Opinion ID: 895304
Heading Depth: 3
Heading Rank: 2

Heading: Net Book Value

Text: The Act required utilities to undertake certain efforts to mitigate stranded costs in the 1998-2001 time frame. Section 39.254 directed utilities to use these efforts to reduce the book value of generation assets. Because stranded costs represent the difference between book value and market value, a reduction in the book value of generation assets had the effect of reducing stranded costs. The Act directed utilities to redirect depreciation expenses from transmission and distribution assets to generation assets, and to apply certain excess earnings to reduce the book value of generation assets. [65] The required mitigation is consistent with the principles that under Chapter 39 utilities may not be permitted to overrecover stranded costs [66] and are only allowed to recoup their net, verifiable, nonmitigable stranded costs. [67] Prior to January 1, 2002, CenterPoint engaged in mitigation efforts by redirecting $841 million in depreciation and applying $1.13 billion in excess earnings to reduce the net book value (NBV) of its generation assets. Section 39.201(h) required the PUC to make a determination of estimated stranded costs based on the ECOM model using updated company-specific inputs. As noted above, Section 39.201 provided for interim rates during the 2002-2003 period, until the calculation of final stranded costs in the Section 39.262 true-up proceeding. The projections indicated that CenterPoint would have no stranded costs. [68] As a result, the PUC concluded that CenterPoint should cease mitigation efforts and should issue excess mitigation credits (EMCs) to all retail electric providers, including its affiliate RERS. The EMCs were deducted from the transmission and distribution charges that retail electric providers paid CenterPoint. The EMCs increased the NBV of CenterPoint's generation assets on a dollar-for-dollar basis. However, the PUC concedes that the ECOM model assumptions underlying the 2001 finding that Center-Point would have no stranded costs  the finding that the PUC used to justify the EMCs  proved to be false. At the 2004 true-up proceeding, CenterPoint established that it had substantial stranded costs. In a mandamus proceeding, CenterPoint objected to the order requiring EMCs. In that proceeding, the PUC represented to this Court in its briefing and at oral argument that CenterPoint could recoup the EMC payments in the true-up proceeding now under review if CenterPoint was ultimately determined to have stranded costs. This Court denied mandamus relief, [69] although three justices would have reached the merits and held the EMCs unlawful as unauthorized by Chapter 39. [70] The PUC terminated EMCs on April 29, 2005. In September 2005, the Third Court of Appeals held that the PUC exceeded its authority in ordering EMCs. [71] In the true-up proceeding, CenterPoint contended all the EMCs it had already paid retailers could be recovered as stranded costs. CenterPoint argued it should not be penalized for following the PUC's mistaken decision to order the EMCs. Intervenor City of Houston argued that CenterPoint should not be allowed to recover $385 million in EMCs paid to its retail affiliate, RERS. The PUC rejected this argument, finding no legal basis for the recommended disallowance and declining to penalize CenterPoint for following a Commission order. One commissioner dissented in part to the true-up Order, solely on this issue. The dissenting commissioner reasoned that the EMC payments to RERS amounted to wealth transfers between two companies who knew they would be joint applicants in this true-up proceeding. The trial court agreed with the PUC majority on this issue. The court of appeals, however, agreed with the dissenting commissioner and held that CenterPoint could not recoup the EMCs paid to RERS. Although the court of appeals assumed that CenterPoint and RERS are completely separate entities, [72] it reasoned that joint true-up applicants are prohibited from overrecovering [stranded costs] as a single unit by Section 39.262(a), which generally prohibits the overrecovery of stranded costs. [73] We reverse the court of appeals and affirm the PUC on this issue. We need not decide whether the PUC could ever order excess mitigation credits. Even if the PUC theoretically possessed the legal authority to order EMCs, as a factual matter the PUC should not have done so in this case. The credits were ordered only because the ECOM model incorrectly predicted that CenterPoint would have no stranded costs. CenterPoint should recover whatever stranded costs it would have recovered if the EMCs had never been paid. EMCs paid to RERS had the same dollar-for-dollar impact on CenterPoint's stranded costs as EMCs paid to unaffiliated retailers. Intervenors concede in their brief that as to EMC payments generally, [f]or every dollar of EMC payments made, CenterPoint wrote up its NBV by one dollar, thus increasing potential stranded costs, and that as to EMC payments to RERS in particular, every dollar that CenterPoint paid to [RERS] resulted in CenterPoint writing up NBV by an equal amount. In either case, the purpose of the EMCs was to increase the NBV of CenterPoint's generation assets. The PUC did not err, therefore, in declining to adjust stranded costs by disregarding any of the EMCs paid by CenterPoint, and Intervenors fail to demonstrate a sound legal or factual basis for deducting the EMCs that were paid to RERS. We cannot agree with the court of appeals that the payment of EMCs to CenterPoint's affiliate RERS merits special treatment. Chapter 39, in its express measures for recovering stranded costs and preventing the over-recovery of stranded costs, makes no distinction between affiliated and unaffiliated electric retailers that would warrant special treatment of the EMCs paid to RERs. The EMCs were simply an interim and ultimately unwarranted effort to reverse what the PUC perceived to be an over-recovery of stranded costs before the final true-up. There is no express statutory provision allowing such credits, as the Third Court of Appeals noted in holding that Chapter 39 did not permit them. However, Section 39.201 does provide for the transmission and distribution utility to impose competition transition charges, based on interim estimates of stranded costs. Section 39.107(d) provides that these charges are made to a customer's retail electric provider. These provisions make no exception or distinction for an affiliated retail electric provider. If the interim CTCs result in an over-recovery of stranded costs, Sections 39.201( l ) and 39.262(c) provide for the transmission and distribution utility to refund stranded costs by reducing the CTCs or rates charged to retail providers. Again, in providing for these refunds Chapter 39 makes no statutory distinction between affiliated and unaffiliated retailers, and Chapter 39 indeed generally requires that such distinctions not be drawn when billing retail electric providers and their customers. [74] Because the EMCs, by design, had the effect of increasing the NBV of generation assets regardless of whether they were directed to an affiliated or unaffiliated retail electric provider, and because such an increase in NBV correspondingly increased the amount of stranded costs under the relevant provisions of Chapter 39, the PUC did not err in refusing to reduce stranded costs by the portion of the EMCs paid to RERS.
CenterPoint and Intervenors complain that the PUC erred in its treatment of the RRI Option. Under the business separation plan, Reliant Energy, Inc. conveyed its generation assets to a subsidiary, Genco. Reliant Energy changed its name to CenterPoint. As discussed above, CenterPoint spun off approximately 19 percent of the shares of Genco to CenterPoint's shareholders. CenterPoint also spun off a company named Reliant Resources, Inc. (RRI), by selling approximately 20 percent of the shares in RRI in an initial public offering, with CenterPoint retaining about 80 percent of RRI. [75] RRI, in turn, owned the affiliated retail electric provider, RERS. As part of the business separation plan, which the PUC approved in a separate proceeding, RRI received an option to purchase CenterPoint's shares in Genco. The Option expired on January 24, 2004. The Option price was set at the price for Genco that was to be determined at the true-up proceeding. Under its primary holding that rejected the use of the PSV method, the PUC employed an extra-statutory method that considered various data points for determining market value, as described above. Under this holding, the PUC concluded that its method of calculating fair market value accounted for the effect of the RRI Option. It therefore held under its primary holding that no adjustment to NBV relating to the RRI Option was necessary. The trial court and the court of appeals [76] affirmed this decision. Under its alternative holding, the PUC calculated true-up amounts assuming that the fair market value was properly calculated under the PSV method. As explained above, we conclude that neither the primary nor the alternative holding can be sustained, because the sale of assets method must be used  and not the extra-statutory method used in the primary holding or the PSV method used in the alternative holding. Intervenors complain that if the Court agrees with the primary holding rejecting the use of the PSV method, the PUC nevertheless erred in refusing to make a requested deduction from the NBV calculation to reflect the RRI Option. We need not reach this issue because we reject the primary holding. CenterPoint complains that if as it contends the PSV method must be used, the PUC erred in concluding under its alternative holding that an adjustment should be made to NBV to reflect the RRI option. Again, this issue is moot because we reject the use of the PSV method. However, Intervenors argue that [r]egardless of how market value is determined, an adjustment to NBV should be made for the RRI Option. Insofar as Intervenors argue an adjustment to NBV should be made for the RRI Option even if we agree with them that the sale of assets method should be used to determine market value, [77] we reject this argument. The PUC reasoned in its alternative holding that if it is required to use the PSV method of calculating market value, an adjustment should be made to NBV to reflect the RRI option. It made the adjustment under PURA Section 39.252(d), which provides: An electric utility shall pursue commercially reasonable means to reduce its potential stranded costs, including good faith attempts to renegotiate above-cost fuel and purchased power contracts or the exercise of normal business practices to protect the value of its assets. The commission shall consider the utility's efforts under this subsection when determining the amount of the utility's stranded costs; provided, however, that nothing in this section authorizes the commission to substitute its judgment for a market valuation of generation assets determined under Sections 39.262(h) and (i). Applying this provision, the PUC found that CenterPoint had received no compensation for the Option conveyed to RRI and that the Option placed restrictions on the management and operations of Genco that were not commercially reasonable and did not represent normal business practices. The PUC could consider the commercial reasonableness of the RRI Option in determining NBV. The PUC adjusted NBV in making the stranded cost determination, after finding that the conveyance of the Option was commercially unreasonable and did not represent normal business practices. Section 39.252(d) expressly directs the PUC, when making the stranded cost determination, to consider whether the utility used commercially reasonable means and normal business practices to reduce stranded costs. Since Section 39.252(d) bars the PUC from adjusting the market value component of stranded costs, it necessarily authorizes an adjustment to NBV, the other principal component of stranded costs. CenterPoint points out that in an earlier proceeding approving the business separation plan, the PUC noted that the Option was an integral part of the plan and meets the separation requirements in PURA § 39.051. Section 39.051, however, is the provision requiring the separation of the utility into three separate entities. The PUC's conclusion that the business separation plan complied with this provision did not necessarily mean that CenterPoint had taken all reasonable efforts to minimize stranded costs under Section 39.252(d). Indeed, in the earlier proceeding the PUC expressly stated that it was not approving the RRI Option and other agreements that had not yet been finalized, and that its approval of the business separation plan does not preclude a review in the 2004 true-up proceeding of whether [Center-Point] pursued reasonable means to reduce its potential stranded costs. The PUC considered evidence that the grant of the RRI option was not a normal business practice and had an adverse effect on the value of the generation assets. One of Genco's own SEC filings conceded that the Option limited Genco's ability to (1) merge with another company, (2) sell assets, (3) enter into long-term contracts, (4) engage in other businesses, (5) construct or acquire new plant or capacity, (6) engage in certain hedging activities, (7) encumber assets, (8) issue new securities, (9) pay special dividends, and (10) engage in certain transactions with affiliates. The report states that these restrictions may adversely affect our ability to compete with companies that are not subject to similar restrictions. The PUC also considered expert testimony that the Option was very unusual and did not represent normal business practices, gave RRI an incentive to reduce the value of Genco, was viewed negatively in the investment community, and limited Genco's upside potential. The last point seems obvious, since RRI could derail an outside offer for Genco above the option price by exercising the Option, assuming that RRI had the funds. CenterPoint's own financial advisor on the spinoff of Genco acknowledged in a presentation that the RRI option limits upside potential. Michael Gorman, a witness for Intervenors, opined that the Option was unreasonable because it essentially transferred significant control of [Genco] to RRI, which then had an incentive to minimize the value of Genco, an incentive diametrically opposite of [CenterPoint's] obligation to protect the value of [Genco] and mitigate stranded costs. Another witness for Intervenors, William Purcell, testified that the Option gave RRI in effect the right of first refusal to buy Genco, which acted as a deterrent for [Genco or CenterPoint] to receive independent third party purchase bids or indications of interest  and, accordingly, was a drag on [Genco's] stock price. Gorman calculated the intrinsic value of the Option at approximately $330 million. He made further adjustments to this figure that the PUC rejected because they did not reflect the value the Option would have had in an arms-length transaction. The PUC valued the Option at $330,314,000 and determined the NBV should be reduced by this amount, and further grossed up this amount by an additional $177,874,089 to reflect accumulated deferred federal income taxes. Summarizing Gorman's approach (and ignoring that the PUC only agreed with part of his methodology), the Option was priced at the market price to be determined under the PSV method, with an adjustment for a control premium of up to 10 percent to be determined by the PUC, as Section 39.262(h)(3) specifies. Gorman, however, believed that the actual control premium should be 30 percent, based on premiums over market prices paid in corporate acquisitions of similar companies. The difference between the 30 percent market premium and statutory premium was therefore 20 percent. Gorman determined that Genco's future market value at the Option exercise date would approximately equal its book value of $2.9 billion, took 20 percent of that number ($580 million) to reflect the 20 percent difference in control premiums, took 81 percent of that figure to reflect CenterPoint's ownership in Genco ($469.8 million) and then discounted that value back to the date the Option was granted to arrive at $330 million as the Option's intrinsic value. We have reviewed the administrative record and conclude that while substantial evidence supports the PUC's conclusions that the Option was not commercially reasonable and for a time depressed the value of Genco stock, no adjustment should be made to NBV if the sale of assets method is used. The PUC apparently believed that the $330 million dollar figure derived from Gorman's testimony reflected the negative impact of the Option on the market value of Genco. In a subheading on Market Value, the PUC found that the entire [market] valuation process was not commercially reasonable, and accordingly made an adjustment to NBV as required by Section 39.252(d). Further, the PUC explained that no adjustment to market value under its primary holding was needed because the stock price selected under that method, which included consideration of the market control premium, takes into consideration the operational constraints placed upon [Genco] by the Option and the control premium. When it turned to NBV, the PUC made an adjustment for the Option because of its effect on market value, reasoning that Gorman calculated the amount of the option's below-market pricing by taking the difference between the 10 percent maximum control premium RRI would have had to pay if it had exercised the option, and an average industry control premium of 30 percent, which RRI would likely have had to pay in a bona fide third-party transaction. The PUC apparently concluded that the Option depressed the market value of Genco stock by $330 million, since under Gorman's testimony, as analyzed and accepted in part by the PUC, this amount arguably reflected the difference between what a third-party bid for the company might have brought and the ceiling on market value imposed by the Option. However, this analysis breaks down if the sale of assets method is used, because the actual sale of Genco took place months after the Option expired. The Option expired in January 2004, and the sale of Genco assets occurred in December 2004 and April 2005. There is no evidence that the Option had an impact on the value of the assets sold under the Transaction Agreement. As the PUC notes in its brief to this Court, The announced future sales price for Genco occurred months after the Option expired. Moreover, the sale itself resolved the uncertainty about the future of the company. Thus, that price was unaffected by the unreasonableness of the expired Option. The court of appeals similarly noted that the offer to purchase Genco in the Transaction Agreement came several months after the option expired and after the restrictions placed upon Genco by the option had ended. As a result, any detrimental effect on Genco's value resulting from the option should have dissipated. [78] Further, there is some empirical support for concluding that the sale of Genco long after the Option expired was not affected by the Option, even if the market value of the company had earlier been depressed by it. As CenterPoint notes in a post-submission brief, The $508 million deduction for the grossed-up Option under the alternate holding using the PSV method would reduce CenterPoint's stranded-cost recovery by virtually the same amount  $511 million  as the sale-of-assets method Intervenors advocate. Intervenors nevertheless argue that if CenterPoint had sold the Option instead of imprudently giving it away, the sale of that asset could have been used to reduce net book value and thus mitigate stranded costs. But this simply assumes that the Option could have been sold. There was no evidence that RERS or any third party was interested in purchasing the Option, nor is there any evidence that any party would have actually paid the intrinsic value Gorman calculated if the Option had been put up for sale. On the contrary, CenterPoint offered evidence of extremely difficult market conditions at the time of the business separation that included the Option, which necessitated the spinoff of Genco to existing CenterPoint shareholders in lieu of an IPO. In their briefing to this Court, Intervenors criticize Center-Point for its decision to go forward with the business separation at a time when the wholesale energy markets were in disarray as a result of action undertaken by Enron in California. Nearly all generation company stocks had lost significant value. Accordingly, on remand, the PUC should not make an adjustment to NBV for the RRI Option in conjunction with its use of the sale of assets method to determine market value.
CenterPoint complains that the PUC erred in reducing stranded costs attributable to depreciation on generation assets. The PUC reduced CenterPoint's stranded costs by reducing the NBV of its generation assets by approximately $378 million, a figure representing depreciation on those assets for years 2002 and 2003. The PUC reasoned that this adjustment was necessary to prevent an excessive recovery of stranded costs. It noted that under Section 39.262(a), a utility may not be permitted to overrecover stranded costs through the procedures established by this section, which governs the final stranded cost and capacity auction true-ups. Specifically, the PUC found it inappropriate for the joint applicants to recover the remaining book value of generation assets through stranded-costs recovery while at the same time being guaranteed a level of revenue through the capacity auction that, by design, covers a portion of this same book value. To allow recovery of a portion of the book value through both stranded-costs recovery and the capacity auction true-up is, plain and simple, a double recovery of this portion of book value, and therefore, an overrecovery of stranded costs. The PUC therefore held that an adjustment to NBV must be made in the stranded cost calculation to prevent the perceived double recovery. The trial court and the court of appeals [79] agreed with this result. We agree with CenterPoint that the Commission misread the relevant provisions of Chapter 39. As explained above, Chapter 39 requires both a stranded cost true-up and a capacity auction true-up. Nothing in the world of business or accounting requires both true-ups to transition a regulated industry to a more competitive market. But the Legislature provided for both and requires both. As we noted in our earlier CenterPoint decision, the Legislature chose not to include the capacity auction true-up amount in its definition of stranded costs or to incorporate it into the methods it prescribes for calculating stranded costs. [80] The capacity auction true-up amount does not depend on the amount or existence of stranded costs, but on a specific formula set out in Section 39.262(d) and the Commission's rules thereunder that can result in a positive or negative number. Stranded costs is a different matter and a term of art defined by Chapter 39. In this case it essentially consists of the difference between the book value of the generation assets  established as of December 31, 2001  under Section 39.251(7) [81] and the market value of those assets, which are determined under the methods set out in Section 39.262. The PUC conceded in its Order that stranded-costs recovery requires that book value be determined as of December 31, 2001. On the other hand, as we have previously explained, the capacity auction true-up guarantees consumers and power companies that the power company will receive no more and no less than a margin predetermined by the PUC in 2001 when the ECOM model was run in compliance with section 39.201. [82] This margin is determined by taking the difference between projected power sales and actual power prices obtained through the capacity auctions. [83] Critically, the capacity auction true-up amount is determined for the years 2002 and 2003. We have so stated, explaining that this true-up consists of the difference between the price of power obtained through the capacity auctions and the power cost projections that were employed in the 2001 ECOM model for the years 2002 and 2003. [84] The PUC likewise recognized in its Order that the capacity auction true-up ensures that an affiliated [power-generation company] with significant investment in generation assets will recover the power costs the PUC had projected, in the 2001 ECOM model, would be recovered for the 2002-2003 period. Its Substantive Rule 25.263(i) also defines precisely the formula for calculating the capacity auction true-up, based on the difference between the price of power obtained through capacity auctions conducted for the years 2002 and 2003 and the power cost projections for the same time period as used in the determination of ECOM for that utility in the proceeding under PURA § 39.201. [85] The PUC apparently reasoned that the capacity auction true-up is based on the ECOM market revenue projections used to set interim rates in the 2001 Section 39.201 proceeding. As discussed further below, we agree with the Order that these revenue projections assumed the continuation of regulation. Under traditional rate regulation, rates are set to allow the utility to recover a reasonable return on its capital investments. [86] Since these capital assets are depreciated over time on the books, [87] depreciation affects the NBV of the utility. The PUC apparently further reasoned that stranded costs must be based on book value as of the end of 2001, and this value includes generating plant assets that have not yet been depreciated further in years 2002 and 2003. Since the capacity auction true-up is based on revenue projections under rates intended to recoup investments in plants that are further depreciated in 2002 and 2003, the PUC apparently reasoned that the capacity auction true-up and the stranded costs true-up allowed for a double recovery of a portion of book value. We think the Commission erred in its analysis. Any utility will eventually retire all of its stranded costs, or any other capital investment or portion thereof, if it survives deregulation and continues to operate at a profit for a sufficient period of time. Depreciation is a general term referring to the accounting practice of spreading an asset's cost over the projected useful life of the asset or some other period. [88] In this case, however, stranded costs is a purely legal term that depends entirely on how it is defined by statute. Under Chapter 39, stranded costs depend on book value as of the end of 2001. We agree with CenterPoint that [i]t is indisputable that the NBV of generation assets as of December 31, 2001 would not reflect a reduction for depreciation attributable to 2002 and 2003. An adjustment to stranded costs to reflect further depreciation of power plant assets in 2002 and 2003 is not permitted because the PUC is not allowed to alter the statutory definition of stranded costs. The PUC's view that the adjustment is necessary to prevent a double recovery of stranded costs necessarily depends on its conclusion, in direct contravention of the statute, that stranded costs should be redefined to incorporate further depreciation of generation assets in 2002 and 2003, thereby reducing NBV and correspondingly reducing stranded costs. Statutory stranded costs always depend on the distance between two values  NBV and market value  both of which constantly change over time. [89] The PUC is constrained to determine those values as of the time periods selected by the Legislature. Intervenors contend in their brief: The problem the Commission addressed in the true-up award was that because NBV was frozen as of December 31, 2001, it could not be reduced by the $378 million in depreciation expense that CenterPoint indisputably collected through the capacity auction true-up as a contribution to its fixed costs. The problem with this analysis is that, by statutory definition, the NBV component of stranded costs is frozen as of December 31, 2001, and the PUC's adjustment effectively moved that date in violation of the statute.
Intervenors argue that the Commission erred in not requiring CenterPoint to meet ratemaking requirements for inclusion of construction work in progress (CWIP) in NBV. The court of appeals [90] and the district court agreed with the PUC on this issue, as do we. Inclusion of CWIP increased stranded costs by about $110 million. The PUC's Substantive Rule 25.263(g)(2)(A) [91] provides that the NBV of generation assets includes generation-related construction work in progress. In addressing Intervenors' arguments, the PUC noted that [n]o party claimed accounting mistakes or imprudence on any specific project included in CWIP, and found there is no evidence of any accounting discrepancies or any failure to follow GAAP in connection with these balances. It recognized that under PURA § 36.054, applicable to general ratemaking, CWIP can be included in the rate base only if (1) necessary for the utility's financial integrity and (2) not inefficiently or imprudently planned or managed. The PUC, however, declined Intervenors' request to apply these additional requirements because Chapter 39 is concerned with the unique matter of stranded costs measured by the difference between the NBV of generation assets and market value, while general ratemaking applies ratemaking standards to determine what amounts of book value may be included in the rate base and the appropriate rate of return on that rate base. It also noted that [o]ne significant difference between a traditional rate case and this proceeding . . . is that whereas under traditional regulation a utility is allowed to file rate cases on a recurring basis into the future, this proceeding is strictly a one-time phenomenon. In other words, CWIP can be recovered under Section 36.054 in the exceptional case if the requirements of that provision are met; otherwise, the utility can simply seek recovery for the construction project in a future rate case. There is no analogous recurring procedure for the recovery of stranded costs. Intervenors argue that under Section 39.260(a), [t]he definition and identification of invested capital and other terms. . . that affect the net book value of generation assets . . . shall be treated in accordance with generally accepted accounting principles as modified by regulatory accounting rules generally applicable to utilities. The PUC did not agree that in the calculation of stranded costs this provision requires the application of Section 36.054's special rules regarding CWIP. It noted that Section 39.260(a) did not expressly incorporate those particular standards. The PUC further reasoned: [U]nlike a traditional rate case, there will be no future opportunity for the joint applicants to recover the CWIP costs that are subsequently moved into EPS [electric plant in service]. Second, including CWIP in NBV of generating assets is necessary for an apples-to-apples comparison of book value and market value, because the market value of CWIP is reflected in TGN's stock price. These additional arguments by Center-Point further amplify the difference between a traditional rate case and this proceeding. For [these and other reasons], the joint applicants do not need to satisfy rate-case requirements for including CWIP in NBV in this proceeding. Accordingly, the Commission declines to exclude the $109,966,000 for nonenvironmental CWIP from NBV. We cannot say the Commission's analysis is legally or factually flawed, and we defer to the Commission on this technical issue.