificant risks that could interrupt operations and increase our costs.***

Ownership of generationassets exposes us to risks relating to the breakdown of equipment or processes;fuel supply or transportation interruptions; shortages of equipment, materialand labor; operational restrictions resulting from environmental limitationsand governmental interventions; as well as other operational risks. Inaddition, many of our facilities are old and require significant maintenanceexpenditures. We are party to collective bargaining agreements with laborunions at several of our plants. 

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If ourworkers were to engage in a strike, work stoppage or other slowdown, otheremployees were to become unionized or the terms and conditions in future laboragreements were renegotiated, we could experience a significant disruption inour operations and higher ongoing labor costs. Similarly, we have an agingworkforce at a number of our plants creating potential knowledge and expertisegaps as those workers retire. If we are unable to secure fuel, we will not beable to run our generation units. If a generation unit fails, we may have topurchase replacement power from third parties at higher prices. We haveinsurance, subject to limits and deductibles, covering some types of physicaldamage and business interruption related to our generation units. However, thisinsurance may not always be available on commercially reasonable terms. Inaddition, there is no assurance that insurance proceeds will be sufficient tocover all losses, insurance payments will be timely made or the policiesthemselves will be free of substantial deductibles.

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

We may incur losses ifthird parties default on their contractual obligations, such as obligations topay us money; buy or sell electricity, fuel, emission allowances and othercommodities; or provide us with fuel transportation services, powertransmission or distribution services. For additional information about thirdparty default risk, including our efforts to mitigate against this risk, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Liquidityand Capital Resources—Credit Risk” in Item 7 of this Form 10-Kand note 2(e) to our consolidated financial statements.

***Our costs of compliance with environmental laws aresignificant and can affect our future financial results.***

Our wholesale energysegment is subject to extensive and evolving environmental regulations,particularly our coal- and oil-fired generation units. We incur significantcosts in complying with these regulations and, if we fail to comply, couldincur significant penalties. Our cost estimates for compliance withenvironmental regulations are based on our current assessment of the cost oflabor and materials and the state of evolving technologies. Changes to thepreceding factors, revisions of environmental regulations, litigation and newlegislation and/or regulations, as well as other factors, could cause ouractual costs to vary outside the range of our estimates. In addition, failureto comply with environmental requirements could require us to shut down orreduce production on our generation units or create liability exposure. Newenvironmental laws or regulations may be adopted that would further constrainour operations or increase our environmental compliance costs. We also may beresponsible for the environmental liabilities associated with generation unitseven if a prior owner caused the liabilities. We are required to purchaseemission allowances to operate some of our facilities. Such allowances may beunavailable or only available at costs that would make it uneconomic to operateour generating assets. See “Business—Environmental Matters” in Item 1 of this Form 10-Kand note 13(b) to our consolidated financial statements.

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

To operate our generatingunits and retail electric business, we must obtain and maintain variouspermits, licenses, approvals and certificates from governmental agencies. Insome jurisdictions, we must also meet minimum requirements for customer serviceand comply with local consumer protection and other laws. Our failure to obtainor maintain any necessary governmental permits or licenses or to satisfy theselegal requirements, including environmental compliance provisions, could limitour ability to operate our business or create liability exposure.

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***Significant events beyond our control, such ashurricanes and other weather-related problems or acts of terrorism, could havea material adverse effect on our businesses.***

The uncertainty associatedwith events beyond our control, such as significant weather events and the riskof future terrorist activity, may affect our results of operations andfinancial condition in unpredictable ways. These events could result in adversechanges in the insurance markets and disruptions of power and fuel markets. Inaddition, terrorist actions could damage or shut down our generation facilitiesor the fuel and fuel supply facilities or the power transmission anddistribution facilities upon which our generation and retail businesses aredependent. These events could also adversely affect the United States economy,create instability in the financial markets and, as a result, have an adverseeffect on our ability to access capital on terms and conditions acceptable tous.

**Risks Relating toOur Texas Retail Operations**

***Merrill Lynch provides credit support for our Texasretail business.***

In December 2006, ournew credit-enhanced retail structure became effective. Under the terms of theagreement, Merrill Lynch & Co., Inc. and an affiliate (MerrillLynch) provides guarantees and posts collateral for the supply purchases andrelated transactions of our Texas retail energy business. If we do not complywith the material terms of our agreement, Merrill Lynch could terminate itsfuture obligations to provide guarantees and collateral postings on our behalf.In this event, our ability to operate our Texas retail business could be impaired,which would adversely affect our liquidity, cash flows and financialperformance.

***We depend on thirdparties to provide electricity to supply our Texas retail customers.***

We own a very limitedamount of generation capacity in Texas, which is insufficient to supply theelectricity requirements of our Texas retail operations. We purchasesubstantially all of our Texas supply requirements from third parties. As aresult, our financial performance depends on our ability to obtain adequatesupplies of electric generation from third parties at prices below the priceswe charge our customers.

***Initiativesundertaken by the PUCT may negatively impact the wholesale cost of power.***

In 2006, the PUCTimplemented a new rule on resource adequacy and market power in the ERCOTRegion. In this rule, the PUCT increased the current price cap applicable togeneration offers into the ERCOT energy market, eliminated current market powermitigation measures and adopted new market power guidelines. If a marketparticipant commits market power abuse and it is not adequately mitigated, suchabuse would have the impact of increasing the wholesale cost of power, whichcould adversely impact our gross margins in the Texas retail market.

***Rising power supplycosts could adversely affect the financial performance of our Texas retailelectric operations.***

Ourearnings could be adversely affected in any period in which our power supplycosts rise at a greater rate than our rates charged to customers. The price ofour power supply purchases associated with our energy commitments can bedifferent than that reflected in the rates charged to customers due to:

·       varyingsupply procurement contracts used and the timing of entering into relatedcontracts;

·       subsequentchanges in the overall price of natural gas;

·       daily,monthly or seasonal fluctuations in the price of natural gas relative to the 12-monthforward prices;

·       changesin market heat rate (i.e., the relationship between power and natural gasprices); and

·       other factors.

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***We may lose further market share in the Houston retailelectricity market, which is a significant contributor of income to ourconsolidated results.***

In recent years, we haveexperienced declines in our share of the Houston retail electricity market,which represents approximately 67% of our residential customer base. This trendcould continue if competition increases. In addition, the new competitivemarket has attracted a number of new participants. The emergence of larger,aggressive competitors may put downward pressure on our Houston sales volumesand margins over time. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Business Overview” in Item 7 of this Form 10-K.

***Our ability to set rates at market prices in Texas maybe constrained by new legislative restrictions.***

The Texas legislature isstudying the effects of competition in the Texas retail electricity market. Althoughwe were no longer obligated to make electricity available to Houston areacustomers at the “price-to-beat” rate as of January 1, 2007,new legislation or rules governing the retail electricity market,including prices we are allowed to charge and the possibility of our customersbeing transferred to another provider, could have an adverse effect on ourfinancial condition, results of operations and cash flows.

***We depend on the ERCOT ISO to communicate operatingand system information in a timely and accurate manner. Corrections to priorestimated billing and other information can have an impact on our future reportedfinancial results.***

The ERCOT ISO communicatesinformation relating to a customer’s choice of retail electric provider andother data needed for servicing of customer accounts to utilities and retailelectric providers. Any failure to perform these tasks will result in delaysand other problems in enrolling, switching and billing customers. The ERCOT ISOis also responsible for settling all electricity supply volumes in the ERCOTRegion. Information that is not accurate or timely may result in incorrectestimates of our settled volumes and supply costs that would need to becorrected when such information is received. See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—New AccountingPronouncements, Significant Accounting Policies and Critical AccountingEstimates—Critical Accounting Estimates” in Item 7 of this Form 10-K.

***We could be liable for a share of the payment defaultsof other retail electric providers within the ERCOT market.***

If a retail electricprovider defaults on its payment obligations to ERCOT, we, together with otherERCOT market participants, are liable for a portion of the defaulted amountbased on our respective share of the total load. As of December 31, 2006,we accounted for approximately 20% of the total ERCOT load. In addition, theemergence of smaller, less well-capitalized entities may impose costs andburdens on market participants such as us if they default on their obligationsto the market.

**Risks Related toOur Company**

***Our borrowing levels, debt service obligations andrestrictive covenants may adversely affect our business. We are vulnerable toreductions in our cash flow.***

As of December 31,2006, we had total gross debt of $3.5 billion:

·       Wemust dedicate a substantial portion of our cash flows to pay debt servicerequirements, which reduces the amount of cash available for other businesspurposes;

·       Thecovenants in our debt agreements and in our agreement with Merrill Lynchrestrict our ability to, among other things, obtain additional financing, makeinvestments or acquisitions, create additional liens on our assets and takeother actions to react to changes in our business;

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·       Ifwe do not comply with the payment and other material covenants, including thefinancial ratios, under our debt agreements, our debt holders could require usto repay our debt immediately and, in the case of our revolving creditfacilities, terminate their commitment to lend us money;

·       Solong as our credit ratios remain at historical levels, and substantially allour assets are pledged to secure repayment of our debt, we are unlikely toobtain an investment grade credit rating;

·       Ourdebt levels and credit ratings may affect the evaluation of ourcreditworthiness by customers, which could put us at a competitive disadvantageto competitors with less debt; and

·       Wemay be more vulnerable to adverse economic and industry conditions, includingchanges in short-term interest rates.

If we were unable togenerate sufficient cash flows, access funds from operations or raise cash fromother sources, we would not be able to meet our debt service and otherobligations. These situations could result from adverse developments in theenergy, fuel or capital markets, a disruption in our operations or those ofthird parties or other events adversely affecting our cash flows and financialperformance.

***Our hedging and other risk management activities maynot work as planned.***

Our hedges may not beeffective as a result of basis price differences, transmission issues, pricecorrelation, volume variations or other factors. See “Quantitative andQualitative Disclosures about Non-Trading and Trading Activities and RelatedMarket Risks” in Item 7A of this Form 10-K.

***Changes in the wholesale energy market or sales ofgeneration assets could result in impairments.***

If our outlook for thewholesale energy market changes negatively, or if our ongoing evaluation of ourwholesale energy segment results in decisions to mothball, retire or dispose ofgeneration assets, we could have impairment charges related to goodwill or ourfixed assets. See notes 2(h) and 2(i) to our consolidatedfinancial statements.

***Lawsuits and regulatory proceedings could adverselyaffect our business.***

From time to time,******we are named as a party to lawsuitsand regulatory proceedings. Litigation can involve complex factual and legalquestions and its outcome is uncertain. Any claim that is successfully assertedagainst us could result in significant damage claims and other losses. Even ifwe were to prevail, any litigation could be costly and time-consuming and woulddivert the attention of our management and key personnel from our businessoperations, which could adversely affect our financial condition, results ofoperations or cash flows. See notes 13 and 14 to our consolidatedfinancial statements*.*

***We have entered into outsourcing arrangements withthird party service providers. In addition, our operations are highly dependenton computer and other operating systems, including telecommunications systems. Anyinterruptions in these arrangements or systems could significantly disrupt ourbusiness operations.***

In recent years, we haveentered into outsourcing arrangements, such as information technologyproduction software, infrastructure and development and certain functions withincustomer operations, with third party service providers. If these serviceproviders do not perform their obligations, we may incur significant costs andexperience interruptions in our business operations in connection withswitching to other service providers or assuming these obligations ourselves. Weare also highly dependent on our specialized computer and communicationssystems, the operation of which could be interrupted by fire, flood, powerloss, computer viruses and similar disruptions. Although we have some backupsystems and disaster recovery plans, there is no guarantee that these systemsand plans will be effective.

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

We may seek to purchase ordevelop additional generation units or dispose of existing generation units. Thereis no assurance that our efforts to identify and acquire additional generationunits or to dispose of existing generation assets will be successful. In thesale of generation units, we may be required to indemnify a purchaser againstcertain liabilities. To finance future acquisitions, we may be required toissue additional equity securities or incur additional debt.

**Other Risks**

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

**Item 1B.**               *Unresolved Staff Comments.*

None.

**Item 2.**                        *Properties.*

Our principal executiveoffices are leased through 2018, subject to two five-year renewal options. Ourprincipal generation facilities are described under “Business―Wholesale Energy” in Item1 of this Form 10-K. We believe that our properties are adequate forour present needs. We have satisfactory title, rights and possession to ourowned facilities, subject to exceptions,****which, in ouropinion, would not have a material adverse effect on the use or value of thefacilities.

**Item 3.**                        *Legal Proceedings.*

For a description of ourmaterial pending legal and regulatory proceedings and settlements, seenotes 13 and 14 to our consolidated financial statements.

**Item 4.**                        *Submission of Matters to a Vote of Security Holders.*

None.

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**PART II**

**Item 5.**                        *Market for**Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities*.

Our common stock trades on theNew York Stock Exchange under the ticker symbol “RRI.”  On February 15, 2007, we had 38,750stockholders of record.

The closing price of our common stock on December 31,2006 was $14.21.

| ** **      | ** ** | **Market Price** | ** ** |
|-----------------|------------|-----------------------|------------|
| ** **      | ** ** | **High**              | ** ** | **Low** | ** ** |
| **2006:**       |       |                  |       |   |   |
| First Quarter   |       | $                     | 10.74      |   | $ | 9.57 |   |
| Second Quarter  |       | $                     | 12.55      |   | $ | 10.51 |   |
| Third Quarter   |       | $                     | 13.58      |   | $ | 11.64 |   |
| Fourth Quarter  |       | $                     | 14.40      |   | $ | 12.02 |   |
| **2005:**       |       |                  |       |   |   |
| First Quarter   |       | $                     | 13.75      |   | $ | 10.97 |   |
| Second Quarter  |       | $                     | 13.00      |   | $ | 9.70 |   |
| Third Quarter   |       | $                     | 15.52      |   | $ | 12.20 |   |
| Fourth  Quarter |       | $                     | 15.65      |   | $ | 8.65 |   |

 

We have never paid dividends. Ourdebt agreements restrict the payment of dividends. See note 6 to ourconsolidated financial statements.

*Sales of UnregisteredSecurities*.   In thefourth quarter of 2006, we issued 141,664 shares of unregistered common stockfor warrants pursuant to warrant exercises under an exemption pursuant to Section 4(2) ofthe Securities Act of 1933, as amended.

On December 21, 2006, we completed an exchangeoffer for our 5.00% convertible senior subordinated notes due 2010. Approximately99.2% of the holders accepted the offer ($273 million), resulting in $2 millionoutstanding as of December 31, 2006. We issued an aggregate of 28.6million shares of our common stock (104.8108 shares per $1,000 principal) andpaid an aggregate cash premium of $41 million ($150 per $1,000 principal) tothe holders who validly exchanged their notes. The exchange was made inreliance on the exemption from registration provided by Section 3(a)(9) ofthe Securities Act. We did not receive any proceeds from the exchange offer orthe issuance of the common stock.

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*Stock Price Performance Graph.*   The following line graph compares the yearlypercentage change in our cumulative total stockholder return on common stockwith the cumulative total return of a broad equity market index (Standard &Poor’s 500 Stock Index) and the cumulative total return of a group of our peercompanies comprised of Calpine Corporation, Constellation Energy Group, Inc.,Dominion Resources, Inc., Dynegy Inc., Exelon Corporation, MirantCorporation, NRG Energy, Inc., Sempra Energy and TXU Corp.

This stock price performancegraph is furnished in this Form 10-K and is not filed, as permittedby 17 CFR 229.201(e).

**Item6.**                        *Selected**Financial Data*.

| ** **                                          | ** ** | **2006**(1)(2)(4)      | ** ** | **2005**(1)(3)(4) | ** ** | **2004**(1)(4)(5) | ** ** | **2003**(1)(4)(5)(6)(7)(8) | ** ** | **2002**(1)(5)(8)(9)(10) | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-------------------|------------|-------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                          | ** ** | **(in millions)** | ** ** |
| **Statements  of Operations Data:**                 |       |                   |       |              |       |              |       |                       |       |                     |       |   |   |   |   |   |   |
| Revenues                                            |       |                   | $          | 10,877            |       |              | $          | 9,712                      |       | $                        | 8,098      |   |   | $ | 10,097 |   |   |   | $ | 10,230 |   |   |
| Operating income (loss)                             |       |                   | (24        | )                 |       | (321              | )          | (13                        | )          |                     | (476       | ) |   |   | 249 |   |   |
| Income (loss) from continuing operations            |       |                   | (327       | )                 |       | (441              | )          | (276                       | )          |                     | (916       | ) |   |   | 29 |   |   |
| Cumulative effect of accounting changes, net of tax |       |                   | 1          |              |       | (1                | )          | 7                          |       |                     | (24        | ) |   |   | (234 | ) |   |
| Net  loss                                           |       |                   | (328       | )                 |       | (331              | )          | (29                        | )          |                     | (1,342     | ) |   |   | (560 | ) |   |
|                                                     |            |                        |            |                   |            |                   |            |                            |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                               | ** ** | **2006**(1)(2) | ** ** | **2005**(1)(3) | ** ** | **2004**(1)(5) | ** ** | **2003**(1)(5)(6)(8) | ** ** | **2002**(1)(5)(8)(9)(10) | ** ** |
|------------------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------------|------------|--------------------------|------------|
| **Diluted  Earnings (Loss) per Share:**  |       |           |       |           |       |           |       |                 |       |                     |       |   |   |   |   |
| Income (loss) from continuing operations |       | $              | (1.06      | )              | $          | (1.46          | )          | $                    | (0.93      | )                        |       | $ | (3.12 | ) |   |   | $ | 0.10 |   |   |
|                                          |            |                |            |                |            |                |            |                      |            |                          |            |  |  |  |  |  |  |  |  |  |

 

| ** **                            | ** ** | **2006**(1)(3)         | ** ** | **2005**(1) | ** ** | **2004**(1)(5) | ** ** | **2003**(1) | ** ** | **2002**(1)(10) | ** ** |
|---------------------------------------|------------|------------------------|------------|-------------|------------|----------------|------------|-------------|------------|-----------------|------------|
| ** **                            | ** ** | **(in millions)** | ** ** |
| **Statements  of Cash Flow Data:**    |       |                   |       |        |       |           |       |        |       |            |       |
| Cash flows from operating activities  |       | $                      | 1,276      |        | $          | (917           | )          | $           | 106        |            | $          | 994 |   | $ | 234 |   |
| Cash flows from investing activities  |       | 1,057                  |       | 306         |       | 900            |       | 917         |       | (3,204          | )          |
| Cash  flows from financing activities |       | (1,957                 | )          | 594         |       | (1,047         | )          | (2,889      | )          | 3,985           |       |
|                                       |            |                        |            |             |            |                |            |             |            |                 |            |  |  |  |  |  |

 

| ** **                                                  | ** ** | **December 31,**  | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **2006**(1)(11)        | ** ** | **2005**(1) | ** ** | **2004**(1) | ** ** | **2003**(1)(6)(7) | ** ** | **2002**(1)(9) | ** ** |
| ** **                                                  | ** ** | **(in millions)** | ** ** |
| **Balance  Sheet Data:**                                    |       |                   |       |   |   |   |   |   |   |   |   |
| Net margin deposits                                         |       | $                      | 436        |   | $ | 1,700 |   | $ | 487 |   | $ | 36 |   | $ | 259 |   |
| Total assets                                                |       | 10,567                 |       | 13,569 |   | 12,194 |   | 13,297 |   | 17,219 |   |
| Current portion of long-term debt and short-term borrowings |       | 355                    |       | 789 |   | 619 |   | 129 |   | 518 |   |
| Long-term debt to third parties                             |       | 3,178                  |       | 4,317 |   | 3,939 |   | 4,276 |   | 4,555 |   |
| Stockholders’  equity                                  |       | 3,950                  |       | 3,864 |   | 4,386 |   | 4,372 |   | 5,653 |   |
|                                                             |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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          (1) Our resultsof operations include Orion Power since its acquisition in February 2002. Wesold or transferred the following operations, which have been classified asdiscontinued operations:  Desert Basin,European energy, Orion Power’s hydropower plants, Liberty, Ceredo and OrionPower’s New York plants. We sold the following operations, which are includedin continuing operations:  REMAhydropower plants in April 2005, landfill-gas fueled power plants in July 2005and our El Dorado investment in July 2005. See notes 20 and 21 to ourconsolidated financial statements.

          (2) During 2006, we recorded a $35 million chargerelated to a settlement of certain class action natural gas cases relating tothe Western states energy crisis. See note 14(a) to our consolidatedfinancial statements.

          (3) During 2005, we recorded charges of $359 millionrelating to various settlements associated with the Western states energycrisis, which were paid during 2006. See note 14(a) to ourconsolidated financial statements.

          (4) Effective October 1, 2003, we adopted EITFNo. 03-11 and beganprospectively reporting the settlement of sales and purchases of fuel andpurchased power related to our non-trading commodity derivative activities thatwere not physically delivered on a net basis in our results of operations inthe same line as the item hedged. This resulted in decreased revenues anddecreased purchased power, fuel and cost of gas sold of $3.3 billion, $4.2billion, $2.4 billion and $834 million for 2006, 2005, 2004 and the fourthquarter of 2003, respectively. We did not reclassify amounts for periods priorto October 1, 2003.

          (5) During 2004, 2003 and 2002, we recorded chargesof $2 million, $47 million and $128 million, respectively, relating to apayment made to CenterPoint in 2004 of $177 million. See note 14(d) toour consolidated financial statements.

          (6) During 2003, we recorded a goodwill impairmentcharge of $985 million.

          (7) We adopted FASB Interpretation No. 46 on January 1,2003, as it related to our variable interests in three power generationprojects that were being constructed by off-balance sheet entities, whichpursuant to this guidance required consolidation upon adoption. As a result, weincreased our property, plant and equipment and our secured debt obligations by$1.3 billion.

          (8) We adopted EITF No. 02-03 effective January 1,2003, which affected our accounting for electricity sales to large commercial,industrial and governmental/institutional customers under executed contractsand our accounting for trading and hedging activities. It also impacted thesecontracts executed after October 25, 2002 in 2002.

          (9) During 2002, we recorded an impairment of ourEuropean energy segment’s goodwill of $234 million, net of tax, as a cumulativeeffect of accounting change.

    (10) Effective September 30, 2002, we separatedfrom CenterPoint and prior to that date our financial position and results ofoperations may not reflect as if we had operated as a separate, stand-aloneentity.

    (11) Seenote 13 to our consolidated financial statements for discussion of ourcontingencies.

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***Item 7.***                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

**Business Overview**

Our objective is to be a leader in delivering thebenefits of competitive electricity markets to customers. Our business focuseson the competitive segments of both the retail and wholesale electricitymarkets.

In 2006, we have substantially completed the processbegun in 2003 to reposition our business for future success. As part of thisprocess, we reduced debt and improved our liquidity position by utilizing cashflows from the business, proceeds from a series of asset sales and theimplementation of a credit-enhanced retail structure. This new structurereduced our collateral requirements and the liquidity risk associated withcommodity price volatility. We streamlined processes and reduced operatingcosts while shifting our focus away from energy trading to an asset-performanceculture. Additionally, we improved the percentage of time that our generatingassets were available to run economically to 85.1% compared to 79.3% in 2004. Weresolved a significant amount of legacy litigation, improved corporategovernance and provided transparency into the earnings drivers of our businessby introducing the open wholesale reporting model. In our retail business, weestablished a leadership position and transitioned to a fully competitiveretail market in Texas with a significant portion of our former “price-to-beat”customers selecting one of our longer-term and innovative new products. Webelieve these accomplishments position us to emerge as a leader in competitiveelectricity markets.

Going forward our strategy is based on core beliefsabout the power industry and the retail and wholesale electricity markets.These core beliefs reflect the issues we believe are the primary determinantsof value-creation and risk. Our core beliefs about the power industry are:

·       Volatileand uncertain markets drive variable earnings profiles;

·       Therewill be a mix of competitive and regulated markets with a slow evolution tocompetition; and

·       Environmentalissues will command an increasing focus from regulators and politicians. 

We are committed to delivering superior returns fromcompetitive markets through insights into the fundamentals of our core marketsand a commitment to risk-weighted investments whose return on invested capitalexceeds our weighted-average cost of capital.

*RetailEnergy.*   Theretail energy segment is a low capital investment electricity resale businesswith relatively stable earnings (excluding unrealized gains/losses on energyderivatives). The key earnings drivers in the retail energy segment are thevolume of electricity we sell to customers, the unit margins received on thosesales and the cost of acquiring and serving those customers. We earn a marginby selling electricity to end-use customers and simultaneously acquiring supply.Short-term earnings in this business are impacted by local weather patterns andthe competitive tactics of other retailers in the market. The longer-termearnings drivers of the business are the level of competitive intensity and ourability to retain and grow market share by having a strong brand and excellentcustomer service.

Our core beliefsabout the retail market are:

·       Wehave a leadership position in the competitive electricity retail business,which has a high return on invested capital and relatively stable earnings;

·       Retailcompetition provides opportunities to add value through customer segmentation,product and service innovation and brand;

·       Theconfluence of market forces will provide an opportunity to dramatically alterindustry load; and

·       Continuedsuccess in the Texas retail market will drive new competitive market openings.

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These core beliefsset the stage for our strategic direction. Looking forward, we will focus onthe following value-creation levers:

·       Strengtheningour leadership position in ERCOT by continuing to build and exercise ouroperating capabilities, using customer segmentation to identify and providevalue-added products and services, providing superior customer service,building our brand and developing product and service innovations;

·       Enteringand developing new competitive markets; and

·       Leadingthe development of smart energy to reshape customer load.

*WholesaleEnergy.*   Thewholesale energy segment is a capital-intensive, cyclical business. Earningsare significantly impacted by the level of natural gas prices and spark spreads.The key earnings drivers are the amount of electricity we generate and themargin we earn for each unit of electricity sold. We do not control thosefactors that have the most significant impact on our earnings levels. Thefactor that we have the most control over is the percentage of time that ourgenerating assets are available to run when it is economic for them to do so. Short-termearnings in our wholesale business are impacted by weather and commodity pricevolatility. Longer-term earnings are driven by the level of commodity pricesand regional supply and demand fundamentals.

Our core beliefsabout the wholesale market are:

·       Capitalintensive, cyclical industries generally earn returns below their cost ofcapital over a full cycle;

·       Newbuild investment typically under earns its cost of capital unless there is asignificant cost advantage; and

·       Overthe next several years, we anticipate a significant supply/demand recovery.

These core beliefsset the stage for our strategic direction. Looking forward, we will focus onthe following value-creation levers:

·       Realizingthe value uplift from anticipated improving supply and demand fundamentals inthe wholesale markets from our existing portfolio of assets;

·       Achievingoperating and commercial excellence; and

·       Utilizinga highly-disciplined capital investment process with a return on investedcapital focus to monetize the value of our brownfield sites, acquire assets atdiscounts to replacements and divest non-strategic assets.

*Company-wide.*   Building on our success inrepositioning the company and our rapidly improving credit profile, we willfocus on establishing a flexible capital structure that ensures a competitivecost of capital with an ability to invest in value creating opportunitiesincluding returning capital to shareholders. In addition, we will continue todevelop innovative structures and transactions that improve returns and reducerisk.

We also believe that stockholder value is enhancedthrough the development of a highly motivated and customer-focused work force. Wecontinue to focus on a series of actions designed to build a “great company towork for,” including (a) communicating openly with our employees, (b) fosteringcompany pride among our employees, (c) providing a satisfying and safework environment, (d) recognizing and rewarding employee contributions andcapabilities and (e) motivating our employees to be collaborative leaderscommitted to our future.

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

**Consolidated Results ofOperations**

The following discussionincludes non-GAAP financial measures, which are not standardized; therefore itmay not be possible to compare these financial measures with other companies’non-GAAP financial measures having the same or similar names. We stronglyencourage investors to review our consolidated financial statements andpublicly filed reports in their entirety and not rely on any single financialmeasure.

**2006 Compared to2005 and 2005 Compared to 2004**

We reported $328 million consolidated net loss, or $1.07loss per share, for 2006 compared to $331 million consolidated net loss, or$1.09 loss per share, for 2005 and $29 million consolidated net loss, or $0.10loss per share, for 2004. 

| ** **                                            | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                            | ** ** | **(in millions)** | ** ** |
| Retail energy contribution margin                     |       | $                      | 250        |     | $          | 342      |       | $                                        | 377        |                                     |       | $ | (92 | ) |   |   | $ | (35 | ) |   |
| Wholesale energy contribution margin                  |       | 146                    |       | 110      |       | 247      |       |                                     | 36         |                                     |       |   | (137 | ) |   |
| Corporate contribution margin                         |       | 1                      |       | 4        |       | —   |       |                                     | (3         | )                                        |       |   | 4 |   |   |
| Other general and administrative                      |       | (172                   | )          | (140     | )          | (198     | )          |                                     | (32        | )                                        |       |   | 58 |   |   |
| Loss on sales of receivables                          |       | —                 |       | —   |       | (34      | )          |                                     | —     |                                     |       |   | 34 |   |   |
| Accrual for payment to CenterPoint Energy, Inc.       |       | —                 |       | —   |       | (2       | )          |                                     | —     |                                     |       |   | 2 |   |   |
| Gain on sale of counterparty claim                    |       | —                 |       | —   |       | 30       |       |                                     | —     |                                     |       |   | (30 | ) |   |
| Western states and Cornerstone settlements            |       | (35                    | )          | (359     | )          | —   |       |                                     | 324        |                                     |       |   | (359 | ) |   |
| Gains on sales of assets and emission allowances, net |       | 159                    |       | 168      |       | 20       |       |                                     | (9         | )                                        |       |   | 148 |   |   |
| Depreciation and amortization                         |       | (373                   | )          | (446     | )          | (453     | )          |                                     | 73         |                                     |       |   | 7 |   |   |
| Income (loss) of equity investments, net              |       | 6                      |       | 26       |       | (9       | )          |                                     | (20        | )                                        |       |   | 35 |   |   |
| Debt conversion expense                               |       | (37                    | )          | —   |       | —   |       |                                     | (37        | )                                        |       |   | — |   |   |
| Other, net                                            |       | —                 |       | (23      | )          | 13       |       |                                     | 23         |                                     |       |   | (36 | ) |   |
| Interest expense                                      |       | (428                   | )          | (399     | )          | (418     | )          |                                     | (29        | )                                        |       |   | 19 |   |   |
| Interest income                                       |       | 34                     |       | 23       |       | 35       |       |                                     | 11         |                                     |       |   | (12 | ) |   |
| Income tax benefit                                    |       | 122                    |       | 253      |       | 116      |       |                                     | (131       | )                                        |       |   | 137 |   |   |
| Loss from continuing  operations                      |       | (327                   | )          | (441     | )          | (276     | )          |                                     | 114        |                                     |       |   | (165 | ) |   |
| Income (loss) from discontinued operations            |       | (2                     | )          | 111      |       | 240      |       |                                     | (113       | )                                        |       |   | (129 | ) |   |
| Cumulative effect of accounting changes, net of tax   |       | 1                      |       | (1       | )          | 7        |       |                                     | 2          |                                     |       |   | (8 | ) |   |
| Net loss                                              |       | $                      | (328       | )        | $          | (331     | )          | $                                        | (29        | )                                        |       | $ | 3 |   |   |   | $ | (302 | ) |   |

 

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***Retail Energy Segment***

Our retail energy segment’s contribution margin was$250 million in 2006 compared to $342 million in 2005. The $92 million decreasein contribution margin was primarily due to the increase in unrealized losseson energy derivatives of $218 million. In addition, contribution margin wasimpacted by a $232 million increase in gross margin, excluding unrealizedgains/losses on energy derivatives, and a $106 million increase in operationand maintenance, selling and marketing and bad debt expense. Our retail energysegment’s contribution margin was $342 million in 2005 compared to $377 millionin 2004. The $35 million decrease in contribution margin was primarily due to a$249 million decrease in gross margin, excluding unrealized gains/losses onenergy derivatives. Contribution margin was positively impacted by the $203million net change in unrealized gains/losses on energy derivatives and an $11million decrease in operation and maintenance, selling and marketing and baddebt expense. See “—Retail Energy Margins” below for explanations.

In analyzing the results of our retail energy segment,we use the non-GAAP financial measure “retail energy gross margin, excludingunrealized gains/losses on energy derivatives,” as well as contribution marginand retail energy gross margin. Retail energy gross margin, excludingunrealized gains/losses on energy derivatives should not be relied upon to theexclusion of GAAP financial measures. The item that is excluded from retailenergy gross margin, excluding unrealized gains/losses on energy derivativeshas a recurring effect on our earnings and reflects aspects of our businessthat are not taken into account by this measure.

*Unrealized Gains/Losses onEnergy Derivatives.*   We use derivative instruments to manage operational ormarket constraints and to execute our retail energy segment’s supplyprocurement strategy. We are required to record in our consolidated statementof operations non-cash gains/losses related to future periods based on currentchanges in forward commodity prices for derivative instruments receiving mark-to-marketaccounting treatment. We refer to these gains and losses prior to settlement,as well as ineffectiveness on cash flow hedges, as “unrealized gains/losses onenergy derivatives.”  In some cases, theunderlying transactions being hedged receive accrual accounting treatment,resulting in a mismatch of accounting treatments. Since the application ofmark-to-market accounting has the effect of pulling forward into currentperiods non-cash gains/losses relating to future delivery periods, analysis ofresults of operations from one period to another can be difficult. We believethat excluding these unrealized gains/losses on energy derivatives provides amore meaningful representation of our economic performance in the reportingperiod and is therefore useful to us, investors, analysts and others infacilitating the analysis of our results of operations from one period toanother.

23

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*Retail EnergyRevenues.*

| ** **                                                                           | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                           | ** ** | **(in millions)** | ** ** |
| Retail energy  revenues from end-use retail customers:                               |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| Mass:                                                                                |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| Residential:                                                                         |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| Houston                                                                              |       | $                      | 2,466      |     | $          | 2,357    |       | $                                        | 2,169      |                                     |       | $ | 109 | (1) |   |   | $ | 188 | (2) |   |
| Non-Houston                                                                          |       | 1,109                  |       | 708      |       | 425      |       |                                     | 401        | (3)                                      |       |   | 283 | (4) |   |
| Small Business:                                                                      |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| Houston                                                                              |       | 593                    |       | 476      |       | 491      |       |                                     | 117        | (5)                                      |       |   | (15 | )(6) |   |
| Non-Houston                                                                          |       | 189                    |       | 100      |       | 54       |       |                                     | 89         | (7)                                      |       |   | 46 | (8) |   |
| Total Mass                                                                           |       | 4,357                  |       | 3,641    |       | 3,139    |       |                                     | 716        |                                     |       |   | 502 |   |   |
| Commercial and Industrial:                                                           |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| ERCOT                                                                                |       | 2,964                  |       | 2,549    |       | 2,349    |       |                                     | 415        | (9)                                      |       |   | 200 | (10) |   |
| Non-ERCOT                                                                            |       | 381                    |       | 404      |       | 204      |       |                                     | (23        | )(11)                                    |       |   | 200 | (12) |   |
| Total Commercial and Industrial                                                      |       | 3,345                  |       | 2,953    |       | 2,553    |       |                                     | 392        |                                     |       |   | 400 |   |   |
| Total                                                                                |       | 7,702                  |       | 6,594    |       | 5,692    |       |                                     | 1,108      |                                     |       |   | 902 |   |   |
| Retail energy  revenues from resales of purchased power and other hedging activities |       | 488                    |       | 474      |       | 374      |       |                                     | 14         |                                     |       |   | 100 | (13) |   |
| Market usage  adjustments                                                            |       | 7                      |       | (23      | )          | (2       | )          |                                     | 30         | (14)                                     |       |   | (21 | )(14) |   |
| Total retail  energy revenues                                                        |       | $                      | 8,197      |     | $          | 7,045    |       | $                                        | 6,064      |                                     |       | $ | 1,152 |   |   |   | $ | 981 |   |   |

 

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          (1) Increase primarily dueto increases in unit sales prices to customers, partially offset by lowervolumes due to fewer customers, milder weather and reduced customer usage.

          (2) Increase primarily dueto increases in unit sales prices to customers, partially offset by lowervolumes due to fewer customers.

          (3) Increase primarily dueto (a) increases in unit sales prices to customers and (b) increasedvolumes due to increased customers.

          (4) Increase primarily dueto (a) increased volumes due to increased customers and (b) increasesin unit sales prices to customers.

          (5) Increase primarily dueto increases in unit sales prices to customers.

          (6) Decrease primarily dueto lower volumes due to fewer customers and reduced customer usage, partiallyoffset by increases in unit sales prices to customers.

          (7) Increase primarily dueto (a) increased volumes due to increased customers and (b) increasesin unit sales prices to customers. These increases were partially offset byreduced customer usage.

          (8) Increase primarily dueto (a) increased volume due to increased customers and (b) increasesin unit sales prices.

          (9) Increase primarily dueto (a) fixed price contracts renewed at higher market rates due to higherprices of electricity when the contracts were executed, (b) variable ratecontracts, which are tied to the market price of natural gas and (c) increasedvolumes.

    (10) Increase primarily dueto (a) fixed price contracts renewed at higher market rates due to higherprices of electricity when the contracts were executed and (b) variablerate contracts, which are tied to the market price of natural gas. Theseincreases were partially offset by decreased volumes.

    (11) Decrease primarily dueto lower volumes due to fewer customers. This decrease was partially offset byincreases primarily due to (a) fixed price contracts renewed at highermarket rates due to higher prices of electricity when the contracts wereexecuted and (b) variable rate contracts, which are tied to the marketprice of natural gas.

    (12) Increase primarily dueto (a) increased volumes due to market entry in Maryland and other PJMmarkets in 2004, (b) fixed price contracts renewed at higher market ratesdue to higher prices of electricity when the contracts were executed and (c) variablerate contracts, which are tied to the market price of natural gas.

    (13) Increaseprimarily due to our supply management activities in various markets in Texas.

    (14) See footnote (5) under“Retail Energy Margins.”

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*Retail EnergyPurchased Power.*

| ** **                               | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **(in millions)** | ** ** |
| Costs of  purchased power                |       | $                      | 6,635      |     | $          | 5,676    |       | $                                        | 4,707      |                                     |       | $ | 959 | (1) |   |   | $ | 969 | (1) |   |
| Retail energy  intersegment costs        |       | 571                    |       | 625      |       | 340      |       |                                     | (54        | )(2)                                     |       |   | 285 | (3) |   |
| Market usage  adjustments                |       | 7                      |       | (8       | )          | 16       |       |                                     | 15         | (4)                                      |       |   | (24 | )(4) |   |
| Unrealized losses  on energy derivatives |       | 287                    |       | 69       |       | 272      |       |                                     | 218        | (5)                                      |       |   | (203 | )(6) |   |
| Total retail  energy purchased power     |       | $                      | 7,500      |     | $          | 6,362    |       | $                                        | 5,335      |                                     |       | $ | 1,138 |   |   |   | $ | 1,027 |   |   |

 

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(1)             Increaseprimarily due to higher unit prices of purchased power.

(2)             Decreaseprimarily due to lower prices and volumes.

(3)             Increaseprimarily due to higher volumes.

(4)             Seefootnote (5) under “Retail Energy Margins.”

(5)             Seefootnote (6) under “Retail Energy Margins.”

(6)             Seefootnote (7) under “Retail Energy Margins.”

*Retail Energy Margins.*

| ** **                                                                                 | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                 | ** ** | **(in millions)** | ** ** |
| Mass gross margin                                                                          |       | $                      | 776        |     | $          | 689      |       | $                                        | 808        |                                     |       | $ | 87 | (1) |   |   | $ | (119 | )(2) |   |
| Commercial and industrial gross margin                                                     |       | 208                    |       | 78       |       | 211      |       |                                     | 130        | (3)                                      |       |   | (133 | )(4) |   |
| Market usage adjustments                                                                   |       | —                 |       | (15      | )          | (18      | )          |                                     | 15         | (5)                                      |       |   | 3 | (5) |   |
| Total retail energy gross  margin, excluding unrealized gains/losses on energy derivatives |       | 984                    |       | 752      |       | 1,001    |       |                                     | 232        |                                     |       |   | (249 | ) |   |
| Unrealized losses on energy derivatives                                                    |       | (287                   | )          | (69      | )          | (272     | )          |                                     | (218       | )(6)                                     |       |   | 203 | (7) |   |
| Total retail energy gross  margin                                                          |       | 697                    |       | 683      |       | 729      |       |                                     | 14         |                                     |       |   | (46 | ) |   |
| Operation and maintenance                                                                  |       | (234                   | )          | (190     | )          | (222     | )          |                                     | (44        | )(8)                                     |       |   | 32 | (9) |   |
| Selling and marketing expense                                                              |       | (124                   | )          | (95      | )          | (82      | )          |                                     | (29        | )(10)                                    |       |   | (13 | )(10) |   |
| Bad debt expense                                                                           |       | (89                    | )          | (56      | )          | (48      | )          |                                     | (33        | )(11)                                    |       |   | (8 | )(12) |   |
| Total retail energy contribution margin                                                    |       | $                      | 250        |     | $          | 342      |       | $                                        | 377        |                                     |       | $ | (92 | ) |   |   | $ | (35 | ) |   |

 

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          (1) Unit margins increased primarily due toincreases in unit sales prices to customers. This increase was partially offsetby higher unit prices of purchased power.

          (2) Unit margins decreased primarily due to (a) higherunit prices of purchased power and (b) higher transmission anddistribution losses in ERCOT. These decreases were partially offset byincreases in unit sales prices to customers.

          (3) Unit margins increased primarily due toincreases in unit sales prices to customers, partially offset by higher unitprices of purchased power.

          (4) Unit margins decreased primarily due to (a) higherunit prices of purchased power and (b) higher transmission anddistribution losses in ERCOT. These decreases were partially offset byincreases in unit sales prices to customers.

          (5) The revenues and the related energy supplycosts in our retail energy segment include our estimates of customer usagebased on initial usage information provided by the independent system operatorsand the distribution companies. We revise these estimates and record anychanges in the period as additional settlement information becomes available(collectively referred to as “market usage adjustments”).

25

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          (6) Decrease primarily due to (a) $139 millionloss due to cash flow hedge ineffectiveness and (b) $102 million loss dueto the reversal of previously recognized unrealized gains resulting from thetermination of commodity contracts with a counterparty. These decreases werepartially offset by $85 million gain due to settlements.

          (7) Increase primarily due to (a) $198 milliongain due to settlements and (b) $75 million gain due to cash flow hedgeineffectiveness. These increases were partially offset by $122 million loss dueto changes in prices on our derivatives marked to market.

          (8) Increase primarily due to (a) $26 millionin gross receipts tax due to higher billings and (b) $12 million due toincrease in contract services and professional fees.

          (9) Decrease primarily due to decrease in salariesand benefits.

    (10) Increase primarily due to additional marketingcampaigns.

    (11) Increase primarily due to higher customer defaults in 2006 primarilydue to increases in unit sales prices to customers.

    (12) Increase primarily due to an increase inrevenues.

***Wholesale Energy Segment***

Our wholesaleenergy segment’s contribution margin was $146 million in 2006 compared to $110 millionin 2005. The $36 million increase in contribution margin was primarily due tonet change in unrealized gains/losses on energy derivatives of $179 million anda reduced negative effect of historical wholesale hedges of $108 million. Inaddition, contribution margin was impacted by a $199 million decrease in openwholesale gross margin and a $55 million increase in operation and maintenanceexpenses. Our wholesale energy segment’s contribution margin was $110 millionin 2005 compared to $247 million in 2004. The $137 million decrease incontribution margin was primarily due to a $534 million negative effect ofhistorical wholesale hedges and a $171 million net change in unrealizedgains/losses on energy derivatives. In addition, contribution margin wasimpacted by a $532 million increase in open wholesale gross margin and a $16million decrease in operation and maintenance expenses. See “—Wholesale Energy Margins” below for explanations.

In analyzing the results of our wholesale energysegment, we use the non-GAAP financial measures “open energy gross margin” and “openwholesale gross margin,” which exclude the items described below, as well ascontribution margin and wholesale energy gross margin. Open energy gross marginand open wholesale gross margin should not be relied upon to the exclusion ofGAAP financial measures. The items that are excluded from open energy grossmargin and open wholesale gross margin have or have had a recurring effect onour earnings and reflect aspects of our business that are not taken into accountby these measures.

*UnrealizedGains/Losses on Energy Derivatives.*   We usederivative instruments to manage operational or market constraints and toincrease the return on our generation assets. We are required to record in ourconsolidated statement of operations non-cash gains/losses related to futureperiods based on current changes in forward commodity prices for derivativeinstruments receiving mark-to-market accounting treatment. We referto these gains and losses prior to settlement, as well as ineffectiveness oncash flow hedges, as “unrealized gains/losses on energy derivatives.”  In some cases, the underlying transactionsbeing hedged receive accrual accounting treatment, resulting in a mismatch ofaccounting treatments. Since the application of mark-to-market accounting hasthe effect of pulling forward into current periods non-cash gains/lossesrelating to future delivery periods, analysis of results of operations from oneperiod to another can be difficult. We believe that excluding these unrealizedgains/losses on energy derivatives provides a more meaningful representation ofour economic performance in the reporting period and is therefore useful to us,investors, analysts and others in facilitating the analysis of our results ofoperations from one period to another. These gains/losses are also not afunction of the operating performance of our generation assets, and excludingtheir impact helps isolate the operating performance of our generation assetsunder prevailing market conditions.

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*Historical WholesaleHedges.**  *We exclude the effect of certainhistorical, although recurring until the contracts terminate, wholesale hedgesthat were entered into in order to hedge the economics of our wholesaleoperations. We believe that it is useful to us, investors, analysts and othersto show our results in the absence of these hedges. The impact of thesehistorical hedges on our financial results is not a function of the operatingperformance of our generation assets and excluding the impact better reflectsthe operating performance of our generation assets based on prevailing marketconditions.

*Changes inCalifornia-Related Receivables and Reserves.**  *We excluded the impact of changesin receivables and reserves relating to energy sales in California fromOctober 2000 through June 2001. We reached a settlement concerningthese receivables during the third quarter of 2005. Because of the marketconditions and regulatory events that underlie the changes in these receivablesand reserves, we believe that excluding this item provides a more meaningfulrepresentation of our results of operations on an ongoing basis and istherefore useful to us, investors, analysts and others in facilitating theanalysis of our results of operations from one period to another. Foradditional information, see note 14(a) to our consolidated financialstatements.

*Wholesale Energy Revenues.*

| ** **                                       | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| Wholesale energy  third-party revenues           |       | $                      | 2,487      |     | $          | 2,879    |       | $                                        | 2,057      |                                     |       | $ | (392 | )(1) |   |   | $ | 822 | (2) |   |
| Wholesale energy  intersegment revenues          |       | 571                    |       | 625      |       | 349      |       |                                     | (54        | )(3)                                     |       |   | 276 | (4) |   |
| Unrealized gains  (losses) on energy derivatives |       | 192                    |       | (218     | )          | (32      | )          |                                     | 410        | (5)                                      |       |   | (186 | )(6) |   |
| Total wholesale energy revenues                  |       | $                      | 3,250      |     | $          | 3,286    |       | $                                        | 2,374      |                                     |       | $ | (36 | ) |   |   | $ | 912 |   |   |

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(1)             Decreaseprimarily due (a) lower natural gas sales prices (related to gastransportation contracts) and (b) lower contracted power sales prices. Thesedecreases were partially offset by an increase in natural gas and power salesvolumes.

(2)             Increaseprimarily due to (a) $248 million due to certain gas transactions, whichprior to April 1, 2004, were recorded net as a part of the tradingactivity and are now recorded gross in revenues and purchased power, fuel andcost of gas sold, (b) increase in natural gas prices and volumes (relatedto gas transportation contracts). These increases were partially offset by lowercontracted power sales prices and power sales volumes.

(3)             Decreaseprimarily due to lower prices and volumes.

(4)             Increaseprimarily due to higher volumes due to more retail energy segment sales in thePJM Market.

(5)             See footnote (19)under “Wholesale Energy Margins.”

(6)             See footnote (20)under “Wholesale Energy Margins.”

*Wholesale Energy Purchased Power, Fuel and Cost of GasSold.*

| ** **                                       | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| Wholesale energy  third-party costs              |       | $                      | 2,371      |     | $          | 2,725    |       | $                                        | 1,649      |                                     |       | $ | (354 | )(1) |   |   | $ | 1,076 | (2) |   |
| Unrealized (gains)  losses on energy derivatives |       | 136                    |       | (95      | )          | (80      | )          |                                     | 231        | (3)                                      |       |   | (15 | )(4) |   |
| Total wholesale energy                           |       | $                      | 2,507      |     | $          | 2,630    |       | $                                        | 1,569      |                                     |       | $ | (123 | ) |   |   | $ | 1,061 |   |   |

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(1)             Decrease primarilydue to (a) lower prices paid for natural gas and purchased power and (b) decreasedoil volumes. These decreases were partially offset by (a) increasedpurchased gas volumes and (b) higher contracted prices of coal.

(2)             Increase primarilydue to (a) $254 million due to certain gas transactions, which prior to April 1,2004, were recorded net as part of the trading activity and are now recordedgross in revenues and purchased power, fuel and cost of gas sold (see footnote (2)under “Wholesale Energy Revenues”), (b) higher prices paid for naturalgas, oil and coal and (c) increased volumes of natural gas and coalpurchased.

(3)             See footnote (19)under “Wholesale Energy Margins.”

(4)             See footnote (20)under “Wholesale Energy Margins.”

27

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*Wholesale Energy Margins.*

| ** **                                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                             | ** ** | **(in millions)** | ** ** |
| Open  energy gross margin(1):                          |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| PJM Coal                                               |       | $                      | 528        |     | $          | 640      |       | $                                        | 310        |                                     |       | $ | (112 | )(2) |   |   | $ | 330 | (3) |   |
| MISO Coal                                              |       | 119                    |       | 196      |       | 62       |       |                                     | (77        | )(4)                                     |       |   | 134 | (5) |   |
| PJM/MISO Gas                                           |       | 37                     |       | 38       |       | (4       | )          |                                     | (1         | )                                        |       |   | 42 | (6) |   |
| West                                                   |       | 12                     |       | (10      | )          | 21       |       |                                     | 22         | (7)                                      |       |   | (31 | )(8) |   |
| Other                                                  |       | 4                      |       | 27       |       | 41       |       |                                     | (23        | )(9)                                     |       |   | (14 | ) |   |
| Total                                                  |       | 700                    |       | 891      |       | 430      |       |                                     | (191       | )                                        |       |   | 461 |   |   |
| Other margin:(10)                                      |       |                   |       |     |       |     |       |                                     |       |                                     |       |   |   |   |   |
| PJM Coal                                               |       | 37                     |       | 41       |       | 16       |       |                                     | (4         | )                                        |       |   | 25 |   |   |
| MISO Coal                                              |       | 10                     |       | 10       |       | 26       |       |                                     | —     |                                     |       |   | (16 | ) |   |
| PJM/MISO Gas                                           |       | 50                     |       | 42       |       | 41       |       |                                     | 8          |                                     |       |   | 1 |   |   |
| West                                                   |       | 155                    |       | 187      |       | 140      |       |                                     | (32        | )(11)                                    |       |   | 47 | (12) |   |
| Other                                                  |       | 111                    |       | 91       |       | 77       |       |                                     | 20         | (13)                                     |       |   | 14 |   |   |
| Total                                                  |       | 363                    |       | 371      |       | 300      |       |                                     | (8         | )                                        |       |   | 71 |   |   |
| Total open wholesale gross  margin                     |       | 1,063                  |       | 1,262    |       | 730      |       |                                     | (199       | )(14)                                    |       |   | 532 | (15) |   |
| Historical wholesale hedges(16)                        |       | (376                   | )          | (484     | )          | 50       |       |                                     | 108        | (17)                                     |       |   | (534 | )(18) |   |
| Net unrealized gains (losses) on energy derivatives    |       | 56                     |       | (123     | )          | 48       |       |                                     | 179        | (19)                                     |       |   | (171 | )(20) |   |
| Changes in California-related receivables and reserves |       | —                 |       | 1        |       | (23      | )          |                                     | (1         | )                                        |       |   | 24 |   |   |
| Wholesale energy gross margin                          |       | 743                    |       | 656      |       | 805      |       |                                     | 87         |                                     |       |   | (149 | ) |   |
| Operation and maintenance                              |       | (599                   | )          | (544     | )          | (560     | )          |                                     | (55        | )(21)                                    |       |   | 16 | (22) |   |
| Bad debt expense                                       |       | 2                      |       | (2       | )          | 2        |       |                                     | 4          |                                     |       |   | (4 | ) |   |
| Total wholesale energy contribution margin             |       | $                      | 146        |     | $          | 110      |       | $                                        | 247        |                                     |       | $ | 36 |   |   |   | $ | (137 | ) |   |

----

          (1) Open energy gross margin is calculated usingthe power sales prices received by the plants less delivered spot fuel prices.  This figure excludes the effects of ourhistorical wholesale hedges and prices actually paid for fuel.

          (2) Decrease primarily due to lower unit margins(lower power prices partially offset by lower coal costs). This decrease waspartially offset by improved commercial capacity factor.

          (3) Increase primarily due to (a) higher unitmargins (higher power prices) and (b) increased economic generation drivenby Seward achieving commercial operation in October 2004 versus full yearin 2005.

          (4) Decrease primarily due to lower unit margins(lower power prices partially offset by lower coal costs).

          (5) Increase primarily due to (a) higher unitmargins (higher power prices due to “provider of last resort” contracts thatwere priced lower than market ending in the fourth quarter of 2004) and (b) highercommercial capacity factor due to plant availability. These increases were partiallyoffset by lower economic generation due to the shift from a “full requirements”model in 2004 to a “market-based” model in 2005.

          (6) Increase primarily due to (a) higher unitmargins (higher power prices partially offset by higher fuel costs) and (b) highereconomic generation due to improved market conditions in 2005.

          (7) Increase primarily due to higher unit margins(lower fuel costs partially offset by lower power prices) and increasedeconomic generation. These increases were partially offset by lower commercialcapacity factor.

          (8) Decrease primarily due to lower unit margins(higher fuel costs partially offset by higher power prices).

28

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          (9) Decrease primarily due to lower unit margins(lower power prices partially offset by lower fuel costs).

    (10) Other margin represents power purchaseagreements, capacity payments and ancillary revenues. In addition, other marginincludes settlement of forward power and fuel sales and purchases for the Westregion.

    (11) Decrease primarily due to lower gains on hedgesales resulting from higher spot prices, which created less favorable marketconditions in 2006 compared to 2005 for the selective hedge strategiesexecuted.

    (12) Increase primarily due to additional volumesunder power purchase agreements in 2005.

    (13) Increase primarily due to (a) Indian Riverbeing under a power purchase agreement for nine months in 2005 compared to afull year in 2006 and (b) Osceola contracting additional volumes under apower purchase agreement in the second quarter of 2006.

    (14) Decrease primarily due to (a) lower unitmargins and (b) lower economic generation. These decreases were partiallyoffset with improved commercial capacity factor in the PJM and MISO regions.

    (15) Increase primarily due to (a) higher unitmargins, (b) higher economic generation and (c) improved commercialcapacity factor.

    (16) Historical wholesalehedges were entered into to primarily hedge the economics of our wholesaleoperations. These amounts primarily relate to settlements of forward power andfuel hedges, long-term tolling purchases, long-term natural gas transportationcontracts, storage contracts and our legacy energy trading. These amounts arederived based on methodology consistent with the calculation of open energygross margin.

    (17) Increase primarily due to a $387 milliondecrease in losses from power sales, resulting from a 41% decrease in hedgedvolumes and 55% decrease in the average loss on hedges, reduced by $187 millionof losses on 2006 power hedges closed in the third quarter of 2005. Thisincrease was partially offset by $98 million due to a decrease of coal marketprices combined with an increase in coal contract prices.

    (18) Decrease due to unfavorable differences betweenprices received by our coal plants and settlement prices on our hedged powersales.

    (19) Increase primarily due to (a) $113 milliongain due to settlements and (b) $74 million gain due to changes in priceson our derivatives marked to market.

    (20) Decrease primarily dueto (a) $89 million loss due to changes in prices on our derivatives markedto market and (b) $80 million loss from de-designated hedge positions.

    (21) Increase primarily due to $46 million increasein planned outages and maintenance spending primarily at our coal plants.

    (22) Decrease primarily due to (a) $18 milliondecrease in taxes other than income primarily due to the resolution ofpotential tax liabilities in 2005, (b) $7 million decrease in salaries andbenefits, excluding plant personnel, (c) $7 million decrease as a resultof the termination of certain services to Texas Genco Holdings, Inc. andits subsidiaries in May 2004 and (d) $6 million decrease in severance.These decreases were partially offset by a $21 million increase in expense dueto Bighorn and Seward plants achieving commercial operations in February 2004and October 2004, respectively.

*Other General and Administrative.*

| ** **                                                                | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                | ** ** | **(in millions)** | ** ** |
| Salaries and benefits                                                     |       | $                      | 90         |     | $          | 66       |       | $                                        | 95         |                                     |       | $ | 24 | (1) |   |   | $ | (29 | )(2) |   |
| Professional fees, contract services and information systems  maintenance |       | 29                     |       | 22       |       | 29       |       |                                     | 7          |                                     |       |   | (7 | ) |   |
| Rent and utilities                                                        |       | 20                     |       | 20       |       | 40       |       |                                     | —     |                                     |       |   | (20 | )(3) |   |
| Credit-enhanced retail structure fee                                      |       | 13                     |       | —   |       | —   |       |                                     | 13         | (4)                                      |       |   | — |   |   |
| Legal costs                                                               |       | 11                     |       | 17       |       | 15       |       |                                     | (6         | )(5)                                     |       |   | 2 |   |   |
| Settlement of shareholder class action lawsuits                           |       | —                 |       | 8        |       | —   |       |                                     | (8         | )                                        |       |   | 8 |   |   |
| Severance related to restructuring                                        |       | —                 |       | —   |       | 12       |       |                                     | —     |                                     |       |   | (12 | ) |   |
| Other, net                                                                |       | 9                      |       | 7        |       | 7        |       |                                     | 2          |                                     |       |   | — |   |   |
| Other general and administrative                                          |       | $                      | 172        |     | $          | 140      |       | $                                        | 198        |                                     |       | $ | 32 |   |   |   | $ | (58 | ) |   |

----

(1)             Increaseprimarily due to impact of increased stock price on stock-based incentiveplan expense.

(2)             Decreaseprimarily due to impact of decreased stock price on stock-based incentive planexpense.

29

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(3)             Decreaseprimarily due to a $13 million charge during 2004 related to restructuringcosts associated with the lease on our corporate headquarters.

(4)             Seenote 7 to our consolidated financial statements.

(5)             Decreaseprimarily due to Western states litigation expense in 2005.

*Western States and Cornerstone Settlements.  *See note 14(a) toour consolidated financial statements.

*Loss on Sales ofReceivables.**  *Loss onsales of receivables decreased from $34 million in 2004 to $0 in 2005 and 2006as these fees related to our retail receivables facility, which we consolidatedin late 2004 and we terminated in 2006. See notes 6 and 7 to ourconsolidated financial statements.

*Gain on Sale ofCounterparty Claim.**  *Seenote 14(e) to our consolidated financial statements.

*Gains on Sales of Assetsand Emission Allowances, Net.*   See note 20 to our consolidatedfinancial statements.

*Depreciation and Amortization.*

| ** **                          | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                          | ** ** | **(in millions)** | ** ** |
| Depreciation on plants              |       | $                      | 247        |     | $          | 264      |       | $                                        | 261        |                                     |       | $ | (17 | )(1) |   |   | $ | 3 | (2) |   |
| Depreciation on information systems |       | 50                     |       | 76       |       | 102      |       |                                     | (26        | )(3)                                     |       |   | (26 | )(3) |   |
| Other, net—depreciation        |       | 6                      |       | 11       |       | 9        |       |                                     | (5         | )                                        |       |   | 2 |   |   |
| Depreciation                        |       | 303                    |       | 351      |       | 372      |       |                                     | (48        | )                                        |       |   | (21 | ) |   |
| Amortization of emission allowances |       | 65                     |       | 90       |       | 77       |       |                                     | (25        | )(4)                                     |       |   | 13 | (5) |   |
| Other, net—amortization        |       | 5                      |       | 5        |       | 4        |       |                                     | —     |                                     |       |   | 1 |   |   |
| Amortization                        |       | 70                     |       | 95       |       | 81       |       |                                     | (25        | )                                        |       |   | 14 |   |   |
| Depreciation and amortization       |       | $                      | 373        |     | $          | 446      |       | $                                        | 453        |                                     |       | $ | (73 | ) |   |   | $ | (7 | ) |   |

----

(1)             Decrease primarilydue to $20 million charge in 2005 related to early retirements at somefacilities.

(2)             Increase primarilydue to (a) $22 million as the Bighorn and Seward plants achievedcommercial operation in February and October 2004, respectively and (b) $20million charge in 2005 related to early retirements at some facilities. Theseincreases were partially offset by (a) $16 million equipment impairmentcharge in 2004 related to turbines and generators, (b) $12 million chargein 2004 due to early retirement of the Wayne facility and (c) other 2004impairments and retirements.

(3)             Decrease primarilydue to assets becoming fully depreciated.

(4)             Decrease primarilydue to lower weighted average cost of allowances used.

(5)             Increase primarilydue to (a) higher weighted average cost of allowances used and (b) Sewardplant achieved commercial operation in October 2004.

*Income (Loss) of Equity Investments, Net.*

| ** **                               | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **(in millions)** | ** ** |
| El Dorado Energy, LLC                    |       |                   | $          | —   |       |     |       | $                                        | 20         | (1)                                      |       | $ | (13 | ) |   | $ | (20 | ) |   |   | $ | 33 |   |   |
| Sabine Cogen, LP                         |       |                   | 6          |     |       |     | 6          |                                     |       | 4                                        |       |   | — |   |   |   | 2 |   |   |
| Income (loss) of equity investments, net |       |                   | $          | 6        |       |     |       | $                                        | 26         |                                     |       | $ | (9 | ) |   | $ | (20 | ) |   |   | $ | 35 |   |   |

----

(1)             We sold thisinvestment in 2005. See note 20 to our consolidated financial statements.

30

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*Debt ConversionExpense.  *See note 6(c) to our consolidated financial statements.

*Other, Net.*

| ** **               | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|--------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **               | ** ** | **(in millions)** | ** ** |
| Impairment of investment |       |                   | $          | —   |       |     | $          | (23                                      | )(1)       |                                     | $          | — |   |   |   | $ | 23 |   |   |   | $ | (23 | ) |   |
| Other, net               |       |                   | —     |     |       | —   |       |                                     | 13         |                                     |       |   | — |   |   |   | (13 | ) |   |
| Other, net               |       |                   | $          | —   |       |     | $          | (23                                      | )          |                                     | $          | 13 |   |   |   | $ | 23 |   |   |   | $ | (36 | ) |   |

----

(1)             Seenote 19 to our consolidated financial statements.

*Interest Expense.*

| ** **                                                     | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                     | ** ** | **(in millions)** | ** ** |
| Fixed-rate debt                                                |       | $                      | 256        |     | $          | 256      |       | $                                        | 174        |                                     |       | $ | — |   |   |   | $ | 82 |   |   |
| Variable-rate debt                                             |       | 106                    |       | 85       |       | 141      |       |                                     | 21         | (1)                                      |       |   | (56 | )(2) |   |
| Deferred financing costs                                       |       | 32                     |       | 15       |       | 78       |       |                                     | 17         |                                     |       |   | (63 | ) |   |
| Financing fees expensed                                        |       | 27                     |       | 30       |       | 53       |       |                                     | (3         | )                                        |       |   | (23 | ) |   |
| Unrealized losses on derivatives                               |       | 11                     |       | 16       |       | 24       |       |                                     | (5         | )                                        |       |   | (8 | ) |   |
| Credit-enhanced retail structure fees for MWh’s delivered |       | 2                      | (3)        | —   |       | —   |       |                                     | 2          |                                     |       |   | — |   |   |
| Capitalized interest                                           |       | —                 |       | —   |       | (46      | )          |                                     | —     |                                     |       |   | 46 |   |   |
| Amortization of fair value adjustment of acquired debt         |       | (9                     | )          | (9       | )          | (9       | )          |                                     | —     |                                     |       |   | — |   |   |
| Other, net                                                     |       | 3                      |       | 6        |       | 3        |       |                                     | (3         | )                                        |       |   | 3 |   |   |
| Interest expense                                               |       | $                      | 428        |     | $          | 399      |       | $                                        | 418        |                                     |       | $ | 29 |   |   |   | $ | (19 | ) |   |

----

(1)             Increaseprimarily due to $27 million due to increase in rates, partially offset by $6million due to decrease in balances.

(2)             Decreaseprimarily due to $61 million due to decrease in balances, partially offset by$5 million due to increase in rates.

(3)             See note 7 toour consolidated financial statements.

*Interest Income.*

| ** **                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|----------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **(in millions)** | ** ** |
| Net margin deposits                    |       |                   | $          | 27       |       |     |       | $                                        | 13         |                                     |       |   | $ | 3 |   |   |   | $ | 14 |   |   |   | $ | 10 |   |   |
| Interest on California net receivables |       |                   | —     |     |       |     | 6          |                                     |       |                                     | 16         |   |   |   | (6 | ) |   |   | (10 | ) |   |
| Receivables facility                   |       |                   | —     |     |       |     | —     |                                     |       |                                     | 12         |   |   |   | — |   |   |   | (12 | ) |   |
| Other, net                             |       |                   | 7          |     |       |     | 4          |                                     |       |                                     | 4          |   |   |   | 3 |   |   |   | — |   |   |
| Interest income                        |       |                   | $          | 34       |       |     |       | $                                        | 23         |                                     |       |   | $ | 35 |   |   |   | $ | 11 |   |   |   | $ | (12 | ) |   |

 

*Income Tax Benefit.  *See note 11 to ourconsolidated financial statements.

*Income (Loss) fromDiscontinued Operations.  *See note 21 to our consolidated financialstatements.

31

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**Liquidity andCapital Resources**

**Sources ofLiquidity and Capital Resources**

*Our principal sources of liquidityand capital resources are cash flows from operations, borrowings, net proceedsfrom asset sales and securities offerings. For a description of factors that could affect ourliquidity and capital resources, see “Risk Factors” in Item 1A of this Form 10-Kand the discussion of restrictive covenants in notes 6 and 7 to ourconsolidated financial statements.*

During 2006, we generated $1.3 billion in operatingcash flows from continuing operations including the changes in margin depositsof $1.3 billion and $160 million in payments relating to the Western states andCornerstone settlements. The change in margin deposits was primarily due to (a) ourcredit-enhanced retail structure and (b) the expiration of certain hedgesconsistent with our objective of reducing wholesale generation hedges. Inaddition, we received $182 million of net proceeds from sales of emissionallowances.

The December 2006 refinancings related to thecredit-enhanced retail structure included (a) reducing the size of ourrevolving credit facility from $1.7 billion to $700 million, (b) issuing anew $300 million letter of credit facility, (c) reducing our aggregateterm loan balances from $530 million to $400 million, (d) terminating our$450 million receivables securitization facility and (e) entering into a$300 million retail working capital facility. In February and March 2006,we used net proceeds of $952 million relating to the sale of our New Yorkplants to pay down debt.

As of February 15,2007, we had total available liquidity of $1.5 billion, comprised of unusedborrowing capacity, letters of credit capacity and cash and cash equivalents.

***Liquidityand Capital Requirements***

Our liquidity and capital requirements primarilyreflect our working capital needs, capital expenditures, debt service andcollateral requirements. Examples of working capital needs include purchases offuel and electricity, purchases of emission allowances, plant maintenance costs(including environmental expenditures) and corporate costs such as payroll. Settlementcosts associated with litigation and regulatory proceedings can also have asignificant impact on our liquidity and cash requirements. For settlements, seenote 14 to our consolidated financial statements.

Collateral posting requirements have beensignificantly reduced due to our credit-enhanced retail structure. Seenote 7 to our consolidated financial statements. As of December 31,2006, we had total collateral postings of $814 million (which includes $361million of letters of credit), which is a $1.8 billion decrease from December 31,2005. We retain collateral posting obligations for our wholesale energy segmentand certain other activities. The collateral amounts fluctuate depending oncommodity prices, price volatility, levels of hedging activity, seasonality andother factors, including changes in our perceived credit standing. As of February 15,2007, we had total collateral postings of $784 million, which is a $30 milliondecrease from December 31, 2006 due primarily to the expiration of certainhistorical wholesale hedges.

We are considering transferring our interest in Channelview,together with its debt of $342 million. See note 6 to our consolidatedfinancial statements.

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*Capital Requirements.*   The following table providesinformation about our actual and estimated future capital requirements:

| ** **                                | ** ** | **2006**               | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009**   | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **(in millions)** | ** ** |
| Maintenance  capital expenditures:        | ** ** |                   | ** ** | ** ** |       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Retail energy                             |       |                   | $          | 9          | ** ** |       | $          | 8          |       | $ | 8 |   | $ | 8 |   |
| Wholesale energy(1)                       |       |                   | 50         | ** ** |       | 83         |       | 76         |       | 66 |   |
| Other operations                          |       |                   | 10         | ** ** |       | 7          |       | 4          |       | 4 |   |
|                                      |       |                   | 69         | ** ** |       | 98         |       | 88         |       | 78 |   |
| Environmental                             |       |                   | 27         | ** ** |       | 140        |       | 220        |       | 105 | (2) |
| Construction of new generating facilities |       |                   | 1          | ** ** |       | —     |       | —     |       | — |   |
| Total capital expenditures                |       |                   | $          | 97         | ** ** |       | $          | 238        |       | $ | 308 |   | $ | 183 |   |

----

(1)             Excludes $7 million for 2007 through 2014 forpre-existing environmental conditions and remediation, which have been accruedfor in our consolidated balance sheet as of December 31, 2006.

(2)             We have estimated environmental capitalexpenditures of $105 million to $110 million for 2009 and have included the lowend of the range in the table.

*Contractual Obligations.**  *The following table includes our obligations andcommitments to make future payments under contracts as of December 31,2006:

| **Contractual Obligations**     | ** ** | ** **             | ** ** | **Total** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|
| ** **                           | ** ** | **(in millions)** | ** ** |
| Debt, including credit facilities(1) |       | $                      | 5,733      |      | $          | 637      | (2)        | $        | 269        |     | $          | 269      |       | $        | 1,548      |                          | $          | 137 |   |   | $ | 2,873 |   |   |
| Other commodity commitments(3)       |       | 1,969                  |       | 347       |       | 201      |       | 184      |       | 141      |       | 131      |       |     | 965        |                          |       |
| Derivative liabilities               |       | 1,586                  |       | 1,165     |       | 286      |       | 64       |       | 32       |       | 24       |       |     | 15         |                          |       |
| REMA operating lease payments        |       | 1,124                  |       | 65        |       | 62       |       | 63       |       | 52       |       | 63       |       |     | 819        |                          |       |
| Maintenance agreements obligations   |       | 903                    |       | 29        |       | 45       |       | 32       |       | 63       |       | 44       |       |     | 690        |                          |       |
| Other operating lease payments       |       | 507                    |       | 76        |       | 69       |       | 66       |       | 64       |       | 62       |       |     | 170        |                          |       |
| Plant and equipment commitments(4)   |       | 402                    |       | 174       |       | 179      |       | 48       |       | 1        |       | —   |       |     | —     |                          |       |
| Other(5)                             |       | 456                    |       | 83        |       | 35       |       | 30       |       | 26       |       | 26       |       |     | 256        |                          |       |
| Total contractual cash obligations   |       | $                      | 12,680     |      | $          | 2,576    |       | $        | 1,146      |     | $          | 756      |       | $        | 1,927      |                          | $          | 487 |   |   | $ | 5,788 |   |   |

----

(1)             Includes interest payments. Floating rate debtinterest was estimated using projected forward LIBOR rates as of December 31,2006.

(2)             Includes $367 million relating to Channelview’sdebt. See note 6(c) to our consolidated financial statements.

(3)             Includes commitments with both fixed and variablepricing components. See note 12(c) to our consolidated financialstatements.

(4)             These amounts are included in the capitalrequirements table above under either maintenance capital expenditures forwholesale energy or environmental.

(5)             Includes Western states settlements, stadiumnaming rights, credit-enhanced retail structure fee on sales commitments,estimated pension and post retirement benefit payments and other contractualobligations.

33

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As of December 31,2006, we have estimated minimum salescommitments, which are not classified as derivative assets and liabilities, of(in millions):

| 2007     |   | $     | 4,396  |   |
|----------|--------|-------|--------|--------|
| 2008     |   | 2,043 |   |
| 2009     |   | 807   |   |
| 2010     |   | 283   |   |
| 2011     |   | 67    |   |
| Total(1) |   | $     | 7,596  |   |

----

(1)             Includessales commitments with both fixed and variable pricing components. Seenote 12(c) to our consolidated financial statements.

*Contingencies andGuarantees.**  *We are involved in a number of legal,environmental and other proceedingsbefore courts and are subject to ongoing investigations by certain governmentalagencies that could negatively impact our liquidity. See notes 11(e) and13 to our consolidated financial statements.

We also enter intoguarantee and indemnification arrangements in the normal course of business,none of which is expected to materially impact our liquidity. See note 12(b) toour consolidated financial statements.

**Credit Risk**

Byextending credit to our counterparties, we are exposed to credit risk. For adiscussion of our credit risk and policy, see note 2(e) to ourconsolidated financial statements.

As of December 31, 2006, our derivative assets andaccounts receivable from our wholesale energy and ERCOT power supplycounterparties, after taking into consideration netting within each contractand any master netting contracts with counterparties, are:

| **Credit Rating Equivalent**      | ** ** | ** **                          | ** ** | **Exposure  Before  Collateral**(1) | ** ** | **Credit  Collateral  Held**(2) | ** ** | **Exposure  Net of  Collateral** | ** ** | **Number of  Counterparties  >10%**(3) | ** ** | **Net Exposure of  Counterparties  >10%**(3) | ** ** |
|---------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                  | ** ** | **(dollars in millions)** | ** ** |
| Investment grade                            |       |                                | $          | 199                                 |       |                            |       | $                                     | 22         |                                           |       |                                                      | $          | 177 |   |   |   | — |   |   |   | $ | — |   |   |
| Non-investment grade                        |       |                                | 377        |                                |       |                            | 1          |                                  |       |                                           | 376        |                                                      |       |   | 2 |   |   |   | 359 |   |   |
| No external ratings:(4)                     |       |                                |       |                                |       |                            |       |                                  |       |                                           |       |                                                      |       |   |   |   |   |   |   |   |   |
| Internally  rated—Investment  grade    |       |                                | 84         |                                |       |                            | —     |                                  |       |                                           | 84         |                                                      |       |   | — |   |   |   | — |   |   |
| Internally  rated—Non-investment grade |       |                                | 16         |                                |       |                            | 5          |                                  |       |                                           | 11         |                                                      |       |   | — |   |   |   | — |   |   |
| Total                                       |       |                                | $          | 676                                 |       |                            |       | $                                     | 28         |                                           |       |                                                      | $          | 648 |   |   |   | 2 |   |   |   | $ | 359 |   |   |

----

(1)             Thetable excludes amounts related to contracts classified as normalpurchase/normal sale and non-derivative contractual commitments that are notrecorded in our consolidated balance sheets, except for any related accountsreceivable. Such contractual commitments contain credit and economic risk if acounterparty does not perform. Nonperformance could have a material adverseimpact on our future results of operations,financial condition and cash flows.

(2)             Collateralconsists of cash, standby letters of credit and other forms approved bymanagement.

(3)             Seenote 2(e) to our consolidated financial statements.

(4)             Forunrated counterparties, we perform credit analyses including review offinancial statements, contractual rights and restrictions and credit supportsuch as parent company guarantees to create an internal credit rating.

**Off-Balance Sheet Arrangements**

As of December 31, 2006, we have no off-balancesheet arrangements. For information regarding our principles of consolidation,see note 2(b) to our consolidated financial statements.

34

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**Historical Cash Flows**

**Cash Flows—Operating Activities**

*2006 Compared to 2005 and 2005 Compared to 2004.*

| ** **                                                                        | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                        | ** ** | **(in millions)** | ** ** |
| Operating  loss                                                                   |       | $                      | (24        | )        | $          | (321     | )          | $                                        | (13        | )                                        |       | $ | 297 |   |   |   | $ | (308 | ) |   |
| Depreciation  and amortization                                                    |       | 373                    |       | 446      |       | 453      |       |                                     | (73        | )                                        |       |   | (7 | ) |   |
| Gains  on sales of assets and emission allowances,  net                           |       | (159                   | )          | (168     | )          | (20      | )          |                                     | 9          |                                     |       |   | (148 | ) |   |
| Net  changes in energy derivatives                                                |       | 317                    |       | 192      |       | 224      |       |                                     | 125        |                                     |       |   | (32 | ) |   |
| Debt  conversion expense                                                          |       | 37                     |       | —   |       | —   |       |                                     | 37         |                                     |       |   | — |   |   |
| Western  states and Cornerstone settlements                                       |       | 35                     |       | 359      |       | —   |       |                                     | (324       | )                                        |       |   | 359 |   |   |
| Western  states and Cornerstone settlement payments                               |       | (160                   | )          | —   |       | —   |       |                                     | (160       | )                                        |       |   | — |   |   |
| California  reserve changes                                                       |       | —                 |       | (1       | )          | 11       |       |                                     | 1          |                                     |       |   | (12 | ) |   |
| Payment  to CenterPoint, net.                                                     |       | —                 |       | —   |       | (175     | )          |                                     | —     |                                     |       |   | 175 |   |   |
| Receivables  facility proceeds, net                                               |       | —                 |       | —   |       | 232      |       |                                     | —     |                                     |       |   | (232 | ) |   |
| Margin  deposits, net                                                             |       | 1,264                  | (1)        | (1,214   | )(2)       | (451     | )(2)       |                                     | 2,478      |                                     |       |   | (763 | ) |   |
| Settlements  of exchange transactions prior to contractual period(3)              |       | 22                     |       | (8       | )          | —   |       |                                     | 30         |                                     |       |   | (8 | ) |   |
| Net  option premiums sold (purchased)                                             |       | (53                    | )          | 3        |       | (5       | )          |                                     | (56        | )                                        |       |   | 8 |   |   |
| Interest  payments                                                                |       | (385                   | )          | (347     | )          | (326     | )          |                                     | (38        | )                                        |       |   | (21 | ) |   |
| Change  in accounts and notes receivable, net and accounts payable                |       | 32                     |       | 35       |       | —   |       |                                     | (3         | )                                        |       |   | 35 |   |   |
| Income  tax refunds received (net of income taxes paid)                           |       | (29                    | )          | (22      | )          | 62       |       |                                     | (7         | )                                        |       |   | (84 | ) |   |
| Other,  net                                                                       |       | 60                     |       | (64      | )          | 13       |       |                                     | 124        |                                     |       |   | (77 | ) |   |
| Net cash provided by (used in) continuing operations from operating  activities   |       | 1,330                  |       | (1,110   | )          | 5        |       |                                     | 2,440      |                                     |       |   | (1,115 | ) |   |
| Net cash provided by (used in) discontinued operations from operating  activities |       | (54                    | )          | 193      |       | 101      |       |                                     | (247       | )                                        |       |   | 92 |   |   |
| Net cash provided by (used in) operating  activities                              |       | $                      | 1,276      |     | $          | (917     | )          | $                                        | 106        |                                     |       | $ | 2,193 |   |   |   | $ | (1,023 | ) |   |

 

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(1)             Changeprimarily due to our credit-enhanced retail structure and the expiration ofcertain hedges.

(2)             Changeprimarily due to both a decrease in net unrealized value of our broker accountsand increased counterparty obligations.

(3)             Represents exchangetransactions financially settled in three business days prior to the contractualdelivery month.

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**Cash Flows—Investing Activities**

*2006Compared to 2005 and 2005 Compared to 2004.*

| ** **                                                                      | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                      | ** ** | **(in millions)** | ** ** |
| Capital expenditures                                                            |       | $                      | (97        | )        | $          | (82      | )          | $                                        | (160       | )                                        |       | $ | (15 | ) |   |   | $ | 78 | (1) |   |
| Proceeds from sales of assets, net                                              |       | 1                      |       | 149      | (2)        | 11       |       |                                     | (148       | )                                        |       |   | 138 |   |   |
| Proceeds from sales of emission allowances                                      |       | 205                    |       | 234      |       | 60       |       |                                     | (29        | )                                        |       |   | 174 |   |   |
| Purchases of emission allowances                                                |       | (23                    | )          | (146     | )          | (125     | )          |                                     | 123        |                                     |       |   | (21 | ) |   |
| Restricted cash                                                                 |       | 2                      |       | 14       |       | 179      |       |                                     | (12        | )                                        |       |   | (165 | )(3) |   |
| Other, net                                                                      |       | 1                      |       | 6        |       | 16       |       |                                     | (5         | )                                        |       |   | (10 | ) |   |
| Net cash provided by (used in)  continuing operations from investing activities |       | 89                     |       | 175      |       | (19      | )          |                                     | (86        | )                                        |       |   | 194 |   |   |
| Net cash provided by  discontinued operations  from investing activities        |       | 968                    | (4)        | 131      | (5)        | 919      | (6)        |                                     | 837        |                                     |       |   | (788 | ) |   |
| Net cash provided by investing activities                                       |       | $                      | 1,057      |     | $          | 306      |       | $                                        | 900        |                                     |       | $ | 751 |   |   |   | $ | (594 | ) |   |

 

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(1)             Decrease primarily due to completion of our powergeneration development projects. Bighorn was completed in February 2004and Seward was completed in October 2004.

(2)             Includes $76 million, $42 million and $28 millionrelated to sales of El Dorado, REMA hydropower plants and landfill-gas fueledpower plants, respectively.

(3)             Change primarily due to the refinancing in December 2004.

(4)             Includes $952 million of net cash proceeds fromthe sale of New York plants.

(5)             Includes $100 million of net cash proceeds fromthe sale of Ceredo.

(6)             Includes$804 million of net cash proceeds from the sale of Orion Power hydropowerplants.

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**Cash Flows—Financing Activities**

*2006Compared to 2005 and 2005 Compared to 2004.*

| ** **                                                                      | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** | **Change  from 2005  to 2006** | ** ** | **Change  from 2004  to 2005** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                      | ** ** | **(in millions)** | ** ** |
| Net proceeds from (payments on) term loans                                      |       | $                      | (452       | )        | $          | 190      |       | $                                        | (485       | )                                        |       | $ | (642 | ) |   |   | $ | 675 |   |   |
| Net borrowings under (payments on) receivables facility                         |       | (450                   | )          | 223      |       | (123     | )          |                                     | (673       | )                                        |       |   | 346 |   |   |
| Net borrowings under (payments on) senior  secured revolver due 2009            |       | (383                   | )          | 184      |       | 199      |       |                                     | (567       | )                                        |       |   | (15 | ) |   |
| Payments of Orion Power MidWest, L.P. term  loan and credit facility            |       | —                 |       | —   |       | (427     | )          |                                     | —     |                                     |       |   | 427 |   |   |
| Payments on senior secured revolver due 2007                                    |       | —                 |       | —   |       | (183     | )          |                                     | —     |                                     |       |   | 183 |   |   |
| Premium paid for conversion of senior  subordinated notes                       |       | (36                    | )          | —   |       | —   |       |                                     | (36        | )                                        |       |   | — |   |   |
| Payments of financing costs                                                     |       | (17                    | )          | (1       | )          | (72      | )          |                                     | (16        | )                                        |       |   | 71 |   |   |
| Payments under REMA’s term loans                                           |       | —                 |       | (28      | )          | (14      | )          |                                     | 28         |                                     |       |   | (14 | ) |   |
| Proceeds from additional PEDFA bond issuance  for Seward plant                  |       | —                 |       | —   |       | 100      |       |                                     | —     |                                     |       |   | (100 | ) |   |
| Proceeds from senior secured notes                                              |       | —                 |       | —   |       | 750      |       |                                     | —     |                                     |       |   | (750 | ) |   |
| Proceeds from issuance of stock                                                 |       | 25                     |       | 37       |       | 25       |       |                                     | (12        | )                                        |       |   | 12 |   |   |
| Other, net                                                                      |       | (6                     | )          | (11      | )          | (1       | )          |                                     | 5          |                                     |       |   | (10 | ) |   |
| Net cash provided by (used in)  continuing operations from financing activities |       | (1,319                 | )          | 594      |       | (231     | )          |                                     | (1,913     | )                                        |       |   | 825 |   |   |
| Net cash used in discontinued  operations from financing activities             |       | (638                   | )          | —   |       | (816     | )          |                                     | (638       | )                                        |       |   | 816 |   |   |
| Net cash provided by (used in) financing  activities                            |       | $                      | (1,957     | )        | $          | 594      |       | $                                        | (1,047     | )                                        |       | $ | (2,551 | ) |   |   | $ | 1,641 |   |   |

 

**New AccountingPronouncements, Significant Accounting Policies and Critical AccountingEstimates**

**New AccountingPronouncements**

See notes 2, 10(b) and 11(f)to our consolidated financial statements.

**SignificantAccounting Policies**

See note 2 to ourconsolidated financial statements.

**Critical AccountingEstimates**

We make a number ofestimates and judgments in preparing our consolidated financial statements. Theseestimates can differ from actual results and have a significant impact on ourrecorded assets, liabilities, revenues and expenses and related disclosure ofcontingent assets and liabilities. We consider an estimate to be a criticalaccounting estimate if it requires a high level of subjectivity or judgment anda significant change in the estimate would have a material impact on ourfinancial condition or results of operations. Each critical accounting estimateaffects both our retail energy and wholesale energy segments, unless indicatedotherwise. The Audit Committee of our Board of Directors reviews each criticalaccounting estimate with our senior management. Further discussion of theseaccounting policies and estimates is in the notes to our consolidated financialstatements.

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*Goodwill.*

We consider the estimateof fair value to be a critical accounting estimate for our wholesale energysegment because (a) a goodwill impairment could have a material impact onour financial position and results of operations and (b) the estimate isbased on a number of highly subjective judgments and assumptions. Seenotes 2(i) and 4 to our consolidated financial statements.

*Property, Plant andEquipment.*

We consider thefair value estimate used to calculate impairment of property, plant andequipment a critical accounting estimate. This estimate primarily affects ourwholesale energy segment, which holds approximately 98% of our total netproperty, plant and equipment. See note 2(h) to our consolidatedfinancial statements. In determiningthe existence of an impairment in carrying value, we make a number ofsubjective assumptions as to:

·       whetherthere is an indication of impairment;

·       thegrouping of assets;

·       theintention of “holding” versus “selling” an asset;

·       theforecast of undiscounted expected future cash flow over the asset’s estimateduseful life; and

·       if an impairment exists,the fair value of the asset or asset group.

*Derivative Assetsand Liabilities.*

We report ourderivative assets and liabilities, for which the normal purchase/normal saleexception has not been made, at fair value and consider it to be a criticalaccounting estimate because they are highly susceptible to change from periodto period and are dependent on many subjective factors, including:

·       estimatedforward market price curves;

·       valuationadjustments relating to time value;

·       liquidityvaluation adjustments;

·       costsof administering future obligations under existing contracts; and

·       creditadjustments, based on estimated defaults by counterparties.

To determine the fair value for energy derivativeswhere there are no market quotes or external valuation services, we rely onvarious modeling techniques. There is inherent risk in valuation modeling giventhe complexity and volatility of energy markets. Therefore, it is possible thatresults in future periods may be materially different as contracts areultimately settled.

For additional informationregarding our derivative assets and liabilities, see notes 2(d) and 5to our consolidated financial statements and “Quantitative and QualitativeDisclosures about Non-Trading and Trading Activities and Related Market Risks”in Item 7A of this Form 10-K.

*Retail EnergySegment Estimated Revenues and Energy Supply Costs.*

*AccruedUnbilled Revenues.*   Accrued unbilled revenues of $416 million as of December 31,2006 represented 4% of our consolidated revenues and 5% of our retail energysegment’s revenues for 2006. Accrued unbilled revenues of $400 million as of December 31,2005 represented 4% of our consolidated revenues and 6% of our retail energysegment’s revenues for 2005.

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Accrued unbilled revenues are critical accountingestimates as volumes and rates are not precisely known at the end of eachreporting period and the revenue amounts are material. If our estimate ofelectricity usage were to increase or decrease by 3%, our accrued unbilledrevenues as of December 31, 2006 would have increased or decreased byapproximately $13 million.

*EstimatedEnergy Supply Costs.**  *Werecord energy supply costs for electricity sales and services to retailcustomers based on estimated supply volumes and an estimated rate per MWh forthe applicable reporting period. This is a critical accounting estimate asvolumes and rates are not known at the end of each reporting period and thepurchased power amounts are material.

A portion of our energy supply costs ($61 million and$53 million as of December 31, 2006 and 2005, respectively) consisted ofestimated transmission and distribution charges not yet billed by thetransmission and distribution utilities.

In estimating supply volumes, we consider the effectsof historical customer volumes, weather factors and usage by customer class. Weestimate our transmission and distribution delivery fees using the same methodthat we use for electricity sales and services to retail customers. Inaddition, we estimate ERCOT ISO fees based on historical trends, estimatedsupply volumes and initial ERCOT ISO settlements. Volume estimates are then multipliedby the estimated rate and recorded as purchased power in the applicablereporting period. If our estimate of electricity usage volumes increased ordecreased by 3%, our energy supply costs would have increased or decreased byapproximately $12 million as of December 31, 2006. Changes in our volumeusage would have resulted in a similar offsetting change in billed volumes,thus partially mitigating our energy supply costs.

*Dependenceon ERCOT ISO Settlement Procedures.*   Preliminarysettlement information is due from the ERCOT ISO within two months afterelectricity is delivered. Final settlement information is due from the ERCOTISO within six months after electricity is delivered. The six month settlementreceived from ERCOT is considered final as ERCOT will only resettle if thereare data errors greater than 2% of that day’s transaction dollars or ifalternate dispute resolutions are granted. We record our estimated supply costsand related fees using estimated supply volumes, as discussed above, and adjustthose costs upon receipt of the ERCOT ISO information. Delays in settlementscould materially affect the accuracy of our recorded energy supply costs andrelated fees.

*Market Usage Adjustments.*   Therevenues and the related energy supply costs in our retail energy segmentinclude our estimates of customer usage based on initial usage informationprovided by the independent system operators and the distribution companies. Werevise these estimates and record any changes in the period as additional settlementinformation becomes available (collectively referred to as “market usageadjustments”).

*Loss Contingencies.*

We record losscontingencies when it is probable that a liability has been incurred and theamount can be reasonably estimated. We consider loss contingency estimates tobe critical accounting estimates because they entail significant judgmentregarding probabilities and ranges of exposure, and the ultimate outcome of theproceedings is unknown and could have a material adverse effect on our resultsof operations, financial condition and cash flows. See notes 13 and 14 toour consolidated financial statements.

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*Deferred TaxAssets, Valuation Allowances and Tax Liabilities.*

We estimate (a) income taxes in the jurisdictionsin which we operate, (b) net deferred tax assets and liabilities based onexpected future taxes in the jurisdictions in which we operate, (c) federaland state valuation allowances for deferred tax assets and (d) contingenttax liabilities for estimated exposures related to our current tax positions.These estimates are considered critical accounting estimates because theyrequire projecting future operating results (which is inherently imprecise) andjudgments related to the ultimate determination of tax positions by taxingauthorities. Also, these estimates depend on assumptions regarding our abilityto generate future taxable income during the periods in which temporarydifferences are deductible. See note 11 to our consolidated financialstatements for additional information.

We assess quarterly ourfuture ability to use federal, state and foreign net operating losses, capitallosses and other deferred tax assets using the more-likely-than-not criteria.These assessments include an evaluation of our recent history of earnings andlosses, future reversals of temporary differences and identification of othersources of future taxable income, including the identification of tax planningstrategies in certain situations. As a result of our recent history of lossesand the change in our net federal deferred tax assets, we recorded a federalvaluation allowance of $68 million during 2006. It is not expected that the netdeferred tax assets will be realizable until we have experienced several yearsof profitable operations.

**Item 7A.**                *Quantitative and QualitativeDisclosures About Market Risk*

**Market Risks andRisk Management**

Ourprimary market risk exposure relates to fluctuations in commodity prices. Wealso have market risk exposure related to changes in interest rates. Asdescribed in note 2(d) to our consolidated financial statements, we have a risk controlframework to manage our risk exposure. However,the effectiveness of this framework can never be completely estimated or fullyassured. For example, we could experience hedge ineffectiveness from basisprice differences, transmission issues, price correlation issues, volumevariation or other factors. In addition, a reduction in market liquiditymay impair the effectiveness of our risk management practices and resultinghedge strategies. These and other factors could have a material adverse effecton our results of operations, financial condition and cash flows.

**Non-trading Market Risks**

**Commodity PriceRisk**

Changes in commodity prices prior to the energydelivery period are inherent in our wholesale and retail energy businesses. Weuse derivative instruments such as futures, forwards, swaps and options, toexecute our wholesale hedge strategy and retail supply procurement strategy.

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As of December 31, 2006, the fair values of thecontracts related to our net non-trading derivative assets and liabilities are:

| **Source of Fair Value**                 | ** ** | ** **             | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total fair  value** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|----------------------------|------------|
| ** **                                              | ** ** | **(in millions)** | ** ** |
| Prices actively quoted(1)                               |       | $                      | (16        | )        | $          | 2        |       | $        | (1         | )        | $          | —   |       | $                             | —     |                       |       | $ | — |   |   |   | $ | (15 | ) |   |
| Prices provided by other  external  sources(2)          |       | (469                   | )          | (36      | )          | (6       | )          | —   |       | —   |       |     | —     |                          |       |                       | (511       | ) |   |
| Prices based on models  and other  valuation methods(3) |       | (31                    | )          | (43      | )          | (8       | )          | (2       | )          | —   |       |     | 7          |                          |       |                       | (77        | ) |   |
| Total mark-to-market  non-trading derivatives           |       | (516                   | )          | (77      | )          | (15      | )          | (2       | )          | —   |       |     | 7          |                          |       |                       | (603       | ) |   |
| Cash flow hedges                                        |       | (156                   | )          | (54      | )          | (26      | )          | (25      | )          | (22      | )          |     | (15        | )                             |       |                       | (298       | ) |   |
| Total                                                   |       | $                      | (672       | )        | $          | (131     | )          | $        | (41        | )        | $          | (27      | )          | $                             | (22        | )                          |       | $ | (8 | ) |   |   | $ | (901 | ) |   |

 

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(1)             Representsour NYMEX futures positions in natural gas, crude oil and power, which havequoted prices for the next 72, 30 and 36 months, respectively.

(2)             Representsour forward positions in natural gas, coal and crude oil and power at pointsfor which over-the-counter market broker quotes are available, which onaverage, extend 24 or 36 months into the future. Positions are valued againstinternally developed forward market price curves that are validated and recalibratedagainst over-the-counter broker quotes. This category includes sometransactions whose prices are obtained from external sources and then modeledto hourly, daily or monthly prices, as appropriate.

(3)             Representsthe value of (a) our valuation adjustments for liquidity, credit andadministrative costs, (b) options or structured transactions not quoted byan exchange or over-the-counter broker, but for which the prices of theunderlying position are available and (c) transactions for which an internallydeveloped price curve was constructed as a result of the long-dated nature ofthe transaction or the illiquidity of the market point.

The fair values shown inthe table above are subject to significant changes due to fluctuating naturalgas and power forward market prices, volatility and credit risk. Market pricesassume a functioning market with an adequate number of buyers and sellers toprovide liquidity. Insufficient market liquidity could significantly affect thevalues that could be obtained for these contracts, as well as the costs atwhich these contracts could be hedged.

Ahypothetical 10% movement in the underlying energy prices would have thefollowing potential gain (loss) impacts on our non-trading derivatives:

| **As of December 31,** | ** ** | ** **    | ** ** | **Market Prices** | ** ** | **Fair Value of  Cash Flow Hedges** | ** ** | **Earnings Impact of  Other Derivatives** | ** ** | **Total Potential  Loss in Fair Value** | ** ** |
|---------------------------------------|------------|---------------|------------|------------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| 2006                                  |       | 10% decrease  |       |                   | $          | 33                                                      |       |                                                     |       | $                                                           | (328       | ) |   |   | $ | (295 | ) |   |
| 2005                                  |       | 10%  decrease |       |                   | (19        | )                                                       |       |                                                     | (174       | )                                                           |       |   | (193 | ) |   |

 

Thisrisk analysis does not include the favorable impact that the same hypotheticalprice movements would have on our physical purchases and sales of fuel andpower to which the hedges relate. The adverse impact of changes in commodityprices on our portfolio of non-trading energy derivatives held for hedgingpurposes would be offset (although not necessarily in the same period) by afavorable impact on the underlying hedged physical transactions, assuming:

·       the derivatives are not closed out in advance oftheir expected term;

·       the derivatives continue to function effectivelyas hedges of the underlying risk; and

·       asapplicable, anticipated underlying transactions settle as expected.

Ifany of these assumptions cease to be true, we may experience a benefit or lossrelative to the exposure hedged. Non-tradingenergy derivatives that qualify andare effective as cash flow hedges may 

41

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still have some percentage that is not effective. Seenotes 2(d) and 5 to our consolidated financial statements.

**Interest Rate Risk**

As of December 31,2005, all of our interest rate derivatives either expired or were terminated. Weremain subject to the benefits or losses associated with movements in marketinterest rates related to a portion ($667 million as of December 31, 2006)of our debt and certain margin deposits, which are most vulnerable to changesin LIBOR and the prime rate.

We assess interest raterisks using a sensitivity analysis that measures the potential change in ourinterest expense based on a hypothetical one percentage point movement in theunderlying variable interest rate indices. If interest ratesincreased/decreased one percentage point from their December 31, 2006 and2005 levels, our annual interest expense would have increased/decreased by $15million and $14 million, respectively, and our annual interest expense, net ofinterest income, would have increased/decreased by $8 million.

We estimated these amountsby considering the impact of hypothetical changes in interest rates on ourvariable-rate debt adjusted for: cash and cash equivalents and net margindeposits outstanding at the respective balance sheet dates.

If interest ratesdecreased by one percentage point from their December 31, 2006 and 2005levels, the fair market values of our fixed-rate debt would have increased by$189 million and $200 million, respectively.

**TradingMarket Risks**

Priorto March 2003, we engaged in proprietary trading activities as discussedin note 5 to our consolidated financial statements. Trading positionsentered into prior to our decision to exit this business are being closed oneconomical terms or are being retained and settled over the contract terms.

As of December 31, 2006, the fair values of thecontracts related to our legacy trading positions and recorded as netderivative assets and liabilities are:

| **Source of Fair Value**             | ** ** | ** **             | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total fair  value** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|----------------------------|------------|
| ** **                                          | ** ** | **(in millions)** | ** ** |
| Prices actively  quoted                             |       | $                      | (23        | )        | $          | (39      | )          | $        | (11        | )        |       | $        | —     |                          |       |                       | $          | — |   |   |   | $ | — |   |   |   | $ | (73 | ) |   |
| Prices provided  by other external sources          |       | 23                     |       | 49       |       | 13       |       |     | —     |     |       |     | —     |                          |       |                       | —     |   |   |   | 85 |   |   |
| Prices based on  models and other valuation methods |       | (3                     | )          | —   |       | —   |       |     | —     |     |       |     | —     |                          |       |                       | —     |   |   |   | (3 | ) |   |
| Total                                               |       | $                      | (3         | )        | $          | 10       |       | $        | 2          |     |       | $        | —     |                          |       |                       | $          | — |   |   |   | $ | — |   |   |   | $ | 9 |   |   |

 

The fair values in theabove table are subject to significant changes based on fluctuating market pricesand conditions. For further discussion of items that impact our portfolio oftrading contracts and an explanation of the sources of fair value, see the discussion related to non-tradingderivative assets and liabilities.

Our consolidated realized and unrealized marginsrelating to these positions are (income (loss)):

| ** ** | ** ** | **2006**               | ** ** | **2005** | ** ** |
|------------|------------|------------------------|------------|----------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| Realized   |       |                   | $          | (3       | )          |   | $ | (17 | ) |
| Unrealized |       |                   | 30         |     |       | (28 | ) |
| Total      |       |                   | $          | 27       |       |   | $ | (45 | ) |

 

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An analysis of these net derivative assets andliabilities is:

| ** **                                                                    | ** ** | **2006**               | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                    | ** ** | **(in millions)** | ** ** |
| Fair value of contracts outstanding, beginning of period                      |       | $                      | (20        | )        | $          | 26 |   |
| Contracts transferred to non-trading                                          |       | —                 |       | (4       | )          |
| Contracts realized or settled                                                 |       | (2                     | )(1)       | 22       | (2)        |
| Changes in valuation techniques                                               |       | (8                     | )          | —   |       |
| Changes in fair values attributable to market price and  other market changes |       | 39                     |       | (64      | )          |
| Fair  value of contracts outstanding, end of period                           |       | $                      | 9          |     | $          | (20 | ) |

 

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(1)             Amount includes realized loss of $3 millionoffset by deferred settlements of $5 million.

(2)             Amount includes realized loss of $17 million anddeferred settlements of $5 million.

Weprimarily assess the risk of our legacy trading positions using a value-at-riskmethod to maintain our total exposure within limits set by the Audit Committeeof our Board of Directors. Value-at-risk is the potential loss in value oftrading positions due to adverse market movements over a defined time periodwithin a specified confidence level. We use the parametric variance/covariancemethod with delta/gamma approximation to calculate value-at-risk.

Our value-at-risk model utilizes four major parameters:

·       *Confidence level*—95% for natural gas and petroleum productsand 99% for power products;

·       *Volatility*—calculated daily from historical forward pricesusing the exponentially weighted moving average method;

·       *Correlation*—calculated daily from daily volatilities andhistorical forward prices using the exponentially weighted moving averagemethod; and

·       *Holding period*—natural gas and petroleum products generallyhave two day-holding periods. Power products have holding periods of five to 20days based on the risk profile of the portfolio and the liquidation period.

Whilewe believe that our value-at-risk assumptions and approximations arereasonable, different assumptions and/or approximations could producematerially different estimates. An inherent limitation of value-at-risk is thatpast market risk may not produce accurate predictions of future market risk. In addition,value-at-risk calculated for a specified holding period does not fully capturethe market risk of positions that cannot be liquidated or offset with hedgeswithin that specified period. Future transactions, market volatility, reductionof market liquidity, failure of counterparties to satisfy their contractualobligations and/or a failure of risk controls could result in material lossesfrom our legacy trading positions.

The daily value-at-risk for our legacy trading positionsis:

| ** **                   | ** ** | **2006**               | ** ** | **2005** | ** ** |
|------------------------------|------------|------------------------|------------|----------|------------|
| ** **                   | ** ** | **(in millions)** | ** ** |
| As of December 31       |       |                   | $          | 2        |       |   |   | $ | 7 |   |   |
| Year Ended December 31: |       |                   |       |     |       |   |   |   |   |
| Average                      |       |                   | 3          |     |       |   | 3 |   |   |
| High                         |       |                   | 7          |     |       |   | 9 |   |   |
| Low                          |       |                   | 1          |     |       |   | — |   |   |

 

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**Item 8.**                        *Financial Statements and Supplementary Data.*

The information requiredby this Item is incorporated by reference from the consolidated financialstatements beginning on page F-1.

**Item 9.**                        *Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure.*

None.

**Item 9A.**                *Controls and Procedures.*

**Evaluation ofDisclosure Controls and Procedures**

Our Chief ExecutiveOfficer and Chief Financial Officer have evaluated the effectiveness of ourdisclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) as of the end of theperiod covered by this report. Based on this evaluation, these officers haveconcluded that, as of the end of such period, our disclosure controls andprocedures are effective in alerting them on a timely basis to materialinformation required to be included in our reports filed or submitted under theSecurities Exchange Act of 1934, as amended.

**Management’s AnnualReport on Internal Control Over Financial Reporting**

The information requiredby this Item is incorporated by reference from “Reliant Energy Inc.’s Report onInternal Control Over Financial Reporting” on page F-1.

**Changes in InternalControl Over Financial Reporting**

In connection with the evaluationdescribed above, we identified no change in our internal control over financialreporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) underthe Securities Exchange Act of 1934, as amended) during our fiscal quarterended December 31, 2006 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

**Item 9B.**               *Other Information.*

None.

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**PART III**

**Item 10.**                 *Directors, Executive Officers and Corporate Governance.*

See “Business—ExecutiveOfficers” in Item 1 of this Form 10-K. Pursuant to General Instruction Gto Form 10-K, we incorporate by reference the information to be disclosedin our definitive proxy statement for the annual stockholder meeting at whichwe will elect directors (“Proxy Statement”).

**Item 11.**                 *Executive Compensation.*

**Item 12.**                 *Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters.*

**Item 13.**                 *Certain Relationships and Related Transactions, and DirectorIndependence.*

**Item 14.**                 *Principal Accountant Fees and Services.*

Pursuant to General Instruction G to Form 10-K,we incorporate by reference into each of these items the information to bedisclosed in our Proxy Statement.

45

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**PART IV**

**Item15.**                 *Exhibits and Financial Statement Schedules*.
| *(a)      List of Documents Filed  as Part of this Report* |   |                                                                                                                                             |
|------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                          | *(1)*  | *Index to Consolidated Financial Statements of  Reliant Energy, Inc. and Subsidiaries.*                                                     |   |   |
|                                                                                     |   | Reliant  Energy, Inc.’s Report on Internal Control Over Financial Reporting                                                            | F-1 |   |
|                                                                                     |   | Report  of Independent Registered Public Accounting Firm                                                                                         | F-2 |   |
|                                                                                     |   | Report  of Independent Registered Public Accounting Firm                                                                                         | F-3 |   |
|                                                                                     |   | Report of Independent Registered Public Accounting  Firm                                                                                         | F-4 |   |
|                                                                                     |   | Consolidated  Statements of Operations for the Years Ended December 31, 2006, 2005 and  2004             | F-5 |   |
|                                                                                     |   | Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                                               | F-6 |   |
|                                                                                     |   | Consolidated  Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and  2004             | F-7 |   |
|                                                                                     |   | Consolidated  Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the  Years Ended December 31, 2006, 2005 and 2004 | F-8 |   |
|                                                                                     |   | Notes  to Consolidated Financial Statements                                                                                                      | F-14 |   |
| * *                                                                                 | *(2)*  | *Financial Statement Schedule.*                                                                                                                  |   |   |
|                                                                                     |   | Schedule  II—Reliant Energy, Inc. and Subsidiaries—Valuation and Qualifying  Accounts for 2006, 2005 and 2004                     | F-71 |   |

 

The following schedules are omitted because of theabsence of the conditions under which they are required or because the requiredinformation is included in the financial statements: III, IV and V.

Thefollowing financial statements are included in this report pursuant to Item 3-16of Regulation S-X:
|        | * * | *Consolidated  Financial Statements of RERH Holdings, LLC and Subsidiaries.*                                                   |   |   |
|--------|----------|--------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |     | Report  of Independent Registered Public Accounting Firm                                                                       | F-72   |   |
|   |     | Consolidated  Statement of Operations for  the Year Ended December 31, 2006                                               | F-73   |   |
|   |     | Consolidated  Balance Sheet as of December 31, 2006                                                                       | F-74   |   |
|   |     | Consolidated  Statement of Cash Flows for the Year Ended December 31, 2006                                                | F-75   |   |
|   |     | Consolidated  Statement of Members’ Equity and Comprehensive Income for the Year Ended  December 31, 2006            | F-76   |   |
|   |     | Notes  to Consolidated Financial Statements                                                                                    | F-77   |   |
|   | * * | *Consolidated  Financial Statements of Reliant Energy Retail Holdings, LLC and Subsidiaries.*                                  |   |   |
|   |     | Report  of Independent Registered Public Accounting Firm                                                                       | F-89   |   |
|   |     | Consolidated  Statements of Operations for  the Years Ended December 31, 2005 and 2004                     | F-90   |   |
|   |     | Consolidated  Balance Sheet as of December 31, 2005                                                                       | F-91   |   |
|   |     | Consolidated  Statements of Cash Flows for the Years Ended December 31, 2005 and 2004                      | F-92   |   |
|   |     | Consolidated  Statements of Member’s Equity and Comprehensive Income for the Years Ended  December 31, 2005 and 2004 | F-93   |   |
|   |     | Notes  to Consolidated Financial Statements                                                                                    | F-94   |   |

46

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|          | * * | *Consolidated  Financial Statements of Reliant Energy Mid-Atlantic Power Holdings, LLC and  Subsidiaries.*                                       |   |   |   |
|----------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|     |     | Report  of Independent Registered Public Accounting Firm                                                                                         | F-108  |   |   |
|     |     | Report  of Independent Registered Public Accounting Firm                                                                                         | F-109  |   |   |
|     |     | Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and  2004                        | F-110  |   |
|     |     | Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                                               | F-111  |   |
|     |     | Consolidated  Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and  2004                       | F-112  |   |
|     |     | Consolidated  Statements of Member’s Equity and Comprehensive Income (Loss) for the Years  Ended December 31, 2006, 2005 and 2004      | F-113  |   |
|     |     | Notes  to Consolidated Financial Statements                                                                                                      | F-115  |   |
| * * | * * | *Consolidated  Financial Statements of Orion Power Holdings, Inc. and Subsidiaries.*                                                        |   |   |
|     |     | Report  of Independent Registered Public Accounting Firm                                                                                         | F-133  |   |
|     |     | Report  of Independent Registered Public Accounting Firm                                                                                         | F-134  |   |
|     |     | Consolidated  Statements of Operations for the Years Ended December 31, 2006, 2005 and  2004                       | F-135  |   |
|     |     | Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                                               | F-136  |   |
|     |     | Consolidated  Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and  2004                       | F-137  |   |
|     |     | Consolidated  Statements of Stockholder’s Equity and Comprehensive Income (Loss) for the  Years Ended December 31, 2006, 2005 and 2004 | F-138  |   |
|     |     | Notes  to Consolidated Financial Statements                                                                                                      | F-140  |   |
|          |          |                                                                                                                                                  |        |        |        |  |

 

47

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*(3) Index toExhibits.*

Theexhibits with the cross symbol (+) are filed with the Form 10-K. Theexhibits with the asterisk symbol (*) are compensatory arrangements filedpursuant to Item 601(b)(10)(iii) of Regulation S-K. 

|             | ** ** | ** **                                                                                                                                                                                                         | ** ** | ** **                                                                                                                             | ** ** | **SEC File or**  | ** ** | ** **    |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|---------------|
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                         | ** ** | **Report or Registration**                                                                                                             | ** ** | **Registration** | ** ** | **Exhibit**   |
| **Number**  | ** ** | **Document Description**                                                                                                                                                                                           | ** ** | **Statement**                                                                                                                          | ** ** | **Number**       | ** ** | **Reference** |
| 3.1         |       | Restated Certificate of Incorporation                                                                                                                                                                              |       | Reliant Energy, Inc.’s Amendment No. 8 to  Registration Statement on Form S-1, filed April 27, 2001           |       | 333-48038        |       | 3.1           |
| 3.2         |       | Second Amended and  Restated Bylaws                                                                                                                                                                                |       | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed September 21,  2004                                      |       | 1-16455          |       | 99.1          |
| 3.3         |       | Certificate of Ownership  and Merger merging a wholly-owned subsidiary into registrant pursuant to  Section 253 of the General Corporation Law of the State of Delaware,  effective as of April 26, 2004 |       | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed April 26,  2004                                          |       | 1-16455          |       | 3.1           |
| 4.1         |       | Specimen Stock  Certificate                                                                                                                                                                                        |       | Reliant  Energy, Inc.’s Amendment No. 5 to Registration Statement on  Form S-1, filed March 23, 2001          |       | 333-48038        |       | 4.1           |
| 4.2         |       | Rights Agreement between  Reliant Resources, Inc. and The Chase Manhattan Bank, as Rights Agent,  including a form of Rights Certificate, dated as of January 15, 2001                                   |       | Reliant  Energy, Inc.’s Amendment No. 8 to Registration Statement on  Form S-1, filed April 27, 2001          |       | 333-48038        |       | 4.2           |
| 4.3         |       | Common Stock Warrant  Agreement by Reliant Resources, Inc. for the benefit of the holders from  time to time, dated as of March 28, 2003                                                                 |       | Reliant  Energy, Inc.’s Amendment No. 1 to Annual Report on Form 10-K/A  for the year ended December 31, 2002 |       | 1-16455          |       | 4.3           |
| 4.4         |       | Indenture relating to  5.00% Convertible Senior Subordinated Notes due 2010 between Reliant  Resources, Inc. and Wilmington Trust Company, as Trustee, dated as of  June 24, 2003                        |       | Reliant  Energy, Inc.’s Registration Statement on Form S-3, filed  July 24, 2003                                   |       | 333-107295       |       | 4.5           |

48

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| 4.5  |   | Registration Rights Agreement relating to 5.00%  Convertible Senior Subordinated Notes due 2010 among Reliant  Resources, Inc., Deutsche Bank Securities Inc., Goldman,  Sachs & Co. and Banc of America Securities LLC, dated as of  June 24, 2003 |   | Reliant Energy, Inc.’s Registration Statement  on Form S-3, filed July 24, 2003  |   | 333-107295 |   | 4.7    |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|------------|--------|--------|
| 4.6  |   | Indenture relating to  9.25% Senior Secured Notes due 2010 among Reliant Resources, Inc., the  Guarantors listed in Schedule I thereto and Wilmington Trust Company, as  Trustee, dated as of July 1, 2003                                              |   | Reliant  Energy, Inc.’s Registration Statement on Form S-4, filed  July 24, 2003 |   | 333-107297 |   | 4.5    |
| +4.7 |   | Supplemental Indenture  relating to the 9.25% Senior Secured Notes due 2010, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of November 19, 2004                                                         |   |                                                                                                 |   |       |   |   |
| +4.8 |   | Second Supplemental  Indenture relating to the 9.25% Senior Secured Notes due 2010, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of September 21, 2006                                                 |   |                                                                                                 |   |       |   |   |
| 4.9  |   | Third Supplemental  Indenture relating to the 9.25% Senior Secured Notes due 2010, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of December 1, 2006                                                    |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006      |   | 1-16455    |   | 4.1    |
| 4.10 |   | Indenture relating to  9.50% Senior Secured Notes due 2013 among Reliant Resources, Inc., the  Guarantors listed in Schedule I thereto and Wilmington Trust Company, as  Trustee, dated as of July 1, 2003                                              |   | Reliant  Energy, Inc.’s Registration Statement on Form S-4, filed July 24,  2003 |   | 333-107297 |   | 4.7    |

49

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| +4.11 |   | Supplemental Indenture relating to the 9.50% Senior  Secured Notes due 2013, among Reliant Energy, Inc., the Guarantors  listed therein and Wilmington Trust Company, dated as of November 19,  2004         |   |                                                                                                                             |   |       |   |   |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------|--------|------------|--------|--------|
| +4.12 |   | Second Supplemental  Indenture relating to the 9.50% Senior Secured Notes due 2013, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of September 21, 2006 |   |                                                                                                                             |   |       |   |   |
| 4.13  |   | Third Supplemental  Indenture relating to the 9.50% Senior Secured Notes due 2013, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of December 1, 2006    |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006                                  |   | 1-16455    |   | 4.2    |
| 4.14  |   | Form of Senior  Indenture to be issued under universal shelf                                                                                                                                                      |   | Reliant  Energy, Inc.’s Amendment No. 1 to Registration Statement on  Form S-3, filed December 10, 2003 |   | 333-107296 |   | 4.5    |
| 4.15  |   | Form of  Subordinated Indenture to be issued under universal shelf                                                                                                                                                |   | Reliant Energy, Inc.’s  Amendment No. 1 to Registration Statement on Form S-3, filed  December 10, 2003 |   | 333-107296 |   | 4.6    |
| 4.16  |   | Senior Indenture  relating to the 6.75% Senior Secured Notes due 2014, among Reliant  Energy, Inc. and Wilmington Trust Company, dated as of December 22,  2004                                              |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004                                 |   | 1-16455    |   | 4.1    |
| 4.17  |   | First Supplemental  Indenture relating to the 6.75% Senior Secured Notes due 2014, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of December 22, 2004   |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004                                 |   | 1-16455    |   | 4.2    |

50

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| +4.18 |   | Second Supplemental Indenture relating to the 6.75%  Senior Secured Notes due 2014, among Reliant Energy, Inc., the  Guarantors listed therein and Wilmington Trust Company, dated as of  September 21, 2006 |   |                                                                                                                                                                            |   |      |   |   |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|--------|
| 4.19  |   | Third Supplemental  Indenture relating to the 6.75% Senior Secured Notes due 2014, among Reliant  Energy, Inc., the Guarantors listed therein and Wilmington Trust  Company, dated as of December 1, 2006    |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006                                                                                 |   | 1-16455   |   | 4.3    |
| 4.20  |   | Indenture between Orion  Power Holdings, Inc. and Wilmington Trust Company, dated as of  April 27, 2000                                                                                                      |   | Orion Power  Holdings, Inc.’s Registration Statement on Form S-1, filed  August 18, 2000                                                                    |   | 333-44118 |   | 4.1    |
| 10.1  |   | Master Separation  Agreement between Reliant Resources, Inc. and Reliant Energy,  Incorporated, dated as of December 31, 2000                                                                                |   | CenterPoint Energy Houston  Electric, LLC’s (formerly known as Reliant Energy, Incorporated) Quarterly  Report on Form 10-Q for the quarter ended March 31, 2001 |   | 1-3187    |   | 10.1   |
| 10.2  |   | Tax Allocation Agreement  between Reliant Resources, Inc. and Reliant Energy, Incorporated, dated  as of December 31, 2000                                                                                   |   | CenterPoint Energy  Houston Electric, LLC’s (formerly known as Reliant Energy, Incorporated)  Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 |   | 1-3187    |   | 10.8   |

51

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| 10.3  |   | Third Amended and Restated Credit and Guaranty  Agreement among (i) Reliant Energy, Inc., as Borrower;  (ii) the Other Loan Parties referred to therein, as Guarantors;  (iii) the Lenders party thereto; (iv) Bank of America, N.A., as  Administrative Agent and Collateral Agent; (v) Barclays Bank PLC and  Deutsche Bank Securities Inc., as Syndication Agents; and (vi) Goldman  Sachs Credit Partners L.P. and Merrill Lynch Capital Corporation, as  Documentation Agents, dated as of December 1, 2006 |   | Reliant Energy, Inc.’s Current Report on  Form 8-K, filed December 7, 2006                     |   | 1-16455 |   | 10.6  |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|---------|--------|-------|
| 10.4  |   | Credit Sleeve and  Reimbursement Agreement among Reliant Energy Power Supply, LLC, the  Guarantors listed therein, Merrill Lynch Commodities, Inc., and Merrill  Lynch & Co., Inc., dated as of September 24, 2006                                                                                                                                                                                                                                                                                                               |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed September 25,  2006                  |   | 1-16455 |   | 10.1  |
| 10.5  |   | Schedules and Exhibits  to the Credit Sleeve and Reimbursement Agreement dated as of  September 24, 2006 (Portions of this Exhibit have been omitted  pursuant to a request for confidential treatment)                                                                                                                                                                                                                                                                                                                                        |   | Reliant  Energy, Inc.’s Quarterly Report on Form 10-Q for the period  ended September 30, 2006 |   | 1-16455 |   | 10.7B |
| 10.6A |   | Amended and Restated  Credit Sleeve and Reimbursement Agreement among Reliant Energy Power Supply,  LLC, the Guarantors listed therein, Merrill Lynch Commodities, Inc., and  Merrill Lynch & Co., Inc., dated as of December 1, 2006                                                                                                                                                                                                                                                                                            |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006                    |   | 1-16455 |   | 99.2  |

52

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| +10.6B |   | Schedules and Exhibits to the Amended and Restated  Credit Sleeve and Reimbursement Agreement dated as of December 1, 2006  (Portions of this Exhibit have been omitted pursuant to a request for  confidential treatment)                                                                                                   |   |                                                                                              |   |    |   |   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| 10.7   |   | Working Capital Facility  among Reliant Energy Power Supply, LLC, the Guarantors listed therein and  Merrill Lynch Capital Corporation, dated as of September 24, 2006                                                                                                                                                            |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed September 25,  2006 |   | 1-16455 |   | 10.2   |
| 10.8   |   | Amended and Restated  Working Capital Facility Agreement among Reliant Energy Power Supply, LLC,  the Guarantors listed therein and Merrill Lynch Capital Corporation, dated as  of December 1, 2006                                                                                                                              |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006   |   | 1-16455 |   | 99.1   |
| 10.9   |   | Guarantee Agreement  relating to Pennsylvania Economic Development Financing Authority Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2001A between Reliant Energy, Inc., as Guarantor, and J.P.  Morgan Trust Company, National Association, as Trustee, dated as of December 22,  2004 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004  |   | 1-16455 |   | 10.2   |
| 10.10  |   | Guarantee Agreement  relating to Pennsylvania Economic Development Financing Authority Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2002A between Reliant Energy, Inc., as Guarantor, and J.P.  Morgan Trust Company, National Association, as Trustee, dated as of  December 22, 2004 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004  |   | 1-16455 |   | 10.3   |

53

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| 10.11  |   | Guarantee Agreement relating to Pennsylvania  Economic Development Financing Authority Exempt Facilities Revenue Bonds  (Reliant Energy Seward, LLC Project) Series 2002B between Reliant  Energy, Inc., as Guarantor, and J.P. Morgan Trust Company, National  Association, as Trustee, dated as of December 22, 2004                                          |   | Reliant Energy, Inc.’s Current Report on  Form 8-K, filed December 27, 2004  |   | 1-16455 |   | 10.4   |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| 10.12  |   | Guarantee Agreement  relating to Pennsylvania Economic Development Financing Authority Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2003A between Reliant Energy, Inc., as Guarantor, and J.P.  Morgan Trust Company, National Association, as Trustee, dated as of  December 22, 2004                                         |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004 |   | 1-16455 |   | 10.5   |
| 10.13  |   | Guarantee Agreement  relating to Pennsylvania Economic Development Financing Authority Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2004A between Reliant Energy, Inc., as Guarantor, and J.P.  Morgan Trust Company, National Association, as Trustee, dated as of  December 22, 2004                                         |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 27,  2004 |   | 1-16455 |   | 10.6   |
| +10.14 |   | Supplemental Guarantee  Agreement relating to Pennsylvania Economic Development Financing Authority’s  outstanding Exempt Facilities Revenue Bonds (Reliant Energy Seward, LLC  Project) Series 2001A among Reliant Energy, Inc., the Guarantors  listed therein and The Bank of New York Trust Company, N.A., as trustee, dated  as of September 21, 2006 |   |                                                                                             |   |    |   |   |

54

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| +10.15 |   | Supplemental Guarantee Agreement relating to  Pennsylvania Economic Development Financing Authority’s outstanding Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2002A among Reliant Energy, Inc., the Guarantors listed  therein and The Bank of New York Trust Company, N.A., as trustee, dated as of  September 21, 2006 |   |   |   |   |   |   |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
| +10.16 |   | Supplemental Guarantee  Agreement relating to Pennsylvania Economic Development Financing Authority’s  outstanding Exempt Facilities Revenue Bonds (Reliant Energy Seward, LLC  Project) Series 2002B among Reliant Energy, Inc., the Guarantors  listed therein and The Bank of New York Trust Company, N.A., as trustee,  dated as of September 21, 2006 |   |   |   |   |   |   |
| +10.17 |   | Supplemental Guarantee  Agreement relating to Pennsylvania Economic Development Financing Authority’s  outstanding Exempt Facilities Revenue Bonds (Reliant Energy Seward, LLC  Project) Series 2003A among Reliant Energy, Inc., the Guarantors  listed therein and The Bank of New York Trust Company, N.A., as trustee,  dated as of September 21, 2006 |   |   |   |   |   |   |

55

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| +10.18 |   | Supplemental Guarantee Agreement relating to  Pennsylvania Economic Development Financing Authority’s outstanding Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project)  Series 2004A among Reliant Energy, Inc., the Guarantors listed  therein and The Bank of New York Trust Company, N.A., as trustee, dated as of  September 21, 2006      |   |                                                                                            |   |    |   |   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| 10.19  |   | Second Supplemental  Guarantee Agreement relating to Pennsylvania Economic Development Financing  Authority’s outstanding Exempt Facilities Revenue Bonds (Reliant Energy  Seward, LLC Project) Series 2001A among Reliant Energy, Inc., the  Guarantors listed therein and The Bank of New York Trust Company, N.A., as  trustee, dated as of December 1, 2006 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006 |   | 1-16455 |   | 10.1   |
| 10.20  |   | Second Supplemental  Guarantee Agreement relating to Pennsylvania Economic Development Financing  Authority’s outstanding Exempt Facilities Revenue Bonds (Reliant Energy  Seward, LLC Project) Series 2002A among Reliant Energy, Inc., the  Guarantors listed therein and The Bank of New York Trust Company, N.A., as  trustee, dated as of December 1, 2006 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006 |   | 1-16455 |   | 10.2   |

56

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| 10.21 |   | Second Supplemental Guarantee Agreement relating to  Pennsylvania Economic Development Financing Authority’s outstanding Exempt  Facilities Revenue Bonds (Reliant Energy Seward, LLC Project) Series 2002B  among Reliant Energy, Inc., the Guarantors listed therein and The Bank  of New York Trust Company, N.A., as trustee, dated as of December 1,  2006 |   | Reliant Energy, Inc.’s Current Report on  Form 8-K, filed December 7, 2006                                |   | 1-16455   |   | 10.3 |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|------|
| 10.22 |   | Second Supplemental  Guarantee Agreement relating to Pennsylvania Economic Development Financing  Authority’s outstanding Exempt Facilities Revenue Bonds (Reliant Energy  Seward, LLC Project) Series 2003A among Reliant Energy, Inc., the  Guarantors listed therein and The Bank of New York Trust Company, N.A., as  trustee, dated as of December 1, 2006 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006                               |   | 1-16455   |   | 10.4 |
| 10.23 |   | Third Supplemental  Guarantee Agreement relating to Pennsylvania Economic Development Financing  Authority’s outstanding Exempt Facilities Revenue Bonds (Reliant Energy  Seward, LLC Project) Series 2004A among Reliant Energy, Inc., the  Guarantors listed therein and The Bank of New York Trust Company, N.A., as  trustee, dated as of December 1, 2006  |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed December 7,  2006                               |   | 1-16455   |   | 10.5 |
| 10.24 |   | Facility Lease Agreement  between Conemaugh Lessor Genco LLC and Reliant Energy Mid-Atlantic Power  Holdings, LLC, dated as of August 24, 2000                                                                                                                                                                                                                                 |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.6a |

57

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| 10.25 |   | Schedule identifying substantially identical  agreements to Facility Lease Agreement constituting Exhibit 10.14                                                                                                                                                                                                                                                                                                                                             |   | Reliant Energy Mid-Atlantic Power Holdings, LLC’s  Registration Statement on Form S-4, filed December 8, 2000  |   | 333-51464 |   | 4.6b  |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|-------|
| 10.26 |   | Pass Through Trust  Agreement between Reliant Energy Mid-Atlantic Power Holdings, LLC and Bankers  Trust Company, made with respect to the formation of the Series A Pass  Through Trust and the issuance of 8.554% Series A Pass Through  Certificates, dated as of August 24, 2000                                                                                                                                                              |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.4a  |
| 10.27 |   | Schedule identifying  substantially identical agreements to Pass Through Trust Agreement  constituting Exhibit 10.16                                                                                                                                                                                                                                                                                                                                        |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.4b  |
| 10.28 |   | Participation Agreement  among (i) Conemaugh Lessor Genco LLC, as Owner Lessor; (ii) Reliant  Energy Mid-Atlantic Power Holdings, LLC, as Facility Lessee;  (iii) Wilmington Trust Company, as Lessor Manager; (iv) PSEGR  Conemaugh Generation, LLC, as Owner Participant; (v) Bankers Trust  Company, as Lease Indenture Trustee; and (vi) and Bankers Trust Company,  as Pass Through Trustee, dated as of August 24, 2000 |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.5a  |
| 10.29 |   | Schedule identifying  substantially identical agreements to Participation Agreement constituting  Exhibit 10.18                                                                                                                                                                                                                                                                                                                                             |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.5b  |
| 10.30 |   | First Amendment to  Participation Agreement, dated as of November 15, 2001                                                                                                                                                                                                                                                                                                                                                                                  |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005                  |   | 1-16455   |   | 10.20 |

58

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| 10.31 |   | Schedule identifying substantially identical  agreements to First Amendment to Participation Agreement constituting  Exhibit 10.20                                                                                        |   | Reliant Energy, Inc.’s Annual Report on  Form 10-K for the year ended December 31, 2005                   |   | 1-16455   |   | 10.21 |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|-------|
| 10.32 |   | Second Amendment to  Participation Agreement, dated as of June 18, 2003                                                                                                                                                   |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005                  |   | 1-16455   |   | 10.22 |
| 10.33 |   | Schedule identifying  substantially identical agreements to Second Amendment to Participation  Agreement constituting Exhibit 10.22                                                                                       |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005                  |   | 1-16455   |   | 10.23 |
| 10.34 |   | Lease Indenture of  Trust, Mortgage and Security Agreement between Conemaugh Lessor Genco LLC, as  Owner Lessor, and Bankers Trust Company, as Lease Indenture Trustee, dated as  of August 24, 2000                      |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.8a  |
| 10.35 |   | Schedule identifying  substantially identical agreements to Lease Indenture of Trust constituting  Exhibit 10.24                                                                                                          |   | Reliant Energy  Mid-Atlantic Power Holdings, LLC’s Registration Statement on Form S-4,  filed December 8, 2000 |   | 333-51464 |   | 4.8b  |
| 10.36 |   | Purchase and Sale  Agreement by and between Orion Power Holdings, Inc., Reliant  Energy, Inc., Great Lakes Power Inc. and Brascan Corporation, dated as  of May 18, 2004                                        |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed May 21, 2004                                    |   | 1-16455   |   | 99.2  |
| 10.37 |   | Purchase and Sale  Agreement between Orion Power Holdings, Inc., as Seller, Reliant  Energy, Inc., as Guarantor, and Astoria Generating Company Acquisitions,  L.L.C., as Buyer, dated as of September 30, 2005 |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed October 6,  2005                                |   | 1-16455   |   | 10.1  |

59

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| 10.38  |   | Settlement and Release of Claims Agreement among  each of the Reliant Parties, OMOI, each of the California Parties, each of  the Additional Claimants, each of the Class Action Parties and each of  the Local Governmental Parties (each as defined therein), dated as of  October 12, 2005 |   | Reliant Energy, Inc.’s Current Report on  Form 8-K, filed October 20, 2005                                |   | 1-16455   |   | 10.1        |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|-------------|
| 10.39  |   | Settlement Agreement  between Reliant Energy, Inc. and Seneca Capital, L.P. dated  April 18, 2006                                                                                                                                                                                             |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed April 18,  2006                                 |   | 1-16455   |   | 10.1        |
| *10.40 |   | Executive  Life Insurance Plan, effective as of January 1, 1994, including the  first and second amendments thereto (Reliant Energy, Inc. has  adopted certain obligations under this plan with respect to the following individuals:  James Ajello, Daniel Hannon and Brian  Landrum)        |   | Reliant  Energy, Inc.’s Amendment No. 8 to Registration Statement on  Form S-1, filed April 27, 2001 |   | 333-48038 |   | 10.30       |
| *10.41 |   | Transition Stock Plan,  effective as of May 4, 2001                                                                                                                                                                                                                                                |   | Reliant Energy, Inc.’s  Annual Report on Form 10-K for the year ended December 31, 2001                   |   | 1-16455   |   | 10.37       |
| *10.42 |   | 2002 Stock Plan,  effective as of March 1,  2002                                                                                                                                                                                                                                                   |   | Reliant  Energy, Inc.’s Registration Statement on Form S-8, filed  April 19, 2002                         |   | 333-86610 |   | 4.5         |
| *10.43 |   | Annual Incentive  Compensation Plan, effective as of January 1, 2001                                                                                                                                                                                                                               |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2001                  |   | 1-16455   |   | 10.9        |
| *10.44 |   | 2002 Annual Incentive  Compensation Plan for Executive Officers, effective as of March 1, 2002                                                                                                                                                                                                     |   | Reliant  Energy, Inc.’s 2002 Proxy Statement on Schedule 14A                                                   |   | 1-16455   |   | Appendix  I |
| *10.45 |   | Long Term Incentive  Plan, effective as of January 1, 2001                                                                                                                                                                                                                                         |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2001                  |   | 1-16455   |   | 10.10       |
| *10.46 |   | 2002 Long-Term Incentive  Plan, effective as of June 6,  2002                                                                                                                                                                                                                                      |   | Reliant  Energy, Inc.’s Registration  Statement on Form S-8, filed April 19, 2002                         |   | 333-86612 |   | 4.5         |

60

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| *10.47 |   | Deferral Plan, effective as of January 1, 2002                                                                                                                                                   |   | Reliant Energy, Inc.’s Registration Statement on Form S-8,  filed December 7, 2001                         |   | 333-74790 |   | 4.1   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|-------|
| *10.48 |   | First Amendment to  Deferral Plan, effective as  of January 14, 2003                                                                                                                             |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2003                   |   | 1-16455   |   | 10.5  |
| *10.49 |   | Successor Deferral Plan,  effective as of January 1, 2002                                                                                                                                        |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004                   |   | 1-16455   |   | 10.30 |
| *10.50 |   | Deferred Compensation  Plan, effective as of September 1, 1985, including the first nine  amendments thereto (This is now a part of the plan listed as  Exhibit 10.38)                      |   | Reliant  Energy, Inc.’s Amendment No. 8 to Registration Statement on  Form S-1, filed April 27, 2001  |   | 333-48038 |   | 10.25 |
| *10.51 |   | Deferred Compensation  Plan, as amended and restated effective as of January 1, 1989, including  the first nine amendments (This is now a part of the plan listed as  Exhibit 10.38)        |   | Reliant  Energy, Inc.’s Amendment No. 8 to Registration Statement on  Form S-1, filed April 27, 2001  |   | 333-48038 |   | 10.26 |
| *10.52 |   | Deferred Compensation  Plan, as amended and restated effective as of January 1, 1991, including  the first ten amendments thereto (This is now a part of the plan listed as  Exhibit 10.38) |   | Reliant  Energy, Inc.’s Amendment No. 8 to Registration Statement on Form S-1,  filed April 27, 2001  |   | 333-48038 |   | 10.27 |
| *10.53 |   | Benefit Restoration  Plan, as amended and restated effective as of July 1, 1991, including  the first amendment thereto (This is now a part of the plan listed as  Exhibit 10.38)           |   | Reliant  Energy, Inc.’s Amendment  No. 8 to Registration Statement on Form S-1, filed  April 27, 2001 |   | 333-48038 |   | 10.12 |
| *10.54 |   | Key Employee Award  Program 2004-2006 of the 2002 Long-Term Incentive Plan and the  Form of Agreement for Key Employee Award Program, effective as of February 13,  2004                    |   | Reliant  Energy, Inc.’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2004                 |   | 1-16455   |   | 10.1  |

61

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| *10.55 |   | First Amendment to the Key Employee Award Program,  effective as of August 10, 2005                                                                             |   | Reliant Energy, Inc.’s Annual Report on Form 10-K  for the year ended December 31, 2005  |   | 1-16455 |   | 10.44 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|--------|---------|--------|-------|
| *10.56 |   | Form of 2002 Stock  Plan Nonqualified Stock Option Award Agreement, 2003 Grants                                                                                 |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004 |   | 1-16455 |   | 10.39 |
| *10.57 |   | Change in Control  Agreement between Reliant Energy, Inc., Reliant Energy Corporate  Services, LLC and Joel V. Staff, effective as of January 15, 2006     |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.47 |
| *10.58 |   | Severance Agreement  between Reliant Resources, Inc. and Mark M. Jacobs, effective as of  August 1, 2005                                              |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.48 |
| *10.59 |   | Change in Control  Agreement between Reliant Energy, Inc., Reliant Energy Corporate  Services, LLC and Mark M. Jacobs, effective as of March 13, 2006 |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.49 |
| *10.60 |   | Change in Control  Agreement between Reliant Energy, Inc., Reliant Energy Corporate  Services, LLC and Michael L. Jines, effective as of January 15, 2006  |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.50 |
| *10.61 |   | Change in Control  Agreement between Reliant Energy, Inc., Reliant Energy Corporate  Services, LLC and Brian Landrum, effective as of January 15, 2006     |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.51 |
| *10.62 |   | Change in Control  Agreement between Reliant Energy, Inc., Reliant Energy Corporate  Services, LLC and Jerry J. Langdon, effective as of January 15, 2006  |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005 |   | 1-16455 |   | 10.52 |
| *10.63 |   | Severance Agreement  between Reliant Resources, Inc. and James B. Robb, effective as of  January 14, 2003                                                  |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2003 |   | 1-16455 |   | 10.4  |

62

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| *10.64 |   | Amendment to Severance Agreement between Reliant  Resources, Inc. and James B. Robb, effective as of November 29,  2005  |   | Reliant Energy, Inc.’s Annual Report on  Form 10-K for the year ended December 31, 2005    |   | 1-16455 |   | 10.54 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------|--------|---------|--------|-------|
| *10.65 |   | Severance Agreement  between Reliant Resources, Inc. and Robert W. Harvey, effective as of  May 30, 2003                 |   | Reliant  Energy, Inc.’s Quarterly Report on Form 10-Q for the quarter  ended June 30, 2003 |   | 1-16455 |   | 10.1  |
| *10.66 |   | Amendment to Severance  Agreement between Reliant Energy, Inc. and Robert W. Harvey, effective  as of February 21, 2005  |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004   |   | 1-16455 |   | 10.43 |
| *10.67 |   | Reliant  Energy, Inc. Executive Severance Plan, effective as of January 1,  2006                                         |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2005   |   | 1-16455 |   | 10.57 |
| *10.68 |   | Form of 2002  Long-Term Incentive Plan Nonqualified Stock Option Award Agreement for Directors                                |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004   |   | 1-16455 |   | 10.53 |
| *10.69 |   | Form of 2002  Long-Term Incentive Plan Restricted Stock Award Agreement for Directors                                         |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004   |   | 1-16455 |   | 10.54 |
| *10.70 |   | Form of 2002  Long-Term Incentive Plan Quarterly Restricted and Premium Restricted Stock  Units Award Agreement for Directors |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004   |   | 1-16455 |   | 10.55 |
| *10.71 |   | Form of 2002  Long-Term Incentive Plan Quarterly Common Stock and Premium Restricted Stock  Award Agreement for Directors     |   | Reliant  Energy, Inc.’s Annual Report on Form 10-K for the year ended  December 31, 2004   |   | 1-16455 |   | 10.56 |
| 10.72  |   | Form of 2002  Long-Term Incentive Plan Restricted Stock Award Agreement for Directors                                         |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed May 25, 2006                     |   | 1-16455 |   | 10.1  |
| 10.73  |   | Form of Long-Term  Incentive Plan Restricted Stock Award Agreement for Directors’ initial grant                          |   | Reliant  Energy, Inc.’s Current Report on Form 8-K, filed August 24, 2006                  |   | 1-16455 |   | 10.1  |

63

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| *10.74  |   | Reliant Energy, Inc. Non-Employee Directors’  Compensation Program, effective as of January 1, 2006                                                                                                                               |   | Reliant Energy, Inc.’s Annual Report on  Form 10-K for the year ended December 31, 2005 |   | 1-16455 |   | 10.63  |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| +*10.75 |   | Annual Base Salaries of Named  Executive Officers                                                                                                                                                                                                |   |                                                                                                        |   |    |   |   |
| +12.1   |   | Reliant  Energy, Inc. and Subsidiaries Ratio of Earnings from Continuing  Operations to Fixed Charges                                                                                                                                       |   |                                                                                                        |   |    |   |   |
| +21.1   |   | Subsidiaries of Reliant  Energy, Inc.                                                                                                                                                                                                       |   |                                                                                                        |   |    |   |   |
| +23.1   |   | Consent of KPMG LLP,  independent registered public accounting firm of Reliant Energy, Inc.                                                                                                                                                 |   |                                                                                                        |   |    |   |   |
| +23.2   |   | Consent of  Deloitte & Touche LLP, former independent registered public  accounting firm of Reliant Energy, Inc.                                                                                                                   |   |                                                                                                        |   |    |   |   |
| +31.1   |   | Certification of the  Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                    |   |                                                                                                        |   |    |   |   |
| +31.2   |   | Certification of the  Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                    |   |                                                                                                        |   |    |   |   |
| +32.1   |   | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of  Section 1350, Chapter 63 of Title 18, United States Code) |   |                                                                                                        |   |    |   |   |

 

64

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                        | RELIANT  ENERGY, INC. |
|------------------------|----------------------------|
|                   | (Registrant)               |
| February 27, 2007 | By:                        | /s/ JOEL V.  STAFF |
|                   |                       | Joel V. Staff |
|                   |                       | **Chairman and Chief Executive Officer** |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities indicatedas of February 27, 2007.
|                           | **Signature** | ** **                                                | ** ** | ** ** | **Title** | ** ** |
|---------------------------|---------------|-----------------------------------------------------------|------------|------------|-----------|------------|
| /s/ JOEL V.  STAFF        | ** **    | **Chairman  and Chief Executive Officer**                 |
| **Joel V. Staff**         | ** **    | **(Principal Executive Officer)**                         |
| /s/ MARK M.  JACOBS       | ** **    | **Executive  Vice President and Chief Financial Officer** |
| **Mark M. Jacobs**        |          | **(Principal Financial Officer)**                         |
| /s/ THOMAS C.  LIVENGOOD  | ** **    | **Senior  Vice President and Controller**                 |
| **Thomas C. Livengood**   |          | **(Principal Accounting Officer)**                        |
| /s/ E. WILLIAM  BARNETT   | ** **    | **Director**                                              |
| **E. William Barnett**    |          | ** **                                                |
| /s/ SARAH M.  BARPOULIS   | ** **    | **Director**                                              |
| **Sarah M. Barpoulis**    | ** **    | ** **                                                |
| /s/ DONALD J.  BREEDING   | ** **    | **Director**                                              |
| **Donald J. Breeding**    | ** **    | ** **                                                |
| /s/ KIRBYJON  H. CALDWELL | ** **    | **Director**                                              |
| **Kirbyjon H. Caldwell**  | ** **    |                                                      |

 

65

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| /s/ STEVEN L. MILLER         | ** ** | **Director** |
|------------------------------|------------|--------------|
| **Steven  L. Miller**        | ** ** | ** **   |
| /s/  LAREE E. PEREZ          | ** ** | **Director** |
| **Laree  E. Perez**          | ** ** | ** **   |
| /s/ EVAN J. SILVERSTEIN | ** ** | **Director** |
| **Evan  J. Silverstein**     | ** ** | ** **   |
| /s/  WILLIAM L. TRANSIER     | ** ** | **Director** |
| **William  L. Transier**     | ** ** |         |

 

66

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**RELIANT ENERGY,INC.’S REPORT ON INTERNALCONTROL OVER FINANCIAL REPORTING**

The management of Reliant Energy, Inc. and itssubsidiaries (the Company) is responsible for establishing and maintainingadequate internal control over financial reporting. The Company’s internalcontrol system was designed to provide reasonable assurance to our managementand Board of Directors regarding the preparation and fair presentation ofpublished financial statements.

All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation.

Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2006. Inmaking this assessment, our management used the criteria set forth in Internal**Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission. Based on our assessment webelieve that, as of December 31, 2006, our internal control over financialreporting is effective based on those criteria.

Ourindependent auditors have issued an audit report on our assessment of ourinternal control over financial reporting. This report appears on page F-2.
| /s/ JOEL V. STAFF                        |   | /s/ MARK M. JACOBS                                       |
|------------------------------------------|--------|----------------------------------------------------------|
| Joel V. Staff                            |   | Mark M. Jacobs                                           |
| *Chairman  and  Chief Executive Officer* |   | *Executive  Vice President and  Chief Financial Officer* |

 

F-1

----

**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and StockholdersReliant Energy, Inc.:

We have audited management’sassessment, included in the accompanying Reliant Energy, Inc.’s Report onInternal Control Over Financial Reporting on page F-1, that ReliantEnergy, Inc. and subsidiaries (the Company) maintained effective internalcontrol over financial reporting as of December 31, 2006, based oncriteria established in *Internal Control**—**IntegratedFramework*issued by the Committee of Sponsoring Organizations of the TreadwayCommission. The Company’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that the Company maintained effective internal control overfinancial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on criteria established in *Internal Control**—**IntegratedFramework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Also,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2006, basedon criteria established in *Internal Control**—**IntegratedFramework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission.

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of ReliantEnergy, Inc. and subsidiaries as of December 31, 2006, and therelated consolidated statements of operations, stockholders’ equity andcomprehensive income (loss), and cash flows for the year then ended, and ourreport dated February 26, 2007 expressed an unqualified opinion on thoseconsolidated financial statements.
| KPMG LLP                |
|-------------------------|
| Houston, Texas          |
| February 26,  2007 |

 

F-2

----

**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and StockholdersReliant Energy, Inc.:

We have audited theaccompanying consolidated balance sheet of Reliant Energy, Inc. andsubsidiaries (the Company), as of December 31, 2006, and the relatedconsolidated statements of operations, stockholders’ equity and comprehensiveincome (loss), and cash flows for the year then ended. In connection with ouraudit of the consolidated financial statements, we also have audited financialstatement schedule II—Valuation and Qualifying Accounts for 2006. Theseconsolidated financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements and financial statementschedule based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Reliant Energy, Inc. andsubsidiaries as of December 31, 2006, and the results of their operationsand their cash flows for the year then ended, in conformity with U.S. generallyaccepted accounting principles. Also in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the 2006 information set forth therein.

As discussed innotes 10(a) and 10(b) to the consolidated financial statements,in 2006, the Company changed its accounting for share-based paymenttransactions and defined benefit pension and other postretirement plans,respectively.

We also have audited theadjustments to the financial information in note 16 to the 2005 and 2004consolidated financial statements to retrospectively reflect the change insubsidiary guarantors of the Company’s senior secured notes as described inthat note. In our opinion, such adjustments are appropriate and have beenproperly applied. We were not engaged to audit, review, or apply any proceduresto the 2005 and 2004 consolidated financial statements of the Company otherthan with respect to the adjustments and, accordingly we do not express anopinion or any other form of assurance on the 2005 and 2004 consolidatedfinancial statements taken as a whole.

Wealso have audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2006, based oncriteria established in *Internal Control**—**Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission, and our report dated February 26,2007 expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.
| KPMG LLP                |
|-------------------------|
| Houston, Texas          |
| February 26,  2007 |

 

F-3

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofReliant Energy, Inc. and SubsidiariesHouston, Texas

We have audited, before the effects of the adjustmentsto retrospectively account for the change in subsidiary guarantors as describedin note 16, the accompanying consolidated balance sheet of Reliant Energy, Inc.and subsidiaries (the “Company”), as of December 31, 2005, and the relatedconsolidated statements of operations, stockholders’ equity and comprehensiveincome (loss), and cash flows for each of the two years in the period ended December 31,2005 (the 2005 and 2004 consolidated financial statements before the effects ofthe adjustments discussed in note 16 are not presented herein). Our auditsalso included the financial statement schedule (Schedule II—Valuation AndQualifying Accounts) listed in the Index at Item 15(a)(2) for the twoyears in the period ended December 31, 2005. These financialstatements and financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thefinancial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financialstatements, before the effects of the adjustments to retrospectively accountfor the change in subsidiary guarantors as described in note 16, present fairly,in all material respects, the financial position of Reliant Energy, Inc.and subsidiaries at December 31, 2005, and the results of their operationsand their cash flows for each of the two years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, such financial statement schedule,when considered in relation to the basic consolidated financial statementstaken as a whole, presents fairly in all material respects the information setforth therein.

We were not engaged to audit, review, or apply anyprocedures to the adjustments to retrospectively account for the change insubsidiary guarantors as described in note 16 to the consolidatedfinancial statements and, accordingly, we do not express an opinion or anyother form of assurance about whether such adjustments are appropriate and havebeen properly applied. Those adjustments were audited by other auditors.

Asdiscussed in note 2 to the consolidated financial statements, the Companychanged its accounting for major maintenance to the “expense as incurred”method in 2004.
| DELOITTE & TOUCHE  LLP |
|---------------------------------|
| Houston, Texas                  |
| March 14,  2006            |

 

F-4

----

**RELIANTENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**(Thousands of Dollars,except per share amounts)

| ** **                                                                                                           | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|-----------|------------|
| **Revenues:**                                                                                                        |       |       |       |       |       |      |       |
| Revenues (including $191,405, $(218,081) and  $(32,007) unrealized gains (losses))                                   |       | $          | 10,877,385 |       | $          | 9,711,995 |       | $ | 8,098,222 |   |
| **Expenses:**                                                                                                        |       |       |       |       |       |      |       |
| Purchased power, fuel and cost of gas sold  (including $(422,325), $25,846 and $(192,395) unrealized gains (losses)) |       | 9,435,892  |       | 8,365,921  |       | 6,564,137 |       |
| Operation and maintenance                                                                                            |       | 833,094    |       | 736,954    |       | 782,462   |       |
| Selling, general and administrative                                                                                  |       | 383,977    |       | 292,486    |       | 326,171   |       |
| Western states and Cornerstone settlements                                                                           |       | 35,000     |       | 359,436    |       | —    |       |
| Loss on sales of receivables                                                                                         |       | —     |       | —     |       | 33,741    |       |
| Accrual for payment to CenterPoint Energy, Inc.                                                                 |       | —     |       | —     |       | 1,600     |       |
| Gain on sale of counterparty claim                                                                                   |       | —     |       | —     |       | (30,000   | )          |
| Gains on sales of assets and emission allowances,  net                                                               |       | (159,386   | )          | (168,114   | )          | (19,834   | )          |
| Depreciation and amortization                                                                                        |       | 372,616    |       | 445,871    |       | 453,042   |       |
| Total operating expense                                                                                              |       | 10,901,193 |       | 10,032,554 |       | 8,111,319 |       |
| **Operating  Loss**                                                                                                  |       | (23,808    | )          | (320,559   | )          | (13,097   | )          |
| **Other Income (Expense):**                                                                                          |       |       |       |       |       |      |       |
| Income (loss) of equity investments, net                                                                             |       | 5,791      |       | 25,458     |       | (9,478    | )          |
| Debt conversion expense                                                                                              |       | (37,257    | )          | —     |       | —    |       |
| Other, net                                                                                                           |       | 203        |       | (22,672    | )          | 13,455    |       |
| Interest expense                                                                                                     |       | (427,867   | )          | (399,281   | )          | (417,514  | )          |
| Interest income                                                                                                      |       | 34,317     |       | 23,227     |       | 34,960    |       |
| Total other expense                                                                                                  |       | (424,813   | )          | (373,268   | )          | (378,577  | )          |
| **Loss  from Continuing Operations Before Income Taxes**                                                             |       | (448,621   | )          | (693,827   | )          | (391,674  | )          |
| Income tax benefit                                                                                                   |       | (121,929   | )          | (253,080   | )          | (115,214  | )          |
| **Loss  from Continuing Operations**                                                                                 |       | (326,692   | )          | (440,747   | )          | (276,460  | )          |
| Income (loss) from discontinued operations                                                                           |       | (2,088     | )          | 110,799    |       | 239,800   |       |
| **Loss  Before Cumulative Effect of Accounting Changes**                                                             |       | (328,780   | )          | (329,948   | )          | (36,660   | )          |
| Cumulative effect of accounting changes, net of tax                                                                  |       | 968        |       | (608       | )          | 7,290     |       |
| **Net  Loss**                                                                                                        |       | $          | (327,812   | )          | $          | (330,556  | )          | $ | (29,370 | ) |
| **Basic  and Diluted Earnings (Loss) per Share:**                                                                    |       |       |       |       |       |      |       |
| Loss from continuing operations                                                                                      |       | $          | (1.06      | )          | $          | (1.46     | )          | $ | (0.93 | ) |
| Income (loss) from discontinued operations                                                                           |       | (0.01      | )          | 0.37       |       | 0.81      |       |
| Loss before cumulative effect of accounting changes                                                                  |       | (1.07      | )          | (1.09      | )          | (0.12     | )          |
| Cumulative effect of accounting changes, net of tax                                                                  |       | —     |       | —     |       | 0.02      |       |
| Net loss                                                                                                             |       | $          | (1.07      | )          | $          | (1.09     | )          | $ | (0.10 | ) |

 

See Notes to our Consolidated Financial Statements

F-5

----

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Thousands of Dollars, except per share amounts)**

| ** **                                                                                                            | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                            | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                            |       |                  |       |   |   |
| **Current Assets:**                                                                                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                                                                            |       | $                     | 463,909    |   | $ | 88,397 |   |
| Restricted cash                                                                                                       |       | 24,980                |       | 26,906 |   |
| Accounts and notes  receivable, principally customer, net of allowance of $33,332 and $34,054                         |       | 1,043,637             |       | 1,171,673 |   |
| Inventory                                                                                                             |       | 275,437               |       | 299,099 |   |
| Derivative assets                                                                                                     |       | 489,726               |       | 725,964 |   |
| Margin deposits                                                                                                       |       | 452,605               |       | 1,716,035 |   |
| Accumulated deferred  income taxes                                                                                    |       | 279,479               |       | 361,547 |   |
| Prepayments and  other current assets                                                                                 |       | 141,016               |       | 137,498 |   |
| Current assets of  discontinued operations                                                                            |       | 2,460                 |       | 203,332 |   |
| Total current  assets                                                                                                 |       | 3,173,249             |       | 4,730,451 |   |
| **Property,  Plant and Equipment, net**                                                                               |       | 5,741,995             |       | 5,934,060 |   |
| **Other Assets:**                                                                                                     | ** ** | ** **            | ** ** | ** ** | ** ** |
| Goodwill                                                                                                              |       | 381,594               |       | 386,594 |   |
| Other intangibles,  net                                                                                               |       | 423,745               |       | 510,582 |   |
| Derivative assets                                                                                                     |       | 203,857               |       | 527,799 |   |
| Accumulated  deferred income taxes                                                                                    |       | 87,858                |       | 32,527 |   |
| Prepaid lease                                                                                                         |       | 264,328               |       | 259,412 |   |
| Other                                                                                                                 |       | 290,507               |       | 306,585 |   |
| Long-term assets  of discontinued operations                                                                          |       | —                |       | 880,796 |   |
| Total other assets                                                                                                    |       | 1,651,889             |       | 2,904,295 |   |
| **Total  Assets**                                                                                                     |       | $                     | 10,567,133 |   | $ | 13,568,806 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                        |       |                  |       |   |   |
| **Current Liabilities:**                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current portion of  long-term debt and short-term borrowings                                                          |       | $                     | 355,264    |   | $ | 789,325 |   |
| Accounts payable,  principally trade                                                                                  |       | 664,630               |       | 886,965 |   |
| Derivative  liabilities                                                                                               |       | 1,164,809             |       | 1,219,954 |   |
| Margin deposits                                                                                                       |       | 16,490                |       | 15,588 |   |
| Other                                                                                                                 |       | 488,764               |       | 397,942 |   |
| Current liabilities  of discontinued operations                                                                       |       | 3,286                 |       | 96,456 |   |
| Total current  liabilities                                                                                            |       | 2,693,243             |       | 3,406,230 |   |
| **Other Liabilities:**                                                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| Derivative  liabilities                                                                                               |       | 420,534               |       | 812,695 |   |
| Other                                                                                                                 |       | 324,145               |       | 389,083 |   |
| Long-term  liabilities of discontinued operations                                                                     |       | —                |       | 779,678 |   |
| Total other  liabilities                                                                                              |       | 744,679               |       | 1,981,456 |   |
| **Long-term  Debt**                                                                                                   |       | 3,177,691             |       | 4,317,427 |   |
| **Commitments  and Contingencies**                                                                                    |       |                  |       |   |   |
| **Temporary  Equity Stock-based Compensation**                                                                        |       | 1,647                 |       | — |   |
| **Stockholders’ Equity:**                                                                                        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Preferred stock;  par value $0.001 per share (125,000,000 shares authorized; none outstanding)                        |       | —                |       | — |   |
| Common stock; par  value $0.001 per share (2,000,000,000 shares authorized; 337,623,392 and  304,900,193 issued) |       | 99                    |       | 66 |   |
| Additional paid-in  capital                                                                                           |       | 6,174,665             |       | 5,846,747 |   |
| Retained deficit                                                                                                      |       | (2,026,316            | )          | (1,698,504 | ) |
| Accumulated other  comprehensive loss                                                                                 |       | (198,575              | )          | (284,281 | ) |
| Accumulated other  comprehensive loss of discontinued operations                                                      |       | —                |       | (335 | ) |
| Total  stockholders’ equity                                                                                      |       | 3,949,873             |       | 3,863,693 |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                  |       | $                     | 10,567,133 |   | $ | 13,568,806 |   |

 

See Notes to our Consolidated Financial Statements

F-6

----

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Thousands of Dollars)**

| ** **                                                                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash Flows from Operating  Activities:**                                                 |       |       |       |       |       |       |       |
| Net loss                                                                                   |       | $          | (327,812   | )          | $          | (330,556   | )          | $ | (29,370 | ) |
| (Income) loss from discontinued operations                                                 |       | 2,088      |       | (110,799   | )          | (239,800   | )          |
| Net loss from continuing operations and cumulative  effect of accounting changes           |       | (325,724   | )          | (441,355   | )          | (269,170   | )          |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities: |       |       |       |       |       |       |       |
| Cumulative effect of accounting changes                                                    |       | (968       | )          | 608        |       | (7,290     | )          |
| Depreciation and amortization                                                              |       | 372,616    |       | 445,871    |       | 453,042    |       |
| Deferred income taxes                                                                      |       | (152,431   | )          | (278,992   | )          | (108,688   | )          |
| Net changes in energy derivatives                                                          |       | 316,742    |       | 192,235    |       | 224,402    |       |
| Amortization of deferred financing costs                                                   |       | 31,508     |       | 15,110     |       | 77,881     |       |
| Debt conversion expense                                                                    |       | 37,257     |       | —     |       | —     |       |
| Gains on sales of assets and emission allowances, net                                      |       | (159,386   | )          | (168,114   | )          | (19,834    | )          |
| Western states and Cornerstone settlements                                                 |       | 35,000     |       | 359,436    |       | —     |       |
| (Income) loss of equity investments, net                                                   |       | (5,791     | )          | (25,458    | )          | 9,478      |       |
| Accrual for payment to CenterPoint Energy, Inc.                                       |       | —     |       | —     |       | 1,600      |       |
| Other, net                                                                                 |       | 12,590     |       | 27,498     |       | (7,058     | )          |
| Changes  in other assets and liabilities:                                                  |       |       |       |       |       |       |       |
| Accounts and notes receivable, net                                                         |       | 129,161    |       | (109,736   | )          | (59,723    | )          |
| Receivables facility proceeds, net                                                         |       | —     |       | —     |       | 232,000    |       |
| Inventory                                                                                  |       | 18,157     |       | (42,253    | )          | (14,744    | )          |
| Margin deposits, net                                                                       |       | 1,264,332  |       | (1,213,940 | )          | (450,851   | )          |
| Net derivative assets and liabilities                                                      |       | (30,313    | )          | 10,978     |       | 12,547     |       |
| Western states and Cornerstone settlement payments                                         |       | (159,885   | )          | —     |       | —     |       |
| Accounts payable                                                                           |       | (97,117    | )          | 144,466    |       | 59,233     |       |
| Payment to CenterPoint Energy, Inc.                                                   |       | —     |       | —     |       | (176,600   | )          |
| Other current assets                                                                       |       | 17,284     |       | 33,071     |       | (37,399    | )          |
| Other assets                                                                               |       | (35,373    | )          | (32,605    | )          | (5,562     | )          |
| Taxes payable/receivable                                                                   |       | 1,302      |       | 3,053      |       | 47,652     |       |
| Other current liabilities                                                                  |       | 64,046     |       | (34,479    | )          | 1,815      |       |
| Other liabilities                                                                          |       | (2,963     | )          | 4,495      |       | 42,617     |       |
| Net cash provided by (used in) continuing operations  from operating activities            |       | 1,330,044  |       | (1,110,111 | )          | 5,348      |       |
| Net cash provided by (used in) discontinued  operations from operating activities          |       | (54,171    | )          | 192,948    |       | 100,165    |       |
| Net cash provided by (used in) operating activities                                        |       | 1,275,873  |       | (917,163   | )          | 105,513    |       |
| **Cash Flows from Investing  Activities:**                                                 |       |       |       |       |       |       |       |
| Capital expenditures                                                                       |       | (96,793    | )          | (82,296    | )          | (159,671   | )          |
| Proceeds from sales of assets, net                                                         |       | 1,417      |       | 149,345    |       | 11,325     |       |
| Proceeds from sales of emission allowances                                                 |       | 205,510    |       | 234,421    |       | 59,662     |       |
| Purchases of emission allowances                                                           |       | (22,575    | )          | (145,769   | )          | (124,241   | )          |
| Restricted cash                                                                            |       | 1,926      |       | 14,251     |       | 178,885    |       |
| Other                                                                                      |       | —     |       | 5,500      |       | 16,207     |       |
| Net cash provided by (used in) continuing operations  from investing activities            |       | 89,485     |       | 175,452    |       | (17,833    | )          |
| Net cash provided by discontinued operations from  investing activities                    |       | 967,566    |       | 130,700    |       | 919,043    |       |
| Net cash provided by investing activities                                                  |       | 1,057,051  |       | 306,152    |       | 901,210    |       |
| **Cash Flows from Financing  Activities:**                                                 |       |       |       |       |       |       |       |
| Proceeds from long-term debt                                                               |       | 400,000    |       | 299,000    |       | 1,512,000  |       |
| Payments of long-term debt                                                                 |       | (865,870   | )          | (148,333   | )          | (1,597,568 | )          |
| Increase (decrease) in short-term borrowings and  revolving credit facilities, net         |       | (825,554   | )          | 407,000    |       | (108,350   | )          |
| Premium paid for conversion of senior subordinated  notes                                  |       | (36,157    | )          | —     |       | —     |       |
| Payments of financing costs                                                                |       | (16,673    | )          | (1,198     | )          | (71,884    | )          |
| Proceeds from issuances of stock                                                           |       | 24,842     |       | 37,885     |       | 24,618     |       |
| Other, net                                                                                 |       | —     |       | —     |       | 9,156      |       |
| Net cash provided by (used in) continuing operations  from financing activities            |       | (1,319,412 | )          | 594,354    |       | (232,028   | )          |
| Net cash used in discontinued operations from  financing activities                        |       | (638,000   | )          | —     |       | (815,885   | )          |
| Net cash provided by (used in) financing activities                                        |       | (1,957,412 | )          | 594,354    |       | (1,047,913 | )          |
| **Net Change in Cash and Cash Equivalents**                                                |       | 375,512    |       | (16,657    | )          | (41,190    | )          |
| **Cash and Cash Equivalents at Beginning of Period**                                       |       | 88,397     |       | 105,054    |       | 146,244    |       |
| **Cash and Cash Equivalents at End of Period**                                             |       | $          | 463,909    |       | $          | 88,397     |       | $ | 105,054 |   |
| **Supplemental Disclosure of Cash  Flow Information:**                                     |       |       |       |       |       |       |       |
| Cash  Payments:                                                                            |       |       |       |       |       |       |       |
| Interest paid (net of amounts capitalized) for  continuing operations                      |       | $          | 385,055    |       | $          | 347,249    |       | $ | 326,366 |   |
| Income taxes paid  (net of income tax refunds received) for continuing operations          |       | $          | 28,649     |       | $          | 21,812     |       | $ | (61,808 | ) |

 

See Notes to our Consolidated Financial Statements

F-7

----

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Thousands of Dollars)**

| ** **                                                                                                                   | ** ** | **Common  Stock** | ** ** | **Additional  Paid  In Capital** | ** ** | **Treasury  Stock** | ** ** | **Retained  Deficit** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|---------------------------------------|------------|---------------------|------------|-----------------------|------------|
| **Balance December 31, 2003**                                                                                           |       |              | $          | 61                                    |       |                |       | $                     | 5,841,438  |   |   |   | $ | (89,769 | ) |   | $ | (1,338,578 | ) |
| Net loss                                                                                                                     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   | (29,370 | ) |
| Distribution to CenterPoint Energy, Inc.                                                                                |       |              |       |                                  |       |                | (509       | )                     |       |   |   |   |   |   |   |
| Warrants                                                                                                                     |       |              |       |                                  |       |                | 57         |                  |       |   |   |   |   |   |   |
| Transactions under stock plans                                                                                               |       |              |       |                                  |       |                | (50,979    | )                     |       |   | 87,560 |   |   |   |   |
| Other comprehensive income (loss):                                                                                           |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Foreign currency translation adjustments, net of tax  of $0                                                                  |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Changes in minimum pension liability, net of tax of  $1 million                                                              |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Deferred gain (loss) from cash flow hedges, net of  tax of $24 million and $1 million                                        |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges into net loss, net of tax of $35 million and $11 million |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Unrealized loss on available-for-sale securities, net  of tax of $0                                                          |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Reclassification adjustments for gains on sales of  available-for-sale securities realized in net loss, net of tax of $0     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Other comprehensive income from discontinued  operations                                                                     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Comprehensive loss                                                                                                           |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| **Balance  December 31, 2004**                                                                                          |       |              | $          | 61                                    |       |                |       | $                     | 5,790,007  |   |   |   | $ | (2,209 | ) |   | $ | (1,367,948 | ) |

 

F-8

----

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** ** | ** ** | **Accumulated Other Comprehensive Income (Loss)**  | ** ** | ** **                                | ** ** | ** **                                      | ** ** | ** **                       | ** ** |
|------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------|------------|
| ** ** | ** ** | **Unrealized  Gain (Loss)  on  Available  For  Sale  Securities** | ** ** | **Deferred  Derivative  Gains  (Losses)** | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Actuarial  Net  Gain  (Loss)** | ** ** | **Net  Prior  Service  Costs** | ** ** | **Additional  Minimum  Benefits  Liability** | ** ** | **Total  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Discontinued  Operations  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** | **Comprehensive  Income (Loss)** | ** ** |
|            |            |                                                                        |            |                                           |            |                                                 |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

| **Balance December 31, 2003**                                                                                                                |   |   | $      | 2      |   |   |    | $      | (18,300 | )      |   |   | $      | (981   | )      |   |   | $      | — |   |   |   | $      | — |   |   |    | $      | (1,277 | )      |   |   | $      | (20,556 | )       |   |   | $      | (20,797 | )       |   |   | $ | 4,371,799 |   |   |   |   |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|---------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|---------|---------|--------|--------|--------|---------|---------|--------|--------|---|-----------|--------|--------|--------|--------|--------|--------|
| Net loss                                                                                                                                          |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    | (29,370 | )      |   |   | $       | (29,370 | )      |   |
| Distribution to CenterPoint Energy, Inc.                                                                                                     |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    | (509    | )      |   |   |    |    |   |
| Warrants                                                                                                                                          |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    | 57      |   |   |   |    |    |   |
| Transactions under stock plans                                                                                                                    |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    | 36,581  |   |   |   |    |    |   |
| Other  comprehensive income (loss):                                                                                                          |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    |    |   |   |   |    |    |   |
| Foreign currency translation adjustments, net  of tax of $0                                                                                  |   |   |   |   |   |   |    |   |    |   | 981    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 981     |   |   |   |   |   |   |    | 981     |   |   |   | 981     |    |   |
| Changes in minimum pension liability, net of tax  of $1 million                                                                         |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,129  |   |   |   | 1,129   |   |   |   |   |   |   |    | 1,129   |   |   |   | 1,129   |    |   |
| Deferred gain (loss) from cash flow hedges,  net of tax of $24 million and $1 million                                         |   |   |   |   |   |   | 42,387  |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 42,387  |   |   |   | 813    |   |   |    | 43,200  |   |   |   | 42,387  |    |   |
| Reclassification of net deferred (gain) loss  from cash flow hedges into net loss, net of tax of $35 million  and $11 million |   |   |   |   |   |   | (53,298 | )      |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (53,298 | )      |   |   | 15,778 |   |   |    | (37,520 | )      |   |   | (53,298 | )       |   |
| Unrealized loss on available-for-sale securities, net  of tax of $0                                                                          |   |   | (8     | )      |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (8      | )      |   |   |   |   |   |    | (8      | )      |   |   | (8      | )       |   |
| Reclassification adjustments for gains on sales  of available-for-sale securities realized in net loss,  net of tax of $0     |   |   | 14     |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 14      |   |   |   |   |   |   |    | 14      |   |   |   | 14      |    |   |
| Other comprehensive income from discontinued  operations                                                                                          |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    |    |   |   |   | 16,591  |    |   |
| Comprehensive loss                                                                                                                                |   |   |   |   |   |   |    |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |    |    |   |   |   | $       | (21,574 | )      |   |
| **Balance  December 31, 2004**                                                                                                               |   |   | $      | 8      |   |   |    | $      | (29,211 | )      |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |    | $      | (148   | )      |   |   | $      | (29,351 | )       |   |   | $      | (4,206  | )       |   |   | $ | 4,386,354 |   |   |   |   |   |   |

 

F-9

----

** **

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** **                                                                                                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid  In Capital** | ** ** | **Treasury  Stock** | ** ** | **Retained  Deficit** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|---------------------------------------|------------|---------------------|------------|-----------------------|------------|
| **Balance December 31, 2004**                                                                                         |       |              | $          | 61                                    |       |                |       | $                     | 5,790,007  |   |   |   | $ | (2,209 | ) |   | $ | (1,367,948 | ) |
| Net loss                                                                                                                   |       |              |       |                                  |       |                |       |                  |       |   |   |   |   | (330,556 | ) |
| Contribution from CenterPoint Energy, Inc.                                                                            |       |              |       |                                  |       |                | 7,079      |                  |       |   |   |   |   |   |   |
| Warrants                                                                                                                   |       |              |       |                                  |       |                | 1,411      |                  |       |   |   |   |   |   |   |
| Transactions under stock plans                                                                                             |       |              | 5          |                                  |       |                | 48,250     |                  |       |   | 2,209 |   |   |   |   |
| Other comprehensive income (loss):                                                                                         |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Deferred gain (loss) from cash flow hedges, net of  tax of $160 million and $1 million                                     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges into net loss, net of tax of $9 million and $1 million |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Unrealized loss on available-for-sale securities, net  of tax of $0                                                        |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Other comprehensive income from discontinued operations                                                                    |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Comprehensive loss                                                                                                         |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| **Balance  December 31, 2005**                                                                                        |       |              | $          | 66                                    |       |                |       | $                     | 5,846,747  |   |   |   | $ | — |   |   | $ | (1,698,504 | ) |

 

F-10

----

 

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** ** | ** ** | **Accumulated Other Comprehensive Income (Loss)**  | ** ** | ** **                                | ** ** | ** **                                      | ** ** | ** **                       | ** ** |
|------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------|------------|
| ** ** | ** ** | **Unrealized  Gain (Loss)  on  Available  For  Sale  Securities** | ** ** | **Deferred  Derivative  Gains  (Losses)** | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Actuarial  Net  Gain  (Loss)** | ** ** | **Net  Prior  Service  Costs** | ** ** | **Additional  Minimum  Benefits  Liability** | ** ** | **Total  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Discontinued  Operations  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** | **Comprehensive  Income (Loss)** | ** ** |
|            |            |                                                                        |            |                                           |            |                                                 |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

| **Balance December 31, 2004**                                                                                              |   |   | $      | 8      |   |   |     | $      | (29,211  | )      |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |     | $      | (148   | )      |   |   | $      | (29,351  | )        |   |   | $      | (4,206   | )        |   |   | $ | 4,386,354 |   |   |   |   |   |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|----------|--------|----------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|----------|--------|--------|--------|--------|--------|--------|----------|----------|--------|--------|--------|----------|----------|--------|--------|---|-----------|--------|--------|--------|--------|--------|--------|
| Net loss                                                                                                                        |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     | (330,556 | )      |   |   | $        | (330,556 | )      |   |
| Contribution from CenterPoint Energy, Inc.                                                                                 |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     | 7,079    |   |   |   |     |     |   |
| Warrants                                                                                                                        |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     | 1,411    |   |   |   |     |     |   |
| Transactions under stock plans                                                                                                  |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     | 50,464   |   |   |   |     |     |   |
| Other comprehensive income (loss):                                                                                              |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     |     |   |   |   |     |     |   |
| Deferred gain (loss) from cash flow hedges, net  of tax of $160 million and $1 million                                |   |   |   |   |   |   | (233,234 | )      |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (233,234 | )      |   |   | 2,378  |   |   |     | (230,856 | )      |   |   | (233,234 | )        |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges into net loss, net of tax of $9 million and $1 million |   |   |   |   |   |   | (21,688  | )      |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (21,688  | )      |   |   | 1,493  |   |   |     | (20,195  | )      |   |   | (21,688  | )        |   |
| Unrealized loss on available-for-sale securities, net  of tax of $0                                                             |   |   | (8     | )      |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (8       | )      |   |   |   |   |   |     | (8       | )      |   |   | (8       | )        |   |
| Other comprehensive income from discontinued  operations                                                                        |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     |     |   |   |   | 3,871    |     |   |
| Comprehensive loss                                                                                                              |   |   |   |   |   |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |     |   |   |   |   |   |   |     |     |   |   |   | $        | (581,615 | )      |   |
| **Balance  December 31, 2005**                                                                                             |   |   | $      | — |   |   |     | $      | (284,133 | )      |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |     | $      | (148   | )      |   |   | $      | (284,281 | )        |   |   | $      | (335     | )        |   |   | $ | 3,863,693 |   |   |   |   |   |   |

 

F-11

----

 

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** **                                                                                                             | ** ** | **Common  Stock** | ** ** | **Additional  Paid  In Capital** | ** ** | **Treasury  Stock** | ** ** | **Retained  Deficit** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|---------------------------------------|------------|---------------------|------------|-----------------------|------------|
| **Balance December 31, 2005**                                                                                     |       |              | $          | 66                                    |       |                |       | $                     | 5,846,747  |   |   |   | $ | — |   |   | $ | (1,698,504 | ) |
| Adjustment to initially apply FASB Statement  No. 123R                                                            |       |              |       |                                  |       |                | 18,099     |                  |       |   |   |   |   |   |   |
| Balance after initial adjustment to apply FASB  Statement No. 123R                                                |       |              | 66         |                                  |       |                | 5,864,846  |                  |       |   | — |   |   | (1,698,504 | ) |
| Net loss                                                                                                               |       |              |       |                                  |       |                |       |                  |       |   |   |   |   | (327,812 | ) |
| Distribution to CenterPoint Energy, Inc.                                                                          |       |              |       |                                  |       |                | (3,774     | )                     |       |   |   |   |   |   |   |
| Warrants                                                                                                               |       |              |       |                                  |       |                | 970        |                  |       |   |   |   |   |   |   |
| Transactions under stock plans                                                                                         |       |              | 3          |                                  |       |                | 45,201     |                  |       |   |   |   |   |   |   |
| Conversion of convertible senior subordinated notes  to common stock                                                   |       |              | 30         |                                  |       |                | 267,422    |                  |       |   |   |   |   |   |   |
| Other comprehensive income (loss):                                                                                     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Changes in minimum pension liability, net of tax of  $1 million                                                        |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Deferred gain (loss) from cash flow hedges, net of  tax of $79 million                                                 |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges into net loss, net of tax of $(150) million and $0 |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Other comprehensive income from discontinued  operations                                                               |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Adjustment to initially apply FASB Statement  No. 158, net of tax of $0, $0 and $(2) million                 |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| Comprehensive loss                                                                                                     |       |              |       |                                  |       |                |       |                  |       |   |   |   |   |   |   |
| **Balance  December 31, 2006**                                                                                    |       |              | $          | 99                                    |       |                |       | $                     | 6,174,665  |   |   |   | $ | — |   |   | $ | (2,026,316 | ) |

 

F-12

----

**RELIANT ENERGY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** ** | ** ** | **Accumulated Other Comprehensive Income (Loss)**  | ** ** | ** **                                | ** ** | ** **                                      | ** ** | ** **                       | ** ** |
|------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------|------------|
| ** ** | ** ** | **Unrealized  Gain (Loss)  on  Available  For  Sale  Securities** | ** ** | **Deferred  Derivative  Gains  (Losses)** | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Actuarial  Net  Gain  (Loss)** | ** ** | **Net  Prior  Service  Costs** | ** ** | **Additional  Minimum  Benefits  Liability** | ** ** | **Total  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Discontinued  Operations  Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** | **Comprehensive  Income (Loss)** | ** ** |
|            |            |                                                                        |            |                                           |            |                                                 |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

| **Balance December 31, 2005**                                                                                                     |   |   | $      | — |   |   |     | $      | (284,133 | )      |   |   | $      | — |    |   |   | $       | —  |   |   | $      | —  |   |     | $      | (148   | )      |   |   | $      | (284,281 | )         |   |   | $      | (335     | )        |   |   | $ | 3,863,693 |   |   |   |   |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|----------|--------|----------|--------|--------|--------|--------|--------|---------|--------|--------|---------|---------|--------|--------|--------|---------|--------|----------|--------|--------|--------|--------|--------|--------|----------|-----------|--------|--------|--------|----------|----------|--------|--------|---|-----------|--------|--------|--------|--------|--------|--------|
| Adjustment to initially apply FASB  Statement No. 123R                                                                       |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | 18,099    |   |   |   |     |     |   |
| Balance after initial adjustment to apply  FASB Statement No. 123R                                                           |   |   | — |   |   |   | (284,133 | )      |     |   | — |   |   |   | —  |   |   | —  |    |   | (148   | )      |    |   | (284,281 | )      |   |   | (335   | )      |   |     | 3,881,792 |   |   |   |     |     |   |
| Net loss                                                                                                                               |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | (327,812  | )      |   |   | $        | (327,812 | )      |   |
| Distribution to CenterPoint Energy, Inc.                                                                                          |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | (3,774    | )      |   |   |     |     |   |
| Warrants                                                                                                                               |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | 970       |   |   |   |     |     |   |
| Transactions under stock plans                                                                                                         |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | 45,204    |   |   |   |     |     |   |
| Conversion of convertible senior  subordinated notes to common stock                                                              |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     | 267,452   |   |   |   |     |     |   |
| Other  comprehensive income (loss):                                                                                                    |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     |      |   |   |   |     |     |   |
| Changes in minimum pension liability, net of tax  of $1 million                                                                   |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   | (2,121 | )      |    |   | (2,121   | )      |   |   |   |   |   |     | (2,121    | )      |   |   | (2,121   | )        |   |
| Deferred gain (loss) from cash flow hedges, net of  tax of $79 million                                                                 |   |   |   |   |   |   | (129,081 | )      |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   | (129,081 | )      |   |   |   |   |   |     | (129,081  | )      |   |   | (129,081 | )        |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges into net loss, net of tax of $(150) million  and $0 |   |   |   |   |   |   | 240,971  |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   | 240,971  |   |   |   | 335    |   |   |     | 241,306   |   |   |   | 240,971  |     |   |
| Other comprehensive income from discontinued  operations                                                                               |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     |      |   |   |   | 335      |     |   |
| Adjustment to initially apply FASB  Statement No. 158, net of tax of $0,  $0 and $(2) million                 |   |   |   |   |   |   |     |   |     |   |   |   |   |   | (15,463 | )      |   | (10,869 | )       |   | 2,269  |   |    |   | (24,063  | )      |   |   |   |   |   |     | (24,063   | )      |   |   |     |     |   |
| Comprehensive loss                                                                                                                     |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     |      |   |   |   | $        | (217,708 | )      |   |
|                                                                                                                                   |   |   |   |   |   |   |     |   |     |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |     |   |   |   |   |   |   |     |      |   |   |   |     |     |   |
| **Balance  December 31, 2006**                                                                                                    |   |   | $      | — |   |   |     | $      | (172,243 | )      |   |   | $      | — |    |   |   | $       | (15,463 | )      |   | $      | (10,869 | )      |     | $      | — |   |   |   | $      | (198,575 | )         |   |   | $      | —   |     |   |   | $ | 3,949,873 |   |   |   |   |   |   |

 

See Notes to our Consolidated Financial Statements

F-13

----

**RELIANT ENERGY,INC. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(1)**          Backgroundand Basis of Presentation

*Background.  **“Reliant Energy” refers to ReliantEnergy, Inc. and “we,” “us” and “our” refer to Reliant Energy, Inc.and its consolidated subsidiaries. Our business consists primarily of twobusiness segments, retail energy and wholesale energy. See note 18.*

Reliant Energy, a Delaware corporation, was formed in August 2000by CenterPoint Energy, Inc. (CenterPoint) (known as Reliant Energy,Incorporated at the time) in connection with the planned separation of itsregulated and unregulated operations. CenterPoint transferred substantially allof its unregulated businesses to us. In May 2001, Reliant Energy became apublicly traded company and in September 2002, CenterPoint distributed itsremaining ownership of our common stock to its shareholders.

*Basis of Presentation.**  *All significant intercompanytransactions have been eliminated. We have reclassified some amounts on the December 31,2005 consolidated balance sheet to conform to the 2006 presentation.

**(2)**          Summaryof Significant Accounting Policies

***(a)***          Useof Estimates and Market Risk and Uncertainties.

Management makesestimates and assumptions to prepare financial statements in conformity withaccounting principles generally accepted in the United States of America (GAAP)that affect:

·       thereported amount of assets, liabilities and equity,

·       thereported amounts of revenues and expenses and

·       ourdisclosure of contingent assets and liabilities at the date of the financialstatements.

Our critical accounting estimates include: (a) goodwill,(b) property, plant and equipment, (c) derivative assets andliabilities, (d) retail energy segment estimated revenues and energysupply costs, (e) loss contingencies and (f) deferred tax assets,valuation allowances and tax liabilities. Actual results could differ from ourestimates.

We are subject to variousrisks inherent in doing business. See notes 2(c), 2(d), 2(e), 2(h), 2(o),3(b), 4, 5, 6, 7, 10, 11, 12 and 13.

***(b)***           Principlesof Consolidation.

We include our accountsand those of our wholly-owned and majority-owned subsidiaries in ourconsolidated financial statements. We do not consolidate three power generatingfacilities (see note 12(a)), which are under operating leases, or a 50%equity investment in a cogeneration plant. Since September 28, 2004, weconsolidated our receivables facility arrangement until it was terminated on December 1,2006. See note 6.

***(c)***            Revenues.

*PowerGeneration Revenues.**  *Werecord gross revenues from the sale of electricity and other energy servicesunder the accrual method. Electric power and other energy services are sold atmarket-based prices through existing power exchanges or through third partycontracts. Energy sales and services that have been delivered but not billed byperiod-end are estimated.

F-14

----

*NaturalGas Sales Revenues.**  *Werecord gross revenues from the sales of natural gas under the accrual method. Thesesales are sold at market-based prices through third party contracts. Sales thathave been delivered but not billed by period-end are estimated.

*RetailEnergy Revenues.**  *Gross revenues for energy sales andservices to residential and small business customers and our electric sales tocommercial, industrial and governmental/institutional customers are recognizedupon delivery and include estimated energy and services delivered but notbilled by the end of the period.

As of December 31,2006 and 2005, we recorded unbilled revenues of $416 million and $400 million, respectively,for retail energy sales. Accrued unbilled revenues are based on our estimatesof customer usage since the date of the last meter reading provided by theindependent system operators or electric distribution companies. Volumeestimates are based on daily forecasted volumes and estimated customer usage byclass. Unbilled revenues are calculated by multiplying volume estimates by theapplicable rate by customer class. Estimated amounts are adjusted when actualusage is known and billed.

***(d)***           Derivativesand Hedging Activities.

We account for our derivatives instruments and hedgingactivities in accordance with SFAS No. 133, “Accounting for DerivativesInstruments and Hedging Activities,” as amended (SFAS No. 133).

In the fourth quarter of 2005, we commenced anevaluation of our wholesale energy segment’s hedging strategy (which includesboth designated and non-designated hedging derivative instruments) and use ofcapital. In early 2006, we concluded that the benefits of hedging ourgeneration do not justify the costs, including collateral postings. As aresult, we decided to substantially reduce new hedges of our generation. Wecontinue to enter into selective hedges, including originated transactions,based on (a) our assessment of market fundamentals to increase the returnfrom our generation assets and (b) operational and market limitationsrequiring us to enter into fuel, capacity and emissions transactions to manageour generation assets. We believe that this strategy significantly reduces ourwholesale energy segment’s use of capital; however, our earnings are subject tovolatility based on market price changes.

We own a very limited amount of generation capacity inTexas, which is insufficient to supply the electricity requirements of ourTexas retail operations. For our retail energy segment, we continue to focusour supply procurement strategy on (a) matching supply costs and supplytiming with sales commitments, (b) managing periodic adjustments ofphysical supply to manage ongoing operational and customer usage changes and (c) managingprocurement needs within available market liquidity.

We may also enter into derivatives to manage ourexposure to changes in interest rates.

For our hedging activities, we use both derivative andnon-derivative contracts that provide for settlement in cash or by delivery ofa commodity. The primary types of derivative instruments we use are forwards,futures, swaps and options. We account for our derivatives under one of threeaccounting methods (cash flow hedge, mark-to-market or accrual accounting(under the normal purchase/normal sale exception)) based on facts andcircumstances. The fair values of our derivative activities are determined by (a) pricesactively quoted, (b) prices provided by other external sources or (c) pricesbased on models and other valuation methods.

If certain conditions are met, a derivative instrumentmay be designated as a cash flow hedge. A derivative is recognized at fairvalue in the balance sheet whether or not it is designated as a hedge, exceptfor derivative contracts designated as normal purchase/normal sale exceptions,which are not in our consolidated balance sheet or results of operations priorto settlement resulting in accrual accounting treatment.

F-15

----

Derivatives designated as cashflow hedges must have a high correlation between price movements in thederivative and the hedged item. The changes in fair value of cash flow hedgesare deferred in accumulated other comprehensive income (loss), net of tax, tothe extent the contracts are effective as hedges, until the forecastedtransactions affect earnings. At the time the forecasted transactions affectearnings, we reclassify the amounts in accumulated other comprehensive income(loss) into earnings. We record the ineffective portion of changes in fairvalue of cash flow hedges immediately into earnings. For all other derivatives,changes in fair value are recorded as unrealized gains or losses in our resultsof operations.

If and when an acceptablelevel of correlation no longer exists, hedge accounting ceases and changes infair value are recognized in our results of operations. If it becomes probablethat a forecasted transaction will not occur, we immediately recognize therelated deferred gains or losses in our results of operations. The associatedhedging instrument is then marked to market through our results of operationsfor the remainder of the contract term unless a new hedging relationship isredesignated.

Realizedgains and losses on derivatives contracts not held for trading purposes arereported either on a net or gross basis based on the relevant facts andcircumstances. Hedging transactions that do not physically flow are included inthe same caption as the items being hedged. A summary of our derivativeactivities and classification in our results of operations is:

| **Instrument**                                                    | ** ** | ** **                                                                    | ** ** | **Purpose for Holding or  Issuing Instrument**(1) | ** ** | **Transactions that  Physically Flow**      | ** ** | **Transactions that  Financially Settle**(2) |
|-------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|
| Power futures, forward,  swap and option contracts                |       | Power sales to end-use retail customers                                       |       | Revenues                                          |       | N/A(3)                                      |
|                                                              |       | Power sales from wholesale operations                                         |       | Revenues                                          |       | Revenues                                    |
|                                                              |       | Supply management revenues                                                    |       | Revenues                                          |       | Purchased power, fuel and cost of gas sold  |
|                                                              |       | Power purchases related to our retail operations                              |       | Purchased power, fuel and cost of gas sold        |       | Purchased power, fuel and cost of gas sold  |
|                                                              |       | Power purchases related to wholesale operations                               |       | Purchased power, fuel and cost of gas sold        |       | Revenues                                    |
|                                                              |       | Power purchases/sales related to our legacy trading  positions                |       | Revenues                                          |       | Revenues                                    |
| Natural gas and  fuel futures, forward, swap and option contracts |       | Natural gas and fuel  purchases/sales related to our retail operations        |       | N/A(3)                                            |       | Purchased power, fuel  and cost of gas sold |
|                                                              |       | Natural gas and fuel sales related to wholesale  operations                   |       | Revenues                                          |       | Purchased power, fuel and cost of gas sold  |
|                                                              |       | Natural gas and fuel purchases related to wholesale  operations               |       | Purchased power, fuel and cost of gas sold        |       | Purchased power, fuel and cost of gas sold  |
|                                                              |       | Natural gas and fuel purchases/sales related to our  legacy trading positions |       | Purchased power, fuel and cost of gas sold        |       | Purchased power, fuel and cost of gas sold  |
| Interest rate swaps and  caps                                     |       | Interest rate risk associated with floating-rate  debt                        |       | N/A(3)                                            |       | Interest expense                            |

 

----

(1)             Thepurpose for holding or issuing is not impacted by the accounting method electedfor each instrument.

F-16

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(2)             Includesclassification for mark-to-market derivatives and amounts reclassified fromaccumulated other comprehensive income (loss) related to cash flow hedges.

(3)             N/Ais not applicable.

In addition to market risk, we are exposed to creditand operational risk. We have a riskcontrol framework to manage these risks, which include:  (a) measuringand monitoring these risks, (b) review and approval of newtransactions relative to these risks, (c) transaction validation and (d) portfoliovaluation and reporting. We use mark-to-market valuation, value-at-risk andother metrics in monitoring and measuring risk. Our risk control frameworkincludes a variety of separate but complementaryprocesses, which involve commercial and senior management and our Board ofDirectors. See note 2(e) for further discussion of our credit policy.

*EarningsVolatility from Derivative Instruments.**  *We purchase most of the generationcapacity necessary to supply our retail energy business in Texas from thirdparties. Our primary objective is to satisfy the forecasted retail load andmaintain adequate capacity reserves to manage operational and marketconstraints. We routinely hedge our fixed purchase and sale commitments. Sometypes of transactions may cause us to experience volatility in our earnings dueto the revenue receiving accrual treatment while a portion of the relatedsupply is marked to market.

We procure natural gas, coal, oil, natural gastransportation and storage capacity and other energy-related commodities tosupport our electric generation assets. Some types of transactions may cause usto experience volatility in our earnings due to natural gas inventory relatedto transportation and storage generally receiving accrual treatment while therelated derivative instruments are marked to market through earnings.

Over the past several years, we have substantiallydecreased derivatives accounted for as cash flow hedges, in favor of utilizingthe mark-to-market method of accounting or the normalpurchase/normal sale exception for these derivatives. Effective July 1,2004, we began utilizing the mark-to-market method of accounting for new transactionsand transactions in the West region that were previously designated as cashflow hedges. During the third quarter of 2004, for certain new power capacitycommitments, we began utilizing the mark-to-market method of accounting topartially offset the potential impact of price volatility on our shortpositions in natural gas used to convert fixed price power purchases to heatrate supply. Effective September 1, 2005, we began marking to marketthrough earnings a portion of our previously designated cash flow hedgeportfolio related to our PJM coal plants for October 2005 through December 2007due to ineffectiveness. The ineffectiveness resulted from transmissionconstraints impacting our generating plants, hotter than average weather andhigher natural gas prices.

Effective September 1, 2006, we de-designatedcertain cash flow hedges of coal contracts in our PJM and MISO regions andeither began utilizing the mark-to-market method of accounting or elected thenormal purchase/normal sale exception. During the fourth quarter of 2006, inconnection with the credit-enhanced retail structure, we (a) de-designatedcash flow hedges of natural gas futures and swap transactions used to hedge ourretail energy business and began utilizing the mark-to-market method ofaccounting and (b) closed out a majority of our remaining generationhedges in the PJM region.

*Set-off of DerivativeAssets and Liabilities.**  *Wherederivative instruments are subject to a master netting agreement and theaccounting criteria to offset are met, we present our derivative assets andliabilities on a net basis. Derivative assets/liabilities and accountsreceivable/payable are presented and set-off separately in our consolidatedbalance sheets although in most cases contracts permit the set-off ofderivative assets/liabilities and accounts receivable/payable with a givencounterparty.

F-17

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***(e)***            CreditRisk.

We have a credit policy that governs the management ofcredit risk, including the establishment of counterparty credit limits andspecific transaction approvals. Credit risk is monitored daily and thefinancial condition of our counterparties is reviewed periodically. We try tomitigate credit risk by entering into contracts that permit netting and allowus to terminate upon the occurrence of certain events of default. We measurecredit risk as the replacement cost for our derivative positions plus amountsowed for settled transactions.

Our credit exposure isbased on our derivative assets and accountsreceivable from our wholesale energy and ERCOT power supply counterparties,after taking into consideration netting within each contract and any masternetting contracts with counterparties. As of December 31, 2006, twonon-investment grade counterparties represented 53% ($359 million) of ourcredit exposure. As of December 31, 2005, two non-investment gradecounterparties and one investment grade counterparty represented 56% ($918million) and 11% ($183 million), respectively, of our credit exposure. As of December 31,2006 and 2005, we held no collateral from these counterparties. There were noother counterparties representing greater than 10% of our credit exposure. SinceDecember 31, 2005, our credit exposure decreased primarily due to changesin commodity prices and the liquidation of existing transactions.

***(f)***             Selling,General and Administrative Expenses.

Selling, general andadministrative expenses include (a) selling and marketing, (b) baddebt expense and (c) other general and administrative expenses. Othergeneral and administrative expenses include, among other items, (a) financialservices, (b) legal costs, (c) regulatory costs and (d) certainbenefit costs.

***(g)***           SeveranceCosts.

During 2006, 2005 and2004, we incurred $4 million, $9 million and $31 million, respectively, inseverance costs (included in both operation and maintenance and selling,general and administrative expenses), which were substantially paid in eachapplicable period.

***(h)***          Property,Plant and Equipment and Depreciation Expense.

Wecompute depreciation using the straight-line method based on estimated usefullives. Depreciation expense was $303 million, $351 million and $372 millionduring 2006, 2005 and 2004, respectively.

| ** **                          | ** ** | **Estimated Useful** | ** **   | **December 31,**  | ** ** |
|-------------------------------------|------------|---------------------------|--------------|------------------------|------------|
| ** **                          | ** ** | **Lives (Years)**    | ** **   | **2006**               | ** ** | **2005** | ** ** |
| ** **                          | ** ** | ** **                | ** **   | **(in millions)** | ** ** |
| Electric  generation facilities     |       |                      | 10 – 35 |                   |       | $ | 6,311 |   | $ | 6,313 |   |
| Building and  building improvements |       |                      | 5 – 15  |                   |       | 30 |   | 31 |   |
| Land improvements                   |       |                      | 20 – 35 |                   |       | 238 |   | 194 |   |
| Other                               |       |                      | 3 – 10  |                   |       | 451 |   | 445 |   |
| Land                                |       |                      |         |                   |       | 95 |   | 96 |   |
| Assets under  construction          |       |                      |         |                   |       | 67 |   | 34 |   |
| Total                               |       |                      |         |                   |       | 7,192 |   | 7,113 |   |
| Accumulated  depreciation           |       |                      |         |                   |       | (1,450 | ) | (1,179 | ) |
| Property, plant  and equipment, net |       |                      |         |                   |       | $ | 5,742 |   | $ | 5,934 |   |

 

We periodically evaluate property, plant and equipmentfor impairment when events or circumstances indicate that the carrying value ofthese assets may not be recoverable. The evaluation is highly dependent 

F-18

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on the underlyingassumptions of related cash flows. We recorded no material property, plant andequipment impairments during 2006, 2005 and 2004.

In the future, we couldrecognize impairments if our wholesale energy market outlook changes negatively.In addition, our ongoing evaluation of our wholesale energy business couldresult in decisions to mothball, retire or dispose of additional generationassets, any of which could result in impairment charges.

***(i)***             IntangibleAssets and Amortization Expense.

*Goodwill.*   Weperform our goodwill impairment test annually on April 1 and when eventsor changes in circumstances indicate that the carrying value may not berecoverable. During 2004, our annual impairment test date was November 1.

*Other Intangibles.*   Werecognize specifically identifiable intangible assets, including emissionallowances, contractual rights, powergeneration site permits and water rights, when specific rights andcontracts are acquired. We have no intangible assets with indefinite livesrecorded as of December 31, 2006 and 2005.

***(j)***              Capitalizationof Interest Expense.

During 2006, 2005 and2004, we capitalized $0, $0 and $46 million of interest expense, respectively.

***(k)***           Cashand Cash Equivalents.

We record all highlyliquid short-term investments with maturities of three months or less as cashequivalents.

***(l)***              RestrictedCash.

Restricted cash includescash at certain subsidiaries, the distribution or transfer of which isrestricted by financing and other agreements.

***(m)***       Allowancefor Doubtful Accounts.

We accrue an allowance fordoubtful accounts based on estimates of uncollectible revenues by analyzingcounterparty credit ratings, historical collections, accounts receivable agingsand other factors. We write-off accounts receivable balances against theallowance for doubtful accounts when we determine a receivable is uncollectible.Write-offs related to refunds for energy sales in California were recorded inrevenues (see note 14(a)).

***(n)   Inventory.***

Wevalue fuel inventories at the lower of average cost or market. We remove theseinventories as they are used in the production of electricity. We valuematerials and supplies at average cost. We remove these inventories when theyare used for repairs, maintenance or capital projects.

| ** **                                     | ** ** | **December 31,**  | ** ** |
|------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in millions)** | ** ** |
| Materials and  supplies, including spare parts |       | $                      | 155        |   | $ | 149 |   |
| Coal                                           |       | 51                     |       | 63 |   |
| Natural gas                                    |       | 20                     |       | 32 |   |
| Heating oil                                    |       | 49                     |       | 55 |   |
| Total inventory                                |       | $                      | 275        |   | $ | 299 |   |

 

F-19

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***(o)***           EnvironmentalCosts.

We expense environmentalexpenditures related to existing conditions that do not have future economicbenefit. We capitalize environmental expenditures for which there is a futureeconomic benefit. We record liabilities for expected future costs, on anundiscounted basis, related to environmental assessments and/or remediationwhen they are probable and can be reasonably estimated. See note 13(b).

***(p)***           AssetRetirement Obligations.

Our asset retirement obligations relate to futurecosts primarily associated with dismantling power plants and ash disposal siteclosures. Our asset retirement obligations were $21 million as of December 31,2006 and 2005. As of December 31, 2006, we have $15 million (classified inother long-term assets) on deposit with the state of Pennsylvania toguarantee our obligation related to future closures of ash disposal sites. Seenote 13(b).

During 2005, we adopted anaccounting interpretation relating to asset retirement obligations. Thisinterpretation clarifies that an asset retirement obligation is unconditional even thoughuncertainty exists about the timing and/or method of settlement and requiresthat a liability be recognized if it can be reasonably estimated. Based onthis, we (a) recorded a cumulative effect of an accounting change, net oftax, of $1 million ($0.00 per share), (b) increased other long-termliabilities by $2 million and (c) increased property, plant and equipmentby $1 million.

***(q)***           Repairand Maintenance Costs for Power Generation Assets.

We recognize repair andmaintenance costs as incurred. Prior to January 2004, we recognized repairand maintenance costs associated with planned major maintenance under the “accrue-in-advance”method for assets acquired prior to December 31, 1999. Effective January 2004,we began expensing these costs as incurred for all of our assets. As a resultof this change, we recognized a cumulative effect of an accounting changeresulting in an increase in net income of $7 million, net of tax of $3 million,or $0.02 per share.

***(r)***            DeferredFinancing Costs.

Weincur costs, which are deferred and amortized over the life of the debt, inconnection with obtaining financings. See note 6. Changes in deferredfinancing costs, classified in other long-term assets are:

| ** **                           | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                           | ** ** | **(in millions)** | ** ** |
| Beginning of year                    |       | $                      | 112        |     | $          | 126      |       | $ | 143 |   |
| Capitalized                          |       | 17                     |       | 1        |       | 61       |       |
| Amortized                            |       | (16                    | )          | (15      | )          | (28      | )          |
| Accelerated  amortization/write-offs |       | (21                    | )(1)       | —   |       | (50      | )          |
| End of year                          |       | $                      | 92         |     | $          | 112      |       | $ | 126 |   |

 

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(1)             Ofthis amount, $5 million was recorded to additional-paid-in capitalin connection with converting our debt to equity. See note 6(c).

F-20

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***(s)***            NewAccounting Pronouncement Not Yet Adopted—Fair Value.

The FASB issued Statementof Financial Accounting Standards No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair value inGAAP and expands disclosures about fair value measurements. This statement isapplicable for us beginning in 2008. It applies under other accountingpronouncements that require or permit fair value measurements. The adoption,which we plan to assess during 2007, could have a significant impact on ourconsolidated financial statements.

***(t)***             SECStaff Guidance—Quantifying Financial Statement Misstatements.

The SEC staff issued StaffAccounting Bulletin No. 108, which addresses how the effects of prior yearuncorrected misstatements should be considered when quantifying misstatementsin current year financial statements. During the fourth quarter of 2006, weadopted this guidance and it had no impact on our consolidated financialstatements.

**(3)**          RelatedParty Transactions

***(a)***          EquityContributions/Distributions.

During 2006, 2005 and2004, we received/made non-cash contributions (distributions) of $(4) million,$7 million and $(1) million, respectively, from/to CenterPoint insettlement of certain tax matters. See note 11(e).

***(b)***           Indemnitiesand Releases.

As part of our separationfrom CenterPoint, we agreed to indemnify our former parent company forliabilities associated with the business we acquired and relating to ourinitial public offering. See notes 11(e) and 12(b).

**(4)**          IntangibleAssets

***(a)***          Goodwill.

Thefollowing table shows goodwill by segment and the changes:
|                                         | ** ** | **Retail Energy** | ** ** | **Wholesale Energy** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|------------------------|------------|---------------------------|------------|-----------|------------|
| ** **                              | ** ** | **(in millions)** | ** ** |
| As of January 1, 2005              |       |                   | $          | 53                        |       |      |       | $ | 388 |   |   | $ | 441 |   |
| Transfer to discontinued  operations(1) |       |                   | —     |                      |       |      | (42        | ) |   | (42 | ) |
| Other(2)                                |       |                   | —     |                      |       |      | (12        | ) |   | (12 | ) |
| As of December 31, 2005            |       |                   | 53         |                      |       |      | 334        |   |   | 387 |   |
| Other                                   |       |                   | —     |                      |       |      | (5         | ) |   | (5 | ) |
| As  of December 31, 2006           |       |                   | $          | 53                        |       |      |       | $ | 329 |   |   | $ | 382 |   |

----

(1)             Goodwillrelated to our Ceredo plant ($4 million) and New York plants ($38 million). Seenote 21.

(2)             Goodwillrelated to (a) revisions to the Orion Power Holdings, Inc. (OrionPower Holdings) and its subsidiaries (Orion Power) purchase price allocationfor tax matters of $9 million and (b) various asset sales totaling $3million.

As of December 31, 2006 and 2005, we had $82million and $72 million, respectively, of goodwill that is deductible for United States income tax purposesin future periods.

*GoodwillImpairment Tests.**  *Weperformed impairment tests at the following dates:  May 2004, November 2004, January 2005,March 2005, April 2005, August 2005, September 2005 and April 2006due to either asset sales or our annual impairment tests. No impairments wereindicated in these tests.

F-21

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*Estimation of ourWholesale Energy Reporting Unit’s Fair Value.**  *We estimate the fair value of ourwholesale energy reporting unit basedon a number of subjective factors, including: (a) appropriate weighting of valuation approaches(income approach, market approach and comparable public company approach), (b) projectionsabout future power generation margins, (c) estimates of our future coststructure, (d) discount rates for our estimated cash flows, (e) selectionof peer group companies for the public company approach, (f) requiredlevel of working capital, (g) assumed EBITDA multiple for terminal valuesand (h) time horizon of cash flow forecasts.

Managementhas determined the fair value of our wholesale energy reporting unit with theassistance of an independent appraiser. In determining the fair value of ourwholesale energy reporting unit, we made the following key assumptions: (a) themarkets in which we operate will continue to be deregulated; (b) therewill be a recovery in electricity margins over time such that companiesbuilding new generation facilities can earn a reasonable rate of return ontheir investment and (c) the economics of future construction of newgeneration facilities will likely be driven by integrated utilities. As part ofour process, we modeled all of our power generation facilities and those ofothers in the regions in which we operate. Our assumptions for each of ourgoodwill impairment tests during 2004, 2005 and 2006 were:
| Number of years used in  internal cash flow analysis                                                      |   | 15  |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----|--------|
| EBITDA(1) multiple for terminal  values (through August 2005 test and for April 2006 test) |   | 7.5 |   |
| EBITDA multiple for  terminal values (for September 2005 test)(2)                                    |   | 8.0 |   |
| Risk-adjusted discount  rate for our estimated cash flows                                                 |   | 9.0 | %      |
| Approximate average  anticipated growth rate for demand in power                                          |   | 2.0 | %      |
| Long-term after-tax return on investment for new  investment                                              |   | 7.5 | %      |

----

(1)             Defined as earnings(loss) before interest expense, interest income, income taxes, depreciation andamortization expenses.

(2)             Increase for September 2005test primarily due to higher equity valuations for our peer group companies.

***(b)***           OtherIntangibles.
|                                    | ** ** | **Remaining**           | ** ** | ** **             | ** ** | ** **            | ** ** | ** **   | ** ** | ** **       | ** ** |
|------------------------------------|------------|-------------------------|------------|------------------------|------------|-----------------------|------------|--------------|------------|------------------|------------|
| ** **                         | ** ** | **Weighted**            | ** ** | **December 31,**  | ** ** |
| ** **                         | ** ** | **Average**             | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                         | ** ** | **Amortization**        | ** ** | **Carrying**           | ** ** | **Accumulated ** | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** |
| ** **                         | ** ** | **Period (Years)** | ** ** | **Amount**             | ** ** | **Amortization**      | ** ** | **Amount**   | ** ** | **Amortization** | ** ** |
| ** **                         | ** ** | ** **              | ** ** | **(in millions)** | ** ** |
| SO2 emission allowances(1)(2) |       |                    | —     | (1)                    |       |                  | $          | 357          |       |             |       | $ | (222 | ) |   |   | $ | 371 |   |   |   | $ | (179 | ) |   |
| NOx emission allowances(1)(3) |       |                    | —     | (1)                    |       |                  | 339        |         |       |             | (170       | ) |   |   | 344 |   |   |   | (147 | ) |   |
| Contractual  rights(4)             |       |                    | —     |                   |       |                  | 4          |         |       |             | (4         | ) |   |   | 4 |   |   |   | (3 | ) |   |
| Power  generation site permits(5)  |       |                    | 28         |                   |       |                  | 73         |         |       |             | (10        | ) |   |   | 73 |   |   |   | (7 | ) |   |
| Water  rights(5)                   |       |                    | 28         |                   |       |                  | 67         |         |       |             | (14        | ) |   |   | 67 |   |   |   | (12 | ) |   |
| Other(5)                           |       |                    | —     |                   |       |                  | 4          |         |       |             | —     |   |   |   | 3 |   |   |   | (3 | ) |   |
| Total                              |       |                    |       |                   |       |                  | $          | 844          |       |             |       | $ | (420 | ) |   |   | $ | 862 |   |   |   | $ | (351 | ) |   |

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(1)             SO2 issulfur dioxide and NOx is nitrogen oxides. Amortized to amortizationexpense on a units-of-production basis. As of December 31, 2006, we haverecorded (a) SO2 emissionallowances through the 2039 vintage year and (b) NOx emission allowances through the 2039 vintageyear.

(2)             During 2006, 2005 and2004, we purchased $22 million, $130 million and $61 million, respectively, ofSO2 emission allowances. See note 20 forsales.

(3)             During 2006, 2005 and2004, we purchased $1 million, $16 million and $64 million, respectively, of NOx emission allowances. See note 20 forsales.

(4)             Amortized to revenuesand purchased power, fuel and cost of gas sold, as applicable, based on theestimated realization of the fair value established on the acquisition dateover the contractual lives.

(5)             Amortized toamortization expense on a straight-line basis over the estimated lives.

F-22

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Amortizationexpense consists of:
|                                                                        | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                             | ** ** | **(in millions)** | ** ** |
| Other intangibles,  excluding contractual rights and obligations(1)(2) |       |                   | $          | 70       |       |     |       | $ | 95 |   |   |   | $ | 81 |   |   |
| Contractual rights(3)                                                  |       |                   | $          | (1       | )          |     |       | $ | (1 | ) |   |   | $ | (1 | ) |   |
| Contractual obligations(1)(3)                                          |       |                   | 3          |     |       |     | 9          |   |   |   | 30 |   |   |
| Net                                                                    |       |                   | $          | 2        |       |     |       | $ | 8 |   |   |   | $ | 29 |   |   |

----

(1)             Contractualobligations are in other long-term liabilities.

(2)             Includes amortizationof emission allowances of $65 million, $90 million and $77 million during 2006,2005 and 2004, respectively.

(3)             Amortized to revenuesand purchased power, fuel and cost of gas sold, as applicable, based on theestimated realization of the fair value established on the acquisition dateover the contractual lives.

Estimatedamortization expense based on our intangibles as of December 31, 2006 forthe next five years is (in millions):
| 2007 |   | $  | 28     |   |
|------|--------|----|--------|--------|
| 2008 |   | 11 |   |
| 2009 |   | 13 |   |
| 2010 |   | 16 |   |
| 2011 |   | 16 |   |

 

**(5)**          Derivativesand Hedging Activities

We use derivativeinstruments to manage operational or market constraints, to increase return onour generation assets and to execute our retail energy segment’s supplyprocurement strategy. The instruments used are fixed-price derivative contractsto hedge the variability in future cash flows from forecasted sales of powerand purchases of fuel and power. Our objective in entering into thesefixed-price derivatives is to fix the price for a portion of these transactions.See note 2(d).

Our derivative portfolio,excluding cash flow hedges, is $594 million (net liability) and $308 million(net liability) as of December 31, 2006 and 2005, respectively. Our cashflow hedges are valued at $298 million (net liability) and $471 million (netliability) as of December 31, 2006 and 2005, respectively.

As of December 31,2006 and 2005, the maximum length of time we are hedging our exposure to thevariability in future cash flows that may result from changes in commodityprices was six years and seven years, respectively.

Amounts included inaccumulated other comprehensive loss:

| ** **                      | ** ** | **December 31, 2006**                       | ** ** |
|---------------------------------|------------|-------------------------------------------------------|------------|
| ** **                      | ** ** | **At the End of the Period** | ** ** | **Expected to be  Reclassified into  Results of Operations  in Next 12 Months** | ** ** |
| ** **                      | ** ** | **(in millions)**                                | ** ** |
| Designated cash  flow hedges    |       |                                                  | $          | (80 | ) |   |   | $ | (11 | )(1) |   |
| De-designated  cash flow hedges |       |                                                  | (92        | ) |   |   | (77 | ) |   |
|                            |       |                                                  | $          | (172 | ) |   |   | $ | (88 | ) |   |

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(1)             Theactual amount reclassified into our results of operations will vary from theamounts recorded as of December 31, 2006, due to future changes in marketprices.

F-23

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Althoughwe discontinued our proprietary trading business in March 2003, we havelegacy positions, which will be closed as economically feasible or inaccordance with their terms. The impacts associated with these transactions are(income (loss)):
|                                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                  | ** ** | **(in millions)** | ** ** |
| Revenues                                    |       |                   | $          | 1        |       |     | $          | (15 | ) |   | $ | — |   |   |
| Purchased power,  fuel and cost of gas sold |       |                   | 26         |     |       | (30      | )          |   | 4 |   |   |
| Total                                       |       |                   | $          | 27       |       |     | $          | (45 | ) |   | $ | 4 |   |   |

 

The income (loss) of our energy and interest ratederivative instruments is:
|                                      | ** ** | **2006**               | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **(in millions)** | ** ** |
| Energy derivatives:                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Hedge ineffectiveness gains (losses) |       | $                      | (69        | )          | $          | 71         |       | $ | (17 | ) |
| Other net unrealized losses          |       | (162                   | )          | (263       | )          | (207       | )          |
| Interest rate  derivatives:          |       |                   |       |       |       |       |       |
| Other net unrealized losses          |       | (11                    | )          | (16        | )          | (24        | )          |
| Total(1)(2)                          |       | $                      | (242       | )          | $          | (208       | )          | $ | (248 | ) |

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(1)             Nocomponent of the derivatives’ gain or loss was excluded from the assessment ofeffectiveness.

(2)             Includes$3 million loss, $0 and $16 million gain for 2006, 2005 and 2004, respectively,recognized in our results of continuing operations as a result of thediscontinuance of cash flow hedges for forecasted transactions that wedetermined were probable of not occurring.

For a discussion of our interest rate derivatives, seenote 6(e).

During the second quarter of 2006, we refined ourmethodology for estimating fair value of derivative instruments cleared andsettled through brokers by modifying our discounting assumptions to beconsistent with discounting assumptions used in estimating fair value ofexchange-traded futures contracts. This change in accounting estimate had animpact during 2006 as follows (income (loss)):

| ** **                  | ** ** | **2006**                                                                             | ** ** |
|-----------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Income/Loss from  Continuing Operations  before Income Taxes** | ** ** | **Net Loss** | ** ** |
| ** **                  | ** ** | **(in millions)**                                                               | ** ** |
| Cash flow hedges(1)         |       |                                                                                 | $          | — |   |   |   | $ | — |   |   |
| Mark-to-market  derivatives |       |                                                                                 | (32        | )(2) |   |   | (20 | ) |   |
| Total                       |       |                                                                                 | $          | (32 | ) |   |   | $ | (20 | )(3) |   |

----

(1)             Theimpact relating to cash flow hedges was an increase in our net derivativeliabilities of $9 million and a $5 million increase in accumulated othercomprehensive loss, net of income taxes.

(2)             Thisamount represented an increase in our net derivative liabilities and anincrease in net unrealized losses on energy derivatives, which were recorded $(1) millionin revenues and $(31) million in purchased power, fuel and cost of gas sold.

(3)             Thisrepresents a $0.07 impact on loss per share for 2006.

F-24

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**(6)**          Debt

*(a)*          Overview.

Ouroutstanding debt:

| ** **                                                          | ** ** | **December 31,**                                        | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                                     | ** ** | **2005** | ** ** |
| ** **                                                          | ** ** | **Weighted  Average  Stated  Interest  Rate**(1)             | ** ** | **Long-term** | ** ** | **Current** | ** ** | **Weighted  Average  Stated  Interest  Rate**(1) | ** ** | **Long-term** | ** ** | **Current** | ** ** |
| ** **                                                          | ** ** | **(in millions, except interest rates)** | ** ** |
| ***Facilities,  Bonds and Notes:***                                 | * *   | * *                                                     | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| **Reliant  Energy:**                                                |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Senior secured revolver  due 2009                                   |       |                                                         | 9.63       | % |   |   | $ | — |   |   |   | $ | — |   |   |   | 8.40 | % |   |   | $ | 383 |   |   |   | $ | — |   |   |
| Senior secured term loans (B)  due 2010                             |       |                                                         | 7.73       |   |   |   | 397 |   |   |   | 3 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Senior secured term loans (B1)(2)                                   |       |                                                         | —     |   |   |   | — |   |   |   | — |   |   |   | 6.09 |   |   |   | 240 |   |   |   | 313 |   |   |
| Senior secured term loans (B2)                                      |       |                                                         | —     |   |   |   | — |   |   |   | — |   |   |   | 6.91 |   |   |   | 296 |   |   |   | 3 |   |   |
| Senior secured notes due 2010                                       |       |                                                         | 9.25       |   |   |   | 550 |   |   |   | — |   |   |   | 9.25 |   |   |   | 550 |   |   |   | — |   |   |
| Senior secured notes due 2013                                       |       |                                                         | 9.50       |   |   |   | 550 |   |   |   | — |   |   |   | 9.50 |   |   |   | 550 |   |   |   | — |   |   |
| Senior secured notes due 2014                                       |       |                                                         | 6.75       |   |   |   | 750 |   |   |   | — |   |   |   | 6.75 |   |   |   | 750 |   |   |   | — |   |   |
| Convertible senior subordinated notes due 2010  (unsecured)         |       |                                                         | 5.00       |   |   |   | 2 |   |   |   | — |   |   |   | 5.00 |   |   |   | 275 |   |   |   | — |   |   |
| **Subsidiary Obligations:**                                         |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Orion Power Holdings senior notes due 2010  (unsecured)             |       |                                                         | 12.00      |   |   |   | 400 |   |   |   | — |   |   |   | 12.00 |   |   |   | 400 |   |   |   | — |   |   |
| Reliant Energy Seward, LLC PEDFA(3) fixed-rate bonds due  2036 |       |                                                         | 6.75       |   |   |   | 500 |   |   |   | — |   |   |   | 6.75 |   |   |   | 500 |   |   |   | — |   |   |
| Reliant Energy  Channelview, L.P.:                                  |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Term loans and  revolving working capital facility:                 |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Floating rate debt due 2006 to 2024                                 |       |                                                         | 6.95       |   |   |   | — |   |   |   | 267 |   |   |   | 6.04 |   |   |   | 259 |   |   |   | 14 |   |   |
| Fixed rate debt due 2014 to 2024                                    |       |                                                         | 9.55       |   |   |   | — |   |   |   | 75 |   |   |   | 9.55 |   |   |   | 75 |   |   |   | — |   |   |
| Reliant Energy Power Supply, LLC working capital  facility due 2012 |       |                                                         | 5.80       |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| RE Retail Receivables,  LLC facility                                |       |                                                         | —     |   |   |   | — |   |   |   | — |   |   |   | 4.71 |   |   |   | — |   |   |   | 450 |   |   |
| Total facilities, bonds and notes                                   |       |                                                         |       |   |   |   | 3,149 |   |   |   | 345 |   |   |   |   |   |   |   | 4,278 |   |   |   | 780 |   |   |
| ***Other:***                                                        | * *   | * *                                                     | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Adjustment to fair value of debt(4)                                 |       |                                                         |       |   |   |   | 29 |   |   |   | 10 |   |   |   |   |   |   |   | 39 |   |   |   | 9 |   |   |
| Total other debt                                                    |       |                                                         |       |   |   |   | 29 |   |   |   | 10 |   |   |   |   |   |   |   | 39 |   |   |   | 9 |   |   |
| Total debt                                                          |       |                                                         |       |   |   |   | $ | 3,178 |   |   |   | $ | 355 |   |   |   |   |   |   |   | $ | 4,317 |   |   |   | $ | 789 |   |   |

----

(1)             Theweighted average stated interest rates are as of December 31, 2006 or2005.

(2)             Asof December 31, 2005, we classified $638 million as discontinuedoperations. See note 21.

(3)             PEDFAis the Pennsylvania Economic Development Financing Authority.

(4)             Debtacquired in the Orion Power acquisition was adjusted to fair market value as ofthe acquisition date. Included in interest expense is amortization of $9million for valuation adjustments for debt for 2006, 2005 and 2004.

F-25

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Amountsborrowed and available for borrowing under our revolving credit agreements asof December 31, 2006 are:

| ** **                                                                          | ** ** | **Total Committed  Credit** | ** ** | **Drawn  Amount** | ** ** | **Letters  of Credit** | ** ** | **Unused  Amount** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|-------------------|------------|-----------------------------|------------|--------------------|------------|
| ** **                                                                          | ** ** | **(in millions)**           | ** ** |
| Reliant Energy senior secured revolver due 2009                                     |       |                             | $          | 700               |       |                        |       | $                  | —     |   |   |   | $ | 109 |   |   |   | $ | 591 |   |   |
| Letter of credit facility due 2010                                                  |       |                             | 300        |              |       |                        | —     |               |       |   | 252 |   |   |   | 48 |   |   |
| Retail working capital facility due 2012                                            |       |                             | 300        |              |       |                        | —     |               |       |   | — |   |   |   | 300 |   |   |
| Reliant Energy Channelview, LP revolving working capital facility  due 2007(1) |       |                             | 14         |              |       |                        | 7          |               |       |   | — |   |   |   | 7 |   |   |
|                                                                                |       |                             | $          | 1,314             |       |                        |       | $                  | 7          |   |   |   | $ | 361 |   |   |   | $ | 946 |   |   |

----

(1)             Seenote (c) below.

Debt maturities as of December 31, 2006 are:

| ** **          | ** ** | **Reliant Energy** | ** ** | **Reliant Energy  Consolidated** | ** ** |
|---------------------|------------|-------------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **(in millions)**  | ** ** |
| 2007                |       |                    | $          | 3                                     |       |   |   | $ | 345 | (1) |   |
| 2008                |       |                    | 4          |                                  |       |   | 4 |   |   |
| 2009                |       |                    | 4          |                                  |       |   | 4 |   |   |
| 2010                |       |                    | 941        |                                  |       |   | 1,341 |   |   |
| 2011                |       |                    | —     |                                  |       |   | — |   |   |
| 2012 and thereafter |       |                    | 1,300      |                                  |       |   | 1,800 |   |   |
|                |       |                    | $          | 2,252                                 |       |   |   | $ | 3,494 |   |   |

----

(1)             IncludesChannelview debt of $342 million, of which $320 million is not currentlyscheduled to mature in 2007. See note (c) below.

***(b)***           FinancingActivity.

*2006Financing Activity.*   In connection with thecredit-enhanced retail structure (see note 7), we completed arefinancing in December 2006, the components of which included:

·       Amendmentand downsize of:

·       $1.7billion to $700 million senior secured revolver, and

·       $530million to $400 million senior secured term loans;

·       Issuanceof:

·       $300million letter of credit facility, and

·       $300million retail working capital facility; and

·       Repaymentof $450 million retail receivables facility.

We also amended our senior secured revolver and termloans, senior secured notes and the guarantee of our PEDFA bonds to allow us togrant liens to Merrill Lynch & Co., Inc. and affiliates (MerrillLynch) in connection with the credit-enhanced retail structure and theretail working capital facility.

F-26

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*2004Financing Activity.*   In December 2004, we completed a $4.25 billionrefinancing, the components of which included:

·       Amendmentand downsize of:

·       $2.1billion to $1.7 billion senior secured revolver, and

·       $1.7billion to $1.3 billion senior secured term loans; and

·       Issuanceof:

·       $750million senior secured notes, and

·       $100million fixed rate PEDFA bonds (in addition to $400 million floating-rate PEDFAbonds which were converted to fixed rate); and

·       Repaymentof $255 million of Orion Power MidWest, L.P. (Orion MidWest) debt andassociated interest rate swap agreements.

*REMATerm Loans.*   ReliantEnergy Mid-Atlantic Power Holdings, LLC (REMA LLC) and its subsidiaries (REMA)have sale-leaseback agreements with respect to three of their generatingfacilities. During 2005, term loans (which provided required credit support)were paid in full and replaced with letters of credit. See note 12(a).

***(c)***            CreditFacilities and Debt.

*SeniorSecured Term Loans, Letter of Credit Facility and Senior Secured Revolver (the December 2006credit facilities).*   Our term loan B andrevolving credit facility currently bear interest at London Inter Bank OfferingRate (LIBOR) plus 2.375% or a base rate plus 1.375%. Our revolving creditfacility and letter of credit facility provide for the issuance of up to $700million and $300 million of letters of credit, respectively. Beginning April 1,2007, we must make quarterly principal payments on the term loan B of $1 million.

The December 2006 credit facilities restrict ourability to, among other actions, (a) encumber our assets, (b) enterinto business combinations or divest our assets, (c) incur additional debtor engage in sale and leaseback transactions, (d) pay dividends or paysubordinated debt, (e) make investments or acquisitions, (f) enterinto transactions with affiliates, (g) make capital expenditures, (h) materiallychange our business, (i) amend our debt agreements, (j) repurchaseour capital stock, (k) engage in certain types of trading activities or (l) utilizeproceeds from asset sales and equity issuances. In addition, we are required toachieve specified levels for the ratios of (a) adjusted net debt toadjusted net earnings (loss) before interest expense, interest income, incometaxes, depreciation, amortization and certain lease expenses (EBITDAR)(consolidated leverage ratio) and (b) adjusted consolidated EBITDAR toadjusted interest expense (consolidated interest coverage ratio).

If certain credit ratings or consolidated leverageratios are met in the future, interest rates will decline to LIBOR plus 2.125%or base rate plus 1.125%.

The December 2006 credit facilities are (a) guaranteedby certain subsidiaries and (b) secured by the assets and stock of thosesubsidiaries, as well as the stock of RERH Holdings, LLC, REMA LLC and OrionPower Holdings. See note 16.

*SeniorSecured Notes.**  *Withlimited exceptions, the collateral that secures the December 2006credit facilities also secures the senior secured notes. If certain creditratios are achieved for two consecutive quarters and the December 2006credit facilities become unsecured, the senior secured notes will becomeunsecured. The senior secured notes have covenants similar to those in our December 2006credit facilities. Certain of those covenants will be suspended in the event weachieve investment grade credit ratings.

F-27

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*ConvertibleSenior Subordinated Notes.*   On December 21, 2006, we completed an exchange offerfor our 5.00% convertible senior subordinated notes. Approximately 99.2% of theholders accepted the offer, resulting in $2 million outstanding as of December 31,2006. We (a) issued an aggregate of 28.6 million shares of our commonstock (104.8108 shares per $1,000 principal) and paid an aggregate cash premiumof $41 million ($150 per $1,000 principal) to the holders who validly exchangedtheir notes and (b) recognized a charge of $37 million for the debtconversion expense during 2006. This represented a non-cash conversion ofdebt to equity of $273 million.

*OrionPower Holdings Senior Notes.**  *These notes were recorded at a fair value of $479 million uponthe acquisition of Orion Power. The $79 million premium is being amortized tointerest expense over the life of the notes. The senior notes are senior unsecured obligations of Orion Power Holdings,are not guaranteed by any of Orion Power Holdings’ subsidiaries and arenon-recourse to Reliant Energy. The senior notes have covenants that restrictthe ability of Orion Power Holdings and its subsidiaries to, among otheractions, (a) pay dividends or pay subordinated debt, (b) incurindebtedness or issue preferred stock, (c) make investments, (d) divestassets, (e) encumber its assets, (f) enter into transactions withaffiliates, (g) engage in unrelated businesses and (h) engage in saleand leaseback transactions. As of December 31, 2006, conditions underthese covenants were not met that allow the payment of dividends. As of December 31,2006, the adjusted net assets of Orion Power that are restricted to ReliantEnergy are $1.3 billion.

*ReliantEnergy Seward, LLC PEDFA Bonds.**  *Reliant Energy Seward, LLC (Seward)partially financed the construction of its power plant with proceeds from theissuance of tax-exempt revenue bonds by PEDFA. These bonds are guaranteed byReliant Energy and the guarantee is secured by the same collateral as and hascovenants similar to our senior secured notes.

*ReliantEnergy Channelview, L.P.**  *Reliant Energy Channelview, L.P. (Channelview)entered into a credit agreement that financed the construction of a power plant.The credit agreement consisted of (a) $369 million in term loans and (b) $14million revolving working capital facility that matures in August 2007.

With the exception of a fixed-rate tranche ($75million), the loans bear a floating interest rate based either on LIBOR or baserates plus a margin that increases over time. The facility is secured bysubstantially all of the assets of Channelview and is non-recourse to ReliantEnergy. The facility prohibits Channelview from taking certain actions,including paying dividends or paying subordinated debt unless, among otherthings, it maintains specified debt service coverage ratios and debt serviceaccount balances. As of December 31, 2006, the conditions under thesecovenants were not met, and we do not expect Channelview to satisfy theseconditions in 2007.

We are considering various strategic alternatives withrespect to our interest in Channelview, including a transfer of ownership tothe lenders, selling our equity interests to a third party or placingChannelview in bankruptcy. There can be no assurances regarding the outcome ofthis process. As of December 31, 2006, Channelview’s net property, plantand equipment is $368 million and its debt is $342 million. As of December 31,2006, our net investment in the Channelview companies, before considering anyincome tax impacts, is approximately $70 million. In addition, as Channelviewmay be in default during 2007, we have classified the Channelview debt as acurrent liability as of December 31, 2006.

*Retail Working CapitalFacility.**  *Inconnection with the credit-enhanced retail structure, on December 1, 2006,we entered into a $300 million working capital facility agreement with MerrillLynch. Loans bear interest at LIBOR plus 0.45% or a base rate. Borrowings underthis facility will mature on the 90th day after the termination of the credit sleeveand reimbursement agreement with Merrill Lynch. The working capital facilityincludes a $150 million minimum adjusted EBITDA requirement for RERH Holdings,LLC and its subsidiaries (RERH Holdings) for each trailing four-quarter period.The covenants under the credit sleeve and reimbursement agreement with MerrillLynch also apply to the working capital 

F-28

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facility. Seenote 7 for discussion on security for the retail working capital facility.The obligations of RERH Holdings are non-recourse to Reliant Energy.

***(d)***           Warrants.

In March 2003, weissued 7.8 million common stock warrants with an exercise price of $5.09 pershare in connection with a credit facility. As of December 31, 2006 and2005, 6,920,122 and 7,448,332 warrants, respectively, were outstanding andexpire in August 2008. We recorded the fair value of the warrants ($15million) as a discount to debt and an increase to additional paid-in capital. Weamortize the debt discount to interest expense over the life of the relateddebt (through 2009). During 2006, 2005 and 2004, we amortized $0, $0 and$7 million, respectively, to interest expense.

***(e)***            InterestRate Derivative Instruments.

Historically, we have used interest rate swaps and capsto hedge a portion of the floating interest rate risk associated with ourfloating rate long-term debt. Some swaps used to hedge our exposure weredesignated as cash flow hedges*,*with the effective portion of gains and losses, net of tax, recorded in accumulatedother comprehensive loss. The interest rate derivatives not designated as cashflow hedges were marked to market. We reclassify gains and losses on thedesignated hedges from accumulated other comprehensive loss into interestexpense during the periods in which the interest payments being hedged occurred.See notes 2(d) and 5 for information regarding our derivatives.

*Expirations.**  *As of December 31, 2005, theLIBOR interest rate caps associated with Reliant Energy’s credit facilities andthe interest rate swaps related to the Channelview credit facilities expired. During2005 and 2004, we recorded $9 million and $21 million, respectively, ininterest expense related to these instruments.

*Terminations.**  *In 2002, we liquidatedforward-starting interest rate swaps having a notional value of $1.0 billion. Asof December 31, 2006 and 2005, we have $4 million and $11 million,respectively, of deferred losses in accumulated other comprehensive lossrelated to these interest rate swaps. We are amortizing these losses intointerest expense through 2012 for the forward-starting interest rate swaps.  As of December 31, 2006, $3 million ofaccumulated other comprehensive loss is expected to be reclassified intointerest expense during the next 12 months.

**(7)**          Credit-EnhancedRetail Structure

The credit sleeve and reimbursement agreement (theagreement) and a working capital facility agreement, providing for revolvingcredit loans, each with Merrill Lynch became effective on December 1,2006, which substantially eliminated collateral postings for our Texas retailenergy business.

Under the agreement, Merrill Lynch provides guaranteesand the posting of collateral to our counterparties in supply transactions forour Texas retail energy business. Cash flow activity in connection with thesecontracts and related collateral is classified as operating cash flow. Werecorded an unrealized loss on energy derivatives of $18 million due to thedifferences in quantity between our contracts with Merrill Lynch and itscontracts with the exchange relating to existing financially settled supplycontracts.

We paid Merrill Lynch a one-time structuring fee of$13 million, which was expensed as general and administrative costs. We alsopay a fee to Merrill Lynch of $0.40 for each megawatt hour (MWh) of power thatwe deliver to our Texas retail customers. This fee is classified as interestexpense. We are obligated to reimburse Merrill Lynch to the extent that anyguarantees are called upon or any collateral posted by Merrill Lynch isforeclosed upon.

The initial term of the agreement is five years. Weare permitted to terminate at any time, subject to a make-whole payment duringthe first two years of the agreement. Merrill Lynch does not have an early 

F-29

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termination option. Theagreement (a) restricts the ability of RERH Holdings to, among otheractions, (i) encumber its assets, (ii) sell certain assets, (iii) incuradditional debt, (iv) pay dividends or pay subordinated debt, (v) makeinvestments or acquisitions or (vi) enter into transactions withaffiliates and (b) requires us to manage our risks related to commodityprices.

In connection with theagreement, we implemented a structure so that the entities comprising our Texasretail energy business became subsidiaries of RERH Holdings, LLC. Ourobligations under the agreement with Merrill Lynch and the retail workingcapital facility are secured by first liens on the assets of RERH Holdings. RERHHoldings, as well as our subsidiaries Reliant Energy Trademark Trust andReliant Energy IT Trust that provide trademark assets and informationtechnology services to our retail energy business, are designed to maintain theseparate nature of their assets, avoid consolidation of such assets with thebankruptcy estate of Reliant Energy in the event Reliant Energy ever becomes subjectto such a proceeding, and ensure that such assets are available first andforemost to satisfy their creditors’ claims. The obligations of RERH Holdingsunder the agreement and the retail working capital facility are non-recourse toReliant Energy. See note 6 for discussion of the retail working capitalfacility.

**(8)**          Stockholders’Equity

Thefollowing describes our capital stock activity:

| ** **                    | ** ** | **Common Stock**               | ** ** | **Treasury Stock** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **(shares in thousands)** | ** ** |
| As of  January 1, 2004   |       |                                | 294,592    |                    |       |   | 5,212 |   |   |
| Issued to benefit plans       |       |                                | 5,084      |                    |       |   | (5,084 | ) |   |
| Issued for warrants           |       |                                | 8          |                    |       |   | — |   |   |
| As of  December 31, 2004 |       |                                | 299,684    |                    |       |   | 128 |   |   |
| Issued to benefit plans       |       |                                | 4,877      |                    |       |   | (128 | ) |   |
| Issued for warrants           |       |                                | 339        |                    |       |   | — |   |   |
| As of  December 31, 2005 |       |                                | 304,900    |                    |       |   | — |   |   |
| Issued to benefit plans       |       |                                | 3,732      |                    |       |   | — |   |   |
| Issued for warrants           |       |                                | 390        |                    |       |   | — |   |   |
| Issued for converted debt     |       |                                | 28,601     |                    |       |   | — |   |   |
| As of December 31,  2006 |       |                                | 337,623    |                    |       |   | — |   |   |

 

**(9)**          EarningsPer Share

For 2006, 2005 and 2004, basic and diluted weightedaverage shares outstanding are 307,705,000; 302,409,000 and 297,527,000,respectively.

F-30

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Weexcluded the following items from diluted loss per common share due to theanti-dilutive effect:

| ** **                                                                                                                        | ** ** | **     2006     **    | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **(shares in thousands, dollars in millions)** | ** ** |
| Shares excluded from the calculation of diluted loss  per share                                                              |       |                                                                    | 35,951     | (1)(2)                                                               |       |                                                                 | 36,538     | (1) |   |   | 35,869 | (1) |   |
| Shares excluded from the calculation of diluted loss  per share because the exercise price exceeded the average market price |       |                                                                    | 2,536      | (3)                                                                  |       |                                                                 | 4,471      | (3) |   |   | 8,934 | (3) |   |
| Interest expense  (after-tax) that would be added to income if 5.00% convertible  senior subordinated notes were dilutive    |       |                                                                    | $          | 9                                                                    | (2)        |                                                                 |       | $ | 9 |   |   |   | $ | 9 |   |   |
|                                                                                                                                   |            |                                                                         |            |                                                                      |            |                                                                      |            |  |  |  |  |  |  |  |  |  |

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(1)             Potentialshares excluded may consist of convertible senior subordinated notes, warrants,stock options, restricted stock, performance-based shares and/or shares relatedto the employee stock purchase plan.

(2)             OnDecember 21, 2006, we converted 99.2% of our convertible seniorsubordinated notes to common stock. See note 6.

(3)             Relates to stockoptions.

**(10)**   Stock-BasedIncentive Plans and Benefit Plans

***(a)***          Stock-BasedIncentive Plans.

*Overviewof Plans.*   The Compensation Committee of theBoard of Directors administers our stock-based incentive plans. The ReliantEnergy, Inc. 2002 Long-Term Incentive Plan and the Reliant Energy, Inc.2002 Stock Plan permit us to grant various stock-based incentive awards toofficers, key employees and directors. Awards may include stock options, stockappreciation rights, restricted stock, restricted stock units, performanceawards, cash awards and stock awards.

As of December 31, 2006, 36 million shares areauthorized for issuance under our stock-based incentive plans. No more than 25% of these shares can be grantedas stock-based awards other than options. We generally issue newshares when stock options are exercised and for other equity-based awards.

*Summary.**  *Prior to January 1, 2006, weapplied the intrinsic value method of accounting for employee stock-basedincentive plans (APB No. 25). Effective January 1, 2006, we adoptedStatement of Financial Accounting Standards No. 123R, “Share-Based Payment”(SFAS No. 123R) (using the modified prospective method). SFAS No. 123Rrequires compensation costs related to share-based transactions to berecognized in the financial statements based on estimated fair values at the grantdates. Our financial statements as of and for the year ended December 31,2006 reflect the impact of SFAS No. 123R; however, our financialstatements for periods prior to January 1, 2006 have not been restated toreflect, and do not include, the impact of the new standard. Our compensationexpense for our stock-based incentive plans was:

| ** **                                                  | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                  | ** ** | **(in millions)** | ** ** |
| Stock-based  incentive plans compensation expense (pre-tax) |       |                   | $          | 30       |       |     |       | $ | 8 |   |   | $ | 32 |   |
| Income tax impact                                           |       |                   | (9         | )        |       |     | (3         | ) |   | (11 | ) |
| After-tax expense                                           |       |                   | $          | 21       |       |     |       | $ | 5 |   |   | $ | 21 |   |

 

We did not capitalize any stock-based compensationcosts as an asset during 2006, 2005 and 2004.

F-31

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We recorded a cumulative effect of an accountingchange of $2 million ($1 million, net of tax) during the first quarter of 2006for the estimated future forfeitures for the unvested awards outstanding as of January 1,2006.

During the fourth quarter of 2006, we adopted thealternative transition method to calculate excess tax benefits available toabsorb tax deficiencies recognized subsequent to the adoption. This resulted inzero excess tax benefits.

*Valuation Data.**  *Below is the description of the methods used duringthe indicated periods to estimate the fair value of our various awards.

| ** **                         | ** ** | **Prior to January 1, 2006  (APB No. 25)**                 | ** ** | **After January 1, 2006  (SFAS No. 123R)**                                                     |
|------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| **Award:**                         |       |                                                                 |       |                                                                                                     |
| Time-based stock  options(1)       |       | Intrinsic value on the grant date                                    |       | Black-Scholes option-pricing model value on the  grant date                                              |
| Time-based  restricted stock(2)    |       | Market price of our common stock on the grant date                   |       | No change                                                                                                |
| Time-based cash(3)                 |       | Market price of our common stock on each reporting  measurement date |       | No change                                                                                                |
| Key employee  award program:       |       |                                                                 |       |                                                                                                     |
| Performance-based  stock(1)        |       | Market price of our common stock on each reporting  measurement date |       | Market price of our common stock on each reporting  measurement date until accounting grant date         |
| Performance-based options(1)  |       | Intrinsic value of option on each reporting  measurement date        |       | Black-Scholes option-pricing model value on each  reporting measurement date until accounting grant date |
| Performance-based  cash(1)(3)      |       | Market price of our common stock on each reporting  measurement date |       | No change                                                                                                |
| Employee stock  purchase  plan     |       | No compensation expense recorded                                     |       | Black-Scholes option-pricing model value on the  first day of the offering period                        |

----

(1)             Noawards were granted during 2006.

(2)             Restrictedstock and restricted stock units are referred to as “restricted stock.”

(3)             These areliability-classified awards under SFAS No. 123R.

*Time-BasedStock Options.*   We grant time-based stock optionsto officers, key employees and directors at an exercise price equal to themarket value of our common stock on the grant date. Generally, options vest33.33% per year for three years and have a term of 10 years. Beginning January 1,2006, compensation expense is measured at fair value on the grant date, net ofestimated forfeitures, and expensed on a straight-line basis over the requisiteservice period for the entire award.

F-32

----

Summarizedtime-based option activity is:

| ** **                              | ** ** | **2006**    | ** ** |
|-----------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Beginning of  period                    |       | 11,646,667  |       |   | $ | 15.21 |   |   |
| Granted                                 |       | —      |       |   | — |   |   |
| Exercised                               |       | (1,982,128  | )(1)       |   | 8.28 |   |   |
| Forfeited                               |       | (20,638     | )          |   | 3.51 |   |   |
| Expired                                 |       | (1,779,549  | )          |   | 28.48 |   |   |
| End of period                           |       | 7,864,352   |       |   | 13.98 |   |   |
| Weighted average grant  date fair value |       | N/A         |       |   |   |   |   |

----

(1)             Receivedproceeds of $16 million. Intrinsic value was $8 million on the exercise date. Notax benefits were realized in 2006 due to our net operating loss carryforwards.

| ** **                                                                | ** ** | **            2005            ** | ** ** | **            2004            ** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **(in millions, except per unit amounts)**                                                                                      | ** ** |
| Weighted average  grant date fair value of the time-based options granted |       |                                                                                                                                                     | $          | 7.18                                                                                                                                                     |       |   |   | $ | 6.05 |   |   |
| Proceeds from  exercise of time-based options                             |       |                                                                                                                                                     | $          | 29                                                                                                                                                       |       |   |   | $ | 17 |   |   |
| Intrinsic value  of exercised time-based options                          |       |                                                                                                                                                     | $          | 17                                                                                                                                                       |       |   |   | $ | 10 |   |   |
| Tax benefits realized                                                     |       |                                                                                                                                                     | —     | (1)                                                                                                                                                      |       |   | — | (1) |   |

----

(1)             Nonerealized due to our net operating loss carryforwards.

Fortime-based options outstanding as of December 31, 2006:

| ** **  | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average Remaining  Contractual  Term (Years)** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|-------------|------------|-------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **  | ** ** | ** **  | ** ** | ** **                             | ** ** | ** **                                                           | ** ** | **(in millions)**              | ** ** |
| Outstanding |       | 7,864,352   | (1)(2)     |                                   | $          | 13.98                                                                |       |                                |       | 4.5 |   |   |   | $ | 37 |   |   |
| Exercisable |       | 7,834,346   |       |                                   | 13.99      |                                                                 |       |                                | 4.5        |   |   |   | 37 |   |   |

----

(1)             Weestimate that none of these will be forfeited.

(2)             Asof December 31, 2006, the total compensation cost related to nonvestedtime-based stock options not yet recognized and the weighted-average periodover which it is expected to be recognized is $0.1 million and one year,respectively.

*Time-BasedRestricted Stock Awards.*   We grant time-basedrestricted stock awards to officers, key employees and directors. In general,these awards vest, subject to the participant’s continued employment, threeyears from the grant date. Beginning January 1, 2006, compensation expenseis measured at fair value on the grant date, net of estimated forfeitures, andexpensed on a straight-line basis over the requisite service period.

F-33

----

Summarizedrestricted stock award activity is:

| ** **                                                                                                                  | ** ** | **2006**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                                  | ** ** | **Shares** | ** ** | **Weighted  Average Grant  Date Fair Value** | ** ** |
| Beginning of  period                                                                                                        |       | 1,855,583  |       |   | $ | 6.96 |   |   |
| Granted                                                                                                                     |       | 355,995    |       |   | 11.64 |   |   |
| Vested                                                                                                                      |       | (1,005,912 | )(1)       |   | 5.12 |   |   |
| Forfeited                                                                                                                   |       | (110,197   | )          |   | 9.22 |   |   |
| End of period                                                                                                               |       | 1,095,469  | (2)        |   | 9.95 |   |   |
| December 31,  2006 total compensation cost related to nonvested time-based restricted stock  awards not yet recognized |       | $          | 4 million  |   |   |   |   |   |
| Weighted average period  over which the nonvested time-based restricted stock is expected to be  recognized                 |       | 2 years    |       |   |   |   |   |
|                                                                                                                             |            |            |            |  |  |  |  |  |  |

----

(1)             Basedon the market price of our common stock on the vesting date, $11 million infair value vested.

(2)             Weestimate that 121,410 of these will be forfeited.

| ** **                                                                                                            | ** ** | **           2005           ** | ** ** | **           2004           ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **(in millions, except per unit amounts)**                                                                          | ** ** |
| Fair value of  time-based restricted stock that vested based on market price of our common  stock on the vesting date |       |                                                                                                                                         | $          | 9                                                                                                                                            |       |   |   | $ | 9 |   |   |
| Weighted-average grant  date fair value of time-based restricted stock granted                                        |       |                                                                                                                                         | $          | 12.65                                                                                                                                        |       |   |   | $ | 8.20 |   |   |

 

*Time-BasedCash Awards.*   We grant time-based cash awards(cash units with each cash unit having an equivalent fair market value of oneshare of our common stock on the vesting date) to officers and key employees. Ingeneral, these awards vest, subject to the participant’s continued employment,three years from the grant date. Compensation expense is measured at fair valueon each financial reporting measurement date, net of estimated forfeitures, andexpensed on a straight-line basis over the requisite service period. As of December 31,2006, we had a $7 million liability recorded for these awards.

During 2006, 2005 and 2004, no time-based cash awardsvested and we did not pay cash for any stock-based liabilities. As of December 31,2006, the total compensation cost related to nonvested time-based cash awardsnot yet recognized is $4 million and the weighted-average period over which itis expected to be recognized is two years.

*Performance-BasedAwards.*   We grant performance-based awards toofficers and key employees. The number of performance-based awards earned isdetermined at the end of each performance period. All of the outstandingperformance-based awards as of December 31, 2006 are for the 2004-2006performance period, which was the requisite service period. Beginning January 1,2006, compensation expense is measured at fair value, net of estimatedforfeitures, at each reporting measurement date preceding the grant date foraccounting purposes. We have broadly interpreted the criteria for determiningif the service inception date precedes the grant date for our performance-basedawards under SFAS No. 123R. As of December 31, 2006, we had a $15million liability recorded for these awards.

The Compensation Committee granted the 2004-2006performance-based awards through the Key Employee Award Program (the KeyEmployee Program) established under the Reliant Energy, Inc. 2002Long-Term Incentive Plan. Under the Key Employee Program, each performance-basedaward represented a targeted award of (a) 16,000 shares ofperformance-based stock, (b) 68,000 performance-based stock options and (c) 16,000cash units with each cash unit having an equivalent fair market value of 

F-34

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one share of our commonstock on the vesting date. The three-year performance period ended on December 31,2006. On January 26, 2007, the Compensation Committee determined thepayout percentage was 80%.

Summarizedperformance-based stock award activity of the Key Employee Program based on the80% achievement is:

| ** **                     | ** ** | **2006**   | ** ** |
|--------------------------------|------------|------------|------------|
| ** **                     | ** ** | **Shares** | ** ** | **Reporting  Measurement  Date Fair Value** | ** ** |
| Beginning of  period           |       | 1,825,600  | (1)        |   |   |   |   |
| Granted                        |       | —     |       |   |   |   |   |
| Vested                         |       | —     |       |   |   |   |   |
| Forfeited                      |       | (67,200    | )(1)       |   |   |   |   |
| Performance  factor adjustment |       | (753,600   | )          |   |   |   |   |
| End of period                  |       | 1,004,800  | (2)        |   | $ | 14.48 |   |   |
|                                |            |            |            |  |  |  |  |  |

----

(1)             Theseamounts were based on a maximum payout of 140%.

(2)             Theseawards were determined on January 26, 2007 and 745,605 shares were issued,net of shares withheld for income taxes.

Summarizedperformance-based option activity of the Key Employee Program based on the 80%achievement is:

| ** **                              | ** ** | **2006**    | ** ** |
|-----------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (Years)** | ** ** |
| Beginning of  period                    |       | 7,758,800   | (1)        |   | $ | 8.35 |   |   |   |   |   |   |
| Granted                                 |       | —      |       |   | — |   |   |   |   |   |   |
| Exercised                               |       | —      |       |   | — |   |   |   |   |   |   |
| Forfeited                               |       | (285,600    | )(1)       |   | 8.14 |   |   |   |   |   |   |
| Expired                                 |       | —      |       |   | — |   |   |   |   |   |   |
| Performance  factor adjustment          |       | (3,202,800  | )          |   | 8.36 |   |   |   |   |   |   |
| End of period                           |       | 4,270,400   | (2)(3)     |   | 8.36 |   |   |   | 7 |   |   |
| Exercisable at  end of period           |       | —      |       |   | — |   |   |   | — |   |   |
| Weighted average grant  date fair value |       | N/A         |       |   |   |   |   |   |   |   |   |

----

(1)             Theseamounts were based on a maximum payout of 140%.

(2)             Theseoptions were determined on January 26, 2007.

(3)             Theaggregate intrinsic value is $25 million.

| ** **                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Weighted-average  grant date fair value of performance-based stock awards granted  |       | $        | 12.63      |     | $          | 8.15 |   |
| Weighted-average  grant date fair value of performance-based stock options granted |       | $        | 5.54       |     | $          | 5.00 |   |
| Performance-based  options exercised                                               |       | —   |       | —   |       |

 

F-35

----

Ouroption awards under the Key Employee Program are based on the followingweighted average assumptions and resulting fair values:

| ** **                   | ** ** | **2006** | ** ** |
|------------------------------|------------|----------|------------|
| Expected term in  years(1)   |       | 3        |       |
| Estimated  volatility(2)     |       | 31.21    | %          |
| Risk-free  interest rate     |       | 4.9      | %          |
| Dividend yield               |       | 0        | %          |
| Weighted-average fair  value |       | $        | 7.52       |   |
|                              |            |          |            |  |

----

(1)             Theexpected term is based on a projection of exercise behavior considering thecontractual terms and the participants of the option awards.

(2)             Weestimated volatility based on historical and implied volatility of our commonstock.

| ** **                                                                                                              | ** ** | **2006**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                              | ** ** | **(dollars in millions)** | ** ** |
| Fair value of  performance-based awards that vested based on the market price of our common  stock on the vesting date  |       | N/A                                 |       | $        | 1          |     | $          | 2 |   |
| December  31,  2006 total compensation cost related to nonvested performance-based awards  not yet recognized |       | $                                   | —     |     | N/A        |     | N/A        |   |
|                                                                                                                         |            |                                     |            |          |            |          |            |  |  |  |

 

*EmployeeStock Purchase Plan.*   We have 18 million sharesof authorized common stock reserved and approved for issuance under the ReliantEnergy, Inc. Employee Stock Purchase Plan (ESPP). Under the ESPP,substantially all employees can purchase our common stock through payrolldeductions of up to 15% of eligible compensation during semiannual offeringperiods commencing on January 1 and July 1 of each year. The shareprice paid by participants equals 85% of the lesser of the average market priceon the first or last business day of each offering period.

Theestimated fair value of the discounted share price element in our ESPP is basedon the following weighted average assumptions:

| ** **                   | ** ** | **2006** | ** ** | **2005**(1) | ** ** | **2004**(1) | ** ** |
|------------------------------|------------|----------|------------|-------------|------------|-------------|------------|
| Expected term in  years      |       | 0.5      |       | 0.5         |       | 0.5         |       |
| Estimated  volatility(2)     |       | 42.96    | %          | 32.97       | %          | 41.18       | %          |
| Risk-free  interest rate     |       | 4.74     | %          | 2.94        | %          | 1.21        | %          |
| Dividend yield               |       | 0        | %          | 0           | %          | 0           | %          |
| Weighted-average fair  value |       | $        | 3.02       |        | $          | 3.25        |       | $ | 2.29 |   |
|                              |            |          |            |             |            |             |            |  |  |  |

----

(1)             Becausewe applied APB No. 25 during 2005 and 2004, this was only used forpro-forma data.

(2)             Weestimated volatility based on the historical volatility of our common stock.

During 2006, 2005 and 2004, we issued 859,549 shares,838,120 shares and 1,580,295 shares, respectively, under the ESPP and received$8 million, $8 million and $9 million, respectively, from the sale of shares toemployees. Approximately 10.7 million reserved unissued shares were availableunder the ESPP as of December 31, 2006.

F-36

----

*Pro-forma Data for 2005and 2004.**  *Ifemployee stock-based compensation costs had been expensed based on the fairvalue (determined using the Black-Scholes model and market price of our commonstock) method of accounting applied to all stock-based awards, our pro formaresults would be:

| ** **                                                                                                                                              | ** ** | **   2005   **                | ** ** | **   2004   ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                              | ** ** | **(in millions, except  per-share amounts)** | ** ** |
| Net loss, as  reported                                                                                                                                  |       |                                                        | $          | (331                                         | )          |   |   | $ | (29 | ) |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                            |       |                                                        | 5          |                                         |       |   | 21 |   |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |       |                                                        | (17        | )                                            |       |   | (26 | ) |   |
| Pro forma net  loss                                                                                                                                     |       |                                                        | $          | (343                                         | )          |   |   | $ | (34 | ) |   |
| Loss per share:                                                                                                                                         |       |                                                        |       |                                         |       |   |   |   |   |
| Basic and diluted, as reported                                                                                                                          |       |                                                        | $          | (1.09                                        | )          |   |   | $ | (0.10 | ) |   |
| Basic and  diluted, pro forma                                                                                                                           |       |                                                        | $          | (1.13                                        | )          |   |   | $ | (0.12 | ) |   |

 

Weused the Black-Scholes option-pricing model with the following weighted averageassumptions and resulting fair values:

| ** **                   | ** ** | **Options** | ** ** |
|------------------------------|------------|-------------|------------|
| ** **                   | ** ** | **2005**    | ** ** | **2004** | ** ** |
| Expected term in  years      |       | 5           |       | 5 |   |
| Estimated  volatility(1)     |       | 45.75       | %          | 72.85 | % |
| Risk-free  interest rate     |       | 4.18        | %          | 3.01 | % |
| Dividend yield               |       | 0           | %          | 0 | % |
| Weighted-average fair  value |       | $           | 5.72       |   | $ | 5.00 |   |
|                              |            |             |            |  |  |  |  |

----

(1)             For2005 and 2004 options, we estimated volatility based on an equal weighting ofhistorical and implied volatility of our common stock.

*Classification.**  *Through December 31, 2005, ouraccruals for our stock-based incentive awards were recorded as liabilities. BeginningJanuary 1, 2006, for stock-based equity awards, we reclassified ouraccrual of $23 million to equity, of which $5 million was classified astemporary equity stock-based compensation based on the redemption amount of theaward as of the grant date, and the remainder was classified as additionalpaid-in capital in stockholders’ equity. Some of our stock-based equity awardsprovide for the settlement of the award in cash by us pursuant to change ofcontrol provisions and we do not believe it is probable these awards willbecome redeemable.

*Other.**  *We did not use cash to settleequity instruments granted under stock-based compensation plans during 2006,2005 or 2004. During 2006, 2005 and 2004, there were no significantmodifications to our outstanding stock-based awards.

***(b)***           Pensionand Postretirement Benefits.

*BenefitPlans.*   We sponsor multiple defined benefitpension plans. We provide subsidized postretirement benefits to some bargainingemployees but generally do not provide them to non-bargaining employees.

Effective December 31, 2006, we adopted Statementof Financial Accounting Standards No. 158, “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans.”  This statement requires recognition of thefunded status of plans, measured as of year end. We already use the required 

F-37

----

measurement date. Theadoption did not have a material effect on any individual line item of ourconsolidated balance sheet as of December 31, 2006. As of December 31,2006, $0 and $1 million of net gain/loss and net prior service costs,respectively, in accumulated other comprehensive loss are expected to berecognized in net periodic benefit cost during the next 12 months. However, theactual amounts reclassified into earnings will vary from the amounts recordedas of December 31, 2006 due to future changes in market conditions.

We usea December 31 measurement date for our plans. Our benefit obligations andfunded status are:

| ** **                           | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **                           | ** ** | **(in millions)** | ** ** |
| **Change  in Benefit Obligation**    | ** ** | ** **             | ** ** | ** **                       | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Beginning of year                    |       | $                      | 82         |                             | $          | 65 |   |   | $ | 67 |   |   |   | $ | 72 |   |   |
| Service cost                         |       | 6                      |       | 6                                |       |   | 2 |   |   |   | 2 |   |   |
| Interest cost                        |       | 5                      |       | 4                                |       |   | 4 |   |   |   | 4 |   |   |
| Benefits paid                        |       | (2                     | )          | (2                               | )          |   | — |   |   |   | (1 | ) |   |
| Actuarial (gain) loss                |       | (1                     | )          | 9                                |       |   | — |   |   |   | (10 | ) |   |
| End of year                          |       | $                      | 90         |                             | $          | 82 |   |   | $ | 73 |   |   |   | $ | 67 |   |   |
| **Change  in Plan Assets**           | ** ** | ** **             | ** ** | ** **                       | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Beginning of year                    |       | $                      | 50         |                             | $          | 39 |   |   | $ | — |   |   |   | $ | — |   |   |
| Employer contributions               |       | 4                      |       | 11                               |       |   | — |   |   |   | 1 |   |   |
| Benefits paid                        |       | (2                     | )          | (2                               | )          |   | — |   |   |   | (1 | ) |   |
| Actual investment return             |       | 7                      |       | 2                                |       |   | — |   |   |   | — |   |   |
| End of year                          |       | $                      | 59         |                             | $          | 50 |   |   | $ | — |   |   |   | $ | — |   |   |
| **Reconciliation  of Funded Status** | ** ** | ** **             | ** ** | ** **                       | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Funded status                        |       | $                      | (31        | )                                | $          | (32 | ) |   | $ | (73 | ) |   |   | $ | (67 | ) |   |
| Unrecognized prior service cost      |       | —                 |       | 8                                |       |   | — |   |   |   | 4 |   |   |
| Unrecognized actuarial loss          |       | —                 |       | 14                               |       |   | — |   |   |   | 6 |   |   |
| Net amount  recognized               |       | $                      | (31        | )                                | $          | (10 | ) |   | $ | (73 | ) |   |   | $ | (57 | ) |   |

 

Amountsrecognized in the consolidated balance sheets are:

| ** **             | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **             | ** ** | **December 31,**  | ** ** | **December 31,**            | ** ** |
| ** **             | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **             | ** ** | **(in millions)** | ** ** |
| Current  liabilities   |       | $                      | —     |                             | $          | — |   |   | $ | (1 | ) |   |   | $ | — |   |   |
| Noncurrent liabilities |       | (31                    | )          | (16                              | )          |   | (72 | ) |   |   | (57 | ) |   |
| Intangible asset       |       | —                 |       | 6                                |       |   | — |   |   |   | — |   |   |
| Net amount  recognized |       | $                      | (31        | )                                | $          | (10 | ) |   | $ | (73 | ) |   |   | $ | (57 | ) |   |

 

The accumulated benefit obligation for all pensionplans was $81 million and $73 million as of December 31, 2006 and 2005,respectively. All pension plans have accumulated benefit obligations in excessof plan assets.

F-38

----

Netbenefit costs are:

| ** **                             | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|----------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                             | ** ** | **(in millions)** | ** ** |
| Service cost                           |       |                   | $          | 6                                |       |   |   | $ | 6 |   |   |   | $ | 6 |   |   |   | $ | 2 |   |   |   | $ | 2 |   |   |   | $ | 2 |   |   |
| Interest cost                          |       |                   | 5          |                             |       |   | 4 |   |   |   | 3 |   |   |   | 4 |   |   |   | 4 |   |   |   | 4 |   |   |
| Expected return  on plan assets        |       |                   | (4         | )                                |       |   | (3 | ) |   |   | (2 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Curtailments and  benefits enhancement |       |                   | —     |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Net amortization                       |       |                   | 1          |                             |       |   | 1 |   |   |   | 1 |   |   |   | — |   |   |   | 2 |   |   |   | 2 |   |   |
| Net benefit cost                       |       |                   | $          | 8                                |       |   |   | $ | 8 |   |   |   | $ | 8 |   |   |   | $ | 6 |   |   |   | $ | 8 |   |   |   | $ | 6 |   |   |

 

*Assumptions.*   Thesignificant weighted average assumptions used to determine the benefitobligations are:

| ** **                               | ** ** | **Pension**           | ** ** | **Postretirement Benefits** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **December 31,** | ** ** | **December 31,**            | ** ** |
| ** **                               | ** ** | **2006**              | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| Discount rate                            |       | 5.75                  | %          | 5.75                             | %          |   | 5.75 | % |   |   | 5.75 | % |   |
| Rate of increase in  compensation levels |       | 3.0                   | %          | 3.0                              | %          |   | 3.0 | % |   |   | 3.0 | % |   |

 

Thesignificant weighted average assumptions used to determine the net benefitcosts are:

| ** **                                   | ** ** | **Pension** | ** ** | **Postretirement Benefits** | ** ** |
|----------------------------------------------|------------|-------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2006**    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Discount rate                                |       | 5.75        | %          | 5.75                             | %          | 6.25 | % | 5.75 | % | 5.75 | % | 6.25 | % |
| Rate of increase  in compensation levels     |       | 3.0         | %          | 3.0                              | %          | 4.5 | % | 3.0 | % | 3.0 | % | 4.5 | % |
| Expected long-term rate  of return on assets |       | 7.5         | %          | 7.5                              | %          | 7.5 | % | N/A |   | N/A |   | N/A |   |

 

As of December 31, 2006 and 2005, we developedour expected long-term rate of return on pension plan assets based on thirdparty models. These models consider expected inflation, current dividendyields, expected corporate earnings growth and risk premiums based on theexpected volatility of each asset category. We weight the expected long-termrates of return for each asset category to determine our overall expectedlong-term rate of return on pension plan assets. In addition, we review peerdata and historical returns.

Ourassumed health care cost trend rates used to measure the expected cost ofbenefits covered by our postretirement plans are:

| ** **                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                     |       | 9.0      | %          | 9.0      | %          | 9.75     | %          |
| Rate to which the  cost trend rate is assumed to gradually decline     |       | 5.5      | %          | 5.5      | %          | 5.5      | %          |
| Year that the rate  reaches the rate to which it is assumed to decline |       | 2015     |       | 2011     |       | 2011     |       |

 

Assumed health care cost trend rates can have asignificant effect on the amounts reported for our health care plans. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects as of December 31, 2006:

| ** **                                               | ** ** | **One-Percentage Point** | ** ** |
|----------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                               | ** ** | ** Increase **      | ** ** | ** Decrease ** | ** ** |
| ** **                                               | ** ** | **(in millions)**        | ** ** |
| Effect on service  and interest cost                     |       |                          | $          | 1 |   |   |   | $ | (1 | ) |   |
| Effect on accumulated  postretirement benefit obligation |       |                          | 10         |   |   |   | (9 | ) |   |

 

F-39

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*Plan Assets.*   Ourpension weighted average asset allocations and target allocation by assetcategory are:

| ** **                       | ** ** | **Percentage of Plan Assets  as of December 31,**  | ** ** | **Target Allocation**                                                       | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** | **2007** | ** ** |
| Domestic equity  securities      |       |                                                                             | 50         | %                                                                                |       |   | 50 | % |   |   | 50 | % |   |
| International  equity securities |       |                                                                             | 11         |                                                                             |       |   | 11 |   |   |   | 10 |   |   |
| Global equity  securities        |       |                                                                             | 11         |                                                                             |       |   | 10 |   |   |   | 10 |   |   |
| Debt securities                  |       |                                                                             | 28         |                                                                             |       |   | 29 |   |   |   | 30 |   |   |
| Total                            |       |                                                                             | 100        | %                                                                                |       |   | 100 | % |   |   | 100 | % |   |

 

Inmanaging the investments associated with the pension plans, our objective is toexceed, on a net-of-fee basis, the rate of return of a performance benchmarkcomposed of the following indices:

| **Asset Class**             | ** ** | ** **                            | ** ** | **Index** | ** ** | **Weight** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-----------|------------|------------|------------|
| Domestic equity  securities      |       | Wilshire  5000 Index                  |       |      | 50         | %          |       |
| International  equity securities |       | MSCI  All Country World Ex-U.S. Index |       |      | 10         |       |       |
| Global equity  securities        |       | MSCI  All Country World Index         |       |      | 10         |       |       |
| Debt securities                  |       | Lehman  Brothers Aggregate Bond Index |       |      | 30         |       |       |
| Total                            |       |                                  |       |      | 100        | %          |       |

 

As a secondary measure, we compare asset performanceto the returns of a universe of comparable funds, where applicable, over a fullmarket cycle. Our Benefits Committee reviews plan asset performance eachquarter by comparing the actual quarterly returns of each asset class to itsrelated benchmark. Our plan assets have generally performed in accordance withthe benchmarks.

*Cash Obligations.*   Weexpect pension cash contributions to approximate $5 million during 2007. Expectedbenefit payments for the next ten years, which reflect future service asappropriate, are:

| ** ** | ** ** | **Pension**            | ** ** | **Postretirement  Benefits** | ** ** |
|------------|------------|------------------------|------------|------------------------------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| 2007       |       |                   | $          | 1                            |       |   |   | $ | 1 |   |   |
| 2008       |       |                   | 2          |                         |       |   | 2 |   |   |
| 2009       |       |                   | 2          |                         |       |   | 3 |   |   |
| 2010       |       |                   | 3          |                         |       |   | 3 |   |   |
| 2011       |       |                   | 4          |                         |       |   | 4 |   |   |
| 2012-2016  |       |                   | 31         |                         |       |   | 30 |   |   |

 

***(c)***            SavingsPlan.

We have employee savings plans under Sections 401(a) and401(k) of the Internal Revenue Code. Under the plans, participatingemployees may contribute a portion of their compensation generally up to amaximum of 50% in total for pre-tax and/or Roth 401(k) plus 16%after-tax during 2006, 50% pre-tax and 16% after-tax during 2005 and 16%pre-tax or after-tax during 2004, with the exception of the Orion PowerHoldings savings plan under which contributions are generally up to a maximumof 18% of compensation. Bargaining employees contribute based on theirrespective agreements. Our savings plans benefit expense, including thematching contributions of generally up to 6% and discretionary contributions,was $19 million, $19 million and $23 million during 2006, 2005 and 2004,respectively.

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We sponsor non-qualifieddeferred compensation plans for key and highly compensated employees. Ourobligations under these plans were $39 million and $37 million and related rabbi trust investments were $28million and $27 million as of December 31, 2006 and 2005, respectively.

***(d)***           OtherEmployee Matters.

As of December 31,2006, approximately 32% of our employees are subject to collective bargainingarrangements. Approximately 20% of our employees are subject to collectivebargaining arrangements that will expire in 2007.

**(11)**   IncomeTaxes

***(a)***          Summary.

Ourincome tax expense (benefit) is:

| ** **                                       | ** ** | **2006**               | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| **Current:**                                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal                                          |       | $                      | —     |       | $          | 7          |       | $ | (5 | ) |
| State                                            |       | 30                     |       | 19         |       | (2         | )          |
| Total current                                    |       | 30                     |       | 26         |       | (7         | )          |
| **Deferred:**                                    | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal                                          |       | (19                    | )          | (305       | )          | (149       | )          |
| State                                            |       | (133                   | )          | 26         |       | 40         |       |
| Total deferred                                   |       | (152                   | )          | (279       | )          | (109       | )          |
| Income tax  benefit from continuing operations   |       | $                      | (122       | )          | $          | (253       | )          | $ | (116 | ) |
| Income tax benefit from  discontinued operations |       | $                      | (5         | )          | $          | (68        | )          | $ | (19 | ) |

 

Areconciliation of the federal statutory income tax rate to the effective incometax rate is:

| ** **                                                   | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                   | ** ** | **(in millions)** | ** ** |
| Loss from  continuing operations before income taxes         |       | $                      | (449       | )        | $          | (694     | )          | $ | (392 | ) |
| Federal statutory  rate                                      |       | 35                     | %          | 35       | %          | 35       | %          |
| Income tax  benefit at statutory rate                        |       | (157                   | )          | (243     | )          | (137     | )          |
| Net addition  (reduction) in taxes resulting from:           |       |                   |       |     |       |     |       |
| Federal tax reserves                                         |       | 12                     |       | 1        |       | (12      | )          |
| Federal valuation allowance                                  |       | 68                     | (1)        | —   |       | —   |       |
| State income taxes, net of federal income taxes              |       | (55                    | )(2)       | 29       |       | 25       |       |
| Capital loss valuation allowances                            |       | —                 |       | (82      | )          | —   |       |
| Debt conversion expense                                      |       | 13                     |       | —   |       | —   |       |
| Changes in estimates of deferred tax assets and  liabilities |       | —                 |       | 29       |       | —   |       |
| Other, net                                                   |       | (3                     | )          | 13       |       | 8        |       |
| Total                                                        |       | 35                     |       | (10      | )          | 21       |       |
| Income tax  benefit from continuing operations               |       | $                      | (122       | )        | $          | (253     | )          | $ | (116 | ) |
| Effective rate                                               |       | 27                     | %          | 36       | %          | 29       | %          |

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(1)             Ofthis amount, $18 million relates to the reduction of net deferred tax assets.

(2)             Ofthis amount, $40 million relates to Pennsylvania state law changes, whicheffectively decreased all limitations to use net operating losses in thatstate.

F-41

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| ** **                                            | ** ** | **December 31,**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | **(in millions)** | ** ** |
| **Deferred tax assets:**                              |       |                   |       |   |   |
| Current:                                              |       |                   |       |   |   |
| Derivative liabilities, net                           |       | $                      | 275        |   | $ | 211 |   |
| Capital loss carryforwards                            |       | —                 |       | 86 |   |
| Western states settlement                             |       | 13                     |       | 51 |   |
| Allowance for doubtful accounts and credit provisions |       | 13                     |       | 11 |   |
| Employee benefits                                     |       | 4                      |       | 4 |   |
| Federal valuation allowance                           |       | (10                    | )          | — |   |
| State valuation allowances                            |       | (15                    | )          | — |   |
| Other                                                 |       | 4                      |       | 4 |   |
| Total current deferred tax assets                     |       | 284                    |       | 367 |   |
| Non-current:                                          |       |                   |       |   |   |
| Employee benefits                                     |       | 73                     |       | 51 |   |
| Net operating loss carryforwards                      |       | 620                    |       | 489 |   |
| Capital loss carryforwards                            |       | —                 |       | 40 |   |
| State tax credit carryforwards                        |       | —                 |       | 17 |   |
| Environmental reserves                                |       | 11                     |       | 12 |   |
| Derivative liabilities, net                           |       | 92                     |       | 106 |   |
| Other                                                 |       | 44                     |       | 19 |   |
| Federal valuation allowance                           |       | (50                    | )          | — |   |
| State valuation allowances                            |       | (70                    | )          | (95 | ) |
| Other valuation allowances                            |       | (18                    | )          | (21 | ) |
| Total non-current deferred tax assets                 |       | 702                    |       | 618 |   |
| Total deferred tax assets                             |       | $                      | 986        |   | $ | 985 |   |
| **Deferred tax liabilities:**                         | ** ** | ** **             | ** ** | ** ** | ** ** |
| Current:                                              |       |                   |       |   |   |
| Other                                                 |       | $                      | 9          |   | $ | — |   |
| Total current deferred tax liabilities                |       | 9                      |       | — |   |
| Non-current:                                          |       |                   |       |   |   |
| Depreciation and amortization                         |       | 622                    |       | 649 |   |
| Other                                                 |       | 6                      |       | 6 |   |
| Total non-current deferred tax liabilities            |       | 628                    |       | 655 |   |
| Total deferred tax liabilities                        |       | $                      | 637        |   | $ | 655 |   |
| Accumulated  deferred income taxes, net               |       | $                      | 349        |   | $ | 330 |   |

 

***(b)***           TaxAttribute Carryovers.

| ** **                             | ** ** | **December 31,  2006** | ** ** | **Statutory  Carryforward  Period** | ** ** | **Expiration  Year(s)** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **(in millions)**      | ** ** | **(in years)**                 | ** ** | ** **              | ** ** |
| Net Operating  Loss Carryforwards:     |       |                        |       |                                |       |                    |       |   |   |   |   |
| Federal                                |       |                        | $          | 1,294                               |       |                    |       | 20 |   |   | 2022 through 2026 |   |
| State                                  |       |                        | 3,231      |                                |       |                    | 5 to 20    |   |   | 2007 through 2026 |   |
| Foreign                                |       |                        | 54         |                                |       |                    | 7 to 20    |   |   | 2008 through 2014 |   |
| Charitable  Contribution Carryforwards |       |                        | 4          |                                |       |                    | 5          |   |   | 2009 through 2011 |   |
| State Tax Credit  Carryforwards        |       |                        | 1          |                                |       |                    | 10         |   |   | 2016 |   |
|                                        |            |                             |            |                                     |            |                         |            |  |  |  |  |  |

 

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***(c)***            Agreementwith CenterPoint.

We ceased being a memberof the CenterPoint consolidated tax group as of September 30, 2002 andcould be limited in our ability to use tax attributes related to periodsthrough that date. CenterPoint’s income tax returns for the 1997 to 2002 taxreporting periods are under audit by federal and state taxing authorities. Wehave a tax allocation agreement that addresses the allocation of taxespertaining to our separation from CenterPoint. This agreement provides that wemay carry back net operating losses generated subsequent to September 30,2002 to tax years when we were part of CenterPoint’s consolidated tax group. Thisagreement is subject to CenterPoint’s consent and any existing statutorycarryback limitations. We carried back net operating losses related to 2002 toprior CenterPoint tax years and received a tax refund of $76 million during2004. In addition, pursuant to this agreement with CenterPoint, we will (a) recognizeany costs incurred by CenterPoint for temporary differences related to theperiods prior to September 30, 2002 up to $15 million as an equitycontribution and (b) recognize any benefits realized by CenterPoint fortemporary differences related to the periods prior to September 30, 2002up to $1 million as an equity distribution. Generally, amounts for temporarydifferences in excess of the $15 million and $1 million thresholds will besettled in cash between us and CenterPoint. Pursuant to this agreement,generally, taxes related to permanent differences are the responsibility ofCenterPoint. As of December 31, 2006, we cannot predict the amount of anycontingent liabilities or assets that we may incur or realize under thisagreement.

***(d)***           Federaland State Valuation Allowances.

We assess quarterly our future ability to use federal,state and foreign net operating losses, capital losses and other deferred taxassets. These assessments included an evaluation of our recent history ofearnings and losses, future reversals of temporary differences andidentification of other sources of future taxable income, including theidentification of tax planning strategies in certain situations.

Ourvaluation allowances are:

| ** **                                                                            | ** ** | **Federal**       | ** ** | **State** | ** ** | **Capital, Foreign  and Other, Net** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------|------------|-----------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **(in millions)** | ** ** |
| As of  January 1, 2004                                                           |       |              | $          | —    |       |                                                | $          | 44 |   |   | $ | 226 |   |   |
| Changes in valuation allowance                                                        |       |              | —     |      |       | 52                                                  |       |   | (88 | )(1) |   |
| As of  December 31, 2004                                                         |       |              | —     |      |       | 96                                                  |       |   | 138 |   |   |
| Changes in valuation allowance                                                        |       |              | —     |      |       | (1                                                  | )          |   | (117 | )(2) |   |
| As of  December 31, 2005                                                         |       |              | —     |      |       | 95                                                  |       |   | 21 |   |   |
| Changes in valuation allowance                                                        |       |              | 50         | (3)       |       | (14                                                 | )          |   | (3 | ) |   |
| Changes in valuation allowance included in  accumulated other comprehensive loss |       |              | 10         |      |       | —                                              |       |   | — |   |   |
| Other, net                                                                            |       |              | —     |      |       | 4                                                   |       |   | — |   |   |
| As of December 31,  2006                                                         |       |              | $          | 60        |       |                                                | $          | 85 |   |   | $ | 18 |   |   |

 

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(1)             Netdecrease is primarily due to the utilization of $77 million of previouslyreserved net capital losses from the sale of our European energy operationsprimarily resulting from the sale of our hydropower plants, partially offset bythe transfer of our Liberty operations, which is recorded in discontinuedoperations. See note 21.

(2)             Netdecrease is primarily due to net capital gains recorded during the year and theidentification of various tax planning strategies with respect to the sale ofassets. See note 21. Of the capital loss carryforward impact of $120million, $82 million is recorded in continuing operations and $38 million isrecorded in discontinued operations.

(3)             Net increase isprimarily due to our recent history of losses and the change in our net federaldeferred tax assets.

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***(e)***            TaxContingencies.

Our income tax returns, including years when we wereincluded in CenterPoint’s consolidated tax group, for the 1997 to 2004 taxreporting periods are under audit by federal and state taxing authorities. Theseaudits may result in additional taxes, interest and penalties or revisions ofthe timing of tax payments. We classify interest and penalties related toincome taxes in income tax expense/benefit. We evaluate the need for contingenttax liabilities on a quarterly basis and record any estimable and probable taxexposures in our results of operations. In addition, we disclose any materialtax contingencies as to which we believe there is a reasonable possibility of afuture tax assessment.

We have received proposed tax adjustments andassessments from certain taxing authorities, which are currently at varyingstages of appeals. The issues primarily relate to temporary differences andinclude deductions for bad debts, capitalization of costs to plant andinventory, depreciation, start-up costs and various other matters. It couldtake several years to resolve these contingencies. As of December 31, 2006and 2005, we have accrued contingent federal and state tax liabilities relatedto our continuing operations of $38 million and $46 million, respectively. Thesebalances are classified in other current liabilities and other long-termliabilities. We anticipate settling some of these issues (primarily related toour tax period for the fourth quarter of 2002) during the next 12 months.

As of December 31, 2006 and 2005, we have accruedcontingent federal tax liabilities related to our discontinued European energyoperations of $12 million and $11 million, respectively, included in otherlong-term liabilities in continuing operations. We reserved these amounts forpotential future federal income tax assessments on certain income from theoperations and disposition of our former European subsidiaries. If sustained,the tax assessments from the European operating income would increase ourcapital loss carryforwards by $45 million and reduce our tax net operating losscarryforwards by the same amount. The decrease of $45 million, which isrecorded in discontinued operations, during 2005 is the result of net capitalgains recorded during the year and the identification of tax planningstrategies that would make the realization of additional capital losscarryforwards more likely than not. With respect to the disposition of ourEuropean operations, we cannot predict the amount of any contingent taxes.

We believe that thesubstantial majority of certain payments and charges are deductible for incometax purposes; however, no assurance can be given that the Internal RevenueService would not assert, or that a court would not sustain, a contraryposition. These payments and/or charges include:

·       $177million to CenterPoint during 2004 related to our residential customers. Seenote 14(d).

·       $68million during 2005 to settle the class action lawsuits against us for claimsalleging violations of securities laws. See note 14(c).

·       Apre-tax charge of $351 million during 2005 to settle certain civil litigationand claims relating to the Western states energy crisis. See note 14(a).

·       A pre-tax charge of $35million during 2006 for the settlement of certain class action natural gascases relating to the Western states energy crisis. See note 14(a).

***(f)***             Changesin Accounting for Income Taxes or Tax Laws.

The FASB issued guidance clarifying the accounting foruncertainty in income taxes. Pursuant to the new guidance, which is effectivefor us in 2007, tax benefits are only recorded for positions where it ismore-likely-than-not that our reported tax return treatment would be sustainedif audited by relevant taxing authorities. Additional rules are providedfor interest, penalties, changes in benefit recognition and other relatedmatters. We are currently in the process of determining the impact of thisadoption. Based on our latest estimates, we do not expect the adoption to havea material impact on our consolidated financial statements.

F-44

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In May 2006, theState of Texas enacted substantial changes to its tax system. Effective January 1,2007, the current Texas franchise tax comprised of taxable capital and earnedsurplus components was replaced with a revised franchise tax based on modifiedgross revenue. As a result of the Texas law change, during 2006, we decreasedour net deferred state tax liabilities by $9 million to reflect the estimatedcumulative change to deferred tax items.

**(12)**   Commitments

***(a)***          LeaseCommitments.

*REMALeases.**  *Oneof our subsidiaries, REMA, entered into sale-leaseback transactions, underoperating leases that are non-recourse to us. We lease 16.45% and 16.67%interests in the Conemaugh and Keystone facilities, respectively. The leasesexpire in 2034 and we expect to make payments through 2029. We also lease a100% interest in the Shawville facility. This lease expires in 2026 and weexpect to make payments through that date. At the expiration of these leases,there are several renewal options related to fair market value. REMA LLC’ssubsidiaries guarantee the lease obligations and we have pledged the equityinterests in these subsidiaries as collateral. We provide credit support forREMA’s lease obligations in the form of letters of credit under the December 2006credit facilities. See note 6. During 2006, 2005 and 2004, we made leasepayments under these leases of $64 million, $75 million and $85 million,respectively. As of December 31, 2006 and 2005, we have recorded a prepaidlease of $59 million in other current assets and $264 million and $259 million,respectively, in long-term assets. REMA operates the Conemaugh and Keystonefacilities under agreements that could terminate annually with one year’snotice and received fees of $9 million during 2006, 2005 and 2004. These fees,which are recorded in operation and maintenance expense, are primarily to coverREMA’s administrative support costs of providing these services.

REMA’s ability to pay dividends or pay subordinatedobligations is restricted by conditions within the lease documents. As of December 31,2006, REMA was not limited by these restrictions.

*TollingAgreements.*   We have two tolling arrangementsthat extend through 2007 and 2012. These arrangements, which qualify asoperating leases, entitle us to purchase and dispatch electric generatingcapacity. We paid $63 million, $64 million and $61 million in tolling paymentsduring 2006, 2005 and 2004, respectively.

*OfficeSpace Lease.**  *In 2003,we entered into a long-term operating lease for our corporate headquarters. Thelease expires in 2018 and is subject to two five-year renewal options.

*Cash Obligations UnderOperating Leases.*   Our projected cash obligationsunder non-cancelable long-term operating leases as of December 31, 2006are:

| ** **           | ** ** | **REMA Leases**   | ** ** | **Other**(1)(2) | ** ** | **Total** | ** ** |
|----------------------|------------|------------------------|------------|-----------------|------------|-----------|------------|
| ** **           | ** ** | **(in millions)** | ** ** |
| 2007                 |       |                   | $          | 65              |       |      |       | $ | 76 |   |   | $ | 141 |   |
| 2008                 |       |                   | 62         |            |       |      | 69         |   |   | 131 |   |
| 2009                 |       |                   | 63         |            |       |      | 66         |   |   | 129 |   |
| 2010                 |       |                   | 52         |            |       |      | 64         |   |   | 116 |   |
| 2011                 |       |                   | 63         |            |       |      | 62         |   |   | 125 |   |
| 2012 and  thereafter |       |                   | 819        |            |       |      | 170        |   |   | 989 |   |
| Total                |       |                   | $          | 1,124           |       |      |       | $ | 507 |   |   | $ | 1,631 |   |

 

----

(1)             Includestolling arrangements, rental agreements for office space and capacitycommitments accounted for as leases.

(2)             Excludesprojected sublease income on office space of $38 million.

F-45

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*Operating Lease Expense.*   Totallease expense for all operating leases was $156 million, $152 million and $169million during 2006, 2005 and 2004, respectively.

***(b)***           Guaranteesand Indemnifications.

We have guaranteed some non-qualified benefits ofCenterPoint’s existing retirees at September 20, 2002. The estimatedmaximum potential amount of future payments under the guarantee wasapproximately $56 million as of December 31, 2006. We believe thelikelihood that we would incur any significant losses under this guarantee isremote and, therefore, have not recorded a liability in our consolidatedbalance sheet as of December 31, 2006.

In addition, we are also required to indemnifyCenterPoint for certain liabilities relating to the initial public offering ofour common stock.

We also guarantee the $500 million PEDFA bonds, whichare included in our consolidated balance sheet as outstanding debt. Ourguarantees are secured by guarantees from all of our subsidiaries thatguarantee the December 2006 credit facilities. The guarantees require usto comply with covenants substantially identical to those in the senior securednotes indentures. The PEDFA bonds will become secured by certain assets ofSeward if the collateral supporting both the senior secured notes and ourguarantees is released. Our maximum potential obligation under the guaranteesis for payment of the principal of $500 million and related interest charges ata fixed rate of 6.75%.

We have guaranteed payments to a third party relatingto energy sales from El Dorado Energy, LLC, a former investment. The estimatedmaximum potential amount of future payments under this guarantee isapproximately $21 million as of December 31, 2006. We secured aportion of the guarantee with letters of credit. We have not recorded aliability in our consolidated balance sheet for this guarantee.

We enter into contracts that include indemnificationand guarantee provisions. In general, we enter into contracts with indemnitiesfor matters such as breaches of representations and warranties and covenantscontained in the contract and/or against certain specified liabilities. Examplesof these contracts include asset sales agreements, retail supply agreements,service agreements and procurement agreements.

In our debt agreements, we typically indemnify againstliabilities that arise from the preparation, entry into, administration orenforcement of the agreement.

We are unable to estimate our maximum potentialexposure under these provisions until an event triggering payment under theseprovisions occurs. We do not expect to make any material payments under theseprovisions.

Reliant Energy has issued guarantees in conjunctionwith certain performance agreements and commodity and derivative contracts andother contracts that provide financial assurance to third parties on behalf ofa subsidiary or an unconsolidated third party. The guarantees on behalf ofsubsidiaries are entered into primarily to support or enhance thecreditworthiness otherwise attributed to a subsidiary on a stand-alone basis,thereby facilitating the extension of sufficient credit to accomplish therelevant subsidiary’s intended commercial purposes.

F-46

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Thefollowing table details Reliant Energy’s various guarantees:

| ** **                                                                                                          | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| **Type of Guarantee**                                                                                     | ** ** | ** **                      | ** ** | **Stated  Maximum  Potential  Amount of  Future Payments** | ** ** | **Amount Utilized**(1) | ** ** | **Assets Held as  Collateral** | ** ** | **Carrying Amount  of Liability  Recorded on  Balance Sheet** | ** ** |
| ** **                                                                                                          | ** ** | **(in millions)**          | ** ** |
| Commodity  obligations(2)                                                                                           |       |                            | $          | 3,759 |   |   |   | $ | 265 |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Payment and  performance obligations under power purchase agreements for power generation  assets and renewables(3) |       |                            | 244        |   |   |   | 51 |   |   |   | — |   |   |   | — |   |   |
| Standby letters  of credit(4)                                                                                       |       |                            | 138        |   |   |   | 138 |   |   |   | — |   |   |   | — |   |   |
| Payment and  performance obligations under service contracts and leases(5)                                     |       |                            | 85         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Non-qualified benefits  of CenterPoint’s retirees(6)                                                           |       |                            | 56         |   |   |   | 56 |   |   |   | — |   |   |   | — |   |   |
| Sale of  electricity to commercial, industrial and institutional customers(7)                                       |       |                            | 9          |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total guarantees                                                                                                    |       |                            | $          | 4,291 |   |   |   | $ | 510 |   |   |   | $ | — |   |   |   | $ | — |   |   |
|                                                                                                                     |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             Thisrepresents the estimated portion of the maximum potential amount of futurepayments that is utilized as of December 31, 2006. For those guaranteesrelated to obligations that are recorded as liabilities by our subsidiaries,this includes the recorded amount.

(2)             ReliantEnergy has guaranteed the performance of certain of its wholly-ownedsubsidiaries’ commodity obligations. These guarantees were provided tocounterparties in order to facilitate physical and financial agreements inelectricity, gas, oil, transportation and related commodities and services. Theseguarantees have varying expiration dates.

(3)             ReliantEnergy has guaranteed the payment and performance obligations of certainwholly-owned subsidiaries arising under certain power purchase agreements. Asof December 31, 2006, these guarantees have varying expiration datesthrough May 2012.

(4)             ReliantEnergy has outstanding standby letters of credit, which guarantee theperformance of certain of its wholly-owned subsidiaries. As of December 31,2006, these letters of credit expire on various dates through January 2008.

(5)             ReliantEnergy has guaranteed the payment obligations of certain wholly-ownedsubsidiaries arising under long-term service agreements and leases for certainfacilities. As of December 31, 2006, these guarantees expire over varyingyears through June 2018.

(6)             Seenote 13(c).

(7)             ReliantEnergy has guaranteed commodity related payments for certain wholly-ownedsubsidiaries’ sale of electricity to commercial, industrial and institutionalcustomers to facilitate the physical and financial transactions of electricityservices. As of December 31, 2006, these guarantees expire on variousdates through December 2008.

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Unless otherwise noted, failure by the primary obligorto perform under the terms of the various agreements and contracts guaranteedmay result in the beneficiary requesting immediate payment from Reliant Energy.To the extent liabilities exist under the various agreements and contracts thatReliant Energy guarantees, such liabilities are recorded in Reliant Energy’ssubsidiaries’ balance sheets as of December 31, 2006. We do not expectReliant Energy to make any material payments under these provisions.

***(c)***            Other Commitments.

*Property,Plant and Equipment Commitments.**  *Asof December 31, 2006, we have contractual commitments to spendapproximately $400 million on plant and equipment relating primarily to SO2 emissions reductions.

*Fuel Supply, CommodityTransportation, Purchased Power and Electric Capacity Commitments.**  *We are a party to fuel supplycontracts, commodity transportation contracts and purchased power and electriccapacity contracts of various quantities and durations that are not classifiedas derivative assets and liabilities. These contracts are not included in ourconsolidated balance sheet as of December 31, 2006. Minimum purchasecommitment obligations under these agreements are as follows as of December 31, 2006:

| ** **           | ** ** | **Fuel  Commitments**  | ** ** | **Transportation  Commitments** | ** ** | **Purchased Power  and Electric  Capacity Commitments** | ** ** |
|----------------------|------------|------------------------|------------|---------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **           | ** ** | **Fixed  Pricing**     | ** ** | **Variable  Pricing**(1)        | ** ** | **Fixed  Pricing**                                                     | ** ** | **Fixed  Pricing** | ** ** | **Variable  Pricing** (2) | ** ** |
| ** **           | ** ** | **(in millions)** | ** ** |
| 2007                 |       |                   | $          | 149                             |       |                                                                   |       | $ | 6 |   |   |   | $ | 121 |   |   |   | $ | 50 |   |   |   | $ | 21 |   |   |
| 2008                 |       |                   | 60         |                            |       |                                                                   | 7          |   |   |   | 123 |   |   |   | — |   |   |   | 11 |   |   |
| 2009                 |       |                   | 54         |                            |       |                                                                   | 7          |   |   |   | 114 |   |   |   | — |   |   |   | 9 |   |   |
| 2010                 |       |                   | 24         |                            |       |                                                                   | 7          |   |   |   | 110 |   |   |   | — |   |   |   | — |   |   |
| 2011                 |       |                   | 20         |                            |       |                                                                   | 7          |   |   |   | 104 |   |   |   | — |   |   |   | — |   |   |
| 2012 and  thereafter |       |                   | 158        |                            |       |                                                                   | 43         |   |   |   | 762 |   |   |   | 2 |   |   |   | — |   |   |
| Total                |       |                   | $          | 465                             |       |                                                                   |       | $ | 77 |   |   |   | $ | 1,334 |   |   |   | $ | 52 |   |   |   | $ | 41 |   |   |

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(1)             Forcontracts with variable pricing components, we estimated prices based onassumptions on escalations per the contractual terms.

(2)             Forcontracts with variable pricing components, we estimated prices based onforward commodity curves as of December 29, 2006.

As of December 31, 2006, the maximum remainingterms under any individual fuel supply contract is 14 years, any transportationcontract is 17 years and any purchased power and electric capacity contract is10 years.

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*Sales Commitments.**  *As of December 31, 2006, wehave sales commitments, including electric energy and capacity sales contracts,which are not classified as derivative assets and liabilities. The estimatedminimum sales commitments under these contracts are as follows:

| ** ** | ** ** | **Retail Energy** | ** ** | **Wholesale Energy**   | ** ** |
|------------|------------|------------------------|------------|-----------------------------|------------|
| ** ** | ** ** | **Fixed  Pricing**(1)  | ** ** | **Variable  Pricing**(1)(2) | ** ** | **Fixed  Pricing** | ** ** |
| ** ** | ** ** | **(in millions)** | ** ** |
| 2007       |       |                   | $          | 2,378                       |       |   |   | $ | 1,784 |   |   |   | $ | 234 |   |   |
| 2008       |       |                   | 583        |                        |       |   | 1,263 |   |   |   | 197 |   |   |
| 2009       |       |                   | 320        |                        |       |   | 324 |   |   |   | 163 |   |   |
| 2010       |       |                   | 64         |                        |       |   | 69 |   |   |   | 150 |   |   |
| 2011       |       |                   | 3          |                        |       |   | 8 |   |   |   | 56 |   |   |
| Total      |       |                   | $          | 3,348                       |       |   |   | $ | 3,448 |   |   |   | $ | 800 |   |   |

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(1)             Inconnection with our credit-enhanced retail structure, we estimate the feefor each MWh delivered under these sales commitments to be $16 million, $8million, $3 million and $1 million during 2007, 2008, 2009 and 2010,respectively.

(2)             Forcontracts with variable pricing components, we estimated prices based onforward commodity curves as of December 29, 2006.

*NamingRights to Houston Sports Complex.**  *We acquired the naming rights, including advertising and otherbenefits, for a football stadium and other convention and entertainmentfacilities included in the stadium complex. Pursuant to this agreement, we arerequired to pay $10 million per year from 2002 through 2032.

*Long-term Power GenerationMaintenance Agreements.**  *We have entered into long-term maintenance agreementsthat cover some periodic maintenance, including parts, on power generationturbines. The long-term maintenance agreements terminate from 2008 to 2036based on turbine usage. During 2006, 2005 and 2004, we incurred expenses of $17million, $16 million and $14 million, respectively. Estimated cash paymentsover the next five years for these agreements are as follows (in millions):

| 2007  |   | $  | 29     |   |
|-------|--------|----|--------|--------|
| 2008  |   | 45 |   |
| 2009  |   | 32 |   |
| 2010  |   | 63 |   |
| 2011  |   | 44 |   |
| Total |   | $  | 213    |   |

 

**(13)**   Contingencies

We are party to many legalproceedings, some of which may involve substantial amounts. Unless otherwisenoted, we cannot predict the outcome of the matters described below.

***(a)***          LegalProceedings.

***Pending Electricity and Natural Gas Litigation***

The following proceedings relate to alleged conduct inthe electricity and natural gas markets. In 2005 and 2006, we settled a numberof these proceedings that were pending in California and other Western states;however, a number of other proceedings remain pending.

*ElectricityActions.*   We are party to two remaining lawsuits relating to our participation inalleged conduct to increase electricity prices in violation of antitrust laws,unfair competition laws and similar laws. The lawsuits seek treble damages,restitution and expenses. These lawsuits are on appeal from orders of 

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the United States DistrictCourt, Western District of Washington and the United States District Court,District of Oregon, respectively, that dismissed these cases in our favor. Athird related case was recently dismissed in our favor from the Superior Courtof California Santa Clara County. The other electricity lawsuits were settledas part of our 2005 settlement. While there are certain issues on appeal inthese other cases, we do not believe the appeals will materially impact theunderlying settlement.

*NaturalGas Actions.**  *Weare party to 28 lawsuits, several of which are class action lawsuits, includingan action brought by the Nevada Attorney General on behalf of gas consumers inNevada, in state and federal courts in California, Colorado, Kansas, Missouri,Nevada and Tennessee and a lawsuit filed in December 2006 in the CircuitCourt of Dane County, Wisconsin. These lawsuits relate to alleged conduct toincrease natural gas prices in violation of antitrust and similar laws. Thelawsuits seek treble damages, restitution and/or expenses. The lawsuits alsoname our subsidiary, Reliant Energy Services, Inc. (Reliant EnergyServices), and a number of unaffiliated energy companies as parties. In December 2006,we reached a settlement of 12 natural gas cases pending in state court inCalifornia. See note 14(a).

One of the natural gas cases is a case filed by theLos Angeles Department of Water and Power (LADWP) in the California SuperiorCourt in 2004. The lawsuit alleges that we conspired to manipulate natural gasprices in breach of our supply contract with LADWP and in violation ofCalifornia’s antitrust laws and the California False Claims Act. The lawsuitseeks treble damages for the alleged overcharges (estimated to be $218 million)for gas purchased by LADWP, interest and legal costs. The lawsuit also seeks (a) adetermination that an extension of the contract with LADWP was invalid in thatthe required municipal approvals for the extension were allegedly not obtainedand (b) a return of all money paid by LADWP during that period (estimatedto be $681 million).

*Criminal Proceeding—ReliantEnergy Services.**  *InApril 2004, a California federal grand jury indicted Reliant EnergyServices and some of its former and current employees for alleged violations ofthe Commodity Exchange Act, wire fraud and on conspiracy charges. Theindictment claims Reliant Energy Services manipulated prices by curtailingelectricity generation in California on two days in June 2000. We believethe actions alleged in the indictment did not violate laws in effect duringthis period and are contesting the indictment vigorously. In February 2006,the judge denied the motions to dismiss that were filed by Reliant EnergyServices and some of its former and current employees in this proceeding. Thiscase has been set for trial in March 2007 in the United States DistrictCourt for the Northern District of California. If convicted, our subsidiarycould be assessed statutory penalties equal to twice the alleged benefit to usfrom the conduct or twice the alleged harm to the market from the conduct. Theindictment alleges that the conduct could have resulted in harm to the marketof up to $32 million. In addition, a criminal conviction of Reliant EnergyServices could result in potential suspension or debarment from governmentcontracting. We do not believe that the indictment will have any materialadverse impact on our business operations.

***PUCT Cases***

There are variousproceedings pending before the state district court in Travis County, Texas,seeking reviews of the Public Utility Commission of Texas (PUCT) ordersrelating to the fuel factor component used in our “price-to-beat” tariff. Theseproceedings pertain to the same issues affirmed by a district court in TravisCounty and later by the Travis County Court of Appeals in 2004 in a separateproceeding.

***(b)***           EnvironmentalMatters.

*NewSource Review Matters.**  *TheUnited States Environmental Protection Agency (EPA) and various states areinvestigating compliance of coal-fueled electric generating stations with the “NewSource Review” requirements of the Clean Air Act. The EPA has agreed to shareinformation relating to its investigations with state environmental agencies. Weare unable to predict the ultimate outcome of the 

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EPA’s investigation. In November 2005,we received a notice of intent to sue pursuant to the Clean Air Act from thestate of New Jersey relating to one of our power plants located in Pennsylvania.The allegations relate to conduct that occurred prior to our ownership of thepower plant. If the state of New Jersey sues us and is successful, we couldincur significant capital expenditures associated with the implementation ofemissions reductions on an accelerated basis and possible penalties. In February 2007,the state of New Jersey filed suit against the EPA to force a ruling on thepetition filed by the state of New Jersey relating to renewal of an air permitfor our plant.

*AshDisposal Site Closures.**  *We are responsible for environmental costs related tothe future closures of seven ash disposal sites, five of which are owned inwhole or in part by REMA and two of which are owned by Orion MidWest. Based onour evaluations with assistance from third-party consultants and engineers, werecorded the estimated discounted costs associated with these environmentalliabilities as part of our asset retirement obligations. See note 2(p).

*RemediationObligations.*   We are responsible forenvironmental costs related to site contamination investigations andremediation requirements at four power plants in New Jersey. Based on ourevaluations with assistance from third-party consultants and engineers, werecorded the estimated liability for the remediation costs of $7 million as of December 31,2006 and 2005.

*NewCastle Notice of Violation.*   In December 2006,we received a Notice of Violation from the Pennsylvania Department ofEnvironmental Protection regarding the elevation of the permitted coal ashlandfill at Orion MidWest’s generating site in New Castle, Pennsylvania. We arecurrently negotiating a penalty amount with the agency, which we estimate willbe approximately $100,000.

*Conemaugh Notice of Intentto Sue.**  *InFebruary 2007, we received notice of intent to sue from PennEnvironmentand the Sierra Club alleging that the Conemaugh plant is in violation of itswater discharge permit and related state and federal laws. The Conemaugh plantis jointly owned by us and seven other companies and is governed by a consentorder agreement with the Pennsylvania Department of Environmental Protection. Weare confident that the Conemaugh plant has operated and will continue tooperate in material compliance with that agreement, its water discharge permitand related state and federal laws. If PennEnvironment and the Sierra Club sueus and are successful, we could incur significant capital expendituresassociated with the implementation of discharge reductions on an acceleratedbasis and possible penalties.

***(c)***            Other.

*PUCTComplaint.**  *A marketparticipant has filed a complaint at the PUCT relating to ERCOT’s procedure forallocating replacement reserve charges for 2006. Although it is very early inthe process and we are still evaluating the complaint, if the PUCT ordersresettlement of the charges and depending on the method of resettlement, ourshare of the resettlement charges could be up to $25 million.

*CenterPoint Indemnity.**  *We have agreed to indemnify CenterPoint againstcertain losses relating to the lawsuits described in note 13(a) under“Pending Electricity and Natural Gas Litigation—Natural Gas Actions.” We havealso agreed to indemnify CenterPoint against losses relating to an allegedbreach of fiduciary duties in violation of the Employee Retirement IncomeSecurity Act in a class action lawsuit in the United States District Court forthe Southern District of Texas. The lawsuit seeks monetary damages andrestitution. In January 2006, the court granted CenterPoint’s motion forsummary judgment and dismissed the case with prejudice. The court’s decision ison appeal to the United States Court of Appeals for the Fifth Circuit.

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**(14)**   Settlementsand Other Charges

***(a)***          WesternStates and Cornerstone Settlements.

In August 2005, we entered into an agreement,which the FERC approved in December 2005, with the states of California,Oregon and Washington, California’s three largest investor-owned utilities anda number of other parties that resolves as to the settling parties a number ofthe regulatory and civil proceedings and claims related to the Western statesenergy crisis of 2000 and 2001.

Although the settlement resolves a number of theregulatory and civil proceedings relating to the Western states energy crisisof 2000 and 2001, it did not resolve the following Western states electricityand natural gas proceedings:  (a) thecriminal proceeding against Reliant Energy Services, (b) lawsuits filed byprivate class action litigants and individual consumers regarding an allegedconspiracy to increase natural gas prices (a number of these class actions haverecently been settled as described below) and (c) two pending lawsuitsfiled by individual electricity consumers. See note 13(a).

Additionally, in December 2005, we agreed inprinciple to settle the class action lawsuits filed in New York involvingallegations of manipulation of NYMEX natural gas contracts (the Cornerstonesettlement). The settlement was approved in May 2006.

During2005, we recorded charges of $359 million, which include cash payments of $160million during 2006. As part of the settlement, we waived claims to andtransferred our interest in our receivables for power deliveries from January 1,2000 to June 20, 2001, as well as the interest owed on those receivables. Thecomponents of the settlement charge are (in millions):

| Accounts  receivable related to the period from October 2000 through  June 2001, excluding estimated refund obligation |   | $   | 268    |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|-----|--------|--------|
| Estimated refund obligation                                                                                                      |   | (87 | )      |
| Discount                                                                                                                         |   | (14 | )      |
| Interest  receivable                                                                                                             |   | 41  |   |
| Cash payments                                                                                                                    |   | 150 | (1)    |
| Cornerstone  settlement                                                                                                          |   | 8   |   |
| Other                                                                                                                            |   | (7  | )      |
| Total                                                                                                                            |   | $   | 359    | (2)    |

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(1)             Thispayable was included in accounts payable as of December 31, 2005.

(2)             Thesettlement also included undertakings not involving the payment of cash or thewaiver of rights to receivables.

Priorto reaching a settlement in August 2005, we regularly adjusted ourestimated refund obligation, credit reserve and receivables (netted inrevenues) and interest income (recorded in interest income) related to theseenergy sales in California as new information was obtained or events occurred(income (loss)):

| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
| Estimated refund  obligation             |       |     | $          | 2        |       |   | $ | (8 | ) |
| Credit reserve                           |       |     | —     |     |       | 21 |   |
| Direct adjustments  to gross receivables |       |     | —     |     |       | (11 | ) |
| Discount                                 |       |     | (1         | )        |       | (13 | ) |
| Interest  receivable                     |       |     | 6          |     |       | 16 |   |
| Net impact                               |       |     | $          | 7        |       |   | $ | 5 |   |

 

In December 2006, wereached a settlement of the 12 class action natural gas cases pending in statecourt in California. The settlement requires us to pay $35 million, which weexpensed during the third 

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quarterof 2006. The settlement does not include similar cases filed by individualplaintiffs and cases filed in jurisdictions other than California, which wecontinue to vigorously defend. The settlement is subject to a fairness hearingand court approval, which we expect to occur in the first or second quarter of2007. We have not admitted wrongdoing or liability and we continue to deny theplaintiff’s allegations.

***(b)***           NevadaPower.

In August 2005, weentered into a settlement agreement with Nevada Power Company resolving (a) acomplaint filed by Nevada Power Company with the FERC seeking to revise theprices of long-term forward power contracts and (b) an arbitration claimrelating to our alleged participation in an unlawful conspiracy to increase theprice of natural gas in Nevada from 2001 to 2002. We recognized a charge of $8million during 2005.

***(c)***            ShareholderClass Action Lawsuits.

In July 2005, we reached a settlement agreement relatedto the class action lawsuits against us for claims alleging violations ofsecurities laws. The settlement agreement provides for a total settlementpayment by us of $68 million, of which $61.5 million is covered by director andofficer insurance policies. In addition, Deloitte & Touche LLP, ourindependent auditor at the time and a defendant in the litigation, agreed tomake a payment of $7 million. The settlement also includes releases to allclaims asserted by the plaintiffs against some of our former officers. Duringthe second quarter of 2005, we recognized a charge of $8 million related to thesettlement and associated legal expenses.

***(d)***           Paymentto CenterPoint.

In connection with ourseparation agreement, we made a payment of $177 million to CenterPoint in 2004related to our residential customers. We recognized $2 million, $47 million and$128 million during 2004, 2003, and 2002, respectively.

***(e)   Gain on Sale of Counterparty Claim.***

In June 2004, weentered into a settlement agreement with Enron. The settlement agreementprovided for the dismissal of all pending litigation between Enron and us andprovided for certain allowed bankruptcy claims against Enron. In August 2004,we sold and assigned our claim to a third party. As we had previously writtenoff our net receivables and derivative assets from Enron, we recognized a $30million gain upon the sale during the third quarter of 2004.

***(f)***             FERCInvestigations of Western Market Issues.

In January 2003,in connection with the FERC’s investigation of potential manipulation ofelectricity and natural gas prices in the Western United States, the FERCapproved an agreement between its staff and us relating to certain actionstaken by some of our traders over a two-day period in June 2000. Under theagreement (as amended by the Western states settlement), we agreed, among otherthings, to (a) pay $14 million (which was expensed in 2002) directly tocustomers of the California Power Exchange and (b) submit bids for all ofour uncommitted, available capacity from our plants located in California intoa California spot market two additional years following termination of theexisting must offer obligation or until December 31, 2006, whichever islater.

In October 2003,we entered into a settlement agreement with the FERC resolving all but one ofits investigations and proceedings in connection with its ongoing review ofwestern energy markets (which was in addition to the proceedings describedunder “Pending Electricity and Natural Gas Litigation—Electricity Actions” innote 13(a) and related settlement described in note 14(a)). Thesettlement provided, among other things, that we (a) make three cashsettlement payments, totaling $25 million, into 

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a fund established for thebenefit of California and western market electricity consumers of which we paid$15 million in 2003, $5 million in 2005 and $5 million in 2006 and (b) offercapacity from a portion of our generation portfolio in California to the market(totaling 824 MW) for one-year terms for delivery commencing in 2004, 2005 and2006 on a unit-contingent, gas-tolling basis for which we will pay thedifference, up to $25 million, between the collected auction revenues and ourprojected cash costs to generate the power into the fund described above. Wepaid $22 million in 2006 and $3 million in January 2007.

In 2003, we offered, butdid not receive qualifying bids under the settlement agreement for the 12-monthperiod beginning April 2004. During September 2004, we entered into athird party multi-year tolling agreement for the power capacity from two of ourpower generation units in California. The FERC approved our request to treatthe tolling arrangement as meeting our obligation to offer capacity describedin the paragraph above. In 2003, we recognized a $37 million loss for thesettlement. In 2004, as a result of entering into the multi-year tollingagreement, we accrued an additional $12 million for the obligation tocontribute to the above-described fund.

**(15)**   EstimatedFair Value of Financial Instruments

Thefair values of cash and cash equivalents, accounts receivable and payable,margin deposits and derivative assets and liabilities equal their carryingamounts. Values of ourdebt (see note 6) are:

| ** **             | ** ** | **December 31,**  | ** ** |
|------------------------|------------|------------------------|------------|
| ** **             | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **             | ** ** | **Carrying  Value**    | ** ** | **Fair Market  Value**(1) | ** ** | **Carrying  Value** | ** ** | **Fair Market  Value**(1) | ** ** |
| ** **             | ** ** | **(in millions)** | ** ** |
| Fixed rate debt        |       |                   | $          | 2,866 |   |   |   | $ | 3,026 |   |   |   | $ | 3,148 |   |   |   | $ | 3,201 |   |   |
| Floating rate  debt(2) |       |                   | 667        |   |   |   | 669 |   |   |   | 1,958 |   |   |   | 1,937 |   |   |
| Total debt             |       |                   | $          | 3,533 |   |   |   | $ | 3,695 |   |   |   | $ | 5,106 |   |   |   | $ | 5,138 |   |   |

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(1)             Webased the fair market values of our fixed rate and floating rate debt on (a) incrementalborrowing rates for similar borrowing arrangements or (b) information frommarket participants.

(2)             Includes warrantvalues.

**(16)**   SupplementalGuarantor Information

Our 100% owned subsidiaries are either (a) fulland unconditional guarantors, jointly and severally, or (b) non-guarantorsof the senior secured notes. The primary guarantors are:  Reliant Energy California Holdings, LLC;Reliant Energy Northeast Holdings, Inc.; Reliant Energy Power Generation, Inc.and Reliant Energy Services. The primary non-guarantors are:  Channelview, Orion Power, REMA and RERHHoldings. Effective with the December 2006 refinancing and thecredit-enhanced retail structure, RERH Holdings, LLC and its subsidiaries,which comprise our Texas retail energy business, became non-guarantors. Wehave retrospectively adjusted 2005 and 2004 to be comparable to 2006.

Certain of Reliant Energy’s subsidiaries haveeffective restrictions on their ability to pay dividends or make intercompanyloans and advances pursuant to their financing arrangements or other thirdparty agreements. The amount of restricted net assets of Reliant Energy’ssubsidiaries as of December 31, 2006 is approximately $1.4 billion. Suchrestrictions are on the net assets of Orion Power, RERH Holdings andChannelview.

During 2006, 2005 and 2004, Reliant Energy receivedcash distributions from Orion Power for $209 million, $340 million and $718million, respectively. During 2006, Reliant Energy received cash distributionsfrom Reliant Energy Services for $475 million.

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*Condensed Consolidating Statements of Operations.*

| ** **                                                        | ** ** | **2006**                | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                        | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(1) | ** ** | **Consolidated** | ** ** |
| ** **                                                        | ** ** | **(in millions)**  | ** ** |
| Revenues                                                          |       |                    | $          | — |   |   |   | $ | 8,811 |   |   |   | $ | 9,805 |   |   |   | $ | (7,739 | ) |   |   | $ | 10,877 |   |   |
| Purchased power, fuel and cost of gas sold                        |       |                    | —     |   |   |   | 8,734 |   |   |   | 8,439 |   |   |   | (7,737 | ) |   |   | 9,436 |   |   |
| Operation and maintenance                                         |       |                    | —     |   |   |   | 177 |   |   |   | 658 |   |   |   | (2 | ) |   |   | 833 |   |   |
| Selling, general and administrative                               |       |                    | 1          |   |   |   | 9 |   |   |   | 373 |   |   |   | — |   |   |   | 383 |   |   |
| (Gain) loss on sales of receivables                               |       |                    | —     |   |   |   | 7 |   |   |   | (7 | ) |   |   | — |   |   |   | — |   |   |
| Western states settlement                                         |       |                    | —     |   |   |   | 35 |   |   |   | — |   |   |   | — |   |   |   | 35 |   |   |
| Gains on sales of assets and emission allowances, net             |       |                    | —     |   |   |   | (21 | ) |   |   | (138 | ) |   |   | — |   |   |   | (159 | ) |   |
| Depreciation and amortization                                     |       |                    | —     |   |   |   | 152 |   |   |   | 221 |   |   |   | — |   |   |   | 373 |   |   |
| Total                                                             |       |                    | 1          |   |   |   | 9,093 |   |   |   | 9,546 |   |   |   | (7,739 | ) |   |   | 10,901 |   |   |
| Operating income (loss)                                           |       |                    | (1         | ) |   |   | (282 | ) |   |   | 259 |   |   |   | — |   |   |   | (24 | ) |   |
| Income of equity investments, net                                 |       |                    | —     |   |   |   | 6 |   |   |   | — |   |   |   | — |   |   |   | 6 |   |   |
| Income (loss) of equity investments of consolidated  subsidiaries |       |                    | (189       | ) |   |   | (9 | ) |   |   | 4 |   |   |   | 194 |   |   |   | — |   |   |
| Debt conversion expense                                           |       |                    | (37        | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (37 | ) |   |
| Interest expense                                                  |       |                    | (299       | ) |   |   | (35 | ) |   |   | (94 | ) |   |   | — |   |   |   | (428 | ) |   |
| Interest income                                                   |       |                    | 2          |   |   |   | 27 |   |   |   | 5 |   |   |   | — |   |   |   | 34 |   |   |
| Interest income (expense)—affiliated companies, net          |       |                    | 267        |   |   |   | (296 | ) |   |   | 29 |   |   |   | — |   |   |   | — |   |   |
| Total other expense                                               |       |                    | (256       | ) |   |   | (307 | ) |   |   | (56 | ) |   |   | 194 |   |   |   | (425 | ) |   |
| Income (loss) from continuing operations before  income taxes     |       |                    | (257       | ) |   |   | (589 | ) |   |   | 203 |   |   |   | 194 |   |   |   | (449 | ) |   |
| Income tax expense (benefit)(2)                                   |       |                    | 66         |   |   |   | (230 | ) |   |   | 42 |   |   |   | — |   |   |   | (122 | ) |   |
| Income (loss) from continuing operations                          |       |                    | (323       | ) |   |   | (359 | ) |   |   | 161 |   |   |   | 194 |   |   |   | (327 | ) |   |
| Income (loss) from discontinued operations                        |       |                    | (5         | ) |   |   | (2 | ) |   |   | 5 |   |   |   | — |   |   |   | (2 | ) |   |
| Income (loss) before cumulative effect of accounting  change      |       |                    | (328       | ) |   |   | (361 | ) |   |   | 166 |   |   |   | 194 |   |   |   | (329 | ) |   |
| Cumulative effect of accounting change, net of tax                |       |                    | —     |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |   | 1 |   |   |
| Net income (loss)                                                 |       |                    | $          | (328 | ) |   |   | $ | (360 | ) |   |   | $ | 166 |   |   |   | $ | 194 |   |   |   | $ | (328 | ) |   |

 

F-55

----

 

| ** **                                                        | ** ** | **2005**                | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                        | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(1) | ** ** | **Consolidated** | ** ** |
| ** **                                                        | ** ** | **(in millions)**  | ** ** |
| Revenues                                                          |       |                    | $          | — |   |   |   | $ | 8,518 |   |   |   | $ | 7,893 |   |   |   | $ | (6,699 | ) |   |   | $ | 9,712 |   |   |
| Purchased power, fuel and cost of gas sold                        |       |                    | (1         | ) |   |   | 8,754 |   |   |   | 6,311 |   |   |   | (6,698 | ) |   |   | 8,366 |   |   |
| Operation and maintenance                                         |       |                    | —     |   |   |   | 171 |   |   |   | 565 |   |   |   | 1 |   |   |   | 737 |   |   |
| Selling, general and administrative                               |       |                    | —     |   |   |   | 9 |   |   |   | 291 |   |   |   | (7 | ) |   |   | 293 |   |   |
| Loss on sales of receivables                                      |       |                    | —     |   |   |   | 8 |   |   |   | (8 | ) |   |   | — |   |   |   | — |   |   |
| Western states and Cornerstone settlements                        |       |                    | —     |   |   |   | 359 |   |   |   | — |   |   |   | — |   |   |   | 359 |   |   |
| Gains on sales of assets and emission allowances, net             |       |                    | —     |   |   |   | (7 | ) |   |   | (164 | ) |   |   | 3 |   |   |   | (168 | ) |   |
| Depreciation and amortization                                     |       |                    | —     |   |   |   | 165 |   |   |   | 274 |   |   |   | 7 |   |   |   | 446 |   |   |
| Total                                                             |       |                    | (1         | ) |   |   | 9,459 |   |   |   | 7,269 |   |   |   | (6,694 | ) |   |   | 10,033 |   |   |
| Operating income (loss)                                           |       |                    | 1          |   |   |   | (941 | ) |   |   | 624 |   |   |   | (5 | ) |   |   | (321 | ) |   |
| Income of equity investments, net                                 |       |                    | —     |   |   |   | 26 |   |   |   | — |   |   |   | — |   |   |   | 26 |   |   |
| Income (loss) of equity investments of consolidated  subsidiaries |       |                    | (193       | ) |   |   | 96 |   |   |   | (3 | ) |   |   | 100 |   |   |   | — |   |   |
| Other, net                                                        |       |                    | —     |   |   |   | (23 | ) |   |   | — |   |   |   | — |   |   |   | (23 | ) |   |
| Interest expense                                                  |       |                    | (278       | ) |   |   | (35 | ) |   |   | (86 | ) |   |   | — |   |   |   | (399 | ) |   |
| Interest income                                                   |       |                    | 1          |   |   |   | 20 |   |   |   | 2 |   |   |   | — |   |   |   | 23 |   |   |
| Interest income (expense)—affiliated companies, net          |       |                    | 144        |   |   |   | (170 | ) |   |   | 26 |   |   |   | — |   |   |   | — |   |   |
| Total other expense                                               |       |                    | (326       | ) |   |   | (86 | ) |   |   | (61 | ) |   |   | 100 |   |   |   | (373 | ) |   |
| Income (loss) from continuing operations before  income taxes     |       |                    | (325       | ) |   |   | (1,027 | ) |   |   | 563 |   |   |   | 95 |   |   |   | (694 | ) |   |
| Income tax expense (benefit)                                      |       |                    | 12         |   |   |   | (456 | ) |   |   | 185 |   |   |   | 6 |   |   |   | (253 | ) |   |
| Income (loss) from continuing operations                          |       |                    | (337       | ) |   |   | (571 | ) |   |   | 378 |   |   |   | 89 |   |   |   | (441 | ) |   |
| Income (loss) from discontinued operations                        |       |                    | 6          |   |   |   | 130 |   |   |   | (85 | ) |   |   | 60 |   |   |   | 111 |   |   |
| Income (loss) before cumulative effect of accounting  change      |       |                    | (331       | ) |   |   | (441 | ) |   |   | 293 |   |   |   | 149 |   |   |   | (330 | ) |   |
| Cumulative effect of accounting change, net of tax                |       |                    | —     |   |   |   | — |   |   |   | (1 | ) |   |   | — |   |   |   | (1 | ) |   |
| Net income (loss)                                                 |       |                    | $          | (331 | ) |   |   | $ | (441 | ) |   |   | $ | 292 |   |   |   | $ | 149 |   |   |   | $ | (331 | ) |   |

 

F-56

----

 

| ** **                                                        | ** ** | **2004**                | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                        | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(1) | ** ** | **Consolidated** | ** ** |
| ** **                                                        | ** ** | **(in millions)**  | ** ** |
| Revenues                                                          |       |                    | $          | — |   |   |   | $ | 5,849 |   |   |   | $ | 6,342 |   |   |   | $ | (4,093 | ) |   |   | $ | 8,098 |   |   |
| Purchased power,  fuel and cost of gas sold                       |       |                    | —     |   |   |   | 5,826 |   |   |   | 4,831 |   |   |   | (4,093 | ) |   |   | 6,564 |   |   |
| Operation and  maintenance                                        |       |                    | —     |   |   |   | 172 |   |   |   | 610 |   |   |   | — |   |   |   | 782 |   |   |
| Selling, general  and administrative                              |       |                    | (4         | ) |   |   | 1 |   |   |   | 336 |   |   |   | (7 | ) |   |   | 326 |   |   |
| Loss on sales of  receivables                                     |       |                    | —     |   |   |   | 5 |   |   |   | 29 |   |   |   | — |   |   |   | 34 |   |   |
| Accrual for  payment to CenterPoint                               |       |                    | —     |   |   |   | — |   |   |   | 2 |   |   |   | — |   |   |   | 2 |   |   |
| Gain on sale of  counterparty claim                               |       |                    | —     |   |   |   | (8 | ) |   |   | (22 | ) |   |   | — |   |   |   | (30 | ) |   |
| Gains on sales of  assets and emission allowances, net            |       |                    | —     |   |   |   | (3 | ) |   |   | (17 | ) |   |   | — |   |   |   | (20 | ) |   |
| Depreciation and  amortization                                    |       |                    | —     |   |   |   | 187 |   |   |   | 259 |   |   |   | 7 |   |   |   | 453 |   |   |
| Total                                                             |       |                    | (4         | ) |   |   | 6,180 |   |   |   | 6,028 |   |   |   | (4,093 | ) |   |   | 8,111 |   |   |
| Operating income  (loss)                                          |       |                    | 4          |   |   |   | (331 | ) |   |   | 314 |   |   |   | — |   |   |   | (13 | ) |   |
| Loss of equity  investments, net                                  |       |                    | —     |   |   |   | (9 | ) |   |   | — |   |   |   | — |   |   |   | (9 | ) |   |
| Income (loss) of  equity investments of consolidated subsidiaries |       |                    | 88         |   |   |   | (96 | ) |   |   | 55 |   |   |   | (47 | ) |   |   | — |   |   |
| Other, net                                                        |       |                    | —     |   |   |   | 10 |   |   |   | 3 |   |   |   | — |   |   |   | 13 |   |   |
| Interest expense                                                  |       |                    | (303       | ) |   |   | (61 | ) |   |   | (76 | ) |   |   | 22 |   |   |   | (418 | ) |   |
| Interest income                                                   |       |                    | —     |   |   |   | 23 |   |   |   | 12 |   |   |   | — |   |   |   | 35 |   |   |
| Interest income  (expense)—affiliated companies, net         |       |                    | 138        |   |   |   | (93 | ) |   |   | 8 |   |   |   | (53 | ) |   |   | — |   |   |
| Total other income (expense)                                      |       |                    | (77        | ) |   |   | (226 | ) |   |   | 2 |   |   |   | (78 | ) |   |   | (379 | ) |   |
| Income (loss)  from continuing operations before income taxes     |       |                    | (73        | ) |   |   | (557 | ) |   |   | 316 |   |   |   | (78 | ) |   |   | (392 | ) |   |
| Income tax  expense (benefit)                                     |       |                    | (67        | ) |   |   | (140 | ) |   |   | 134 |   |   |   | (43 | ) |   |   | (116 | ) |   |
| Income (loss)  from continuing operations                         |       |                    | (6         | ) |   |   | (417 | ) |   |   | 182 |   |   |   | (35 | ) |   |   | (276 | ) |   |
| Income (loss)  from discontinued operations                       |       |                    | (23        | ) |   |   | 93 |   |   |   | 90 |   |   |   | 80 |   |   |   | 240 |   |   |
| Income (loss)  before cumulative effect of accounting change      |       |                    | (29        | ) |   |   | (324 | ) |   |   | 272 |   |   |   | 45 |   |   |   | (36 | ) |   |
| Cumulative effect  of accounting change, net of tax               |       |                    | —     |   |   |   | 7 |   |   |   | — |   |   |   | — |   |   |   | 7 |   |   |
| Net income (loss)                                                 |       |                    | $          | (29 | ) |   |   | $ | (317 | ) |   |   | $ | 272 |   |   |   | $ | 45 |   |   |   | $ | (29 | ) |   |

----

(1)             Theseamounts relate to either (a) eliminations and adjustments recorded in thenormal consolidation process or (b) reclassifications recorded due todifferences in classifications at the subsidiary levels compared to theconsolidated level.

(2)             During2006, we recorded a federal valuation allowance of $68 million related to ournet federal deferred tax assets. These amounts are reflected in the “ReliantEnergy” column. See note 11(d).

F-57

----

*Condensed Consolidating Balance Sheets.*

| ** **                                                    | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **Reliant Energy**         | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(1) | ** ** | **Consolidated** | ** ** |
| ** **                                                    | ** ** | **(in millions)**          | ** ** |
| **ASSETS**                                                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Current Assets:**                                           |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                    |       |                            | $          | 286 |   |   |   | $ | 24 |   |   |   | $ | 154 |   |   |   | $ | — |   |   |   | $ | 464 |   |   |
| Restricted cash                                               |       |                            | —     |   |   |   | — |   |   |   | 25 |   |   |   | — |   |   |   | 25 |   |   |
| Accounts and notes  receivable, principally customer, net     |       |                            | 10         |   |   |   | 264 |   |   |   | 779 |   |   |   | (9) |   |   |   | 1,044 |   |   |
| Accounts and notes  receivable—affiliated companies      |       |                            | 1,737      |   |   |   | 418 |   |   |   | 259 |   |   |   | (2,414 | ) |   |   | — |   |   |
| Inventory                                                     |       |                            | —     |   |   |   | 144 |   |   |   | 131 |   |   |   | — |   |   |   | 275 |   |   |
| Derivative assets                                             |       |                            | —     |   |   |   | 61 |   |   |   | 429 |   |   |   | — |   |   |   | 490 |   |   |
| Other current  assets                                         |       |                            | 7          |   |   |   | 529 |   |   |   | 354 |   |   |   | (17 | ) |   |   | 873 |   |   |
| Current assets of  discontinued operations                    |       |                            | —     |   |   |   | — |   |   |   | 2 |   |   |   | — |   |   |   | 2 |   |   |
| Total current  assets                                         |       |                            | 2,040      |   |   |   | 1,440 |   |   |   | 2,133 |   |   |   | (2,440 | ) |   |   | 3,173 |   |   |
| **Property,  Plant and Equipment, net**                       |       |                            | —     |   |   |   | 3,044 |   |   |   | 2,698 |   |   |   | — |   |   |   | 5,742 |   |   |
| **Other Assets:**                                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                      |       |                            | —     |   |   |   | 51 |   |   |   | 212 |   |   |   | 119 |   |   |   | 382 |   |   |
| Other intangibles,  net                                       |       |                            | —     |   |   |   | 131 |   |   |   | 293 |   |   |   | — |   |   |   | 424 |   |   |
| Notes receivable—affiliated  companies                   |       |                            | 3,249      |   |   |   | 789 |   |   |   | 94 |   |   |   | (4,132 | ) |   |   | — |   |   |
| Equity investments  of consolidated subsidiaries              |       |                            | 1,377      |   |   |   | 328 |   |   |   | 5 |   |   |   | (1,710 | ) |   |   | — |   |   |
| Derivative assets                                             |       |                            | —     |   |   |   | 77 |   |   |   | 127 |   |   |   | — |   |   |   | 204 |   |   |
| Other long-term  assets                                       |       |                            | 76         |   |   |   | 730 |   |   |   | 400 |   |   |   | (564 | ) |   |   | 642 |   |   |
| Total other assets                                            |       |                            | 4,702      |   |   |   | 2,106 |   |   |   | 1,131 |   |   |   | (6,287 | ) |   |   | 1,652 |   |   |
| **Total  Assets**                                             |       |                            | $          | 6,742 |   |   |   | $ | 6,590 |   |   |   | $ | 5,962 |   |   |   | $ | (8,727 | ) |   |   | $ | 10,567 |   |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Current Liabilities:**                                      |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current portion of  long-term debt  and short-term borrowings |       |                            | $          | 3 |   |   |   | $ | — |   |   |   | $ | 352 |   |   |   | $ | — |   |   |   | $ | 355 |   |   |
| Accounts payable,  principally trade                          |       |                            | —     |   |   |   | 224 |   |   |   | 444 |   |   |   | (3) |   |   |   | 665 |   |   |
| Accounts and notes  payable—affiliated companies         |       |                            | —     |   |   |   | 2,021 |   |   |   | 393 |   |   |   | (2,414 | ) |   |   | — |   |   |
| Derivative  liabilities                                       |       |                            | —     |   |   |   | 238 |   |   |   | 927 |   |   |   | — |   |   |   | 1,165 |   |   |
| Other current  liabilities                                    |       |                            | 55         |   |   |   | 159 |   |   |   | 313 |   |   |   | (23 | ) |   |   | 504 |   |   |
| Current  liabilities of discontinued operations               |       |                            | —     |   |   |   | — |   |   |   | 3 |   |   |   | — |   |   |   | 3 |   |   |
| Total current  liabilities                                    |       |                            | 58         |   |   |   | 2,642 |   |   |   | 2,432 |   |   |   | (2,440 | ) |   |   | 2,692 |   |   |
| **Other Liabilities:**                                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Notes payable—affiliated  companies                      |       |                            | —     |   |   |   | 3,251 |   |   |   | 881 |   |   |   | (4,132 | ) |   |   | — |   |   |
| Derivative  liabilities                                       |       |                            | —     |   |   |   | 77 |   |   |   | 344 |   |   |   | — |   |   |   | 421 |   |   |
| Other long-term  liabilities                                  |       |                            | 484        |   |   |   | 167 |   |   |   | 237 |   |   |   | (564 | ) |   |   | 324 |   |   |
| Total other liabilities                                       |       |                            | 484        |   |   |   | 3,495 |   |   |   | 1,462 |   |   |   | (4,696 | ) |   |   | 745 |   |   |
| **Long-term  Debt**                                           |       |                            | 2,248      |   |   |   | 501 |   |   |   | 429 |   |   |   | — |   |   |   | 3,178 |   |   |
| **Commitments and Contingencies**                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Temporary  Equity Stock-based Compensation**                |       |                            | 2          |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 2 |   |   |
| **Total  Stockholders’ Equity**                          |       |                            | 3,950      |   |   |   | (48 | ) |   |   | 1,639 |   |   |   | (1,591 | ) |   |   | 3,950 |   |   |
| **Total  Liabilities and  Stockholders’ Equity**         |       |                            | $          | 6,742 |   |   |   | $ | 6,590 |   |   |   | $ | 5,962 |   |   |   | $ | (8,727 | ) |   |   | $ | 10,567 |   |   |

 

F-58

----

| ** **                                                   | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **Reliant Energy**         | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(1) | ** ** | **Consolidated** | ** ** |
| ** **                                                   | ** ** | **(in millions)**          | ** ** |
| **ASSETS**                                                   |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Current Assets:**                                          |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                    |       |                            | $          | 3 |   |   |   | $ | 36 |   |   |   | $ | 49 |   |   |   | $ | — |   |   |   | $ | 88 |   |   |
| Restricted cash                                              |       |                            | —     |   |   |   | — |   |   |   | 27 |   |   |   | — |   |   |   | 27 |   |   |
| Accounts and notes  receivable, principally customer, net    |       |                            | —     |   |   |   | 284 |   |   |   | 905 |   |   |   | (17 | ) |   |   | 1,172 |   |   |
| Accounts and notes  receivable—  affiliated companies   |       |                            | 802        |   |   |   | 1,493 |   |   |   | 1,264 |   |   |   | (3,559 | ) |   |   | — |   |   |
| Inventory                                                    |       |                            | —     |   |   |   | 161 |   |   |   | 138 |   |   |   | — |   |   |   | 299 |   |   |
| Derivative assets                                            |       |                            | —     |   |   |   | 639 |   |   |   | 87 |   |   |   | — |   |   |   | 726 |   |   |
| Other current assets                                         |       |                            | 1          |   |   |   | 2,102 |   |   |   | 118 |   |   |   | (6 | ) |   |   | 2,215 |   |   |
| Current assets of  discontinued  operations                  |       |                            | 2          |   |   |   | 46 |   |   |   | 157 |   |   |   | (2 | ) |   |   | 203 |   |   |
| Total current assets                                         |       |                            | 808        |   |   |   | 4,761 |   |   |   | 2,745 |   |   |   | (3,584 | ) |   |   | 4,730 |   |   |
| **Property,  Plant and Equipment, net**                      |       |                            | —     |   |   |   | 3,172 |   |   |   | 2,762 |   |   |   | — |   |   |   | 5,934 |   |   |
| **Other Assets:**                                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                     |       |                            | —     |   |   |   | 51 |   |   |   | 217 |   |   |   | 119 |   |   |   | 387 |   |   |
| Other intangibles, net                                       |       |                            | —     |   |   |   | 182 |   |   |   | 329 |   |   |   | — |   |   |   | 511 |   |   |
| Notes receivable—affiliated  companies                  |       |                            | 2,506      |   |   |   | 812 |   |   |   | 2 |   |   |   | (3,320 | ) |   |   | — |   |   |
| Equity investments                                           |       |                            | —     |   |   |   | 30 |   |   |   | — |   |   |   | — |   |   |   | 30 |   |   |
| Equity investments of  consolidated subsidiaries             |       |                            | 3,721      |   |   |   | 345 |   |   |   | — |   |   |   | (4,066 | ) |   |   | — |   |   |
| Derivative assets                                            |       |                            | —     |   |   |   | 521 |   |   |   | 7 |   |   |   | — |   |   |   | 528 |   |   |
| Other long-term assets                                       |       |                            | 188        |   |   |   | 170 |   |   |   | 378 |   |   |   | (168 | ) |   |   | 568 |   |   |
| Long-term assets of  discontinued operations                 |       |                            | 720        |   |   |   | — |   |   |   | 873 |   |   |   | (712 | ) |   |   | 881 |   |   |
| Total other assets                                           |       |                            | 7,135      |   |   |   | 2,111 |   |   |   | 1,806 |   |   |   | (8,147 | ) |   |   | 2,905 |   |   |
| **Total  Assets**                                            |       |                            | $          | 7,943 |   |   |   | $ | 10,044 |   |   |   | $ | 7,313 |   |   |   | $ | (11,731 | ) |   |   | $ | 13,569 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Current Liabilities:**                                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current portion of  long-term debt and short-term borrowings |       |                            | $          | 316 |   |   |   | $ | — |   |   |   | $ | 473 |   |   |   | $ | — |   |   |   | $ | 789 |   |   |
| Accounts payable,  principally trade                         |       |                            | 8          |   |   |   | 724 |   |   |   | 155 |   |   |   | — |   |   |   | 887 |   |   |
| Accounts and notes  payable—affiliated companies        |       |                            | —     |   |   |   | 3,559 |   |   |   | — |   |   |   | (3,559 | ) |   |   | — |   |   |
| Derivative liabilities                                       |       |                            | —     |   |   |   | 1,081 |   |   |   | 139 |   |   |   | — |   |   |   | 1,220 |   |   |
| Other current liabilities                                    |       |                            | 62         |   |   |   | 121 |   |   |   | 254 |   |   |   | (23 | ) |   |   | 414 |   |   |
| Current liabilities of  discontinued operations              |       |                            | —     |   |   |   | 49 |   |   |   | 49 |   |   |   | (2 | ) |   |   | 96 |   |   |
| Total current liabilities                                    |       |                            | 386        |   |   |   | 5,534 |   |   |   | 1,070 |   |   |   | (3,584 | ) |   |   | 3,406 |   |   |
| **Other Liabilities:**                                       |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Notes payable—affiliated  companies                     |       |                            | —     |   |   |   | 2,512 |   |   |   | 808 |   |   |   | (3,320 | ) |   |   | — |   |   |
| Derivative liabilities                                       |       |                            | —     |   |   |   | 657 |   |   |   | 156 |   |   |   | — |   |   |   | 813 |   |   |
| Other long-term  liabilities                                 |       |                            | 11         |   |   |   | 245 |   |   |   | 301 |   |   |   | (168 | ) |   |   | 389 |   |   |
| Long-term liabilities of  discontinued operations            |       |                            | 638        |   |   |   | — |   |   |   | 854 |   |   |   | (712 | ) |   |   | 780 |   |   |
| Total other liabilities                                      |       |                            | 649        |   |   |   | 3,414 |   |   |   | 2,119 |   |   |   | (4,200 | ) |   |   | 1,982 |   |   |
| **Long-term  Debt**                                          |       |                            | 3,044      |   |   |   | 501 |   |   |   | 772 |   |   |   | — |   |   |   | 4,317 |   |   |
| **Commitments and Contingencies**                            | ** ** |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  Stockholders’ Equity**                         |       |                            | 3,864      |   |   |   | 595 |   |   |   | 3,352 |   |   |   | (3,947 | ) |   |   | 3,864 |   |   |
| **Total Liabilities and Stockholders’ Equity**          |       |                            | $          | 7,943 |   |   |   | $ | 10,044 |   |   |   | $ | 7,313 |   |   |   | $ | (11,731 | ) |   |   | $ | 13,569 |   |   |

----

(1)             Theseamounts relate to either (a) eliminations and adjustments recorded in thenormal consolidation process or (b) reclassifications recorded due todifferences in classifications at the subsidiary levels compared to theconsolidated level.

(2)             Seefootnote (2) above under condensed consolidating statements of operations.

F-59

----

*Condensed Consolidating Statements of Cash Flows.*

| ** **                                                                         | ** ** | **2006**                | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors**(1) | ** ** | **Adjustments**(2) | ** ** | **Consolidated** | ** ** |
| ** **                                                                         | ** ** | **(in millions)**  | ** ** |
| **Cash Flows from Operating  Activities:**                                         |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by continuing operations from  operating activities              |       |                    | $          | 10 |   |   |   | $ | 414 |   |   |   | $ | 906 |   |   |   | $ | — |   |   |   | $ | 1,330 |   |   |
| Net cash provided by (used in) discontinued  operations from operating activities  |       |                    | 3          |   |   |   | (7 | ) |   |   | (50 | ) |   |   | — |   |   |   | (54 | ) |   |
| Net cash provided by operating activities                                          |       |                    | 13         |   |   |   | 407 |   |   |   | 856 |   |   |   | — |   |   |   | 1,276 |   |   |
| **Cash Flows from Investing  Activities:**                                         |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital expenditures                                                               |       |                    | —     |   |   |   | (24 | ) |   |   | (73 | ) |   |   | — |   |   |   | (97 | ) |   |
| Investments in, advances to and from and  distributions from subsidiaries, net(3)  |       |                    | 1,059      |   |   |   | (468 | ) |   |   | (216 | ) |   |   | (375 | ) |   |   | — |   |   |
| Proceeds from sales of assets, net                                                 |       |                    | —     |   |   |   | — |   |   |   | 1 |   |   |   | — |   |   |   | 1 |   |   |
| Net proceeds from sale of emission allowances                                      |       |                    | —     |   |   |   | 88 |   |   |   | 94 |   |   |   | — |   |   |   | 182 |   |   |
| Restricted cash                                                                    |       |                    | —     |   |   |   | — |   |   |   | 2 |   |   |   | — |   |   |   | 2 |   |   |
| Other, net                                                                         |       |                    | —     |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |   | 1 |   |   |
| Net cash provided by (used in) continuing operations  from investing activities    |       |                    | 1,059      |   |   |   | (403 | ) |   |   | (192 | ) |   |   | (375 | ) |   |   | 89 |   |   |
| Net cash provided by discontinued operations from  investing activities            |       |                    | 712        |   |   |   | — |   |   |   | 968 |   |   |   | (712 | ) |   |   | 968 |   |   |
| Net cash provided by (used in) investing activities                                |       |                    | 1,771      |   |   |   | (403 | ) |   |   | 776 |   |   |   | (1,087 | ) |   |   | 1,057 |   |   |
| **Cash Flows from Financing  Activities:**                                         |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from long-term debt                                                       |       |                    | 400        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 400 |   |   |
| Payments of long-term debt                                                         |       |                    | (852       | ) |   |   | — |   |   |   | (14 | ) |   |   | — |   |   |   | (866 | ) |   |
| Increase (decrease) in short-term borrowings and  revolving credit facilities, net |       |                    | (383       | ) |   |   | — |   |   |   | (442 | ) |   |   | — |   |   |   | (825 | ) |   |
| Changes in notes with affiliated companies, net(4)                                 |       |                    | —     |   |   |   | (16 | ) |   |   | (359 | ) |   |   | 375 |   |   |   | — |   |   |
| Premium paid for conversion of senior subordinated   notes                         |       |                    | (36        | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (36 | ) |   |
| Proceeds from issuances of stock                                                   |       |                    | 25         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 25 |   |   |
| Payments of financing costs                                                        |       |                    | (17        | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (17 | ) |   |
| Net cash used in continuing operations from financing  activities                  |       |                    | (863       | ) |   |   | (16 | ) |   |   | (815 | ) |   |   | 375 |   |   |   | (1,319 | ) |   |
| Net cash used in discontinued operations from  financing activities           |       |                    | (638       | ) |   |   | — |   |   |   | (712 | ) |   |   | 712 |   |   |   | (638 | ) |   |
| Net cash used in financing activities                                              |       |                    | (1,501     | ) |   |   | (16 | ) |   |   | (1,527 | ) |   |   | 1,087 |   |   |   | (1,957 | ) |   |
| **Net Change in Cash and Cash Equivalents**                                        |       |                    | 283        |   |   |   | (12 | ) |   |   | 105 |   |   |   | — |   |   |   | 376 |   |   |
| **Cash and Cash Equivalents at Beginning of Period**                               |       |                    | 3          |   |   |   | 36 |   |   |   | 49 |   |   |   | — |   |   |   | 88 |   |   |
| **Cash and  Cash Equivalents at End of Period**                                    |       |                    | $          | 286 |   |   |   | $ | 24 |   |   |   | $ | 154 |   |   |   | $ | — |   |   |   | $ | 464 |   |   |

 

F-60

----

| ** **                                                                                                            | ** ** | **2005**                | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                            | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(2) | ** ** | **Consolidated** | ** ** |
| ** **                                                                                                            | ** ** | **(in millions)**  | ** ** |
| **Cash Flows from Operating Activities:**                                                                             | ** ** |                    | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net cash provided  by (used in) continuing operations from operating activities                                       |       |                    | $          | (95 | ) |   |   | $ | (1,989 | ) |   |   | $ | 974 |   |   |   | $ | — |   |   |   | $ | (1,110 | ) |   |
| Net cash provided  by discontinued operations from operating activities                                               |       |                    | 13         |   |   |   | 8 |   |   |   | 172 |   |   |   | — |   |   |   | 193 |   |   |
| Net cash provided  by (used in) operating activities                                                                  |       |                    | (82        | ) |   |   | (1,981 | ) |   |   | 1,146 |   |   |   | — |   |   |   | (917 | ) |   |
| **Cash Flows from Investing Activities:**                                                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                                                                 |       |                    | —     |   |   |   | (49 | ) |   |   | (33 | ) |   |   | — |   |   |   | (82 | ) |   |
| Investments in and  distributions from subsidiaries, net and advances to and distributions  from subsidiaries, net(3) |       |                    | (460       | ) |   |   | 1 |   |   |   | (341 | ) |   |   | 800 |   |   |   | — |   |   |
| Proceeds from  sales of assets, net                                                                                   |       |                    | —     |   |   |   | 77 |   |   |   | 72 |   |   |   | — |   |   |   | 149 |   |   |
| Net sales  (purchases) of emission allowances                                                                         |       |                    | —     |   |   |   | (49 | ) |   |   | 137 |   |   |   | — |   |   |   | 88 |   |   |
| Restricted cash                                                                                                       |       |                    | —     |   |   |   | — |   |   |   | 14 |   |   |   | — |   |   |   | 14 |   |   |
| Other, net                                                                                                            |       |                    | —     |   |   |   | 6 |   |   |   | — |   |   |   | — |   |   |   | 6 |   |   |
| Net cash provided  by (used in) continuing operations from investing activities                                       |       |                    | (460       | ) |   |   | (14 | ) |   |   | (151 | ) |   |   | 800 |   |   |   | 175 |   |   |
| Net cash provided  by discontinued operations from investing activities                                          |       |                    | 110        |   |   |   | 51 |   |   |   | 80 |   |   |   | (110 | ) |   |   | 131 |   |   |
| Net cash provided  by (used in) investing activities                                                                  |       |                    | (350       | ) |   |   | 37 |   |   |   | (71 | ) |   |   | 690 |   |   |   | 306 |   |   |
| **Cash Flows from Financing Activities:**                                                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from  long-term debt                                                                                         |       |                    | 299        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 299 |   |   |
| Payments of  long-term debt                                                                                           |       |                    | (109       | ) |   |   | (1 | ) |   |   | (38 | ) |   |   | — |   |   |   | (148 | ) |   |
| Increase in  short-term borrowings and revolving credit facilities,  net                                              |       |                    | 184        |   |   |   | — |   |   |   | 223 |   |   |   | — |   |   |   | 407 |   |   |
| Changes in notes  with affiliated companies, net(4)                                                                   |       |                    | —     |   |   |   | 1,956 |   |   |   | (1,156 | ) |   |   | (800 | ) |   |   | — |   |   |
| Proceeds from  issuances of stock                                                                                     |       |                    | 37         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 37 |   |   |
| Payments of financing  costs                                                                                          |       |                    | (1         | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1 | ) |   |
| Net cash provided  by (used in) continuing operations from financing activities                                       |       |                    | 410        |   |   |   | 1,955 |   |   |   | (971 | ) |   |   | (800 | ) |   |   | 594 |   |   |
| Net cash used in  discontinued operations from financing activities                                                   |       |                    | —     |   |   |   | — |   |   |   | (110 | ) |   |   | 110 |   |   |   | — |   |   |
| Net cash provided  by (used in) financing activities                                                                  |       |                    | 410        |   |   |   | 1,955 |   |   |   | (1,081 | ) |   |   | (690 | ) |   |   | 594 |   |   |
| **Net  Change in Cash and Cash Equivalents**                                                                          |       |                    | (22        | ) |   |   | 11 |   |   |   | (6 | ) |   |   | — |   |   |   | (17 | ) |   |
| **Cash and  Cash Equivalents at Beginning of Period**                                                                 |       |                    | 25         |   |   |   | 25 |   |   |   | 55 |   |   |   | — |   |   |   | 105 |   |   |
| **Cash and  Cash Equivalents at End  of Period**                                                                      |       |                    | $          | 3 |   |   |   | $ | 36 |   |   |   | $ | 49 |   |   |   | $ | — |   |   |   | $ | 88 |   |   |

 

F-61

----

| ** **                                                                                                            | ** ** | **2004**                | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                            | ** ** | **Reliant Energy** | ** ** | **Guarantors** | ** ** | **Non-Guarantors** | ** ** | **Adjustments**(2) | ** ** | **Consolidated** | ** ** |
| ** **                                                                                                            | ** ** | **(in millions)**  | ** ** |
| **Cash Flows from Operating Activities:**                                                                             | ** ** |                    | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net cash provided  by (used in) continuing operations from operating activities                                       |       |                    | $          | (3 | ) |   |   | $ | (358 | ) |   |   | $ | 423 |   |   |   | $ | (57 | ) |   |   | $ | 5 |   |   |
| Net cash provided  by (used in) discontinued operations from operating activities                           |       |                    | (30        | ) |   |   | 1 |   |   |   | 73 |   |   |   | 57 |   |   |   | 101 |   |   |
| Net cash provided  by (used in) operating activities                                                                  |       |                    | (33        | ) |   |   | (357 | ) |   |   | 496 |   |   |   | — |   |   |   | 106 |   |   |
| **Cash Flows from Investing Activities:**                                                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                                                                 |       |                    | —     |   |   |   | (112 | ) |   |   | (48 | ) |   |   | — |   |   |   | (160 | ) |   |
| Investments in and  distributions from subsidiaries, net and advances to and distributions from  subsidiaries, net(3) |       |                    | 606        |   |   |   | 4 |   |   |   | (715 | ) |   |   | 105 |   |   |   | — |   |   |
| Purchase and sale  of permits and licenses to affiliates                                                         |       |                    | —     |   |   |   | (20 | ) |   |   | 20 |   |   |   | — |   |   |   | — |   |   |
| Proceeds from  sales of assets, net                                                                                   |       |                    | —     |   |   |   | 9 |   |   |   | 2 |   |   |   | — |   |   |   | 11 |   |   |
| Net purchases of  emission allowances                                                                                 |       |                    | —     |   |   |   | (6 | ) |   |   | (59 | ) |   |   | — |   |   |   | (65 | ) |   |
| Restricted cash                                                                                                       |       |                    | 7          |   |   |   | — |   |   |   | 172 |   |   |   | — |   |   |   | 179 |   |   |
| Other, net                                                                                                            |       |                    | —     |   |   |   | 16 |   |   |   | — |   |   |   | — |   |   |   | 16 |   |   |
| Net cash provided  by (used in) continuing operations from investing activities                             |       |                    | 613        |   |   |   | (109 | ) |   |   | (628 | ) |   |   | 105 |   |   |   | (19 | ) |   |
| Net cash provided  by (used in) discontinued operations from investing activities                                |       |                    | (823       | ) |   |   | 8 |   |   |   | 911 |   |   |   | 823 |   |   |   | 919 |   |   |
| Net cash provided  by (used in) investing activities                                                             |       |                    | (210       | ) |   |   | (101 | ) |   |   | 283 |   |   |   | 928 |   |   |   | 900 |   |   |
| **Cash Flows from Financing Activities:**                                                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from  long-term debt                                                                                         |       |                    | 1,412      |   |   |   | 100 |   |   |   | — |   |   |   | — |   |   |   | 1,512 |   |   |
| Payments of  long-term debt                                                                                           |       |                    | (1,147     | ) |   |   | — |   |   |   | (23 | ) |   |   | (427 | ) |   |   | (1,597 | ) |   |
| Increase (decrease)  in short-term borrowings and revolving credit facilities, net                          |       |                    | 16         |   |   |   | — |   |   |   | (124 | ) |   |   | — |   |   |   | (108 | ) |   |
| Changes in notes  with affiliated companies, net(4)                                                              |       |                    | —     |   |   |   | 340 |   |   |   | (235 | ) |   |   | (105 | ) |   |   | — |   |   |
| Proceeds from  issuances of stock                                                                                     |       |                    | 25         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 25 |   |   |
| Payments of  financing costs                                                                                          |       |                    | (60        | ) |   |   | (12 | ) |   |   | — |   |   |   | — |   |   |   | (72 | ) |   |
| Other, net                                                                                                            |       |                    | 9          |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Net cash provided  by (used in) continuing operations from financing activities                             |       |                    | 255        |   |   |   | 428 |   |   |   | (382 | ) |   |   | (532 | ) |   |   | (231 | ) |   |
| Net cash used in  discontinued operations from financing activities                                              |       |                    | (10        | ) |   |   | — |   |   |   | (410 | ) |   |   | (396 | ) |   |   | (816 | ) |   |
| Net cash provided  by (used in) financing activities                                                             |       |                    | 245        |   |   |   | 428 |   |   |   | (792 | ) |   |   | (928 | ) |   |   | (1,047 | ) |   |
| **Net  Change in Cash and Cash Equivalents**                                                                          |       |                    | 2          |   |   |   | (30 | ) |   |   | (13 | ) |   |   | — |   |   |   | (41 | ) |   |
| **Cash and  Cash Equivalents at Beginning of Period**                                                                 |       |                    | 23         |   |   |   | 55 |   |   |   | 68 |   |   |   | — |   |   |   | 146 |   |   |
| **Cash and  Cash Equivalents at End of Period**                                                                       |       |                    | $          | 25 |   |   |   | $ | 25 |   |   |   | $ | 55 |   |   |   | $ | — |   |   |   | $ | 105 |   |   |

----

(1)              During 2006, Reliant Energy Retail Holdings, LLC, anon-guarantor, made a non-cash capital distribution (related to intercompanyreceivables) of $1.9 billion to Reliant Energy.

(2)              These amounts relate to either (a) eliminationsand adjustments recorded in the normal consolidation process or (b) reclassificationsrecorded due to differences in classifications at the subsidiary levelscompared to the consolidated level.

(3)              Net investments in, advances to and from anddistributions from subsidiaries are classified as investing activities.

(4)              Net changes in notes with affiliated companies areclassified as financing activities for subsidiaries of Reliant Energy and asinvesting activities for Reliant Energy.

F-62

----

**(17)**   UnauditedQuarterly Information

| ** **                                                        | ** ** | **2006**                                                             | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **First Quarter**                                               | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
| ** **                                                        | ** ** | **(in millions, except per share amounts)** | ** ** |
| Revenues                                                          |       |                                                                 | $          | 2,453 |   |   |   | $ | 2,775 |   |   |   | $ | 3,305 |   |   |   | $ | 2,344 |   |   |
| Gross margin(1)                                                   |       |                                                                 | 203        |   |   |   | 541 |   |   |   | 315 |   |   |   | 382 |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | (139       | ) |   |   | 23 |   |   |   | (154 | ) |   |   | (57 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 5          |   |   |   | (9 | ) |   |   | (1 | ) |   |   | 3 |   |   |
| Income (loss)  before cumulative effect of accounting change |       |                                                                 | (134       | ) |   |   | 14 |   |   |   | (155 | ) |   |   | (54 | ) |   |
| Net income (loss)                                                 |       |                                                                 | (133       | ) |   |   | 14 |   |   |   | (155 | ) |   |   | (54 | ) |   |
| Basic Earnings (Loss) Per Share:                                  |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | $          | (0.46 | ) |   |   | $ | 0.07 |   |   |   | $ | (0.50 | ) |   |   | $ | (0.18 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 0.02       |   |   |   | (0.02 | ) |   |   | — |   |   |   | 0.01 |   |   |
| Income (loss) before cumulative  effect of accounting change |       |                                                                 | (0.44      | ) |   |   | 0.05 |   |   |   | (0.50 | ) |   |   | (0.17 | ) |   |
| Cumulative effect of  accounting change, net of tax               |       |                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                                 |       |                                                                 | $          | (0.44 | ) |   |   | $ | 0.05 |   |   |   | $ | (0.50 | ) |   |   | $ | (0.17 | ) |   |
| Diluted Earnings (Loss) Per Share:                                |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | $          | (0.46 | ) |   |   | $ | 0.07 |   |   |   | $ | (0.50 | ) |   |   | $ | (0.18 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 0.02       |   |   |   | (0.02 | ) |   |   | — |   |   |   | 0.01 |   |   |
| Income (loss) before cumulative  effect of accounting change |       |                                                                 | (0.44      | ) |   |   | 0.05 |   |   |   | (0.50 | ) |   |   | (0.17 | ) |   |
| Cumulative effect of  accounting change, net of tax               |       |                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                                 |       |                                                                 | $          | (0.44 | ) |   |   | $ | 0.05 |   |   |   | $ | (0.50 | ) |   |   | $ | (0.17 | ) |   |

 

| ** **                                                        | ** ** | **2005**                                                             | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **First Quarter**                                               | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
| ** **                                                        | ** ** | **(in millions, except per share amounts)** | ** ** |
| Revenues                                                          |       |                                                                 | $          | 1,717 |   |   |   | $ | 2,432 |   |   |   | $ | 2,963 |   |   |   | $ | 2,600 |   |   |
| Gross margin(1)                                                   |       |                                                                 | 375        |   |   |   | 593 |   |   |   | 266 |   |   |   | 112 |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | (41        | ) |   |   | 50 |   |   |   | (267 | ) |   |   | (183 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 16         |   |   |   | 49 |   |   |   | (3 | ) |   |   | 49 |   |   |
| Income (loss)  before cumulative effect of accounting change |       |                                                                 | (25        | ) |   |   | 99 |   |   |   | (270 | ) |   |   | (134 | ) |   |
| Net income (loss)                                                 |       |                                                                 | (25        | ) |   |   | 99 |   |   |   | (270 | ) |   |   | (135 | ) |   |
| Basic Earnings (Loss) Per Share:                                  |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | $          | (0.14 | ) |   |   | $ | 0.17 |   |   |   | $ | (0.88 | ) |   |   | $ | (0.60 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 0.06       |   |   |   | 0.16 |   |   |   | (0.01 | ) |   |   | 0.16 |   |   |
| Income (loss)  before cumulative effect of accounting change |       |                                                                 | (0.08      | ) |   |   | 0.33 |   |   |   | (0.89 | ) |   |   | (0.44 | ) |   |
| Cumulative effect  of accounting change, net of tax               |       |                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                                 |       |                                                                 | $          | (0.08 | ) |   |   | $ | 0.33 |   |   |   | $ | (0.89 | ) |   |   | $ | (0.44 | ) |   |
| Diluted Earnings (Loss) Per Share:                                |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  continuing operations                         |       |                                                                 | $          | (0.14 | ) |   |   | $ | 0.16 |   |   |   | $ | (0.88 | ) |   |   | $ | (0.60 | ) |   |
| Income (loss) from  discontinued operations                       |       |                                                                 | 0.06       |   |   |   | 0.14 |   |   |   | (0.01 | ) |   |   | 0.16 |   |   |
| Income (loss)  before cumulative effect of accounting change |       |                                                                 | (0.08      | ) |   |   | 0.30 |   |   |   | (0.89 | ) |   |   | (0.44 | ) |   |
| Cumulative effect  of accounting change, net of tax               |       |                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                                 |       |                                                                 | $          | (0.08 | ) |   |   | $ | 0.30 |   |   |   | $ | (0.89 | ) |   |   | $ | (0.44 | ) |   |

----

(1)             Grossmargin (revenues less purchased power, fuel and cost of gas sold) excludesdepreciation, amortization, labor and other product costs.

F-63

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Variances in revenues andgross margin from quarter to quarter were primarily due to (a) seasonalfluctuations in demand for electric energy and energy services and (b) changesin energy commodity prices, including unrealized gains/losses on energy derivatives.During 2006, we incurred $231 million in unrealized losses on energyderivatives ($23 million gain in the first quarter, $52 million gain in thesecond quarter, $355 million loss in the third quarter and $49 million gain inthe fourth quarter). During 2005, we incurred $192 million in unrealized losseson energy derivatives ($120 million gain in the first quarter, $143 milliongain****in the second quarter, $354 millionloss in the third quarter and $101 million loss in the fourth quarter,including $15 million due to the reclassification of a derivative contract froma cash flow hedge to mark-to-market).

Changes in net income(loss) from quarter to quarter were primarily due to:

·       seasonalfluctuations in demand for electric energy and energy services;

·       changesin energy commodity prices, including unrealized gains/losses on energyderivatives; and

·       timingof maintenance expenses.

Inaddition, net income (loss) changed from quarter to quarter in 2006 by (amountsare pre-tax unless indicated otherwise):

·       $159million gain on sales of emission allowances ($151 million gain in the firstquarter, $5 million gain in the second quarter and $3 million gain in the thirdquarter);

·       $68million change in income tax expense/benefit due to our federal valuationallowance ($70 million increase during the first quarter, $20 million increaseduring the second quarter, $30 million decrease during the third quarter and $8million increase during the fourth quarter);

·       $40million income tax benefit in the fourth quarter related to Pennsylvania statelaw changes; and

·       $35million charge related to the settlement of certain class action natural gascases relating to the Western states energy crisis during the third quarter.

Also,net income (loss) changed from quarter to quarter in 2005 by (amounts arepre-tax unless indicated otherwise):

·       $359million charge related to the Western states and Cornerstone settlements ($351million in the third quarter and $8 million in the fourth quarter);

·       $239million loss in discontinued operations related to the loss on disposition ofour New York plants ($149 million loss in the third quarter and $90 millionloss in the fourth quarter);

·       $160million gain on sales of emission allowances ($93 million gain in the thirdquarter and $53 million gain in the fourth quarter);

·       $27million loss in discontinued operations related to the loss on disposition ofour Ceredo plant in the third quarter;

·       $25million gain on the sale of El Dorado in the third quarter;

·       $23million charge for the impairment of an investment in the second quarter;

·       $53million decrease in income tax expense due to changes in valuation allowancesand changes in estimates of deferred tax assets and liabilities ($6 millionincrease in the second quarter, $21 million decrease in the third quarter and$38 million decrease in the fourth quarter) (see note 10);

·       $12million gain on the sale of the REMA hydropower plants in the second quarter;and

·       $8 million net chargerelated to the settlement of the shareholder class action lawsuits in thesecond quarter.

F-64

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**(18)**   ReportableSegments

We have twoprincipal****business segments:

·       Retailenergy—provides electricity and energy services to approximately 1.9 millionretail electricity customers in Texas, including residential and small businesscustomers and commercial, industrial and governmental/institutional customers. Approximately68% of our residential and small business customers are in the Houston area. Wealso serve commercial, industrial and governmental/ institutional customers inthe PJM market, and we regularly evaluate entering other markets; and

·       Wholesaleenergy—provides electricity and energy services in the competitive wholesaleenergy markets in the United States through our ownership and operation orcontracting for power generation capacity. As of December 31, 2006, we hadapproximately 16,000 MW of owned, leased or contracted for generation capacityin operation.

We also have unallocated corporate functions and otherinvestments.

Our segments are the strategic operating units underwhich we manage our business, including the allocation of resources andassessment of performance. We use contribution margin to evaluate our businesssegments because we use that measure in organizing and managing our business. Contributionmargin is defined as total revenues less (a) purchased power, fuel andcost of gas sold, (b) operation and maintenance, (c) selling and marketingand (d) bad debt expense. We manage the costs not included in contributionmargin (other general and administrative, depreciation, amortization, interestand income taxes) on a company-wide basis.

The accounting policies of our segments are describedin note 2. We account for intersegment revenues at current market prices.

F-65

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Financialdata for our segments are as follows:

| ** **                                       | ** ** | **Retail  Energy**     | ** ** | **Wholesale  Energy** | ** ** | **Other  Operations** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------------------|------------|------------------|------------|------------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| **2006:**                                        |       |                   |       |                  |       |                  |       |             |       |             |       |   |   |   |   |   |   |   |   |   |
| Revenues from external  customers(1)             |       | $                      | 8,197      |                  |       | $                     | 2,679      | (2)              |       |             | $          | 1 |   |   |   | $ | — |   |   |   | $ | 10,877 |   |   |   |
| Intersegment revenues                            |       | —                 |       |                  | 571        |                  |       |             | 1          |             |       |   | (572 | ) |   |   | — |   |   |   |
| Purchased power, fuel  and cost of gas sold      |       | 7,500                  |       |                  | 2,507      |                  |       |             | —     |             |       |   | (571 | ) |   |   | 9,436 |   |   |   |
| Gross margin(3)(4)                               |       | 697                    |       |                  | 743        |                  |       |             | 2          |             |       |   | (1 | ) |   |   | 1,441 |   |   |   |
| Operation and  maintenance expenses              |       | 234                    |       |                  | 599        |                  |       |             | 1          |             |       |   | (1 | ) |   |   | 833 |   |   |   |
| Selling and marketing  expenses                  |       | 124                    |       |                  | —     |                  |       |             | —     |             |       |   | — |   |   |   | 124 |   |   |   |
| Bad debt expense                                 |       | 89                     |       |                  | (2         | )                     |       |             | —     |             |       |   | — |   |   |   | 87 |   |   |   |
| Contribution margin(4)                           |       | 250                    |       |                  | 146        |                  |       |             | 1          |             |       |   | — |   |   |   | 397 |   |   |   |
| Expenditures for  long-lived assets(5)           |       | 9                      |       |                  | 78         |                  |       |             | 10         |             |       |   | — |   |   |   | 97 |   |   |   |
| Equity investments as of  December 31, 2006 |       | —                 |       |                  | 25         |                  |       |             | —     |             |       |   | — |   |   |   | 25 |   |   |   |
| Total assets as of  December 31, 2006       |       | 1,984                  |       |                  | 8,402      |                  |       |             | 848        | (6)              |       |   | (667 | ) |   |   | 10,567 |   |   |   |
| **2005:**                                        |       |                   |       |                  |       |                  |       |             |       |             |       |   |   |   |   |   |   |   |   |   |
| Revenues from external  customers(1)             |       | $                      | 7,045      |                  |       | $                     | 2,661      |             |       |             | $          | 6 |   |   |   | $ | — |   |   |   | $ | 9,712 |   |   |   |
| Intersegment revenues                            |       | —                 |       |                  | 625        |                  |       |             | —     |             |       |   | (625 | ) |   |   | — |   |   |   |
| Purchased power, fuel  and cost of gas sold      |       | 6,362                  |       |                  | 2,630      |                  |       |             | (1         | )                |       |   | (625 | ) |   |   | 8,366 |   |   |   |
| Gross margin(3)(7)                               |       | 683                    |       |                  | 656        |                  |       |             | 7          |             |       |   | — |   |   |   | 1,346 |   |   |   |
| Operation and  maintenance expenses              |       | 190                    |       |                  | 544        |                  |       |             | 3          |             |       |   | — |   |   |   | 737 |   |   |   |
| Selling and marketing  expenses                  |       | 95                     |       |                  | —     |                  |       |             | —     |             |       |   | — |   |   |   | 95 |   |   |   |
| Bad debt expense                                 |       | 56                     |       |                  | 2          |                  |       |             | —     |             |       |   | — |   |   |   | 58 |   |   |   |
| Contribution margin(7)                           |       | 342                    |       |                  | 110        |                  |       |             | 4          |             |       |   | — |   |   |   | 456 |   |   |   |
| Expenditures for  long-lived assets(5)           |       | 9                      |       |                  | 66         |                  |       |             | 7          |             |       |   | — |   |   |   | 82 |   |   |   |
| Equity investments as of  December 31, 2005 |       | —                 |       |                  | 30         |                  |       |             | —     |             |       |   | — |   |   |   | 30 |   |   |   |
| Total assets as of  December 31, 2005       |       | 2,762                  |       |                  | 9,871      |                  |       |             | 1,691      | (6)              |       |   | (755 | ) |   |   | 13,569 |   |   |   |
| **2004:**                                        |       |                   |       |                  |       |                  |       |             |       |             |       |   |   |   |   |   |   |   |   |   |
| Revenues from external  customers(1)             |       | $                      | 6,064      |                  |       | $                     | 2,034      | (8)              |       |             | $          | — |   |   |   | $ | — |   |   |   | $ | 8,098 |   |   |   |
| Intersegment revenues                            |       | —                 |       |                  | 340        |                  |       |             | —     |             |       |   | (340 | ) |   |   | — |   |   |   |
| Purchased power, fuel  and cost of gas sold      |       | 5,335                  |       |                  | 1,569      |                  |       |             | —     |             |       |   | (340 | ) |   |   | 6,564 |   |   |   |
| Gross margin(3)(9)                               |       | 729                    |       |                  | 805        |                  |       |             | —     |             |       |   | — |   |   |   | 1,534 |   |   |   |
| Operation and  maintenance expenses              |       | 222                    |       |                  | 560        |                  |       |             | —     |             |       |   | — |   |   |   | 782 |   |   |   |
| Selling and marketing  expenses                  |       | 82                     |       |                  | —     |                  |       |             | —     |             |       |   | — |   |   |   | 82 |   |   |   |
| Bad debt expense                                 |       | 48                     |       |                  | (2         | )                     |       |             | —     |             |       |   | — |   |   |   | 46 |   |   |   |
| Contribution margin(9)                           |       | 377                    |       |                  | 247        |                  |       |             | —     |             |       |   | — |   |   |   | 624 |   |   |   |
| Expenditures for  long-lived assets(5)           |       | 3                      |       |                  | 151        |                  |       |             | 6          |             |       |   | — |   |   |   | 160 |   |   |   |
| Equity investments as of  December 31, 2004 |       | —                 |       |                  | 84         |                  |       |             | —     |             |       |   | — |   |   |   | 84 |   |   |   |
| Total assets as of December 31, 2004        |       | 1,391                  |       |                  | 9,759      |                  |       |             | 1,546      | (6)              |       |   | (502 | ) |   |   | 12,194 |   |   |   |

----

(1)             Substantiallyall revenues are in the United States.

(2)             Includes$1.2 billion in revenues from a single counterparty, which represented 11% ofour consolidated revenues and 45% of our wholesale energy segment’s revenues. Asof December 31, 2006, $16 million is outstanding from this counterparty.

(3)             Grossmargin (revenues less purchased power, fuel and cost of gas sold) excludesdepreciation, amortization, labor and other product costs.

(4)             Includes$(287) million, $56 million and $231 million in retail energy, wholesale energyand consolidated, respectively, results relating to unrealized gains (losses)on energy derivatives, which is a non-cash item.

(5)             Long-livedassets include net property, plant and equipment, net goodwill, net otherintangibles and equity investments. All of our long-lived assets are in theUnited States.

(6)             Otheroperations include discontinued operations of $2 million, $1,084 million and$1,137 million as of December 31, 2006, 2005 and 2004, respectively.

F-66

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(7)             Includes$(69) million, $(123) million and $(192) million in retail energy, wholesaleenergy and consolidated, respectively, results relating to unrealized gains(losses) on energy derivatives, which is a non-cash item.

(8)             Includes$792 million in revenues from a single counterparty, which represented 10% ofour consolidated revenues and 39% of our wholesale energy segment’s revenues. Asof December 31, 2004, no amounts were outstanding from this counterparty.

(9)             Includes$(272) million, $48 million and $(224) million in retail energy, wholesaleenergy and consolidated, respectively, results relating to unrealized gains(losses) on energy derivatives, which is a non-cash item.

| ** **                                                                                   | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                   | ** ** | **(in millions)** | ** ** |
| **Reconciliation  of Contribution Margin to Operating Loss and Operating Loss to Net Loss:** |       |                   |       |     |       |     |       |
| Contribution margin                                                                          |       | $                      | 397        |     | $          | 456      |       | $ | 624 |   |
| Other general and administrative                                                             |       | 172                    |       | 140      |       | 198      |       |
| Western states and Cornerstone settlements                                                   |       | 35                     |       | 359      |       | —   |       |
| Loss on sales of receivables                                                                 |       | —                 |       | —   |       | 34       |       |
| Accrual for payment to CenterPoint                                                           |       | —                 |       | —   |       | 2        |       |
| Gain on sale of counterparty claim                                                           |       | —                 |       | —   |       | (30      | )          |
| Gains on sales of assets and emission allowances,  net                                       |       | (159                   | )          | (168     | )          | (20      | )          |
| Depreciation and amortization                                                                |       | 373                    |       | 446      |       | 453      |       |
| Operating loss                                                                               |       | (24                    | )          | (321     | )          | (13      | )          |
| Income (loss) of equity investments, net                                                     |       | 6                      |       | 26       |       | (9       | )          |
| Debt conversion expense                                                                      |       | (37                    | )          | —   |       | —   |       |
| Other, net                                                                                   |       | —                 |       | (23      | )          | 13       |       |
| Interest expense                                                                             |       | (428                   | )          | (399     | )          | (418     | )          |
| Interest income                                                                              |       | 34                     |       | 23       |       | 35       |       |
| Loss from continuing operations before income taxes                                          |       | (449                   | )          | (694     | )          | (392     | )          |
| Income tax benefit                                                                           |       | (122                   | )          | (253     | )          | (116     | )          |
| Loss from continuing operations                                                              |       | (327                   | )          | (441     | )          | (276     | )          |
| Income (loss) from discontinued operations                                                   |       | (2                     | )          | 111      |       | 240      |       |
| Loss before cumulative effect of accounting changes                                          |       | (329                   | )          | (330     | )          | (36      | )          |
| Cumulative effect of accounting changes, net of tax                                          |       | 1                      |       | (1       | )          | 7        |       |
| Net loss                                                                                     |       | $                      | (328       | )        | $          | (331     | )          | $ | (29 | ) |

 

**(19) Impairment of Cost Method Investment**

During the second quarterof 2005, we recorded a non-cash charge of $23 million (recorded in other, net)for the impairment of our investment in a communications services company. Theimpairment charge was based on an internal valuation of projected future cashflows and earnings conducted in connection with the preparation of our interimfinancial statements. As of December 31, 2006, our remaining non-energyinvestments have a net book value of $5 million and are included in otherlong-term assets.

**(20) Sales of Assets and Emission Allowances**

We included the following (all from our wholesaleenergy segment) in our results of operations through the date of sale.

*REMAHydropower Plants.**  *Twohydropower plants sold for $42 million in April 2005.

*Landfill-gasFueled Power Plants.*   Our landfill-gas fueledpower plants sold for $28 million in July 2005.

F-67

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*ElDorado Investment.**  *Our50% interest in El Dorado Energy, LLC sold for $132 million in July 2005and we received $76 million after adjustment for net project debt. Werecognized a gain on the disposal of $25 million (recorded in income of equityinvestments, net) during the third quarter of 2005.

*Emission Allowances.*   Sales consist of:

| ** ** | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| SO2        |       | $                      | 202        | (1)      | $          | 209      | (2)        |   | $ | 40 |   |   |
| NOx        |       | —                 |       | 28       | (3)        |     | 20         |   |   |
|       |       | $                      | 202        |     | $          | 237      |       |   | $ | 60 |   |   |

----

(1)             Sold182,000 tons relating to 2006 through 2010 vintage years.

(2)             Sold242,000 tons relating to 2005 through 2009 vintage years.

(3)             Sold 9,000 tonsrelating to 2005 through 2007 vintage years.

*Summary of Gains andLosses.*

| ** **                                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(in millions)** | ** ** |
| Emission  allowances                                   |       | $                      | 159        |     | $          | 160      |       |   | $ | 19 |   |   |
| REMA hydropower  plants                                |       | —                 |       | 12       |       |     | —     |   |   |
| Landfill-gas  fueled power plants                      |       | —                 |       | (4       | )          |     | —     |   |   |
| Other, net                                             |       | —                 |       | —   |       |     | 1          |   |   |
| Gains on sales of  assets and emission allowances, net |       | $                      | 159        |     | $          | 168      |       |   | $ | 20 |   |   |

 

**(21) Discontinued Operations**

***(a)   New York Plants.***

*General.*   In February 2006, weclosed on the sale of our three remaining New York plants with an aggregate netgenerating capacity of approximately 2,100 MW for $979 million. During thethird quarter of 2005, we began to report the results of the New York plants asdiscontinued operations. These plants were a part of our wholesale energysegment.

*Useof Proceeds.*   Weapplied $952 million of cash proceeds, which is net of estimated city, stateand transfer taxes and transaction costs, to pay down our senior secured termloans.

*Assumptions Related toDebt, Deferred Financing Costs and Interest Expense on Discontinued Operations.**  *Based on our contractual obligation(at the time the purchase and sale agreement was executed) to utilize a portionof the net proceeds from the sale to prepay debt, we have classified $638million of debt as discontinued operations as of December 31, 2005. Wehave also classified as discontinued operations the related deferred financingcosts and interest expense on this debt. We allocated $15 million, $39 millionand $50 million of related interest expense during 2006, 2005 and 2004,respectively, to discontinued operations.

***(b)    Ceredo Plant.***

In 2005, we sold our 505MW Ceredo power plant for $100 million. We used the net cash proceeds of $100million to pay down a portion of our senior secured term loans. During thethird quarter of 2005, we began to report results of Ceredo’s operations asdiscontinued operations effective January 1, 2005. The plant was a part ofour wholesale energy segment.

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***(c)    Liberty.***

In 2004, we transferredour ownership interests in Liberty, including its non-recourse debt, to Liberty’slenders. Liberty owned a 530 MW power generation facility and had been indefault under its credit agreement. The plant was a part of our wholesaleenergy segment. We have reported the results of our Liberty operations asdiscontinued operations since the fourth quarter of 2004. We did not provide orreceive any cash consideration in connection with the transfer to Liberty’slenders. We allocated $21 million of related interest expense during 2004 todiscontinued operations.

***(d)    Orion Power Hydropower Plants.***

In 2004, we sold 71hydropower plants and a gas-fired generation plant with a total aggregate netgenerating capacity of 770 MW for $870 million. The plants were a part of ourwholesale energy segment. We have reported the results of our Hydropower plantoperations as discontinued operations since the second quarter of 2004. Ourestimated net proceeds after transaction and related costs were $804 million. Weused the net proceeds from the sale to repay debt, pay taxes and settle an interestrate swap termination.

Pursuant to the terms ofcertain credit agreements to apply all net cash proceeds from the sale to payoff indebtedness (including swap obligations), we have reported the debt repaidthrough the sale, related interest rate swaps and related deferred financingcosts, including associated interest, as discontinued operations. We allocated$47 million of related interest expense during 2004 to discontinued operations.

***(e)    European Energy.***

In 2003, we sold ourEuropean energy operations, which formerly were a reportable segment. We havereported the results of our European energy operations as discontinuedoperations since the first quarter of 2003.

In addition to the initialcash proceeds, we are entitled to receive 90% of any cash distributions inexcess of Euro 110 million received by the purchaser from the formercoordinating body for the Dutch electricity sector as contingent considerationfor the sale. We received payments of $52 million and $8 million during 2005and 2004, respectively.

***(f)    AllDiscontinued Operations.***

The following summarizescertain financial information of the businesses reported as discontinuedoperations:

| ** **                                            | ** ** | **New York  Plants** | ** ** | **Ceredo  Plant**(1) | ** ** | **Liberty** | ** ** | **Orion Power  Hydropower Plants** | ** ** | **European   Energy** | ** ** | **Total** | ** ** |
|-------------------------------------------------------|------------|---------------------------|------------|----------------------|------------|-------------|------------|----------------------------------------------|------------|----------------------------|------------|-----------|------------|
| ***2006***                                            |       |                      |       |                 |       |        |       |                                         |       |                       |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                              |       |                      | $          | 108                  |       |        |       | $                                            | —     |                       |       |      | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 108 |   |
| Loss before income tax expense/benefit                |       |                      | (7         | )(2)                 |       |        | —     |                                         |       |                       | —     |      |       |   | — |   |   |   | — |   |   | (7 | ) |
| ***2005***                                            |       |                      |       |                 |       |        |       |                                         |       |                       |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                              |       |                      | $          | 996                  |       |        |       | $                                            | —     |                       |       |      | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 996 |   |
| Income (loss) before income  tax expense/benefit |       |                      | 18         | (3)                  |       |        | (27        | )(4)                                         |       |                       | —     |      |       |   | — |   |   |   | 52 |   |   | 43 |   |
| ***2004***                                            |       |                      |       |                 |       |        |       |                                         |       |                       |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                              |       |                      | $          | 633                  |       |        |       | N/A                                          |       |                       |       | $         | 86         |   |   |   | $ | 95 |   |   |   | $ | — |   |   | $ | 814 |   |
| Income (loss) before income   tax expense/benefit     |       |                      | 123        |                 |       |        | N/A        |                                         |       |                       | (98        | )(5)      |       |   | 187 | (6) |   |   | 9 |   |   | 221 |   |

----

(1)             Priorto January 1, 2005, Ceredo did not qualify for discontinued operations.

F-69

----

(2)             Includesan additional pre-tax loss on disposal of $16 million primarily due to changesin derivative assets not terminated as of the date of sale. The cumulative pre-taxloss on disposal through December 31, 2006 is $255 million.

(3)             Includes$239 million estimated loss on disposal.

(4)             Includes$27 million loss on disposal.

(5)             Includes$70 million loss on disposal.

(6)             Includes$208 million gain on disposal.

Thefollowing summarizes the assets and liabilities related to New Yorkdiscontinued operations:

| ** **                             | ** ** | **December 31,**  | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in millions)** | ** ** |
| **Current Assets:**                    |       |                   |       |   |   |   |   |
| Accounts receivable, net               |       |                   | $          | 2 |   |   | $ | 51 |   |
| Derivative assets                      |       |                   | —     |   |   | 87 |   |
| Other current assets                   |       |                   | —     |   |   | 65 |   |
| Total current assets                   |       |                   | 2          |   |   | 203 |   |
| **Property, Plant and Equipment, net** |       |                   | —     |   |   | 761 |   |
| **Other Assets:**                      |       |                   |       |   |   |   |   |
| Other intangibles, net                 |       |                   | —     |   |   | 69 |   |
| Derivative assets                      |       |                   | —     |   |   | 43 |   |
| Other                                  |       |                   | —     |   |   | 8 |   |
| Total long-term assets                 |       |                   | —     |   |   | 881 |   |
| Total Assets                           |       |                   | $          | 2 |   |   | $ | 1,084 |   |
| **Current Liabilities:**               |       |                   |       |   |   |   |   |
| Accounts payable, principally trade    |       |                   | —     |   |   | $ | 30 |   |
| Derivative liabilities                 |       |                   | —     |   |   | 50 |   |
| Other current liabilities              |       |                   | 3          |   |   | 16 |   |
| Total current liabilities              |       |                   | 3          |   |   | 96 |   |
| **Other Liabilities:**                 |       |                   |       |   |   |   |   |
| Accumulated deferred income taxes      |       |                   | —     |   |   | 120 |   |
| Other liabilities                      |       |                   | —     |   |   | 22 |   |
| Total other liabilities                |       |                   | —     |   |   | 142 |   |
| **Long-term Debt**                     |       |                   | —     |   |   | 638 |   |
| Total long-term liabilities            |       |                   | —     |   |   | 780 |   |
| Total Liabilities                      |       |                   | 3          |   |   | 876 |   |
| Accumulated other comprehensive loss   |       |                   | $          | — |   |   | $ | — |   |

 

F-70

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**RELIANT ENERGY,INC. AND SUBSIDIARIES**

**SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS**

**2006,2005 and 2004**

**(Thousandsof Dollars)**

| **Column A**                                  | ** ** | **Column B**                              | ** ** | **Column C**       | ** ** | **Column D**                       | ** ** | **Column E**                 | ** ** |
|----------------------------------------------------|------------|------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|
| ** **                                         | ** ** | ** **                                     | ** ** | **Additions**           | ** ** | ** **                              | ** ** | ** **                        | ** ** |
| **Description**                                    | ** ** | **Balance at  Beginning  of Period** | ** ** | **Charged  to  Income** | ** ** | **Charged  to Other  Accounts**(1) | ** ** | **Deductions  from  Reserves**(2) | ** ** | **Balance at  End  of Period** | ** ** |
| *2006*                                             |       |                                           |       |                    |       |                                    |       |                              |       |   |   |   |   |   |   |
| Allowance for  doubtful accounts                   |       | $                                              | 34,054     |                    | $          | 86,961                                  |       |                              | $          | — |   |   |   | $ | (87,683 | ) |   | $ | 33,332 |   |
| Reserves deducted  from  derivative assets         |       | 197,384                                        |       | (68,240                 | )          |                                    | —     |                              |       |   | (2,434 | ) |   | 126,710 |   |
| Reserves for  severance                            |       | 1,860                                          |       | 3,845                   |       |                                    | —     |                              |       |   | (5,705 | ) |   | — |   |
| *2005*                                             |       |                                           |       |                    |       |                                    |       |                              |       |   |   |   |   |   |   |
| Allowance for  doubtful accounts                   |       | 41,636                                         |       | 57,817                  |       |                                    | —     |                              |       |   | (65,399 | ) |   | 34,054 |   |
| Reserves deducted  from  derivative assets         |       | 87,323                                         |       | 128,306                 |       |                                    | 33         |                              |       |   | (18,278 | ) |   | 197,384 |   |
| Reserves for  severance                            |       | 1,325                                          |       | 8,664                   |       |                                    | —     |                              |       |   | (8,129 | ) |   | 1,860 |   |
| *2004*                                             |       |                                           |       |                    |       |                                    |       |                              |       |   |   |   |   |   |   |
| Allowance for  doubtful accounts                   |       | 46,184                                         |       | 45,707                  |       |                                    | —     |                              |       |   | (50,255 | ) |   | 41,636 |   |
| Reserves deducted  from  derivative assets         |       | 16,273                                         |       | 52,110                  |       |                                    | 19,948     |                              |       |   | (1,008 | ) |   | 87,323 |   |
| Reserves for  accrue-in-advance  major maintenance |       | 9,647                                          |       | (9,647                  | )(3)       |                                    | —     |                              |       |   | — |   |   | — |   |
| Reserves for severance                             |       | 4,592                                          |       | 30,618                  |       |                                    | —     |                              |       |   | (33,885 | ) |   | 1,325 |   |
|                                                    |            |                                                |            |                         |            |                                         |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |

----

(1)             Representscharges to accumulated other comprehensive income/loss.

(2)             Deductionsfrom reserves represent losses or expenses for which the respective reserveswere created. In the case of the allowance for doubtful accounts, suchdeductions are net of recoveries of amounts previously written off.

(3)             Seenote 2(q) to our consolidated financial statements.

F-71

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and MembersRERH Holdings, LLC:

We have audited theaccompanying consolidated balance sheet of RERH Holdings, LLC and subsidiaries(the Company), as of December 31, 2006, and the related consolidatedstatements of operations, members’ equity and comprehensive income, and cashflows for the year then ended. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audit.

We conducted our audit inaccordance with the auditing standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The Company is not required tohave, nor were we engaged to perform, an audit of its internal control overfinancial reporting. Our audit included consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audit provides areasonable basis for our opinion.

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of RERH Holdings, LLCand subsidiaries as of December 31, 2006, and the results of theiroperations and their cash flows for the year then ended in conformity with U.S.generally accepted accounting principles.

KPMG LLP

Houston, TexasFebruary 26, 2007

F-72

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**RERH HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENT OF OPERATIONS**(Thousands of Dollars)

| ** **                                          | ** ** | **2006**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|
| **Revenues:**                                       | ** ** | ** ** | ** ** |
| Electricity sales and services revenues             |       | $          | 7,460,341  |   |
| **Expenses:**                                       | ** ** | ** ** | ** ** |
| Purchased power                                     |       | 2,790,009  |       |
| Purchased power—affiliates                     |       | 3,937,469  |       |
| Operation and maintenance                           |       | 206,397    |       |
| Operation and maintenance—affiliates           |       | 25,917     |       |
| Selling, general and administrative                 |       | 231,692    |       |
| Selling, general and administrative—affiliates |       | 70,060     |       |
| Depreciation and amortization                       |       | 29,490     |       |
| Total operating expense                             |       | 7,291,034  |       |
| **Operating  Income**                               |       | 169,307    |       |
| **Other Income (Expense):**                         | ** ** | ** ** | ** ** |
| Other, net                                          |       | 22         |       |
| Interest expense                                    |       | (28,198    | )          |
| Interest income                                     |       | 2,481      |       |
| Interest income, net—affiliates                |       | 104,427    |       |
| Total other income                                  |       | 78,732     |       |
| **Income  Before Income Taxes**                     |       | 248,039    |       |
| Income tax expense                                  |       | 96,180     |       |
| **Net Income**                                      |       | $          | 151,859    |   |

 

See Notes to the Consolidated Financial Statements

F-73

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**RERH HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED BALANCE SHEET(Thousands of Dollars)**

| ** **                                                                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                   | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                   |       |                  |       |   |   |
| **Current Assets:**                                                                          | ** ** |                  |       |   |   |
| Cash and cash equivalents                                                                    |       |                  | $          | 136,017 |   |   |
| Restricted cash                                                                              |       |                  | 13,000     |   |   |
| Accounts receivable and unbilled revenue,  principally customer, net of allowance of $29,386 |       |                  | 732,975    |   |   |
| Accumulated deferred income taxes                                                            |       |                  | 206,795    |   |   |
| Derivative assets                                                                            |       |                  | 422,098    |   |   |
| Prepayments and other current assets                                                         |       |                  | 41,603     |   |   |
| Total current assets                                                                         |       |                  | 1,552,488  |   |   |
| **Property,  Plant and Equipment, net**                                                      |       |                  | 54,340     |   |   |
| **Other Assets:**                                                                            | ** ** |                  |       |   |   |
| Goodwill                                                                                     |       |                  | 31,631     |   |   |
| Derivative assets                                                                            |       |                  | 127,028    |   |   |
| Accumulated deferred  income taxes                                                           |       |                  | 30,365     |   |   |
| Other                                                                                        |       |                  | 17,069     |   |   |
| Total other assets                                                                           |       |                  | 206,093    |   |   |
| **Total  Assets**                                                                            |       |                  | $          | 1,812,921 |   |   |
| **LIABILITIES AND MEMBERS’ EQUITY**                                                     |       |                  |       |   |   |
| **Current Liabilities:**                                                                     | ** ** |                  |       |   |   |
| Accounts payable, principally trade                                                          |       |                  | $          | 396,728 |   |   |
| Payable to affiliates, net                                                                   |       |                  | 38,970     |   |   |
| Retail customer deposits                                                                     |       |                  | 67,068     |   |   |
| State income taxes payable                                                                   |       |                  | 23,166     |   |   |
| Other taxes payable                                                                          |       |                  | 53,585     |   |   |
| Accrual for transmission and distribution charges                                            |       |                  | 60,654     |   |   |
| Derivative liabilities                                                                       |       |                  | 904,108    |   |   |
| Other                                                                                        |       |                  | 52,331     |   |   |
| Total current liabilities                                                                    |       |                  | 1,596,610  |   |   |
| **Other Liabilities:**                                                                       | ** ** |                  |       |   |   |
| Derivative liabilities                                                                       |       |                  | 225,997    |   |   |
| Other                                                                                        |       |                  | 19,043     |   |   |
| Total other liabilities                                                                      |       |                  | 245,040    |   |   |
| **Commitments and Contingencies**                                                            | ** ** |                  |       |   |   |
| **Members’ Equity:**                                                                    | ** ** |                  |       |   |   |
| Members’ equity                                                                         |       |                  | (28,729    | ) |   |
| **Total members’ equity**                                                               |       |                  | (28,729    | ) |   |
| **Total Liabilities and Members’  Equity**                                              |       |                  | $1,812,921 |   |   |

 

See Notes to the Consolidated Financial Statements

F-74

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**RERH HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CASH FLOWS(Thousands of Dollars)**

| ** **                                                                                                                        | ** ** | **2006**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **Cash Flows from Operating  Activities:**                                                                                        |       |       |       |
| Net income                                                                                                                        |       | $          | 151,859    |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:                                                |       |       |       |
| Depreciation and amortization                                                                                                     |       | 29,490     |       |
| Deferred income taxes                                                                                                             |       | (108,547   | )          |
| Net changes in energy derivatives                                                                                                 |       | 407,649    |       |
| Non-cash federal income tax contributions from Reliant  Energy, Inc., net                                                         |       | 179,222    |       |
| Other, net                                                                                                                        |       | 1,118      |       |
| Changes  in other assets and liabilities:                                                                                         |       |       |       |
| Accounts receivable and unbilled revenue, net                                                                                     |       | 196,846    |       |
| Receivables/payables—affiliates                                                                                              |       | (481,521   | )          |
| Margin deposits, net                                                                                                              |       | (2,775     | )          |
| Net derivative assets and liabilities                                                                                             |       | (76,112    | )          |
| Accounts payable                                                                                                                  |       | 271,019    |       |
| Other current assets                                                                                                              |       | 10,763     |       |
| Other current liabilities                                                                                                         |       | 31,057     |       |
| Other assets                                                                                                                      |       | 342        |       |
| Retail customer deposits                                                                                                          |       | 6,158      |       |
| State income taxes payable                                                                                                        |       | 9,032      |       |
| Other taxes payable                                                                                                               |       | 14,311     |       |
| Accrual for transmission and distribution charges                                                                                 |       | 16,344     |       |
| Other liabilities                                                                                                                 |       | (3,477     | )          |
| Net cash provided by operating activities                                                                                         |       | 652,778    |       |
| **Cash Flows from Investing Activities:**                                                                                         |       |       |       |
| Restricted cash                                                                                                                   |       | (13,000    | )          |
| Capital expenditures                                                                                                              |       | (9,424     | )          |
| Net cash used in investing activities                                                                                             |       | (22,424    | )          |
| **Cash Flows from Financing Activities:**                                                                                         |       |       |       |
| Decrease in short-term borrowings, net                                                                                            |       | (450,000   | )          |
| Distributions to Reliant Energy, Inc.                                                                                        |       | (2,944     | )          |
| Changes in note with Reliant Energy, Inc., net                                                                               |       | (50,115    | )          |
| Net cash used in financing activities                                                                                             |       | (503,059   | )          |
| **Net Change in Cash and Cash Equivalents**                                                                                       |       | 127,295    |       |
| **Cash and Cash Equivalents at Beginning of Period**                                                                              |       | 8,722      |       |
| **Cash and Cash Equivalents at End of Period**                                                                                    |       | $          | 136,017    |   |
| **Supplemental Disclosure of Cash Flow  Information:**                                                                            |       |       |       |
| Cash  Payments:                                                                                                                   |       |       |       |
| Interest paid to affiliate                                                                                                        |       | $          | 2,942      |   |
| Interest paid (net of amounts capitalized) to third  parties                                                                      |       | 29,090     |       |
| Income taxes paid (net of income tax refunds  received)                                                                           |       | 16,472     |       |
| Non-cash  Disclosure:                                                                                                             |       |       |       |
| Contributions from Reliant Energy, Inc., net                                                                                 |       | 171,629    |       |
| Transfer of certain assets and liabilities from  Reliant Energy Electric Solutions, LLC to Reliant Energy Power Supply, LLC,  net |       | 329,807    |       |
| Transfer of certain assets and liabilities from  Reliant Energy Services, Inc. to Reliant Energy Power Supply, LLC, net      |       | (329,773   | )          |
| Distribution to Reliant Energy, Inc. of Reliant  Energy Solutions East, LLC                                                  |       | (2,058     | )          |
| Distribution to  Reliant Energy, Inc. of note receivable                                                                     |       | (1,943,943 | )          |

 

See Notes to the Consolidated Financial Statements

F-75

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**RERH HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF MEMBERS’ EQUITY AND COMPREHENSIVE INCOME**(Thousands ofDollars)

| ** **                                                                                                                        | ** ** | **Members’  Equity** | ** ** | **Comprehensive  Income** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **Balance  at December 31, 2005**                                                                                            |       | $                         | 1,596,694  |                      |       |   |   |   |
| Net income                                                                                                                        |       | 151,859                   |       |                      | $          | 151,859 |   |   |
| Contributions  from Reliant Energy, Inc., net                                                                                |       | 171,629                   |       |                      |       |   |   |
| Distribution to  Reliant Energy, Inc. of Reliant Energy Solutions East, LLC                                                  |       | (5,002                    | )          |                      |       |   |   |
| Distribution to  Reliant Energy, Inc. of note receivable                                                                     |       | (1,943,943                | )          |                      |       |   |   |
| Transfer of  certain assets and liabilities from Reliant Energy Electric Solutions, LLC to  Reliant Energy Power Supply, LLC, net |       | 329,807                   |       |                      |       |   |   |
| Transfer of  certain assets and liabilities from Reliant Energy Services, Inc.  to Reliant Energy Power Supply, LLC, net     |       | (329,773                  | )          |                      |       |   |   |
| Comprehensive  income                                                                                                             |       |                      |       |                      | $          | 151,859 |   |   |
| **Balance at December 31,  2006**                                                                                            |       | $                         | (28,729    | )                         |       |   |   |   |

 

See Notes to the Consolidated Financial Statements

F-76

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**RERH HOLDINGS, LLCAND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(1)**          Backgroundand Basis of Presentation

*Background.**  *“Retail Holdings” refers to RERHHoldings, LLC, a Delaware limited liability company, which is a wholly-ownedsubsidiary of Reliant Energy, Inc. and was formed in July 2006. However,no activity occurred until December 1, 2006. The transfer of ReliantEnergy Retail Holdings, LLC and its subsidiaries by Reliant Energy, Inc.into Retail Holdings is a transfer of equity interests between entities undercommon control. Accordingly, the results of operations of RERH Holdings, LLCand its consolidated subsidiaries (RERH Holdings) reflect the transfer as if itoccurred at the beginning of 2006. “Reliant Energy” refers to Reliant Energy, Inc.and its consolidated subsidiaries. Reliant Energy, Inc. is the sole Class Amember and holds all 1,000 membership units of that class of Retail Holdings. Inconnection with the credit-enhanced retail structure, Merrill LynchCommodities, Inc. owns one Class B membership unit, which is all ofthe issued and outstanding units of that class for Retail Holdings. The Class Bmember has only limited rights to vote on certain matters and no interest inprofits and losses.

In preparation forand in connection with the credit-enhanced retail structure, RERH Holdings madeownership changes relating to entities, assets and liabilities during 2006. Thefollowing occurred (related amounts are included on the consolidated statementsof members’ equity and comprehensive income):

·       FormedReliant Energy Power Supply, LLC in April 2006 to procure the purchasedpower for RERH Holdings’ Texas retail customers. Reliant Energy Power Supply,LLC began procuring power in July 2006.

·       ReliantEnergy Solutions East, LLC was distributed to Reliant Energy, Inc. on October 1,2006 as this entity does business for retail customers outside of Texas.

·       Certainassets and liabilities were transferred from Reliant Energy Electric Solutions,LLC and Reliant Energy Services, Inc. (both of which are not subsidiariesof Retail Holdings) to Reliant Energy Power Supply, LLC in the third and fourthquarters of 2006 as these related to supply positions for the Texas retailcustomers.

RERH Holdings provides electricity products andrelated services to end-use customers ranging from residential and smallbusiness customers to commercial, industrial and governmental/institutionalcustomers in Texas. Approximately 68% of RERH Holdings’ residential and smallbusiness customers are in the Houston area. Through September 30, 2006,RERH Holdings included the operations and related revenues and expenses forReliant Energy’s business with retail customers outside of Texas in the marketoperated by PJM Interconnection, LLC, primarily in New Jersey, Maryland, theDistrict of Columbia and Pennsylvania.

As of December 31,2006, RERH Holdings’ subsidiaries include:

| **Subsidiary**                                               | ** ** | ** **          | ** ** | **Formation Date** | ** ** |
|--------------------------------------------------------------|------------|---------------------|------------|-------------------------|------------|
| Reliant Energy Retail Holdings, LLC (the predecessor parent) |       | September 2000 |       |
| Reliant Energy Retail Services, LLC                          |       | September 2000 |       |
| RE Retail Receivables, LLC                                   |       | June 2002      |       |
| Reliant  Energy Power Supply, LLC                            |       | April 2006     |       |

 

*Basis of Presentation.**  *These consolidated statementsinclude all revenues and costs directly attributable to RERH Holdings includingcosts for facilities and costs for functions and services performed 

F-77

----

by Reliant Energy and charged to RERH Holdings. Allsignificant intercompany transactions have been eliminated.

**(2)**          Summaryof Significant Accounting Policies

***(a)***          Useof Estimates and Market Risk and Uncertainties.

Management makesestimates and assumptions to prepare financial statements in conformity withaccounting principles generally accepted in the United States of America (GAAP)that affect:

·       thereported amount of assets, liabilities and equity,

·       thereported amounts of revenues and expenses and

·       disclosureof contingent assets and liabilities at the date of the financial statements.

RERH Holdings’ critical accounting estimatesinclude:  (a) derivative assets andliabilities; (b) estimated revenues and energy supply costs; and (c) deferredtax assets, valuation allowances and tax liabilities. Actual results coulddiffer from the estimates.

RERHHoldings is subject to various risks inherent in doing business. Seenotes 2(c), 2(d), 2(e), 2(g), 4, 6, 7, 8, 9 and 10.

***(b)***           Principlesof Consolidation.

RetailHoldings includes its accounts and those of its wholly-owned subsidiaries inits consolidated financial statements.

***(c)***            Revenues.

Gross revenues forenergy sales and services to residential and small business customers andelectric sales to commercial, industrial and governmental/institutionalcustomers are recognized upon delivery and include estimated energy andservices delivered but not billed by the end of the period.

As of December 31,2006, RERH Holdings recorded unbilled revenues of $398 million for retailenergy sales. Accrued unbilled revenues are based on RERH Holdings’ estimatesof customer usage since the date of the last meter reading provided by theindependent system operators or electric distribution companies. Volumeestimates are based on daily forecasted volumes and estimated customer usage byclass. Unbilled revenues are calculated by multiplying volume estimates by theapplicable rate by customer class. Estimated amounts are adjusted when actualusage is known and billed.

***(d)***           Derivativesand Hedging Activities.

RERH Holdings accounts for its derivatives instrumentsand hedging activities in accordance with SFAS No. 133, “Accounting forDerivatives Instruments and Hedging Activities,” as amended (SFAS No. 133).

For hedging activities, RERH Holdings uses bothderivative and non-derivative contracts that provide for settlement in cash orby delivery of a commodity. The primary types of derivative instruments RERHHoldings uses are forwards, futures, swaps and options. RERH Holdings accountsfor its derivatives under one of two****accountingmethods (mark-to-market or accrual accounting (under the normal purchase/normalsale exception)) based on facts and circumstances. The fair values ofderivative activities are determined by (a) prices actively quoted, (b) pricesprovided by other external sources or (c) prices based on models and othervaluation methods.

F-78

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Realizedgains and losses on derivatives contracts not held for trading purposes arereported either on a net or gross basis based on the relevant facts andcircumstances. Hedging transactions that do not physically flow are included inthe same caption as the items being hedged. A summary of RERH Holdings’derivative activities and classification in its results of operations is:

| Instrument                                                        | ** ** | **Purpose for Holding or  Issuing Instrument**(1) | ** ** | **Transactions that  Physically Flow** | ** ** | **Transactions that  Financially Settle**(2) |
|-------------------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------|
| Power futures, forward, swap  and                                 |       | Power sales to end-use retail customers           |       | Revenues                               |       | N/A(3)                                       |
| option contracts                                                  |       | Supply management revenues                        |       | Revenues                               |       | Purchased power                              |
|                                                                   |       | Power purchases                                   |       | Purchased power                        |       | Purchased power                              |
|                                                              |       |                                              |       |                                   |       |                                         |
| Natural gas and fuel  futures, forward, swap and option contracts |       | Natural gas and fuel purchases/sales              |       | N/A(3)                                 |       | Purchased power                              |

----

(1)             Thepurpose for holding or issuing is not impacted by the accounting method electedfor each instrument.

(2)             Includesclassification for mark-to-market derivatives.

(3)             N/A is notapplicable.

In addition to market risk, RERH Holdings is exposedto credit and operational risk. ReliantEnergy has a risk control framework, to which RERH Holdings is subject, tomanage these risks, which include:  (a) measuring and monitoring these risks,(b) review and approval of new transactions relative to theserisks, (c) transaction validation and (d) portfolio valuation andreporting. RERH Holdings uses mark-to-market valuation, value-at-risk and othermetrics in monitoring and measuring risk. Reliant Energy’s risk controlframework includes a variety of separatebut complementary processes, which involve commercial and senior management andReliant Energy’s Board of Directors. See note 2(e) for furtherdiscussion of RERH Holdings’ credit policy.

*Set-off of DerivativeAssets and Liabilities.**  *Wherederivative instruments are subject to a master netting agreement and theaccounting criteria to offset are met, RERH Holdings presents its derivativeassets and liabilities on a net basis. Derivative assets/liabilities andaccounts receivable/payable are presented and set-off separately in theconsolidated balance sheets although in most cases contracts permit the set-offof derivative assets/liabilities and accounts receivable/payable with a givencounterparty.

***(e)***            CreditRisk.

RERH Holdings has a credit policy that governs themanagement of credit risk, including the establishment of counterparty creditlimits and specific transaction approvals. Credit risk is monitored daily andthe financial condition of counterparties is reviewed periodically. RERHHoldings tries to mitigate credit risk by entering into contracts that permitnetting and allow it to terminate upon the occurrence of certain events ofdefault. RERH Holdings measures credit risk as the replacement cost for itsderivative positions plus amounts owed for settled transactions.

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RERHHoldings’ credit exposure is based on itsderivative assets and accounts receivable from its power supply counterparties,after taking into consideration netting within each contract and any masternetting contracts with counterparties. As of December 31, 2006, onenon-investment grade counterparty represented 99% ($261 million) of RERHHoldings’ credit exposure.

***(f)***             Selling,General and Administrative Expenses.

Selling,general and administrative expenses include, among other items,  (a) selling and marketing, (b) baddebt expense, (c) financial services, (d) legal costs, (e) regulatorycosts and (f) certain benefit costs. Some of the expenses are allocatedfrom affiliates (see note 3).

***(g)***           Property,Plant and Equipment and Depreciation Expense.

RERHHoldings computes depreciation using the straight-line method based onestimated useful lives. Depreciation expense was $29 million during 2006.

| ** **                            | ** ** | **Estimated Useful** | ** **  | **December 31,**  | ** ** |
|---------------------------------------|------------|---------------------------|-------------|------------------------|------------|
| ** **                            | ** ** | **Lives (Years)**    | ** **  | **2006**               | ** ** |
| ** **                            | ** ** | ** **                | ** **  | **(in millions)** | ** ** |
| Information  technology               |       |                      | 3 – 10 |                   |       |   | $ | 174 |   |   |
| Furniture and  leasehold improvements |       |                      | 3 – 10 |                   |       |   | 6 |   |   |
| Assets under  construction            |       |                      |        |                   |       |   | 5 |   |   |
| Total                                 |       |                      |        |                   |       |   | 185 |   |   |
| Accumulated  depreciation             |       |                      |        |                   |       |   | (131 | ) |   |
| Property, plant and  equipment, net   |       |                      |        |                   |       |   | $ | 54 |   |   |

 

RERHHoldings periodically evaluates property, plant and equipment for impairmentwhen events or circumstances indicate that the carrying value of these assetsmay not be recoverable. The evaluation is highly dependent on the underlyingassumptions of related cash flows. RERH Holdings recorded no material property,plant and equipment impairments during 2006.

***(h)***          IntangibleAssets and Amortization Expense.

*Goodwill.*   RERHHoldings performs its goodwill impairment test annually on April 1 andwhen events or changes in circumstances indicate that the carrying value maynot be recoverable. As of December 31, 2006, RERH Holdings had $19 millionof goodwill that is deductible for United States income tax purposes in futureperiods.

*Other Intangibles.*   RERHHoldings recognizes specifically identifiable intangible assets, includingrenewable energy credits, when specific rights and contracts are acquired. RERHHoldings has no intangible assets with indefinite lives recorded as of December 31,2006.

***(i)***             Income Taxes.

*Federal.**  *RERH Holdings is included in the consolidated federalincome tax returns of Reliant Energy and calculates its income tax provision ona separate return basis, whereby Reliant Energy pays all federal income taxeson RERH Holdings’ behalf and is entitled to any related tax savings. Thedifference between RERH Holdings’ current federal income tax expense orbenefit, as calculated on a separate return basis, and related amounts paidto/received from Reliant Energy, if any, are recorded in RERH Holdings’financial statements as adjustments to members’ equity. Deferred federal incometaxes reflected on RERH Holdings’ consolidated balance sheet will ultimately besettled with Reliant Energy. See notes 3 and 8.

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*State.*   RERHHoldings is included in the consolidated state income tax returns of ReliantEnergy. It calculates its state provision, related payables or receivables anddeferred state income taxes on a separate return basis and primarily settlesthe related assets and liabilities directly with the governmental entity. See note 8.

***(j)***              Cashand Cash Equivalents.

RERHHoldings records all highly liquid short-term investments with maturities ofthree months or less as cash equivalents.

***(k)***           RestrictedCash.

Restrictedcash is comprised of funds received in error and subsequently returned.

***(l)***              Allowancefor Doubtful Accounts.

RERHHoldings accrues an allowance for doubtful accounts based on estimates of uncollectiblerevenues by analyzing counterparty credit ratings (for commercial andindustrial customers), historical collections, accounts receivable agings andother factors. RERH Holdings writes-off accounts receivable balances againstthe allowance for doubtful accounts when it determines a receivable isuncollectible.

***(m)***       NewAccounting Pronouncement NotYet Adopted—Fair Value.

TheFASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements,” which defines fair value, establishes a framework formeasuring fair value in GAAP and expands disclosures about fair valuemeasurements. This statement is applicable for RERH Holdings beginning in 2008.It applies under other accounting pronouncements that require or permit fairvalue measurements. The adoption, which RERH Holdings plans to assess during2007, could have a significant impact on its consolidated financial statements.

**(3)**          RelatedParty Transactions

These financial statements include the impact ofsignificant transactions between RERH Holdings and Reliant Energy. The majorityof these transactions involve the purchase or sale of energy, capacity orrelated services from or to RERH Holdings and allocations of costs to RERHHoldings for support services.

*Supportand Technical Services.**  *Reliant Energy provides commercial support, technicalservices and other corporate services to RERH Holdings. During 2006, ReliantEnergy allocates certain support services costs to RERH Holdings based on RERHHoldings’ underlying planned operating expenses relative to the underlyingplanned operating expenses of other entities to which Reliant Energy providessimilar services and also charges RERH Holdings for certain other servicesbased on usage. Management believes this method of allocation is reasonable. Theseallocations and charges were not necessarily indicative of what would have beenincurred had RERH Holdings been an unaffiliated entity. Effective with thecredit-enhanced retail structure, beginning December 1, 2006, ReliantEnergy charges a fee for these services calculated in the same manner andincluding a mark-up percentage of 1.5%, which was insignificant in 2006.

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Thefollowing details the amounts recorded as operation and maintenance—affiliatesand selling, general and administrative—affiliates:

| ** **                                 | ** ** | **2006**               | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **(in millions)** | ** ** |
| Allocated or  charged by Reliant Energy(1) |       |                   | $          | 96 |   |   |
|                                            |            |                        |            |  |  |  |

----

(1)             Includes $3 millionfor RERH Holdings’ share of allocated rent expense.

*Services fromReliant Energy Electric Solutions, LLC and Reliant Energy Services, Inc.**  *Reliant Energy Retail Holdings, LLC****transferred its interest in Reliant Energy ElectricSolutions, LLC (REES) to Reliant Energy on January 1, 2005. During 2006(through November 30, 2006), REES and Reliant Energy Services, Inc.(RES) primarily provided the energy supply services to RERH Holdings. Theadministrative costs for these services are included in the corporate supportservices allocations discussed above. Prior to December 1, 2006, REES andRES entered into contracts with third parties for the purposes of supplyingRERH Holdings with some of the electricity necessary to serve its retailcustomers. RERH Holdings reimbursed REES and RES for the ultimate price of anyelectricity sold from REES/RES to RERH Holdings, including costs of derivativeinstruments, upon final delivery of that electricity. These supply contractsare subject to the provisions of the master commodity purchase and saleagreements, master netting arrangements and other contractual arrangements thatREES and RES utilize with third-party customers and suppliers in connectionwith their supply portfolio management activities, including those activitiesundertaken for RERH Holdings. Effective December 1, 2006, RERH Holdingsmanages primarily all of its electricity supply portfolio directly with thirdparties.

| ** **                                                                 | ** ** | **2006**               | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **(in millions)** | ** ** |
| Purchased power  from Reliant Energy under various commodity agreements(1) |       |                   | $          | 3,937 |   |   |
|                                                                            |            |                        |            |  |  |  |

----

(1)             Recorded in purchasedpower—affiliates.

*NotesReceivable—Reliant Energy, Inc.**  *Reliant Energy manages RERH Holdings’ daily cashbalances. Prior to the credit-enhanced retail structure, excess cash wasadvanced to Reliant Energy, which provided a cash management function, and wasrecorded in notes receivable from Reliant Energy, Inc. RERH Holdingsrecorded interest income or expense, based on whether RERH Holdings investedexcess funds, or borrowed funds from Reliant Energy. The amount of net interestincome was $104 million during 2006. During 2006, this note receivable wasdistributed to Reliant Energy as a non-cash equity distribution in theamount of $1.9 billion.

*NamingRights to Houston Sports Complex.**  *In 2000, Reliant Energy acquiredthe naming rights, including advertising and other benefits, for a footballstadium and other convention and entertainment facilities. Pursuant to thisagreement, Reliant Energy is required to pay $10 million per year from 2002through 2032. These costs are charged to RERH Holdings by Reliant Energy andare included in selling, general and administrative expense.

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*Income Taxes.*   Seediscussion in note 2(i) regarding RERH Holdings’ policy with regardsto income taxes.

| ** **                                                                     | ** ** | **2006**               | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **(in millions)** | ** ** |
| Non-cash federal  income tax contributions from Reliant Energy, Inc., net |       |                   | $          | 179 |   |   |
|                                                                                |            |                        |            |  |  |  |

 

**(4)**          Derivativesand Hedging Activities

RERHHoldings’ derivative portfolio is $581 million (net liability) as of December 31,2006. RERH Holdings has no cash flow hedges as of December 31, 2006.

**(5)**          Debt

***(a)***          WorkingCapital Facility.

Inconnection with the credit-enhanced retail structure, on December 1, 2006,RERH Holdings entered into a $300 million working capital facility agreementwith Merrill Lynch & Co., Inc. and affiliates (Merrill Lynch). Asof December 31, 2006, no amount was outstanding under this facility. Loansbear interest at LIBOR plus 0.45% or a base rate. Borrowings under thisfacility will mature on the 90th day after the termination of the credit sleeveand reimbursement agreement with Merrill Lynch. The working capital facilityincludes a $150 million minimum adjusted EBITDA (earnings before interest,taxes, depreciation and amortization) requirement for RERH Holdings for eachtrailing four-quarter period. The covenants under the credit sleeve andreimbursement agreement with Merrill Lynch also apply to the working capitalfacility. The obligations of RERH Holdings are non-recourse to ReliantEnergy.

***(b)***           ReceivablesFacility.

RERHHoldings had a receivables facility arrangement to sell an undividedinterest in accounts receivable from its business to financial institutions onan ongoing basis. In connection with the credit-enhanced retailstructure, this agreement was terminated and RERH Holdings repaid $450 millionon December 1, 2006.

Theborrowings under the facility bore interest at floating rates that includedfees based on the facility’s level of commitment and utilization. RERH Holdings serviced the receivables andreceived a fee of 0.4% of cash collected during 2006, which approximated theactual service costs.

**(6)**          Credit-EnhancedRetail Structure

The credit sleeve and reimbursement agreement (theagreement) and a working capital facility agreement, providing for revolvingcredit loans, each with Merrill Lynch became effective on December 1,2006, which substantially eliminated collateral postings for RERH Holdings’business, although these collateral postings were made by Reliant Energy, notRERH Holdings.

Under the agreement, Merrill Lynch provides guaranteesand the posting of collateral to RERH Holdings’ counterparties in supplytransactions for its Texas retail energy business. Cash flow activity in connectionwith these contracts and related collateral is classified as operating cashflow. RERH Holdings recorded an unrealized loss on energy derivatives of $18million due to the differences in quantity between contracts with Merrill Lynchand its contracts with the exchange relating to existing financially settledsupply contracts.

RERH Holdings paid Merrill Lynch a one-timestructuring fee of $13 million, which was expensed as general andadministrative costs. RERH Holdings also pays a fee to Merrill Lynch of $0.40for each megawatt hour (MWh) of power that it delivers to its Texas retailcustomers. This fee is classified as 

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interest expense. RERHHoldings is obligated to reimburse Merrill Lynch to the extent that anyguarantees are called upon or any collateral posted by Merrill Lynch isforeclosed upon.

The initial term of the agreement is five years. RERHHoldings is permitted to terminate at any time, subject to a make-whole paymentduring the first two years of the agreement. Merrill Lynch does not have anearly termination option. The agreement (a) restricts the ability of RERHHoldings to, among other actions, (i) encumber its assets, (ii) sellcertain assets, (iii) incur additional debt, (iv) pay dividends orpay subordinated debt, (v) make investments or acquisitions or (vi) enterinto transactions with affiliates and (b) requires RERH Holdings to manageits risks related to commodity prices.

Inconnection with the agreement, Reliant Energy implemented a structure so thatthe entities comprising its Texas retail energy business became subsidiaries ofRetail Holdings. RERH Holdings’ obligations under the agreement with MerrillLynch and the retail working capital facility are secured by first liens on theassets of RERH Holdings. Retail Holdings and its subsidiaries are designed tomaintain the separate nature of their assets, avoid consolidation of suchassets with the bankruptcy estate of Reliant Energy in the event Reliant Energyever becomes subject to such a proceeding, and ensure that such assets areavailable first and foremost to satisfy their creditors’ claims. Theobligations of RERH Holdings under the agreement and the retail working capitalfacility are non-recourse to Reliant Energy. See note 5(a) fordiscussion of the retail working capital facility.

**(7)**          BenefitPlans

RERH Holdings’ eligibleemployees participate in Reliant Energy’s stock-based incentive plans. During2006, RERH Holdings’ after-tax stock-based incentive plans compensation expensewas $3 million.

RERH Holdings’ employeesparticipate in Reliant Energy’s employee savings plans under Sections 401(a) and401(k) of the Internal Revenue Code. Under the plans, participatingemployees may contribute a portion of their compensation generally up to amaximum of 50% in total for pre-tax and/or Roth 401(k) plus 16%after-tax during 2006. RERH Holdings’ savings plan benefit expense, includingmatching and discretionary contributions, was $4 million during 2006.

**(8)**          Income Taxes

***(a)***          Summary.

RERHHoldings’ income tax expense (benefit) is:

| ** **         | ** ** | **2006**               | ** ** |
|--------------------|------------|------------------------|------------|
| ** **         | ** ** | **(in millions)** | ** ** |
| **Current:**       |       |                   |       |   |   |
| Federal            |       |                   | $          | 179 |   |   |
| State              |       |                   | 26         |   |   |
| Total current      |       |                   | 205        |   |   |
| **Deferred:**      |       |                   |       |   |   |
| Federal            |       |                   | (95        | ) |   |
| State              |       |                   | (14        | ) |   |
| Total deferred     |       |                   | (109       | ) |   |
| Income tax expense |       |                   | $          | 96 |   |   |

 

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Areconciliation of the federal statutory income tax rate to the effective incometax rate is:

| ** **                                         | ** ** | **2006**               | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **(in millions)** | ** ** |
| Income before  income taxes                        |       |                   | $          | 248 |   |   |
| Federal statutory  rate                            |       |                   | 35         | % |   |
| Income tax  expense at statutory rate              |       |                   | 87         |   |   |
| Net addition (reduction)  in taxes resulting from: |       |                   |       |   |   |
| State income taxes, net of federal income taxes    |       |                   | 8          |   |   |
| Other, net                                         |       |                   | 1          |   |   |
| Total                                              |       |                   | 9          |   |   |
| Income tax  expense                                |       |                   | $          | 96 |   |   |
| Effective rate                                     |       |                   | 39         | % |   |

 

| ** **                                             | ** ** | **December 31,**  | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2006**               | ** ** |
| ** **                                             | ** ** | **(in millions)** | ** ** |
| **Deferred tax assets:**                               |       |                   |       |   |   |
| Current:                                               |       |                   |       |   |   |
| Derivative liabilities, net                            |       |                   | $          | 202 |   |   |
| Allowance for doubtful accounts and credit  provisions |       |                   | 11         |   |   |
| Employee benefits                                      |       |                   | 1          |   |   |
| Total current deferred tax assets                      |       |                   | 214        |   |   |
| Non-current:                                           |       |                   |       |   |   |
| Derivative liabilities, net                            |       |                   | 39         |   |   |
| Employee benefits                                      |       |                   | 2          |   |   |
| Total non-current deferred tax assets                  |       |                   | 41         |   |   |
| Total deferred tax assets                              |       |                   | $          | 255 |   |   |
| **Deferred tax liabilities:**                          | ** ** |                   |       |   |   |
| Current:                                               |       |                   |       |   |   |
| Other                                                  |       |                   | 7          |   |   |
| Total current deferred tax liabilities                 |       |                   | 7          |   |   |
| Non-current:                                           |       |                   |       |   |   |
| Depreciation and amortization                          |       |                   | $          | 17 |   |   |
| Other                                                  |       |                   | 1          |   |   |
| Total non-current deferred tax liabilities             |       |                   | 18         |   |   |
| Total deferred tax liabilities                         |       |                   | $          | 25 |   |   |
| Accumulated  deferred income taxes, net                |       |                   | $          | 230 |   |   |

 

***(b)***           Valuation Allowances.

RERH Holdings assessesquarterly its future ability to use deferred tax assets. These assessmentsincluded an evaluation of its recent history of earnings and losses, futurereversals of temporary differences and identification of other sources offuture taxable income, including the identification of tax planning strategiesin certain situations. Based on the analysis, RERH Holdings determined that novaluation allowance is needed for its deferred tax assets as of December 31,2006.

***(c)***            Tax Contingencies.

Reliant Energy’s income tax returns, including yearswhen it was included in CenterPoint’s consolidated tax group, for the 1997 to2004 tax reporting periods are under audit by federal and state 

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taxing authorities. Theseaudits may result in additional taxes, interest and penalties or revisions ofthe timing of tax payments. RERH Holdings classifies interest and penaltiesrelated to income taxes in income tax expense/benefit. As RERH Holdings is apart of the consolidated income tax returns of Reliant Energy, it could besubject to additional taxes. RERH Holdings evaluates the need for contingenttax liabilities on a quarterly basis and records any estimable and probable taxexposures in its results of operations. In addition, RERH Holdings disclosesany material tax contingencies as to which it believes there is a reasonablepossibility of a future tax assessment.

As of December 31, 2006, RERH Holdings does nothave any accrued contingent federal or state tax liabilities.

RERH Holdingsbelieves that the substantial majority of certain payments and charges aredeductible for income tax purposes; however, no assurance can be given that theInternal Revenue Service would not assert, or that a court would not sustain, acontrary position. This payment includes:

·       $177 million to CenterPointduring 2004 related to residential customers.

***(d)***           Changesin Accounting for Income Taxes or Tax Laws.

The FASB issued guidance clarifying the accounting foruncertainty in income taxes. Pursuant to the new guidance, which is effectivefor RERH Holdings in 2007, tax benefits are only recorded for positions whereit is more-likely-than-not that reported tax return treatment would besustained if audited by relevant taxing authorities. Additional rules areprovided for interest, penalties, changes in benefit recognition and otherrelated matters. RERH Holdings is currently in the process of determining theimpact of this adoption. Based on its latest estimates, RERH Holdings does notexpect the adoption to have a material impact on its consolidated financialstatements.

In May 2006, theState of Texas enacted substantial changes to its tax system. Effective January 1,2007, the current Texas franchise tax comprised of taxable capital and earnedsurplus components was replaced with a revised franchise tax based on modifiedgross revenue. As a result of the Texas law change, during 2006, RERH Holdingsdecreased its net deferred state tax liabilities by $9 million to reflect theestimated cumulative change to deferred tax items.

**(9)**          Commitments

***(a)***          LeaseCommitments.

*Cash Obligations UnderOperating Leases.*   RERH Holdings’ projected cashobligations under non-cancelable long-term operating leases as of December 31,2006 are (in millions):

| 2007                 |   | $ | 12     |   |
|----------------------|--------|---|--------|--------|
| 2008                 |   | 7 |   |
| 2009                 |   | 4 |   |
| 2010                 |   | 4 |   |
| 2011                 |   | 3 |   |
| 2012 and  thereafter |   | 1 |   |
| Total                |   | $ | 31     |   |

* *

*Operating Lease Expense.*   Totallease expense for all operating leases was $12 million during 2006.

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***(b)***           Guaranteesand Indemnifications.

*EquityPledged as Collateral to Reliant Energy.**  *Retail Holdings’ equity is pledgedas collateral under certain of Reliant Energy’s credit and debt agreements,which have an outstanding balance of $2.8 billion as of December 31, 2006.

*Other.**  *RERH Holdings enters into contracts that includeindemnification and guarantee provisions. In general, RERH Holdings enters intocontracts with indemnities for matters such as breaches of representations andwarranties and covenants contained in the contract and/or against certainspecified liabilities. Examples of these contracts include asset salesagreements, retail supply agreements, service agreements and procurementagreements.

RERH Holdings is unable toestimate its maximum potential exposure under these provisions until an eventtriggering payment under these provisions occurs. RERH Holdings does not expectto make any material payments under these provisions.

***(c)***            OtherCommitments.

*Purchased PowerCommitments.**  *RERHHoldings is a party to purchased power contracts of various quantities anddurations that are not classified as derivative assets and liabilities. Thesecontracts are not included in the consolidated balance sheet as of December 31,2006. Minimum purchase commitment obligations under these agreements are asfollows as of December 31, 2006:

| ** **           | ** ** | **Purchased Power Commitments** | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **Fixed Pricing**                    | ** ** | **Variable Pricing**(1) | ** ** |
| ** **           | ** ** | **(in millions)**                    | ** ** |
| 2007                 |       |                                      | $          | 50 |   |   |   | $ | 21 |   |   |
| 2008                 |       |                                      | —     |   |   |   | 11 |   |   |
| 2009                 |       |                                      | —     |   |   |   | 9 |   |   |
| 2010                 |       |                                      | —     |   |   |   | — |   |   |
| 2011                 |       |                                      | —     |   |   |   | — |   |   |
| 2012 and  thereafter |       |                                      | —     |   |   |   | — |   |   |
| Total                |       |                                      | $          | 50 |   |   |   | $ | 41 |   |   |

----

(1)             Forcontracts with variable pricing components, RERH Holdings estimated pricesbased on forward commodity curves as of December 29, 2006.

As of December 31, 2006, the maximum remainingterm under any individual purchased power contract is three years.

*Sales Commitments.**  *As of December 31, 2006, RERHHoldings has sales commitments, including electric energy and capacity salescontracts, which are not classified as derivative assets and liabilities. Theestimated minimum sales commitments under these contracts are as follows:

| ** ** | ** ** | **Fixed Pricing**(1) | ** ** | **Variable Pricing**(1)(2) | ** ** |
|------------|------------|---------------------------|------------|---------------------------------|------------|
| ** ** | ** ** | **(in millions)**    | ** ** |
| 2007       |       |                      | $          | 2,378                           |       |   |   | $ | 1,553 |   |   |
| 2008       |       |                      | 583        |                            |       |   | 1,156 |   |   |
| 2009       |       |                      | 320        |                            |       |   | 281 |   |   |
| 2010       |       |                      | 64         |                            |       |   | 54 |   |   |
| 2011       |       |                      | 3          |                            |       |   | 8 |   |   |
| Total      |       |                      | $          | 3,348                           |       |   |   | $ | 3,052 |   |   |

----

(1)             Inconnection with the credit-enhanced retail structure, RERH Holdingsestimates the fee for each MWh delivered under these sales commitments to be$16 million, $8 million, $3 million and $1 million during 2007, 2008, 2009 and2010, respectively.

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(2)             For contracts withvariable pricing components, RERH Holdings estimated prices based on forwardcommodity curves as of December 29, 2006.

**(10)**   Contingencies

RERH Holdings is involved in legal and other mattersbefore courts and governmental agencies. Unless otherwise noted, RERH Holdingscannot predict the outcome of these matters.

*PUCTCases.**  *Thereare various proceedings pending before the state district court in TravisCounty, Texas, seeking reviews of the Public Utility Commission of Texas (PUCT)orders relating to the fuel factor component used in the “price-to-beat” tariff.These proceedings pertain to the same issues affirmed by a district court inTravis County and later by the Travis County Court of Appeals in 2004 in aseparate proceeding.

*PUCT Complaint.**  *A market participant has filed a complaint at thePUCT relating to ERCOT’s procedure for allocating replacement reserve chargesfor 2006. Although it is very early in the process and RERH Holdings is stillevaluating the complaint, if the PUCT orders resettlement of the charges anddepending on the method of resettlement, RERH Holdings’ share of theresettlement charges could be up to $25 million.

**(11)**   EstimatedFair Value of Financial Instruments

The fair values of cash and cash equivalents, accountsreceivable and payable and derivative assets and liabilities equal theircarrying amounts.

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors of Reliant Energy, Inc.,Sole Member of Reliant Energy Retail Holdings, LLC Houston, Texas

We have audited the accompanying consolidated balancesheet of Reliant Energy Retail Holdings, LLC and subsidiaries (the “Company”),as of December 31, 2005, and the related consolidated statements ofoperations, member’s equity and comprehensive income, and cash flows for eachof the two years in the period ended December 31, 2005. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the financial statements based onour audits.

We conducted our audits in accordance with theauditing standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Reliant Energy Retail Holdings, LLC and subsidiaries at December 31,2005, and the results of their operations and their cash flows for each of thetwo years in the period ended December 31, 2005, in conformity withaccounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

Houston, TexasMarch 14, 2006

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**RELIANT ENERGY RETAIL HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**(Thousands of Dollars)

| ** **                                                | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------------|------------|-----------|------------|-----------|------------|
| **Revenues:**                                             |       |      |       |      |       |
| Electricity sales and services revenues                   |       | $         | 5,997,644  |      | $          | 5,820,647 |   |
| **Expenses:**                                             |       |      |       |      |       |
| Purchased power                                           |       | 621,075   |       | 3,399,267 |       |
| Purchased power—affiliates                           |       | 4,629,342 |       | 1,392,472 |       |
| Operation and maintenance                                 |       | 175,382   |       | 205,387   |       |
| Operation and maintenance—affiliates                 |       | 17,401    |       | 12,834    |       |
| Selling, general and administrative                       |       | 153,792   |       | 138,279   |       |
| Selling, general and administrative—affiliates       |       | 49,568    |       | 85,557    |       |
| Loss on sales of receivables                              |       | —    |       | 33,741    |       |
| Accrual for payment to CenterPoint Energy, Inc.      |       | —    |       | 1,600     |       |
| Loss on sales of assets                                   |       | 4,329     |       | —    |       |
| Depreciation and amortization                             |       | 48,656    |       | 43,894    |       |
| Total operating expense                                   |       | 5,699,545 |       | 5,313,031 |       |
| **Operating  Income**                                     |       | 298,099   |       | 507,616   |       |
| **Other Income (Expense):**                               |       |      |       |      |       |
| Other, net                                                |       | 275       |       | 309       |       |
| Interest expense                                          |       | (19,196   | )          | (10,070   | )          |
| Interest income                                           |       | 300       |       | 12,298    |       |
| Interest income, net—affiliates                      |       | 102,244   |       | 83,040    |       |
| Total other income                                        |       | 83,623    |       | 85,577    |       |
| **Income  Before Income Taxes**                           |       | 381,722   |       | 593,193   |       |
| Income tax expense                                        |       | 148,824   |       | 221,279   |       |
| **Income  Before Cumulative Effect of Accounting Change** |       | 232,898   |       | 371,914   |       |
| Cumulative effect of accounting change, net of tax        |       | —    |       | —    |       |
| **Net Income**                                            |       | $         | 232,898    |      | $          | 371,914 |   |

 

See Notes to the Consolidated Financial Statements

F-90

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**RELIANT ENERGY RETAIL HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED BALANCE SHEET(Thousands of Dollars)**

| ** **                                                                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                             | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                             |       |                  |       |   |   |
| **Current Assets:**                                                                                    |       |                  |       |   |   |
| Cash and cash equivalents                                                                              |       |                  | $          | 8,722 |   |   |
| Accounts and notes receivable and unbilled revenue, principally  customer, net of allowance of $29,556 |       |                  | 852,686    |   |   |
| Margin deposits on energy trading and hedging  activities                                              |       |                  | 250        |   |   |
| Accumulated deferred income taxes                                                                      |       |                  | 9,882      |   |   |
| Prepayments and other current assets                                                                   |       |                  | 17,171     |   |   |
| Total current assets                                                                                   |       |                  | 888,711    |   |   |
| **Property,  Plant and Equipment, net**                                                                |       |                  | 73,468     |   |   |
| **Other Assets:**                                                                                      |       |                  |       |   |   |
| Goodwill                                                                                               |       |                  | 31,631     |   |   |
| Other intangibles, net                                                                                 |       |                  | 203        |   |   |
| Notes receivable—affiliate                                                                        |       |                  | 1,893,828  |   |   |
| Other                                                                                                  |       |                  | 1,492      |   |   |
| Total other assets                                                                                     |       |                  | 1,927,154  |   |   |
| **Total  Assets**                                                                                      |       |                  | $          | 2,889,333 |   |   |
| **LIABILITIES AND MEMBER’S EQUITY**                                                               |       |                  |       |   |   |
| **Current Liabilities:**                                                                               |       |                  |       |   |   |
| Short-term borrowings                                                                                  |       |                  | $          | 450,000 |   |   |
| Accounts payable, principally trade                                                                    |       |                  | 125,036    |   |   |
| Accounts payable—affiliates                                                                       |       |                  | 491,683    |   |   |
| Retail customer deposits                                                                               |       |                  | 62,450     |   |   |
| State income taxes payable                                                                             |       |                  | 16,850     |   |   |
| Other taxes payable                                                                                    |       |                  | 42,121     |   |   |
| Accrual for transmission and distribution charges                                                      |       |                  | 44,310     |   |   |
| Other                                                                                                  |       |                  | 20,247     |   |   |
| Total current liabilities                                                                              |       |                  | 1,252,697  |   |   |
| **Other Liabilities:**                                                                                 |       |                  |       |   |   |
| Accumulated deferred income taxes                                                                      |       |                  | 24,023     |   |   |
| Other                                                                                                  |       |                  | 15,919     |   |   |
| Total other liabilities                                                                                |       |                  | 39,942     |   |   |
| **Commitments and Contingencies**                                                                      |       |                  |       |   |   |
| **Member’s Equity:**                                                                              |       |                  |       |   |   |
| Other member’s equity                                                                             |       |                  | 1,596,694  |   |   |
| Accumulated other comprehensive loss                                                                   |       |                  | —     |   |   |
| **Total member’s equity**                                                                         |       |                  | 1,596,694  |   |   |
| **Total Liabilities and Member’s  Equity**                                                        |       |                  | $          | 2,889,333 |   |   |

 

See Notes to the Consolidated Financial Statements

F-91

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**RELIANT ENERGY RETAIL HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Thousands of Dollars)**

| ** **                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Cash Flows from Operating Activities:**                                          |       |     |       |     |       |
| Net income                                                                         |       | $        | 232,898    |     | $          | 371,914 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |     |       |     |       |
| Depreciation and  amortization                                                     |       | 48,656   |       | 43,894   |       |
| Deferred income taxes                                                              |       | (6,203   | )          | 80,723   |       |
| Federal income tax  contributions from Reliant Energy, Inc., net              |       | 136,564  |       | 130,450  |       |
| Net unrealized (gains)  losses on energy derivatives                               |       | —   |       | (20,335  | )          |
| Accrual for payment to  CenterPoint Energy, Inc.                              |       | —   |       | 1,600    |       |
| Loss on sale of assets                                                             |       | 4,329    |       | —   |       |
| Changes in other assets and liabilities:                                           |       |     |       |     |       |
| Accounts and notes  receivable and unbilled revenue, net                           |       | (201,964 | )          | (44,331  | )          |
| Receivables facility  proceeds, net                                                |       | —   |       | 232,000  |       |
| Accounts  receivable/payable—affiliates                                       |       | 122,966  |       | 77,201   |       |
| Margin deposits on energy  trading and hedging activities, net                     |       | —   |       | (4,700   | )          |
| Net derivative assets and  liabilities                                             |       | 350      |       | 13,576   |       |
| Accounts payable                                                                   |       | 14,123   |       | 35,533   |       |
| Other current assets                                                               |       | 2,564    |       | (29,561  | )          |
| Other current liabilities                                                          |       | 5,384    |       | (22,518  | )          |
| Other assets                                                                       |       | 654      |       | 1,364    |       |
| Retail customer deposits                                                           |       | 163      |       | 5,118    |       |
| State income taxes  payable                                                        |       | 4,244    |       | (25,178  | )          |
| Other taxes payable                                                                |       | 5,327    |       | 4,480    |       |
| Payment to CenterPoint  Energy, Inc.                                          |       | —   |       | (176,600 | )          |
| Accrual for transmission  and distribution charges                                 |       | 317      |       | 4,578    |       |
| Other liabilities                                                                  |       | 2,707    |       | 5,344    |       |
| Net cash provided by  operating activities                                         |       | 373,079  |       | 684,552  |       |
| **Cash Flows from Investing Activities:**                                          |       |     |       |     |       |
| Capital expenditures                                                               |       | (9,239   | )          | (5,371   | )          |
| Proceeds from sale of  assets, net                                                 |       | 27,303   |       | —   |       |
| Net cash provided by  (used in) investing activities                               |       | 18,064   |       | (5,371   | )          |
| **Cash Flows from Financing Activities:**                                          |       |     |       |     |       |
| Payments of long-term  debt                                                        |       | —   |       | (1,721   | )          |
| Increase (decrease) in  short-term borrowings, net                                 |       | 223,000  |       | (123,000 | )          |
| Changes in notes with  Reliant Energy, Inc., net                              |       | (613,383 | )          | (556,354 | )          |
| Net cash used in  financing activities                                             |       | (390,383 | )          | (681,075 | )          |
| **Net  Change in Cash and Cash Equivalents**                                       |       | 760      |       | (1,894   | )          |
| **Cash and  Cash Equivalents at Beginning of Period**                              |       | 7,962    |       | 9,856    |       |
| **Cash and  Cash Equivalents at End of Period**                                    |       | $        | 8,722      |     | $          | 7,962 |   |
| **Supplemental Disclosure of Cash Flow  Information:**                             |       |     |       |     |       |
| Cash Payments:                                                                     |       |     |       |     |       |
| Interest paid to  affiliate                                                        |       | $        | 6,920      |     | $          | 5 |   |
| Interest paid (net of  amounts capitalized) to third party                         |       | 19,355   |       | 9,853    |       |
| Income taxes paid (net of  income tax refunds received)                            |       | 14,096   |       | 35,282   |       |
| Non-cash Disclosure:                                                               |       |     |       |     |       |
| Contributions from  Reliant Energy, Inc., net                                 |       | 133,564  |       | 130,450  |       |
| Transfer of Reliant Energy Electric Solutions, LLC to  Reliant Energy, Inc.   |       | (273,476 | )          | —   |       |

 

See Notes to the Consolidated Financial Statements

F-92

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**RELIANT ENERGY RETAIL HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF MEMBER’S EQUITY AND COMPREHENSIVE INCOME**(Thousands ofDollars)

| ** **                                                                                               | ** ** | **Other  Member’s  Equity** | ** ** | **Accumulated Other  Comprehensive  Income (Loss)** | ** ** | **Total  Member’s  Equity** | ** ** | **Comprehensive  Income** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|
| **Balance  at December 31, 2003**                                                                   |       | $                                | 1,001,346  |                                                          |       | $                                | 9,236      |                      |       | $ | 1,010,582 |   |   |   |   |   |
| Net income                                                                                               |       | 371,914                          |       |                                                          |       |                             |       | 371,914                   |       |   | $ | 371,914 |   |   |
| Contributions  from member                                                                               |       | 130,450                          |       |                                                          |       |                             |       | 130,450                   |       |   |   |   |   |
| Other comprehensive  income (loss):                                                                      |       |                             |       |                                                          |       |                             |       |                      |       |   |   |   |   |
| Deferred gain  from cash flow hedges, net  of tax of $5 million                                          |       |                             |       |                                                          | 7,616      |                             |       | 7,616                     |       |   | 7,616 |   |   |
| Reclassification  of net deferred gain from cash flow hedges into net income, net  of tax of $10 million |       |                             |       |                                                          | (16,854    | )                                |       | (16,854                   | )          |   | (16,854 | ) |   |
| Comprehensive income                                                                                     |       |                             |       |                                                          |       |                             |       |                      |       |   | $ | 362,676 |   |   |
| **Balance  at December 31, 2004**                                                                   |       | 1,503,710                        |       |                                                          | (2         | )                                |       | 1,503,708                 |       |   |   |   |   |
| Net income                                                                                               |       | 232,898                          |       |                                                          |       |                             |       | 232,898                   |       |   | $ | 232,898 |   |   |
| Contributions  from member                                                                               |       | 133,564                          |       |                                                          |       |                             |       | 133,564                   |       |   |   |   |   |
| Transfer of  Reliant Energy Electric Solutions, LLC to Reliant Energy, Inc.                         |       | (273,478                         | )          |                                                          | 2          |                             |       | (273,476                  | )          |   |   |   |   |
| Comprehensive income                                                                                     |       |                             |       |                                                          |       |                             |       |                      |       |   | $ | 232,898 |   |   |
| **Balance at December 31,  2005**                                                                   |       | $                                | 1,596,694  |                                                          |       | $                                | —     |                      |       | $ | 1,596,694 |   |   |   |   |   |

 

See Notes to the Consolidated Financial Statements

F-93

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**RELIANT ENERGYRETAIL HOLDINGS, LLC AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(1)**          Backgroundand Basis of Presentation

*Background.**  *“RERH LLC” refers to Reliant EnergyRetail Holdings, LLC, a Delaware limited liability company. “RERH” refers toReliant Energy Retail Holdings, LLC and its consolidated subsidiaries. “ReliantEnergy” refers to Reliant Energy, Inc. and its consolidated subsidiaries. RERHLLC is a wholly-owned subsidiary of Reliant Energy and was formed in September 2000.Reliant Energy is the sole member and holds all 1,000 shares of RERH LLC.

RERH provides electricity products and relatedservices to end-use customers ranging from residential and small businesscustomers to large commercial, industrial and governmental/institutionalcustomers. During 2003, RERH began providing retail energy products andservices to commercial, industrial and governmental/institutional customers inNew Jersey and Maryland. During 2004, RERH began marketing retail energy tothis same class of customers in other areas of the wholesale and retailelectric market operated by PJM Interconnection, LLC (PJM), primarily in theDistrict of Columbia and Pennsylvania.

As of December 31,2005, RERH’s subsidiaries include:
| Subsidiary                                             | ** ** | ** **          | ** ** | **Formation Date** |
|--------------------------------------------------------|------------|---------------------|------------|--------------------|
| Reliant Energy Retail  Services, LLC (Retail Services) |       | September 2000 |
| Reliant Energy Solutions  East, LLC (Solutions East)   |       | February 2002  |
| RE Retail Receivables, LLC                             |       | June 2002      |

 

In January 2003, RERH purchased all theoutstanding common stock in Reliant Energy Renewables, Inc. (Renewables)from Reliant Energy Power Generation, Inc., an affiliated company and asubsidiary of Reliant Energy for approximately $27,000 and assumed all notespayable to affiliated companies. The purchase price was based on Renewables’book value. The acquisition was treated as a reorganization of entities undercommon control. In July 2005, RERH sold the common stock and all relatedassets and liabilities of Renewables. See note 11.

Effective September 28, 2004, RERH consolidatedRE Retail Receivables, LLC (see note 5). Effective January 1, 2005,Reliant Energy Solutions, LLC was merged into Retail Services and RERHtransferred its interest in Reliant Energy Electric Solutions, LLC (REES) toReliant Energy.

Revenuesand pre-tax income related to REES were as follows:
|                                                           | ** ** | **2004**               | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **(in millions)** | ** ** |
| Income before  income taxes(1)                            |       |                   | $          | 82 |   |   |
| Income before  cumulative effect of accounting changes(1) |       |                   | 51         |   |   |
| Net income(1)                                             |       |                   | 51         |   |   |

----

(1)             Asignificant portion of the results of operations were energy supply managementactivities related to the intercompany activities between REES and certain ofRERH’s wholly-owned subsidiaries, with the remainder being contracts with theGeneral Land Office.

*Basis of Presentation.**  *These consolidated statementsinclude all revenues and costs directly attributable to RERH including costsfor facilities and costs for functions and services performed by Reliant Energyand charged to RERH. All significant intercompany transactions have beeneliminated. RERH has reclassified certain immaterial amounts from prior periodsto conform to the 2005 presentation. These reclassifications had no impact onreported earnings/losses.

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**(2)**          Summaryof Significant Accounting Policies

***(a)***          Useof Estimates and Market Risk and Uncertainties.

Management makesestimates and assumptions to prepare financial statements in conformity withaccounting principles generally accepted in the United States of America (GAAP)that affect:

·       thereported amount of assets and liabilities,

·       thereported amounts of revenues and expenses and

·       ourdisclosure of contingent assets and liabilities at the date of the financialstatements.

RERH’s critical accounting estimates include:  (a) derivative assets and liabilities(prior to 2005); (b) estimated revenues and energy supply costs; and (c) deferredtax assets, valuation allowances and tax liabilities. Actual results coulddiffer from the estimates.

RERH is subject to variousrisks inherent in doing business. See notes 2(c), 2(d), 2(e), 4, 5, 6, 7,8 and 9.

***(b)***           Principlesof Consolidation.

RERH LLC includes theaccounts and those of its wholly-owned and majority-owned subsidiaries in itsconsolidated financial statements. Since September 28, 2004, RERH hasconsolidated its receivables facility arrangement (see note 5).

***(c)***            Revenues.

*RetailRevenues.**  *Grossrevenues for energy sales and services to residential and small businesscustomers and electric sales to large commercial, industrial andgovernmental/institutional customers under contracts executed after October 2002are recognized upon delivery and include estimated energy and servicesdelivered but not billed by the end of the period.

As of December 31, 2005, RERH recorded unbilledrevenues of $363 million for retail energy sales. Accrued unbilled revenues arebased on RERH’s estimates of customer usage since the date of the last meterreading provided by the independent system operators or electric distributioncompanies. Volume estimates are based on daily forecasted volumes, estimatedcustomer usage by class and applicable customer rates. Unbilled revenues arecalculated by multiplying volume estimates by estimated rates by customer class.Estimated amounts are adjusted when actual usage and rates are known andbilled.

*Changes in Estimates.**  *The revenues and the related energysupply costs include estimates of customer usage after consideration of initialusage information provided by the independent system operators and thedistribution companies. RERH revises these estimates and records any changes inthe period as information becomes available (collectively referred to as “marketusage adjustments”). During 2005 and 2004, RERH recognized in gross margin(revenues less purchased power) $13 million of expense and $18 million ofexpense, respectively, related to market usage adjustments.

***(d)***           Derivativesand Hedging Activities.

RERH accounts for its derivatives instruments andhedging activities in accordance with SFAS No. 133, “Accounting forDerivatives Instruments and Hedging Activities,” as amended (SFAS No. 133)

Prior to RERH transferring its interest in REES toReliant Energy, for hedging activities, RERH used both derivative andnon-derivative contracts that provided for settlement in cash or by delivery ofa commodity. The primary types of derivative instruments used were forwards,futures, swaps and options. RERH elected one of three accounting methods (cashflow hedge, mark-to-market or accrual accounting) 

F-95

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for derivatives based onfacts and circumstances. The fair values of derivative activities weredetermined by (a) prices actively quoted, (b) prices provided byother external sources or (c) prices based on models and other valuationmethods.

If certain conditions are met, a derivative instrumentmay be designated as a cash flow hedge. A derivative is recognized at fairvalue in the balance sheet whether or not it is designated as a hedge, exceptfor derivative contracts designated as “normal purchases and sales exceptions,”which are not in its consolidated balance sheet or results of operations priorto settlement. As of December 31, 2005, RERH did not have any derivativesdesignated as cash flow hedges.

Derivatives designated as cash flow hedges must have ahigh correlation between price movements in the derivative and the hedged item.The changes in fair value of cash flow hedges were deferred in accumulatedother comprehensive income (loss), net of tax, to the extent the contracts wereeffective as hedges, until the forecasted transactions affected earnings. Atthe time the forecasted transactions affected earnings, RERH reclassified the amountsin other comprehensive income (loss) into earnings. RERH recorded theineffective portion of changes in fair value of cash flow hedges immediatelyinto earnings. For all other derivatives, changes in fair value were recordedas unrealized gains or losses in its results of operations.

If and when an acceptable level of correlation nolonger exists, hedge accounting ceases and changes in fair value are recognizedin its results of operations. If it becomes probable that a forecastedtransaction will not occur, RERH immediately recognizes the related deferredgains or losses in its results of operations. The associated hedging instrumentis then marked to market through its results of operations for the remainder ofthe contract term unless a new hedging relationship is redesignated.

In July 2003,the EITF issued EITF No. 03-11, which states that realized gains andlosses on derivatives contracts not “held for trading purposes” should bereported either on a net or gross basis based on the relevant facts andcircumstances. EITF No. 03-11 has no impact on margins or net income.Subsequent to October 1, 2003, due to the adoption of EITF No. 03-11,hedging transactions that do not physically flow are included in the samecaption as the items being hedged. A summary of RERH’s derivative activitiesand classification in its results of operations is:

| **Instrument**                                                    | ** ** | ** **                                                                              | ** ** | **Purpose for Holding or  Issuing Instrument**(1) | ** ** | **Transactions that Physically Flow** | ** ** | **Transactions that  Financially Settle**(2) |
|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------------------|
| Power futures,  forward, swap and option contracts                |       | Power sales to end-use  retail customers   Supply management revenues   Power purchases |       | Revenues  Revenues  Purchased power               |       | N/A  Purchased power  Purchased power |
| Natural gas and  fuel futures, forward, swap and option contracts |       | Natural gas and fuel  purchases/sales                                                   |       | N/A                                               |       | Purchased power                       |

----

(1)             Thepurpose for holding or issuing is not impacted by the accounting method electedfor each instrument.

(2)             Includesclassification for mark-to-market derivatives and amounts reclassified fromaccumulated other comprehensive income (loss) related to cash flow hedges.

In addition to market risk, RERH is exposed to creditand operational risk. Reliant Energy has a control framework, to which RERH issubject, to manage these risks, which include: (a) measuring and monitoring these risks, (b) review andapproval of new transactions relative to these risks, (c) transactionvalidation and (d) portfolio valuation and reporting. RERH usesmark-to-market valuation, value-at-risk and other metrics in monitoring andmeasuring risk. Reliant Energy’s risk control framework includes a 

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variety of separate butcomplementary processes, which involve commercial and senior management andReliant Energy’s Board of Directors. See note 2(e) for furtherdiscussion of RERH’s credit policy.

*Set-off of DerivativeAssets and Liabilities.**  *Where derivative instruments are subject to a masternetting agreement and the accounting criteria to net are met, RERH presents itsderivative assets and liabilities on a net basis. Derivative assets/liabilitiesand accounts receivable/payable are presented and set-off separately in theconsolidated balance sheets although in most cases contracts permit the set-offof derivative assets/liabilities and accounts receivable/payable with a given counterparty.

***(e)***            CreditRisk.

RERH has a credit policy that governs the managementof credit risk, including the establishment of counterparty credit limits andspecific transition approvals. Credit risk is monitored and the financialcondition of RERH’s counterparties are reviewed periodically. RERH tries tomitigate credit risk by entering into contracts that permit netting and allowRERH to terminate upon the occurrence of certain events of default. RERHmeasures credit risk as the replacement cost for its derivative positions(through December 31, 2004) plus amounts owed for settled transactions.

As of December 31,2004, one non-investment grade counterparty represented 90% ($107 million) ofRERH’s credit exposure, net of collateral, primarily related to its derivativeassets and Electric Reliability Council of Texas (ERCOT) power supplycounterparties. RERH did not have any credit exposure from this onecounterparty as of December 31, 2005 as the transactions were with REES,which is no longer a subsidiary of RERH. REES has net credit exposure of $708million as of December 31, 2005 to this non-investment grade counterparty.If the counterparty defaulted, RERH would experience increased purchased powercosts going forward. There were no other counterparties representing greaterthan 10% of RERH’s credit exposure, net of collateral.

***(f)***             Selling,General and Administrative Expenses.

Selling, general andadministrative expenses include (a) selling and marketing, (b) baddebt expense and (c) other general and administrative expenses. Othergeneral and administrative expenses include, among other items, (a) financialservices, (b) legal costs, (c) regulatory costs and (d) certainbenefit costs. Some of the expenses are allocated from affiliates (seenote 3).

***(g)***           SeveranceCosts.

During 2005 and 2004, RERHincurred $2 million and $8 million, respectively, in severance costs (includedin both operation and maintenance and selling, general and administrativeexpenses), which were substantially paid in each applicable period.

***(h)***          Property,Plant and Equipment and Depreciation Expense.

RERHcomputes depreciation using the straight-line method based on estimated usefullives. Depreciation expense was $48 million and $43 million during 2005 and2004, respectively.
|                                       | ** ** | **Estimated Useful** | ** ** | **December 31,**  | ** ** |
|---------------------------------------|------------|---------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **Lives (Years)**    | ** ** | **2005**               | ** ** |
| ** **                            | ** ** | ** **                | ** ** | **(in millions)** | ** ** |
| Information  technology               |       |                      | 3-10       |                   |       |   | $ | 174 |   |   |
| Furniture and  leasehold improvements |       |                      | 3-10       |                   |       |   | 9 |   |   |
| Assets under  construction            |       |                      |       |                   |       |   | 5 |   |   |
| Total                                 |       |                      |       |                   |       |   | 188 |   |   |
| Accumulated  depreciation             |       |                      |       |                   |       |   | (115 | ) |   |
| Property, plant  and equipment, net   |       |                      |       |                   |       |   | $ | 73 |   |   |

 

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RERH periodicallyevaluates property, plant and equipment for impairment when events orcircumstances indicate that the carrying value of these assets may not berecoverable. The evaluation is highly dependent on the underlying assumptionsof related cash flows. RERH recorded no material property, plant and equipmentimpairments during 2005 and 2004.

***(i)***             IntangibleAssets and Amortization Expense.

*Goodwill.*   RERHperforms its goodwill impairment test annually and when events or changes incircumstances indicate that the carrying value may not be recoverable. RERHpreviously selected November 1 as its annual goodwill impairment testingdate since Reliant Energy had historically completed its annual strategicplanning process by that date. Reliant Energy has since modified its strategicplanning process, which provides key information used in the analysis of RERH’sgoodwill impairment test, and such information is no longer completed by November 1.In order to align RERH’s annual goodwill impairment test with Reliant Energy’sannual strategic planning process, to meet the accelerated reporting deadlinesand to provide adequate time to complete the analysis each year, beginning in2005, RERH changed the date on which it performs the annual goodwill impairmenttest to April 1. The change is not intended to delay, accelerate or avoidan impairment charge. RERH believes that this accounting change is to analternative accounting principle that is preferable under the circumstances.

*Other Intangibles.*   RERHrecognizes specifically identifiable intangible assets, including emissionallowances, demand side management contracts and permanent seat licenses, whenspecific rights and contracts are acquired. RERH has no intangible assets withindefinite lives recorded as of December 31, 2005.

***(j)***              Stock-basedCompensation.

RERH applies the intrinsic value method of accountingfor employee stock-based compensation and expenses it ratably over the vestingperiod. On January 1, 2006, RERH began to recognize compensation cost forthe unvested portion of pre-January 2006 awards and awards granted fromthat date based on the grant-date fair value of those awards. RERH expects theadoption of the fair value based method of accounting will not have a materialimpact on its financial position or results of operations. Under the intrinsicvalue method, RERH adjusts compensation cost for performance-based stock awardsand options based on changes in Reliant Energy’s stock price; however, underthe fair value based method, RERH recognizes compensation cost based on grantdate fair value recognized over the service period. Under the intrinsic valuemethod, RERH does not recognize compensation cost for time-based stock optionsor Reliant Energy’s employee stock purchase plan; however, under the fair valuebased method, RERH recognizes compensation cost. The fair value based method ofaccounting does not change RERH’s compensation cost for time-based restrictedstock awards or performance-based cash awards.

Usingthe Black-Scholes model for determining fair values, RERH’s pro forma resultsare:

| ** **                                                                                                     | ** ** | **2005**               | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                                                     | ** ** | **(in millions)** | ** ** |
| Net income, as  reported                                                                                       |       | $                      | 233        |     | $          | 372 |   |
| Add: Stock-based  compensation expense included in reported net income, net of tax                             |       | —                 |       | 3        |       |
| Deduct:  Stock-based compensation expense determined under fair value based method for  all awards, net of tax |       | (2                     | )          | (4       | )          |
| Pro forma net income                                                                                           |       | $                      | 231        |     | $          | 371 |   |

 

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RERHuses the Black-Scholes option-pricing model with the following weighted averageassumptions and resulting fair values.

| ** **                   | ** ** | **Reliant Energy   Stock Options** | ** ** | **Reliant Energy  Employee Stock Purchase Plan Rights** | ** ** |
|------------------------------|------------|---------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2005**                                          | ** ** | **2004**                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life in  years      |       | 5                                                 |       | 5                                                                           |       |   | 0.5 |   |   | 0.5 |   |
| Estimated  volatility(1)     |       | 45.75                                             | %          | 72.85                                                                       | %          |   | 32.97 | % |   | 41.18 | % |
| Risk-free  interest rate     |       | 4.18                                              | %          | 3.01                                                                        | %          |   | 2.94 | % |   | 1.21 | % |
| Dividend yield               |       | 0                                                 | %          | 0                                                                           | %          |   | 0 | % |   | 0 | % |
| Weighted-average fair  value |       | $                                                 | 5.72       |                                                                        | $          | 5.00 |   |   | $ | 3.25 |   |   | $ | 2.29 |   |
|                              |            |                                                   |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |

----

(1)             For options, RERHestimated volatility based on an equal weighting of historical and impliedvolatility of Reliant Energy’s common stock. For employee stock purchase planrights, RERH estimated volatility based on the historical volatility of ReliantEnergy’s common stock.

***(k)***           IncomeTaxes.

RERH is included in theconsolidated income tax returns of Reliant Energy and calculates its income taxprovision on a separate return basis, whereby Reliant Energy pays all federalincome taxes on RERH’s behalf and is entitled to any related tax savings. Thedifference between RERH’s current federal income tax expense or benefit, ascalculated on a separate return basis, and related amounts paid or receivedto/from Reliant Energy, if any, are recorded in RERH’s financial statements asadjustments to member’s equity on its consolidated balance sheets. Deferredincome taxes reflected on RERH’s consolidated balance sheet will ultimately besettled with Reliant Energy through member’s equity. See notes 3 and 7.

***(l)***              Cashand Cash Equivalents.

RERH records all highlyliquid short-term investments with maturities of three months or less as cashequivalents.

***(m)***       Allowancefor Doubtful Accounts.

RERH accrues an allowancefor doubtful accounts based on estimates of uncollectible revenues by analyzingcounterparty credit ratings, historical collections, accounts receivable agingsand other factors. RERH writes-off accounts receivable balances against theallowance for doubtful accounts when it determines a receivable isuncollectible.

**(3)**          RelatedParty Transactions

These financial statements include significanttransactions between RERH and Reliant Energy. The majority of thesetransactions involve the purchase or sale of power or related services byReliant Energy from or to RERH and allocations of costs to RERH for certainsupport services. The following describes the impacts on the financialstatements for the particular transactions:

*NotesReceivable—Affiliate.**  *ReliantEnergy manages RERH’s daily cash balances. Excess cash is advanced to ReliantEnergy, which provides a cash management function, and is recorded in long-termnotes receivable—affiliated company. As cash is required to fund operations,Reliant Energy funds RERH’s bank accounts. RERH records interest income orexpense, based on whether RERH invested excess funds, or borrowed funds fromReliant Energy. The amount of net interest income is $102 million and $83million during 2005 and 2004, respectively.

*SupportServices.*   Reliant Energy provides RERHcommercial support and other corporate support services. During 2004, ReliantEnergy allocated certain support services costs to RERH based on RERH’s 

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operating expensesrelative to the operating expenses of other entities to which Reliant Energyprovides similar services, allocated certain other support costs to RERH basedon number of employees and also charged RERH for certain services based onusage and based on number of employees. Effective January 2005, ReliantEnergy began allocating certain support services costs to RERH based on RERH’sunderlying planned operating expenses relative to the underlying plannedoperating expenses of other entities to which Reliant Energy provides similarservices and also began charging RERH for certain services based on usage andbased on number of employees. Management believes these methods of allocationare reasonable and do not yield significantly different results between the twomethodologies. These allocations and charges were not necessarily indicative ofwhat would have been incurred had RERH been an unaffiliated entity. Amountscharged and allocated to RERH for these services were $67 million and $98million during 2005 and 2004, respectively, and are included in operation andmaintenance—affiliates and selling, general and administrative expenses—affiliates.Included in these amounts are $6 million and $13 million for 2005 and 2004,respectively, for RERH’s share of allocated rent expense, which is included inselling, general and administrative expense—affiliates.

*NamingRights to Houston Sports Complex.**  *In 2000, Reliant Energy acquiredthe naming rights, including advertising and other benefits, for a footballstadium and other convention and entertainment facilities. Pursuant to thisagreement, Reliant Energy is required to pay $10 million per year from 2002through 2032. These costs are charged to RERH by Reliant Energy and areincluded in selling, general and administrative expense.

*Paymentto CenterPoint in 2004.*   In connection withReliant Energy’s separation agreement with CenterPoint Energy, Inc. (CenterPoint),Reliant Energy made a payment of $177 million to CenterPoint in November 2004related to RERH’s residential customers. In 2002, RERH entered into anagreement with Reliant Energy to reimburse Reliant Energy for the payment. RERHrecognized $2 million, $47 million and $128 million during 2004, 2003 and 2002,respectively. RERH reduced its long-term notes receivable—affiliate for therelated reimbursement to Reliant Energy. See note 7.

*ReliantEnergy Services and REES Energy Supply Services.**  *Prior to 2003, Reliant EnergyServices primarily provided RERH with its energy supply services. During 2003,certain supply contracts were transferred from Reliant Energy Services to RERH’ssubsidiary at the time, REES. The value of those contracts was $43 million, netof tax of $27 million, in 2003. This transfer was included in contributionsfrom member in 2003. As discussed in note 1, RERH transferred its interestin REES to Reliant Energy on January 1, 2005. During 2005 and 2004, REESand Reliant Energy Services primarily provided the energy supply services toRERH. During 2005 and 2004, the administrative costs for these services wereincluded in the corporate support services allocations.

As discussed above, Reliant Energy Services and REESenter into contracts with third parties for the purposes of supplying RERH withsome of the electricity necessary to serve its retail customers. These supplycontracts are subject to the provisions of the master commodity purchase andsale agreements, master netting arrangements and other contractual arrangementsthat Reliant Energy Services and REES utilize with third-party customers andsuppliers in connection with their supply portfolio management activities,including those activities undertaken for RERH. Consequently, the costassociated with credit support for the supply portfolio managed by ReliantEnergy Services and REES for RERH could differ significantly from those thatRERH would experience if it managed all of its electricity supply portfoliodirectly with third parties.

RERH reimburses Reliant Energy Services and REES forthe ultimate price of any electricity sold from Reliant Energy Services/REES toRERH, including costs of derivative instruments, upon final delivery of thatelectricity. RERH does not account for the unrealized value associated with thederivative instruments executed by Reliant Energy Services/REES with thirdparties because the contracts are executed by Reliant Energy Services/REES.

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Purchased power from REES was $4.6 billion during 2005and purchased power from Reliant Energy Services was $1.4 billion during 2004. Theseamounts were recorded as purchased power—affiliates. During 2004, REES was aconsolidated subsidiary of RERH; therefore, purchased power from REES during2004 is included in purchased power. Sales and purchases of electricity relatedto large commercial, industrial and governmental/institutional customers undercontracts entered into prior to October 25, 2002, are accounted for on themark-to-market basis (see note 2(d) for further discussion) and arepresented on a net basis. During 2005 and 2004, RERH recognized $0.2 millionand $14 million, respectively, of previously unrealized losses related tosupply contracts accounted for on a mark-to-market basis prior to 2003.

*Income Taxes.**  *During 2005 and 2004, ReliantEnergy made equity contributions to RERH for deemed distributions related tofederal income taxes of $133 million and $130 million, respectively. Seenote 7.

**(4)**          Derivativesand Hedging Activities

RERH, through REES and Reliant Energy Services,historically used derivative instruments to manage operational or marketconstraints and to execute its supply procurement strategy. The instrumentsused were fixed-price derivative contracts to hedge the variability in futurecash flows from forecasted sales of power and purchases of power. RERH’sobjective in entering into these fixed-price derivatives was to fix the pricefor a portion of these transactions. See note 2(d).

During 2004, there was nohedge ineffectiveness recognized from derivatives that were designated andqualified as cash flow hedges. In addition, no component of the derivativeinstruments’ gain or loss was excluded from the assessment of effectiveness forthese periods. If it became probable that an anticipated transaction would notoccur, RERH realized in net income (loss) the deferred gains and lossesrecognized in accumulated other comprehensive income/loss. During 2004, therewere no amounts recognized in the results of operations as a result of the discontinuanceof cash flow hedges because it was probable that the forecasted transactionwould not occur. As a result of RERH transferring its interest in REESeffective January 2005, RERH did not have any cash flow hedges or otherderivatives during 2005.

**(5)**          ReceivablesFacility

RERH has a receivables facility arrangement to sell anundivided interest in accounts receivable from its business to financialinstitutions on an ongoing basis. RERH amended this arrangement in September 2005to extend its maturity until September 2006, reduce the fees it ischarged, increase the proportion of receivables against which it can borrow andincrease the maximum capacity available from $350 million to $450 million.

The assets of the special purpose subsidiary thatpurchases the receivables and then resells receivables under the facility areavailable first and foremost to satisfy the claims of its creditors.  The special purpose subsidiary is a separateentity.

Prior toSeptember 28, 2004, these transactions were accounted for as sales ofreceivables; as a result, the related receivables and debt were excluded fromthe consolidated balance sheet. Effective with the September 28, 2004amendment to this facility, the qualified special purpose entity (QSPE) ceasedto be a QSPE and RERH began consolidating its results of operations and theproceeds from receivables sold to the financial institutions were treated as afinancing. As a result, accounts receivable and short-term borrowings of $350million were included in the consolidated balance sheet as of the amendmentdate. The borrowings under the facility bear interest at floating rates thatinclude fees based on the facility’s level of commitment and utilization. RERH services the receivables and received afee of 0.4% of cash collected during 2005 and 2004, which approximates theactual service costs. Reliant Energy also guarantees the performanceobligations of the originators of the receivables and the servicing of thereceivables.

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**(6)**          BenefitPlans

***(a)***          Stock-BasedIncentive Plans.

*Overview.*   RERH’seligible employees participate in stock-based incentive plans described below. TheCompensation Committee of Reliant Energy’s Board of Directors administersReliant Energy’s stock-based incentive plans. The Reliant Energy, Inc.2002 Long-Term Incentive Plan (the 2002 LTIP) and the Reliant Energy, Inc.2002 Stock Plan (the 2002 Stock Plan) permit Reliant Energy to grant variousstock-based incentive awards to officers, key employees and directors. Awardsinclude stock options, stock appreciation rights, restricted stock, performanceawards, cash awards and stock awards.

Prior to the adoption of the plans, participantsreceived awards under the Long-Term Incentive Plan of Reliant Energy, Inc.(the 2001 LTIP) or the Reliant Energy, Inc. Transition Stock Plan(collectively the previous plans). Awards under the previous plans are nolonger permitted.

RERH applies the intrinsic value method of accountingfor employee stock-based incentive plans. Awards to RERH employees underReliant Energy’s stock-based incentive plans resulted in expense of $0 and $5million during 2005 and 2004, respectively. See note 2(j) for proforma information.

*Time-BasedStock Options.*   Reliant Energy grants time-basedstock options to RERH’s employees at an exercise price equal to or greater thanthe fair market value of Reliant Energy’s stock on the grant date without costto participants. Generally, options vest 33.33% per year and have a term of tenyears.

Summarizedtime-based option activity is:

| ** **                  | ** ** | **2005**    | ** ** | **2004**                               | ** ** |
|-----------------------------|------------|-------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Granted                     |       | —      |       |                                   | $          | — |   |   | — |   |   | $ | — |   |   |
| Outstanding at  end of year |       | 1,351,042   |       |                                   | 16.95      |   |   | 1,699,933 |   |   | 16.34 |   |   |
| Exercisable at end of  year |       | 1,250,823   |       |                                   | 18.03      |   |   | 1,389,393 |   |   | 18.46 |   |   |

 

As of December 31, 2005, exercise prices forReliant Energy’s stock options outstanding and held by RERH’s employees rangedfrom $3.51 to $34.03.

*Time-BasedRestricted Stock Awards.*   Reliant Energy grantstime-based restricted stock awards to RERH’s employees without cost toparticipants. In general, these awards vest, subject to the participant’scontinued employment, three years from the grant date.

Summarizedrestricted stock award activity is:

| ** **                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Granted                                 |       | 80,235   |       | 228,062  |       |
| Outstanding at  end of year             |       | 334,904  |       | 260,380  |       |
| Weighted average grant  date fair value |       | $        | 12.63      |     | $          | 8.20 |   |
|                                         |            |          |            |          |            |  |  |

 

*Performance-BasedAwards.*   Reliant Energy grants performance-basedawards to RERH’s employees without cost to participants. The number ofperformance-based awards earned is determined at the end of each performanceperiod. All of the outstanding performance-based awards as of December 31,2005 are for the 2004-2006 performance period.

Reliant Energy’s Compensation Committee granted the2004-2006 performance-based awards through the Key Employee Award Program(the Program) established under the 2002 LTIP. Under the Program, eachperformance-based award represents a targeted award of (a) 16,000 sharesof performance-

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based stock, (b) 68,000performance-based stock options and (c) 16,000 cash units with each cashunit having an equivalent fair market value of one share of Reliant Energy’scommon stock on the vesting date. The Program provides for a payout rangingfrom 0% to 140% of the targeted award level, as determined by Reliant Energy’sCompensation Committee in its sole discretion after considering variousqualitative and quantitative performance criteria. These criteria include (a) reducingReliant Energy’s ratio of adjusted net debt to adjusted EBITDA to at least 3.5,(b) delivering superior customer value and (c) building a greatcompany to work for, taking into consideration market conditions for eachfactor. EBITDA is defined as earnings (loss) before interest expense, interestincome, income taxes, depreciation and amortization expense. Reliant Energy’sCompensation Committee has the discretion to weight the various performanceobjectives as it deems appropriate.

Summarizedperformance-based stock award activity, including the Program and previousprograms and assuming a 140% payout of the Program, is:

| ** **                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Granted                                 |       | —   |       | 358,400  |       |
| Outstanding at  end of year             |       | 179,200  |       | 350,350  |       |
| Weighted average grant  date fair value |       | N/A      |       | $        | 8.24       |   |
|                                         |            |          |            |          |            |  |

 

Summarizedperformance-based option activity of the Program, assuming a 140% payout, is:

| ** **                  | ** ** | **2005**    | ** ** | **2004**                               | ** ** |
|-----------------------------|------------|-------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Granted                     |       | —      |       |                                   | $          | — |   |   | 1,523,200 |   |   | $ | 8.24 |   |   |
| Outstanding at end  of year |       | 761,600     |       |                                   | 8.34       |   |   | 1,332,800 |   |   | 8.25 |   |   |
| Exercisable at end of  year |       | —      |       |                                   | —     |   |   | — |   |   | — |   |   |

 

As of December 31, 2005, exercise prices forReliant Energy’s performance-based stock options outstanding and held by RERH’semployees ranged from $8.14 to $12.63.

*EmployeeStock Purchase Plan.*   Reliant Energy has 18million shares of authorized common stock reserved and approved for issuanceunder the Reliant Energy, Inc. Employee Stock Purchase Plan (ESPP). Underthe ESPP, substantially all regular RERH employees can purchase Reliant Energycommon stock through payroll deductions of up to 15% of eligible compensation. TheESPP provides for semiannual offering periods commencing on January 1 and July 1of each year. The share price paid by an employee equals the lesser of 85% ofthe average market price on the first or last business day of each offeringperiod. Individual ESPP participants are restricted from purchasing more than$25,000 of common stock in a calendar year.

During January 2006and during 2005 and 2004, Reliant Energy issued 72,809 shares, 201,049 sharesand 485,747 shares to RERH’s employees under the ESPP, respectively.

***(b)***           SavingsPlan.

RERH’s employeesparticipate in Reliant Energy’s employee savings plans under Sections 401(a) and401(k) of the Internal Revenue Code. Under the plans, participatingemployees may contribute a portion of their compensation generally up to amaximum of 50% pre-tax and 16% after-tax during 2005 and 16% pre-tax orafter-tax during 2004. RERH’s savings plan benefit expense, including matchingand discretionary contributions, was $5 million and $7 million during 2005 and2004, respectively.

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**(7)**          IncomeTaxes

RERH’sincome tax expense (benefit) is:

| ** **         | ** ** | **2005**               | ** ** | **2004** | ** ** |
|--------------------|------------|------------------------|------------|----------|------------|
| ** **         | ** ** | **(in millions)** | ** ** |
| **Current:**       |       |                   |       |     |       |
| Federal            |       | $                      | 137        |     | $          | 130 |   |
| State              |       | 18                     |       | 10       |       |
| Total current      |       | 155                    |       | 140      |       |
| **Deferred:**      |       |                   |       |     |       |
| Federal            |       | (10                    | )          | 71       |       |
| State              |       | 4                      |       | 10       |       |
| Total deferred     |       | (6                     | )          | 81       |       |
| Income tax expense |       | $                      | 149        |     | $          | 221 |   |

 

Areconciliation of the federal statutory income tax rate to the effective incometax rate is:

| ** **                                         | ** ** | **2005**               | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                         | ** ** | **(in millions)** | ** ** |
| Income before  income taxes                        |       | $                      | 382        |     | $          | 593 |   |
| Federal statutory  rate                            |       | 35                     | %          | 35       | %          |
| Income tax  expense at statutory rate              |       | 134                    |       | 208      |       |
| Net addition (reduction)  in taxes resulting from: |       |                   |       |     |       |
| State income taxes, net of federal income taxes    |       | 14                     |       | 13       |       |
| Other, net                                         |       | 1                      |       | —   |       |
| Total                                              |       | 15                     |       | 13       |       |
| Income tax  expense                                |       | $                      | 149        |     | $          | 221 |   |
| Effective rate                                     |       | 39                     | %          | 37       | %          |

 

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Deferredtax assets and liabilities are:

| ** **                                             | ** ** | **December 31,**  | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2005**               | ** ** |
| ** **                                             | ** ** | **(in millions)** | ** ** |
| **Deferred  tax assets:**                              |       |                   |       |   |   |
| Current:                                               |       |                   |       |   |   |
| Derivative liabilities, net                            |       |                   | $          | — |   |   |
| Allowance for doubtful accounts and credit  provisions |       |                   | 9          |   |   |
| Employee benefits                                      |       |                   | —     |   |   |
| Other                                                  |       |                   | 1          |   |   |
| Total current deferred tax assets                      |       |                   | 10         |   |   |
| Non-current:                                           |       |                   |       |   |   |
| Employee benefits                                      |       |                   | 3          |   |   |
| Net operating loss carryforwards                       |       |                   | 1          |   |   |
| Other                                                  |       |                   | —     |   |   |
| Valuation allowances                                   |       |                   | (1         | ) |   |
| Total non-current deferred tax assets                  |       |                   | 3          |   |   |
| Total deferred tax assets                              |       |                   | $          | 13 |   |   |
| **Deferred  tax liabilities:**                         | ** ** |                   |       |   |   |
| Non-current:                                           |       |                   |       |   |   |
| Depreciation and amortization                          |       |                   | $          | 21 |   |   |
| Derivative assets, net                                 |       |                   | —     |   |   |
| Other                                                  |       |                   | 6          |   |   |
| Total non-current deferred tax liabilities             |       |                   | 27         |   |   |
| Total deferred tax liabilities                         |       |                   | $          | 27 |   |   |
| Accumulated  deferred income taxes, net                |       |                   | $          | (14 | ) |   |

 

*Tax Attribute Carryovers.*   Taxattribute carryovers are:

| ** **                             | ** ** | **December 31,  2005** | ** ** | **Statutory  Carryforward  Period** | ** ** | **Expiration  Year(s)** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **(in millions)**      | ** ** | **(in years)**                 | ** ** | ** **              | ** ** |
| **Net  Operating Loss Carryforwards:** | ** ** |                        | ** ** | ** **                          |       |                    | ** ** | ** ** |   | ** ** | ** ** |
| State                                  |       |                        | $          | 41                                  | ** ** |                    |       | 5 to 7 | ** ** |   | 2007 through 2009 |   |
|                                        |            |                             |            |                                     |            |                         |            |  |  |  |  |  |

 

*TaxContingencies.**  *ReliantEnergy’s income tax returns, including years when it was included inCenterPoint’s consolidated tax group, for the 1997 to 2004 tax reportingperiods are under audit by federal and state taxing authorities. These auditsmay result in additional taxes or revisions of the timing of tax payments. AsRERH is a part of the consolidated income tax returns of Reliant Energy, itcould be subject to additional taxes. RERH evaluates the need for contingenttax liabilities on a quarterly basis and records any estimable and probable taxexposures in its results of operations. In addition, RERH discloses anymaterial tax contingencies as to which it believes there is a reasonablepossibility of a future tax assessment.

Pursuant to the Texaselectric restructuring law, Reliant Energy, which was subsequently reimbursedby RERH, made a payment of $177 million to CenterPoint during 2004 related toRERH’s residential customers. See note 3. RERH believes this payment isdeductible for income tax purposes; however, no assurance can be given that theInternal Revenue Service would not assert, or that a court would not sustain, acontrary position.

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**(8)**          Commitments

***(a)***          LeaseCommitments.

*Cash Obligations UnderOperating Leases.*   RERH’s projected cashobligations under non-cancelable long-term operating leases as of December 31,2005 are (in millions):

| 2006                 |   | $      | 4      |   |
|----------------------|--------|--------|--------|--------|
| 2007                 |   | 3      |   |
| 2008                 |   | 2      |   |
| 2009                 |   | 2      |   |
| 2010                 |   | 2      |   |
| 2011 and  thereafter |   | — |   |
| Total                |   | $      | 13     |   |

 

*Operating Lease Expense.*   Totallease expense for all operating leases was $9 million and $5 million during2005 and 2004, respectively.

**(b)**          Guarantees.

*Guarantor.**  *Together with certain of Reliant Energy’s othersubsidiaries, RERH, excluding RE Retail Receivables, LLC, is a guarantor ofcertain obligations under credit and debt agreements of Reliant Energy. As of December 31,2005, RERH’s maximum potential amount of future payments under these guaranteesis approximately $4.9 billion and $3.6 billion is outstanding for continuingoperations. These obligations mature at various dates from 2009 through 2036.

*EquityPledged as Collateral to Reliant Energy.**  *RERH LLC’s equity is pledged ascollateral under certain of Reliant Energy’s credit and debt agreements, whichhave an outstanding balance from continuing operations of $3.6 billion as of December 31,2005.

*Other.**  *RERH enters into contracts that include indemnificationand guarantee provisions. In general, RERH enters into contracts withindemnities for matters such as breaches of representations and warranties andcovenants contained in the contract and/or against certain specifiedliabilities. Examples of these contracts include asset sales agreements, retailsupply agreements, service agreements and procurement agreements.

RERH is unable to estimateits maximum potential exposure under these provisions until an event triggeringpayment under these provisions occurs. Based on current information, RERHconsiders the likelihood of making any material payments under these provisionsto be remote.

***(c)***            OtherCommitments.

*Sales Commitments.**  *As of December 31, 2005, RERHhas sales commitments, including electric energy and capacity sales contracts,which are not classified as derivative assets and liabilities. The estimatedminimum sales commitments under these contracts are as follows (in millions):

| 2006  |   | $   | 2,043  |   |
|-------|--------|-----|--------|--------|
| 2007  |   | 924 |   |
| 2008  |   | 416 |   |
| 2009  |   | 144 |   |
| 2010  |   | 73  |   |
| Total |   | $   | 3,600  |   |

 

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**(9)**          Contingencies

***Legal Matters.***

RERH is party to a number of legal and otherproceedings before courts and governmental agencies. Unless otherwise noted,RERH cannot predict the outcome of these proceedings.

*TexasCommercial Energy.**  *InJuly 2003, Texas Commercial Energy, LLP (TCE) sued RERH and several otherERCOT power market participants in the United States District Court for theSouthern District of Texas. TCE claimed damages in excess of $535 million foralleged violations of state and federal antitrust laws, fraud, negligentmisrepresentation, breach of fiduciary duty, breach of contract and civilconspiracy. The trial court dismissed the lawsuit. The United States Court ofAppeals for the Fifth Circuit affirmed the dismissal of the lawsuit and deniedTCE’s request for a rehearing. In January 2006, the United States SupremeCourt denied a petition to review the dismissal of the lawsuit.

*UtilityChoice Electric.**  *InFebruary 2005, Utility Choice Electric filed a lawsuit that allegessimilar claims to the TCE lawsuit and additional claims including, amongothers, wire fraud, mail fraud and violations of the Racketeer Influenced andCorrupt Organizations Act. In December 2005, the United States DistrictCourt for the Southern District of Texas granted RERH’s motion to dismiss allfederal claims. The court also dismissed without prejudice the state law claims.Following the dismissal, RERH reachedan agreement to settle the remaining state law claims for an immaterial amount.

*PUCT Cases.**  *There are various proceedingspending before the state district court in Travis County, Texas, seekingreviews of the Public Utility Commission of Texas (PUCT) orders relating to thefuel factor component used in RERH’s “price-to-beat” tariff. These proceedingspertain to the same issues affirmed by a district court in Travis County andlater by the Travis County Court of Appeals in 2004 in a separate proceeding.

**(10)**   EstimatedFair Value of Financial Instruments

The fair values of cashand cash equivalents, accounts receivable and payable and derivative assets andliabilities and third-party debt equal their carrying amounts.

**(11)**   Salesof Landfill-Gas Fueled Power Plants

RERH sold Renewables,which owned landfill-gas fueled power plants, for $28 million in July 2005and recognized a loss of $4 million.

**(12)**   SubsequentEvent (Unaudited)

In connection with a credit-enhanced retail structure,effective December 1, 2006, RERH was contributed to RERH Holdings, LLC (awholly-owned subsidiary of Reliant Energy, Inc. that was formed in July 2006)by Reliant Energy, Inc. However, there is no impact to the consolidatedfinancial statements for RERH for 2004 and 2005 due to this transfer ofentities under common control.

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**Reportof Independent Registered Public Accounting Firm**

The Board of DirectorsReliant Energy Northeast Generation, Inc., Sole Member of Reliant EnergyMid-Atlantic Power Holdings, LLC:

We have audited theaccompanying consolidated balance sheet of Reliant Energy Mid-Atlantic PowerHoldings, LLC and subsidiaries (the Company), as of December 31, 2006, andthe related consolidated statements of operations, member’s equity andcomprehensive income (loss), and cash flows for the year then ended. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audit.

We conducted our audit inaccordance with the auditing standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The Company is not required to have,nor were we engaged to perform, an audit of its internal control over financialreporting. Our audit included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting. Accordingly,we express no such opinion. An audit also includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Reliant Energy Mid-Atlantic PowerHoldings, LLC and subsidiaries as of December 31, 2006, and the results oftheir operations and their cash flows for the year then ended in conformitywith U.S. generally accepted accounting principles.

Asdiscussed in note 7 to the consolidated financial statements, the Companychanged its accounting for defined benefit pension and other postretirementplans in 2006.

KPMG LLP

Houston, TexasFebruary 26, 2007

F-108

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors of Reliant Energy NortheastGeneration, Inc., Sole Member of Reliant Energy Mid-Atlantic PowerHoldings, LLCHouston, Texas

We have audited the accompanying consolidated balancesheet of Reliant Energy Mid-Atlantic Power Holdings, LLC and subsidiaries (the “Company”),as of December 31, 2005, and the related consolidated statements ofoperations, member’s equity and comprehensive income (loss), and cash flows foreach of the two years in the period ended December 31, 2005. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the financial statements based onour audits.

We conducted our audits in accordance with theauditing standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Reliant Energy Mid-Atlantic Power Holdings, LLC andsubsidiaries at December 31, 2005, and the results of their operations andtheir cash flows for each of the two years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America.

DELOITTE & TOUCHE LLP

Houston, TexasMarch 14, 2006

F-109

----

**RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(Thousands of Dollars)**

| ** **                                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Revenues:**                                                     |       |     |       |     |       |     |       |
| Revenues                                                          |       | $        | 26,107     |     | $          | 42,906   |       | $ | 517,908 |   |
| Revenues—affiliates                                          |       | 539,701  |       | 587,336  |       | (31,160  | )          |
| Total                                                             |       | 565,808  |       | 630,242  |       | 486,748  |       |
| **Expenses:**                                                     |       |     |       |     |       |     |       |
| Fuel and purchased power                                          |       | 239,686  |       | 230,391  |       | 204,916  |       |
| Fuel and purchased power—affiliates                          |       | 15,329   |       | 20,465   |       | 8,862    |       |
| Operation and maintenance                                         |       | 91,915   |       | 72,712   |       | 104,416  |       |
| Operation and maintenance—affiliates                         |       | 48,155   |       | 45,997   |       | 27,021   |       |
| Facilities leases                                                 |       | 59,848   |       | 59,848   |       | 59,848   |       |
| General and administrative—affiliates                        |       | 43,017   |       | 44,956   |       | 60,212   |       |
| Gain on sale of counterparty claim                                |       | —   |       | —   |       | (22,000  | )          |
| Gains on sales of assets and emission allowances,  net            |       | (71,323  | )          | (109,798 | )          | (14,955  | )          |
| Depreciation and amortization                                     |       | 71,315   |       | 83,544   |       | 85,988   |       |
| Total operating expense                                           |       | 497,942  |       | 448,115  |       | 514,308  |       |
| **Operating  Income (Loss)**                                      |       | 67,866   |       | 182,127  |       | (27,560  | )          |
| **Other Income (Expense):**                                       |       |     |       |     |       |     |       |
| Other, net                                                        |       | 1        |       | 53       |       | 1,462    |       |
| Interest expense                                                  |       | (1,095   | )          | (1,418   | )          | (2,058   | )          |
| Interest expense—affiliates                                  |       | (68,921  | )          | (64,746  | )          | (59,374  | )          |
| Interest income                                                   |       | 655      |       | 939      |       | 812      |       |
| Total other expense                                               |       | (69,360  | )          | (65,172  | )          | (59,158  | )          |
| **Income  (Loss) Before Income Taxes**                            |       | (1,494   | )          | 116,955  |       | (86,718  | )          |
| Income tax expense (benefit)                                      |       | (9,842   | )          | 14,579   |       | 4,674    |       |
| **Income  (Loss) Before Cumulative Effect of Accounting Changes** |       | 8,348    |       | 102,376  |       | (91,392  | )          |
| Cumulative effect of accounting changes, net of tax               |       | —   |       | (225     | )          | —   |       |
| **Net Income (Loss)**                                             |       | $        | 8,348      |     | $          | 102,151  |       | $ | (91,392 | ) |

 

See Notes to the Consolidated Financial Statements

F-110

----

**RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC ANDSUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Thousands of Dollars)**

| ** **                                                                    | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                    | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                    |       |                  |       |   |   |
| **Current Assets:**                                                           |       |                  |       |   |   |
| Cash and cash equivalents                                                     |       | $                     | 17,274     |   | $ | 31,067 |   |
| Accounts receivable                                                           |       | 4,595                 |       | 4,455 |   |
| Receivables from affiliates, net                                              |       | 11,466                |       | 16,493 |   |
| Inventory                                                                     |       | 80,689                |       | 80,980 |   |
| Prepaid lease                                                                 |       | 59,030                |       | 59,030 |   |
| Derivative assets                                                             |       | 1,744                 |       | 65,206 |   |
| Accumulated deferred income taxes                                             |       | 9,751                 |       | 31,652 |   |
| Prepayments and other current assets                                          |       | 7,558                 |       | 10,736 |   |
| Total current assets                                                          |       | 192,107               |       | 299,619 |   |
| **Property, Plant and Equipment, net**                                        |       | 679,319               |       | 693,865 |   |
| **Other Assets:**                                                             |       |                  |       |   |   |
| Goodwill                                                                      |       | 3,635                 |       | 3,635 |   |
| Other intangibles, net                                                        |       | 105,642               |       | 117,763 |   |
| Accumulated deferred income taxes                                             |       | 68,378                |       | 33,444 |   |
| Prepaid lease                                                                 |       | 264,328               |       | 259,412 |   |
| Other                                                                         |       | 41,098                |       | 31,232 |   |
| Total other assets                                                            |       | 483,081               |       | 445,486 |   |
| **Total Assets**                                                              |       | 1,354,507             |       | $ | 1,438,970 |   |
| **LIABILITIES  AND MEMBER’S EQUITY**                                     |       |                  |       |   |   |
| **Current Liabilities:**                                                      |       |                  |       |   |   |
| Current portion of long-term debt                                             |       | $                     | 83         |   | $ | 77 |   |
| Accounts payable, principally trade                                           |       | 16,142                |       | 11,365 |   |
| Subordinated accounts payable to affiliates, net                              |       | 160,308               |       | 133,492 |   |
| Subordinated interest payable to affiliates, net                              |       | 63,587                |       | 104,759 |   |
| Derivative liabilities                                                        |       | 22,695                |       | 138,615 |   |
| Other                                                                         |       | 17,168                |       | 30,730 |   |
| Total current liabilities                                                     |       | 279,983               |       | 419,038 |   |
| **Other Liabilities:**                                                        |       |                  |       |   |   |
| Derivative liabilities                                                        |       | 117,269               |       | 155,495 |   |
| Benefit obligations                                                           |       | 42,021                |       | 35,000 |   |
| Other                                                                         |       | 18,459                |       | 18,285 |   |
| Total other liabilities                                                       |       | 177,749               |       | 208,780 |   |
| **Subordinated Note Payable to Affiliate**                                    |       | 618,658               |       | 618,658 |   |
| **Long-term Debt**                                                            |       | 731                   |       | 814 |   |
| **Commitments and Contingencies**                                             |       |                  |       |   |   |
| **Member’s Equity:**                                                     |       |                  |       |   |   |
| Common stock; no par value (1,000 shares authorized,  issued and outstanding) |       | —                |       | — |   |
| Additional paid-in capital                                                    |       | 284,672               |       | 251,520 |   |
| Retained earnings                                                             |       | 79,387                |       | 71,039 |   |
| Accumulated other comprehensive loss                                          |       | (86,673               | )          | (130,879 | ) |
| **Total member’s equity**                                                |       | 277,386               |       | 191,680 |   |
| **Total  Liabilities and Member’s Equity**                               |       | $                     | 1,354,507  |   | $ | 1,438,970 |   |

 

See Notes to the Consolidated Financial Statements

F-111

----

**RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Thousands of Dollars)**

| ** **                                                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Cash  Flows from Operating Activities:**                                                           |       |     |       |     |       |     |       |
| Net income (loss)                                                                                    |       | $        | 8,348      |     | $          | 102,151  |       | $ | (91,392 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |     |       |     |       |     |       |
| Cumulative effect of accounting changes                                                              |       | —   |       | 225      |       | —   |       |
| Depreciation and amortization                                                                        |       | 71,315   |       | 83,544   |       | 85,988   |       |
| Deferred income taxes                                                                                |       | (14,112  | )          | 2,385    |       | 15,184   |       |
| Non-cash federal income tax contributions from  (distributions to) Reliant Energy, Inc., net    |       | —   |       | 3,826    |       | (8,392   | )          |
| Net unrealized (gains) losses on energy derivatives                                                  |       | (5,422   | )          | 5,885    |       | (3,985   | )          |
| Gains on sales of assets and emission allowances, net                                                |       | (71,323  | )          | (109,798 | )          | (14,955  | )          |
| Other, net                                                                                           |       | (59      | )          | (493     | )          | 2,363    |       |
| Changes  in other assets and liabilities:                                                            |       |     |       |     |       |     |       |
| Accounts receivable                                                                                  |       | (140     | )          | 1,321    |       | 133      |       |
| Accounts receivable from affiliates, net                                                             |       | 24,823   |       | 13,820   |       | 5,865    |       |
| Inventory                                                                                            |       | 291      |       | (9,216   | )          | 5,272    |       |
| Prepaid lease                                                                                        |       | (4,916   | )          | (15,949  | )          | (25,682  | )          |
| Accounts payable                                                                                     |       | 272      |       | (857     | )          | (4,175   | )          |
| Other current assets                                                                                 |       | 1,602    |       | (8,536   | )          | 1,626    |       |
| Other current liabilities                                                                            |       | 4,328    |       | (1,773   | )          | 2,009    |       |
| Other assets                                                                                         |       | (9,925   | )          | (1,218   | )          | (513     | )          |
| Subordinated accounts payable to affiliates, net                                                     |       | 30,393   |       | (21,700  | )          | (13,104  | )          |
| Subordinated interest payable to affiliates, net                                                     |       | (41,172  | )          | (186,822 | )          | 58,314   |       |
| Income taxes payable/receivable                                                                      |       | (17,051  | )          | 17,279   |       | 720      |       |
| Other liabilities                                                                                    |       | (1,737   | )          | 9,160    |       | 4,118    |       |
| Net cash provided by (used in) operating activities                                                  |       | (24,485  | )          | (116,766 | )          | 19,394   |       |
| **Cash Flows from Investing  Activities:**                                                           |       |     |       |     |       |     |       |
| Capital expenditures                                                                                 |       | (14,360  | )          | (7,785   | )          | (13,113  | )          |
| Proceeds from sales of assets, net                                                                   |       | 1,238    |       | 42,560   |       | —   |       |
| Proceeds from sales of permits and rights to  affiliate                                              |       | —   |       | —   |       | 19,600   |       |
| Proceeds from sales of emission allowances                                                           |       | 1,141    |       | 8,519    |       | 42,525   |       |
| Proceeds from sales of emission allowances—affiliates                                           |       | 73,140   |       | 99,903   |       | 983      |       |
| Purchases of emission allowances                                                                     |       | —   |       | —   |       | (74,927  | )          |
| Purchases of emission allowances—affiliates                                                     |       | (50,467  | )          | (34,834  | )          | (339     | )          |
| Restricted cash                                                                                      |       | —   |       | 28,652   |       | 13,686   |       |
| Other, net                                                                                           |       | —   |       | —   |       | 1,971    |       |
| Net cash provided by (used in) investing activities                                                  |       | 10,692   |       | 137,015  |       | (9,614   | )          |
| **Cash Flows from Financing  Activities:**                                                           |       |     |       |     |       |     |       |
| Payments of long-term debt                                                                           |       | —   |       | (28,211  | )          | (14,093  | )          |
| Net cash used in financing activities                                                                |       | —   |       | (28,211  | )          | (14,093  | )          |
| **Net Change in Cash and Cash Equivalents**                                                          |       | (13,793  | )          | (7,962   | )          | (4,313   | )          |
| **Cash and Cash Equivalents at Beginning of Period**                                                 |       | 31,067   |       | 39,029   |       | 43,342   |       |
| **Cash and Cash Equivalents at End of Period**                                                       |       | $        | 17,274     |     | $          | 31,067   |       | $ | 39,029 |   |
| **Supplemental Disclosure of Cash  Flow Information:**                                               |       |     |       |     |       |     |       |
| Cash  Payments:                                                                                      |       |     |       |     |       |     |       |
| Interest paid to affiliate                                                                           |       | $        | 107,364    |     | $          | 244,976  |       | $ | — |   |
| Interest paid (net of amounts capitalized) to third  parties                                         |       | 1,338    |       | 1,539    |       | 1,983    |       |
| Income taxes paid (net of income tax refunds  received)                                              |       | 21,322   |       | (1,739   | )          | 267      |       |
| Non-cash  Disclosure:                                                                                |       |     |       |     |       |     |       |
| Contributions from  (distributions to) Reliant Energy, Inc., net                                |       | 33,152   |       | 17,826   |       | (8,392   | )          |

 

See Notes to the Consolidated Financial Statements

F-112

----

**RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF MEMBER’S EQUITY AND COMPREHENSIVE INCOME (LOSS)(Thousands of Dollars)**

| ** **                                                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | **Accumulated Other Comprehensive Income (Loss)** | ** ** | ** **         | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|---------------|------------|-----------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | ** **                                                            | ** ** | ** **         | ** ** | ** **             | ** ** | **Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | **Deferred**                                                          | ** ** | **Actuarial**      | ** ** | ** **             | ** ** | **Accumulated** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                              | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **Derivative**                                                        | ** ** | **Net**            | ** ** | ** **             | ** ** | **Other** | ** ** | **Total** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                              | ** ** | **Common Stock** | ** ** | **Pain-In** | ** ** | **Earnings**   | ** ** | **Gains**     | ** ** | **Gain**                                                              | ** ** | **Net Prior** | ** ** | **Comprehensive**      | ** ** | **Member’s** | ** ** | **Income** | ** ** |
| ** **                                                                              | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **(Deficit)** | ** ** | **(Losses)**                                                          | ** ** | **(Loss)**         | ** ** | **Service Costs** | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** | **(Loss)** | ** ** |
| **Balance, December 31, 2003**                                                     |       |                  | 1,000      |        |       |           | $          | —        |       |                                                                  | $          | 242,086            |       | $                      | 60,280     |   | $ | (15,831 | ) |   | $ | — |   |   |   | $ | — |   |   |   | $ | (15,831 | ) |   | $ | 286,535 |   |   |   |   |   |
| Net loss                                                                                |       |                  |       |        |       |           |       |          |       |                                                                  |       | (91,392            | )          |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | (91,392 | ) |   | $ | (91,392 | ) |   |
| Distributions to Reliant  Energy, Inc., net                                        |       |                  |       |        |       |           |       |          |       | (8,392                                                                | )          |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | (8,392 | ) |   |   |   |   |
| Deferred loss from cash  flows hedges, net of tax of $44 million                        |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       | (63,128                | )          |   |   |   |   |   |   |   |   |   | (63,128 | ) |   | (63,128 | ) |   | (63,128 | ) |   |
| Reclassification of net  deferred loss from cash flow hedges, net of tax of $16 million |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       | 23,376                 |       |   |   |   |   |   |   |   |   |   | 23,376 |   |   | 23,376 |   |   | 23,376 |   |   |
| Comprehensive income                                                                    |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | (131,144 | ) |   |
| **Balance, December 31, 2004**                                                     |       |                  | 1,000      |        |       |           | —     |          |       | 233,694                                                               |       | (31,112            | )          | (55,583                | )          |   | — |   |   |   | — |   |   |   | (55,583 | ) |   | 146,999 |   |   |   |   |   |
| Net income                                                                              |       |                  |       |        |       |           |       |          |       |                                                                  |       | 102,151            |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | 102,151 |   |   | $ | 102,151 |   |   |
| Contributions from  Reliant Energy, Inc., net                                      |       |                  |       |        |       |           |       |          |       | 17,826                                                                |       |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | 17,826 |   |   |   |   |   |
| Deferred loss from cash  flow hedges, net of tax of $91 million                         |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       | (128,132               | )          |   |   |   |   |   |   |   |   |   | (128,132 | ) |   | (128,132 | ) |   | (128,132 | ) |   |
| Reclassification of net  deferred loss from cash flow hedges, net of tax of $37 million |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       | 52,836                 |       |   |   |   |   |   |   |   |   |   | 52,836 |   |   | 52,836 |   |   | 52,836 |   |   |
| Comprehensive income                                                                    |       |                  |       |        |       |           |       |          |       |                                                                  |       |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 26,855 |   |   |
| **Balance, December 31, 2005**                                                     |       |                  | 1,000      |        |       |           | $          | —        |       |                                                                  | $          | 251,520            |       | $                      | 71,039     |   | $ | (130,879 | ) |   | $ | — |   |   |   | $ | — |   |   |   | $ | (130,879 | ) |   | $ | 191,680 |   |   |   |   |   |

 

F-113

----

**RELIANT ENERGYMID-ATLANTIC POWER HOLDINGS, LLC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF MEMBER’S EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)(Thousands of Dollars)**

| ** **                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | **Accumulated Other Comprehensive Income (Loss)** | ** ** | ** **    | ** ** | ** **        | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|---------------|------------|-----------------------------------------------------------------------|------------|---------------|------------|-------------------|------------|
| ** **                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | ** **                                                            | ** ** | ** **    | ** ** | ** **        | ** ** | **Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **    | ** ** | **Deferred**                                                          | ** ** | **Actuarial** | ** ** | **Net**           | ** ** | **Accumulated** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **Derivative**                                                        | ** ** | **Net**       | ** ** | **Prior**         | ** ** | **Other** | ** ** | **Total** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                                | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Earnings**   | ** ** | **Gains**     | ** ** | **Gain**                                                              | ** ** | **Service**   | ** ** | **Comprehensive** | ** ** | **Member’s** | ** ** | **Income** | ** ** |
| ** **                                                                                                | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **(Deficit)** | ** ** | **(Losses)**                                                          | ** ** | **(Loss)**    | ** ** | **Costs**         | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** | **(Loss)** | ** ** |
| **Balance,  December 31, 2005**                                                                      |       |                  | 1,000      |        |       |           | $          | —        |       |                                                                  | $          | 251,520       |       | $                 | 71,039     |   | $ | (130,879 | ) |   | $ | — |   |   | $ | — |   |   | $ | (130,879 | ) |   | $ | 191,680 |   |   |   |   |   |
| Net income                                                                                                |       |                  |       |        |       |           |       |          |       |                                                                  |       | 8,348         |       |              |       |   |   |   |   |   |   |   |   |   |   | 8,348 |   |   | $ | 8,348 |   |   |
| Contributions  from Reliant Energy, Inc., net                                                        |       |                  |       |        |       |           |       |          |       | 33,152                                                                |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   | 33,152 |   |   |   |   |   |
| Deferred loss  from cash flow hedges, net of tax of $13 million                                           |       |                  |       |        |       |           |       |          |       |                                                                  |       |          |       | 18,061            |       |   |   |   |   |   |   |   | 18,061 |   |   | 18,061 |   |   | 18,061 |   |   |
| Reclassification  of net deferred loss from cash flow hedges, net of tax of $22 million                   |       |                  |       |        |       |           |       |          |       |                                                                  |       |          |       | 31,743            |       |   |   |   |   |   |   |   | 31,743 |   |   | 31,743 |   |   | 31,743 |   |   |
| Comprehensive  income                                                                                     |       |                  |       |        |       |           |       |          |       |                                                                  |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 58,152 |   |   |
| Adjustment to  initially apply FASB Statement No. 158, net of tax of $2 million and  $2 million |       |                  |       |        |       |           |       |          |       |                                                                  |       |          |       |              |       |   | (2,861 | ) |   | (2,737 | ) |   | (5,598 | ) |   | (5,598 | ) |   |   |   |   |
| **Balance, December 31, 2006**                                                                       |       |                  | 1,000      |        |       |           | $          | —        |       |                                                                  | $          | 284,672       |       | $                 | 79,387     |   | $ | (81,075 | ) |   | $ | (2,861 | ) |   | $ | (2,737 | ) |   | $ | (86,673 | ) |   | $ | 277,386 |   |   |   |   |   |

 

See Notes to the Consolidated Financial Statement

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**RELIANTENERGY MID-ATLANTIC POWER HOLDINGS, LLC AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(1)**          Backgroundand Basis of Presentation

*Background.**  *“REMA LLC” refers to Reliant EnergyMid-Atlantic Power Holdings, LLC, a Delaware limited liability company. “REMA”refers to REMA LLC and its consolidated subsidiaries. “Reliant Energy” refersto Reliant Energy, Inc. and its consolidated subsidiaries. REMA LLC wasformed in December 1998 and is an indirect subsidiary of Reliant EnergyPower Generation, Inc., a wholly-owned subsidiary of Reliant Energy.

REMA owns or leases interests in 16 operating electricgeneration plants in Pennsylvania, New Jersey and Maryland with an annualaverage net generating capacity of approximately 3,576 megawatts (MW).

*Basis of Presentation.**  *These consolidated statementsinclude all revenues and costs directly attributable to REMA including costsfor facilities and costs for functions and services performed by Reliant Energyand charged to REMA. All significant intercompany transactions have beeneliminated. REMA has reclassified some amounts on the December 31, 2005consolidated balance sheet to conform to the 2006 presentation.

**(2)**          Summaryof Significant Accounting Policies

***(a)***          Useof Estimates and Market Risk and Uncertainties.

Management makesestimates and assumptions to prepare financial statements in conformity withaccounting principles generally accepted in the United States of America (GAAP)that affect:

·       thereported amount of assets, liabilities and equity,

·       thereported amounts of revenues and expenses and

·       disclosureof contingent assets and liabilities at the date of the financial statements.

REMA’s critical accounting estimates include:  (a) property, plant and equipment; (b) derivativeassets and liabilities and (c) deferred tax assets, valuation allowancesand tax liabilities. Actual results could differ from the estimates.

REMA is subject to variousrisks inherent in doing business. See notes 2(c), 2(d), 2(e), 2(g), 2(m),4, 5, 6, 7, 8, 9 and 10.

***(b)***           Principlesof Consolidation.

REMA LLC includes itsaccounts and those of its wholly-owned subsidiaries in its consolidatedfinancial statements. REMA does not consolidate three power generating facilities(see note 9(a)), which are under operating leases.

***(c)***            Revenues.

REMA records grossrevenues from the sale of electricity and other energy services under theaccrual method. Electric power and other energy services are sold atmarket-based prices through existing power exchanges, related party affiliatesor through third party contracts. Energy sales and services that have beendelivered but not billed by period-end are estimated.

***(d)***           Derivativesand Hedging Activities.

REMA accounts for its derivatives instruments andhedging activities in accordance with SFAS No. 133, “Accounting forDerivatives Instruments and Hedging Activities,” as amended (SFAS No. 133).

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For REMA’s hedging activities, it uses both derivativeand non-derivative contracts that provide for settlement in cash or by deliveryof a commodity. The primary types of derivative instruments REMA uses areforwards, futures, swaps and options. REMA accounts for its derivatives underone of three accounting methods (cash flow hedge, mark-to-market or accrualaccounting (under the normal purchase/normal sale exception)) based on factsand circumstances. The fair values of derivative activities are determined by (a) pricesactively quoted, (b) prices provided by other external sources or (c) pricesbased on models and other valuation methods.

If certain conditions are met, a derivative instrumentmay be designated as a cash flow hedge. A derivative is recognized at fairvalue in the balance sheet whether or not it is designated as a hedge, exceptfor derivative contracts designated as normal purchase/normal sale exceptions,which are not in the consolidated balance sheet or results of operations priorto settlement resulting in accrual accounting treatment.

Derivatives designated as cash flow hedges must have ahigh correlation between price movements in the derivative and the hedged item.The changes in fair value of cash flow hedges are deferred in accumulated othercomprehensive income (loss), net of tax, to the extent the contracts areeffective as hedges, until the forecasted transactions affect earnings. At thetime the forecasted transactions affect earnings, REMA reclassifies the amountsin accumulated other comprehensive income (loss) into earnings. REMA recordsthe ineffective portion of changes in fair value of cash flow hedgesimmediately into earnings. For all other derivatives, changes in fair value arerecorded as unrealized gains or losses in its results of operations.

If and when an acceptable level of correlation nolonger exists, hedge accounting ceases and changes in fair value are recognizedin its results of operations. If it becomes probable that a forecastedtransaction will not occur, REMA immediately recognizes the related deferredgains or losses in its results of operations. The associated hedging instrumentis then marked to market through its results of operations for the remainder ofthe contract term unless a new hedging relationship is redesignated.

Realized gains and losses on derivatives contracts notheld for trading purposes are reported either on a net or gross basis based onthe relevant facts and circumstances. Hedging transactions that do notphysically flow are included in the same caption as the items being hedged. Asummary of REMA’s derivative activities and classification in its results ofoperations is:

| **Instrument**                                                    | ** ** | ** **                     | ** ** | **Purpose for Holding or  Issuing Instrument**(1) | ** ** | **Transactions that  Physically Flow** | ** ** | **Transactions that  Financially Settle**(2) |
|-------------------------------------------------------------------|------------|--------------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------|
| Power futures, forward, swap and option contracts                 |       | Power sales Power purchases    |       | Revenues Fuel and purchased power                 |       | Revenues Revenues                      |
| Natural gas and  fuel futures, forward, swap and option contracts |       | Natural gas and fuel purchases |       | Fuel and purchased power                          |       | Fuel and purchased power               |

----

(1)             Thepurpose for holding or issuing is not impacted by the accounting method electedfor each instrument.

(2)             Includesclassification for mark-to-market derivatives and amounts reclassified fromaccumulated other comprehensive income (loss) related to cash flow hedges.

In addition to marketrisk, REMA is exposed to credit and operational risk. Reliant Energy has a risk control framework, to which REMA is subject, tomanage these risks, which include:  (a) measuring and monitoring these risks,(b) review and approval of new transactions relative to theserisks, (c) transaction validation and (d) portfolio valuation andreporting. REMA uses mark-to-market valuation, value-at-risk and other metricsin monitoring and measuring risk. Reliant Energy’s risk control frameworkincludes a variety of separate butcomplementary processes, which involve commercial and senior management andReliant Energy’s Board of Directors. See note 2(e) for furtherdiscussion of REMA’s credit policy.

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Effective September 1,2006, REMA de-designated certain cash flow hedges of coal contracts andeither began utilizing the mark-to-market method of accounting orelected the normal purchase/normal sale exception.

*Set-off of DerivativeAssets and Liabilities.**  *Wherederivative instruments are subject to a master netting agreement and theaccounting criteria to offset are met, REMA presents its derivative assets andliabilities on a net basis. Derivative assets/liabilities and accountsreceivable/payable are presented and set-off separately in the consolidatedbalance sheets although in most cases contracts permit the set-off ofderivative assets/liabilities and accounts receivable/payable with a givencounterparty.

***(e)***            CreditRisk.

REMA has a credit policy that governs the managementof credit risk, including the establishment of counterparty credit limits andspecific transaction approvals. Credit risk is monitored daily and thefinancial condition of counterparties is reviewed periodically. REMA tries tomitigate credit risk by entering into contracts that permit netting and allowit to terminate upon the occurrence of certain events of default. REMA measurescredit risk as the replacement cost for its derivative positions plus amountsowed for settled transactions.

REMA’s credit exposure isbased on its derivative assets and accountsreceivable from counterparties, after taking into consideration netting withineach contract and any master netting contracts with counterparties. Asof December 31, 2006, REMA’s credit exposure was not significant. As of December 31,2005, two non-investment grade counterparties represented 91% ($15 million) ofREMA’s credit exposure.

***(f)***             Generaland Administrative Expenses—Affiliates.

General and administrativeexpenses from affiliates include, among other items, (a) selling andmarketing, (b) bad debt expense, (c) financial services, (d) legalcosts, (e) regulatory costs and (f) certain benefit costs. Seenote 3.

***(g)***           Property,Plant and Equipment and Depreciation Expense.

REMAcomputes depreciation using the straight-line method based on estimated usefullives. Depreciation expense was $32 million, $33 million and $47 million during2006, 2005 and 2004, respectively.

| ** **                          | ** ** | **Estimated Useful** | ** **   | **December 31,** | ** ** |
|-------------------------------------|------------|---------------------------|--------------|-----------------------|------------|
| ** **                          | ** ** | **Lives (Years)**    | ** **   | **2006**              | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(in millions)**    | ** **   |
| Electric  generation facilities     |       |                      | 20 – 30 |                  |       |   | $ | 823 |   |   | $ | 813 |   |
| Other                               |       |                      | 3 – 26  |                  |       |   | 11 |   |   | 11 |   |
| Land                                |       |                      |         |                  |       |   | 26 |   |   | 27 |   |
| Assets under  construction          |       |                      |         |                  |       |   | 15 |   |   | 7 |   |
| Total                               |       |                      |         |                  |       |   | 875 |   |   | 858 |   |
| Accumulated  depreciation           |       |                      |         |                  |       |   | (196 | ) |   | (164 | ) |
| Property, plant and  equipment, net |       |                      |         |                  |       |   | $ | 679 |   |   | $ | 694 |   |

 

REMA periodically evaluates property, plant andequipment for impairment when events or circumstances indicate that thecarrying value of these assets may not be recoverable. The evaluation is highlydependent on the underlying assumptions of related cash flows. REMA recorded nomaterial property, plant and equipment impairments during 2006, 2005 and 2004.

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In the future, REMA couldrecognize impairments if its wholesale energy market outlook changes negatively.In addition, REMA’s ongoing evaluation of its business could result indecisions to mothball, retire or dispose of additional generation assets, anyof which could result in impairment charges.

***(h)***          IntangibleAssets and Amortization Expense.

*Goodwill.*   REMAperforms its goodwill impairment test annually on April 1 and when eventsor changes in circumstances indicate that the carrying value may not berecoverable. During 2004, the annual impairment test date was November 1.

*Other Intangibles.*   REMArecognizes specifically identifiable intangible assets, including emissionallowances, when specific rights and contracts are acquired. REMA has nointangible assets with indefinite lives recorded as of December 31, 2006and 2005.

***(i)***             IncomeTaxes.

*Federal.**  *REMA is included in the consolidated federal incometax returns of Reliant Energy and calculates its income tax provision on aseparate return basis, whereby Reliant Energy pays all federal income taxes onREMA’s behalf and is entitled to any related tax savings. The differencebetween REMA’s current federal income tax expense or benefit, as calculated ona separate return basis, and related amounts paid to/received from ReliantEnergy, if any, were recorded in REMA’s financial statements as adjustments toadditional paid-in capital. Reliant Energy changed its funding policy in late December2006 and these differences are recorded to (a) income taxes payable toReliant Energy, Inc. if REMA has cumulative taxable income on a separatereturn basis or (b) deferred tax assets if REMA has cumulative taxablelosses on a separate return basis. Deferred federal income taxes reflected onREMA’s consolidated balance sheet will ultimately be settled with ReliantEnergy. See notes 3 and 8.

*State.*   REMAis included in the consolidated state income tax returns of Reliant Energy. Itcalculates its state provision, related payables or receivables and deferredstate income taxes on a separate return basis and settles the related assetsand liabilities with the governmental entity or Reliant Energy based on the taxstatus of the applicable entities. See note 8.

***(j)***              Cashand Cash Equivalents.

REMA records all highlyliquid short-term investments with maturities of three months or less as cashequivalents.

***(k)***           RestrictedCash.

Restricted cash includescash at certain subsidiaries, the distribution or transfer of which isrestricted by financing and other agreements.

***(l)***              Inventory.

REMA values fuel inventories at the lower of averagecost or market. REMA removes these inventories as they are used in theproduction of electricity. REMA values materials and supplies at average cost. REMAremoves these inventories when they are used for repairs, maintenance orcapital projects.

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| ** **                                     | ** ** | **December 31,**  | ** ** |
|------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in millions)** | ** ** |
| Materials and  supplies, including spare parts |       |                   | $          | 47 |   |   |   | $ | 44 |   |   |
| Coal                                           |       |                   | 17         |   |   |   | 17 |   |   |
| Heating oil                                    |       |                   | 17         |   |   |   | 20 |   |   |
| Total inventory                                |       |                   | $          | 81 |   |   |   | $ | 81 |   |   |

 

***(m)***       EnvironmentalCosts.

REMA expensesenvironmental expenditures related to existing conditions that do not havefuture economic benefit. REMA capitalizes environmental expenditures for whichthere is a future economic benefit. REMA records liabilities for expectedfuture costs, on an undiscounted basis, related to environmental assessmentsand/or remediation when they are probable and can be reasonably estimated. Seenote 10.

***(n)***          AssetRetirement Obligations.

REMA’s asset retirement obligations relate to futurecosts primarily associated with ash disposal site closures. REMA’s assetretirement obligations were $7 million as of December 31, 2006 and 2005. Asof December 31, 2006 REMA has $12 million (classified in other long-termassets) on deposit with the state of Pennsylvania to guarantee its obligationrelated to future closures of ash disposal sites. See note 10.

During 2005, REMA adoptedan accounting interpretation relating to asset retirement obligations. Thisinterpretation clarifies that an asset retirement obligation is unconditional even thoughuncertainty exists about the timing and/or method of settlement and requiresthat a liability be recognized if it can be reasonably estimated. Based onthis, REMA (a) recorded a cumulative effect of an accounting change, netof tax, of $225,000, (b) increased other long-term liabilities by$447,000, (c) increased property, plant and equipment by $77,000 and (d) decreaseddeferred income tax liabilities by $145,000.

***(o)***           Repairand Maintenance Costs for Power Generation Assets.

REMA recognizes repair andmaintenance costs as incurred.

***(p)***           DeferredLease Costs.

REMA incurred costs in connection with itssale-leaseback transactions in 2000 (see note 9(a)). These costs aredeferred and amortized, using the straight-line method, over the life of theindividual sale-leaseback transactions. REMA amortized $1 million to facilitieslease expense during 2006, 2005 and 2004. As of December 31, 2006 and 2005,REMA had $19 million and $20 million, respectively, of net deferred lease costsclassified in other long-term assets in its consolidated balance sheets.

***(q)***           NewAccounting Pronouncement Net Yet Adopted—Fair Value.

The FASB issued Statementof Financial Accounting Standards No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair value inGAAP and expands disclosures about fair value measurements. This statement isapplicable for REMA beginning in 2008. It applies under other accountingpronouncements that require or permit fair value measurements. The adoption,which REMA plans to assess during 2007, could have a significant impact on itsconsolidated financial statements.

**(3)**          RelatedParty Transactions

These financial statements include the impact ofsignificant transactions between REMA and Reliant Energy. The majority of thesetransactions involve the purchase or sale of energy, capacity, fuel, emission 

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allowances or relatedservices (including transportation, transmission and storage services) from orto REMA and allocations of costs to REMA for support services.

*SupportServices.**  *ReliantEnergy provides commercial support, technical services and other corporateservices to REMA. Beginning January 1, 2005, Reliant Energy allocatescertain support services costs to REMA based on REMA’s underlying plannedoperating expenses relative to the underlying planned operating expenses ofother entities to which Reliant Energy provides similar services and also chargesREMA for certain other services based on usage. During 2004, Reliant Energyallocated certain support services costs to REMA based on REMA’s direct laborcosts relative to the direct labor costs of other entities to which ReliantEnergy provided similar services and also charged REMA for certain otherservices based on usage. Management believes these methods of allocation arereasonable and do not yield significantly different results between the twomethodologies. These allocations and charges were not necessarily indicative ofwhat would have been incurred had REMA been an unaffiliated entity. Payments toReliant Energy for services under the support services agreement aresubordinated to certain obligations, including the lease obligations, pursuant tothe lease documents.

Thefollowing details the amounts recorded as operation and maintenance—affiliatesand general and administrative—affiliates:

| ** **                              | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                              | ** ** | **(in millions)** | ** ** |
| Allocated or  charged by Reliant Energy |       |                   | $          | 86       |       |     |       | $ | 86 |   |   |   | $ | 82 |   |   |
|                                         |            |                        |            |          |            |          |            |  |  |  |  |  |  |  |  |  |

 

*Procurement and Marketing.**  *REMA has sales to and purchases from Reliant Energyrelated to support and commodity procurement and marketing services.

| ** **                                                                                                        | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                        | ** ** | **(in millions)** | ** ** |
| Sales to Reliant  Energy under various commodity agreements(1)                                                    |       | $                      | 540        |     | $          | 587      |       | $ | (31 | ) |
| Purchases from  Reliant Energy under various commodity agreements(2)                                              |       | 13                     |       | 18       |       | 8        |       |
| Fees charged by  Reliant Energy for these services and included in operation and maintenance—affiliates |       | 5                      |       | 5        |       | 5        |       |
| Fees charged by  Reliant Energy for these services and included in fuel and purchased power—affiliates       |       | 2                      |       | 2        |       | 1        |       |
| Net purchases of  coal from Reliant Energy(3)                                                                     |       | 14                     |       | 12       |       | 9        |       |
| Sales of emission  allowances to Reliant Energy(4)                                                                |       | 73                     |       | 100      |       | 1        |       |
| Gains on emission  allowances sales to Reliant Energy(5)                                                          |       | 70                     |       | 92       |       | 1        |       |
|                                                                                                                   |            |                        |            |          |            |          |            |  |  |  |

----

(1)             Recordedin revenue—affiliates.

(2)             Recordedin fuel and purchased power—affiliates.

(3)             Reflectsmarket price of coal at purchase and sale dates. Cost of coal is added toinventory similar to other coal purchases from third parties. These purchasesof coal from Reliant Energy are not subordinated.

(4)             Reflectsprice at which Reliant Energy sold the emission allowances to third-parties.

(5)             Recordedin gains on sales of assets and emission allowances, net. See note 13.

*SubordinatedLong-term Note Payable to Affiliate.**  *REMA has a note payable to Reliant Energy. Thenote is due January 1, 2029 and accrues interest at a fixed rate of 9.4%per year. As of December 31, 2006 and 2005, REMA classified the relatedaccrued interest as a current liability since REMA intends to pay the entireamount within the next 12 months from the respective dates. As of December 31,2006 and 2005, REMA had $619 million outstanding under the note. Payments underthis indebtedness are subordinated to certain obligations, including the leaseobligations, pursuant to the lease documents.

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*Working Capital Note.**  *REMA has a revolving note payable to ReliantEnergy under which REMA may borrow, and Reliant Energy is committed to lend, upto $30 million for working capital needs. Borrowings under the note will beunsecured and will rank equal in priority with REMA’s lease obligations. REMAmay replace this note with a working capital facility from an unaffiliatedlender if then permitted under Reliant Energy’s debt agreements. As ofDecember 31, 2006 and 2005, there were no borrowings outstanding underthis note.

*Subordinated WorkingCapital Facility.**  *REMAhas an irrevocably committed subordinated working capital facility with ReliantEnergy. REMA may borrow under this facility to pay operating expenditures,senior indebtedness and rent, but excluding capital expenditures andsubordinated obligations. In addition, Reliant Energy must make advances toREMA and REMA must obtain such advances under such facility up to the maximumavailable commitment under such facility from time to time if REMA’s pro formacoverage ratio does not equal or exceed 1.1 to 1.0, measured at the time rentunder the leases is due. Subject to the maximum available commitment, drawingswill be made in amounts necessary to permit REMA to achieve a pro formacoverage ratio of at least 1.1 to 1.0. The amount available under the subordinatedworking capital facility was $120 million through January 1, 2007.Thereafter, the available amount decreased by $24 million on January 2,2007 and decreases by $24 million each subsequent year through its expirationin 2011. As of December 31, 2006 and 2005, there were no borrowingsoutstanding under this facility.

*Sales of Power GenerationSite Permits and Water Rights to Affiliate.**  *During 2004, REMA sold certain power generationsite permits and water rights to Reliant Energy for $20 million in cash. Thepermits and water rights were no longer needed for REMA’s business. There wasno gain or loss recorded on the sales.

*Letters of Credit.*   Reliant Energy has posted letters ofcredit on behalf of REMA related to its lease obligations. See notes 3 and9(a).

*Income Taxes.*

| ** **                                                                                         | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                         | ** ** | **(in millions)** | ** ** |
| Non-cash federal  income tax contributions from (distributions to) Reliant Energy, Inc.,  net |       |                   | $          | 33       |       |     |       | $ | 18 |   |   |   | $ | (8 | ) |   |
|                                                                                                    |            |                        |            |          |            |          |            |  |  |  |  |  |  |  |  |  |

 

**(4)   IntangibleAssets**

***(c)    Goodwill.***

During 2006, goodwill didnot change. During 2005, REMA reduced goodwill $218,000 related to assets sold.See note 13. As of December 31, 2006 and 2005, REMA had no goodwillthat is deductible for United States incometax purposes in future periods.

***(d)    Other Intangibles.***

| ** **                          | ** ** | **Remaining**                         | ** ** | ** **             | ** ** | ** **                    | ** ** | ** **           | ** ** | ** **                    | ** ** |   |
|-------------------------------------|------------|---------------------------------------|------------|------------------------|------------|-------------------------------|------------|----------------------|------------|-------------------------------|------------|--------|
| ** **                          | ** ** | **Weighted**                          | ** ** | **December 31,**  | ** ** |                          |
| ** **                          | ** ** | **Average**                           | ** ** | **2006**               | ** ** | **2005**                      | ** ** |                 |
| ** **                          | ** ** | **Amortization  Period (Years)** | ** ** | **Carrying  Amount**   | ** ** | **Accumulated  Amortization** | ** ** | **Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |   |
| ** **                          | ** ** | ** **                            | ** ** | **(in millions)** | ** ** |                          |
| SO2 emission  allowances(1)(2) |       |                                  | —     | (1)                    |       |                          | $          | 204                  |       |                          |       | $      | (138 | ) |   |   | $ | 177 |   |   |   | $ | (106 | ) |   |
| NOx emission  allowances(1)(3) |       |                                  | —     | (1)                    |       |                          | 89         |                 |       |                          | (49        | )      |   |   | 89 |   |   |   | (42 | ) |   |
| Total                               |       |                                  |       |                   |       |                          | $          | 293                  |       |                          |       | $      | (187 | ) |   |   | $ | 266 |   |   |   | $ | (148 | ) |   |

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(1)             SO2 is sulfur dioxide and NOx isnitrogen oxides. Amortized to amortization expense on a units-of-productionbasis. As of December 31, 2006, REMA has recorded (a) SO2 emission allowances through the 2030 vintageyear and (b) NOx emission allowances through the 2030 vintageyear.

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(2)             During2006, 2005 and 2004, we purchased $29 million, $35 million and $51 million,respectively, of SO2 emissionallowances, including purchases from affiliates of $29 million, $35 million and$0, respectively. See note 13 for sales.

(3)             During2006, 2005 and 2004, we purchased $2 million, $0 and $24 million, respectively,of NOx emissionallowances, including purchases from affiliates of $2 million, $0 and $0,respectively. See note 13 for sales.

Amortizationexpense consists of:

| ** **          | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **          | ** ** | **(in millions)** | ** ** |
| Emission allowances |       |                   | $          | 39       |       |     |       | $ | 51 |   |   |   | $ | 39 |   |   |
| Total               |       |                   | $          | 39       |       |     |       | $ | 51 |   |   |   | $ | 39 |   |   |

 

Estimatedamortization expense, based on REMA’s intangibles as of December 31, 2006,for the next five years is (in millions):

| 2007 |   | $ | 5      |   |
|------|--------|---|--------|--------|
| 2008 |   | 2 |   |
| 2009 |   | 2 |   |
| 2010 |   | 4 |   |
| 2011 |   | 5 |   |

 

**(5)   Derivatives and Hedging Activities**

REMA uses derivative instruments to manage operationalor market constraints and to increase return on its generation assets. Theinstruments used are fixed-price derivative contracts to hedge the variabilityin future cash flows from forecasted sales of power and purchases of fuel andpower. REMA’s objective in entering into these fixed-price derivatives is tofix the price for a portion of these transactions. See note 2(d).

REMA’ s derivative portfolio, excluding cash flowhedges, is $2 million (net asset) and $1 million (net asset) as of December 31,2006 and 2005, respectively. REMA’s cash flow hedges are valued at $140 million(net liability) and $230 million (net liability) as of December 31, 2006and 2005, respectively.

During 2006, 2005 and 2004, there was an insignificantamount, $1 million gain and $3 million loss, respectively, of hedgeineffectiveness recognized from derivatives that are designated and qualify ascash flow hedges. In addition, no component of the derivatives’ gain or losswas excluded from the assessment of effectiveness for these periods. If itbecomes probable that an anticipated transaction will not occur, REMA realizesin net income (loss) the deferred gains and losses recognized in accumulatedother comprehensive loss. During 2006, 2005 and 2004, there were no amountsrecognized in the results of operations as a result of the discontinuance ofcash flow hedges because it was probable that the forecasted transaction wouldnot occur.

As of December 31, 2006 and 2005, themaximum length of time REMA is hedging its exposure to the variability infuture cash flows that may result from changes in commodity prices is six yearsand seven years, respectively.

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Amountsincluded in accumulated other comprehensive loss:

| ** **                      | ** ** | **December 31, 2006**                       | ** ** |
|---------------------------------|------------|-------------------------------------------------------|------------|
| ** **                      | ** ** | **At the End of the Period** | ** ** | **Expected to be  Reclassified into  Results of Operations  in Next 12 Months**(1) | ** ** |
| ** **                      | ** ** | **(in millions)**                                | ** ** |
| Designated cash  flow hedges    |       |                                                  | $          | (80 | ) |   |   | $ | (11 | )(1) |   |
| De-designated  cash flow hedges |       |                                                  | (1         | ) |   |   | (1 | ) |   |
|                            |       |                                                  | $          | (81 | ) |   |   | $ | (12 | ) |   |

----

(1)             The actual amountreclassified into the results of operations will vary from the amounts recordedas of December 31, 2006, due to future changes in market prices.

**(6)   Debt**

REMA is obligated to provide credit support for itslease obligations (see note 9(a)) in the form of letters of credit and/orcash equal to an amount representing the greater of (a) the next sixmonths’ scheduled rental payments under the related lease or (b) 50% ofthe scheduled rental payments due in the next 12 months under the related lease.In 2003, proceeds from the REMA term loans were used to partially fulfill REMA’srequirement to provide credit support for its obligations under these leases. During2005, the term loans were paid in full and replacement credit support wasprovided in the form of letters of credit issued under Reliant Energy’s creditfacilities. As of December 31, 2006 and 2005, the amount of credit supportwas $32 million. The term loans bore interest at LIBOR plus 3%. The term loanswere non-recourse to Reliant Energy.

See note 3 for debttransactions with affiliates.

**(7)   Benefit Plans**

***(a)   Pension and Postretirement Benefits.***

*BenefitPlans.*   REMA sponsors a defined benefit pensionplan and provides subsidized postretirement benefits to some bargainingemployees but generally does not provide them to non-bargaining employees.

Effective December 31, 2006, REMA adoptedStatement of Financial Accounting Standards No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans.”  This statement requires recognition of thefunded status of plans, measured as of year end. REMA already uses the requiredmeasurement date. The adoption did not have a material effect on any individualline item of REMA’s consolidated balance sheet as of December 31, 2006. Asof December 31, 2006, $0 and $0.4 million of net gain/loss and net priorservice costs, respectively, in accumulated other comprehensive loss areexpected to be recognized in net periodic benefit cost during the next 12months. However, the actual amounts reclassified into earnings will vary fromthe amounts recorded as of December 31, 2006 due to future changes inmarket conditions.

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REMAuses a December 31 measurement date for its plans. The benefit obligationsand funded status are:

| ** **                          | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **                          | ** ** | **(in millions)** | ** ** |
| **Change in Benefit Obligation**    | ** ** |                   | ** ** | ** **                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Beginning of year                   |       |                   | $          | 27                               |       |   |   | $ | 22 |   |   |   | $ | 39 |   |   |   | $ | 48 |   |   |
| Transfer to affiliate               |       |                   | (5         | )                                |       |   | — |   |   |   | (8 | ) |   |   | — |   |   |
| Service cost                        |       |                   | 3          |                             |       |   | 4 |   |   |   | 1 |   |   |   | 2 |   |   |
| Interest cost                       |       |                   | 1          |                             |       |   | 1 |   |   |   | 2 |   |   |   | 3 |   |   |
| Actuarial gain                      |       |                   | (1         | )                                |       |   | — |   |   |   | (2 | ) |   |   | (14 | ) |   |
| End of year                         |       |                   | $          | 25                               |       |   |   | $ | 27 |   |   |   | $ | 32 |   |   |   | $ | 39 |   |   |
| **Change in Plan Assets**           | ** ** |                   | ** ** | ** **                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Beginning of year                   |       |                   | $          | 18                               |       |   |   | $ | 15 |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Transfer to affiliate               |       |                   | (3         | )                                |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Employer contributions              |       |                   | 1          |                             |       |   | 3 |   |   |   | — |   |   |   | — |   |   |
| Actual investment return            |       |                   | 1          |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |
| End of year                         |       |                   | $          | 17                               |       |   |   | $ | 18 |   |   |   | $ | — |   |   |   | $ | — |   |   |
| **Reconciliation of Funded Status** | ** ** |                   | ** ** | ** **                       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Funded status                       |       |                   | $          | (8                               | )          |   |   | $ | (9 | ) |   |   | $ | (32 | ) |   |   | $ | (39 | ) |   |
| Unrecognized prior service cost     |       |                   | —     |                             |       |   | — |   |   |   | — |   |   |   | 7 |   |   |
| Unrecognized actuarial loss         |       |                   | —     |                             |       |   | 3 |   |   |   | — |   |   |   | 6 |   |   |
| Net amount  recognized              |       |                   | $          | (8                               | )          |   |   | $ | (6 | ) |   |   | $ | (32 | ) |   |   | $ | (26 | ) |   |

 

Amountsrecognized in the consolidated balance sheets are:

| ** **              | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|-------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **December 31,**  | ** ** | **December 31,**            | ** ** |
| ** **              | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **              | ** ** | **(in millions)** | ** ** |
| Noncurrent  liabilities |       |                   | $          | (8                               | )          |   |   | $ | (6 | ) |   |   | $ | (32 | ) |   |   | $ | (26 | ) |   |
|                         |            |                        |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accumulated benefit obligation for the pensionplan was $22 million and $23 million as of December 31, 2006 and 2005,respectively. The pension plan has an accumulated benefit obligation in excessof plan assets.

Netbenefit costs are:

| ** **                      | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(in millions)** | ** ** |
| Service cost                    |       |                   | $          | 3                                |       |   |   | $ | 4 |   |   |   | $ | 4 |   |   |   | $ | 1 |   |   |   | $ | 2 |   |   |   | $ | 2 |   |   |
| Interest cost                   |       |                   | 1          |                             |       |   | 1 |   |   |   | 1 |   |   |   | 2 |   |   |   | 3 |   |   |   | 2 |   |   |
| Expected return on  plan assets |       |                   | (1         | )                                |       |   | (1 | ) |   |   | (1 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net amortization                |       |                   | —     |                             |       |   | — |   |   |   | — |   |   |   | 1 |   |   |   | 2 |   |   |   | 2 |   |   |
| Net benefit cost                |       |                   | $          | 3                                |       |   |   | $ | 4 |   |   |   | $ | 4 |   |   |   | $ | 4 |   |   |   | $ | 7 |   |   |   | $ | 6 |   |   |

* *

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*Assumptions.*   Thesignificant weighted average assumptions used to determine the benefit obligationsare:

| ** **                               | ** ** | **Pension**           | ** ** | **Postretirement Benefits** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **December 31,** | ** ** | **December 31,**            | ** ** |
| ** **                               | ** ** | **2006**              | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| Discount rate                            |       | 5.75                  | %          | 5.75                             | %          |   | 5.75 | % |   |   | 5.75 | % |   |
| Rate of increase in  compensation levels |       | 3.0                   | %          | 3.0                              | %          |   | N/A |   |   |   | N/A |   |   |

 

The significantweighted average assumptions used to determine the net benefit costs are:

| ** **                                   | ** ** | **Pension** | ** ** | **Postretirement Benefits** | ** ** |
|----------------------------------------------|------------|-------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2006**    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Discount rate                                |       | 5.75        | %          | 5.75                             | %          | 6.25 | % | 5.75 | % | 5.75 | % | 6.25 | % |
| Rate of increase  in compensation levels     |       | 3.0         | %          | 3.0                              | %          | 4.5 | % | N/A |   | N/A |   | N/A |   |
| Expected long-term rate  of return on assets |       | 7.5         | %          | 7.5                              | %          | 7.5 | % | N/A |   | N/A |   | N/A |   |

 

As of December 31, 2006 and 2005, REMA developedits expected long-term rate of return on pension plan assets based on thirdparty models. These models consider expected inflation, current dividendyields, expected corporate earnings growth and risk premiums based on theexpected volatility of each asset category. REMA weights the expected long-termrates of return for each asset category to determine its overall expectedlong-term rate of return on pension plan assets. In addition, REMA reviews peerdata and historical returns.

REMA’sassumed health care cost trend rates used to measure the expected cost ofbenefits covered by its postretirement plan are:

| ** **                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                     |       | 9.0      | %          | 9.0      | %          | 9.75     | %          |
| Rate to which the  cost trend rate is assumed to gradually decline     |       | 5.5      | %          | 5.5      | %          | 5.5      | %          |
| Year that the rate  reaches the rate to which it is assumed to decline |       | 2015     |       | 2011     |       | 2011     |       |

 

Assumed health care cost trend rates can have asignificant effect on the amounts reported for REMA’s health care plan. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects as of December 31, 2006:

| ** **                                               | ** ** | **One-Percentage Point** | ** ** |
|----------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                               | ** ** | ** Increase **      | ** ** | ** Decrease ** | ** ** |
| ** **                                               | ** ** | **(in millions)**        | ** ** |
| Effect on service  and interest cost                     |       |                          | $          | — |   |   |   | $ | — |   |   |
| Effect on accumulated  postretirement benefit obligation |       |                          | 4          |   |   |   | (4 | ) |   |

 

*PlanAssets*.   REMA’s pension weighted average assetallocations and target allocation by asset category are:

| ** **                       | ** ** | **Percentage of Plan Assets  as of December 31,**  | ** ** | **Target Allocation**                                                       | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** | **2007** | ** ** |
| Domestic equity  securities      |       |                                                                             | 50         | %                                                                                |       |   | 50 | % |   |   | 50 | % |   |
| International  equity securities |       |                                                                             | 11         |                                                                             |       |   | 11 |   |   |   | 10 |   |   |
| Global equity  securities        |       |                                                                             | 11         |                                                                             |       |   | 10 |   |   |   | 10 |   |   |
| Debt securities                  |       |                                                                             | 28         |                                                                             |       |   | 29 |   |   |   | 30 |   |   |
| Total                            |       |                                                                             | 100        | %                                                                                |       |   | 100 | % |   |   | 100 | % |   |

 

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Inmanaging the investments associated with the pension plan, REMA’s objective is toexceed, on a net-of-fee basis, the rate of return of a performance benchmarkcomposed of the following indices:

| **Asset Class**             | ** ** | ** **                            | ** ** | **Index** | ** ** | **Weight** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-----------|------------|------------|------------|
| Domestic equity  securities      |       | Wilshire  5000 Index                  |       |      | 50         | %          |       |
| International  equity securities |       | MSCI  All Country World Ex-U.S. Index |       |      | 10         |       |       |
| Global equity  securities        |       | MSCI  All Country World Index         |       |      | 10         |       |       |
| Debt securities                  |       | Lehman  Brothers Aggregate Bond Index |       |      | 30         |       |       |
| Total                            |       |                                  |       |      | 100        | %          |       |

 

As a secondary measure, REMA compares assetperformance to the returns of a universe of comparable funds, where applicable,over a full market cycle. Reliant Energy’s Benefits Committee reviews planasset performance each quarter by comparing the actual quarterly returns ofeach asset class to its related benchmark. REMA’s plan assets have generallyperformed in accordance with the benchmarks.

*Cash Obligations.*   REMAexpects pension cash contributions to approximate $3 million during 2007. Expectedbenefit payments for the next ten years, which reflect future service asappropriate, are:

| ** ** | ** ** | **Pension**            | ** ** | **Postretirement  Benefits** | ** ** |
|------------|------------|------------------------|------------|------------------------------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| 2007       |       |                   | $          | 1                            |       |   |   | $ | — |   |   |
| 2008       |       |                   | 1          |                         |       |   | 1 |   |   |
| 2009       |       |                   | 1          |                         |       |   | 1 |   |   |
| 2010       |       |                   | 1          |                         |       |   | 1 |   |   |
| 2011       |       |                   | 1          |                         |       |   | 2 |   |   |
| 2012-2016  |       |                   | 10         |                         |       |   | 15 |   |   |

 

***(b)    Savings Plan.***

REMA’s employeesparticipate in Reliant Energy’s employee savings plans under Sections 401(a) and401(k) of the Internal Revenue Code. Under the plans, participatingemployees may contribute a portion of their compensation generally up to amaximum of 50% in total for pre-tax and/or Roth 401(k) plus 16%after-tax during 2006, 50% pre-tax and 16% after-tax during 2005 and 16%pre-tax or after-tax during 2004. Bargaining employees contribute based ontheir respective agreements. REMA’s savings plan benefit expense, includingmatching and discretionary contributions, was $2 million, $2 million and $4million during 2006, 2005 and 2004, respectively.

***(c)    Other Employee Matters.***

As of December 31, 2006, approximately 75% ofREMA’s employees are subject to collective bargaining arrangements. Approximately72% of REMA’s employees are subject to collective bargaining arrangements thatwill expire in 2007. However, negotiations are underway to extend existingarrangements.

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**(8)**          IncomeTaxes

***(a)***          Summary.

REMA’sincome tax expense (benefit) is:

| ** **                    | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                    | ** ** | **(in millions)** | ** ** |
| **Current:**                  |       |                   |       |     |       |     |       |   |   |
| Federal                       |       | $                      | —     |     |       | $        | 3          |   |   | $ | (11 | ) |
| State                         |       | 4                      |       |     | 9          |     |       | 1 |   |
| Total current                 |       | 4                      |       |     | 12         |     |       | (10 | ) |
| **Deferred:**                 |       |                   |       |     |       |     |       |   |   |
| Federal                       |       | 7                      |       |     | 6          |     |       | 7 |   |
| State                         |       | (21                    | )          |     | (3         | )        |       | 8 |   |
| Total deferred                |       | (14                    | )          |     | 3          |     |       | 15 |   |
| Income tax expense  (benefit) |       | $                      | (10        | )        |       | $        | 15         |   |   | $ | 5 |   |

 

Areconciliation of the federal statutory income tax rate to the effective incometax rate is:

| ** **                                         | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                         | ** ** | **(in millions)** | ** ** |
| Income (loss)  before income taxes                 |       | $                      | (1         | )        | $          | 117      |       | $ | (87 | ) |
| Federal statutory  rate                            |       | 35                     | %          | 35       | %          | 35       | %          |
| Income tax  expense (benefit) at statutory rate    |       | (1                     | )          | 41       |       | (30      | )          |
| Net addition  (reduction) in taxes resulting from: |       |                   |       |     |       |     |       |
| State income taxes, net of federal income taxes    |       | (8                     | )(1)       | 4        |       | 6        |       |
| Federal valuation allowances                       |       | —                 |       | (30      | )          | 30       |       |
| Other, net                                         |       | (1                     | )          | —   |       | (1       | )          |
| Total                                              |       | (9                     | )          | (26      | )          | 35       |       |
| Income tax  expense (benefit)                      |       | $                      | (10        | )        | $          | 15       |       | $ | 5 |   |
| Effective rate                                     |       | NM                     | (2)        | 12       | %          | NM       | (3)        |

----

(1)             Ofthis amount, $9 million relates to Pennsylvania state law changes, whicheffectively decreased our limitations to use net operating losses in thatstate.

(2)             NMis not meaningful. The primary reason is due to state income taxes. See above.

(3)             NMis not meaningful. The primary reason is that REMA had a pre-tax loss of $87million and income tax expense of $5 million due to the establishment of afederal operating loss carryforward valuation allowance.

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| ** **                                 | ** ** | **December 31,**  | ** ** |       |
|--------------------------------------------|------------|------------------------|------------|------------|
| ** **                                 | ** ** | **2006**               | ** ** | **2005**   | ** ** |   |
| ** **                                 | ** ** | **(in millions)** | ** ** |       |
| **Deferred  tax assets:**                  | ** ** | ** **             | ** ** | ** ** | ** ** |
| Current:                                   |       | ** **             | ** ** |       |   |
| Derivative liabilities, net                |       | $                      | 9          | ** ** | $ | 28 |   |
| Employee benefits                          |       | 1                      | ** ** | —     |   |
| Other                                      |       | —                 | ** ** | 4          |   |
| Total current deferred tax assets          |       | 10                     | ** ** | 32         |   |
| Non-current:                               |       | ** **             | ** ** |       |   |
| Employee benefits                          |       | 16                     | ** ** | 12         |   |
| Net operating loss carryforwards           |       | 84                     | ** ** | 3          |   |
| Environmental reserves                     |       | 3                      | ** ** | 7          |   |
| Derivative liabilities, net                |       | 49                     | ** ** | 67         |   |
| Other                                      |       | 11                     | ** ** | —     |   |
| Valuation allowance                        |       | —                 | ** ** | (3         | ) |
| Total non-current deferred tax assets      |       | 163                    | ** ** | 86         |   |
| Total deferred tax assets                  |       | $                      | 173        | ** ** | $ | 118 |   |
| **Deferred  tax liabilities:**             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Non-current:                               |       | ** **             | ** ** |       |   |
| Depreciation and amortization              |       | 99                     | ** ** | 49         |   |
| Other                                      |       | —                 | ** ** | 7          |   |
| Total non-current deferred tax liabilities |       | 99                     | ** ** | 56         |   |
| Total deferred tax liabilities             |       | $                      | 99         | ** ** | $ | 56 |   |
| Accumulated  deferred income taxes, net    |       | $                      | 74         | ** ** | $ | 62 |   |
|                                            |            |                        |            |            |  |  |  |  |  |

 

***(b)***           TaxAttribute Carryovers.

| ** **                         | ** ** | **December 31,  2006** | ** ** | **Statutory  Carryforward  Period** | ** ** | **Expiration  Year(s)** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **(in millions)**      | ** ** | **(in years)**                 | ** ** | ** **              | ** ** |
| Net Operating  Loss Carryforwards: |       |                        |       |                                |       |                    |       |   |   |   |   |
| Federal                            |       |                        | $          | 182                                 |       |                    |       | 20 |   |   | 2022 through 2026 |   |
| State                              |       |                        | 219        |                                |       |                    | 20         |   |   | 2010 through 2026 |   |
|                                    |            |                             |            |                                     |            |                         |            |  |  |  |  |  |

 

***(c)***            Federaland State Valuation Allowances.

REMA assesses quarterly its future ability to usefederal and****state net operating losses andother deferred tax assets. These assessments included an evaluation of REMA’srecent history of earnings and losses, future reversals of temporarydifferences and identification of other sources of future taxable income,including the identification of tax planning strategies in certain situations.

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REMA’svaluation allowances are:

| ** **                     | ** ** | **Federal**       | ** ** | **State** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------|------------|
| ** **                     | ** ** | **(in millions)** | ** ** |
| As of  January 1, 2004    |       |              | $          | —    |       |   |   | $ | — |   |   |
| Changes in valuation allowance |       |              | 30         |      |       |   | 5 |   |   |
| As of  December 31, 2004  |       |              | 30         |      |       |   | 5 |   |   |
| Changes in valuation allowance |       |              | (30        | )         |       |   | (2 | ) |   |
| As of  December 31, 2005  |       |              | —     |      |       |   | 3 |   |   |
| Changes in valuation allowance |       |              | —     |      |       |   | (3 | ) |   |
| As of December 31,  2006  |       |              | $          | —    |       |   |   | $ | — |   |   |

 

***(d)***           TaxContingencies.

Reliant Energy’s income tax returns, including yearswhen it was included in CenterPoint’s consolidated tax group, for the 1997 to2004 tax reporting periods are under audit by federal and state taxingauthorities. These audits may result in additional taxes, interest andpenalties or revisions of the timing of tax payments. REMA classifies interestand penalties related to income taxes in income tax expense/benefit. As REMA isa part of the consolidated income tax returns of Reliant Energy, it could be subjectto additional taxes. REMA evaluates the need for contingent tax liabilities ona quarterly basis and records any estimable and probable tax exposures in itsresults of operations. In addition, REMA discloses any material taxcontingencies as to which we believe there is a reasonable possibility of afuture tax assessment.

As of December 31,2006 and 2005, REMA does not have any accrued contingent federal or state taxliabilities.

***(e)***            Changes in Accountingfor Income Taxes or Tax Laws.

The FASB issued guidance clarifyingthe accounting for uncertainty in income taxes. Pursuant to the new guidance,which is effective for REMA in 2007, tax benefits are only recorded forpositions where it is more-likely-than-not that reported tax return treatmentwould be sustained if audited by relevant taxing authorities. Additional rules areprovided for interest, penalties, changes in benefit recognition and otherrelated matters. REMA is currently in the process of determining the impact of thisadoption. Based on its latest estimates, REMA does not expect the adoption tohave a material impact on its consolidated financial statements.

**(9)**          Commitments

***(a)***          LeaseCommitments.

REMA entered into sale-leaseback transactions, underoperating leases that are non-recourse to Reliant Energy. REMA leases 16.45%and 16.67% interests in the Conemaugh and Keystone facilities, respectively. Theleases expire in 2034 and REMA expects to make payments through 2029. REMA alsoleases a 100% interest in the Shawville facility. This lease expires in 2026and REMA expects to make payments through that date. At the expiration of theseleases, there are several renewal options related to fair market value. REMALLC’s subsidiaries guarantee the lease obligations and REMA LLC has pledged theequity interests in these subsidiaries as collateral. Reliant Energy alsoprovides credit support for these lease obligations in the form of letters ofcredit. See note 6. During 2006, 2005 and 2004, REMA made lease paymentsunder these leases of $64 million, $75 million and $85 million, respectively. Asof December 31, 2006 and 2005, REMA has recorded a prepaid lease of $59million in current assets and $264 million and $259 million, respectively, inlong-term assets. REMA operates the Conemaugh and Keystone facilities underagreements that could terminate annually with one year’s notice and received 

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fees of $9 million during2006, 2005 and 2004. These fees, which are recorded in operation andmaintenance expense, are primarily to cover REMA’s administrative support costsof providing these services.

REMA’s ability to pay dividends or pay subordinatedobligations is restricted by conditions within the lease documents. As of December 31,2006, REMA was not limited by these restrictions.

*Cash Obligations UnderOperating Leases.*   REMA’s projected cashobligations under non-cancelable long-term operating leases as of December 31,2006 are (in thousands):

| 2007                 |   | $   | 65     |   |
|----------------------|--------|-----|--------|--------|
| 2008                 |   | 62  |   |
| 2009                 |   | 63  |   |
| 2010                 |   | 52  |   |
| 2011                 |   | 63  |   |
| 2012 and  thereafter |   | 819 |   |
| Total                |   | $   | 1,124  |   |

* *

*Operating Lease Expense.*   Operatinglease expense, including the amortization of deferred lease costs, was $60million during 2006, 2005 and 2004.

***(b)***           Guaranteesand Indemnifications.

*EquityPledged as Collateral to Reliant Energy.**  *REMA LLC’s equity is pledged ascollateral under certain of Reliant Energy’s credit and debt agreements, whichhave an outstanding balance of $2.8 billion as of December 31, 2006.

*Other.**  *REMA enters into contracts that includeindemnification and guarantee provisions. In general, REMA enters intocontracts with indemnities for matters such as breaches of representations andwarranties and covenants contained in the contract and/or against certainspecified liabilities. Examples of these contracts include asset salesagreements, service agreements and procurement agreements.

REMA is unable to estimateits maximum potential exposure under these provisions until an event triggeringpayment under these provisions occurs. REMA does not expect to make anymaterial payments under these provisions.

***(c)***            OtherCommitments.

*Property,Plant and Equipment Commitments.*   As of December 31,2006, REMA has contractual commitments to spend approximately $110 million onplant and equipment relating primarily to SO2 emissions reductions.

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*Fuel Supply Commitments.**  *REMA is a party to fuel supplycontracts of various quantities and durations that are not classified asderivative assets and liabilities. These contracts are not included in theconsolidated balance sheet as of December 31, 2006. Minimum purchasecommitment obligations under these agreements are as follows as of December 31,2006 (in millions):

| 2007                 |   | $   | 93     |   |
|----------------------|--------|-----|--------|--------|
| 2008                 |   | 67  |   |
| 2009                 |   | 61  |   |
| 2010                 |   | 31  |   |
| 2011                 |   | 27  |   |
| 2012 and  thereafter |   | 201 |   |
| Total                |   | $   | 480    | (1)    |

----

(1)             Ofthis amount, $77 million relates to contracts with variable pricing componentsfor which the prices were determined based on assumptions on escalations perthe contractual terms.

As of December 31,2006, the maximum remaining term under any individual fuel supply contract is14 years.

**(10)**   Contingencies

REMA is involved in a number of legal, environmentaland other matters before courts and governmental agencies, some of which mayinvolve substantial amounts. Unless otherwise noted, REMA cannot predict theoutcome of these matters.

*NewSource Review Matters.**  *TheUnited States Environmental Protection Agency (EPA) and various states areinvestigating compliance of coal-fueled electric generating stations with the “NewSource Review” requirements of the Clean Air Act. The EPA has agreed to shareinformation relating to its investigations with state environmental agencies. REMAis unable to predict the ultimate outcome of the EPA’s investigation. In November 2005,REMA received a notice of intent to sue pursuant to the Clean Air Act from thestate of New Jersey relating to one of its power plants located in Pennsylvania.The allegations relate to conduct that occurred prior to Reliant Energy’sownership of the power plant. If the state of New Jersey sues REMA and issuccessful, REMA could incur significant capital expenditures associated withthe implementation of emissions reductions on an accelerated basis and possiblepenalties. In February 2007, the state of New Jersey filed suit againstthe EPA to force a ruling on the petition filed by the state of New Jerseyrelating to renewal of an air permit for the plant.

*AshDisposal Site Closures.**  *REMA is responsible for environmental costs relatedto the future closures of five ash disposal sites. Based on REMA’s evaluationswith assistance from third-party consultants and engineers, REMA recorded theestimated discounted costs associated with these environmental liabilities aspart of its asset retirement obligations. See note 2(n).

*RemediationObligations.*   REMA is responsible forenvironmental costs related to site contamination investigations andremediation requirements at four power plants in New Jersey. Based on REMA’sevaluations with assistance from third-party consultants and engineers, REMArecorded the estimated liability for the remediation costs of $7 million as of December 31,2006 and 2005.

*Conemaugh Notice of Intentto Sue.**  *InFebruary 2007, Reliant Energy received notice of intent to sue fromPennEnvironment and the Sierra Club alleging that the Conemaugh plant is inviolation of its water discharge permit and related state and federal laws. TheConemaugh plant is jointly owned by REMA and seven other companies and isgoverned by a consent order agreement with the Pennsylvania Department ofEnvironmental Protection. Reliant Energy is confident that the Conemaugh planthas operated and will continue to operate in material compliance with thatagreement, its water discharge permit and related 

F-131

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state and federallaws. If PennEnvironment and the Sierra Club sue Reliant Energy and aresuccessful, REMA could incur significant capital expenditures associated withthe implementation of discharge reductions on an accelerated basis and possiblepenalties.

**(11)**   Settlementsand Other Charges

***Gain on Sale of Counterparty Claim.***

In June 2004, ReliantEnergy entered into a settlement agreement with Enron. The settlement agreementprovided for the dismissal of all pending litigation between Enron and ReliantEnergy and provided for certain allowed bankruptcy claims against Enron. In August 2004,Reliant Energy sold and assigned its claim to a third party. As REMA hadpreviously written off its net receivables and derivative assets from Enron,REMA recognized a $22 million gain upon the sale during the third quarter of2004.

**(12)**   EstimatedFair Value of Financial Instruments

The fair values of cashand cash equivalents, accounts receivable and payable and derivative assets andliabilities equal their carrying amounts.

**(13)**   Salesof Assets and Emission Allowances

REMA included the following in its results ofoperations through the date of sale.

Two hydropower plants sold for $42 million in April 2005.

*EmissionAllowances.*   Salesconsist of:

| ** ** | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| SO2(1)     |       |                   | $          | 74       | (2)        |     | $          | 100 | (3) |   | $ | 33 |   |   |
| NOx(4)     |       |                   | —     |     |       | 8        | (5)        |   | 11 |   |   |
|       |       |                   | $          | 74       |       |     | $          | 108 |   |   | $ | 44 |   |   |

----

(1)             Includessales to an affiliate during 2006, 2005 and 2004 of $73 million, $97 millionand $0, respectively.

(2)             Sold71,000 tons to an affiliate relating to 2006 through 2010 vintage years.

(3)             Sold133,000 tons (which includes 130,000 tons to an affiliate) relating to 2005through 2009 vintage years.

(4)             Includessales to an affiliate during 2006, 2005 and 2004 of $0, $3 million and $1million, respectively.

(5)             Sold 3,000 tons(which includes 1,000 tons to an affiliate) relating to 2005 vintage year.

*Summary of Gains and Losses.*

| ** **                                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(in millions)** | ** ** |
| Emission  allowances                                   |       |                   | $          | 71       |       |     | $          | 97 |   |   | $ | 14 |   |   |
| Hydropower plants                                      |       |                   | —     |     |       | 12       |       |   | — |   |   |
| Other, net                                             |       |                   | —     |     |       | 1        |       |   | 1 |   |   |
| Gains on sales of  assets and emission allowances, net |       |                   | $          | 71       |       |     | $          | 110 |   |   | $ | 15 |   |   |

 

F-132

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**Reportof Independent Registered Public Accounting Firm**

The Board of DirectorsOrion Power Holdings, Inc.:

We have audited theaccompanying consolidated balance sheet of Orion Power Holdings, Inc. andsubsidiaries (the Company), as of December 31, 2006, and the relatedconsolidated statements of operations, stockholder’s equity and comprehensiveincome (loss), and cash flows for the year then ended. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audit.

We conducted our audit inaccordance with the auditing standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The Company is not required tohave, nor were we engaged to perform, an audit of its internal control overfinancial reporting. Our audit included consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in circumstances, but not for the purpose of expressing an opinionon the effectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Orion Power Holdings, Inc.and subsidiaries as of December 31, 2006, and the results of theiroperations and their cash flows for the year then ended in conformity with U.S.generally accepted accounting principles.

Asdiscussed in note 7 to the consolidated financial statements, the Companychanged its accounting for defined benefit pension and other postretirementplans in 2006.
| KPMG LLP               |
|------------------------|
| Houston, Texas         |
| February 26, 2007 |

 

F-133

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors of Orion Power Holdings, Inc.and SubsidiariesHouston, Texas

We have audited the accompanying consolidated balancesheet of Orion Power Holdings, Inc. and subsidiaries (the “Company”), asof December 31, 2005, and the related consolidated statements ofoperations, stockholder’s equity and comprehensive income (loss), and cashflows for each of the two years in the period ended December 31, 2005. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the financial statements based onour audits.

We conducted our audits in accordance with theauditing standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In ouropinion, such consolidated financial statements present fairly, in all materialrespects, the financial position of Orion Power Holdings, Inc. andsubsidiaries at December 31, 2005, and the results of their operations andtheir cash flows for each of the two years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America.

| DELOITTE & TOUCHE LLP |
|--------------------------------|
| Houston, Texas                 |
| March 14, 2006            |

 

F-134

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**ORION POWER HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**(Thousands of Dollars,except per share amounts)

| ** **                                                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Revenues:**                                                                    |       |     |       |     |       |     |       |
| Revenues                                                                         |       | $        | 22,861     |     | $          | 91,919   |       | $ | 463,132 |   |
| Revenues—affiliates                                                         |       | 474,851  |       | 548,533  |       | 22,924   |       |
| Total                                                                            |       | 497,712  |       | 640,452  |       | 486,056  |       |
| **Expenses:**                                                                    |       |     |       |     |       |     |       |
| Fuel and purchased power                                                         |       | 222,358  |       | 186,912  |       | 175,733  |       |
| Fuel and purchased power—affiliates                                         |       | 2,427    |       | 68,272   |       | 66,466   |       |
| Operation and maintenance                                                        |       | 143,786  |       | 115,924  |       | 127,483  |       |
| Operation and maintenance—affiliates                                        |       | 35,924   |       | 43,500   |       | 29,001   |       |
| Taxes other than income taxes                                                    |       | 13,089   |       | 3,709    |       | 17,376   |       |
| General and administrative—primarily affiliates                             |       | 27,980   |       | 40,493   |       | 58,006   |       |
| Gains on sales of assets and emission allowances,  net—primarily affiliates |       | (66,964  | )          | (58,189  | )          | (2,355   | )          |
| Depreciation and amortization                                                    |       | 100,107  |       | 126,416  |       | 114,289  |       |
| Total operating expenses                                                         |       | 478,707  |       | 527,037  |       | 585,999  |       |
| **Operating  Income (Loss)**                                                     |       | 19,005   |       | 113,415  |       | (99,943  | )          |
| **Other Income (Expense):**                                                      |       |     |       |     |       |     |       |
| Other, net                                                                       |       | —   |       | 42       |       | 308      |       |
| Interest expense                                                                 |       | (38,472  | )          | (39,949  | )          | (40,781  | )          |
| Interest expense—affiliates                                                 |       | (1,351   | )          | (908     | )          | (1,309   | )          |
| Interest income—primarily affiliates                                        |       | 8,956    |       | 382      |       | 1,875    |       |
| Total other expense                                                              |       | (30,867  | )          | (40,433  | )          | (39,907  | )          |
| **Income  (Loss) from Continuing Operations Before Income Taxes**                |       | (11,862  | )          | 72,982   |       | (139,850 | )          |
| Income tax expense (benefit)                                                     |       | (31,135  | )          | 24,385   |       | (53,008  | )          |
| **Income  (Loss) from Continuing Operations**                                    |       | 19,273   |       | 48,597   |       | (86,842  | )          |
| Income (loss) from discontinued operations                                       |       | 5,375    |       | (86,096  | )          | 89,299   |       |
| **Income  (Loss) Before Cumulative Effect of Accounting Changes**                |       | 24,648   |       | (37,499  | )          | 2,457    |       |
| Cumulative effect of accounting changes, net of tax                              |       | —   |       | (198     | )          | —   |       |
| **Net Income (Loss)**                                                            |       | $        | 24,648     |     | $          | (37,697  | )          | $ | 2,457 |   |

 

See Notes to the Consolidated Financial Statements

F-135

----

**ORION POWER HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Thousands of Dollars, except per share amounts)**

| ** **                                                                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                 | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                 |       |                  |       |   |   |
| **Current Assets:**                                                                        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                                                 |       | $                     | 81         |   | $ | 13,752 |   |
| Accounts  receivable, principally customer, net of allowance of $0 and $6                  |       | 1,664                 |       | 4,079 |   |
| Receivables from  affiliates, net                                                          |       | 33,046                |       | 40,234 |   |
| State income taxes  receivable                                                             |       | 10,084                |       | 18,570 |   |
| Inventory                                                                                  |       | 50,289                |       | 56,464 |   |
| Derivative assets                                                                          |       | 5,086                 |       | 22,118 |   |
| Accumulated  deferred income taxes                                                         |       | 7,359                 |       | 585 |   |
| Collateral posted  under agreement with Reliant Energy, Inc.                          |       | 3,278                 |       | — |   |
| Prepayments and  other current assets                                                      |       | 1,304                 |       | 3,477 |   |
| Current assets of  discontinued operations                                                 |       | 2,460                 |       | 157,059 |   |
| Total current  assets                                                                      |       | 114,651               |       | 316,338 |   |
| **Property,  Plant and Equipment, net**                                                    |       | 1,587,885             |       | 1,613,264 |   |
| **Other Assets:**                                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| Goodwill                                                                                   |       | 175,520               |       | 180,520 |   |
| Other intangibles,  net                                                                    |       | 183,163               |       | 209,802 |   |
| Derivative assets                                                                          |       | —                |       | 6,701 |   |
| Long-term note  receivable from Reliant Energy, Inc.                                  |       | 92,200                |       | — |   |
| Long-term  collateral posted under agreement with Reliant Energy, Inc.                |       | 12,326                |       | — |   |
| Other                                                                                      |       | 59,615                |       | 64,888 |   |
| Long-term assets  of discontinued operations                                               |       | —                |       | 872,650 |   |
| Total other assets                                                                         |       | 522,824               |       | 1,334,561 |   |
| **Total  Assets**                                                                          |       | $                     | 2,225,360  |   | $ | 3,264,163 |   |
| **LIABILITIES  AND STOCKHOLDER’S EQUITY**                                             |       |                  |       |   |   |
| **Current Liabilities:**                                                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current portion of  long-term debt                                                         |       | $                     | 10,505     |   | $ | 9,703 |   |
| Accounts payable,  principally trade                                                       |       | 29,594                |       | 19,533 |   |
| Accrued interest payable                                                                   |       | 7,996                 |       | 8,000 |   |
| Accumulated  deferred income taxes                                                         |       | 623                   |       | 7,320 |   |
| Other taxes  payable                                                                       |       | 10,910                |       | 10,679 |   |
| Other                                                                                      |       | 8,712                 |       | 8,110 |   |
| Current  liabilities of discontinued operations                                            |       | 3,286                 |       | 49,069 |   |
| Total current  liabilities                                                                 |       | 71,626                |       | 112,414 |   |
| **Other Liabilities:**                                                                     | ** ** | ** **            | ** ** | ** ** | ** ** |
| Accumulated  deferred income taxes                                                         |       | 178,042               |       | 174,545 |   |
| Benefit  obligations                                                                       |       | 58,100                |       | 40,780 |   |
| Taxes payable to  Reliant Energy, Inc.                                                |       | 84,310                |       | — |   |
| Other                                                                                      |       | 11,043                |       | 12,794 |   |
| Long-term  liabilities of discontinued operations                                          |       | —                |       | 853,997 |   |
| Total other  liabilities                                                                   |       | 331,495               |       | 1,082,116 |   |
| **Revolving  Credit Facility with Reliant Energy, Inc.**                              |       | 12,683                |       | — |   |
| **Long-term  Debt**                                                                        |       | 428,343               |       | 439,057 |   |
| **Commitments and Contingencies**                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Stockholder’s Equity:**                                                             | ** ** | ** **            | ** ** | ** ** | ** ** |
| Common stock; par  value $1.00 per share (1,000 shares authorized, issued and outstanding) |       | 1                     |       | 1 |   |
| Additional paid-in  capital                                                                |       | 2,211,139             |       | 2,460,551 |   |
| Retained deficit                                                                           |       | (823,693              | )          | (848,341 | ) |
| Accumulated other  comprehensive income (loss)                                             |       | (6,234                | )          | 18,700 |   |
| Accumulated other  comprehensive loss of discontinued operations                           |       | —                |       | (335 | ) |
| Total  stockholder’s equity                                                           |       | 1,381,213             |       | 1,630,576 |   |
| **Total  Liabilities and Stockholder’s Equity**                                       |       | $                     | 2,225,360  |   | $ | 3,264,163 |   |

 

See Notes to the Consolidated Financial Statements

F-136

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**ORION POWER HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Thousands of Dollars)**

| ** **                                                                                                                           | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|
| **Cash Flows from Operating Activities:**                                                                                            |       |       |       |     |       |       |       |
| Net income (loss)                                                                                                                    |       | $          | 24,648     |     | $          | (37,697    | )          | $ | 2,457 |   |
| (Income) loss from  discontinued operations                                                                                          |       | (5,375     | )          | 86,096   |       | (89,299    | )          |
| Net income (loss)  from continuing operations and cumulative effect of accounting changes                                            |       | 19,273     |       | 48,399   |       | (86,842    | )          |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities:                                  |       |       |       |     |       |       |       |
| Cumulative effect  of accounting changes                                                                                             |       | —     |       | 198      |       | —     |       |
| Depreciation and  amortization                                                                                                       |       | 100,107    |       | 126,416  |       | 114,289    |       |
| Deferred income  taxes                                                                                                               |       | (27,474    | )          | 44,581   |       | (196,491   | )          |
| Non-cash equity  contribution of operation and maintenance and general and administrative  costs from Reliant Energy, Inc., net |       | —     |       | 56,890   |       | 66,835     |       |
| Net unrealized  (gains) losses on derivatives                                                                                        |       | (1,108     | )          | 4,846    |       | 90         |       |
| Net amortization  of contractual rights and obligations                                                                              |       | (2,218     | )          | (8,177   | )          | (29,082    | )          |
| Amortization of  revaluation of acquired debt                                                                                        |       | (9,721     | )          | (8,921   | )          | (8,139     | )          |
| Gains on sales of  assets and emission allowances, net—primarily affiliates                                                     |       | (66,964    | )          | (58,189  | )          | (2,355     | )          |
| Non-cash federal  income tax contributions from (distributions to) Reliant  Energy, Inc., net                                   |       | —     |       | (26,361  | )          | 150,511    |       |
| Other, net                                                                                                                           |       | (658       | )          | 2,003    |       | 99         |       |
| Changes in other assets  and liabilities:                                                                                            |       |       |       |     |       |       |       |
| Accounts  receivable, net                                                                                                            |       | 2,415      |       | 48,996   |       | 6,222      |       |
| Inventory                                                                                                                            |       | 3,414      |       | (1,853   | )          | (13,786    | )          |
| Other current  assets                                                                                                                |       | 2,173      |       | (2,603   | )          | 2,826      |       |
| Other assets                                                                                                                         |       | 10,036     |       | 422      |       | (6,108     | )          |
| Accounts payable                                                                                                                     |       | 5,163      |       | 1,644    |       | (6,399     | )          |
| Payable  to/receivable from affiliates, net                                                                                          |       | 7,188      |       | (52,412  | )          | 12,435     |       |
| Collateral posted  under agreement with Reliant Energy, Inc.                                                                    |       | (15,604    | )          | —   |       | —     |       |
| Income taxes  payable/receivable                                                                                                     |       | 13,510     |       | 1,768    |       | 10,210     |       |
| Accrued interest                                                                                                                     |       | (4         | )          | —   |       | —     |       |
| Other current  liabilities                                                                                                           |       | 1,735      |       | (9,881   | )          | 5,648      |       |
| Other liabilities                                                                                                                    |       | 3,726      |       | (5,014   | )          | 10,519     |       |
| Net cash provided  by continuing operations from operating activities                                                                |       | 44,989     |       | 162,752  |       | 30,482     |       |
| Net cash provided  by (used in) discontinued operations from operating activities                                                    |       | (49,689    | )          | 171,800  |       | 72,440     |       |
| Net cash provided  by (used in) operating activities                                                                                 |       | (4,700     | )          | 334,552  |       | 102,922    |       |
| **Cash Flows from Investing Activities:**                                                                                            |       |       |       |     |       |       |       |
| Capital  expenditures                                                                                                                |       | (45,566    | )          | (16,334  | )          | (28,090    | )          |
| Proceeds from  sales of assets, net                                                                                                  |       | —     |       | 2,372    |       | —     |       |
| Proceeds from  sales of emission allowances                                                                                          |       | 1,134      |       | 8,554    |       | 9,792      |       |
| Proceeds from  sales of emission allowances—affiliates                                                                          |       | 69,320     |       | 56,519   |       | 1,700      |       |
| Purchases of  emission allowances                                                                                                    |       | —     |       | —   |       | (38,938    | )          |
| Purchases of  emission allowances—affiliates                                                                                    |       | —     |       | (1,998   | )          | —     |       |
| Restricted cash                                                                                                                      |       | —     |       | —   |       | 130,473    |       |
| Net cash provided  by continuing operations from investing activities                                                                |       | 24,888     |       | 49,113   |       | 74,937     |       |
| Net cash provided  by discontinued operations from investing activities                                                              |       | 967,566    |       | 79,101   |       | 911,227    |       |
| Net cash provided  by investing activities                                                                                           |       | 992,454    |       | 128,214  |       | 986,164    |       |
| **Cash Flows from Financing Activities:**                                                                                            |       |       |       |     |       |       |       |
| Distributions to  Reliant Energy, Inc.                                                                                          |       | (209,400   | )          | (340,000 | )          | (710,738   | )          |
| Changes in  revolving credit facility with Reliant Energy, Inc., net                                                            |       | 12,683     |       | (7,300   | )          | 7,300      |       |
| Loan to Reliant  Energy, Inc.                                                                                                   |       | (92,200    | )          | —   |       | —     |       |
| Payments of  long-term debt                                                                                                          |       | (191       | )          | —   |       | —     |       |
| Net cash used in  continuing operations from financing activities                                                                    |       | (289,108   | )          | (347,300 | )          | (703,438   | )          |
| Net cash used in  discontinued operations from financing activities                                                                  |       | (712,317   | )          | (110,183 | )          | (410,340   | )          |
| Net cash used in  financing activities                                                                                               |       | (1,001,425 | )          | (457,483 | )          | (1,113,778 | )          |
| **Net  Change in Cash and Cash Equivalents**                                                                                         |       | (13,671    | )          | 5,283    |       | (24,692    | )          |
| **Cash and  Cash Equivalents at Beginning of Period**                                                                                |       | 13,752     |       | 8,469    |       | 33,161     |       |
| **Cash and  Cash Equivalents at End of Period**                                                                                      |       | $          | 81         |     | $          | 13,752     |       | $ | 8,469 |   |
| **Supplemental Disclosure of Cash Flow  Information:**                                                                               |       |       |       |     |       |       |       |
| Cash Payments:                                                                                                                       |       |       |       |     |       |       |       |
| Interest paid (net  of amounts capitalized) to third parties for continuing operations                                               |       | $          | 48,360     |     | $          | 48,686     |       | $ | 48,840 |   |
| Income taxes paid  (net of income tax refunds received) for continuing operations                                                    |       | (17,022    | )          | 3,917    |       | (14,478    | )          |
| Non-cash Disclosure:                                                                                                                 |       |       |       |     |       |       |       |
| Contributions from  (distributions to) Reliant Energy, Inc., net for continuing operations                                      |       | (39,543    | )          | (51,471  | )          | 217,346    |       |
| Contributions from  (distributions to) Reliant Energy, Inc., net for discontinued operations                                    |       | —     |       | 30,468   |       | 81,603     |       |

 

See Notes to the Consolidated Financial Statements

F-137

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**ORION POWER HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY AND COMPREHENSIVE INCOME (LOSS)**(Thousands ofDollars)

| ** ** | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | **Accumulated Other Comprehensive Income (Loss)** | ** ** | **Discontinued**         | ** ** | ** **              | ** ** | ** **                        | ** ** |
|------------|------------|-----------------------|------------|-------------------------|------------|--------------|------------|-----------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Retained** | ** ** | **Deferred  Derivative  Gains**                                       | ** ** | **Actuarial  Net  Gain** | ** ** | **Net  Prior  Service** | ** ** | **Additional  Minimum  Benefits** | ** ** | **Total  Accumulated  Other  Comprehensive** | ** ** | **Operations  Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholder’s** | ** ** | **Comprehensive  Income** | ** ** |
| ** ** | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**  | ** ** | **Deficit**                                                           | ** ** | **(Losses)**             | ** ** | **(Loss)**              | ** ** | **Costs**                         | ** ** | **Liability** | ** ** | **Income (Loss)** | ** ** | **Loss** | ** ** | **Equity** | ** ** | **(Loss)** | ** ** |
|            |            |                       |            |                         |            |              |            |                                                                       |            |                          |            |                         |            |                                   |            |  |  |  |  |  |  |  |  |  |  |

| **Balance,  December 31, 2003**                                                                                     |   |   | 1,000  |   |   |   | $ 1 |   |   |   | $ 3,233,308 |   |   | $ (813,101 | )      |   | $ 16,066 |   |   |   | $ — |   |   |   | $ — |   |   |   | $   — |   |   |   | $ 16,066 |   |   |   | $ (20,797                | )      |   |   | $ 2,415,477 |   |   |   |                     |   |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|----------|--------|--------|--------|------------------|--------|--------|-----------------|--------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|---------------------------|--------|--------|--------|---------------|--------|--------|--------|-------------------------------|--------|--------|--------|------------------|--------|--------|--------|--------------------------|--------|--------|
| Net income                                                                                                               |   |   |   |   |   |   |     |   |   |   |             |   |   | 2,457           |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   | 2,457            |   |   |   | $   2,457 |   |   |
| Distributions to Reliant Energy, Inc., net                                                                          |   |   |   |   |   |   |     |   |   |   | (411,756         | )      |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   | (411,756         | )      |   |   |                     |   |   |
| Changes in minimum pension liability, net of tax of  $0                                                                  |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   | (147                      | )      |   |   | (147          | )      |   |   |                          |   |   |   | (147             | )      |   |   | (147                     | )      |   |
| Deferred gain from cash flow hedges, net of tax of  $50 million and $1 million                                           |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | 69,845        |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   | 69,845        |   |   |   | 992                           |   |   |   | 70,837           |   |   |   | 69,845                   |   |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges, net of tax of $29 million and $11 million |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | (40,864       | )      |   |   |          |   |   |   |          |   |   |   |                      |   |   |   | (40,864       | )      |   |   | 16,067                        |   |   |   | (24,797          | )      |   |   | (40,864                  | )      |   |
| Other comprehensive income from discontinued  operations                                                                 |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   |             |   |   |   | 17,059                   |   |   |
| Comprehensive income                                                                                                     |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   |             |   |   |   | $ 48,350            |   |   |
|                                                                                                                     |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   |             |   |   |   |                     |   |   |
| **Balance, December 31, 2004**                                                                                      |   |   | 1,000  |   |   |   | 1        |   |   |   | 2,821,552        |   |   | (810,644        | )      |   | 45,047        |   |   |   | —        |   |   |   | —        |   |   |   | (147                      | )      |   |   | 44,900        |   |   |   | (3,738                        | )      |   |   | 2,052,071        |   |   |   |                     |   |   |
| Net loss                                                                                                                 |   |   |   |   |   |   |     |   |   |   |             |   |   | (37,697         | )      |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   | (37,697          | )      |   |   | $ (37,697           | )      |   |
| Distributions to Reliant Energy, Inc., net                                                                          |   |   |   |   |   |   |     |   |   |   | (361,001         | )      |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   | (361,001         | )      |   |   |                     |   |   |
| Deferred gain from cash flow hedges, net of tax of $3  million                                                           |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | 4,925         |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   | 4,925         |   |   |   |                          |   |   |   | 4,925            |   |   |   | 4,925                    |   |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges, net of tax of $22 million and $2 million  |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | (31,125       | )      |   |   |          |   |   |   |          |   |   |   |                      |   |   |   | (31,125       | )      |   |   | 3,403                         |   |   |   | (27,722          | )      |   |   | (31,125                  | )      |   |
| Other comprehensive income from discontinued  operations                                                                 |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   |             |   |   |   | 3,403                    |   |   |
| Comprehensive loss                                                                                                       |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |          |   |   |   |          |   |   |   |          |   |   |   |                      |   |   |   |          |   |   |   |                          |   |   |   |             |   |   |   | $ (60,494           | )      |   |
| **Balance,  December 31, 2005**                                                                                     |   |   | 1,000  |   |   |   | $ 1 |   |   |   | $ 2,460,551 |   |   | $ (848,341 | )      |   | $ 18,847 |   |   |   | $ — |   |   |   | $ — |   |   |   | $ (147               | )      |   |   | $ 18,700 |   |   |   | $    (335 | )      |   |   | $ 1,630,576 |   |   |   |                     |   |   |

 

F-138

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**ORION POWER HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY AND COMPREHENSIVE INCOME (LOSS)(Continued)**(Thousands ofDollars)

| ** ** | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **  | ** ** | **Accumulated Other Comprehensive Income (Loss)** | ** ** | **Discontinued** | ** ** | ** **   | ** ** | ** **        | ** ** |
|------------|------------|------------------|------------|-------------|------------|----------------|------------|-------------|------------|-----------------------------------------------------------------------|------------|------------------|------------|--------------|------------|-------------------|------------|
| ** ** | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **  | ** ** | ** **                                                            | ** ** | ** **       | ** ** | ** **   | ** ** | ** **        | ** ** | **Total** | ** ** | **Operations** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** ** | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **  | ** ** | **Deferred**                                                          | ** ** | **Actuarial**    | ** ** | **Net**      | ** ** | **Additional**    | ** ** | **Accumulated** | ** ** | **Accumulated** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** ** | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **  | ** ** | **Derivative**                                                        | ** ** | **Net**          | ** ** | **Prior**    | ** ** | **Minimum**       | ** ** | **Other** | ** ** | **Other** | ** ** | **Total** | ** ** | **Comprehensive** | ** ** |
| ** ** | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Retained**   | ** ** | **Gains**   | ** ** | **Gain**                                                              | ** ** | **Service**      | ** ** | **Benefits** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Stockholder’s** | ** ** | **Income** | ** ** |
| ** ** | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Deficit** | ** ** | **(Losses)**                                                          | ** ** | **(Loss)**       | ** ** | **Costs**    | ** ** | **Liability**     | ** ** | **Income (Loss)** | ** ** | **Loss** | ** ** | **Equity** | ** ** | **(Loss)** | ** ** |

| **Balance, December 31, 2005**                                                                                  |   |   | 1,000  |   |   |   | $ 1 |   |   |   | $ 2,460,551 |   |   | $ (848,341 | )      |   | $ 18,847            |   |   |   | $      — |   |   | $      — |   |   | $  (147                           | )      |   |   | $ 18,700 |   |   |   | $ (335               | )      |   |   | $ 1,630,576 |   |   |   |                     |   |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|----------|--------|--------|--------|------------------|--------|--------|-----------------|--------|--------|--------------------------|--------|--------|--------|---------------------------------------------|--------|--------|---------------------------------------------|--------|--------|---------------------------------------------|--------|--------|--------|---------------|--------|--------|--------|---------------------------|--------|--------|--------|------------------|--------|--------|--------|--------------------------|--------|--------|
| Net income                                                                                                           |   |   |   |   |   |   |     |   |   |   |             |   |   | 24,648          |   |   |                     |   |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   |          |   |   |   |                      |   |   |   | 24,648           |   |   |   | $ 24,648            |   |   |
| Distributions to Reliant Energy, Inc., net                                                                      |   |   |   |   |   |   |     |   |   |   | (249,412         | )      |   |            |   |   |                     |   |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   |          |   |   |   |                      |   |   |   | (249,412         | )      |   |   |                     |   |   |
| Changes in minimum pension liability, net of tax of  $1 million                                                      |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |                     |   |   |   |                                        |   |   |                                        |   |   | (2,029                                      | )      |   |   | (2,029        | )      |   |   |                      |   |   |   | (2,029           | )      |   |   | (2,029                   | )      |   |
| Deferred loss from cash flow hedges, net of tax of  $3 million                                                  |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | (4,334                   | )      |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   | (4,334        | )      |   |   |                      |   |   |   | (4,334           | )      |   |   | (4,334                   | )      |   |
| Reclassification of net deferred (gain) loss from  cash flow hedges, net of tax of $8 million $0                |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   | (11,802                  | )      |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   | (11,802       | )      |   |   | 335                       |   |   |   | (11,467          | )      |   |   | (11,802                  | )      |   |
| Other comprehensive income from  discontinued operations                                                             |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |                     |   |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   |          |   |   |   |                      |   |   |   |             |   |   |   | 335                      |   |   |
| Adjustment to initially apply FASB Statement  No. 158, net of tax of $4 million, $2 million and $1 million |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |                     |   |   |   | (5,566                                      | )      |   | (3,379                                      | )      |   | 2,176                                       |   |   |   | (6,769        | )      |   |   |                      |   |   |   | (6,769           | )      |   |   |                     |   |   |
| Comprehensive income                                                                                                 |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |                     |   |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   |          |   |   |   |                      |   |   |   |             |   |   |   | $   6,818 |   |   |
| **Balance,  December 31, 2006**                                                                                 |   |   | 1,000  |   |   |   | $ 1 |   |   |   | $ 2,211,139 |   |   | $ (823,693 | )      |   | $   2,711 |   |   |   | $ (5,566                               | )      |   | $ (3,379                               | )      |   | $      — |   |   |   | $ (6,234 | )      |   |   | $   — |   |   |   | $ 1,381,213 |   |   |   |                     |   |   |
| ** **                                                                                                           |   |   |   |   |   |   |     |   |   |   |             |   |   |            |   |   |                     |   |   |   |                                        |   |   |                                        |   |   |                                        |   |   |   |          |   |   |   |                      |   |   |   |             |   |   |   |                     |   |   |

 

See Notes to the Consolidated Financial Statements

F-139

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**ORION POWERHOLDINGS, INC. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(1)**          Backgroundand Basis of Presentation

*Background.**  *“Orion Power Holdings” refers toOrion Power Holdings, Inc., a Delaware corporation. “Orion Power” refersto Orion Power Holdings and its consolidated subsidiaries. “Reliant Energy”refers to Reliant Energy, Inc. and its consolidated subsidiaries. OrionPower owns and operateselectric generation facilities in Ohio and Pennsylvania with an aggregategenerating capacity of 2,675 megawatts (MW) as of December 31, 2006. OrionPower typically sells its wholesale products to independent system operators,regulated utilities, municipalities, energy supply companies (including ReliantEnergy), cooperatives and retail “load” or customer aggregators.

On February 19, 2002, Reliant Energy acquiredOrion Power through a merger.

*Basis of Presentation.**  *These consolidated statementsinclude all revenues and costs directly attributable to Orion Power includingcosts for facilities and costs for functions and services performed by ReliantEnergy and charged to Orion Power. All significant intercompany transactionshave been eliminated. Orion Power has reclassified some amounts on the December 31,2005 consolidated balance sheet to conform to the 2006 presentation.

**(2)**          Summaryof Significant Accounting Policies

***(a)***          Useof Estimates and Market Risk and Uncertainties.

Management makesestimates and assumptions to prepare financial statements in conformity withaccounting principles generally accepted in the United States of America (GAAP)that affect:

·       thereported amount of assets, liabilities and equity,

·       thereported amounts of revenues and expenses and

·       disclosureof contingent assets and liabilities at the date of the financial statements.

Orion Power’s critical accounting estimates include: (a) goodwill,(b) property, plant and equipment, (c) derivative assets andliabilities and (d) deferred tax assets, valuation allowances and taxliabilities. Actual results could differ from the estimates.

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OrionPower is subject to various risks inherent in doing business. Seenotes 2(c), 2(d), 2(e), 2(h), 2(o), 4, 5, 6, 7, 8, 9 and 10.

***(b)***           Principlesof Consolidation.

OrionPower Holdings includes its accounts and those of its wholly-owned subsidiariesin the consolidated financial statements.

***(c)***            Revenues.

OrionPower records gross revenues from the sale of electricity and other energyservices under the accrual method. Electric power and other energy services aresold at market-based prices through existing power exchanges, related partyaffiliates or through third party contracts. Energy sales and services thathave been delivered but not billed by period-end are estimated.

***(d)***           Derivativesand Hedging Activities.

Orion Power accounts for its derivatives instrumentsand hedging activities in accordance with SFAS No. 133, “Accountingfor Derivatives Instruments and Hedging Activities,” as amended (SFAS No. 133).

For Orion Power’s hedging activities, it uses bothderivative and non-derivative contracts that provide for settlement in cash orby delivery of a commodity. The primary types of derivative instruments OrionPower uses are forwards, futures, swaps and options. Orion Power accounts forits derivatives under one of three accounting methods (cash flow hedge,mark-to-market or accrual accounting (under the normal purchase/normal saleexception)) based on facts and circumstances. The fair values of derivativeactivities are determined by (a) prices actively quoted, (b) pricesprovided by other external sources or (c) prices based on models and othervaluation methods.

If certain conditions are met, a derivative instrumentmay be designated as a cash flow hedge. A derivative is recognized at fairvalue in the balance sheet whether or not it is designated as a hedge, exceptfor derivative contracts designated as normal purchase/normal sale exceptions,which are not in the consolidated balance sheet or results of operations priorto settlement resulting in accrual accounting treatment.

Derivatives designated as cash flow hedges must have ahigh correlation between price movements in the derivative and the hedged item.The changes in fair value of cash flow hedges are deferred in accumulated othercomprehensive income (loss), net of tax, to the extent the contracts areeffective as hedges, until the forecasted transactions affect earnings. At thetime the forecasted transactions affect earnings, Orion Power reclassifies theamounts in accumulated other comprehensive income (loss) into earnings. OrionPower records the ineffective portion of changes in fair value of cash flowhedges immediately into earnings. For all other derivatives, changes in fairvalue are recorded as unrealized gains or losses in its results of operations.

If and when an acceptable level of correlation nolonger exists, hedge accounting ceases and changes in fair value are recognizedin its results of operations. If it becomes probable that a forecastedtransaction will not occur, Orion Power immediately recognizes the relateddeferred gains or losses in its results of operations. The associated hedginginstrument is then marked to market through its results of operations for theremainder of the contract term unless a new hedging relationship isredesignated.

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Realizedgains and losses on derivatives contracts not held for trading purposes arereported either on a net or gross basis based on the relevant facts andcircumstances. Hedging transactions that do not physically flow are included inthe same caption as the items being hedged. A summary of Orion Power’sderivative activities and classification in its results of operations is:

| **Instrument**                                                    | ** ** | ** **                                                 | ** ** | **Purpose for Holding or  Issuing Instrument**(1) | ** ** | **Transactions that  Physically Flow**             | ** ** | **Transactions that  Financially Settle**(2) |
|-------------------------------------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------|
| Power futures, forward, swap  and option contracts                |       | Power sales Power  purchases                               |       | Revenues Fuel and  purchased power                |       | Revenues Revenues                                  |
| Natural gas and fuel futures, forward, swap and  option contracts |       | Natural gas and fuel  sales Natural gas and fuel purchases |       | Revenues Fuel and purchased  power                |       | Fuel and purchased power  Fuel and purchased power |

----

(1)             Thepurpose for holding or issuing is not impacted by the accounting method electedfor each instrument.

(2)             Includesclassification for mark-to-market derivatives and amounts reclassified fromaccumulated other comprehensive income (loss) related to cash flow hedges.

In addition to market risk, Orion Power is exposed tocredit and operational risk. Reliant Energyhas a risk control framework, to which Orion Power is subject, to manage theserisks, which include:  (a) measuring and monitoring these risks,(b) review and approval of new transactions relative to theserisks, (c) transaction validation and (d) portfolio valuation andreporting. Orion Power uses mark-to-market valuation, value-at-risk and othermetrics in monitoring and measuring risk. Reliant Energy’s risk controlframework includes a variety of separatebut complementary processes, which involve commercial and senior management andReliant Energy’s Board of Directors. See note 2(e) for furtherdiscussion of Orion Power’s credit policy.

Effective September 1,2006, Orion Power de-designated certain cash flow hedges of coalcontracts and either began utilizing the mark-to-market method ofaccounting or elected the normal purchase/normal sale exception.

*Set-off of DerivativeAssets and Liabilities.**  *Wherederivative instruments are subject to a master netting agreement and theaccounting criteria to offset are met, Orion Power presents its derivativeassets and liabilities on a net basis. Derivative assets/liabilities andaccounts receivable/payable are presented and set-off separately in theconsolidated balance sheets although in most cases contracts permit the set-offof derivative assets/liabilities and accounts receivable/payable with a givencounterparty.

***(e)***            CreditRisk.

Orion Power has a credit policy that governs themanagement of credit risk, including the establishment of counterparty creditlimits and specific transaction approvals. Credit risk is monitored daily andthe financial condition of counterparties is reviewed periodically. Orion Powertries to mitigate credit risk by entering into contracts that permit nettingand allow it to terminate upon the occurrence of certain events of default. OrionPower measures credit risk as the replacement cost for its derivative positionsplus amounts owed for settled transactions.

OrionPower’s credit exposure is based on itsderivative assets and accounts receivable from counterparties, after takinginto consideration netting within each contract and any master nettingcontracts with counterparties. As of December 31, 2006, onenon-investment grade counterparty 

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represented 100% ($4 million) of Orion Power’s creditexposure. As of December 31, 2005, three non-investment gradecounterparties represented 93% ($32 million) of Orion Power’s credit exposure.

***(f)***             CustomerConcentration.

Nocustomer contributed in excess of 10% of the consolidated revenues during 2006or 2005. The following table represents third party customers who contributedin excess of 10% of the consolidated revenues for 2004 (in millions, exceptpercentages):

| ** **              | ** ** | **2004**   | ** ** |
|-------------------------|------------|------------|------------|
| **Customer**            | ** ** | ** ** | ** ** | **Revenue** | ** ** | **Percentage of Total  Revenue** | ** ** |
| Duquesne Light  Company |       |       | $          | 378 |   |   |   | 78 | % |   |
|                         |            |            |            |  |  |  |  |  |  |  |  |  |

 

Accountsreceivable from third parties was only $2 million as of December 31, 2006.The following table represents accounts receivable balances from third partycustomers in excess of 10% of the total consolidated accounts receivablebalance and the related percentages as of December 31, 2005 (in millions,except percentages):

| ** **                 | ** ** | **December 31, 2005** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| **Customer**               | ** ** | ** **                      | ** ** | **Accounts Receivable  Balance** | ** ** | **Percentage of Total  Accounts Receivable** | ** ** |
| Duquesne Light  Company    |       |                            | $          | 1 |   |   |   | 23 | % |   |
| Exelon Generating  Company |       |                            | 1          |   |   |   | 33 | % |   |
|                            |            |                                 |            |  |  |  |  |  |  |  |  |  |

 

Seenote 3 for transactions with affiliates.

***(g)***           Generaland Administrative Expenses—Primarily Affiliates.

Generaland administrative expenses from affiliates include, among other items, (a) sellingand marketing, (b) bad debt expense, (c) financial services, (d) legalcosts, (e) regulatory costs and (f) certain benefit costs. Seenote 3.

***(h)***          Property,Plant and Equipment and Depreciation Expense.

OrionPower computes depreciation using the straight-line method based on estimateduseful lives. Depreciation expense was $76 million, $95 million and $78 millionduring 2006, 2005 and 2004, respectively.

| ** **                          | ** ** | **Estimated Useful** | ** **   | **December 31,**  | ** ** |
|-------------------------------------|------------|---------------------------|--------------|------------------------|------------|
| ** **                          | ** ** | **Lives (Years)**    | ** **   | **2006**               | ** ** | **2005** | ** ** |
| ** **                          | ** ** | ** **                | ** **   | **(in millions)** | ** ** |
| Electric  generation facilities     |       |                      | 20 – 32 |                   |       | $ | 1,783 |   | $ | 1,757 |   |
| Land improvements                   |       |                      | 20 – 32 |                   |       | 97 |   | 96 |   |
| Other                               |       |                      | 3 – 10  |                   |       | 9 |   | 8 |   |
| Land                                |       |                      |         |                   |       | 12 |   | 12 |   |
| Assets under  construction          |       |                      |         |                   |       | 28 |   | 8 |   |
| Total                               |       |                      |         |                   |       | 1,929 |   | 1,881 |   |
| Accumulated  depreciation           |       |                      |         |                   |       | (341 | ) | (268 | ) |
| Property, plant  and equipment, net |       |                      |         |                   |       | $ | 1,588 |   | $ | 1,613 |   |

 

Orion Power periodically evaluates property, plant andequipment for impairment when events or circumstances indicate that the carryingvalue of these assets may not be recoverable. The evaluation is 

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highly dependent on theunderlying assumptions of related cash flows. Orion Power recorded no materialproperty, plant and equipment impairments during 2006, 2005 and 2004.

In thefuture, Orion Power could recognize impairments if its wholesale energy marketoutlook changes negatively. In addition, Orion Power’s ongoing evaluation ofits business could result in decisions to mothball, retire or dispose ofadditional generation assets, any of which could result in impairment charges.

***(i)***             IntangibleAssets and Amortization Expense.

*Goodwill.*   OrionPower performs its goodwill impairment test annually on April 1 and whenevents or changes in circumstances indicate that the carrying value may not berecoverable. During 2004, the annual impairment test date was November 1.

*Other Intangibles.*   OrionPower recognizes specifically identifiable intangible assets, includingemission allowances and contractual rights, when specific rights and contractsare acquired. Orion Power has no intangible assets with indefinite livesrecorded as of December 31, 2006 and 2005.

***(j)***              IncomeTaxes.

*Federal.**  *Orion Power is included in the consolidated federalincome tax returns of Reliant Energy and calculates its income tax provision ona separate return basis, whereby Reliant Energy pays all federal income taxeson Orion Power’s behalf and is entitled to any related tax savings. Thedifference between Orion Power’s current federal income tax expense or benefit,as calculated on a separate return basis, and related amounts paid to/receivedfrom Reliant Energy, if any, were recorded in Orion Power’s financial statementsas adjustments to additional paid-in capital. Reliant Energy changed itsfunding policy in late December 2006 and these differences are recorded to (a) incometaxes payable to Reliant Energy, Inc. if Orion Power has cumulativetaxable income on a separate return basis or (b) deferred tax assets ifOrion Power has cumulative taxable losses on a separate return basis. Deferredfederal income taxes reflected on Orion Power’s consolidated balance sheet willultimately be settled with Reliant Energy. See notes 3 and 11.

*State.**  *Orion Power is included in the consolidated stateincome tax returns of Reliant Energy. It calculates its state provision,related payables or receivables and deferred state income taxes on a separatereturn basis and settles the related assets and liabilities directly with thegovernmental entity. See note 11.

***(k)***           Cashand Cash Equivalents.

Orion Power records allhighly liquid short-term investments with maturities of three months or less ascash equivalents.

***(l)***              RestrictedCash.

Restricted cash includescash at certain subsidiaries, the distribution or transfer of which isrestricted by financing and other agreements.

***(m)***       Allowancefor Doubtful Accounts.

Orion Power accrues anallowance for doubtful accounts based on estimates of uncollectible revenues byanalyzing counterparty credit ratings, historical collections, accountsreceivable agings and other factors. Orion Power writes-off accounts receivablebalances against the allowance for doubtful accounts when it determines areceivable is uncollectible.

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***(n)***          Inventory.

OrionPower values fuel inventories at the lower of average cost or market. OrionPower removes these inventories as they are used in the production ofelectricity. Orion Power values materials and supplies at average cost. OrionPower removes these inventories when they are used for repairs, maintenance orcapital projects.

| ** **                                     | ** ** | **December 31,**  | ** ** |
|------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in millions)** | ** ** |
| Materials and  supplies, including spare parts |       |                   | $          | 19 |   |   |   | $ | 17 |   |   |
| Coal                                           |       |                   | 30         |   |   |   | 38 |   |   |
| Heating oil                                    |       |                   | 1          |   |   |   | 1 |   |   |
| Total inventory                                |       |                   | $          | 50 |   |   |   | $ | 56 |   |   |

 

***(o)***           EnvironmentalCosts.

OrionPower expenses environmental expenditures related to existing conditions thatdo not have future economic benefit. Orion Power capitalizes environmentalexpenditures for which there is a future economic benefit. Orion Power recordsliabilities for expected future costs, on an undiscounted basis, related toenvironmental assessments and/or remediation when they are probable and can bereasonably estimated. See note 10.

***(p)***           AssetRetirement Obligations.

Orion Power’s assetretirement obligations relate to future costs associated primarily with ashdisposal site closures. Orion Power’s asset retirement obligations were $4million and $5 million as of December 31, 2006 and 2005, respectively. Asof December 31, 2006, Orion Power has $3 million (classified in other long-termassets) on deposit with the state of Pennsylvania to guarantee its obligationrelated to future closures of ash disposal sites. See note 10.

During 2005, Orion Poweradopted an accounting interpretation relating to asset retirementobligations. This interpretation clarifies that an asset retirement obligation is unconditional even thoughuncertainty exists about the timing and/or method of settlement and requiresthat a liability be recognized if it can be reasonably estimated. Based onthis, Orion Power (a) recorded a cumulative effect of an accounting change,net of tax, of $198,000, (b) increased other long-term liabilities by$624,000, (c) increased property, plant and equipment by $317,000 and (d) decreaseddeferred income tax liabilities by $109,000.

***(q)***           Repairand Maintenance Costs for Power Generation Assets.

Orion Power recognizesrepair and maintenance costs as incurred.

***(r)***            NewAccountingPronouncement Not Yet Adopted—Fair Value.

The FASB issued Statementof Financial Accounting Standards No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair value inGAAP and expands disclosures about fair value measurements. This statement isapplicable for Orion Power beginning in 2008. It applies under other accountingpronouncements that require or permit fair value measurements. Orion Power doesnot expect the adoption, which will be assessed during 2007, to have asignificant impact on its consolidated financial statements.

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**(3)**          RelatedParty Transactions

These financial statementsinclude the impact of significant transactions between Orion Power and ReliantEnergy. The majority of these transactions involve the purchase or sale ofenergy, capacity, fuel, emission allowances or related services (includingtransportation, transmission and storage services) from or to Orion Power andallocations of costs to Orion Power for support services.

*Support and TechnicalServices.**  *ReliantEnergy provides commercial support, technical services and other corporateservices to Orion Power. Beginning January 1, 2005, Reliant Energyallocates certain support services costs to Orion Power based on Orion Power’sunderlying planned operating expenses relative to the underlying plannedoperating expenses of other entities to which Reliant Energy provides similarservices and also charges Orion Power for certain other services based on usage.During 2004, Reliant Energy allocated certain support services costs to OrionPower based on Orion Power’s direct labor costs relative to the direct laborcosts of other entities to which Reliant Energy provided similar services andalso charged Orion Power for certain other services based on usage. Managementbelieves these methods of allocation are reasonable and do not yieldsignificantly different results between the two methodologies. These allocationsand charges were not necessarily indicative of what would have been incurredhad Orion Power been an unaffiliated entity. During 2004 and 2005, Orion Poweronly paid a certain amount for these services. Beginning January 2006,Orion Power began paying all of the costs for these services.

Thefollowing details the amounts recorded as operation and maintenance—affiliatesand general and administrative—affiliates:

| ** **                                                                                    | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                    | ** ** | **(in millions)** | ** ** |
| Allocated or  charged by Reliant Energy                                                       |       |                   | $          | 64       |       |     |       | $ | 84 |   |   |   | $ | 87 |   |   |
| Unpaid allocations and  charges recorded as non-cash equity contributions from Reliant Energy |       |                   | —     |     |       |     | 57         |   |   |   | 67 |   |   |

 

*Commodity Procurement andMarketing.**  *OrionPower has sales to and purchases from Reliant Energy related to support andcommodity procurement and marketing services.

| ** **                                                            | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                            | ** ** | **(in millions)** | ** ** |
| Sales to Reliant  Energy under various commodity agreements(1)        |       | $                      | 475        |     | $          | 548      |       |   | $ | 23 |   |   |
| Purchases from  Reliant Energy under various commodity  agreements(2) |       | 7                      |       | 68       |       |     | 66         |   |   |
| Net sales of coal  to Reliant Energy(3)                               |       | 14                     |       | 12       |       |     | 9          |   |   |
| Gains on coal  sales to Reliant Energy(4)                             |       | 5                      |       | 6        |       |     | 4          |   |   |
| Sales of emission  allowances to Reliant Energy(5)                    |       | 69                     |       | 56       |       |     | 2          |   |   |
| Gains on emission  allowances sales to Reliant Energy(6)              |       | 66                     |       | 53       |       |     | —     |   |   |
|                                                                       |            |                        |            |          |            |          |            |  |  |  |  |  |

----

(1)             Recorded in revenue—affiliates.

(2)             Recorded in fuel andpurchased power—affiliates. Amounts for 2006 and 2005 include purchases from anaffiliate to meet requirements of contractual commitments.

(3)             Reflects market priceof coal at sale and purchase dates.

(4)             Recorded in fuel andpurchased power—affiliates.

(5)             Reflects price atwhich Reliant Energy sold the emission allowances to third-parties.

(6)             Recorded in gains onsales of assets and emission allowances, net. See note 12.

*Debt Obligations from/toReliant Energy.**  *InDecember 2004, Orion Power Midwest, L.P. (Orion MidWest) entered into thefollowing with Reliant Energy:  (a) tworelated-party notes for a total of 

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$400 millionand (b) a $75 million revolving credit facility. In December 2004,Orion Power New York, L.P. (Orion New York) entered into thefollowing with Reliant Energy:  (a) arelated-party note for $400 million and (b) a $50 million revolvingcredit facility. The Orion MidWest and Orion New York related party notes boreinterest at 6.5% per year and interest was payable monthly. The revolvingcredit facilities bore interest at London Inter Bank Offering Rate (LIBOR) plus2.875%. Some of these amounts were classified as discontinued operations. Seenote 13. In connection with the sales of the New York plants and theCeredo plant, the related party notes were paid off and the Orion New Yorkrevolving credit facility was terminated. The $75 million Orion MidWestrevolving credit facility matures in December 2007; however, ReliantEnergy plans to extend the maturity each December for 12 months from thatdate. In March 2006, Orion Power made a term loan to Reliant Energy for$92 million, which matures in 2010. The note bears interest at ten percent andinterest is payable monthly.

*Secured Revolving Letterof Credit Facility Agreement with Reliant Energy.*   ReliantEnergy posts letters of credit on behalf of Orion Power. As of December 31,2006 and 2005, Reliant Energy posted letters of credit totaling $16 million and$15 million, respectively, on behalf of Orion Power (for continuing operations).During September 2006, Reliant Energy and Orion Power entered into aSecured Revolving Letter of Credit Facility Agreement whereby Orion Power willprovide cash to Reliant Energy as collateral for letters of credit when issuedup to a maximum of $20 million. The agreement expires on April 30, 2010. Asletters of credit expire, the cash collateral will be returned to Orion Power. OrionPower will reimburse Reliant Energy for the costs of the letters of credit andwill earn interest income on the collateral posted. As of December 31,2006, Orion Power has provided cash collateral of $16 million to Reliant Energy.During 2006, the letters of credit costs, recorded in interest expense, and therelated interest income were insignificant.

*Distributionsto Reliant Energy.*

| ** **                                               | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                               | ** ** | **(in millions)** | ** ** |
| Orion Power  Holdings distributions to Reliant Energy(1) |       | $                      | (209       | )        | $          | (340     | )          | $ | (718 | ) |
|                                                          |            |                        |            |          |            |          |            |  |  |  |

----

(1)             Relatedto cash from Orion Power’s business operations or asset sales. Seenote 13(a).

*Income Taxes.*   Seediscussion in note 2(j) regarding Orion Power’s policy with respectto income taxes and the long-term taxes payable to Reliant Energy, Inc.

| ** **                                                                                                                                 | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                                 | ** ** | **(in millions)** | ** ** |
| Non-cash  contributions from (distributions to) Reliant Energy related to federal  income taxes for continuing and discontinued operations |       | $                      | (40        | )        | $          | (78      | )          | $ | 155 |   |
|                                                                                                                                            |            |                        |            |          |            |          |            |  |  |  |

 

**(4)**          IntangibleAssets

***(a)***          Goodwill.

The following table showsgoodwill and the changes (in millions):

| As of January 1, 2005              |   | $    | 291    |   |
|-----------------------------------------|--------|------|--------|--------|
| Transfer to discontinued  operations(1) |   | (102 | )      |
| Other(2)                                |   | (8   | )      |
| As of December 31, 2005            |   | 181  |   |
| Other(2)                                |   | (5   | )      |
| As  of December 31, 2006           |   | $    | 176    |   |

----

(1)             Goodwillrelated to the Ceredo plant ($10 million) and New York plants ($92 million).See note 13.

(2)             Goodwillrelated to revisions to the Orion Power purchase price allocation for taxmatters.

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As of December 31, 2006 and 2005, Orion Power had$39 million and $44 million, respectively, of goodwill that is deductible for United States income tax purposesin future periods.

*GoodwillImpairment Tests.  *Orion Power performedimpairment tests at the following dates: May 2004, November 2004, April 2005, August 2005, September 2005and April 2006 due to either asset sales or the annual impairment tests. Noimpairments were indicated in these tests.

*Estimationof Fair Value.**  *OrionPower estimates the fair value basedon a number of subjective factors, including: (a) appropriateweighting of valuation approaches (income approach, market approach andcomparable public company approach), (b) projections about future powergeneration margins, (c) estimates of future cost structure, (d) discountrates for estimated cash flows, (e) selection of peer group companies forthe public company approach, (f) required level of working capital, (g) assumedEBITDA multiple for terminal values and (h) time horizon of cash flowforecasts.

Managementhas determined the fair value with the assistance of an independent appraiser. Indetermining the fair value, Orion Power made the following key assumptions: (a) themarkets in which Orion Power operates will continue to be deregulated; (b) therewill be a recovery in electricity margins over time such that companiesbuilding new generation facilities can earn a reasonable rate of return ontheir investment and (c) the economics of future construction of newgeneration facilities will likely be driven by integrated utilities. As part ofthe process, Orion Power modeled all of its power generation facilities andthose of others in the regions in which Orion Power operates. The assumptionsfor each of the goodwill impairment tests during 2004, 2005 and 2006 were:

| Number of years  used in internal cash flow analysis                            |   | 15  |   |
|---------------------------------------------------------------------------------|--------|-----|--------|
| EBITDA(1) multiple for terminal  values (2004 and 2005 tests)              |   | 7.5 |   |
| EBITDA multiple  for terminal values (April 2006 test)(2)                  |   | 7.0 |   |
| Risk-adjusted  discount rate for estimated cash flows (2004 and 2005 tests)     |   | 9.0 | %      |
| Risk-adjusted  discount rate for estimated cash flows (April 2006 test)(3) |   | 9.5 | %      |
| Approximate  average anticipated growth rate for demand in power                |   | 2.0 | %      |
| Long-term after-tax  return on investment for new investment                    |   | 7.5 | %      |

----

(1)             Definedas earnings (loss) before interest expense, interest income, income taxes,depreciation and amortization expenses.

(2)             Decreaseprimarily due to market factors affecting public company comparisons.

(3)             Increase primarilydue to the increase in the small stock premium.

***(b)***           OtherIntangibles.

| ** **                    | ** ** | **Remaining  Weighted**               | ** ** | **December 31,**  | ** ** |
|-------------------------------|------------|---------------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **Average**                           | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **Amortization  Period (Years)** | ** ** | **Carrying  Amount**   | ** ** | **Accumulated  Amortization** | ** ** | **Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | **(in millions)** | ** ** |
| SO2 emission allowances(1)(2) |       |                                  | —     | (1)                    |       |   | $ | 134 |   |   |   | $ | (72 | ) |   |   | $ | 131 |   |   |   | $ | (62 | ) |   |
| NOx emission allowances(1)(3) |       |                                  | —     | (1)                    |       |   | 181 |   |   |   | (60 | ) |   |   | 185 |   |   |   | (45 | ) |   |
| Contractual rights(4)         |       |                                  | —     |                   |       |   | 4 |   |   |   | (4 | ) |   |   | 4 |   |   |   | (3 | ) |   |
| Total                         |       |                                  |       |                   |       |   | $ | 319 |   |   |   | $ | (136 | ) |   |   | $ | 320 |   |   |   | $ | (110 | ) |   |

----

(1)             SO2 is sulfur dioxide and NOx isnitrogen oxides. Amortized to amortization expense on a units-of-productionbasis. As of December 31, 2006, Orion Power has recorded (a) SO2 emission allowances through the 2039 vintageyear and (b) NOx emission allowances through the 2039 vintageyear.

(2)             During2006, 2005 and 2004, Orion Power purchased $0, $0 and $2 million, respectively,of SO2 emission allowances. See note 12 forsales.

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(3)             During2006, 2005 and 2004, Orion Power purchased $0, $2 million and $37 million,respectively, of NOx emission allowances. See note 12 forsales.

(4)             Amortizedto revenues and fuel and purchased power, as applicable, based on the estimatedrealization of the fair value established on the acquisition date over thecontractual lives.

Amortizationexpense consists of:

| ** **                    | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                    | ** ** | **(in millions)** | ** ** |
| Emission allowances           |       |                   | $          | 25       |       |     |       | $ | 31 |   |   |   | $ | 36 |   |   |
| Contractual rights(1)         |       |                   | $          | (1       | )          |     |       | $ | (1 | ) |   |   | $ | (1 | ) |   |
| Contractual obligations(1)(2) |       |                   | 3          |     |       |     | 9          |   |   |   | 30 |   |   |
| Net                           |       |                   | $          | 2        |       |     |       | $ | 8 |   |   |   | $ | 29 |   |   |

----

(1)             Amortizedto revenues and fuel and purchased power, as applicable, based on the estimatedrealization of the fair value established on the acquisition date over thecontractual lives.

(2)             Contractualobligations are in other long-term liabilities.

Estimatedamortization expense based on Orion Power’s intangibles as of December 31,2006 for the next five years is (in millions):

| 2007 |   | $ | 14     |   |
|------|--------|---|--------|--------|
| 2008 |   | 5 |   |
| 2009 |   | 6 |   |
| 2010 |   | 7 |   |
| 2011 |   | 7 |   |

 

**(5)**          Derivativesand Hedging Activities

Orion Power uses derivative instruments to manageoperational or market constraints and to increase return on its generationassets. The instruments used are fixed-price derivative contracts to hedge thevariability in future cash flows from forecasted sales of power and purchasesof fuel and power. Orion Power’s objective in entering into these fixed-pricederivatives is to fix the price for a portion of these transactions. Seenote 2(d).

Orion Power’s derivative portfolio, excluding cashflow hedges, is $1 million (net asset) and $0 as of December 31, 2006 and2005, respectively. Orion Power’s cash flow hedges are valued at $4 million(net asset) and $29 million (net asset) as of December 31, 2006 and 2005,respectively.

During 2006, 2005 and 2004, there was no hedge ineffectivenessrecognized from derivatives that are designated and qualify as cash flow hedges.In addition, no component of the derivatives’ gain or loss was excluded fromthe assessment of effectiveness for these periods. If it becomes probable thatan anticipated transaction will not occur, Orion Power realizes in net income(loss) the deferred gains and losses recognized in accumulated othercomprehensive loss. During 2006, 2005 and 2004, $0, $0 and $16 million,respectively, were recognized in the results of continuing operations as aresult of the discontinuance of cash flow hedges because it was probable thatthe forecasted transaction would not occur.

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As of December 31,2006 and 2005, the maximum length of time Orion Power is hedging its exposureto the variability in future cash flows that may result from changes incommodity prices was one year and two years, respectively. As of December 31,2006, Orion Power expects $3 million of accumulated other comprehensive incometo be reclassified into its results of operations during the next 12 months. However,the actual amount reclassified into earnings will vary from the amountsrecorded as of December 31, 2006, due to future changes in market prices.

**(6)**          Debt

Outstandingdebt to third parties:

| ** **                                              | ** ** | **December 31,**                                        | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                                     | ** ** | **2005** | ** ** |
| ** **                                              | ** ** | **Weighted  Average  Stated  Interest  Rate**(1)             | ** ** | **Long-term** | ** ** | **Current** | ** ** | **Weighted  Average  Stated  Interest  Rate**(1) | ** ** | **Long-term** | ** ** | **Current** | ** ** |
| ** **                                              | ** ** | **(in millions, except interest rates)** | ** ** |
| Orion Power  Holdings senior notes due 2010 (unsecured) |       |                                                         | 12.00      |   |   |   | $ | 400 |   |   |   | $ | — |   |   |   | 12.00 |   |   |   | $ | 400 |   |   |   | $ | — |   |   |
| Adjustment to  fair value of debt(2)                    |       |                                                         |       |   |   |   | 29 |   |   |   | 10 |   |   |   |   |   |   |   | 39 |   |   |   | 9 |   |   |
| Total debt(3)                                           |       |                                                         |       |   |   |   | $ | 429 |   |   |   | $ | 10 |   |   |   |   |   |   |   | $ | 439 |   |   |   | $ | 9 |   |   |

----

(1)             Theweighted average stated interest rates are as of December 31, 2006 or2005.

(2)             Debtacquired by Reliant Energy in the Orion Power acquisition was adjusted to fairmarket value as of the acquisition date. Included in interest expense isamortization of $9 million for valuation adjustments for debt for 2006, 2005and 2004.

(3)             Asof December 31, 2005, Orion Power classified $712 million as discontinuedoperations. See note 13.

Debtmaturities as of December 31, 2006 are (in millions):

| 2007                |   | $      | — |   |
|---------------------|--------|--------|--------|--------|
| 2008                |   | — |   |
| 2009                |   | — |   |
| 2010                |   | 400    |   |
| 2011                |   | — |   |
| 2012 and thereafter |   | — |   |
|                |   | $      | 400    |   |

 

*OrionPower Holdings Senior Notes.**  *These notes were recorded at a fair value of $479 million uponthe acquisition by Reliant Energy. The $79 million premium is being amortizedto interest expense over the life of the notes. The senior notes are senior unsecured obligations of Orion PowerHoldings, are not guaranteed by any of Orion Power Holdings’ subsidiaries andare non-recourse to Reliant Energy. The senior notes have covenants thatrestrict the ability of Orion Power Holdings and its subsidiaries to, amongother actions, (a) pay dividends or pay subordinated debt, (b) incurindebtedness or issue preferred stock, (c) make investments, (d) divestassets, (e) encumber its assets, (f) enter into transactions withaffiliates, (g) engage in unrelated businesses and (h) engage in saleand leaseback transactions. As of December 31, 2006, conditions underthese covenants were not met that allow the payment of dividends. As of December 31,2006, the adjusted net assets of Orion Power that are restricted to Reliant Energy, Inc.are $1.3 billion.

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Seenote 3 for debt transactions with affiliates.

**(7)**          BenefitPlans

***(a)***          Pensionand Postretirement Benefits.

*BenefitPlans.*   Orion Power sponsors multiple definedbenefit pension plans. Orion Power provides subsidized postretirement benefitsto some bargaining employees but generally does not provide them tonon-bargaining employees.

Effective December 31, 2006, Orion Power adoptedStatement of Financial Accounting Standards No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans.” Thisstatement requires recognition of the funded status of plans, measured as ofyear end. Orion Power already uses the required measurement date. The adoptiondid not have a material effect on any individual line item of Orion Power’sconsolidated balance sheet as of December 31, 2006. As of December 31,2006, $0.2 million and $0.4 million of net gain/loss and net prior servicecosts, respectively, in accumulated other comprehensive loss are expected to berecognized in net periodic benefit cost during the next 12 months. However, theactual amounts reclassified into earnings will vary from the amounts recordedas of December 31, 2006 due to future changes in market conditions.

OrionPower uses a December 31 measurement date for its plans. The benefitobligations and funded status are:

| ** **                          | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **                          | ** ** | **(in millions)** | ** ** |
| **Change in Benefit Obligation**    |       |                   |       |                             |       |   |   |   |   |   |   |   |   |
| Beginning of year                   |       | $                      | 52         |                             | $          | 41 |   |   | $ | 28 |   |   |   | $ | 24 |   |   |
| Service cost                        |       | 3                      |       | 2                                |       |   | — |   |   |   | 1 |   |   |
| Interest cost                       |       | 3                      |       | 2                                |       |   | 2 |   |   |   | 1 |   |   |
| Benefits paid                       |       | (1                     | )          | (1                               | )          |   | — |   |   |   | — |   |   |
| Actuarial loss                      |       | —                 |       | 8                                |       |   | 1 |   |   |   | 2 |   |   |
| End of year                         |       | $                      | 57         |                             | $          | 52 |   |   | $ | 31 |   |   |   | $ | 28 |   |   |
| **Change in Plan Assets**           |       |                   |       |                             |       |   |   |   |   |   |   |   |   |
| Beginning of year                   |       | $                      | 30         |                             | $          | 22 |   |   | $ | — |   |   |   | $ | — |   |   |
| Employer contributions              |       | 3                      |       | 8                                |       |   | — |   |   |   | — |   |   |
| Benefits paid                       |       | (1                     | )          | (1                               | )          |   | — |   |   |   | — |   |   |
| Actual investment return            |       | 4                      |       | 1                                |       |   | — |   |   |   | — |   |   |
| End of year                         |       | $                      | 36         |                             | $          | 30 |   |   | $ | — |   |   |   | $ | — |   |   |
| **Reconciliation of Funded Status** |       |                   |       |                             |       |   |   |   |   |   |   |   |   |
| Funded status                       |       | $                      | (21        | )                                | $          | (22 | ) |   | $ | (31 | ) |   |   | $ | (28 | ) |   |
| Unrecognized prior service cost     |       | —                 |       | 8                                |       |   | — |   |   |   | (2 | ) |   |
| Unrecognized actuarial loss         |       | —                 |       | 10                               |       |   | — |   |   |   | — |   |   |
| Net amount  recognized              |       | $                      | (21        | )                                | $          | (4 | ) |   | $ | (31 | ) |   |   | $ | (30 | ) |   |

 

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Amountsrecognized in the consolidated balance sheets are:

| ** **              | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|-------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **December 31,**  | ** ** | **December 31,**            | ** ** |
| ** **              | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **              | ** ** | **(in millions)** | ** ** |
| Current  liabilities    |       | $                      | —     |                             | $          | — |   |   | $ | (1 | ) |   |   | $ | — |   |   |
| Noncurrent  liabilities |       | (21                    | )          | (10                              | )          |   | (30 | ) |   |   | (30 | ) |   |
| Intangible asset        |       | —                 |       | 6                                |       |   | — |   |   |   | — |   |   |
| Net amount  recognized  |       | $                      | (21        | )                                | $          | (4 | ) |   | $ | (31 | ) |   |   | $ | (30 | ) |   |

 

The accumulated benefit obligation for all pensionplans was $51 million and $47 million as of December 31, 2006 and 2005,respectively. All pension plans have accumulated benefit obligations in excessof plan assets.

Netbenefit costs are:

| ** **                      | ** ** | **Pension**            | ** ** | **Postretirement Benefits** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2006**               | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(in millions)** | ** ** |
| Service cost                    |       |                   | $          | 3                                |       |   |   | $ | 2 |   |   |   | $ | 3 |   |   |   | $ | — |   |   |   | $ | 1 |   |   |   | $ | 1 |   |   |
| Interest cost                   |       |                   | 3          |                             |       |   | 2 |   |   |   | 2 |   |   |   | 2 |   |   |   | 1 |   |   |   | 1 |   |   |
| Expected return  on plan assets |       |                   | (2         | )                                |       |   | (1 | ) |   |   | (1 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net amortization                |       |                   | 1          |                             |       |   | 1 |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net benefit cost                |       |                   | $          | 5                                |       |   |   | $ | 4 |   |   |   | $ | 5 |   |   |   | $ | 2 |   |   |   | $ | 2 |   |   |   | $ | 2 |   |   |

 

*Assumptions.*   Thesignificant weighted average assumptions used to determine the benefitobligations are:

| ** **                               | ** ** | **Pension**           | ** ** | **Postretirement Benefits** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **December 31,** | ** ** | **December 31,**            | ** ** |
| ** **                               | ** ** | **2006**              | ** ** | **2005**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Discount rate                            |       | 5.75                  | %          | 5.75                             | %          |   | 5.75 | % |   |   | 5.75 | % |   |
| Rate of increase in  compensation levels |       | 3.0                   | %          | 3.0                              | %          |   | 3.0 | % |   |   | 3.0 | % |   |

 

Thesignificant weighted average assumptions used to determine the net benefitcosts are:

| ** **                                   | ** ** | **Pension** | ** ** | **Postretirement Benefits** | ** ** |
|----------------------------------------------|------------|-------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2006**    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Discount rate                                |       | 5.75        | %          | 5.75                             | %          | 6.25 | % | 5.75 | % | 5.75 | % | 6.25 | % |
| Rate of increase  in compensation levels     |       | 3.0         | %          | 3.0                              | %          | 4.5 | % | 3.0 | % | 3.0 | % | 4.5 | % |
| Expected long-term rate  of return on assets |       | 7.5         | %          | 7.5                              | %          | 7.5 | % | N/A |   | N/A |   | N/A |   |

 

As of December 31, 2006 and 2005, Orion Powerdeveloped its expected long-term rate of return on pension plan assets based onthird party models. These models consider expected inflation, current dividendyields, expected corporate earnings growth and risk premiums based on theexpected volatility of each asset category. Orion Power weights the expectedlong-term rates of return for each asset category to determine its overallexpected long-term rate of return on pension plan assets. In addition, OrionPower reviews peer data and historical returns.

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OrionPower’s assumed health care cost trend rates used to measure the expected costof benefits covered by its postretirement plan are:

| ** **                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                     |       | 9.0      | %          | 9.0      | %          | 9.75     | %          |
| Rate to which the  cost trend rate is assumed to gradually decline     |       | 5.5      | %          | 5.5      | %          | 5.5      | %          |
| Year that the rate  reaches the rate to which it is assumed to decline |       | 2015     |       | 2011     |       | 2011     |       |

 

Assumed health care cost trend rates can have asignificant effect on the amounts reported for Orion Power’s health care plans.A one-percentage-point change in assumed health care cost trend rates wouldhave the following effects as of December 31, 2006:

| ** **                                               | ** ** | **One-Percentage Point**                                | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                               | ** ** | **    Increase    ** | ** ** | **    Decrease    ** | ** ** |
| ** **                                               | ** ** | **(in millions)**                                       | ** ** |
| Effect on service  and interest cost                     |       |                                                         | $          | — |   |   |   | $ | — |   |   |
| Effect on accumulated  postretirement benefit obligation |       |                                                         | 5          |   |   |   | (4 | ) |   |

 

*Plan Assets.*   OrionPower’s pension weighted average asset allocations and target allocation byasset category are:

| ** **                       | ** ** | **Percentage of Plan Assets  as of December 31,**              | ** ** | **Target Allocation**                                                                   | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **       2006       ** | ** ** | **       2005       ** | ** ** | **2007** | ** ** |
| Domestic equity  securities      |       |                                                                                         | 50         | %                                                                                            |       |   | 50 | % |   |   | 50 | % |   |
| International  equity securities |       |                                                                                         | 11         |                                                                                         |       |   | 11 |   |   |   | 10 |   |   |
| Global equity  securities        |       |                                                                                         | 11         |                                                                                         |       |   | 10 |   |   |   | 10 |   |   |
| Debt securities                  |       |                                                                                         | 28         |                                                                                         |       |   | 29 |   |   |   | 30 |   |   |
| Total                            |       |                                                                                         | 100        | %                                                                                            |       |   | 100 | % |   |   | 100 | % |   |

 

Inmanaging the investments associated with the pension plans, Orion Power’sobjective is to exceed, on a net-of-fee basis, the rate of return of aperformance benchmark composed of the following indices:

| **Asset Class**             | ** ** | ** **                            | ** ** | **Index** | ** ** | **Weight** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-----------|------------|------------|------------|
| Domestic equity  securities      |       | Wilshire  5000 Index                  |       |      | 50         | %          |       |
| International  equity securities |       | MSCI  All Country World Ex-U.S. Index |       |      | 10         |       |       |
| Global equity  securities        |       | MSCI  All Country World Index         |       |      | 10         |       |       |
| Debt securities                  |       | Lehman  Brothers Aggregate Bond Index |       |      | 30         |       |       |
| Total                            |       |                                  |       |      | 100        | %          |       |

 

As a secondary measure, Orion Power compares assetperformance to the returns of a universe of comparable funds, where applicable,over a full market cycle. Reliant Energy’s Benefits Committee reviews planasset performance each quarter by comparing the actual quarterly returns ofeach asset class to its related benchmark. Orion Power’s plan assets havegenerally performed in accordance with the benchmarks.

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*Cash Obligations.*   OrionPower expects pension cash contributions to approximate $2 million during 2007.Expected benefit payments for the next ten years, which reflect future serviceas appropriate, are:

| ** ** | ** ** | **Pension**            | ** ** | **Postretirement  Benefits** | ** ** |
|------------|------------|------------------------|------------|------------------------------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| 2007       |       |                   | $          | 1                            |       |   |   | $ | 1 |   |   |
| 2008       |       |                   | 1          |                         |       |   | 1 |   |   |
| 2009       |       |                   | 1          |                         |       |   | 1 |   |   |
| 2010       |       |                   | 2          |                         |       |   | 2 |   |   |
| 2011       |       |                   | 2          |                         |       |   | 2 |   |   |
| 2012-2016  |       |                   | 17         |                         |       |   | 11 |   |   |

 

***(b)***           SavingsPlan.

OrionPower has an employee savings plan under Section 401(a) of theInternal Revenue Code. Under the plan, participating employees may contribute aportion of their compensation generally up to a maximum of 18% pre-tax orafter-tax. Bargaining employees contribute based on their respective agreements.Orion Power’s savings plan benefit expense, including matching anddiscretionary contributions, was $1 million during 2006, 2005 and 2004.

***(c)***            OtherEmployee Matters.

As of December 31,2006, approximately 76% of Orion Power’s employees are subject to collectivebargaining arrangements. Orion Power’s collective bargaining arrangementsexpire at various intervals beginning in 2008.

**(8)**          IncomeTaxes

***(a)***          Summary.

OrionPower’s income tax expense (benefit) is:

| ** **                                                 | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                 | ** ** | **(in millions)** | ** ** |
| **Current:**                                               |       |                   |       |     |       |     |       |
| Federal                                                    |       | $                      | —     |     | $          | (26      | )          | $ | 150 |   |
| State                                                      |       | (4                     | )          | 6        |       | (7       | )          |
| Total current                                              |       | (4                     | )          | (20      | )          | 143      |       |
| **Deferred:**                                              |       |                   |       |     |       |     |       |
| Federal                                                    |       | 11                     |       | 57       |       | (202     | )          |
| State                                                      |       | (38                    | )          | (13      | )          | 6        |       |
| Total deferred                                             |       | (27                    | )          | 44       |       | (196     | )          |
| Income tax  expense (benefit) from continuing operations   |       | $                      | (31        | )        | $          | 24       |       | $ | (53 | ) |
| Income tax expense  (benefit) from discontinued operations |       | $                      | (1         | )        | $          | 6        |       | $ | 67 |   |

 

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Areconciliation of the federal statutory income tax rate to the effective incometax rate is:

| ** **                                                    | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                    | ** ** | **(in millions)** | ** ** |
| Income (loss)  from continuing operations before income taxes |       | $                      | (12        | )        |       | $        | 73         |   |   | $ | (140 | ) |
| Federal statutory  rate                                       |       | 35                     | %          |     | 35         | %        |       | 35 | % |
| Income tax  expense (benefit) at statutory rate               |       | (4                     | )          |     | 26         |     |       | (49 | ) |
| Net addition (reduction)  in taxes resulting from:            |       |                   |       |     |       |     |       |   |   |
| State income taxes, net of federal income taxes               |       | (30                    | )(1)       |     | (4         | )        |       | (1 | ) |
| Other, net                                                    |       | 3                      |       |     | 2          |     |       | (3 | ) |
| Total                                                         |       | (27                    | )          |     | (2         | )        |       | (4 | ) |
| Income tax  expense (benefit) from continuing operations      |       | $                      | (31        | )        |       | $        | 24         |   |   | $ | (53 | ) |
| Effective rate                                                |       | NM                     | (2)        |     | 33         | %        |       | 38 | % |

----

(1)             Ofthis amount, (a) $17 million relates to Pennsylvania state law changes,which effectively decreased our limitations to use net operating losses in thatstate and (b) $7 million relates to changes in valuation allowances.

(2)             Notmeaningful. The primary reason is due to state income taxes. See above.
|                                            | ** ** | **December 31,**  | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in millions)** | ** ** |
| **Deferred  tax assets:**                  | ** ** | ** **             | ** ** | ** ** | ** ** |
| Current:                                   |       | ** **             | ** ** |   |   |
| Employee benefits                          |       | $                      | 1          | ** ** | $ | — |   |
| Other                                      |       | 6                      | ** ** | 5 |   |
| Total current deferred tax assets          |       | 7                      | ** ** | 5 |   |
| Non-current:                               |       | ** **             | ** ** |   |   |
| Employee benefits                          |       | 21                     | ** ** | 17 |   |
| State tax credit carryforwards             |       | —                 | ** ** | 17 |   |
| Net operating loss carryforwards           |       | 29                     | ** ** | 8 |   |
| Environmental reserves                     |       | —                 | ** ** | 2 |   |
| Other                                      |       | 14                     | ** ** | 19 |   |
| Valuation allowance                        |       | (5                     | )          | (24 | ) |
| Total non-current deferred tax assets      |       | 59                     | ** ** | 39 |   |
| Total deferred tax assets                  |       | $                      | 66         | ** ** | $ | 44 |   |
| **Deferred  tax liabilities:**             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Current:                                   |       | ** **             | ** ** |   |   |
| Derivative assets, net                     |       | $                      | —     | ** ** | $ | 10 |   |
| Other                                      |       | —                 | ** ** | 2 |   |
| Total current deferred tax liabilities     |       | —                 | ** ** | 12 |   |
| Non-current:                               |       | ** **             | ** ** |   |   |
| Depreciation and amortization              |       | 209                    | ** ** | 187 |   |
| Derivative assets, net                     |       | —                 | ** ** | 4 |   |
| Other                                      |       | 7                      | ** ** | — |   |
| Total non-current deferred tax liabilities |       | 216                    | ** ** | 191 |   |
| Total deferred tax liabilities             |       | $                      | 216        | ** ** | $ | 203 |   |
| Accumulated  deferred income taxes, net    |       | $                      | (150       | ) | $ | (159 | ) |

 

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***(b)***           TaxAttribute Carryovers.

| ** **                         | ** ** | **December 31,  2006** | ** ** | **Statutory  Carryforward  Period** | ** ** | **Expiration  Year(s)** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **(in millions)**      | ** ** | **(in years)**                 | ** ** | ** **              | ** ** |
| Net Operating Loss  Carryforwards: |       |                        |       |                                |       |                    |       |   |   |   |   |
| State                              |       |                        | $388       |                                |       |                    | 20         |   |   | 2020  through 2026 |   |

 

***(c)***            Federaland State Valuation Allowances.

Orion Power assesses quarterly its future ability touse federal and state net operating losses, capital losses and other deferredtax assets. These assessments included an evaluation of Orion Power’s recenthistory of earnings and losses, future reversals of temporary differences andidentification of other sources of future taxable income, including theidentification of tax planning strategies in certain situations.

OrionPower’s valuation allowances are:

| ** **                     | ** ** | **State**                                      | ** ** |
|--------------------------------|------------|------------------------------------------------|------------|
| ** **                     | ** ** | **  (in millions)  ** | ** ** |
| As of  January 1, 2004    |       |                                           | $          | 41 |   |   |
| Changes in valuation allowance |       |                                           | (16        | ) |   |
| As of  December 31, 2004  |       |                                           | 25         |   |   |
| Changes in valuation allowance |       |                                           | (1         | ) |   |
| As of  December 31, 2005  |       |                                           | 24         |   |   |
| Changes in valuation allowance |       |                                           | (19        | ) |   |
| As of December 31,  2006  |       |                                           | $          | 5 |   |   |

 

***(d)***           TaxContingencies.

Reliant Energy’s income tax returns, including yearswhen it was included in CenterPoint’s consolidated tax group, for the 1997 to2004 tax reporting periods are under audit by federal and state taxingauthorities. These audits may result in additional taxes, interest andpenalties or revisions of the timing of tax payments. Orion Power classifiesinterest and penalties related to income taxes in income tax expense/benefit. AsOrion Power is a part of the consolidated income tax returns of Reliant Energy,it could be subject to additional taxes. Orion Power evaluates the need forcontingent tax liabilities on a quarterly basis and records any estimable andprobable tax exposures in its results of operations. In addition, Orion Powerdiscloses any material tax contingencies as to which we believe there is areasonable possibility of a future tax assessment.

As of December 31,2006 and 2005, Orion Power has accrued contingent state tax liabilities relatedto its continuing operations of $3 million. These balances are primarilyclassified in other long-term liabilities. Orion Power does not believe thesecontingencies will be resolved within the next 12 months.

***(e)***            Changesin Accounting for Income Taxes or Tax Laws.

The FASB issued guidance clarifyingthe accounting for uncertainty in income taxes. Pursuant to the new guidance,which is effective for Orion Power in 2007, tax benefits are only recorded forpositions where it is more-likely-than-not that reported tax return treatmentwould be sustained if audited by relevant taxing authorities. Additional rules areprovided for interest, penalties, changes in benefit recognition and otherrelated matters. Orion Power is currently in the process of determining theimpact of this adoption. Based on its latest estimates, Orion Power does notexpect the adoption to have a material impact on its consolidated financialstatements.

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**(9)**          Commitments

***(a)***          Leases.

*Operating Lease Expense.*   Totallease expense for all operating leases was $2 million, $1 million and $2million during 2006, 2005 and 2004, respectively.

***(b)***           Guaranteesand Indemnifications.

*EquityPledged as Collateral to Reliant Energy.**  *Orion Power Holdings’ equity ispledged as collateral under certain of Reliant Energy’s credit and debtagreements, which have an outstanding balance of $2.8 billion as of December 31,2006.

*InterestsPledged as Collateral to Reliant Energy.**  *In connection with Orion Power’s debt to Reliant Energy(as discussed in note 3), Orion Power Holdings has pledged its interestsin Orion Power Capital, LLC, and its subsidiaries, including Orion New York andOrion MidWest, to Reliant Energy. In connection with the sale of the New Yorkplants, certain of these interests were released.

*Other.**  *Orion Power enters into contracts that includeindemnification and guarantee provisions. In general, Orion Power enters intocontracts with indemnities for matters such as breaches of representations andwarranties and covenants contained in the contract and/or against certainspecified liabilities. Examples of these contracts include asset salesagreements, service agreements and procurement agreements.

Orion Power is unable toestimate its maximum potential exposure under these provisions until an event triggeringpayment under these provisions occurs. Orion Power does not expect to make anymaterial payments under these provisions.

***(c)***            OtherCommitments.

*Property,Plant and Equipment Commitments.**  *Asof December 31, 2006, Orion Power has contractual commitments to spendapproximately $285 million on plant and equipment relating primarily to SO2 emissions reductions.

*Fuel Supply Commitments.**  *Orion Power is a party to fuelsupply contracts of various quantities and durations that are not classified asderivative assets and liabilities. These contracts are not included in theconsolidated balance sheet as of December 31, 2006. Minimum purchasecommitment obligations under these agreements are as follows as of December 31,2006 (in millions):

| 2007                 |   | $      | 62     |   |
|----------------------|--------|--------|--------|--------|
| 2008                 |   | — |   |
| 2009                 |   | — |   |
| 2010                 |   | — |   |
| 2011                 |   | — |   |
| 2012 and  thereafter |   | — |   |
| Total                |   | $      | 62     |   |

 

As of December 31, 2006, the maximum remainingterm under any individual fuel supply contract is one year.

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*Sales Commitments.**  *As of December 31, 2006, Orion Power has salescommitments, which are not classified as derivative assets and liabilities. Theestimated minimum sales commitments under these contracts are as follows (inmillions):

| 2007  |   | $      | 21     |   |
|-------|--------|--------|--------|--------|
| 2008  |   | 10     |   |
| 2009  |   | — |   |
| 2010  |   | — |   |
| 2011  |   | — |   |
| Total |   | $      | 31     |   |

 

**(10)**   Contingencies

Orion Power is involved in a number of legal,environmental and other matters before courts and governmental agencies, someof which may involve substantial amounts. Unless otherwise noted, Orion Powercannot predict the outcome of these matters.

*NewSource Review Matters.**  *TheUnited States Environmental Protection Agency (EPA) and various states areinvestigating compliance of coal-fueled electric generating stations with the “NewSource Review” requirements of the Clean Air Act. The EPA has agreed to shareinformation relating to its investigations with state environmental agencies.

*AshDisposal Site Closures.**  *Orion Power is responsible for environmental costsrelated to the future closures of two ash disposal sites owned by Orion MidWest.Based on Orion Power’s evaluations with assistance from third-party consultantsand engineers, Orion Power recorded the estimated discounted costs associatedwith these environmental liabilities as part of its asset retirementobligations. See note 2(o).

*New Castle Notice ofViolation.*   In December 2006, Orion MidWestreceived a Notice of Violation from the Pennsylvania Department ofEnvironmental Protection regarding the elevation of the permitted coal ashlandfill at its generating site in New Castle, Pennsylvania. Orion Power iscurrently negotiating a penalty amount with the agency, which Orion Powerestimates will be approximately $100,000.

**(11)**   EstimatedFair Value of Financial Instruments

Thefair values of cash and cash equivalents, accounts receivable and payable andderivative assets and liabilities equal their carrying amounts. Values of Orion Power’s debt (see note 6)are:

| ** **      | ** ** | **December 31,**  | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **      | ** ** | **Carrying  Value**    | ** ** | **Fair Market  Value**(1) | ** ** | **Carrying  Value** | ** ** | **Fair Market   Value**(1) | ** ** |
| ** **      | ** ** | **(in millions)** | ** ** |
| Fixed rate debt |       |                   | $          | 439 |   |   |   | $ | 495 |   |   |   | $ | 448 |   |   |   | $ | 453 |   |   |
| Total debt      |       |                   | $          | 439 |   |   |   | $ | 495 |   |   |   | $ | 448 |   |   |   | $ | 453 |   |   |

----

(1)             Orion Power based thefair market values of its fixed rate debt on information from marketparticipants.

**(12)**   Salesof Assets and Emission Allowances

Orion Power included the following in its results ofoperations through the date of sale.

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*Emission Allowances.*   Sales consist of:

| ** ** | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** ** | ** ** | **(in millions)** | ** ** |
| SO2(1)     |       |                   | $          | 70       | (2)        |     |       | $ | 54 | (3) |   |   | $ | 1 |   |   |
| NOx(4)     |       |                   | —     |     |       |     | 11         | (5) |   |   | 10 |   |   |
|       |       |                   | $          | 70       |       |     |       | $ | 65 |   |   |   | $ | 11 |   |   |

----

(1)             Includessales to an affiliate during 2006, 2005 and 2004 of $69 million, $54 millionand $0, respectively.

(2)             Sold56,000 tons to an affiliate relating to 2007 through 2009 vintage years.

(3)             Sold45,000 tons to an affiliate relating to 2008 vintage year.

(4)             Includessales to an affiliate during 2006, 2005 and 2004 of $0, $2 million and $2million, respectively.

(5)             Sold 4,000 tons(which includes 1,000 tons to an affiliate) relating to 2005 through 2006vintage years.

*Summary of Gains and Losses.*

| ** **                                             | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(in millions)** | ** ** |
| Emission  allowances                                   |       |                   | $          | 67       |       |     |       | $ | 56 |   |   |   | $ | 2 |   |   |
| Other, net                                             |       |                   | —     |     |       |     | 2          |   |   |   | — |   |   |
| Gains on sales of  assets and emission allowances, net |       |                   | $          | 67       |       |     |       | $ | 58 |   |   |   | $ | 2 |   |   |

 

**(13)**   DiscontinuedOperations

***(a)***          NewYork Plants.

*General.**  *In February 2006, Orion Powerclosed on the sale of its three remaining New York plants with an aggregate netgenerating capacity of approximately 2,100 MW for $979 million. During thethird quarter of 2005, Orion Power began to report the results of the New Yorkplants as discontinued operations.

*Useof Proceeds.**  *OrionPower applied $704 million of cash proceeds, which is net of estimated city,state and transfer taxes and transaction costs, to pay down the Orion New Yorkand Orion MidWest notes (including outstanding interest) owed to Reliant Energy.After tendering for $0.2 million of the 12% senior notes, the remaining netcash proceeds of $248 million were distributed to/invested in Reliant Energy,including the issuance of a $92 million note. See note 3.

*Assumptions Related toDebt, Deferred Financing Costs and Interest Expense on Discontinued Operations.**  *Based on Orion Power’s obligation to utilize the netproceeds from the sale to prepay debt, Orion Power classified the related debtamounts for the Orion New York and Orion MidWest related party notes and theOrion New York related party revolver (and the related interest expense) asdiscontinued operations as shown below:

| ** **                 | ** ** | **December 31,**  | ** ** |
|----------------------------|------------|------------------------|------------|
| ** **                 | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **(in millions)** | ** ** |
| Orion New York  term notes |       |                   | $          | — |   |   | $ | 400 |   |
| Orion MidWest  term notes  |       |                   | —     |   |   | 300 |   |
| Orion New York  revolver   |       |                   | —     |   |   | 12 |   |
| Total                      |       |                   | $          | — |   |   | $ | 712 |   |

 

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Prior to December 2004(when the notes and revolver with Reliant Energy were issued), Orion Power hadoutstanding debt of $394 million, which was repaid with the proceeds of thenotes from Reliant Energy. This debt (and its related interest expense) hasalso been classified as discontinued operations. Orion Power classified therelated deferred financing costs (and associated interest expense) on all ofthese debt amounts as discontinued operations. Orion Power allocated $1million, $1 million and $31 million of related third party interest expenseduring 2006, 2005 and 2004, respectively, to discontinued operations. OrionPower allocated $7 million and $53 million of related interest expense—affiliatesduring 2006 and 2005, respectively, to discontinued operations.

***(b)***           CeredoPlant.

In 2005, Orion Power soldits 505 MW Ceredo power plant for $100 million. Orion Power used the net cashproceeds of $100 million to pay down the Orion MidWest term notes owed toReliant Energy. During the third quarter of 2005, Orion Power began to reportresults of Ceredo’s operations as discontinued operations effective January 1,2005.

***(c)***            Liberty.

In 2004, Orion Powertransferred its ownership interests in Liberty, including its non-recoursedebt, to Liberty’s lenders. Liberty owned a 530 MW power generation facilityand had been in default under its credit agreement. Orion Power has reportedthe results of its Liberty operations as discontinued operations since thefourth quarter of 2004. Orion Power did not provide or receive any cashconsideration in connection with the transfer to Liberty’s lenders. Orion Powerallocated $21 million of related interest expense during 2004 to discontinuedoperations.

***(d)***           HydropowerPlants.

In 2004, Orion Power sold 71 hydropower plants and agas-fired generation plant with a total aggregate net generating capacity of770 MW for $870 million. Orion Power has reported the results of its hydropowerplant operations as discontinued operations since the second quarter of 2004. OrionPower’s estimated net proceeds after transaction and related costs were $804million. Orion Power used the net proceeds from the sale to repay debt, paytaxes and settle an interest rate swap termination.

Pursuant to the terms ofcertain credit agreements requiring that Orion Power apply all net cashproceeds from the sale to pay off indebtedness (including swap obligations),Orion Power reported the debt repaid through the sale, related interest rateswaps and related deferred financing costs, including associated interest, asdiscontinued operations. Orion Power allocated $47 million of related interestexpense during 2004 to discontinued operations.

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***(e)***            AllDiscontinued Operations.

Thefollowing summarizes certain financial information of the businesses reportedas discontinued operations:

| ** **                                       | ** ** | **New York  Plants** | ** ** | **Ceredo Plant**(1) | ** ** | **Liberty** | ** ** | **Hydropower  Plants** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|--------------------------|------------|-------------|------------|------------------------|------------|-----------|------------|
| ***2006***                                       |       |                      |       |                     |       |        |       |                   |       |      |       |   |   |   |   |   |   |   |   |   |
| Revenues                                         |       |                      | $          | 104                      |       |        |       | $                      | —     |      |       |   | $ | — |   |   |   | $ | — |   |   | $ | 104 |   |   |
| Income before  income tax  expense/benefit       |       |                      | 4          | (2)                      |       |        | —     |                   |       |      | —     |   |   |   | — |   |   | 4 |   |   |
| ***2005***                                       | ** ** |                      |       |                     |       |        |       |                   |       |      |       |   |   |   |   |   | ** ** | ** ** | ** ** |   |
| Revenues                                         |       |                      | $          | 1,014                    |       |        |       | $                      | —     |      |       |   | $ | — |   |   |   | $ | — |   |   | $ | 1,014 |   |   |
| Loss before  income tax expense/benefit          |       |                      | (48        | )(3)                     |       |        | (32        | )(4)                   |       |      | —     |   |   |   | — |   |   | (80 | ) |   |
| ***2004***                                       |       |                      |       |                     |       |        |       |                   |       |      |       |   |   |   |   |   |   |   |   |   |
| Revenues                                         |       |                      | $          | 626                      |       |        |       | N/A                    |       |      |       | $ | 86 |   |   |   | $ | 95 |   |   | $ | 807 |   |   |
| Income (loss) before  income tax expense/benefit |       |                      | 129        |                     |       |        | N/A        |                   |       |      | (98        | )(5) |   |   | 125 | (6) |   | 156 |   |   |

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(1)             Priorto January 1, 2005, Ceredo did not qualify for discontinued operations.

(2)             Includesan additional pre-tax loss on disposal of $16 million during 2006primarily due to changes in derivative assets not terminated as of the date ofsale. The cumulative pre-tax loss on disposal through December 31,2006 is $308 million.

(3)             Includes$292 million estimated loss on disposal.

(4)             Includes$32 million loss on disposal.

(5)             Includes$70 million loss on disposal.

(6)             Includes$146 million gain on disposal.

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Thefollowing summarizes the assets and liabilities related to New Yorkdiscontinued operations:

| ** **                              | ** ** | **December 31,**  | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                              | ** ** | **(in millions)** | ** ** |
| **Current Assets:**                     |       |                   |       |   |   |   |   |
| Accounts receivable, net                |       |                   | $          | 2 |   |   | $ | 51 |   |
| Derivative assets                       |       |                   | —     |   |   | 41 |   |
| Other current assets                    |       |                   | —     |   |   | 65 |   |
| Total current assets                    |       |                   | 2          |   |   | 157 |   |
| **Property,  Plant and Equipment, net** |       |                   | —     |   |   | 761 |   |
| **Other Assets:**                       |       |                   |       |   |   |   |   |
| Other intangibles, net                  |       |                   | —     |   |   | 69 |   |
| Derivative assets                       |       |                   | —     |   |   | 43 |   |
| Total long-term assets                  |       |                   | —     |   |   | 873 |   |
| Total Assets                            |       |                   | $          | 2 |   |   | $ | 1,030 |   |
| **Current  Liabilities:**               |       |                   |       |   |   |   |   |
| Accounts payable, principally trade     |       |                   | $          | — |   |   | $ | 30 |   |
| Other current liabilities               |       |                   | 3          |   |   | 19 |   |
| Total current liabilities               |       |                   | 3          |   |   | 49 |   |
| **Other Liabilities:**                  |       |                   |       |   |   |   |   |
| Accumulated deferred income taxes       |       |                   | —     |   |   | 120 |   |
| Other liabilities                       |       |                   | —     |   |   | 22 |   |
| Total other liabilities                 |       |                   | —     |   |   | 142 |   |
| **Long-term  Debt**                     |       |                   | —     |   |   | 712 |   |
| Total long-term liabilities             |       |                   | —     |   |   | 854 |   |
| Total Liabilities                       |       |                   | $          | 3 |   |   | $ | 903 |   |
| Accumulated other  comprehensive loss   |       |                   | $          | — |   |   | $ | — |   |

 

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