10-Q: CALPINE CORP
(EDGAR Online via COMTEX) -- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Except for historical financial information contained herein, the matters discussed in this quarterly report may be considered "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding the intent, belief or current expectations of Calpine Corporation ("the Company") and its management. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could materially affect actual results such as, but not limited to, (i) changes in government regulations, including pending changes in California, and anticipated deregulation of the electric energy industry, (ii) commercial operations of new plants that may be delayed or prevented because of various development and construction risks, such as a failure to obtain financing and the necessary permits to operate or the failure of third-party contractors to perform their contractual obligations, (iii) cost estimates are preliminary and actual costs may be higher than estimated, (iv) the assurance that the Company will develop additional plants, (v) a competitor's development of a lower-cost generating gas-fired power plant, (vi) the risks associated with marketing and selling power from power plants in the newly competitive energy market, (vii) the risks associated with marketing and selling combustion turbine parts and components in the competitive combustion turbine parts market, (viii) the risks associated with engineering, designing and manufacturing combustion turbine parts and components, or (ix) delivery and performance risks associated with combustion turbine parts and components attributable to production, quality control, suppliers and transportation. You are also cautioned that the California energy market remains uncertain. The Company's management is working closely with a number of parties to resolve the current uncertainty. This is an ongoing process and, therefore, the outcome cannot be predicted. It is possible that any such outcome will include changes in government regulations, business and contractual relationships or other factors that could materially affect the Company; however, the Company believes that a final resolution of the situation in the California energy market will not have a material adverse impact on the Company. For example, Pacific Gas and Electric Company ("PG&E"), which is in bankruptcy, has recently agreed with the Company to assume all of the Company's Qualifying Facility contracts. You are also referred to the other risks identified from time to time in the Company's reports and registration statements filed with the Securities and Exchange Commission.
Overview
Calpine is engaged in the development, acquisition, ownership, and operation of power generation facilities and the sale of electricity and steam in the United States and Canada. At August 13, 2001, we had interests in 58 operating power plants representing 9,626 megawatts of net capacity.
On April 3, 2001, we announced that our affiliate, Calpine Power America, L.P., was certified as a Retail Energy Provider in the Electric Reliability Council of Texas ("ERCOT"). This allows us to offer services to a full range of wholesale and retail customers in Texas. Calpine Power America will sell to large industrials, in addition to municipalities, cooperatives, and investor-owned utilities. Additionally, we received an ERCOT certification to be a Qualified Scheduling Entity ("QSE"). As a QSE, Calpine Power Management, L.P. may act on behalf of generators and consumers in the region and would be responsible for scheduling the generation of energy flowing to the electricity grid with the ERCOT Independent System Operator.
On April 3, 2001, we acquired all of the common shares of WRMS Engineering, Inc. ("WRMS"), a California-based engineering and architectural firm, through a stock-for-stock exchange in which WRMS shareholders received a total of 151,176 shares of Calpine common stock. The aggregate value of the transaction is approximately $7.8 million, including the assumed indebtedness of WRMS. WRMS is expected to provide services to support our c*Power unit, which provides highly reliable, critical power to industrial and high tech customers.
On April 11, 2001, we acquired the development rights from Enron North America for the 750-megawatt natural gas-fired Pastoria Energy Center planned for Kern County, California. The project was licensed by the California Energy Commission in December 2000. Construction began in June 2001 and commercial operation is scheduled for the summer of 2003.
On April 17, 2001, we acquired the development rights from Kirkland, Washington-based National Energy Systems Company for the 248-megawatt natural gas-fired Goldendale Energy Center planned for Goldendale, Washington. Energy generated from the Goldendale facility will be sold directly into the Northwest Power Pool. Construction commenced in April 2001, and energy deliveries are scheduled to begin July 1, 2002.
On April 17, 2001, we acquired assets of The Bayless Companies and its partners with reserves located in the western portion of the San Juan Basin in New Mexico. Currently 35 wells produce approximately 6 million cubic feet equivalent per day ("mmcfe/d"), 96 percent of which is natural gas.
On April 19, 2001, we announced the purchase of 35 model 7FB and 11 model 7FA gas-fired turbines from GE Power Systems. We will take delivery of 5 turbines in 2002, with the remainder of the contract to be filled by the end of 2005.
On April 19, 2001, we acquired all of the common shares of Encal Energy Ltd. ("Encal"), a Calgary, Alberta-based natural gas and petroleum exploration and development company, through a stock-for-stock exchange in which Encal shareholders received, in exchange for each share of Encal common stock, .1493 shares of Calpine common equivalent shares of our subsidiary, Calpine Canada Holdings Ltd. A total of 16,603,633 Calpine common equivalent shares were issued to Encal shareholders in exchange for their Encal common stock. Each Calpine common equivalent share is exchangeable for one share of Calpine common stock. The aggregate value of the transaction is approximately U.S. $1.1 billion, including the assumed indebtedness of Encal. This acquisition was accounted for under the pooling-of-interests method. With the addition of Encal's assets, which currently produce approximately 230 mmcfe per day, net of royalties, our net production is expected to increase to 390 mmcfe per day in North America, enough to fuel approximately 2,300 megawatts of our power fleet.
On April 25, 2001, through our wholly owned financing company, Calpine Canada Energy Finance ULC ("Energy Finance"), we completed a public offering of $1.5 billion of 8 1/2% Senior Notes Due 2008 priced at 99.768%. These senior notes are fully and unconditionally guaranteed by us.
On April 30, 2001, we completed the sale of $1.0 billion of Zero-Coupon Convertible Debentures Due 2021 in a private placement under Rule 144A of the Securities Act of 1933. The securities are convertible into Calpine common shares at a price of $75.35 at the option of the holder at any time. Holders have the right to require us to repurchase their debentures in 2002, 2004, 2006, 2008, 2011 and 2016 at a specified price in cash or our common stock at our option, except in 2016 when the repurchase price must be paid in cash. The debentures are redeemable at the option of Calpine after 2004 at a specified price in cash or our common stock. Proceeds from the offering were used to refinance certain debt, for working capital and for general corporate purposes. The indenture relating to these securities has not been filed with the Securities and Exchange Commission at the date of this filing. We will furnish a copy to the Securities and Exchange Commission upon request.
On May 2, 2001, we jointly announced with Kinder Morgan Energy Partners, L.P. plans to develop the Sonoran Pipeline, subject to a successful open season and all other approvals. As proposed, the Sonoran Pipeline will be a 1,160-mile, high-pressure interstate natural gas pipeline from the San Juan Basin in northern New Mexico to markets in California. The interstate pipeline will be evaluated and developed in two phases, which will be subject to the jurisdiction of the Federal Energy Regulatory Commission ("FERC"). The first phase will run from the San Juan Basin to the California border with the second phase extending from the California border to the San Francisco Bay area. The first phase of the pipeline is expected to be completed in the summer of 2003.
On May 9, 2001, we announced that our emergency energy proposal to the San Francisco Public Utilities Commission was approved by the San Francisco Board of Supervisors. Under the terms of this contract, we will guarantee to provide San Francisco with 50 megawatts of electricity 24 hours-a-day for the next five years starting July 1, 2001.
On May 15, 2001, we announced that we plan to build, own and operate a 1,030-megawatt natural gas-fired electricity generating facility to be located in Berrien, Michigan. We entered into an agreement with Boston-based CME North American Merchant Energy, which had initiated development efforts for the project and will continue to work with us as the project moves forward. The Berrien Energy Center is our first Michigan development project and commercial operation is scheduled to begin in 2004.
On May 15, 2001, we announced that our wholly owned subsidiary, Canada Power Holdings Ltd., entered into a letter of intent to acquire and assume operations of two Canadian power generating facilities from British Columbia-based Westcoast Energy, Inc. for up to approximately US$250 million, plus the assumption of US$14.6 million of debt. We will own a 100 percent interest in the 250-megawatt natural gas-fired Island Cogeneration facility located near Campbell River, British Columbia on Vancouver Island, and a 50 percent interest in the 50-megawatt Whitby Cogeneration facility located in Whitby, Ontario. The acquisition is expected to close in the third quarter of 2001 and is subject to final documentation and various third party and regulatory approvals.
At the Annual Meeting of Stockholders on May 17, 2001, the stockholders elected Ann B. Curtis and Kenneth T. Derr as the Class II Directors, approved the amendment to the Company's Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Common Stock from 500,000,000 to 1,000,000,000, and ratified the appointment of Arthur Andersen LLP as independent accountants for the fiscal year ending December 31, 2001.
On May 23, 2001, we, together with San Francisco-based Bechtel Enterprises Holdings, Inc., filed an Application For Certification with the California Energy Commission ("CEC") for the proposed Russell City Energy Center, a 600-megawatt, natural gas-fired, combined-cycle electric generating facility located in Hayward, California. The filing marks the beginning of an extensive CEC licensing process required to build and operate an electricity generating facility in California. The filing included a request for expedited review that would reduce the licensing review process period from 12 months to 6 months. Based upon successful licensing of the project, construction could begin in the summer of 2002, with commercial operation by the summer of 2004. The Russell City Energy Center would provide electricity for Hayward, western Alameda County and the San Francisco Peninsula.
On June 7, 2001, we jointly announced with Kinder Morgan Energy Partners, L.P. that we received significant interest in the proposed Sonoran Pipeline project during the open seasons that closed on June 1, 2001. More than 1 billion cubic feet ("Bcf") per day of binding precedent agreements and non-binding expressions of interest were received for Phase One of Sonoran, and another 1.5 Bcf per day of non-binding commitments and expressions of interest were received for Phase Two of the project.
On June 7, 2001, we redeemed all $105 million in aggregate outstanding principal amount of our 9 1/4% Senior Notes Due 2004 at a redemption price of 100% of the principal amount plus accrued interest to the redemption date.
On June 8, 2001, we announced plans to build, own and operate a 600-megawatt electric generating facility to be located in southwestern Riverside County, California. The proposed Inland Empire Energy Center will feed directly into Southern California Edison's power grid and is intended to serve the rapidly growing counties of Riverside and San Bernardino. Construction is scheduled to begin in mid-2002, with commercial operation targeted for mid-2004.
On June 20, 2001, we jointly announced with Bechtel Enterprises Holdings, Inc. that the Presiding Members' Proposed Decision, released by the California Energy Commission on June 18, 2001, recommends that the full five-member CEC approve the 600-megawatt, gas-fired Metcalf Energy Center. The CEC's final decision is expected in the third quarter 2001.
On June 28, 2001, we announced that Florida's Power Plant Siting Board granted final state regulatory approval for the proposed 529-megawatt Osprey Energy Center, to be located in Auburndale, Florida. We are the first independent power producer to receive approval of a Site Certification Application for a large-scale combined-cycle generating facility under Florida's complex Power Plant Siting Act.
Transactions Announced or Consummated Subsequent to June 30, 2001, and Recent Developments
On July 2, 2001, we announced commercial operation of our Sutter Energy Center, located near Yuba City, California. The Sutter Energy Center, the first major combined-cycle facility built in California in over a decade, is providing 540 megawatts of electricity to California on a 24 hours-a-day, seven days-a-week availability.
On July 5, 2001, we announced that we had signed a binding agreement to acquire a 1,200-megawatt natural gas-fired power plant at Saltend near Hull, Yorkshire, England from Entergy Wholesale Operations for up to approximately 562.5 million pounds sterling (US$800 million). The Saltend Energy Centre entered commercial operations in November 2000 and is one of the largest natural gas-fired electric power generating facilities in England. As a cogeneration facility, Saltend Energy Centre provides electricity and steam for BP Chemical's Hull Works plant under the terms of a 15-year agreement. The balance of the plant's output is sold into the deregulated United Kingdom power market. The facility incorporates natural gas-fired combustion turbines in combination with steam turbines to optimize fuel efficiency.
On July 9, 2001, we announced initial operation of our Los Medanos Energy Center in Pittsburg, California. This 555-megawatt facility is the second major combined-cycle facility to be licensed and built in California in over a decade and will provide electricity on a 24 hours-a-day, 7 days-a-week availability. As a cogeneration facility, the project also delivers electricity and steam to USS POSCO for use in industrial processing.
On July 10, 2001, we jointly announced with PG&E Corporation's PG&E National Energy Group that we had completed the acquisition of the 500-megawatt natural gas-fired Otay Mesa Generating Project in San Diego County. The PG&E National Energy Group developed the combined-cycle project, which was licensed by the California Energy Commission in April. Construction is expected to begin later this summer, and with completion scheduled for mid-2003, the project will be the first new power facility built in San Diego County in 30 years. Under the terms of the sale, we will build, own and operate the facility and PG&E National Energy Group will contract for up to 250 megawatts of output. The balance of the output will be sold into the California wholesale market through our subsidiary, Calpine Energy Services, LP ("CES").
On July 10, 2001, we announced the acquisition of a majority interest of Michael Petroleum Corporation, a Houston, Texas-based natural gas exploration and development company. These reserves are located exclusively in South Texas. The assets include total proved reserves of 204 bcfe and currently produce 43 mmcfe/d. In addition, this transaction provides an inventory of high quality, low risk drilling locations within a 94,000 acreage position in close proximity to the Magic Valley Generating Station and the Hidalgo Energy Center. The value of the transaction is approximately $338.5 million plus the assumption of $44.1 million of debt. The acquisition is expected to close in the third quarter of 2001.
On July 11, 2001, we jointly announced with Bechtel Enterprises Holdings, Inc. that the Application for Certification of the Russell City Energy Center met the California Energy Commission's data adequacy requirements. The project was also approved for expedited review, making the 600-megawatt Russell City Energy Center the first combined-cycle California energy project to meet the CEC's stringent qualifications for a six-month review.
On July 11, 2001, we announced plans for the 180-megawatt Los Esteros Critical Energy Facility. Located in San Jose, California, our c*Power program will supply U.S. Data Port's planned San Jose Internet Campus with highly reliable critical power and ancillary services. Construction of the facility will be accelerated so that in advance of the initiation and completion of the U.S. Data Port project we will be able to provide 180 megawatts of peaking capacity and energy to the California Department of Water Resources under a power contract beginning May 1, 2002 and continuing through April 30, 2005.
On July 16, 2001, we announced that Michael Polsky had resigned from the Board of Directors and as an officer of the Company. On July 17, 2001, we announced the appointment of Gerald Greenwald to the Board of Directors.
On July 17, 2001, we announced plans to build a 900-megawatt natural gas-fired facility called the Sherry Energy Center in Wood County, Wisconsin. We entered into two separate 10-year agreements to supply 225 megawatts and 141 megawatts of electric capacity and energy from the plant to the Wisconsin Electric Power Company and the Wisconsin Public Service Corporation, respectively. The remaining output will be sold to other Wisconsin utilities and wholesale power purchasers. Construction is expected to begin during the second quarter of 2002, with commercial operation of the simple-cycle units slated for the second quarter of 2003, and commercial operation of the combined-cycle plant expected in the second quarter of 2004.
On July 17, 2001, we signed two 5-year agreements to deliver 1,000 megawatts of power to Reliant Energy Services, Inc., a unit of Reliant Resources, Inc. The contracts will begin with the official start date of deregulation in ERCOT, which is expected to be January 1, 2002. We will serve Reliant's load from our ERCOT system of natural gas-fired power plants totaling approximately 2,700 megawatts of capacity.
On July 18, 2001, we jointly announced with Shell Energy Services Company L.L.C., a wholly owned subsidiary of Shell Oil Company, the signing of an exclusive energy agreement. We will be the exclusive provider of up to 3,000 megawatts of electricity to Shell Energy, a retail electricity provider participating in the Texas Electric Choice pilot program in the ERCOT. Beginning January 1, 2002, we will provide capacity, energy, and ancillary services to Shell for the ERCOT market in accordance with the 5-year full requirements contract.
On July 19, 2001, we announced a ten-year agreement for the sale of 100 megawatts of power to Excelon Generation's Power Team. This power will be produced by the Morris Power Plant located just southwest of Chicago, Illinois.
On August 1, 2001, we announced an agreement with Edison Mission Energy for the purchase of the remaining fifty percent equity interest in a 240-megawatt combined-cycle cogeneration facility located in Gordonsville, Virginia for $35 million. The Gordonsville facility provides electric power and steam to Virginia Electric and Power Company and the Rapidan Service Authority, respectively, under long-term contracts that expire in 2024.
On August 9, 2001, we announced plans to purchase 27 steam turbine generators from Siemens Westinghouse. We expect turbine deliveries to begin in September 2002, with full inventory in place by February 2005. Combined, the turbines represent up to 5,400 megawatts of generating capacity.
California Power Market The deregulation of the California power market has produced significant unanticipated results in the past year and a half. The deregulation froze the rates that utilities can charge their retail and business customers in California, until recent rate increases approved by the California Public Utilities Commission ("CPUC"), and prohibited the utilities from buying power on a forward basis, while wholesale power prices were not subjected to limits.
In the past year and a half, a series of factors have reduced the supply of power to California, which has resulted in wholesale power prices that have been significantly higher than historical levels. Several factors contributed to this increase. These included:
- significantly increased volatility in prices and supplies of natural gas;
- an unusually dry fall and winter in the Pacific Northwest, which reduced the amount of available hydroelectric power from that region (typically, California imports a portion of its power from this source);
- the large number of power generating facilities in California nearing the end of their useful lives, resulting in increased downtime (either for repairs or because they have exhausted their air pollution credits and replacement credits have become too costly to acquire on the secondary market); and
- continued obstacles to new power plant construction in California, which deprived the market of new power sources that could have, in part, ameliorated the adverse effects of the foregoing factors.
As a result of this situation, two major California utilities that are subject to the retail rate freeze, including PG&E, have faced wholesale prices that far exceed the retail prices they are permitted to charge. This has led to significant under-recovery of costs by these utilities. As a consequence, these utilities have defaulted under a variety of contractual obligations, including payment obligations to power generators. PG&E has defaulted on payment obligations to Calpine under Calpine's long-term QF contracts, which are subject to federal regulation under the Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"). The PG&E QF contracts are in place at eleven of our facilities and represent nearly 600 megawatts of electricity for Northern California customers.
PG&E Bankruptcy Proceedings On April 6, 2001, PG&E filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. As of April 6, 2001, we had recorded approximately $266 million in accounts receivable with PG&E under our QF contracts, plus $69 million in notes receivable not yet due and payable. As of June 30, 2001, we had recorded $292 million in accounts receivable and $84 million in notes receivable not yet due and payable. We are currently selling power to PG&E pursuant to our long-term QF contracts, and PG&E is paying on a current basis for these purchases since its bankruptcy filing. With respect to the receivables recorded under these contracts, we announced on July 6, 2001, that we had entered into a binding agreement with PG&E to modify all of our QF contracts with PG&E and that, based upon such modification, PG&E had agreed to assume all of the QF contracts. Under the terms of this agreement, we will continue to receive our contractual capacity payments under the QF contracts, plus a five-year fixed energy price component that averages 5.37 cents per kilowatt-hour in lieu of the short run avoided cost. In addition, all past due receivables under the QF contracts will be elevated to administrative priority status in the PG&E bankruptcy proceeding and will be paid to Calpine, with interest, upon the effective date of a confirmed plan of reorganization. Administrative claims enjoy priority over payments made to the general unsecured creditors in bankruptcy. The bankruptcy court approved the agreement on July 12, 2001. We cannot predict when the bankruptcy court will confirm a plan of reorganization for PG&E.
CPUC Proceedings Regarding QF Contract Pricing Our QF contracts with PG&E provide that the CPUC has the authority to determine the appropriate utility "avoided cost" to be used to set energy payments for certain QF contracts, including those for all of our QF plants in California which sell power to PG&E. Section 390 of the California Public Utility Code provides QFs the option to elect to receive energy payments based on the California Power Exchange ("PX") market clearing price. In mid-2000, our QF facilities elected this option and were paid based upon the PX zonal day ahead clearing price ("PX Price") from summer 2000 until January 19, 2001, when the PX ceased operating a day ahead market. Since that time, the CPUC has ordered that the price to be paid for energy deliveries by QFs electing the PX Price shall be based on a natural gas cost-based "transition formula." The CPUC has conducted proceedings (R.99-11-022) to determine whether the PX Price was the appropriate price for the energy component upon which to base payments to QFs which had elected the PX-based pricing option. The CPUC has issued a proposed decision to the effect that the PX price was the appropriate price for energy payments under the California Public Utility Code. However, a final decision has not been issued to date. Therefore, it is possible that the CPUC could order a payment adjustment based on a different energy price determination. We believe that the PX Price was the appropriate price for energy payments but there can be no assurance that this will be the outcome of the CPUC proceedings.
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