RELIANT ENERGY INC - 10-Q Quarterly Report

Back to GetFilings.com

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from ______________ to _______________

----------

Commission file number 1-3187

RELIANT ENERGY, INCORPORATED
(Exact name of registrant as specified in its charter)

Texas 74-0694415
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)

(713) 207-3000
(Registrant's telephone number, including area code)

----------

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

As of August 9, 2002, Reliant Energy, Incorporated had 304,088,026 shares of
common stock outstanding, including 5,338,887 ESOP shares not deemed outstanding
for financial statement purposes and excluding 166 shares held as treasury
stock.

RELIANT ENERGY, INCORPORATED
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.................................................................1
Statements of Consolidated Income (unaudited)
Three and Six Months Ended June 30, 2001 (as Restated) and 2002 ....................1
Consolidated Balance Sheets (unaudited)
December 31, 2001 and June 30, 2002 ................................................2
Statements of Consolidated Cash Flows (unaudited)
Six Months Ended June 30, 2001 and 2002 ............................................4
Notes to Unaudited Consolidated Financial Statements.....................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations of Reliant Energy and Subsidiaries...........................................46
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........................77

PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................81
Item 4. Submission of Matters to a Vote of Security Holders.................................81
Item 5. Other Information...................................................................81
Item 6. Exhibits and Reports on Form 8-K....................................................83

i

PART I. FINANCIAL INFORMATION
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

See Notes to the Company's Interim Financial Statements

1

RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)

ASSETS

See Notes to the Company's Interim Financial Statements

2

RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)

LIABILITIES AND STOCKHOLDERS' EQUITY

See Notes to the Company's Interim Financial Statements

3

RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)

See Notes to the Company's Interim Financial Statements

4

RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) BACKGROUND AND BASIS OF PRESENTATION

Included in this Quarterly Report on Form 10-Q (Form 10-Q) for Reliant
Energy, Incorporated (Reliant Energy), together with its subsidiaries
(collectively, the Company), are Reliant Energy's consolidated interim financial
statements and notes (Interim Financial Statements) including these companies'
wholly owned and majority owned subsidiaries. The Interim Financial Statements
are unaudited, omit certain financial statement disclosures and should be read
with the amended Annual Report on Form 10-K/A of Reliant Energy (Reliant Energy
Form 10-K/A) for the year ended December 31, 2001 which was filed with the
Securities and Exchange Commission (SEC) on July 5, 2002, and the Quarterly
Report on Form 10-Q of Reliant Energy for the quarter ended March 31, 2002
(First Quarter 10-Q).

RESTATEMENT

Also as more fully described and previously reported in Note 1 to the
Consolidated Financial Statements included in the Reliant Energy Form 10-K/A
(Reliant Energy 10-K/A Notes), which note is incorporated by reference herein,
on May 9, 2002, Reliant Resources, Inc. (Reliant Resources), an entity in which
Reliant Energy owns approximately 83% of the outstanding common stock,
determined that it had engaged in same-day commodity trading transactions
involving purchases and sales with the same counterparty for the same volume at
substantially the same price, which the personnel who effected these
transactions apparently did so with the sole objective of increasing volumes.
Reliant Resources commenced a review to quantify the amount and assess the
impact of these trades (round trip trades). The Audit Committees of each of the
Boards of Directors of Reliant Resources and Reliant Energy (Audit Committees)
also directed an internal investigation by outside legal counsel, with
assistance by outside accountants, of the facts and circumstances relating to
the round trip trades and related matters.

The Company reports all trading, marketing and risk management services
transactions on a gross basis with such transactions being reported in revenues
and expenses except primarily for financial gas transactions such as swaps.
Therefore, the round trip trades were reflected in both the Company's revenues
and expenses. The round trip trades should not have been recognized in revenues
or expenses (i.e., they should have been reflected on a net basis). However,
since the round trip trades were done at the same volume and substantially the
same price, they had no impact on the Company's reported cash flows, operating
income or net income.

Based on Reliant Resources' review, Reliant Resources determined that it
engaged in such round trip trades in 1999, 2000 and 2001. The results of the
Audit Committees' investigations were consistent with the results of Reliant
Resources' review. The round trip trades were for 20 million megawatt hours
(MWh) and 41 MWh of power for the three and six months ended June 30, 2001,
respectively, and 46 billion cubic feet (Bcf) of natural gas for the three and
six months ended June 30, 2001, respectively.

These transactions, referred to above, collectively had the effect of
increasing revenues, fuel and cost of gas sold expense and purchased power
expense by $1.4 billion, $131 million and $1.3 billion, respectively, for the
three months ended June 30, 2001 and by $2.6 billion, $131 million and $2.5
billion, respectively, for the six months ended June 30, 2001.

In the course of Reliant Resources' review, Reliant Resources also
identified and determined that it should record on a net basis several
transactions for energy related services (not involving round trip trades) that
totaled $17 million and $19 million for the three and six months ended June 30,
2001, respectively. These transactions were originally recorded on a gross
basis.

In addition, during the May 2001 through September 2001 time frame, Reliant
Resources entered into four structured transactions involving a series of
forward or swap contracts to buy and sell an energy commodity in 2001 and to buy
and sell an energy commodity in 2002 or 2003 (four structured transactions). The
four structured transactions were intended to increase future cash flow and
earnings and to increase certainty associated with future cash flow and
earnings, albeit at the expense of 2001 cash flow and earnings. Each series of
contracts in a structure

5

were executed with the same counterparty. The contracts in each structure were
offsetting in the aggregate in terms of physical attributes. The transactions
that settled during the three and six months ended June 30, 2001 were previously
recorded on a gross basis with such transactions being reported in revenues and
expenses which resulted in $323 million of revenues, $161 million in fuel and
cost of gas sold and $162 million of purchased power expense being recognized in
each period. Having further reviewed the transactions, Reliant Resources now
believes these transactions should have been accounted for on a net basis.

The consolidated financial statements for the three and six months ended
June 30, 2001 have been restated from amounts previously reported to reflect the
transactions described above on a net basis. The restatement had no impact on
previously reported consolidated cash flows, operating income or net income. A
summary of the principal effects of the restatement are as follows for the three
and six months ended June 30, 2001: (Note - Those line items for which no change
in amounts are shown were not affected by the restatement.)

(1) In the fourth quarter 2001, the Company changed the classification of
receipts of business interruption insurance claims from other non-operating
income to operating revenues. Receipts of $4 million for both the three and six
months ended June 30, 2001 have been reclassified to conform to this
presentation. In addition, as previously reported amounts reflect the
reclassification of the Company's remaining Latin America operations as a
result of the adoption of SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144). For further discussion of the
effect of adoption of SFAS No. 144 on the Company's financial statement, see
Note 2.

The restatement did not impact earnings per share or the Statement of
Consolidated Cash Flows for 2001.

6

In addition to the round trip trades described above, Reliant Resources'
review and the Audit Committees' investigation also considered other
transactions executed on the same day at the same volume, price and delivery
terms and with the same counterparty. These transactions were executed in the
normal course of Reliant Resources' trading and marketing activities, were
historically reported on a gross basis, and were not material.

Also as more fully described in Note 1 to the Reliant Energy 10-K/A Notes,
during the fourth quarter of 2000, two power generation swap contracts with a
fair value of $261 million were terminated and replaced with a substantially
similar contract providing for physical delivery and designated to hedge
electric generation. The termination of the original contracts and execution of
the replacement contract represented a substantive modification to the original
contract. As a result, upon termination of the original contracts, a contractual
liability representing the fair value of the original contracts and a deferred
asset of equal amount should have been recorded. As of January 1, 2001, in
connection with the adoption of Statement of Financial Accounting Standards
(SFAS), "Accounting for Derivative Instruments and Hedging Activities," as
amended (SFAS No. 133), the deferred asset should have been recorded as a
transition adjustment to other comprehensive income totaling $170 million. The
liability and transition adjustment should have been amortized on a
straight-line basis over the term of the power generation contract replacing the
terminated power generation contracts (through May 2004). Reliant Resources
previously did not give accounting recognition to these transactions. As a
result, the Company restated its Consolidated Balance Sheets as of December 31,
2000 and 2001 and the Statement of Consolidated Stockholder's Equity and
Comprehensive Income for the year ended December 31, 2001 in the Reliant Energy
Form 10-K/A. The Company has restated its comprehensive income disclosure for
the three and six months ended June 30, 2001 from amounts previously reported,
to effect this transaction as described above. The restatement increased
comprehensive income by $12 million from a total comprehensive income of $608
million, as previously reported, to $620 million, as restated, for the three
months ended June 30, 2001 and decreased comprehensive income by $146 million
(including the $170 million transition adjustment discussed above) from a total
comprehensive income of $805 million, as previously reported, to $659 million,
as restated, for the six months ended June 30, 2001. The restatement had no
impact on the Company's reported consolidated cash flows, operating income or
net income.

BASIS OF PRESENTATION

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

The Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations for the respective periods. Amounts
reported in the Company's Statements of Consolidated Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (a) seasonal fluctuations in demand for energy and energy
services, (b) changes in energy commodity prices, (c) timing of maintenance and
other expenditures and (d) acquisitions and dispositions of businesses, assets
and other interests. In addition, certain amounts from the prior year have been
reclassified to conform to the Company's presentation of financial statements in
the current year. These reclassifications do not affect the earnings of the
Company.

The following notes to the consolidated financial statements in the Reliant
Energy Form 10-K/A relate to certain contingencies. These notes, as updated
herein, are incorporated herein by reference:

Reliant Energy 10-K/A Notes: Note 2(e) (Long-Lived Assets and Intangibles),
Note 2(f) (Regulatory Assets and Liabilities), Note 3 (Business
Acquisitions), Note 4 (Regulatory Matters), Note 5 (Derivative Financial
Instruments), Note 8 (Indexed Debt Securities (ACES and ZENS) and AOL Time
Warner Securities), Note 14 (Commitments and Contingencies), Note 21
(Bankruptcy of Enron Corp. and its Affiliates) and Note 22 (Subsequent
Events).

For information regarding certain legal, tax and regulatory proceedings and
environmental matters, see Note 13.

RESTRUCTURING

Reliant Energy is in the process of separating its regulated and
unregulated businesses into two publicly traded companies that will be
independent of each other: CenterPoint Energy, Inc. (CenterPoint Energy) and
Reliant Resources. In December 2000, Reliant Energy transferred a significant
portion of its unregulated businesses to Reliant Resources, which, at the time,
was a wholly owned subsidiary of Reliant Energy. Reliant Resources conducted an
initial public offering of approximately 20% of its common stock in May 2001. In
December 2001, Reliant Energy's shareholders approved an agreement and plan of
merger by which, subject to regulatory approvals, the following will occur
(which is referred to herein as the Restructuring):

o CenterPoint Energy will become the holding company for the Reliant
Energy group of companies;

o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and

o each share of Reliant Energy common stock will be converted into one
share of CenterPoint Energy common stock.

After the Restructuring, the Company plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing the shares of common stock
of

7

Reliant Resources that the Company owns to the Company's shareholders (which is
referred to herein as the Distribution). The Company currently expects to
complete the Restructuring by August 31, 2002 and the Distribution early in the
fall of 2002. However, no assurance can be provided that the Distribution will
occur as described above or that it will occur within this time period. From the
consummation of the Restructuring until the Distribution, the Company expects
that CenterPoint Energy will do business under the name Reliant Energy,
Incorporated and that CenterPoint Energy's common stock will trade under the
symbol "REI".

On July 5, 2002, Reliant Energy received an order from the Securities and
Exchange Commission (SEC) approving Reliant Energy's restructuring plan and the
Distribution under the Public Utility Holding Company Act of 1935 (1935 Act). On
July 31, 2002, Reliant Energy received a private letter ruling from the Internal
Revenue Service which confirms that the Distribution will be tax-free to Reliant
Energy and its shareholders.

Contemporaneous with the Restructuring, CenterPoint Energy expects to
register and become subject, with its subsidiaries, to regulation as a
registered holding company system under the 1935 Act. The 1935 Act directs the
SEC to regulate, among other things, financings, sales or acquisitions of assets
and intra-system transactions.

In connection with the Restructuring, in order to enable CenterPoint Energy
ultimately to satisfy the requirements for an exemption from regulation as a
registered holding company under the 1935 Act, Reliant Energy is seeking
authority to divide the gas distribution businesses conducted by Reliant Energy
Resources Corp.'s (RERC Corp.) three unincorporated gas distribution divisions,
Reliant Energy Entex, Reliant Energy Arkla and Reliant Energy Minnegasco, among
three separate entities. The entity that will hold the Reliant Energy Entex
assets will also hold ownership of Reliant Energy Resources' natural gas
pipelines and gathering business. Reliant Energy has obtained approval of these
transactions from the public service commissions of Minnesota, Louisiana,
Mississippi, Oklahoma and Arkansas. Although the Company expects that this
business restructuring of RERC Corp. can be completed, the Company can provide
no assurance that this will, in fact, occur, or that CenterPoint Energy will
ultimately be exempt from registration under the 1935 Act. For further
information on the RERC Corp. restructuring, see "Our Business --RERC Corp.
Restructuring" in Item 1 of the Reliant Energy Form 10-K/A, which is
incorporated herein by reference.

RETAIL ELECTRIC DEREGULATION

During 2001, the Electric Operations business segment reflected the
regulated electric utility business, including generation, transmission and
distribution, and retail electric sales. As of January 1, 2002, with the opening
of the Texas market to full retail electric competition, generation and retail
sales were deregulated. Retail electric sales involve the sale of electricity
and related services to end users of electricity and were included as part of
the bundled regulated electric utility business prior to 2002. Retail electric
sales are now reported as the Retail Energy business segment of Reliant
Resources. Although the Company's retail sales are now conducted by Reliant
Resources, retail customers remained regulated customers of Reliant Energy HL&P
through the date of their first meter reading in January 2002. Sales of
electricity to retail customers in 2002 prior to this meter reading are
reflected in the Electric Transmission and Distribution business segment.

Beginning in 2002, Reliant Energy is reporting two new business segments
for what was the former Electric Operations business segment:

o Electric Transmission and Distribution; and

o Electric Generation.

The previously regulated generation operations in Texas are being reported
in the new Electric Generation business segment and will be called Texas Genco
after the Restructuring. The transmission and distribution function is now
reported separately in the Electric Transmission and Distribution business
segment, which also includes all revenues and the effects from
generation-related regulatory assets recoverable by the regulated utility,
including the Excess Cost Over Market (ECOM) true-up component of stranded
costs. For additional information regarding regulatory matters affecting the
Company's electric segments, see Note 4 to the Reliant Energy 10-K/A Notes,
which note is incorporated herein by reference, and Note 3 below.

8

(2) NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141 "Business Combinations" (SFAS No. 141). SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting and broadens the criteria for recording intangible
assets separate from goodwill. Recorded goodwill and intangibles will be
evaluated against these new criteria and may result in certain intangibles being
transferred to goodwill, or alternatively, amounts initially recorded as
goodwill may be separately identified and recognized apart from goodwill. The
Company adopted the provisions of the statement which apply to goodwill and
intangible assets acquired prior to June 30, 2001 on January 1, 2002. The
adoption of SFAS No. 141 did not have a material impact on the Company's
historical results of operations or financial position.

In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," while retaining many of the requirements of these two statements.
Under SFAS No. 144, assets held for sale that are a component of an entity will
be included in discontinued operations if the operations and cash flows will be
or have been eliminated from the ongoing operations of the entity and the entity
will not have any significant continuing involvement in the operations
prospectively. SFAS No. 144 did not materially change the methods used by the
Company to measure impairment losses on long-lived assets, but may result in
additional future dispositions being reported as discontinued operations than
was previously permitted. The Company adopted SFAS No. 144 on January 1, 2002.
As a result of the adoption of SFAS No. 144, the Company's remaining Latin
America operations have been presented on a gross basis in the consolidated
financial statements.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a sale-leaseback transaction. The changes related to debt extinguishment will
be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. The Company will apply this guidance prospectively.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The
principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for cost associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with an exit or disposal activity when it is incurred. A
liability is incurred when a transaction or event occurs that leaves an entity
little or no discretion to avoid the future transfer or use of assets to settle
the liability. Under EITF No. 94-3, a liability for an exit cost was recognized
at the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002 with early application encouraged. The Company will apply the provisions of
SFAS No. 146 to all exit or disposal activities initiated after December 31,
2002.

See Note 4 for a discussion of the Company's adoption of SFAS No. 133, on
January 1, 2001 and adoption of subsequent cleared guidance. See Note 6 for a
discussion of the Company's adoption of SFAS No. 142 "Goodwill and Other
Intangible Assets" (SFAS No. 142) on January 1, 2002.

9

In June 2002, the EITF reached a consensus on EITF No. 02-03 that all
mark-to-market gains and losses on energy trading contracts should be shown net
in the income statement whether or not settled physically. An entity should
disclose the gross transaction volumes for those energy-trading contracts that
are physically settled. The EITF did not reach a consensus on whether
recognition of dealer profit, or unrealized gains and losses at inception of an
energy-trading contract, is appropriate in the absence of quoted market prices
or current market transactions for contracts with similar terms. The FASB staff
indicated that until such time as a consensus is reached, the FASB staff will
continue to hold the view that previous EITF consensus do not allow for
recognition of dealer profit, unless evidenced by quoted market prices or other
current market transactions for energy trading contracts with similar terms and
counterparties. During the six months ended June 30, 2002, the Company recorded
$46 million of fair value at the contract inception related to trading and
marketing activities. The consensus on presenting gains and losses on energy
trading contracts net is effective for financial statements issued for periods
ending after July 15, 2002. Upon application of the consensus, comparative
financial statements for prior periods should be reclassified to conform to the
consensus. The Company currently reports all trading, marketing and risk
management services transactions on a gross basis with such transactions being
reported in revenues and expenses except primarily for financial gas
transactions such as swaps. Beginning with the quarter ended September 30, 2002,
the Company will report all energy trading and marketing activities on a net
basis in the Statements of Consolidated Income pursuant to EITF No. 02-03.
Although the Company is in the process of determining the effect of the adoption
of EITF No. 02-03 on its Statements of Consolidated Income, the Company expects
the adoption will result in a substantial reduction in operating revenues, fuel
and cost of gas sold, and purchased power.

(3) REGULATORY MATTERS

(a) Excess Cost Over Market (ECOM) True-Up.

Reliant Energy's Electric Generation business segment auctions entitlements
to all of its installed electric generation capacity. In September, October and
December 2001, and March and July 2002, it conducted auctions, as required by
the Public Utility Commission of Texas (Texas Utility Commission) and its Master
Separation Agreement with Reliant Resources.

Excluding reserves for planned and forced outages and certain entitlements
which failed to sell during the auctions, the Company's Texas generation
business has sold through these auctions entitlements to all of its capacity
through 2002 and 12% of its capacity for 2003. In the contractually mandated
auctions held so far, Reliant Resources has purchased 45% of the 2002 capacity
sold by Reliant Energy and 51% of Reliant Energy's 2003 capacity sold in the
auctions. These purchases have been made either through the exercise by Reliant
Resources of its contractual rights to purchase 50% of the entitlements
auctioned in the contractually mandated auctions or through the submission of
bids in the auctions. Capacity entitlements which did not sell during the
auctions will be sold on a short-term basis as conditions make such sales
profitable to the Company.

The capacity auctions were consummated at market-based prices that are
substantially below the historical regulated return on the facilities in the
Company's Texas generation business. The Texas electric restructuring law
provides for the recovery in a "true-up" proceeding in 2004 (2004 True-Up
Proceeding) of any difference between market power prices and the earlier
estimates of those market prices by the Texas Utility Commission, using the
prices received in the auctions required by the Texas Utility Commission as the
measure of market prices. For the three months and six months ended June 30,
2002, respectively, Reliant Energy recorded approximately $170 million and $311
million in revenue related to the recovery of the difference between the market
power prices and the Texas Utility Commission's earlier estimates. For
additional information regarding the capacity auctions and the related true-up
proceeding, please read Note 4(a) to the Reliant Energy 10-K/A Notes.

(b) Generation Asset Impairment Contingency.

The Company evaluates the recoverability of its long-lived assets in
accordance with SFAS No. 144. As of June 30, 2002, no impairment had been
indicated in its Texas generation assets. The Company anticipates that future
events, such as the trading price of the stock after the expected distribution
to the Company's shareholders of up to 20% of the outstanding stock of the
subsidiary that will conduct the Company's Texas generation operations, a change
in the estimated holding period of the Texas generation assets, or a change in
market demand for electricity, will require the Company to re-evaluate these
assets for impairment between now and 2004. If an impairment is indicated, it
could be material and may not be fully recoverable through the 2004 True-Up
Proceeding.

10

The Texas electric restructuring law provides for the Company to recover
the regulatory book value of its Texas generating assets to the extent the
regulatory book value exceeds the estimated market value. If the Texas
generating assets are sold in the future, a loss on sale of these assets, or an
impairment of the recorded recoverable electric generation plant mitigation
regulatory asset, will occur to the extent the recorded book value of the Texas
generating assets exceeds the regulatory book value. As of June 30, 2002, the
recorded book value was $629 million in excess of the regulatory book value.
This amount declines as the recorded book value is depreciated and increases by
the amount of non-environmental capital expenditures. For further discussion of
the difference between the regulatory book value and the recorded book value,
see Note 4(a) to the Reliant Energy 10-K/A Notes.

(c) Regulatory Assets Contingency.

As of June 30, 2002, in contemplation of the 2004 True-up Proceeding, the
Company's Electric Transmission and Distribution business segment has recorded a
regulatory asset of $2.0 billion representing the estimated future recovery of
previously incurred stranded costs, which includes $1.0 billion of previously
recorded accelerated depreciation (an amount equal to earnings above a stated
overall annual rate of return on invested capital that was used to recover the
Company's investment in generation assets) plus redirected depreciation, both
reversed in 2001. Offsetting this regulatory asset is the $1.0 billion
regulatory liability to refund the excess mitigation to ratepayers. This
estimated recovery is based upon current projections of the market value of the
Company's Texas generation assets to be covered by the 2004 True-up Proceeding
calculations. These projections depend on many assumptions which may not occur,
for example, the construction of additional generating units in Texas. The
regulatory liability reflects a current refund obligation arising from prior
mitigation of stranded costs deemed excessive by the Texas Utility Commission.
The Company's Electric Transmission and Distribution business segment began
refunding excess mitigation credits with the January 2002 unbundled bills, these
credits to be refunded over a seven year period. Because accounting principles
generally accepted in the United States of America require the Company to
estimate fair market values in advance of the final reconciliation, the
financial impacts of the Texas electric restructuring law with respect to the
final determination of stranded costs in the 2004 True-Up Proceeding are subject
to material changes. Factors affecting such changes may include estimation risk,
uncertainty of future energy and commodity prices and the economic lives of the
plants. If events were to occur that made the recovery of some of the remaining
generation related regulatory assets no longer probable, the Company would write
off the unrecoverable balance of such assets as a charge against earnings.

(d) Fuel Reconciliation Contingency.

Reliant Energy filed its final fuel reconciliation proceeding with the
Texas Utility Commission on July 1, 2002. Although previous fuel reconciliation
proceedings have generally covered three year periods, this filing covers $8.6
billion in fuel expense and interest incurred between August 1, 1997 and January
30, 2002. Also included in this amount is an under-recovery of $94 million,
which was the balance as of July 31, 1997. During this period of time, Reliant
Energy collected $8.5 billion in fuel revenues. This results in an
undercollection, including interest, of $144 million as of June 30, 2002.
Current substantive rules require that the Texas Utility Commission rule on this
case by March 1, 2003. A procedural schedule has been set with a hearing
scheduled to begin November 19, 2002. Under the Texas electric restructuring
law, the final fuel balance found to be reasonable by the Texas Utility
Commission will be reflected in the 2004 true-up proceeding.

(e) Arkla Rate Case.

In November 2001, Reliant Energy Arkla filed a rate request in Arkansas
seeking rates to yield approximately $47 million in additional annual revenue.
On August 9, 2002, a settlement was approved by the Arkansas Public Service
Commission (APSC) which will result in an increase in base rates of
approximately $32 million annually. In addition, the APSC approved a gas main
replacement surcharge which is expected to provide $2 million of additional
revenue in 2003 and additional amounts in subsequent years. The settlement
provides for a new residential rate design which increases the monthly customer
charge. The new rates are expected to be effective September 21, 2002.

(f) Oklahoma Rate Case.

In May 2002, Reliant Energy Arkla filed a rate change request for an
increase in rates that would yield approximately $13.7 million annually in
Oklahoma. A decision on this request is expected from the Oklahoma Corporation
Commission no later than early 2003.

(g) City of Tyler, Texas Hearing on Gas Costs.

By letter to Reliant Energy Entex dated July 31, 2002, the City of Tyler,
Texas expressed "serious concerns" regarding amounts that Entex has paid for
gas purchased for resale to residential and small commercial customers in that
city under supply agreements in effect since 1992. Entex's gas costs for its
Tyler system are recovered from customers pursuant to tariffs approved by the
city and filed with both the city and the Railroad Commission of Texas. In the
July 31 letter, the city forwarded various computations of what it believes to
be excessive costs ranging from approximately $2.8 million to $39.2 million.
The City has called a hearing for September 25, 2002 to consider these issues.
The Company believes (i) that all gas costs for Entex's Tyler distribution
system have been properly included and recovered from customers pursuant to
Entex's filed tariffs (ii) that the City has no legal or factual support for
the statements made in its letter and (iii) that the city has no authority to
require or demand refunds of any amounts Entex has charged its customers in the
City of Tyler.

(4) DERIVATIVE FINANCIAL INSTRUMENTS

Adoption of SFAS No. 133 on January 1, 2001 resulted in an after-tax
increase in net income of $61 million and a cumulative after-tax increase in
accumulated other comprehensive loss of $422 million. For additional information
regarding the adoption of SFAS No. 133 and the Company's accounting policies for
derivative financial instruments, see Note 5 to the Reliant Energy 10-K/A Notes,
which note is incorporated herein by reference.

The application of SFAS No. 133 is still evolving as the FASB clears issues
submitted for consideration. During the second quarter of 2001, an issue that
applies exclusively to the electric industry and allows the normal purchases and
normal sales exception for option-type contracts if certain criteria are met was
approved by the FASB with an effective date of July 1, 2001. The adoption of
this cleared guidance had no impact on the Company's results of operations.
Certain criteria of this issue were revised in October and December 2001 and
became effective on April 1, 2002. The adoption of the revised guidance did not
impact the Company's consolidated financial statements.

11

During the third quarter of 2001, the FASB cleared an issue related to
application of the normal purchases and normal sales exception to contracts that
combine forward and purchased option contracts. The effective date of this
guidance was April 1, 2002, and the effect of adoption of this guidance did not
impact the Company's consolidated financial statements.

Cash Flow Hedges. During the six months ended June 30, 2002, the amount of
hedge ineffectiveness recognized in earnings from derivatives that are
designated and qualify as cash flow hedges was a $12 million gain. During the
six months ended June 30, 2001, the amount of hedge ineffectiveness recognized
in earnings from derivatives that are designated and qualify as cash flow hedges
was immaterial. No component of the derivative instruments' gain or loss was
excluded from this assessment of effectiveness. During the six months ended June
30, 2002, a $1.1 million deferred loss was recognized in earnings as a result of
the discontinuance of cash flow hedges because it was no longer probable that
the forecasted transaction would occur. As of June 30, 2002, the Company expects
$31 million in accumulated other comprehensive income to be reclassified into
net income during the next twelve months.

Interest Rate Swaps. As of June 30, 2002, the Company had outstanding
interest rate swaps with an aggregate notional amount of $2.0 billion to fix the
interest rate applicable to floating rate short-term debt and floating rate
long-term debt. Of these swaps, $0.8 billion relating to short-term debt do not
qualify as cash flow hedges under SFAS No. 133, and are marked to market in the
Company's Consolidated Balance Sheets with changes reflected in interest expense
in the Statements of Consolidated Income. The remaining $1.2 billion in swaps
relating to both short-term and long-term debt qualify for hedge accounting
under SFAS No. 133 and the periodic settlements are recognized as an adjustment
to interest expense in the Statements of Consolidated Income over the term of
the swap agreements. The Company has also entered into forward-starting interest
rate swaps having an aggregate notional amount of $2.0 billion to hedge the
interest rate on future offerings of long-term fixed-rate notes. These swaps
qualify as cash flow hedges under SFAS No. 133. On May 9, 2002, the Company
liquidated $500 million of the forward starting interest rate swaps that were
entered into in January 2002. The liquidation of these swaps resulted in a loss
of $3 million, which was recorded in other comprehensive income and will be
amortized into interest expense in the same period during which the forecasted
interest payment affects earnings. Should the forecasted interest payments no
longer be probable, any remaining deferred amount will be recognized immediately
as an expense. In the second quarter of 2002, an expense of $1.7 million was
recorded as a result of changing the start date on $1.0 billion of forward
starting swaps from June 2002 to September 2002. The maximum length of time the
Company is hedging its exposure to the payment of variable interest rates is 8
years.

Hedge of Net Investment in Foreign Subsidiaries. The Company has
substantially hedged its net investment in its European subsidiaries to reduce
the Company's exposure to changes in foreign exchange rates through a
combination of Euro-denominated borrowings, foreign currency swaps and foreign
currency option contracts. During the six months ended June 30, 2002, the
derivative and non-derivative instruments designated as hedging the net
investment in the Company's European subsidiaries resulted in a loss of $16
million, which is included in the balance of the cumulative translation
adjustment in accumulated other comprehensive income.

Other Derivatives. In December 2000, the Dutch parliament adopted
legislation allocating to the Dutch generation sector, including Reliant Energy
Power Generation Benelux N.V. (REPGB), financial responsibility for various
out-of-market contracts and other liabilities. The legislation became effective
in all material respects on January 1, 2001. In particular, the legislation
allocated to the Dutch generation sector, including REPGB, financial
responsibility to purchase imported electricity and gas under certain long-term
power contracts and a gas contract entered into by NEA B.V. (NEA), the regulated
entity which formerly purchased and sold energy in the Netherlands.

The Company accounts for the gas supply contract at fair value as a
non-trading derivative pursuant to SFAS No. 133. Prior to amending the
electricity import contracts in May 2002, the Company also accounted for the
electricity import contracts at fair value as non-trading derivatives pursuant
to SFAS No. 133. However, subsequent to amending the electricity import
contracts, the Company began to account for the electricity contracts as a part
of the Company's energy trading activities.

As of December 31, 2001, the Company recorded a liability of $369 million
for stranded cost gas and electric commitments in non-trading derivative
liabilities. As of June 30, 2002, the Company recorded a liability of $155
million for the REPGB stranded cost gas supply contract in non-trading
derivative liabilities. Pursuant to SFAS No.

12

133, during the three and six months ended June 30, 2002, the Company recognized
a $3 million loss and net $16 million gain, respectively, recorded in fuel
expense related to changes in the valuation of these non-trading derivative
liabilities, excluding the effects of the gain related to amending the two power
contracts as discussed in Note 13(e).

For additional information regarding REPGB's obligations under these
out-of-market contracts and the related indemnification by former shareholders
of these stranded costs during 2001, see Note 14(h) to the Reliant Energy 10-K/A
Notes.

During the May 2001 through September 2001 time frame, Reliant Resources
entered into two structured transactions which were recorded on the balance
sheet in non-trading derivative assets and liabilities involving a series of
forward contracts to buy and sell an energy commodity in 2001 and to buy and
sell an energy commodity in 2002 or 2003. The change in fair value of these
derivative assets and liabilities must be recorded in the Statement of Income
for each reporting period. As of December 31, 2001, the Company has recognized
$221 million of non-trading derivative assets and $103 million of non-trading
derivative liabilities related to these transactions. During the three and six
months ended June 30, 2002, $26 million and $50 million, respectively, of net
non-trading derivative assets were settled related to these transactions, and a
pre-tax unrealized gain of $1 million and $2 million, respectively, was
recognized. As of June 30, 2002, the Company has recognized $163 million of
non-trading derivative assets and $93 million of non-trading derivative
liabilities related to these transactions.

(5) ACQUISITION OF ORION POWER HOLDINGS, INC.

In February 2002, Reliant Resources acquired all of the outstanding shares
of common stock of Orion Power Holdings, Inc. (Orion Power) for $26.80 per share
in cash for an aggregate purchase price of $2.9 billion. Reliant Resources
funded the Orion Power acquisition with a $2.9 billion credit facility and $41
million of cash on hand. As a result of the acquisition, Reliant Resources'
consolidated net debt obligations also increased by the amount of Orion Power's
net debt obligations. As of February 19, 2002, Orion Power's debt obligations
were $2.4 billion ($2.1 billion net of restricted cash pursuant to debt
covenants). Orion Power is an electric power generating company formed in March
1998 to acquire, develop, own and operate power-generating facilities in certain
deregulated wholesale markets throughout North America. As of February 19, 2002,
Orion Power had 81 power plants with a total generating capacity of 5,644 MW and
two development projects with an additional 804 MW of capacity under
construction. As of June 30, 2002, both projects under construction had reached
commercial operation.

The Company accounted for the acquisition as a purchase with assets and
liabilities of Orion Power reflected at their estimated fair values. The
Company's fair value adjustments included adjustments in property, plant and
equipment, contracts, severance liabilities, debt, unrecognized pension and
postretirement benefits liabilities and related deferred taxes. The Company
expects to finalize these fair value adjustments no later than February 2003,
based on valuations of property, plant and equipment, intangible assets and
other assets and obligations.

The Company's results of operations include the results of Orion Power only
for the period beginning February 19, 2002. The following table presents
selected financial information and unaudited pro forma information for the three
months ended June 30, 2001 and six months ended June 30, 2001 and 2002, as if
the acquisition had occurred on January 1, 2001 and 2002, as applicable.

These unaudited pro forma results, based on assumptions deemed appropriate
by the Company's management, have been prepared for informational purposes only
and are not necessarily indicative of the amounts that would have resulted if
the acquisition of Orion Power had occurred on January 1, 2001 and 2002, as
applicable. Purchase-related adjustments to the results of operations include
the effects on depreciation and amortization, interest expense, interest income
and income taxes. The unaudited pro forma condensed consolidated financial
statements reflect the acquisition of Orion Power in accordance with SFAS No.
141 and SFAS No. 142. For additional information regarding the Company's
adoption of SFAS No. 141 and SFAS No. 142, see Notes 2 and 6.

(6) GOODWILL AND INTANGIBLES

In July 2001, the FASB issued SFAS No. 142, which provides that goodwill
and certain intangibles with indefinite lives will not be amortized into results
of operations, but instead will be reviewed periodically for impairment and
written down and charged to results of operations only in the periods in which
the recorded value of goodwill and certain intangibles with indefinite lives is
more than its fair value. The Company adopted the provisions of the statement
which apply to goodwill and intangible assets acquired prior to June 30, 2001 on
January 1, 2002.

With the adoption of SFAS No. 142, the Company ceased amortization of
goodwill as of January 1, 2002. A reconciliation of previously reported net
income and earnings per share to the amounts adjusted for the exclusion of
goodwill amortization follows:

The components of the Company's other intangible assets consist of the
following:

The Company recognizes specifically identifiable intangibles, including air
emissions regulatory allowances and water and land use rights and permits, when
specific rights and contracts are acquired. The Company has no intangible assets
with indefinite lives recorded as of June 30, 2002. The Company amortizes air
emissions regulatory allowances primarily on a units-of-production basis as
utilized. The Company amortizes other acquired intangibles, excluding
contractual rights, on a straight-line basis over the lesser of their
contractual or estimated useful lives.

In connection with the acquisition of Orion Power, Reliant Resources
recorded the fair value of certain fuel and power contracts acquired. Reliant
Resources estimated the fair value of the contracts using forward pricing curves
over the life of each contract. Those contracts for which net fair value
exceeded book value at the date of acquisition were recorded to intangible
assets (Contractual Rights) and those contracts for which net fair value was
below book value at the date of acquisition (Contractual Obligations) were
recorded to other current and long-term liabilities in the Consolidated Balance
Sheet.

Contractual Rights and Contractual Obligations are amortized to fuel
expense and revenues, as applicable, on the pattern in which the economic
effects are estimated to be realized over the contractual lives. Amortization in
future periods will be disclosed as the purchase price allocation is finalized.

Amortization expense for other intangibles, excluding Contractual Rights,
for the three months ended June 30, 2001 and 2002 was $7 million and $4 million,
respectively. Amortization expense for other intangibles, excluding Contractual
Rights, for the six months ended June 30, 2001 and 2002 was $31 million and $9
million, respectively. Reliant Resources amortized $7 million of Contractual
Rights and $10 million of Contractual Obligations during both the three and six
months ended June 30, 2002. Estimated amortization expense, excluding
Contractual Rights, for the remainder of 2002 and the five succeeding fiscal
years is as follows (in millions):

15

2002........................................ $ 8
2003........................................ 15
2004........................................ 16
2005........................................ 16
2006........................................ 15
2007........................................ 15
---------
Total..................................... $ 85
=========

Changes in the carrying amount of goodwill for the six months ended June
30, 2002, by reportable business segment, are as follows:

The Company is in the process of determining further effects of adoption of
SFAS No. 142 on its consolidated financial statements, including the review of
goodwill for impairment. The Company has completed its review pursuant to SFAS
No. 142 for its reporting units in the Natural Gas Distribution and Pipelines
and Gathering business segments. No impairment was indicated as a result of this
assessment. Reliant Resources has not completed their review pursuant to SFAS
No. 142 for their reporting units. Reliant Resources has completed, the first
step of the goodwill impairment test, used to identify potential impairments,
which compares the fair value of a reporting unit with its carrying amount,
including goodwill. Based on the first step of the goodwill impairment test,
Reliant Resources' European Energy business segment's goodwill is impaired by
approximately $250 million. Reliant Resources believes that its final impairment
loss will approximate the impairment loss indicated in the first step of the
goodwill impairment. Reliant Resources has retained an outside valuation firm to
assist in their review and will finalize their review of goodwill of the
European Energy business segment during 2002. The impairment loss resulting from
the transitional impairment test will be recorded retroactively as a cumulative
effect of a change in accounting principle for the quarter ended March 31, 2002.
Based on the first step of the goodwill impairment test, no other Reliant
Resources' reporting units' goodwill was impaired.

16

(7) COMPREHENSIVE INCOME

The following table summarizes the components of total comprehensive
income:

Included in "Reclassification of deferred loss (gain) from cash flow hedges
realized in net income" above for the six months ended June 30, 2001 and 2002 is
$12 million of amortization for both the three months ended March 31, 2001 and
2002 related to the amortization of the transition adjustment arising from the
termination and replacement of two power generation swap contracts referred to
in Note 1. Included in "Cumulative effect of adoption of SFAS No. 133" above for
the six months ended June 30, 2001 is a $170 million transition adjustment
referred to in Note 1. Such amounts have not been previously reported in the
Company's comprehensive income disclosure for the three months ended March 31,
2001 and 2002.

(8) SHORT-TERM BORROWINGS

Reliant Energy (to become CenterPoint Energy subsequent to the Restructuring),
excluding Reliant Resources

Credit Facilities. As of June 30, 2002, Reliant Energy (excluding Reliant
Resources) had credit facilities, including facilities of Houston Industries
FinanceCo LP (FinanceCo) and RERC Corp., that provided for an aggregate of $5.2
billion in committed credit. As of June 30, 2002, $4.5 billion was outstanding
under these facilities including $1.0 billion of commercial paper supported by
the facilities, borrowings of $3.5 billion and letters of credit of $2.5
million.

The following table summarizes amounts available under these credit
facilities at June 30, 2002 and commitments expiring in 2002 (in millions):

In July 2002, the termination dates of the $400 million Reliant Energy
facility and the $4.3 billion of FinanceCo facilities were extended to October
10, 2002. The termination date of each of these facilities may be changed from
October 10, 2002 to September 10, 2002 upon direction prior to September 5, 2002
from banks with aggregate commitments of at least 51% of the total amount of the
particular facility.

Reliant Energy expects to replace up to $4.7 billion of existing credit
facilities of Reliant Energy and FinanceCo which expire on October 10, 2002 with
new 364-day facilities. Facilities aggregating $4.7 billion are expected to be
sufficient to meet Reliant Energy's short-term liquidity needs. Proceeds from an

17

expected debt issuance in the capital markets will be used to retire a portion
of Reliant Energy's short-term debt, and the amount of credit facilities needed
for liquidity purposes may be reduced in the event such proceeds are received.
The terms of any new credit facilities are expected to be adversely affected by
the leverage of Reliant Energy, the amount of bank capacity utilized by Reliant
Energy and its subsidiaries, any delay in the date of Restructuring and
Distribution, any reduction or withdrawal of one or more of Reliant Energy's
credit ratings, conditions in the bank market and factors affecting Reliant
Energy's industry. These same factors are expected to make the syndication of
new credit facilities more difficult. If Reliant Energy is unable to replace
its existing credit facilities on terms that are acceptable to it, Reliant
Energy's financial condition and future results of operations could be
materially adversely affected.

Pursuant to the terms of the existing agreements (but subject to certain
conditions precedent which Reliant Energy anticipates will be met) the revolving
credit agreements aggregating $4.3 billion of FinanceCo will terminate and
CenterPoint Energy revolving credit facilities of the same amount and with the
same termination dates will become effective on the date of Restructuring. There
is a ratings-related condition precedent to the conversion from the existing
FinanceCo bank credit facilities to facilities under which CenterPoint Energy
will become the obligor. The condition precedent requires that CenterPoint
Energy's senior long-term debt be rated at least BBB by Standard & Poors Ratings
Group (S&P) and Baa2 by Moody's Investors Service, Inc. (Moody's) at the time of
Restructuring. Indicative ratings on such debt are BBB from S&P and Baa2 from
Moody's. Reliant Energy believes that it could obtain a waiver of this
condition, if necessary. However, if Reliant Energy was unable to obtain such a
waiver, the facilities would remain obligations of FinanceCo until the earlier
of 90 days after the date of Restructuring or the expiration of the facilities
in October 2002, subject to compliance with applicable covenants. See Note
15(d) for a discussion of Reliant Energy's credit ratings.

The $150 million RERC Corp. receivables facility was scheduled to expire on
August 14, 2002. RERC Corp. has extended the facility to October 31, 2002,
during which time RERC Corp. expects to negotiate a new receivables facility
with the financial institution that provides the current facility. The $350
million RERC Corp. revolving credit facility expires March 31, 2003. The
borrowing capacity provided by this revolving credit facility is expected to be
replaced with one or more credit facilities in 2003.

The revolving credit facilities contain various business and financial
covenants requiring Reliant Energy to, among other things, maintain leverage (as
defined in the credit facilities) below specified ratios. Reliant Energy is in
compliance with the covenants under all of these credit agreements. In order to
obtain additional borrowings under the revolving credit facilities, Reliant
Energy must generally represent that there has been no material adverse change
in its ability to perform its obligations under the agreement. Reliant Energy is
currently able to make such representations.

In July 2002, as part of the terms of the extension discussed above, $1.875
billion of FinanceCo's revolving credit agreements was converted to a term loan.
Following this conversion, the revolving credit facilities aggregate $3.2
billion and support a commercial paper program. The maximum amount of
outstanding commercial paper of Reliant Energy, Finance Co., or RERC Corp. is
limited to the amount of that issuer's aggregate revolving credit facilities
less any direct loans or letters of credit obtained under its revolvers. Due to
an inability to consistently satisfy all short-term borrowing needs by issuing
commercial paper, short-term borrowing needs in the second quarter were met with
a combination of commercial paper and bank loans. On July 8, 2002, all remaining
commercial paper was repaid with proceeds from bank loans. The extent to which
commercial paper will be issued in lieu of bank loans will depend on market
conditions, the credit ratings of the commercial paper issuers and the terms of
Reliant Energy's credit agreements.

Reliant Resources (unregulated businesses)

Credit Facilities. As of June 30, 2002, Reliant Resources had $8.3 billion
in committed credit facilities of which $1.2 billion remained unused. Credit
facilities aggregating $5.4 billion were unsecured. As of June 30, 2002, letters
of credit outstanding under these facilities aggregated $803 million. As of
June 30, 2002, borrowings of $6.3 billion were outstanding under these
facilities of which $602 million were classified as long-term debt, based upon
the availability of committed credit facilities and management's intention to
maintain these borrowings in excess of one year.

18

The following table provides a summary of the amounts owed and amounts
available as of June 30, 2002 under Reliant Resources' various credit
facilities.

- ----------

(1) Reliant Resources has given notice that it intends to exercise its option
to convert this facility to a one-year loan with a maturity of
August 22, 2003.

(2) Excludes $369 million of facilities expiring in November 2002 as borrowings
under such facilities are convertible into a long-term loan.

These facilities include a term loan facility entered into during the
fourth quarter of 2001 and amended in January 2002 that provided for $2.9
billion in funding to finance the purchase of Orion Power. Interest rates on the
borrowings under this facility are based on London inter-bank offered rate
(LIBOR) plus a margin or a base rate. This facility was funded on February 19,
2002 for $2.9 billion. As of June 30, 2002, the weighted average interest rate
on outstanding borrowings was 2.79%. This term loan must be repaid within one
year from the date on which it was funded. For discussion of the acquisition of
Orion Power, see Note 5.

In addition to credit facilities, Reliant Resources had long-term debt
totaling $529 million of which $411 million related to bonds issued by Orion
Power.

Refinancing Issues. As a result of several recent events, including the
United States economic recession, the general common stock price decline of
participants in Reliant Resources' industry sector, the general credit rating
downgrades of the participants in Reliant Resources' industry sector, and
Reliant Resources' credit rating downgrades and Reliant Resources' placement on
review for future downgrades, the availability and cost of capital for Reliant
Resources' business has been adversely affected. The credit environment may
require Reliant Resources' future facilities to include terms that are more
restrictive or burdensome or at higher borrowing rates than those of Reliant
Resources' current facilities and that may require them to provide collateral as
security. In addition, certain financial institutions may limit the amount of
additional financings or discontinue providing financings to Reliant Resources.
The terms of any new credit facilities may also be adversely affected by any
delay in the date of the Distribution. In addition, any future reduction or
withdrawal of one or more of Reliant Resources' credit ratings could have a
material adverse impact on Reliant Resources' ability to access capital on
acceptable terms, including the ability to refinance debt obligations as they
mature.

As of June 30, 2002, Reliant Resources had $6.3 billion of committed credit
facilities which will expire by June 30, 2003 of which $2.8 billion will expire
by December 31, 2002. Reliant Resources expects to extend or replace these
facilities. In order to meet Reliant Resources' future needs, it may obtain
financings that are secured by certain of Reliant

19

Resources' assets or the operations of Reliant Resources' subsidiaries. In
addition to giving security, other terms, conditions, covenants or restrictions
may be imposed as part of these financings that may adversely affect Reliant
Resources. Providing collateral to obtain future financings or refinancings may
adversely affect Reliant Resources' credit ratings thereby increasing the cost
of Reliant Resources' debt. Although Reliant Resources expects to obtain future
financings, there can be no assurance that Reliant Resources will be successful.

Reliant Resources' $800 million unsecured 364-day revolving credit facility
expires on August 22, 2002. The facility agreement allows Reliant Resources the
option to borrow the entire amount and convert it, provided that there is no
default on the conversion date, to a one-year term loan with a maturity of
August 22, 2003. Reliant Resources has given notice that they intend to exercise
this option.

Reliant Resources is currently negotiating with the banks regarding the
appropriate terms and conditions for an extension of the maturity of the $2.9
billion Orion acquisition term loan, which is scheduled to mature on February
19, 2003. Reliant Resources expects to complete this extension in the second
half of 2002.

Reliant Resources is also in negotiations with the lead arrangers for a
refinancing of the facilities at Orion Power, Orion Power MidWest, LP (Orion
MidWest) and Orion Power New York, LP (Orion NY), which are discussed below.
Reliant Resources anticipates that the new financings will total approximately
$1.3 billion and will be completed in September 2002. Similar to the existing
Orion MidWest and Orion NY credit agreements, the refinancings for Orion MidWest
and Orion NY will likely be secured by the assets of both Orion MidWest and
Orion NY.

Reliant Resources' refinancing plan contemplates the simultaneous
refinancing of the $2.9 billion term loan, the $800 million 364-day revolving
credit facility, the $800 million three-year revolving credit facility, and the
Orion NY and Orion MidWest credit agreements.

The Euro 600 million (approximately $595 million) term loan facility at
Reliant Energy Capital Europe, Inc. matures on March 1, 2003. Preliminary work
has commenced on the refinancing of this term loan facility. Reliant Resources
plans to execute such refinancing during the fourth quarter of 2002 or first
quarter of 2003.

In May 2002, Reliant Resources established a $300 million commercial paper
program which is supported by its existing credit facilities. Due to market
conditions and Reliant Resources' current credit ratings, Reliant Resources' has
not yet attempted to issue commercial paper. It is unlikely that Reliant
Resources will be able to issue commercial paper in the near future.

During July 2002, Reliant Resources, through a subsidiary, established a
receivables facility to finance certain of Reliant Resources' Retail Energy
business segment's receivables up to $250 million. For further discussion, see
Note 15(b).

During July 2002, REPGB renewed its 364-day revolving credit facility
through July 2003. The amount of the credit facility was reduced from Euro 250
million (approximately $248 million) to Euro 184 million (approximately $182
million). An option was added that permits REPGB to utilize up to Euro 100
million (approximately $99 million) of the facility for letters of credit. For
further discussion, see Note 15(c).

Orion Power's Debt Obligations. As a result of Reliant Resources'
acquisition of Orion Power, Reliant Resources' consolidated net debt obligations
also increased by the amount of Orion Power's net debt obligations, which are
discussed below.

New York Credit Agreement. As of June 30, 2002, Orion Power New York, LP
(Orion NY), a wholly owned subsidiary of Orion Power, had a secured credit
agreement (New York Credit Agreement), which includes a $502 million acquisition
facility and a $30 million revolving working capital facility. As of June 30,
2002, Orion NY had $502 million of acquisition loans outstanding. As of June 30,
2002, there were no revolving loans outstanding. A total of $10 million in
letters of credit were also outstanding under the New York Credit Agreement. The
loans bear interest at the borrower's option at (a) a base rate or (b) LIBOR
plus a margin. The weighted average interest rate on outstanding borrowings as
of June 30, 2002, was 3.61%. The credit agreement is secured by substantially
all of the assets of Orion NY. The credit agreement expires in December 2002.

MidWest Credit Agreement. As of June 30, 2002, Orion Power MidWest LP
(Orion MidWest), a wholly owned subsidiary of Orion Power, had a secured credit
agreement (MidWest Credit Agreement), which includes a $988 million acquisition
facility and a $75 million revolving working capital facility. As of June 30,
2002, Orion MidWest had $988 million and $40 million of acquisition loans and
revolving loans outstanding, respectively. A total of $15 million in letters of
credit were also outstanding under the MidWest Credit Agreement. The loans bear
interest at the borrower's option at (a) a base rate or (b) LIBOR plus a margin.
The weighted average interest rate on outstanding borrowings as of June 30,
2002, was 3.88%. Borrowings under the MidWest Credit Agreement are secured by
substantially all the assets of Orion MidWest. The credit agreement expires in
October 2002.

20

The New York Credit Agreement and the Midwest Credit Agreement
(collectively, the Orion Credit Agreements) contain restrictive covenants that
restrict the ability of Orion NY or Orion MidWest to, among other things, make
dividend distributions unless Orion NY or Orion MidWest satisfy various
conditions. As of June 30, 2002, restricted cash under the Orion Credit
Agreements totaled $346 million.

In connection with the Orion Power acquisition, the existing interest rate
swaps for the Orion Credit Agreements were bifurcated into a debt component and
a derivative component. The fair value of the debt component, approximately $31
million for the New York Credit Agreement and $59 million for the MidWest Credit
Agreement, was based on Reliant Resources' incremental borrowing rates at the
acquisition date for similar types of borrowing arrangements. The value of the
debt component will be amortized to interest expense over the life of the
interest rate swaps to which they relate. For the period from February 20, 2002
through June 30, 2002, $3 million and $7 million was amortized to interest
expense for the New York Credit Agreement and MidWest Credit Agreement,
respectively. See Note 4 for information regarding Reliant Resources' derivative
financial instruments.

The Orion Credit Agreements contain various business and financial
covenants requiring Orion NY or Orion MidWest to, among other things, maintain a
debt service coverage ratio of at least 1.5 to 1.0. Because it was anticipated
that Orion MidWest would not meet this ratio for the quarter ended June 30,
2002, the MidWest Credit Agreement was amended to provide that Orion MidWest is
not required to meet this ratio until the quarter ending September 30, 2002.
Orion MidWest may not be able to meet this debt service coverage ratio for the
quarter ending September 30, 2002. It is Reliant Resources' current intention to
arrange for the repayment, refinancing or amendment of these facilities prior to
September 30, 2002. If the MidWest Credit Agreement is not repaid, refinanced or
amended prior to that date, and if a waiver is required under this credit
facility, Reliant Resources currently believes that it will be able to obtain
such a waiver. However, Reliant Resources currently has no assurance that it
will be able to obtain such a waiver or amendment from the lender group if
required under the MidWest Credit Agreement. If the debt service coverage ratio
is not met, and the MidWest Credit Agreement is not repaid, refinanced or
amended or no waiver is obtained, the MidWest Credit Agreement would be in
default and the lenders could demand payment of all outstanding amounts under
the MidWest Credit Agreement.

Liberty Credit Agreement. Liberty Electric Power, LLC (LEP) and Liberty
Electric PA, LLC (Liberty), wholly owned subsidiaries of Orion Power, entered
into a facility that provides for (a) a construction/term loan in an amount of
up to $105 million; (b) an institutional term loan in an amount of up to $165
million; (c) a revolving working capital facility for an amount of up to $5
million; and (d) a debt service reserve letter of credit facility of $17.5
million (Liberty Credit Agreement).

In May 2002, the construction loan was converted to a term loan. As of the
conversion date, the term loan had an outstanding principal balance of $270
million, with $105 million having a final maturity in 2012 and the balance in
2026. On the conversion date, Reliant Resources made the required cash equity
contribution of $30 million into Liberty, which was used to repay a like amount
of equity bridge loans advanced by the lenders. A related $41 million letter of
credit furnished by Orion Power as credit support was returned for cancellation.
In addition, on the conversion date, a $17.5 million letter of credit was issued
in satisfaction of Liberty's obligation to provide a debt service reserve fund.
The project financing facility also provides for a $5 million working capital
line of credit. The debt service reserve letter of credit facility and the
working capital facility expire in May 2007.

Amounts outstanding under the Liberty Credit Agreement bear interest at a
floating rate for a portion of the facility, which may be either (a) a base rate
or (b) LIBOR plus a margin, except for the institutional term loan which bears
interest at a fixed rate. At June 30, 2002, the weighted average interest rate
on the outstanding borrowings was 3.12% on the floating rate component and 9.02%
on the fixed rate portion. As of June 30, 2002, Liberty had $105 million and
$165 million of the floating rate and fixed rate portions of the facility
outstanding, respectively. A total of $17.5 million in letters of credit were
also outstanding under the Liberty Credit Agreement.

The lenders under the Liberty Credit Agreement have a security interest in
substantially all of the assets of Liberty. The Liberty Credit Agreement
contains restrictive covenants that restrict Liberty's ability to, among other
things, make dividend distributions unless Liberty satisfies various conditions.
As of June 30, 2002, restricted cash under the Liberty Credit Agreement totaled
$20 million.

21

Senior Notes. Orion Power has outstanding $400 million aggregate principal
amount of 12% senior notes due 2010 (Senior Notes). The Senior Notes are senior
unsecured obligations of Orion Power. Orion Power is not required to make any
mandatory redemption or sinking fund payments with respect to the Senior Notes.
The Senior Notes are not guaranteed by any of Orion Power's subsidiaries. In
connection with the Orion Power acquisition, Reliant Resources recorded the
Senior Notes at estimated fair value of $479 million. The $79 million premium
will be amortized against interest expense over the life of the Senior Notes.
For the six months ended June 30, 2002, $2 million was amortized to interest
expense for the Senior Notes. The fair value of the Senior Notes is based on
Reliant Resources' current incremental borrowing rates for similar types of
borrowing arrangements. The Senior Notes indenture contains covenants that
include among others, restrictions on the payment of dividends by Orion Power.

Pursuant to certain change of control provisions, Orion Power commenced an
offer to repurchase the Senior Notes on March 21, 2002. The offer to repurchase
expired on April 18, 2002. There were no acceptances of the offer to repurchase
and the entire $400 million aggregate principal amount remains outstanding.

Before May 1, 2003, Orion Power may redeem up to 35% of the Senior Notes
issued under the indenture at a redemption price of 112% of the principal amount
of the notes redeemed, plus accrued and unpaid interest and special interest,
with the net cash proceeds of an equity offering provided that certain
provisions under the indenture are met.

Revolving Senior Credit Facility. Orion Power has an unsecured $75 million
revolving senior credit facility that matures in December 2002. Amounts
outstanding under the facility bear interest at a floating rate. As of June 30,
2002, there were $43 million of borrowings outstanding under this facility, and
a total of $24 million in letters of credit were also outstanding. This credit
facility contains various covenants that include, among others, restrictions on
the payment of dividends by Orion Power. As of June 30, 2002, restricted cash
under this revolving senior credit facility totaled $7 million.

The senior credit facility of Orion Power contains various business and
financial covenants that require Orion Power to, among other things, maintain a
debt service coverage ratio of at least 1.4 to 1.0. Orion Power did not meet the
debt service coverage ratio for the three months ended March 31, 2002 and June
30, 2002, as required. While the failure to meet such ratio for two consecutive
fiscal quarters is a default under the senior credit facility, the senior credit
facility was amended to provide that such failure will not be considered to be
an event of default until September 30, 2002. It is Reliant Resources' current
intention to arrange for the repayment, refinancing or amendment of this
facility prior to September 30, 2002. If this facility is not repaid, refinanced
or amended prior to that date, and if a waiver is required under this credit
facility, Reliant Resources currently believes that it will be able to obtain
such a waiver. However, Reliant Resources currently has no assurance that it
will be able to obtain such a waiver or amendment from the lender groups if
required under this credit facility. If the debt service coverage ratio is not
met, and the senior credit facility is not repaid, refinanced or amended or no
waiver is obtained, the senior credit facility would be in default and the
lenders could demand payment of all outstanding amounts under the senior credit
facility.

Convertible Senior Notes. Orion Power had outstanding $200 million of
aggregate principal amount of 4.5% convertible senior notes, due on June 1, 2008
(Convertible Senior Notes). Pursuant to certain change of control provisions,
Orion Power commenced an offer to repurchase the Convertible Senior Notes on
March 1, 2002, which expired on April 10, 2002. During the second quarter of
2002, Reliant Resources repurchased $189 million in principal amount under the
offer to repurchase and $11 million aggregate principal amount of the
Convertible Senior Notes remains outstanding.

22

(9) EARNINGS PER SHARE

The following table presents Reliant Energy's basic and diluted earnings
per share (EPS) calculation:

- ----------

(1) For the three months ended June 30, 2001 and 2002, the computation of
diluted EPS excludes 1,860,256 and 5,693,413 purchase options,
respectively, for shares of common stock that have exercise prices (ranging
from $45.57 to $50.00 per share and $22.19 to $50.00 per share for the
second quarter 2001 and 2002, respectively) greater than the per share
average market price for the period and would thus be anti-dilutive if
exercised.

For the six months ended June 30, 2001 and 2002, the computation of diluted
EPS excludes 1,978,698 and 5,597,490 purchase options, respectively, for
shares of common stock that have exercise prices (ranging from $41.69 to
$50.00 per share and $22.44 to $50.00 per share for the first six months of
2001 and 2002, respectively) greater than the per share average market
price for the period and would thus be anti-dilutive if exercised.

(10) CAPITAL STOCK

Common Stock. Reliant Energy has 700,000,000 authorized shares of common
stock. At December 31, 2001, 302,943,709 shares of Reliant Energy common stock
were issued and 295,873,820 shares of Reliant Energy common stock were
outstanding. At June 30, 2002, 303,590,608 shares of Reliant Energy common stock
were issued and 298,033,163 shares of Reliant Energy common stock were
outstanding. Outstanding common shares exclude (a) shares pledged to secure a
loan to Reliant Energy's Employee Stock Ownership Plan (7,069,889 and 5,557,279
at December 31, 2001 and June 30, 2002, respectively) and (b) treasury shares
(-0- and 166 at December 31, 2001 and June 30, 2002, respectively). Reliant
Energy declared dividends of $0.375 per share in the second quarter of 2001 and
2002 and $0.75 per share in the first six months of 2001 and 2002.

23

(11) TRUST PREFERRED SECURITIES

(a) Reliant Energy.

Statutory business trusts created by Reliant Energy have issued trust
preferred securities, the terms of which, and the related series of junior
subordinated debentures, are described below (in millions):

For additional information regarding the $625 million of preferred
securities and the $100 million of capital securities, see Note 11 to the
Reliant Energy 10-K/A Notes, which note is incorporated herein by reference. The
sole asset of each trust consists of junior subordinated debentures of Reliant
Energy having interest rates and maturity dates that correspond to the
distribution rates and the mandatory redemption dates for each series of
preferred securities or capital securities, and the principal amounts
corresponding to the common and preferred securities or capital securities
issued by that trust.

(b) RERC Corp.

A statutory business trust created by RERC Corp. (RERC Trust) has issued
convertible trust preferred securities, the terms of which, and the related
series of convertible junior subordinated debentures, are described below (in
millions):

For additional information regarding the convertible preferred securities,
see Note 11 to the Reliant Energy 10-K/A Notes. The sole asset of the trust
consists of convertible junior subordinated debentures of RERC Corp. having an
interest rate and maturity date that correspond to the distribution rate and
mandatory redemption date of the convertible preferred securities, and the
principal amount corresponding to the common and convertible preferred
securities issued by the trust.

(12) PRICE TO BEAT FUEL FACTOR ADJUSTMENT

The Texas Utility Commission regulations allow Reliant Resources to request
an adjustment to the fuel factor in its price to beat for its Houston area
residential and small commercial customers based on the percentage change in the
price of natural gas, or increases in the price of purchased energy, up to twice
a year. Reliant Resources' price to beat fuel factor was initially set by the
Texas Utility Commission in December 2001 based on an average forward 12-month
natural gas price of $3.11/mmbtu. On May 2, 2002, Reliant Resources filed a
request with the Texas Utility Commission to increase the price to beat fuel
factor based on a 20% increase in the price of natural gas.

24

Reliant Resources' requested increase was based on an average forward 12-month
natural gas price of $3.73/mmbtu. The requested increase represents a 5.9%
increase in the total bill of a residential customer using, on average, 1,000
kWh per month. On June 6, 2002 the administrative law judge recommended to the
Texas Utility Commission approval of a 19.9% increase to the price to beat fuel
factor based on application of the Texas Utility Commission's price to beat
rule. On July 15, 2002, the Texas Utility Commission issued an order delaying
Reliant Resources' request as well as the request of each of the other four
affiliated retail electric providers requesting adjustments to the price to beat
fuel factors and remanded the cases to the administrative law judges requesting
additional information in order to validate the Texas Utility Commission's rule.
On July 24, 2002, Reliant Resources filed a request in the Travis County
District Court that the court declare that the Texas Utility Commission must
apply its current rules to Reliant Resources' request and grant the fuel factor
adjustment in accordance with the formula in the rule that the Texas Utility
Commission had already approved. The other four affiliated retail electric
providers also filed similar requests with the Travis County District Court. The
Court issued an order on August 9, 2002 agreeing with Reliant Resources that the
Texas Utility Commission must follow the existing rules that govern the
adjustment of the price to beat fuel factor. Unless the Texas Utility Commission
convenes a special meeting, the earliest a new price to beat could go into
effect would be after August 23, 2002, the date of the Texas Utility
Commission's next normally scheduled meeting.

(13) COMMITMENTS AND CONTINGENCIES

(a) Legal Matters.

Reliant Energy HL&P Municipal Franchise Fee Lawsuits. In February 1996, the
cities of Wharton, Galveston and Pasadena filed suit, for themselves and a
proposed class of all similarly situated cities in Reliant Energy HL&P's service
area, against Reliant Energy and Houston Industries Finance, Inc. (formerly a
wholly owned subsidiary of Reliant Energy) alleging underpayment of municipal
franchise fees. Plaintiffs claim that they are entitled to 4% of all receipts of
any kind for business conducted within these cities over the previous four
decades. Because the franchise ordinances at issue affecting Reliant Energy HL&P
expressly impose fees only on its own receipts and only from sales of
electricity for consumption within a city, the Company regards all of
plaintiffs' allegations as spurious and is vigorously contesting the case. The
plaintiffs' pleadings asserted that their damages exceeded $250 million. The
269th Judicial District Court for Harris County granted partial summary judgment
in favor of Reliant Energy dismissing all claims for franchise fees based on
sales tax collections. Other motions for partial summary judgment were denied. A
six-week jury trial of the original claimant cities (but not the class of
cities) ended on April 4, 2000 (Three Cities case). Although the jury found for
Reliant Energy on many issues, they found in favor of the original claimant
cities on three issues, and assessed a total of $4 million in actual and $30
million in punitive damages. However, the jury also found in favor of Reliant
Energy on the affirmative defense of laches, a defense similar to a statute of
limitations defense, due to the original claimant cities having unreasonably
delayed bringing their claims during the 43 years since the alleged wrongs
began.

The trial court in the Three Cities case granted most of Reliant Energy's
motions to disregard the jury's findings. The trial court's rulings reduced the
judgment to $1.7 million, including interest, plus an award of $13.7 million in
legal fees. In addition, the trial court granted Reliant Energy's motion to
decertify the class and vacated its prior orders certifying a class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.

The Three Cities case has been appealed. The Company believes that the $1.7
million damage award resulted from serious errors of law and that it will be set
aside by the Texas appellate courts. In addition, the Company believes that
because of an agreement between the parties limiting fees to a percentage of the
damages, reversal of the award of $13.7 million in attorneys' fees in the Three
Cities case is probable.

The extent to which issues in the Three Cities case may affect the claims
of the other cities served by Reliant Energy HL&P cannot be assessed until
judgments are final and no longer subject to appeal. However, the trial court's
rulings disregarding most of the jury's findings are consistent with Texas
Supreme Court opinions over the past decade. The Company estimates the range of
possible outcomes for the plaintiffs in the Three Cities case to be between zero
and $18 million inclusive of interest and attorneys' fees.

25

Southern California Class Actions. Reliant Energy, Reliant Energy Services,
Inc. (Reliant Energy Services), REPG and several other subsidiaries of Reliant
Resources, as well as two former officers and one present officer of some of
these companies, have been named as defendants in class action lawsuits and
other lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. Three of
these lawsuits were filed in the Superior Court of the State of California, San
Diego County; two were filed in the Superior Court in San Francisco County; and
one was filed in the Superior Court of Los Angeles County. While the plaintiffs
allege various violations by the defendants of state antitrust laws and state
laws against unfair and unlawful business practices, each of the lawsuits is
grounded on the central allegation that defendants conspired to drive up the
wholesale price of electricity. In addition to injunctive relief, the plaintiffs
in these lawsuits seek treble the amount of damages alleged, restitution of
alleged overpayments, disgorgement of alleged unlawful profits for sales of
electricity, costs of suit and attorneys' fees. Plaintiffs have voluntarily
dismissed Reliant Energy from two of the three class actions in which it was
named as a defendant.

The cases were initially removed to federal court and were then assigned to
Judge Robert H. Whaley, United States District Judge, pursuant to the federal
procedures for multi-district litigation. On July 30, 2000, Judge Whaley
remanded the cases to state court. Upon remand to state court, the cases were
assigned to Superior Court Judge Janis L. Sammartino pursuant to the California
state coordination procedures. On March 4, 2002, Judge Sammartino adopted a
schedule proposed by the parties that would result in a trial beginning on March
1, 2004. On March 8, 2002, the plaintiffs filed a single, consolidated complaint
naming numerous defendants, including Reliant Energy Services and other Reliant
Resources' subsidiaries, that restated the allegations described above and
alleged that damages against all defendants could be as much as $1 billion. On
April 22 and 23, 2002, Reliant Resources and Duke Energy filed cross complaints
in the coordinated proceedings seeking, in an alternative pleading, relief
against other market participants in California, the surrounding states, Canada
and Mexico including Powerex Corp., the Los Angeles Department of Water and
Power and the Bonneville Power Administration. Powerex Corp. and Bonneville
Power Administration removed the case once again to federal court where it was
reassigned to Judge Whaley. On July 10, 2002, a motion to dismiss was filed in
coordinated proceedings seeking dismissal of the complaints on the basis of the
filed rate doctrine and federal preemption.

On March 11, 2002, the California Attorney General filed a civil lawsuit in
San Francisco Superior Court naming Reliant Energy, Reliant Resources, Reliant
Energy Services, REPG, and several other subsidiaries of Reliant Resources as
defendants. The Attorney General alleges various violations by the defendants of
state laws against unfair and unlawful business practices arising out of
transactions in the markets for ancillary services run by the California
Independent System Operator (Cal ISO). In addition to injunctive relief, the
Attorney General seeks restitution and disgorgement of alleged unlawful profits
for sales of electricity, and civil penalties. Reliant Resources removed this
lawsuit to federal court in April 2002, where it has been assigned to Judge
Vaughn Walker in the Northern District of California.

On March 19, 2002, the California Attorney General filed a complaint with
the Federal Energy Regulatory Commission (FERC) naming Reliant Energy Services
and "all other public utility sellers" in California as defendants. The
complaint alleges that sellers with market-based rates have violated their
tariffs by not filing with the FERC transaction-specific information about all
of their sales and purchases at market-based rates. The California Attorney
General argues that, as a result, all past sales should be subject to refund if
found to be above just and reasonable levels. On May 31, 2002, the FERC issued
an Order that largely denied the compliant and

26

required only that Reliant Energy Services and other sellers file revised
transaction reports regarding prior sales in California spot markets.

On April 15, 2002, the California Attorney General filed a lawsuit in San
Francisco County Superior Court against Reliant Energy, Reliant Resources,
Reliant Energy Services and several other subsidiaries of Reliant Resources. The
complaint is substantially similar to the complaint described above filed by the
California Attorney General with the FERC on March 19, 2002. The complaint also
alleges that Reliant Resources consistently charged unjust and unreasonable
prices for electricity, and that each instance of overcharge violated California
law. The lawsuit seeks fines of up to $2,500 for each alleged violation, and
"other equitable relief as appropriate." Reliant Resources has removed this
case to federal court, where it has been assigned to Judge Vaughn Walker in the
Northern District of California.

On April 15, 2002, the California Attorney General and the California
Department of Water Resources (CDWR) filed a complaint in the United States
District Court for the Northern District of California against Reliant Energy,
Reliant Resources and a number of its subsidiaries. In this lawsuit, the
Attorney General alleges that Reliant Resources' acquisition of electric
generating facilities from Southern California Edison in 1998 violated Section 7
of the Clayton Act, which prohibits mergers or acquisitions that substantially
lessen competition. The lawsuit claims that the acquisitions gave Reliant
Resources market power which it then exercised to overcharge California
consumers for electricity. The lawsuit seeks injunctive relief against alleged
unfair competition, divestiture of Reliant Resources' California facilities,
disgorgement of alleged illegal profits, damages, and civil penalties for each
alleged exercise of market power. This lawsuit also has been assigned to Judge
Vaughn Walker. Judge Walker has denied the California Attorney General's
motion to remand the two above-mentioned cases to state court and it is
anticipated that he will rule in the near future in Reliant Resources' motion to
dismiss all three cases.

Northern California Class Actions. In the wake of the filing of the
Attorney General cases, there have been seven new class action cases filed in
state courts in Northern California. Each of these purports to represent the
same class of California ratepayers, assert the same claims as asserted in the
Southern California class action cases, and in some instances repeat as well the
allegations in the Attorney General cases. All of these cases have been removed
to federal court and have been conditionally assigned to Judge Whaley by the
Panel on Multi-District Litigation. The plaintiffs in the Southern California
class actions have opposed this transfer and it is likely that there will be a
hearing before the Panel at its next meeting in September 2002.

Washington/Oregon Class Action. After the filing of the Northern California
class actions, a separate class action suit was filed in federal court in Los
Angeles on behalf of the Snohomish County Public Utility District and its
customers in the State of Washington. A motion has been made to transfer this
case to Judge Whaley.

Reliant Resources has not answered any of these cases; however, it has
moved to dismiss the cases on the grounds that the claims are barred by federal
preemption and by the filed rate doctrine.

On April 11, 2002, the FERC set for hearing a series of complaints filed by
Nevada Power Company, which seeks reformation of certain forward power
contracts, including contracts with Reliant Energy Services that have since been
terminated. Proceedings are ongoing before an administrative law judge who
anticipates issuing a decision in December 2002 for consideration by the FERC.
PacifiCorp Company filed a similar complaint challenging two ninety-day
contracts with Reliant Energy Services, which the FERC also has set for hearing.
The FERC has stated that it intends to issue a decision in this case by May 31,
2003.

Pursuant to the terms of the master separation agreement, Reliant Resources
has agreed to indemnify Reliant Energy for any damages arising under these
lawsuits and may elect to defend these lawsuits at Reliant Resources' own
expense. The above-described lawsuits and proceedings regarding California
electricity sales are currently the subject of intense, highly-charged media and
political attention. Their ultimate outcome cannot be predicted at this time.

Trading and Marketing Activities. Reliant Resources is party to numerous
lawsuits and regulatory proceedings relating to its trading and marketing
activities, including (i) round trip trades, as more fully described in Note 1,
and (ii) structured transactions. In addition, various state and federal
governmental agencies have commenced investigations relating to such activities.
Their ultimate outcome cannot be predicted at this time. Additional information
regarding certain of these matters is set forth below.

27

In June 2002, the SEC advised Reliant Resources that it had issued a formal
order in connection with its investigation of Reliant Resources' financial
reporting, internal controls and related matters. Reliant Resources understands
that the investigation is focused on its round trip trades and structured
transactions. These matters were previously the subject of an informal inquiry
by the SEC. The SEC's formal order is also addressed to Reliant Energy. Reliant
Resources and Reliant Energy are cooperating with the SEC staff.

As part of the Commodity Futures Trading Commission's (CFTC) industry-wide
investigation of so-called round trip trading, the CFTC has subpoenaed documents
and requested information relating to Reliant Resources' natural gas and power
trading activities, including round trip trades, occurring since January 1,
1999. Reliant Resources is cooperating with the CFTC staff.

On August 13, 2002, the FERC staff issued its Initial Report on Fact
Finding Investigation of Potential Manipulation of Electric and Gas Prices
(Initial Report). While Reliant Resources is still in the process of reviewing
the Initial Report, certain findings, conclusions and observations in the staff
report if adopted or otherwise acted on by the FERC, could have a material
adverse effect on Reliant Resources. For example, in the Initial Report the FERC
staff recommends that the mitigated market clearing prices for purposes of
determining refunds in the pending refund proceeding described in Note 13(c)
should be based, not on published indices but rather should be calculated using
producing basin spot prices plus regulated transportation costs. The use of such
a calculation for determining gas prices for refund purposes will likely have an
adverse impact on Reliant Resources' potential refund obligations. Other
findings, conclusions and observations in the report may likewise have a
material adverse effect on Reliant Resources if adopted or otherwise acted on.

In the Initial Report, the FERC indicated that it is continuing to receive
and review data, including information relevant to the subjects covered in the
report. In this regard, Reliant Resources has provided information to FERC about
its trading activities in the Western United States during 2000 and 2001.
Included among the data requests Reliant Resources has received from the FERC
are requests asking for information regarding all power trading activity,
natural gas trading for specific periods or locations, Enron-like trading
practices, round trip trades and compliance with supplemental dispatch requests.
Reliant Resources expects to receive additional data requests regarding its
plant operations and gas and power trading in the West. Reliant Resources is
cooperating and will continue to cooperate with the FERC. The ultimate outcome
of the investigation cannot be predicted at this time.

Reliant Resources has received subpoenas from the United States Attorney
for the Southern District of New York requesting documents pertaining to the
round trip trades, and anticipates investigations of energy trading activities
by Reliant Resources and numerous other companies that parallel those of the
SEC, the CFTC and the FERC. Reliant Resources is cooperating with the office of
the United States Attorney.

In connection with the Texas Utility Commission's industry-wide
investigation into potential manipulation of the ERCOT market on and after
July 31, 2001, Reliant Energy and Reliant Resources have provided information to
the Texas Utility Commission concerning their scheduling and trading activities.

In May, June and July 2002, eleven class action lawsuits were filed on
behalf of purchasers of securities of Reliant Resources and/or Reliant Energy.
Reliant Resources and several of its executive officers are named as defendants.
Reliant Energy is also named as a defendant in three of the lawsuits. Two of the
lawsuits also name as defendants the underwriters of the IPO. One of those two
lawsuits also names Reliant Resources' and Reliant Energy's independent auditors
as a defendant. The dates of filing of these lawsuits are as follows: two
lawsuits on May 15, 2002; two lawsuits on May 16, 2002; one lawsuit on May 17,
2002; one lawsuit on May 20, 2002; one lawsuit on May 21, 2002; one lawsuit on
May 23, 2002; one lawsuit on June 19, 2002; one lawsuit on June 20, 2002; and
one lawsuit on July 1, 2002. Ten of the lawsuits were filed in the United States
District Court, Southern District of Texas, Houston Division. One lawsuit was
filed in the United States District Court, Eastern District of Texas, Texarkana
Division.

The complaints allege that the defendants overstated the revenues of the
Company by including transactions involving the purchase and sale of commodities
with the same counterparty at the same price and that the Company improperly
accounted for certain other transactions, among other things. The complaints
seek monetary damages and, in one of the lawsuits rescission, on behalf of a
supposed class. In eight of the lawsuits, the supposed class is composed of
persons who purchased or otherwise acquired Reliant Resources and/or Reliant
Energy securities during specified class periods. The three lawsuits that
include Reliant Energy as a named defendant were also filed on behalf of
purchasers of securities of Reliant Resources and/or Reliant Energy during
specified class periods.

Additionally, in May and June 2002, four class action lawsuits were filed
on behalf of purchasers of securities of Reliant Energy. Reliant Energy and
several of its executive officers are named as defendants. The dates of filing
of the four lawsuits are as follows: one on May 16, 2002; one on May 21, 2002;
one on June 13, 2002; and one on June 17, 2002. The lawsuits were filed in the
United States District Court, Southern District of Texas, Houston Division. The
complaints allege that the defendants violated federal securities laws by
issuing false and misleading statements to the public. The plaintiffs allege
that the defendants made false and misleading statements as part of an alleged
scheme to artificially inflate trading volumes and revenues by including
transactions involving the purchase and sale of commodities with the same
counterparty at the same price, to spin-off Reliant Resources to avoid exposure
to Reliant Resources' liabilities and to cause the price of Reliant Resources'
stock to rise artificially, among other things. The complaints seek monetary
damages on behalf of persons who purchased Reliant Energy securities during
specified class periods.

In May 2002, three class action lawsuits were filed on behalf of
participants in various employee benefits plans sponsored by Reliant Energy.
Reliant Energy and its directors are named as defendants in all of the lawsuits.
Reliant Resources is named as a defendant in two of the lawsuits. The lawsuits
were filed on May 29, 2002, May 30, 2002, and May 31, 2002. All of the lawsuits
were filed in the United States District Court, Southern District of

28

Texas, Houston Division. By order dated June 20, 2002, the Court granted the
motion for voluntary dismissal filed by the plaintiffs in one of the cases and
dismissed that case without prejudice.

The two remaining complaints allege that the defendants breached their
fiduciary duties to various employee benefits plans sponsored by Reliant Energy,
in violation of the Employee Retirement Income Security Act. The plaintiffs
allege that the defendants permitted the plans to purchase or hold securities
issued by Reliant Energy when it was imprudent to do so, including after the
prices for such securities became artificially inflated because of alleged
securities fraud engaged in by the defendants. The complaints seek monetary
damages for losses suffered by a putative class of plan participants whose
accounts held Reliant Energy or Reliant Resources securities, as well as
equitable relief in the form of restitution.

In May 2002, a derivative action was filed against the directors and
independent auditors of Reliant Resources. The lawsuit was filed on May 17,
2002, in the 269th Judicial District, Harris County, Texas. The petition alleges
that the defendants breached their fiduciary duties to Reliant Resources. The
shareholder plaintiff alleges that the defendants caused Reliant Resources to
conduct its business in an imprudent and unlawful manner, including allegedly
failing to implement and maintain an adequate internal accounting control
system, engaging in transactions involving the purchase and sale of commodities
with the same counterparty at the same price, and disseminating materially
misleading and inaccurate information regarding Reliant Resources' revenue and
trading volume. The petition seeks monetary damages on behalf of Reliant
Resources.

Natural Gas Measurement Lawsuits. In 1997, a suit was filed under the
Federal False Claim Act against RERC Corp. and certain of its subsidiaries
alleging mismeasurement of natural gas produced from federal and Indian lands.
The suit seeks undisclosed damages, along with statutory penalties, interest,
costs, and fees. The complaint is part of a larger series of complaints filed
against 77 natural gas pipelines and their subsidiaries and affiliates. An
earlier single action making substantially similar allegations against the
pipelines was dismissed by the U.S. District Court for the District of Columbia
on grounds of improper joinder and lack of jurisdiction. As a result, the
various individual complaints were filed in numerous courts throughout the
country. This case was consolidated, together with the other similar False Claim
Act cases filed and transferred to the District of Wyoming. Motions to dismiss
were denied. The defendants intend to vigorously contest this case.

In addition, RERC Corp., Reliant Energy Gas Transmission Company (REGT),
Reliant Energy Field Services, Inc. (REFS) and Mississippi River Transmission
Corporation (MRT) have been named as defendants in a class action filed in May
1999 against approximately 245 pipeline companies and their affiliates. The
plaintiffs in the case purport to represent a class of natural gas producers and
fee royalty owners who allege that they have been subject to systematic gas
mismeasurement by the defendants, including certain Reliant Energy entities, for
more than 25 years. The plaintiffs seek compensatory damages, along with
statutory penalties, treble damages, interest, costs and fees. The action is
currently pending in state court in Stevens County, Kansas. Plaintiffs initially
sued Reliant Energy Services, but that company was dismissed without prejudice
on June 8, 2001. Other Reliant Energy entities that were misnamed or duplicative
have also been dismissed. MRT and REFS have filed motions to dismiss for lack of
personal jurisdiction and are currently responding to discovery on personal
jurisdiction. All four Reliant Energy defendants have joined in a motion to
dismiss.

The defendants plan to raise significant affirmative defenses based on the
terms of the applicable contracts, as well as on the broad waivers and releases
in take or pay settlements that were granted by the producer-sellers of natural
gas who are putative class members.

(b) Environmental Matters.

Clean Air Standards. Based on current limitations of the Texas Natural
Resource Conservation Commission regarding emission of oxides of nitrogen (NOx)
in the Houston area, the Company anticipates investing up to $776 million for
emission control equipment through 2006, including $472 million expended since
1999 through June 30, 2002, and potentially up to an additional $88 million by
2007.

The Texas electric restructuring law provides for stranded cost recovery
for expenditures incurred before May 1, 2003 to achieve the NOx reduction
requirements. Incurred costs include costs for which contractual obligations
have been made. The Texas Utility Commission had determined that the Company's
emission control plan is the most effective control option and that up to $699
million is eligible for cost recovery. In addition, the Company is

29

required to provide $16.2 million in funding for certain NOx reduction projects
associated with East Texas pipeline companies. These funds are also eligible for
cost recovery.

Hydrocarbon Contamination. On August 24, 2001, 37 plaintiffs filed suit
against REGT, Reliant Energy Pipeline Services, Inc., RERC Corp., Reliant Energy
Services, other Reliant Energy entities and third parties (Docket No. 460,
916-Div. "B"), in the 1st Judicial District Court, Caddo Parish, Louisiana. The
petition has now been supplemented five times. As of July 29, 2002, there were
649 plaintiffs, a majority of whom are Louisiana residents. In addition to the
Reliant Energy entities, the plaintiffs have sued the State of Louisiana through
its Department of Environmental Quality, several individuals, some of whom are
present employees of the State of Louisiana, the Bayou South Gas Gathering
Company, L.L.C., Martin Timber Company, Inc., and several trusts. Additionally
on April 4, 2002, two plaintiffs filed a separate suit with identical
allegations against the same parties (Docket No. 465, 944-Div. "B") in the same
court.

The suits allege that, at some unspecified date prior to 1985, the
defendants allowed or caused hydrocarbon or chemical contamination of the Wilcox
Aquifer which lies beneath property owned or leased by certain of the defendants
and which is the sole or primary drinking water aquifer in the area. The primary
source of the contamination is alleged by the plaintiffs to be a gas processing
facility in Haughton, Bossier Parish, Louisiana known as the "Sligo Facility."
This facility was purportedly used for gathering natural gas from surrounding
wells, separating gasoline and hydrocarbons from the natural gas for marketing,
and transmission of natural gas for distribution. This site was originally
leased and operated by predecessors of REGT in the late 1940s and was operated
until Arkansas Louisiana Gas Company ceased operations of the plant in the late
1970s.

Beginning about 1985, the predecessors of certain Reliant Energy defendants
engaged in a voluntary remediation of any subsurface contamination of the
groundwater below the property they own or lease. This work has been done in
conjunction with and under the direction of the Louisiana Department of
Environmental Quality. The plaintiffs seek monetary damages for alleged damage
to the aquifer underlying their property, unspecified alleged personal injuries,
alleged fear of cancer, alleged property damage or diminution of value of their
property, and, in addition, seek damages for trespass, punitive, and exemplary
damages. The quantity of monetary damages sought is unspecified. As of June 30,
2002, the Company is unable to estimate the monetary damages, if any, that the
plaintiffs may be awarded in these matters.

Manufactured Gas Plant Sites. RERC Corp. and its predecessors operated a
manufactured gas plant (MGP) until 1960 adjacent to the Mississippi River in
Minnesota, formerly known as Minneapolis Gas Works (MGW). RERC Corp. has
substantially completed remediation of the main site other than ongoing water
monitoring and treatment. The manufactured gas was stored in separate holders.
RERC Corp. is negotiating clean-up of one such holder. There are six other
former MGP sites in the Minnesota service territory. Remediation has been
completed on one site. Of the remaining five sites, RERC Corp. believes that two
were neither owned nor operated by RERC Corp. RERC Corp. believes it has no
liability with respect to the sites it neither owned nor operated.

At June 30, 2002, RERC Corp. had accrued $23 million for remediation of the
Minnesota sites. At June 30, 2002, the estimated range of possible remediation
costs was $11 million to $49 million. The cost estimates of the MGW site are
based on studies of that site. The remediation costs for the other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties (PRP), if any, and
the remediation methods used.

Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. The Company has received notices from the
United States Environmental Protection Agency and others regarding its status as
a PRP for other sites. Based on current information, the Company has not been
able to quantify a range of environmental expenditures for potential remediation
expenditures with respect to other MGP sites.

Other Minnesota Matters. At June 30, 2002, RERC had recorded accruals of
$5 million for other environmental matters in Minnesota for which remediation
may be required. At June 30, 2002, the estimated range of possible remediation
costs was $4 million to $8 million.

30

Mercury Contamination. The Company's pipeline and distribution operations
have in the past employed elemental mercury in measuring and regulating
equipment. It is possible that small amounts of mercury may have been spilled in
the course of normal maintenance and replacement operations and that these
spills may have contaminated the immediate area with elemental mercury. This
type of contamination has been found by the Company at some sites in the past,
and the Company has conducted remediation at these sites. It is possible that
other contaminated sites may exist and that remediation costs may be incurred
for these sites. Although the total amount of these costs cannot be known at
this time, based on experience by the Company and that of others in the natural
gas industry to date and on the current regulations regarding remediation of
these sites, the Company believes that the costs of any remediation of these
sites will not be material to the Company's financial position, results of
operations or cash flows.

REMA Ash Disposal Site Closures and Site Contaminations. Under the
agreement to acquire Reliant Energy Mid-Atlantic Power Holdings, LLC (REMA) (see
Note 3(a) to the Reliant Energy 10-K/A Notes), the Company became responsible
for liabilities associated with ash disposal site closures and site
contamination at the acquired facilities in Pennsylvania and New Jersey prior to
a plant closing, except for the first $6 million of remediation costs at the
Seward Generating Station. A prior owner retained liabilities associated with
the disposal of hazardous substances to off-site locations prior to November 24,
1999. As of June 30, 2002, REMA had liabilities associated with six future ash
disposal site closures and six current site investigations and environmental
remediations. The Company has recorded its estimate of these environmental
liabilities in the amount of $33 million as of June 30, 2002. The Company
expects approximately $14 million will be paid over the next five years.

REPGB Asbestos Abatement and Environmental Remediation. Prior to the
Company's acquisition of REPGB (see Note 3(b) to the Reliant Energy 10-K/A
Notes), REPGB had a $23 million obligation primarily related to asbestos
abatement, as required by Dutch law, and soil remediation at six sites. During
2000, the Company initiated a review of potential environmental matters
associated with REPGB's properties. REPGB began remediation in 2000 of the
properties identified to have exposed asbestos and soil contamination, as
required by Dutch law and the terms of some leasehold agreements with
municipalities in which the contaminated properties are located. All remediation
efforts are to be fully completed by 2005. As of June 30, 2002, the recorded
undiscounted liability for this asbestos abatement and soil remediation was $20
million.

Orion Power Environmental Contingencies. In connection with Orion Power's
acquisition of 70 hydroelectric plants in northern and central New York and four
gas- or oil-fired plants in New York City, Orion Power assumed the liability for
the cost of environmental remediation at several properties. Orion Power
developed remediation plans for each of these properties and entered into
Consent Orders with the New York State Department of Environmental Conservation
at two New York City sites and one hydro site for releases of petroleum and
other substances by the prior owners. The liability assumed and recorded by the
Company for all New York assets was approximately $10 million which is expected
to be paid out through 2006.

In connection with the acquisition of MidWest assets by Orion Power, Orion
Power became responsible for the liability associated with the closure of three
ash disposal sites in Pennsylvania. The liability assumed and recorded by the
Company for these disposal sites was approximately $12 million, with $1 million
to be paid over the next five years.

Other. From time to time the Company has received notices from regulatory
authorities or others regarding its status as a PRP in connection with sites
found to require remediation due to the presence of environmental contaminants.
In addition, the Company has been named as a defendant in litigation related to
such sites and in recent years has been named, along with numerous others, as a
defendant in several lawsuits filed by a large number of individuals who claim
injury due to exposure to asbestos while working at sites along the Texas Gulf
Coast. Most of these claimants have been workers who participated in
construction of various industrial facilities, including power plants, and some
of the claimants have worked at locations owned by the Company. The Company
anticipates that additional claims like those received may be asserted in the
future and intends to continue vigorously contesting claims which it does not
consider to have merit. Although their ultimate outcome cannot be predicted at
this time, the Company does not believe, based on its experience to date, that
these matters, either individually or in the aggregate, will have a material
adverse effect on the Company's financial position, results of operations or
cash flows.

31

(c) Other Legal and Environmental Matters.

The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.

(d) California Wholesale Market Uncertainty.

Receivables. During portions of 2000 and 2001, prices for wholesale
electricity in California increased dramatically as a result of a combination of
factors, including higher natural gas prices and emission allowance costs,
reduction in available hydroelectric generation resources, increased demand,
decreased net electric imports and limitations on supply as a result of
maintenance and other outages. The resulting supply and demand imbalance
disproportionately impacted California utilities that relied too heavily on
short-term power markets to meet their load requirements. Although wholesale
prices increased, California's deregulation legislation kept retail rates frozen
at 10% below 1996 levels for two of California's public utilities, Pacific Gas
and Electric (PG&E) and Southern California Edison Company (SCE), until rates
were raised by the California Public Utilities Commission (CPUC) early in 2001.

Due to the disparity between wholesale and retail rates, the credit ratings
of PG&E and SCE fell below investment grade. Additionally, PG&E filed for
protection under the bankruptcy laws on April 6, 2001. As a result, PG&E and SCE
are no longer considered creditworthy, and since January 17, 2001, have not
directly purchased power from third-party suppliers through the Cal ISO to serve
that portion of load that cannot be met from their own supply sources (net short
load). Pursuant to emergency legislation enacted by the California Legislature,
the CDWR has negotiated and purchased power through short- and long-term
contracts and through real-time markets operated by the Cal ISO to serve the net
short load requirements of PG&E and SCE. In December 2001, the CDWR began making
payments to the Cal ISO for real-time transactions. On May 15, 2002, the FERC
issued an order stating that sellers, including the Company, should receive
interest payments on past due amounts owed by the Cal ISO and CDWR. The CDWR has
now made payment through the Cal ISO for its real-time energy deliveries
subsequent to January 17, 2001, although the Cal ISO's application of CDWR's
payment for the month of January 2001, including the allocation of interest,
which is subject of motions that the Company has filed with the FERC objecting
to the Cal ISO's failure to allocate January payments and interest solely to
post-January 17, 2001 transactions. In addition, Reliant Resources is
prosecuting a lawsuit in California to recover the market value of forward
contracts seized by California Governor Gray Davis in violation of the Federal
Power Act. Governor Davis' actions prevented the liquidation of the contracts by
the California Power Exchange (Cal PX) to satisfy the outstanding obligations of
SCE and PG&E to wholesale suppliers, including Reliant Resources. The timing and
ultimate resolution of this claim is uncertain at this time.

On September 20, 2001, PG&E filed a Plan of Reorganization and an
accompanying disclosure statement with the bankruptcy court. Under this plan,
PG&E would pay all allowed creditor claims in full, through a combination of
cash and long-term notes. Components of the plan will require the approval of
the FERC, the SEC and the Nuclear Energy Regulatory Commission, in addition to
the bankruptcy court. PG&E has stated it seeks to have this plan confirmed by
December 31, 2002. On April 24, 2002, the bankruptcy judge approved PG&E's
disclosure statement. A number of parties are contesting PG&E's reorganization
plan, including a number of California parties and agencies. The bankruptcy
judge in the PG&E case has ordered that the CPUC may file a competing plan. The
ability of PG&E to have its reorganization plan confirmed, including the
provision providing for the payment in full of unsecured creditors, is uncertain
at this time. The CPUC has filed a competing plan and disclosure statement. The
CPUC's plan provides for payment of allowed creditor claims in full in cash. The
CPUC disclosure statement was approved on May 15, 2002. The timing and
probability of confirmation of either plan, including the provision for payment
in full of all unsecured creditors, is uncertain at this time. Reliant Resources
signed a stipulation with PG&E whereby it has agreed to vote for PG&E's
reorganization plan and PG&E has agreed to pay amounts it indirectly owed to
Reliant Resources subject to refunds ordered by the FERC. The stipulation does
not preclude Reliant Resources from approving other reorganization plans,
including the CPUC plan.

On October 5, 2001, a federal district court in California entered a
stipulated judgment approving a settlement between SCE and the CPUC in an action
brought by SCE regarding the recovery of its wholesale power costs under the
filed rate doctrine. Under the stipulated judgment, a rate increase approved
earlier in 2001 will remain in place until the earlier of SCE recovering $3.3
billion or December 31, 2002. After that date, the CPUC will review the

32

sufficiency of retail rates through December 31, 2005. A consumer organization
has appealed the judgment to the Ninth Circuit Court of Appeals, and no hearing
has been held to date. Under the stipulated judgment, any settlement with SCE's
creditors that is entered into after March 1, 2002 must be approved by the CPUC.
The Company has appealed this provision of the judgment. On March 1, 2002, SCE
made a payment to the Cal PX that included amounts it owed Reliant Resources.
Reliant Resources has made a filing with FERC seeking an order providing for the
disbursement of the funds owed to the suppliers. The FERC and the bankruptcy
court governing the Cal PX bankruptcy proceedings are considering how to
dispense this money and it remains uncertain when those funds will be paid over
to Reliant Resources.

As of December 31, 2001 and June 30, 2002, Reliant Resources was owed a
total of $302 million and $239 million (net of refund provision), respectively,
by the Cal ISO, the Cal PX, the CDWR, and California Energy Resources Scheduling
for energy sales in the California wholesale market during the fourth quarter of
2000 through June 30, 2002. From June 30, 2002 through August 9, 2002, Reliant
Resources has collected $1 million of these receivable balances. As of December
31, 2001, Reliant Resources had a pre-tax credit provision of $68 million
against receivable balances related to energy sales in the California market.
For the six months ended June 30, 2002, $38 million of a previously accrued
credit provision for energy sales in California was reversed. The reversal
resulted from collections of outstanding receivables during the period coupled
with a determination that credit risk had been reduced on the remaining
outstanding receivables as a result of payments in 2002 to the Cal PX and the
reversal of $5 million of credit provision due to the write-off of receivables
as a result of a May 15, 2002 FERC order discussed below. As of June 30, 2002,
Reliant Resources had a remaining pre-tax credit provision of $30 million
against these receivable balances. Management will continue to assess the
collectability of these receivables based on further developments affecting the
California electricity market and the market participants described herein.

FERC Market Mitigation. In response to the filing of a number of complaints
challenging the level of wholesale prices, the FERC initiated a staff
investigation and issued a number of orders implementing a series of wholesale
market reforms. In these orders, the FERC also instituted a refund proceeding,
described below, as a result of which Reliant Resources may face an as yet
undetermined amount of refund liability. See "- FERC Refunds" below. Prior to
adopting a methodology for calculating refunds in the refund proceeding, the
FERC has identified, for the period January 1, 2001 through June 19, 2001,
approximately $20 million of the $149 million charged by Reliant Resources for
sales in California to the Cal ISO and the Cal PX as being subject to possible
refunds. During the six months ended June 30, 2001, Reliant Resources accrued
refunds of $15 million.

On April 26, 2001, the FERC issued an order replacing previous price review
procedures and establishing a market monitoring and mitigation plan, effective
May 29, 2001, for the California markets. The plan establishes a cap on prices
during periods when power reserves fall below 7% in the Cal ISO (reserve
deficiency periods). The Cal ISO was instructed to use data submitted
confidentially by gas-fired generators in California and daily indices of
natural gas to establish the proxy market-clearing price in real-time based on
the marginal cost of the highest-cost generator called to run. The plan also
requires generators in California to offer all their available capacity for sale
in the real-time market, and conditions sellers' market-based rate authority
such that prices charged by sellers engaging in certain bidding practices will
be subject to increased scrutiny by the FERC, such sellers could face potential
refunds and even revocation of their market-based rate authority. On June 19,
2001, the FERC issued an order modifying the market monitoring and mitigation
plan adopted, effective on June 20, 2001 and extending until September 30, 2002,
to apply price controls to all hours, instead of just hours of low operating
reserve, and to extend the mitigation measures to other Western states in
addition to California, including Arizona, Colorado, Idaho, Montana, Nevada, New
Mexico, Oregon, Utah, Washington and Wyoming. The FERC set July 2, 2001 as the
refund effective date for sales subject to the price mitigation plan throughout
the West region. This means that transactions after that date may be subject to
refund if they exceed the proxy market clearing price calculated under the June
19 order, during periods of reserve deficiency. In non-reserve deficiency hours
in California, the maximum price in California and the other Western states will
be capped at 85% of the highest Cal ISO hourly market clearing price established
during the most recent reserve deficiency period. Effective July 11, 2002, the
FERC modified the proxy market clearing price to establish a fixed price cap of
$91.87/MWh. Sellers other than marketers will be allowed to bid higher than the
capped price, but such bids are subject to justification and potential refund.
Justification of higher prices is limited to demonstrating higher actual gas
costs than the gas price index used in the proxy price calculation together with
showing that conditions in natural gas markets changed significantly.

33

On December 19, 2001, the FERC issued additional orders on price mitigation
in California and the West region. These orders largely maintained existing
mitigation mechanisms, including the June 19, 2001 order's requirement that
generators must offer all available capacity for sale in the real-time market.
As a result of this requirement, Reliant Resources' opportunity to sell
ancillary services in the West region is reduced. During 2001, Reliant Resources
recorded $42 million in revenues related to ancillary services in the West
region.

On May 15, 2002, the FERC issued several orders clarifying and modifying
its mitigation measures. These orders removed the possibility that the Cal ISO
would retroactively adjust mitigated market clearing prices for 2001 and
provided the Cal ISO with further instructions for payment of minimum load costs
owed to sellers complying with the must offer obligation.

On July 17, 2002, FERC issued an order directing short-term and longer-term
redesign of the California wholesale electricity market. These new principles
will replace the market mitigation measures discussed above. Effective October
1, 2002, the July 17 order imposes a $250/MWh bid cap in place of existing price
controls, and implements automatic mitigation procedures that may be applied if
a bid is in excess of $91.87/MWh, results in a 200% or $100/MWh increase above
an as yet undetermined unit-specific reference level, and results in a 200% or
$50/MWh increase in the market clearing price. A variation of this formula will
be used to cap bids in congested areas. The order also approves new penalties
for generators that operate outside of Cal ISO instructed quantities, and
extends the requirement that generators offer all available supply into the
California market, effective October 1, 2002. In addition, the July 17 order
instructs that the Cal ISO develop a day-ahead market for implementation January
1, 2003, and that the Cal ISO and California market participants work to develop
a capacity procurement system for implementation as soon as possible. Other
long-term aspects of the redesign of the Cal ISO market remain open for
consideration by FERC.

In a separate order issued July 17, 2002, FERC ordered that the current Cal
ISO Board of Governors be disbanded and replaced with an independent Board by
January 1, 2003. There are some indications that the Cal ISO Board will seek to
stay the FERC's order or otherwise resist this instruction from FERC.

As noted above, the mitigation plan allows sellers, such as the Company, to
justify prices above the proxy price. However, previous efforts by Reliant
Resources to justify prices above the proxy price have been rejected by the FERC
and there is no certainty that the FERC will allow for the recovery of costs
above the proxy price.

FERC Refunds. The FERC issued an order on July 25, 2001 adopting a refund
methodology and initiating a hearing schedule to determine (a) revised mitigated
prices for each hour from October 2, 2000 through June 20, 2001; (b) the amount
owed in refunds by each supplier according to the methodology (these amounts may
be in addition to or in place of the refund amounts previously determined by the
FERC); and (c) the amount currently owed to each supplier. The amounts of any
refunds will be determined by the FERC after the conclusion of the hearing
process which is scheduled to conclude in August 2002. On December 19, 2001, the
FERC issued an order modifying the methodology to be used to determine refund
amounts. The schedule currently anticipates that the Administrative Law Judge
will make his refund amount recommendations to the FERC in October 2002.
However, Reliant Resources does not know when the FERC will issue its final
decision. Based on the FERC's May 15, 2002 order, Reliant Resources estimates
its refund obligation to be $49 million to $79 million for energy sales in the
West region. During the second quarter of 2002, Reliant Resources recorded an
additional reserve for refunds of $34 million related to energy sales in the
West region based on the May 15, 2002 order. As discussed above, $15 million was
recognized in the second quarter of 2001. As of June 30, 2002, Reliant
Resources' total reserve for refunds related to energy sales in the West region
is $49 million. Refunds will likely be offset against unpaid amounts owed to
Reliant Resources for its prior sales.

On November 20, 2001, the FERC instituted an investigation under Section
206 of the Federal Power Act regarding the tariffs of all sellers with
market-based rates authority, including Reliant Resources. In this proceeding,
the FERC proposes to condition the market-based rate authority of all sellers on
their not engaging in anti-competitive behavior. Such condition would depend
upon a further order from FERC establishing a refund effective date. This
condition would allow the FERC, if it determines that a seller has engaged in
anti-competitive behavior subsequent to the start of the refund effective
period, to order refunds back to the date of such behavior. The FERC invited
comments regarding this proposal, and Reliant Resources has filed comments in
opposition to the proposal. On March 11, 2002, the FERC's Staff held a
conference with market participants to discuss the comments FERC has received,
and possible modification of the proposed conditions to address concerns raised
in the comments while

34

protecting consumers against anticompetitive behavior. The timing of further
action by FERC is uncertain, although the FERC has publicly indicated that it is
considering modifications that would limit the scope and application of its
original proposal. If the FERC does not modify or reject its proposed approach
for dealing with anti-competitive behavior, the implementation of the refund
obligation could effect Reliant Resources' future earnings.

On February 13, 2002, the FERC issued an order initiating a staff
investigation into potential manipulation of electric and natural gas prices in
the West region for the period January 1, 2000 forward. While this order does
not propose any action against Reliant Resources, if the investigation results
in findings that markets were dysfunctional during this period, those findings
may be used in support of existing or future claims by the FERC or others that
prices for sales in the West region after January 1, 2000 should be altered. As
part of the investigation and in response to the disclosure of documents
describing certain electricity trading strategies used by Enron Power Marketing,
the FERC issued several requests for admissions and associated data to all
sellers of wholesale electricity and ancillary services in the Cal ISO and Cal
PX markets during the years 2000 through 2001, including Reliant Resources. The
May 8, 2002 data request sought information concerning whether Reliant Resources
and approximately 150 other sellers used the same or similar trading strategies
and practices as described in the Enron documents. The May 21 data request
sought information concerning whether Reliant Resources and approximately 150
other sellers engaged in "wash" or "round trip" sales of energy in the west. A
May 22 data request sought the same information from sellers of wholesale
natural gas regarding natural gas trades. The FERC has not yet publicly stated
whether it may assert that any of these strategies and practices was
impermissible under market rules in effect during the period in question. After
reviewing records and conducting internal interviews, Reliant Resources
responded to the data requests regarding the trading strategies and practices as
described in the Enron documents. Reliant Resources also responded to FERC's
data requests regarding round trip electricity and natural gas trades, including
the identification of a round trip electricity trade responsive to the FERC's
data request. Reliant Resources has provided similar information to the
California Senate Select Committee for its investigation of price manipulation
of the wholesale energy market.

The above-described lawsuits and proceedings regarding California
electricity sales are currently the subject of intense, highly-charged media and
political attention. Their ultimate outcome cannot be predicted at this time.

Other Investigations. In addition to the FERC investigation discussed
above, several state and other federal regulatory investigations and complaints
have commenced in connection with the wholesale electricity prices in California
and other neighboring Western states to determine the causes of the high prices
and potentially to recommend remedial action. In California, the California
State Senate and the California Office of the Attorney General have separate
ongoing investigations into the high prices and their causes. Although these
investigations have not been completed and no findings have been made in
connection with either of them, the California Attorney General has filed a
civil lawsuit in San Francisco Superior Court alleging that the Company has
violated state laws against unfair and unlawful business practices and a
complaint with the FERC alleging the Company violated the terms of its tariff
with the FERC (see Note 13(a)). Adverse findings or rulings could result in
punitive legislation, sanctions, fines or even criminal charges against Reliant
Resources or its employees. Reliant Resources is cooperating with both
investigations and has produced a substantial amount of information requested in
subpoenas issued by each body. The Washington and Oregon attorneys general have
also begun similar investigations.

Legislative Efforts. Since the inception of the California energy crisis,
various pieces of legislation, including tax proposals, have been introduced in
the U.S. Congress and the California Legislature addressing several issues
related to the increase in wholesale power prices in 2000 and 2001. For example,
a bill was introduced in the California legislature that would have created a
"windfall profits" tax on wholesale electricity sales and would subject exempt
wholesale generators, such as Reliant Resources' subsidiaries that own
generation facilities in California, to regulation by the CPUC as "public
utilities." To date, only a few energy-related bills have passed, such as the
recently enacted plant inspection law, which would empower the CPUC to monitor
activities of Reliant Resources' generating plants. Reliant Resources believes
this bill is vulnerable to challenge based on the preemptive effect of the
Federal Power Act. Reliant Resources does not believe that this or other
legislation that has been enacted to date will have a material adverse effect on
Reliant Resources. However, it is possible that legislation could be enacted on
either the state or federal level that could have a material adverse effect on
Reliant Resources' financial condition, results of operations and cash flows.

35

(e) Dutch Stranded Costs.

Background. In January 2001, the Dutch Electricity Production Sector
Transitional Arrangements Act (Transition Act) became effective. Among other
things, the Transition Act allocated to REPGB and the three other large-scale
Dutch generation companies, a share of the assets, liabilities and stranded cost
commitments of NEA. Prior to the enactment of the Transition Act, NEA acted as
the national electricity pooling and coordinating body for the generation output
of REPGB and the three other large-scale national Dutch generation companies.
REPGB and the three other large-scale Dutch generation companies are
shareholders of NEA.

The Transition Act and related agreements specify that REPGB has a 22.5%
share of NEA's assets, liabilities and stranded cost commitments. NEA's stranded
cost commitments consisted primarily of various uneconomical or stranded cost
investments and commitments, including a gas supply contract, three power
contracts entered into prior to the liberalization of the Dutch wholesale
electricity market and a contract relating to the construction of an
interconnection cable between Norway and the Netherlands subject to a long-term
power exchange agreement (PEA) (the "NorNed Project"). REPGB's stranded cost
obligations also include uneconomical district heating contracts which were
previously administrated by NEA prior to deregulation of the Dutch power market.

In January 2001, NEA assigned to REPGB a 22.5% interest in the stranded
cost contracts, including the gas supply contract, which expires in 2016, and
provides for gas imports aggregating 2.283 billion cubic meters per year. During
December 2001, one of the stranded power contracts was settled. In May 2002, NEA
amended the two remaining long-term power contracts in order to bring them to
market-conforming terms and, in connection with these amendments, assigned the
contracts to NEA's shareholders. The district heating obligations related to
three water heating supply contracts entered into with various municipalities
expiring from 2008 through 2015. Under the district heating contracts, the
municipal districts are required to take annually a combined minimum of 5,549
terajoules (TJ) increasing annually to 7,955 TJ over the life of the contracts.

The Transition Act provided that, subject to the approval of the European
Commission, the Dutch government will provide financial compensation to the
Dutch generation companies, including REPGB, for liabilities associated with
long-term district heating contracts. In July 2001, the European Commission
ruled that under certain conditions the Dutch government can provide financial
compensation to the generation companies for the district heating contracts. To
the extent that this compensation is not ultimately provided to the generation
companies by the Dutch government, REPGB is entitled to claim compensation
directly from the former shareholders as further discussed below.

Settlement of Stranded Cost Indemnification Agreement. Until December 2001,
the former shareholders were obligated to indemnify REPGB for up to NLG 1.9
billion of its share of NEA's stranded cost liabilities. In December 2001, REPGB
and its former shareholders agreed to settle the indemnity obligations of the
former shareholders in so far as they related to NEA's stranded cost gas supply
and power contracts and other obligations of NEA (excluding district heating).

Under the settlement agreement, the former shareholders paid REPGB NLG 500
million ($202 million) in the first quarter of 2002. REPGB deposited the
settlement payment into an escrow account, withdrawals from which are at the
discretion of REPGB for use in discharging stranded cost obligations related to
the gas and electric import contracts. As of June 30, 2002, the escrow funds
equaled $65 million, of which $2 million and $63 million were recorded in
restricted cash and long-term assets, respectively. Any remaining funds as of
January 1, 2004 will be distributed to REPGB.

Under the settlement agreement, the former shareholders continue to be
under an obligation to indemnify REPGB for certain district heating contracts.
Under the terms of the indemnity, REPGB can elect between two forms of
indemnification within 21 days after the date that the Ministry of Economic
Affairs of the Netherlands publishes regulations for compensation of stranded
costs associated with district heating projects. If the compensation to be paid
by the Netherlands under these rules is at least as much as the compensation to
be paid under the original indemnification agreement, REPGB can elect to receive
a one-time payment of NLG 60 million ($24 million). In addition, unless the
decree implementing the new compensation rules provides for compensation for the
lifetime of the district heating projects, REPGB can receive an additional cash
payment of NLG 15 million ($6 million). If the compensation rules do not provide
for compensation at least equal to that provided under the original
indemnification agreement, REPGB can claim indemnification for stranded cost
losses up to a maximum of NLG 700 million ($282 million) less the amount of
compensation provided by the new compensation rules and certain proceeds
received from arbitrations. If no new compensation rules have taken effect on or
prior to December 31, 2003, REPGB is entitled, but not obligated, to elect to
receive indemnification under the formula described above. As of August 9, 2002,
the Ministry of Economic Affairs had not published its compensation rules. Based
on current assumptions, it is not anticipated that such rules will be published
until, at the earliest, the fourth quarter of 2002.

36

Prior to the settlement agreement, pursuant to the purchase agreement of
REPGB, as amended, REPGB was entitled to a NLG 125 million (approximately $51
million) dividend from NEA with any remainder owing to the former shareholders.
Under the settlement agreement, the former shareholders waived all rights to
distributions of NEA.

As a result of this settlement, the Company recognized in the fourth
quarter of 2001 a net gain of $37 million for the difference between the sum of
(a) the cash settlement payment of $202 million and the additional rights to
claim distributions of the NEA investment recognized of $248 million and (b) the
amount recorded as stranded cost indemnity receivable related to the stranded
cost gas and electric commitments of $369 million and claims receivable related
to stranded costs incurred in 2001 of $44 million, both previously recorded in
the Company's Consolidated Balance Sheet.

Amendments to Stranded Cost Electricity Import Contracts. In May 2002, NEA
and its four shareholders (including REPGB) entered into agreements amending the
terms of the two remaining power supply agreements (Settlement Agreements).
These two contracts provide for the following capacities and terms: (a) 300 MW
through 2003, and (b) 600 MW through March 2002, increasing to 750 MW through
March 2009.

Under the terms of the Settlement Agreements, NEA paid the counterparties a
net aggregate payment of Euro 485 million, approximately $446 million (the
Settlement Payment) (of which REPGB's proportionate share as a NEA shareholder
was Euro 109 million, approximately $100 million). In July 2002, REPGB paid its
share of the Settlement Payment with funds from the stranded cost indemnity
escrow account, as discussed above. In exchange for its portion of the
Settlement Payment, the counterparties to the power contracts replaced the
existing terms with a market-based electricity price index for comparable
electricity products in addition to other changes.

As a result of the Settlement Agreements, in the second quarter of 2002,
the Company recognized a pre-tax net gain of $109 million for the difference
between (a) the fair values of the original power contracts ($203 million net
liability previously recorded in non-trading derivative liabilities) and the
fair values of the amended power contracts ($6 million net asset recorded in
trading and marketing assets) and (b) the Settlement Payment of $100 million, as
described above. The pre-tax net gain of $109 million was recorded as a
reduction of purchased power expense in the Statement of Consolidated Income in
the second quarter of 2002. In the future, these two power trading contracts
will be marked-to-market as a part of the Company's energy trading activities.

Separately, in May 2002, following the execution of the Settlement
Agreements, NEA declared a Euro 625 million, approximately $619 million, cash
dividend to its shareholders, which was paid on July 1, 2002. REPGB's share of
the dividend was Euro 141 million, approximately $139 million. As of June 30,
2002, the dividend receivable from NEA was recorded in other current assets in
the Company's Consolidated Balance Sheet.

Remaining Liability for Original Stranded Costs. In January 2001, the
Company recognized an out-of-market, net stranded cost liability for its gas and
electric import contracts and district heating commitments. At such time, the
Company recorded a corresponding asset of equal amount for the indemnification
of this obligation from REPGB's former shareholders and the Dutch government, as
applicable. As of December 31, 2001, the Company has recorded a liability of
$369 million for its stranded cost gas and electric commitments in non-trading
derivative liabilities and a liability of $206 million for its district heating
commitments in current and non-current other liabilities. As of June 30, 2002,
the Company has recorded a liability of $155 million for its stranded cost gas
contract in non-trading derivative liabilities, an asset of $7 million for its
amended power contracts in trading and marketing assets, and a liability of $229
million for its district heating commitments in current and non-current other

37

liabilities. As of December 31, 2001 and June 30, 2002, the Company has recorded
an indemnification receivable for the district heating stranded cost liability
of $206 million and $229 million, respectively.

Pursuant to SFAS No. 133, the Company marks-to-market the stranded cost gas
contract (see Note 4). Prior to the amendments to the remaining power contracts,
pursuant to SFAS No. 133, the power contracts were marked-to-market. Subsequent
to amending the remaining power contracts, the power contracts are
marked-to-market as a part of the Company's energy trading activities. Pursuant
to SFAS No. 133, during the three and six months ended June 30, 2002, the
Company recognized a $3 million loss and net $16 million gain, respectively,
recorded in fuel expense related to changes in the valuation of the stranded
cost contracts, excluding the effects of the gain related to amending the two
power contracts discussed above.

NorNed Project. NEA entered into commitments with certain Norwegian
counterparties (the Norwegian Counterparties) for the construction of a grid
interconnector cable between the Netherlands and Norway, subject to the
operation of a bi-directional, long-term (25 years in duration) PEA. The PEA
contemplates, among other terms, exclusive use and cost free access to the cable
by NEA and the Norwegian counterparties. The PEA is subject to, among other
things, clearance by the European Commission and the Dutch regulatory
authorities of the terms and conditions of the PEA. In 2001, NEA and the
Norwegian counterparties filed a notification request regarding the PEA with the
European Commission. It is not expected that the European Commission will
respond to the notification request until the third quarter of 2003. Under the
Transition Act, NEA is entitled to recover the cable construction costs from
TenneT, the Netherlands grid operator. However, at this early stage it is not
entirely clear how NEA will receive the transport tariff funds intended to
recover the construction costs of the cable, and whether the ultimate transport
tariff rate approved by the Dutch power regulation (Dte) will be sufficient to
cover the ultimate construction costs. However, assuming that the Transition Act
is fully implemented with respect to this matter, REPGB believes that NEA will
ultimately recover the full cost of the cable.

For additional information regarding the indemnification and settlement of
stranded costs, see Note 14(h) to the Reliant Energy 10-K/A Notes.

Investment in NEA. During the second quarter of 2001, the Company recorded
a $51 million pre-tax gain (NLG 125 million) recorded as equity income for the
preacquisition gain contingency related to the acquisition of REPGB for the
value of its equity investment in NEA. This gain was based on the Company's
evaluation of NEA's financial position and fair value. The fair value of the
Company's investment in NEA is dependent upon the ultimate resolution of its
existing contingencies and proceeds received from liquidating its remaining net
assets. Prior to the settlement agreement discussed above, pursuant to the
purchase agreement of REPGB, as amended, REPGB was entitled to a NLG 125 million
dividend from NEA with any remainder owing to the former shareholders.

(f) Construction Agency Agreements and Equipment Financing Structure.

In 2001, Reliant Resources, through several of its subsidiaries, entered
into operative documents with special purpose entities to facilitate the
development, construction, financing and leasing of several power generation
projects. The special purpose entities are not consolidated by the Company. As
a result of the decision to cancel one of the projects, the commitments were
reallocated in June 2002 so that the special purpose entities now have an
aggregate financing commitment from equity and debt participants (Investors) of
$1.9 billion of which the last $515 million is currently available only if cash
collaterized. The availability of the commitment is subject to satisfaction of
various conditions, including the obligation to provide cash collateral for the
loans and letters of credit outstanding on November 29, 2004. Reliant Resources,
through several of its subsidiaries, acts as construction agent for the special
purpose entities and is responsible for completing construction of these
projects by December 31, 2004, but Reliant Resources has generally limited its
risk during construction to an amount not in excess of 89.9% of costs incurred
to date, except in certain events. Upon completion of an individual project and
exercise of the lease option, Reliant Resources' subsidiaries will be required
to make lease payments in an amount sufficient to provide a return to the
Investors. If Reliant Resources does not exercise its option to lease any
project upon its completion, Reliant Resources must purchase the project or
remarket the project on behalf of the special purpose entities. Reliant
Resources' ability to exercise the lease option is subject to certain
conditions. Reliant Resources must guarantee that the Investors will receive an
amount at least equal to 89.9% of their investment in the case of a remarketing
sale at the end of construction. At the end of an individual project's initial
operating lease term (approximately five years from construction completion),
Reliant Resources' subsidiary lessees have the option to extend the lease with
the

38

approval of Investors, purchase the project at a fixed amount equal to the
original construction cost, or act as a remarketing agent and sell the project
to an independent third party. If the lessees elect the remarketing option, they
may be required to make a payment of an amount not to exceed 85% of the project
cost, if the proceeds from remarketing are not sufficient to repay the
Investors. Reliant Resources has guaranteed the performance and payment of its
subsidiaries' obligations during the construction periods and, if the lease
option is exercised, each lessee's obligations during the lease period. At any
time during the construction period or during the lease, Reliant Resources may
purchase a facility by paying an amount approximately equal to the outstanding
balance plus costs. As of June 30, 2002, the special purpose entities had
property, plant and equipment of $1.0 billion, net other assets of $90 million
and debt obligations of $1.1 billion. As of June 30, 2002, the special purpose
entities had equity from unaffiliated third parties of $40 million.

Reliant Resources, through its subsidiary, REPG, has entered into an
agreement with a bank whereby the bank, as owner, entered or will enter into
contracts for the purchase and construction of power generation equipment and
REPG, or its subagent, acts as the bank's agent in connection with administering
the contracts for such equipment. Under the agreement, the bank has agreed to
provide up to a maximum aggregate amount of $650 million. REPG and its subagents
must cash collateralize their obligation to administer the contracts. This cash
collateral is approximately equivalent to the total payments by the bank for the
equipment, interest and other fees. As of June 30, 2002, the bank had assumed
contracts for the purchase of three turbines, and two heat recovery steam
generators with an aggregate cost of $121 million. REPG, or its designee, has
the option at any time to purchase, or, at equipment completion, subject to
certain conditions, including the agreement of the bank to extend financing, to
lease the equipment, or to assist in the remarketing of the equipment under
terms specified in the agreement. All costs, including the purchase commitment
on the turbines, are the responsibility of the bank. The cash collateral is
deposited by REPG or the subagent into a collateral account with the bank and
earns interest at LIBOR less 0.15%. Under certain circumstances, the collateral
deposit or a portion of it, will be returned to REPG or its designee. Otherwise,
it will be retained by the bank. At December 31, 2001 and June 30, 2002, REPG
and/or its subagent had deposits of $230 million and $92 million, respectively,
in the collateral account. In May 2002, REPG was assigned and exercised a
purchase option for a contract for an air cooled condenser totaling $20 million
under which payments and interest during construction totaling $8 million had
been made. REPG used $8 million of its collateral deposits to complete the
purchase. After the purchase, REPG canceled the contract and paid a cancellation
payment of $1.7 million to the manufacturer. In January 2002, the bank sold to
the parties to the construction agency agreements discussed above, equipment
contracts with a total contractual obligation of $258 million, under which
payments and interest during construction totaled $142 million. Accordingly,
$142 million of collateral deposits were returned to Reliant Resources. While
the remaining equipment is not designated for current planned power generation
construction projects, Reliant Resources believes the equipment will be used in
future projects. Therefore, Reliant Resources anticipates that it will purchase
the equipment, but can also assist in the remarketing of the equipment or
negotiate to cancel the related contracts.

(g) REMA Sale/Leaseback Transactions.

In August 2000, subsidiaries of Reliant Resources entered into separate
sale/leaseback transactions with each of the three owner-lessors for the
Company's respective 16.45%, 16.67% and 100% interests in the Conemaugh,
Keystone and Shawville generating stations, respectively, which Reliant
Resources acquired in the REMA acquisition. The lease documents contain some
restrictive covenants that restrict REMA's ability to, among other things, make
dividend distributions unless REMA satisfies various conditions. As of June 30,
2002, these various conditions were satisfied by REMA. As of December 31, 2001,
REMA had $167 million of restricted funds that were available for REMA's working
capital needs and to make future lease payments. For additional discussion of
these lease transactions, please read Notes 3(a) and 14(b) to the Reliant Energy
10-K/A Notes.

(h) Nuclear Insurance.

The Company has a 30.8% interest in the South Texas Project Electric
Generating Station (South Texas Project), which consists of two 1,250 MW nuclear
generating units and bears a corresponding 30.8% share of capital and operating
costs associated with the project. The South Texas Project is owned as a tenancy
in common among its four co-owners, with each owner retaining its undivided
ownership interest in the two nuclear-fueled generating units and the electrical
output from those units. The Company and the other owners of the South Texas
Project maintain nuclear property and nuclear liability insurance coverage as
required by law and periodically review available limits and coverage for
additional protection. The owners of the South Texas Project currently maintain

39

$2.75 billion in property damage insurance coverage, which is above the legally
required minimum, but is less than the total amount of insurance currently
available for such losses.

Pursuant to the Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants was $9.3 billion as of June 30, 2002. Owners are
required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. The Company and the other owners of the
South Texas Project currently maintain the required nuclear liability insurance
and participate in the industry retrospective rating plan under which the owners
of the South Texas Project are subject to maximum retrospective assessments in
the aggregate per incident of up to $88 million per reactor. The owners are
jointly and severally liable at a rate not to exceed $10 million per incident
per year.

There can be no assurance that all potential losses or liabilities will be
insurable, or that the amount of insurance will be sufficient to cover them. Any
substantial losses not covered by insurance would have a material effect on the
Company's financial condition, results of operations and cash flows.

(i) Nuclear Decommissioning.

The Company contributed $14.8 million in 2001 to trusts established to fund
its share of the decommissioning costs for the South Texas Project. Pursuant to
an October 3, 2001 Order from the Texas Utility Commission, beginning in 2002,
the Company will contribute $2.9 million per year to these trusts. There are
various investment restrictions imposed upon the Company by the Texas Utility
Commission and the Nuclear Regulatory Commission (NRC) relating to the Company's
nuclear decommissioning trusts. Additionally, the Company's board of directors
has appointed the Nuclear Decommissioning Trust Investment Committee to
establish the investment policy of the trusts and oversee the investment of the
trusts' assets. The securities held by the trusts for decommissioning costs had
an estimated fair value of $169 million as of June 30, 2002, of which
approximately 45% were fixed-rate debt securities and the remaining 55% were
equity securities. For a discussion of the accounting treatment for the
securities held in the Company's nuclear decommissioning trusts, see Note 2(l)
to the Reliant Energy 10-K/A Notes, which note is incorporated herein by
reference. In July 1999, an outside consultant estimated the Company's portion
of decommissioning costs to be approximately $363 million. While the current
funding levels exceed minimum NRC requirements, no assurance can be given that
the amounts held in trust will be adequate to cover the actual decommissioning
costs of the South Texas Project. Such costs may vary because of changes in the
assumed date of decommissioning and changes in regulatory requirements,
technology and costs of labor, materials and equipment. Pursuant to the Texas
electric restructuring law, costs associated with nuclear decommissioning that
have not been recovered as of January 1, 2002, will continue to be subject to
cost-of-service rate regulation and will be included in a charge to transmission
and distribution customers.

Pursuant to the terms of the master separation agreement between the
Company and Reliant Resources and the applicable NRC regulations, the
responsibility for the decommissioning trusts will transfer to Texas Genco at
the time of the Restructuring. The Electric Transmission and Distribution
business segment will continue to collect charges relating to decommissioning
funding from customers and to transmit the amounts collected to Texas Genco for
deposit into the decommissioning trusts.

(14) REPORTABLE BUSINESS SEGMENTS

The Company's determination of reportable business segments considers the
strategic operating units under which the Company manages sales, allocates
resources and assesses performance of various products and services to wholesale
or retail customers in differing regulatory environments. The Company has
identified the following reportable business segments: Electric Transmission and
Distribution, Electric Generation, Natural Gas Distribution, Pipelines and
Gathering, Wholesale Energy, European Energy, Retail Energy and Other
Operations. Effective with the deregulation of the Texas electric industry
beginning January 1, 2002, the basis of business segment reporting has changed
for the Company's electric operations. Although the Company's retail sales are
now conducted by Reliant Resources, retail customers remained regulated
customers of Reliant Energy HL&P through the date of their first meter reading
in January 2002. Sales of electricity in 2002 prior to such meter reading are
reflected in the Electric Transmission and Distribution business segment. The
Texas generation operations of Reliant Energy's former integrated utility,
Reliant Energy HL&P, are now a separate reportable business segment, whereas
they previously had been part of the Electric Operations business segment. The
remaining transmission and distribution function is now reported separately in
the Electric Transmission and Distribution business segment, which also

40

includes all impacts from generation-related regulatory assets recoverable by
the regulated utility, including the ECOM true-up component of stranded costs.
In 2001, Latin America was a separate business segment, but is now reported in
the Other Operations business segment beginning in 2002. Reportable business
segments from 2001 have been restated to conform to the 2002 presentation. Note
that estimates have been used to separate historical, pre-January 1, 2002,
Electric Generation business segment data from the Electric Transmission and
Distribution segment (see notes to the following tables). For descriptions of
these reportable business segments, see Note 1 to the Reliant Energy 10-K/A
Notes.

Beginning in the first quarter of 2002, the Company began to evaluate
business segment performance on an earnings (loss) before interest expense,
minority interest and income taxes (EBIT) basis. Prior to 2002, the Company
evaluated performance based upon operating income. EBIT, as defined, is shown
because it is a widely accepted measure of financial performance used by
analysts and investors to analyze and compare companies on the basis of
operating performance. EBIT is not defined under accounting principles generally
accepted in the United States of America (GAAP), and should not be considered in
isolation or as a substitute for a measure of performance prepared in accordance
with GAAP and is not indicative of operating income from operations as
determined under GAAP. Additionally, the Company's computation of EBIT may not
be comparable to other similarly titled measures computed by other companies,
because all companies do not calculate it in the same fashion.

Financial data for the reportable business segments are as follows:

- ----------

(1) Retail customers remained regulated customers of Reliant Energy HL&P,
an unincorporated division of the Company, through the date of their
first meter reading in January 2002. Sales of electricity to retail
customers in 2002 prior to this meter reading are reflected in the
Electric Transmission and Distribution business segment.

(2) For 2001, revenues were derived based on an allowed regulatory rate of
return on invested capital with Reliant Energy HL&P being the sole
customer of the Electric Generation business segment. Expenses, such
as fuel and cost of gas sold, operations and maintenance and
depreciation and amortization, and assets, such as property, plant and
equipment and inventory, were specifically identified by function and
reported accordingly. Various allocations were used to disaggregate
other common expenses, assets and liabilities between the Electric
Generation and the Electric Transmission and Distribution business
segments. Interest expense was calculated based upon an allocation
methodology that charged the Electric Generation business segment with
financing and equity costs from Reliant Energy in proportion to its
share of total net assets prior to the effects of deregulation. For
2002, the Electric Generation business segment's operations reflect
market prices for power established by capacity auctions.

(3) Reliant Resources' Retail Energy business segment became a provider of
retail electricity in Texas when that market began opening to retail
competition in late 2001 and fully opened to retail competition in
January 2002. As a retail electric provider, Reliant Resources' Retail
Energy business segment generally procures or buys electricity from
wholesale generators at unregulated rates, sells electricity at
generally unregulated rates to retail customers and pays the local
transmission and distribution regulated utilities a

42

regulated tariff rate for delivering electricity. In January 2002,
Reliant Resources' Retail Energy business segment began to provide
retail electric services to all of the approximately 1.7 million
customers of Reliant Energy HL&P's electric utility located in its
service area who did not take action to select another retail electric
provider.

Reconciliation of Operating Income to EBIT and EBIT to Net Income
Attributable to Common Stockholders:

(15) SUBSEQUENT EVENTS

(a) Exchange of Zero-Premium Exchangeable Subordinated Notes due 2029 (ZENS).

From July 1, 2002 through August 9, 2002, holders of approximately 12% of
the ZENS outstanding exercised their right to exchange their ZENS for cash,
resulting in aggregate cash payments by Reliant Energy of $33 million. Holders
of ZENS submitted for exchange are entitled to receive a cash payment equal to
95% of the market value of the reference shares of AOL Time Warner common stock.
There are 1.5 reference shares of AOL Time Warner common stock for each of the
17.2 million ZENS units originally issued. The exchange market value is
calculated using the average closing price per share of AOL Time Warner common
stock on the New York Stock Exchange on one or more trading days following the
notice date. Payment must be made no later than ten trading days following the
notice date. The Company recorded a gain of $9 million related to the
liquidation of the AOL Time Warner common stock.

A subsidiary of Reliant Energy owns the reference shares of AOL Time Warner
common stock and has elected to liquidate such holdings in an amount sufficient
to make the cash payments. In connection with exchanges through August 9, 2002,
Reliant Energy received net proceeds of $31 million from the liquidation of 3.1
million shares of AOL Time Warner common stock at an average price of $10 per
share.

(b) Sale of Receivables.

In July 2002, Reliant Resources entered into an arrangement (Receivables
Facility) with a financial institution to sell an undivided interest in accounts
receivable from residential and small commercial retail electric customers under
which, on an ongoing basis, a maximum of $250 million can be sold from a
designated pool. The term of the Receivables Facility is one year and may be
renewed at Reliant Resources' option and the option of the financial
institutions participating in the Receivables Facility. Reliant Resources
received net proceeds in an initial amount of $230 million. The amount of
funding available to Reliant Resources under the Receivables Facility will
fluctuate based on the amount of receivables available. The Receivables Facility
may be increased to an amount greater than $250 million on a seasonal basis,
subject to the availability of receivables and approval by the participating
financial institutions. Pursuant to the Receivables Facility, Reliant Resources
formed a qualified special purpose entity

43

(QSPE), a bankruptcy remote subsidiary. The QSPE was formed for the sole purpose
of buying and selling receivables generated by Reliant Resources. Reliant
Resources, irrevocably and without recourse, will transfer receivables to the
QSPE. The QSPE, in turn, will sell an undivided interest in these receivables to
the participating financial institutions. Reliant Resources is not ultimately
liable for any failure of payment of the obligors on the receivables. Reliant
Resources has, however, guaranteed the obligations of the sellers and the
servicer of the receivables under the related documents.

The two-step transaction is accounted for as a sale of receivables under
the provisions of SFAS No. 140 "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" (SFAS No. 140), and, as a
result, the related receivables will be excluded from the Consolidated Balance
Sheet. Costs associated with the sale of receivables, primarily the discount and
loss on sale, will be included in other expense in the Statement of Consolidated
Income.

(c) Refinancing of Certain REPGB Debt.

During July 2002, REPGB renewed its 364-day revolving credit facility for
another year. The term of this facility is now scheduled to expire in July 2003.
The amount of the credit facility was reduced from Euro 250 million
(approximately $248 million) to Euro 184 million (approximately $182 million).
An option was added that permits REPGB to utilize up to Euro 100 million of the
facility for letters of credit. The revolving credit facility bears interest at
the rate of EURIBOR plus a margin, depending on REPGB's credit rating. As of
August 9, 2002, the facility bears interest at an annual rate of 4.77%. The
credit facility contains certain covenants and negative pledges that must be met
by REPGB to borrow funds or obtain letters of credit, that require REPGB to,
among other things, maintain a ratio of net balance sheet debt to the sum of net
balance sheet debt and total equity of 0.60 to 1.00. These covenants are not
anticipated to materially restrict Reliant Resources from borrowing funds or
obtaining letters of credit, as applicable, under this facility.

(d) Credit Ratings.

Reliant Energy (to become CenterPoint Energy subsequent to the Restructuring)

On July 31, 2002, Moody's downgraded the senior unsecured long-term debt
ratings of Reliant Energy and Reliant Energy FinanceCo II LP to Baa2 from Baa1
and left the securities on review for a potential downgrade. Moody's placed the
long-term and short-term ratings of Reliant Energy and RERC Corp. on review for
potential downgrade.

On July 31, 2002, S&P affirmed the corporate credit rating of Reliant
Energy as BBB+ in anticipation that it will spin off its ownership interest of
Reliant Resources by late September 2002.

Consistent with the expected ratings announced February 8, 2001, Fitch
downgraded the long-term ratings of Reliant Energy and RERC Corp. on July 18,
2002. The senior unsecured long-term debt ratings of Reliant Energy and RERC
Corp. are now BBB- and BBB, respectively. A negative outlook was also announced.

Reliant Energy cannot assure that these ratings will remain in effect for
any given period of time or that one or more of these ratings will not be
lowered again. Reliant Energy notes that these credit ratings are not
recommendations to buy, sell or hold its securities and may be revised or
withdrawn at any time by such rating agency. Each rating should be evaluated
independently of any other rating. Any future incremental reduction or
withdrawal of one or more of Reliant Energy's credit ratings could have a
material adverse impact on its ability to access capital on acceptable terms,
including its ability to refinance debt obligations as they mature.

Should Reliant Energy's credit ratings fall below investment grade, Reliant
Energy expects that any credit support required of it by its commercial and
industrial trading counterparties would not be material.

Reliant Resources (unregulated businesses)

Credit ratings impact Reliant Resources' ability to obtain short- and
long-term financing, the cost of such financing and the execution of its
commercial strategies. As of August 9, 2002, Reliant Resources' credit ratings
for its senior unsecured debt were as follows:

- ----------

(1) On July 31, 2002, Moody's downgraded the issuer rating and bank loan
ratings assigned to Reliant Resources to Ba3 from Baa3 and assigned a
senior implied rating of Ba3. Moody's stated in its press release that
Reliant Resources' downgrade reflects Moody's view that Reliant Resources'
cash flow from operations is unpredictable relative to Reliant Resources'
debt load and Reliant Resources' financial flexibility is limited. Going
forward, the review for downgrade will focus on: 1) the

44

timing for stabilization of cash flow in Reliant Resources' Wholesale
Energy business segment; 2) Reliant Resources' ability to refinance its
bank debt and the terms of such refinancings; 3) the resolution of various
government investigations into trading improprieties, including round trip
trades; and 4) Reliant Resources' ability to execute its business plan
including the implementation of cost cutting measures.

(2) On August 7, 2002, Fitch downgraded Reliant Resources' senior unsecured
debt rating to BBB- from BBB. The ratings remain on rating watch negative.
The rating action reflects Reliant Resources' reduced financial flexibility
and the substantial debt refinancing burden Reliant Resources faces over
the next several months.

(3) On July 31, 2002, S&P lowered Reliant Resources' corporate credit ratings
and those of its rated subsidiaries to BBB- from BBB. The ratings remain on
credit watch with negative implications. S&P stated in its press release
that the ratings action reflects Reliant Resources' downgrade by another
rating agency to non-investment grade, and the increased collateral calls
that will be triggered by this action.

Reliant Resources cannot assure that these ratings will remain in effect
for any given period of time or that one or more of these ratings will not be
lowered again. Reliant Resources notes that these credit ratings are not
recommendations to buy, sell or hold its securities and may be revised or
withdrawn at any time by such rating agency. Each rating should be evaluated
independently of any other rating. Any future incremental reduction or
withdrawal of one or more of Reliant Resources' credit ratings could have an
additional material adverse impact on its ability to access capital on
acceptable terms, including its ability to refinance debt obligations as they
mature. Reliant Resources' financial and operational flexibility is likely to be
reduced as a result of more restrictive covenants, the requirement for security
and other terms that are typically imposed on split-rated or sub-investment
grade borrowers.

Reliant Resources has commercial arrangements that have been adversely
impacted by its recent downgrade to sub-investment grade by Moody's. Reliant
Resources also has numerous commercial arrangements that would be further
adversely impacted in the event of any downgrades to sub-investment grade by
Fitch or Standard & Poor's. These commercial arrangements primarily include: (a)
commercial contracts and/or guarantees related to Reliant Resources' wholesale
and retail trading, marketing, risk management and hedging activities; (b)
certain Texas Utility Commission requirements related to the credit strength of
retail electric providers in the State of Texas; and (c) surety bonds and
contractual obligations related to the development and construction or
refurbishment of power plants and related facilities.

In most cases, the consequences of ratings downgrades are limited to the
requirement by Reliant Resources' counterparties that Reliant Resources provides
credit support to the counterparties in the form of a pledge of cash collateral,
a letter of credit or other similar credit support. In some instances, if
Reliant Resources' credit ratings decline below certain credit rating
thresholds, its trading partners and other commercial counterparties may refuse
to trade with Reliant Resources or trade only on terms less favorable to them.
In addition, certain of Reliant Resources' retail electricity contracts with
large commercial, industrial and institutional customers of the Retail Energy
business segment provide the customers the ability to terminate their contract
early if Reliant Resources' unsecured debt ratings fall below investment grade
or if its investment grade ratings are withdrawn entirely by a rating agency.

Reliant Resources is working with its various commercial counterparties so
as to minimize their possible demands for credit support and in order to
minimize the disruption to Reliant Resources' normal commercial activities. In
addition, Reliant Resources has been working with many counterparties to reduce
the magnitude of the collateral they must post in support of its obligations to
such counterparties.

As of August 9, 2002, Reliant Resources has posted cash collateral and
letters of credit in support of various obligations in the amount of $263
million and $350 million, respectively. These relate primarily to commercial
activities in Reliant Resources' Wholesale and Retail businesses. Reliant
Resources expects these collateral requirements to grow, and, in the event that
S&P were to reduce the credit rating of Reliant Resources to below investment
grade, Reliant Resources estimates that they would post additional credit
support (cash and letters of credit) of up to approximately $570 million over
time, excluding the effects of commodity price volatility. As of August 9, 2002,
Reliant Resources had $1.2 billion in unrestricted available cash and short-term
investments and $188 million available under committed corporate credit
facilities. These amounts are available to meet the possible future requirements
for credit support related to Reliant Resources' credit ratings.

45

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF RELIANT ENERGY AND SUBSIDIARIES

The following discussion and analysis should be read in combination with
our Interim Financial Statements contained in this Form 10-Q.

OVERVIEW

We currently engage directly in electric generation, transmission and
distribution in a 5,000-square mile area of the Texas Gulf Coast that includes
Houston. Our wholly owned subsidiary, Reliant Energy Resources Corp. (RERC
Corp.), owns distribution systems that together form one of the United States'
largest natural gas distribution operations in terms of customers served, as
well as two interstate natural gas pipelines. We also own approximately 83% of
the outstanding stock of Reliant Resources, Inc. (Reliant Resources), which owns
and operates electric generation plants and engages in various unregulated
energy service and trading businesses.

We are in the process of separating our regulated and unregulated
businesses into two publicly traded companies that will be independent of each
other: CenterPoint Energy, Inc. (CenterPoint Energy) and Reliant Resources.
CenterPoint Energy will be a holding company created as part of a corporate
restructuring of our businesses in compliance with the Texas electric
restructuring law. See "-The Restructuring" below. Following the restructuring,
CenterPoint Energy's wholly owned operating subsidiaries will own and operate
our electric generation plants in Texas, our electric transmission and
distribution facilities, and our natural gas distribution facilities and natural
gas pipelines. CenterPoint Energy's wholly owned subsidiaries will include:

o CenterPoint Energy Houston Electric, LLC, which will engage in our
electric transmission and distribution business in the Texas Gulf
Coast area;

o Texas Genco, LP, which will own and operate our Texas
generating plants; and

o CenterPoint Energy Resources Corp. (currently RERC Corp.).

Our 83%-ownership interest in Reliant Resources is expected to be
distributed to CenterPoint Energy's shareholders shortly after the holding
company restructuring. Reliant Resources will continue to engage in:

o domestic unregulated power generation and energy trading and marketing
operations;

o retail electric, telecommunications and internet services businesses
(including the Texas retail electric business in which we engaged
directly as an integrated electric utility prior to January 1, 2002);
and

o European power generation and energy trading and marketing operations.

In this section we discuss our results of operations on a consolidated
basis and individually for each of our business segments. We also discuss our
liquidity, capital resources and critical accounting policies. Our financial
reporting business segments include the following which will be continued at
CenterPoint Energy:

o Electric Transmission and Distribution,

o Electric Generation,

o Natural Gas Distribution,

o Pipelines and Gathering, and

o Other Operations;

and the following which will be continued at Reliant Resources:

o Wholesale Energy,

o European Energy, and

o Retail Energy.

Effective with the full deregulation of sales of electric energy to retail
customers in Texas beginning January 1, 2002, power generators and retail
electric providers in Texas ceased to be subject to traditional cost-based
regulation. Since that date, we have sold generation capacity, energy and
ancillary services related to these functions at prices determined by the
market. Our transmission and distribution services remain subject to rate
regulation.

46

Beginning January 1, 2002, the basis of business segment reporting has
changed for our Texas electric operations. Although our retail sales are now
conducted by Reliant Resources, retail customers remained regulated customers of
our former integrated electric utility, Reliant Energy HL&P, through the date of
their first meter reading in 2002. Sales of electricity to retail customers in
2002 prior to this meter reading are reflected in the Electric Transmission and
Distribution business segment. The Texas generation operations of Reliant Energy
HL&P are now a separate reportable business segment, Electric Generation,
whereas they previously had been part of the Electric Operations business
segment. The remaining transmission and distribution function is now reported
separately in the Electric Transmission and Distribution business segment. In
2001, Latin America was a separate business segment, but is now reported in the
Other Operations business segment beginning in 2002. Reportable business
segments from 2001 have been restated to conform to the 2002 presentation. For
business segment reporting information, please read Notes 1 and 14 to our
Interim Financial Statements, which notes are incorporated by reference herein.

The Restructuring

In December 2000, we transferred a significant portion of our unregulated
businesses to Reliant Resources, which, at the time, was a wholly owned
subsidiary. Reliant Resources conducted an initial public offering of
approximately 20% of its common stock in May 2001. In December 2001, our
shareholders approved an agreement and plan of merger by which, subject to
regulatory approvals, the following will occur (which we refer to herein as the
Restructuring):

o CenterPoint Energy will become the holding company for the Reliant
Energy group of companies;

o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and

o each share of Reliant Energy common stock will be converted into one
share of CenterPoint Energy common stock.

After the Restructuring, we plan, subject to further corporate approvals,
market and other conditions, to complete the separation of our regulated and
unregulated businesses by distributing the shares of common stock of Reliant
Resources that we own to our shareholders (which we refer to herein as the
Distribution). We currently expect to complete the Restructuring by August 31,
2002 and the Distribution early in the fall of 2002. However, no assurance can
be provided that the Distribution will occur as described above or that it will
occur within this time period. From the consummation of the Restructuring until
the Distribution, CenterPoint Energy expects that it will do business under the
name Reliant Energy, Incorporated and that CenterPoint Energy's common stock
will trade under the symbol "REI".

On July 5, 2002, we received an order from the Securities and Exchange
Commission (SEC) approving our restructuring plan and the Distribution under the
Public Utility Holding Company Act of 1935 (1935 Act). On July 31, 2002, we
received a private letter ruling from the Internal Revenue Service which
confirms that the Distribution will be tax-free to Reliant Energy and its
shareholders.

Contemporaneous with the Restructuring, CenterPoint Energy expects to
register and become subject, with its subsidiaries, to regulation as a
registered holding company system under the 1935 Act. The 1935 Act directs the
SEC to regulate, among other things, financings, sales or acquisitions of assets
and intra-system transactions.

In connection with the Restructuring, in order to enable CenterPoint Energy
ultimately to satisfy the requirements for an exemption from regulation as a
registered holding company under the 1935 Act, we are seeking authority to
divide the gas distribution businesses conducted by RERC Corp.'s three
unincorporated gas distribution divisions, Reliant Energy Entex, Reliant Energy
Arkla and Reliant Energy Minnegasco, among three separate entities. The entity
that will hold the Reliant Energy Entex assets will also hold ownership of
Reliant Energy Resources' natural gas pipelines and gathering business. We have
obtained approval of these transactions from the public service commissions of
Minnesota, Louisiana, Mississippi, Oklahoma and Arkansas. Although we expect
this business restructuring of RERC Corp. can be completed, we can provide no
assurance that this will, in fact, occur, or that CenterPoint Energy will
ultimately be exempt from registration under the 1935 Act. For further
information on the RERC Corp. restructuring, see "Our Business --RERC Corp.
Restructuring" in Item 1 of the Reliant Energy Form 10-K/A, which is
incorporated by reference herein.

47

EFFECTS OF RESTATEMENT ON THE INTERIM FINANCIAL STATEMENTS FOR THE
THREE AND SIX MONTHS ENDED JUNE 30, 2001

As more fully described and previously reported in Note 1 to the Reliant
Energy 10-K/A Notes, which note is incorporated by reference herein, on May 9,
2002, Reliant Resources, an entity in which Reliant Energy owns approximately
83% of the outstanding common stock, determined that it had engaged in same-day
commodity trading transactions involving purchases and sales with the same
counterparty for the same volume at substantially the same price, which the
personnel who effected these transactions apparently did so with the sole
objective of increasing volumes. Reliant Resources commenced a review to
quantify the amount and assess the impact of these trades (round trip trades).
The Audit Committees of each of the Boards of Directors of Reliant Resources and
Reliant Energy (Audit Committees) also directed an internal investigation by
outside legal counsel, with assistance by outside accountants, of the facts and
circumstances relating to the round trip trades and related matters.

We report all trading, marketing and risk management services transactions
on a gross basis with such transactions being reported in revenues and expenses
except primarily for financial gas transactions such as swaps. Therefore, the
round trip trades were reflected in both our revenues and expenses. The round
trip trades should not have been recognized in revenues or expenses (i.e., they
should have been reflected on a net basis). However, since the round trip trades
were done at the same volume and substantially the same price, they had no
impact on our reported cash flows, operating income or net income.

Based on Reliant Resources' review, Reliant Resources determined that it
engaged in such round trip trades in 1999, 2000 and 2001. The results of the
Audit Committees' investigations were consistent with the results of Reliant
Resources' review. The round trip trades were for 20 million megawatt hours
(MWh) and 41 MWh of power for the three and six months ended June 30, 2001,
respectively, and 46 billion cubic feet (Bcf) of natural gas for the three and
six months ended June 30, 2001.

These transactions, referred to above, collectively had the effect of
increasing revenues, fuel and cost of gas sold expense and purchased power
expense by $1.4 billion, $131 million and $1.3 billion, respectively, for the
three months ended June 30, 2001 and by $2.6 billion, $131 million and $2.5
billion, respectively, for the six months ended June 30, 2001.

In the course of Reliant Resources' review, Reliant Resources also
identified and determined that they should record on a net basis several
transactions for energy related services (not involving round trip trades) that
totaled $17 million and $19 million for the three and six months ended June 30,
2001, respectively. These transactions were originally recorded on a gross
basis.

In addition, during the May 2001 through September 2001 time frame, Reliant
Resources entered into four structured transactions involving a series of
forward or swap contracts to buy and sell an energy commodity in 2001 and to buy
and sell an energy commodity in 2002 or 2003 (four structured transactions). The
four structured transactions were intended to increase future cash flow and
earnings and to increase certainty associated with future cash flow and
earnings, albeit at the expense of 2001 cash flow and earnings. Each series of
contracts in a structure were executed with the same counterparty. The contracts
in each structure were offsetting in the aggregate in terms of physical
attributes. The transactions that settled during the three and six months ended
June 30, 2001 were previously recorded on a gross basis with such transactions
being reported in revenues and expenses which resulted in $323 million of
revenues, $161 million in fuel and cost of gas sold and $162 million of
purchased power expense being recognized in each period. Having further reviewed
the transactions, Reliant Resources now believes these transactions should have
been accounted for on a net basis.

The consolidated financial statements for the three and six months ended
June 30, 2001 have been restated from amounts previously reported to reflect the
transactions discussed above on a net basis. The restatement had no impact on
previously reported consolidated cash flows, operating income or net income. A
summary of the principal effects of the restatement on our interim financial
statements are set forth in Note 1 to our Interim Financial Statements.

48

CONSOLIDATED RESULTS OF OPERATIONS

Three months ended June 30, 2001 compared to three months ended June 30, 2002

Net Income. We reported consolidated net income of $236 million ($0.79 per
diluted share) for the three months ended June 30, 2002 compared to $316 million
($1.08 per diluted share) for the three months ended June 30, 2001. The 2001
results reflect a $33 million after-tax gain recorded in equity income related
to a preacquisition contingency for the value of SEP, the coordinating body for
the Dutch electricity generating sector, offset by related minority interest of
$6 million. Effective January 1, 2002, we discontinued amortizing goodwill in
accordance with Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets" (SFAS No. 142). During the second quarter
of 2001, we recognized $21 million of goodwill amortization expense. The
decrease in net income attributable to common stockholders for the second
quarter of 2002 as compared to the second quarter of 2001 was primarily due to
the following:

o a $267 million decrease in earnings before interest and taxes (EBIT)
from Reliant Resources' Wholesale Energy business segment;

o a $104 million decrease in EBIT from our Electric business segments,
reflecting the movement of a portion of this business to Reliant
Resources' Retail Energy business segment;

o a $13 million negative impact related to our investment in AOL Time
Warner securities and related indexed debt securities; and

o a $55 million increase in interest expense.

The above items were partially offset by:

o a $207 million increase in EBIT from Reliant Resources' Retail Energy
business segment;

49

o a $55 million increase in EBIT from our Natural Gas Distribution
business segment; and

o a $43 million increase in EBIT from Reliant Resources' European Energy
business segment.

Earnings Before Interest and Income Taxes. For an explanation of changes in
EBIT, please read the discussion below under "- Earnings Before Interest and
Income Taxes by Business Segment."

Interest Expense. We incurred interest expense of $205 million during the
three months ended June 30, 2002 compared to $150 million in the same period of
2001. The increase in interest expense of $55 million resulted primarily from
increased borrowing levels due to the acquisition of Orion Power Holdings, Inc.
(Orion Power) on February 19, 2002 as discussed in Note 5 to our Interim
Financial Statements, which note is incorporated by reference herein.

Income Tax Expense. During the three months ended June 30, 2001 and 2002,
our effective tax rate was 36.7% and 38.6%, respectively. The increase in the
effective tax rate for the second quarter of 2002 compared to the second quarter
of 2001 was primarily due to higher taxes on Reliant Energy Power Generation
Benelux N.V.'s (REPGB) earnings offset by the discontinuance of goodwill
amortization in accordance with SFAS No. 142. In 2001, the earnings of REPGB
were subject to a zero percent Dutch corporate income tax rate as a result of a
tax holiday for the Dutch electricity industry. In 2002, REPGB's earnings in the
Netherlands are subject to the standard Dutch corporate income tax rate, which
is currently 34.5%.

Six months ended June 30, 2001 compared to six months ended June 30, 2002

Net Income. We reported consolidated net income of $461 million ($1.55 per
diluted share) for the six months ended June 30, 2002 compared to $578 million
($1.99 per diluted share) for the six months ended June 30, 2001. The 2001
results reflect a $61 million after-tax non-cash gain from the adoption of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended (SFAS No. 133). For additional discussion of the adoption of SFAS No.
133, please read Note 5 to the Reliant Energy 10-K/A Notes, which note is
incorporated herein by reference. Effective January 1, 2002, we discontinued
amortizing goodwill in accordance with SFAS No. 142. During the first six months
of 2001, we recognized $42 million of goodwill amortization expense. The
decrease in net income attributable to common stockholders for the six months
ended June 30, 2002 as compared to the same period in 2001 was primarily due to
the following:

o a $382 million decrease in EBIT from Reliant Resources' Wholesale
Energy business segment;

o a $95 million decrease in EBIT from our Electric business segments,
reflecting the movement of a portion of this business to Reliant
Resources' Retail Energy business segment;

o a $30 million negative impact related to our investment in AOL Time
Warner securities and related indexed debt securities;

o a $13 million increase in minority interest expense primarily related
to minority interest in Reliant Resources as a result of the initial
public offering of Reliant Resources' common stock in May 2001;

o a $61 million after-tax non-cash gain in the first six months of 2001
from the adoption of SFAS No. 133; and

o a $31 million increase in interest expense.

The above items were partially offset by:

o a $101 million pre-tax ($65 million after-tax), non-cash charge
incurred in the first quarter of 2001 relating to the redesign of some
of our benefit plans in anticipation of our separation from Reliant
Resources;

o a $259 million increase in EBIT from Reliant Resources' Retail Energy
business segment;

o a $28 million increase in EBIT from our Natural Gas Distribution
business segment; and

50

o a $40 million increase in EBIT from Reliant Resources' European Energy
business segment.

Earnings Before Interest and Income Taxes. For an explanation of changes in
EBIT, please read the discussion below under "- Earnings Before Interest and
Income Taxes by Business Segment."

Interest Expense. We incurred interest expense of $359 million during the
six months ended June 30, 2002 compared to $328 million in the same period of
2001. The increase in interest expense of $31 million resulted primarily from
increased borrowing levels due to the acquisition of Orion Power on February 19,
2002 as discussed in Note 5 to our Interim Financial Statements.

Income Tax Expense. During the six months ended June 30, 2001 and 2002, our
effective tax rate was 36.0% and 36.3%, respectively. The increase in the
effective tax rate for the first six months of 2002 compared to the first six
months of 2001 was primarily due to higher taxes on REPGB's earnings offset by
the discontinuance of goodwill amortization in accordance with SFAS No. 142. In
2001, the earnings of REPGB were subject to a zero percent Dutch corporate
income tax rate as a result of a tax holiday for the Dutch electricity industry.
In 2002, REPGB's earnings in the Netherlands are subject to the standard Dutch
corporate income tax rate, which is currently 34.5%.

As discussed in Note 14(h) to the Reliant Energy 10-K/A Notes and Note
13(e) to our Interim Financial Statements, which notes are incorporated by
reference herein, the Dutch parliament has adopted legislation allocating to the
Dutch generation sector, including REPGB, financial responsibility for certain
stranded costs and other liabilities incurred by NEA prior to the deregulation
of the Dutch wholesale market. These obligations include NEA's obligations under
an out-of-market gas supply contract and three out-of-market electricity
contracts. REPGB's allocated share of these liabilities is 22.5%. As a result,
Reliant Resources recorded a net stranded cost liability of $369 million and a
related deferred tax asset of $127 million at December 31, 2001 for their
statutorily allocated share of these gas supply and electricity contracts. Prior
to the second quarter of 2002, Reliant Resources believed that the costs
incurred by REPGB subsequent to the tax holiday ending in 2001 related to these
contracts would be deductible for Dutch tax purposes. However, due to
uncertainties related to the deductibility of these costs, Reliant Resources
recorded an offsetting liability in other liabilities in the consolidated
financial statements of $127 million as of December 31, 2001. Reliant Resources
now believes, based upon discussions with the Dutch tax authorities, obtaining a
tax deduction for these costs will require litigation in the Netherlands, and
accordingly, has reversed both the deferred tax assets and related liability in
the second quarter of 2002.

EARNINGS BEFORE INTEREST AND INCOME TAXES BY BUSINESS SEGMENT

The following table presents EBIT for each of our business segments for the
three and six months ended June 30, 2001 and 2002. EBIT represents earnings
(loss) before interest expense, minority interest and income taxes. EBIT, as
defined, is shown because it is a widely accepted measure of financial
performance used by analysts and investors to analyze and compare companies on
the basis of operating performance. It is not defined under generally accepted
accounting principles, and should not be considered in isolation or as a
substitute for a measure of performance prepared in accordance with accounting
principles generally accepted in the United States (GAAP) and is not indicative
of operating income from operations as determined under GAAP. Additionally, our
computation of EBIT may not be comparable to other similarly titled measures
computed by other companies, because all companies do not calculate it in the
same fashion. For a reconciliation of our business segments' operating income
(loss) to EBIT and EBIT to net income, please read Note 14 to our Interim
Financial Statements.

51

ELECTRIC BUSINESS SEGMENTS

For information regarding factors that may affect the future results of
operations of our Electric business segments, please read "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Factors Affecting Our Future Earnings -- Factors Affecting the Results
of Our Electric Operations" in the Reliant Energy Form 10-K/A, which is
incorporated herein by reference.

The following tables provide summary data, including EBIT, of our Electric
business segments for the three months and six months ended June 30, 2001 and
2002:

- ----------

(1) Gigawatt hours

52

During 2001, our Electric Operations business segment reflected the
regulated electric utility business, including generation, transmission and
distribution, and retail electric sales. As of January 1, 2002, with the opening
of the Texas market to full retail electric competition, generation and retail
sales are no longer subject to cost of service regulation. Retail electric sales
involve the sale of electricity and related services to end users of electricity
and were included as part of the bundled regulated service prior to 2002. Retail
electric sales are now reported as the Retail Energy business segment of Reliant
Resources.

Beginning in 2002, we are reporting two new business segments for what was
the former Electric Operations business segment:

o Electric Transmission and Distribution; and

o Electric Generation.

The previously regulated generation operations in Texas are being reported
in the new Electric Generation business segment. The Electric Transmission and
Distribution business segment will report results from two sources. This
business segment includes the regulated electric transmission and distribution
operations as well as impacts of generation-related stranded costs recoverable
by the regulated utility.

As a result of the implementation of deregulation and the corresponding new
business segments, the regulated transmission and distribution utility recovers
the cost of its service through an energy delivery charge, and not as a
component of the prior bundled rate. Accordingly, there are no meaningful
comparisons for these business segments against prior periods. The design of the
new energy delivery rate, which is based on an 11.25% return on equity, differs
from the prior bundled energy rate. The winter/summer rate differential for
residential customers has been eliminated and large commercial and industrial
rates no longer have an energy-based component, but are demand driven. This new
rate design will tend to lessen some of the pronounced seasonal variation of
revenues which has been experienced in prior periods. For estimates of
historical Electric Generation revenues, please read Note 14 to our Interim
Financial Statements.

54

Although our retail sales are now conducted by Reliant Resources, retail
customers remained regulated customers of Reliant Energy HL&P through the date
of their first meter reading in 2002. Operations during this transition period,
reflected in the Electric Transmission and Distribution business segment,
produced a $7 million loss before interest and taxes for the three months ended
June 30, 2002 and EBIT of $7 million for the six months ended June 30, 2002. We
expect to incur additional transition expenses during the remainder of the year
and a substantial portion of the earnings from retail sales in January 2002 are
expected to be offset.

The new Electric Generation business segment is comprised of over 14,000
Megawatts of electric generation located entirely in the state of Texas, and
will be called Texas Genco after the Restructuring. This business segment
reported a loss before interest and taxes of $26 million and $78 million for the
three months and six months ended June 30, 2002, respectively, primarily due to
low natural gas prices and ample generating capacity in Texas, which created a
weak price environment when the capacity auctions described below were conducted
in late 2001 and early 2002.

The new Electric Transmission and Distribution business segment reported
EBIT of $277 million for the three months ended June 30, 2002, consisting of
EBIT of $114 million for the regulated electric transmission and distribution
business, loss before interest and taxes of $7 million from sales during the
transition period as discussed above and EBIT of $170 million associated with
certain generation-related regulatory assets (ECOM, or Excess Cost Over Market,
true-up) recorded pursuant to the Texas electric restructuring law as explained
below. The Electric Transmission and Distribution business segment reported EBIT
of $536 million for the six months ended June 30, 2002, consisting of EBIT of
$218 million for the regulated electric transmission and distribution business,
EBIT of $7 million from sales during the transition period as discussed above
and EBIT of $311 million associated with the ECOM true-up.

Under the Texas electric restructuring law, each power generator that is
unbundled from an integrated electric utility in Texas has an obligation to
conduct state-mandated capacity auctions of 15 percent of its capacity. In
addition, under a master separation agreement between Reliant Energy and Reliant
Resources, Texas Genco is contractually obligated to auction all capacity in
excess of the state-mandated capacity auctions. The auctions conducted
periodically between September 2001 and March 2002 were consummated at prices
below those used in the ECOM model by the Public Utility Commission of Texas
(Texas Utility Commission). Under the Texas electric restructuring law, a
regulated utility may recover any difference between market prices received
through the state-mandated auctions and the Texas Utility Commission's earlier
estimates of those market prices. This difference, recorded as a regulatory
asset, produced $170 million of EBIT in the second quarter of 2002 and $311
million of EBIT in the first six months of 2002.

In the Electric Transmission and Distribution business segment, throughput
declined 9 percent and 7 percent, respectively, for the three months and six
months ended June 30, 2002 as compared to the prior periods in 2001. The
decrease was primarily due to reduced energy delivery in the industrial sector
resulting from self-generation by several major customers, partially offset by
increased residential usage due to warmer weather and increased demand from
non-weather related factors such as price elasticity. Additionally, despite a
slowing economy, total metered customers grew by 32,000 since June of 2001,
which approximates a 2% annual growth rate.

Operation and maintenance expenses decreased by $15 million and $28 million
for the quarter and six months ended June 30, 2002, respectively, compared to
the same periods in 2001. The decrease was primarily due to the elimination of
factoring expense as a result of the termination of an agreement under which the
former Electric Operations business segment had sold its customer accounts
receivable and fewer plant outages in 2002, partially offset by higher benefits
expense.

Depreciation and amortization expense in the second quarter of 2002
decreased $24 million compared to the same period in 2001. The decrease was
primarily due to decreased amortization of the impairment loss recorded in June
1999, which was fully amortized in December 2001, offset by the discontinuance
of redirection of depreciation expense related to Electric Transmission and
Distribution assets. Depreciation and amortization expense was $209 million and
$208 million for the six months ended June 30, 2002 and 2001, respectively.

Other operating expense in the second quarter of 2002 decreased $18 million
compared to the same period in 2001. The decrease was primarily due to lower
gross receipts taxes which became the responsibility of the retail electric
provider upon deregulation. Other operating expense decreased $47 million in the
six months ended June

55

30, 2002, compared to the same period in 2001, primarily due to lower franchise
fees and lower property and gross receipts taxes.

NATURAL GAS DISTRIBUTION

Our Natural Gas Distribution business segment's operations consist of
intrastate natural gas sales to, and natural gas transportation for residential,
commercial and industrial customers in Arkansas, Louisiana, Minnesota,
Mississippi, Oklahoma and Texas and some non-rate regulated retail marketing of
natural gas.

For information regarding factors that may affect the future results of
operations of our Natural Gas Distribution business segment, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of RERC's Operations" in the Reliant Energy Form 10-K/A, which is
incorporated herein by reference.

The following table provides summary data, including EBIT, of our Natural
Gas Distribution business segment for the three months and six months ended June
30, 2001 and 2002:

- ----------

(1) Billion cubic feet.

Our Natural Gas Distribution business segment's EBIT increased $55 million
and $28 million for the three months and six months ended June 30, 2002,
respectively, as compared to the same periods in 2001. These increases were
primarily due to a significant improvement in bad debt expense in the second
quarter of 2002 as a result of improved collections and lower gas prices in 2002
and changes in estimates of unbilled revenues and deferred gas costs, which
negatively impacted the second quarter of 2001. For the six months ended June
30, 2002, the above increases were partially offset by decreased earnings due to
significantly milder weather and the resulting decreased usage in 2002 as
compared to 2001. Depreciation and amortization expense decreased approximately
$5 million and $11 million for the three months and six months ended June 30,
2002, respectively, primarily as a result of the discontinuance of goodwill
amortization in accordance with SFAS No. 142 as further discussed in Note 6 to
our Interim Financial Statements, which note is incorporated by reference
herein. Goodwill amortization was $8 million and $15 million for the three
months and six months ended June 30, 2001, respectively. Other operating
expenses remained flat in the second quarter but decreased $14 million for the
six months ended June 30, 2002 as compared to the same period in 2001, due
primarily to reduced franchise fees as a result of decreased revenues.

56

PIPELINES AND GATHERING

Our Pipelines and Gathering business segment operates two interstate
natural gas pipelines as well as provides gathering and pipeline services.

For information regarding factors that may affect the future results of
operations of our Pipelines and Gathering business segment, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of RERC's Operations" in the Reliant Energy Form 10-K/A, which is
incorporated herein by reference.

The following table provides summary data, including EBIT, of our Pipelines
and Gathering business segment for the three months and six months ended June
30, 2001 and 2002:

- ----------

(1) Elimination of volumes both transported and sold.

Our Pipelines and Gathering business segment's EBIT for the three months
and six months ended June 30, 2002 compared to the same periods in 2001,
increased $7 million and $6 million, respectively. Operation and maintenance
expenses increased $7 million and $13 million for the three and six months ended
June 30, 2002, respectively, compared to the same periods in 2001 primarily due
to project work consisting of construction management, engineering, project
planning and other services. Project work expenses are offset by revenues billed
for these services. Depreciation and amortization expense decreased $5 million
and $9 million for the three months and six months ended June 30, 2002,
respectively, as compared to the same periods in 2001, as a result of the
discontinuance of goodwill amortization in accordance with SFAS No. 142 as
further discussed in Note 6 to our Interim Financial Statements. Other income
increased $2 million and $3 million for the three months and six months ended
June 30, 2002, respectively, as compared to the same periods in 2001, primarily
due to interest accrued on a fuel tax refund.

WHOLESALE ENERGY

Reliant Resources' Wholesale Energy business segment includes their
non-regulated power generation operations in the United States, excluding Texas
generation operations, and their wholesale energy trading, marketing,
origination and risk management operations in North America. Trading and
marketing purchases fuel to supply existing generation assets, sells the
electricity produced by these assets, and manages the day-to-day trading and
dispatch associated with these portfolios.

Reliant Resources is in the process of evaluating their trading, marketing,
power origination and risk management services strategies. In the future,
Reliant Resources may reduce their trading, marketing and origination
activities, which would likely result in a corresponding decrease in earnings
and cash flows.

For information regarding factors that may affect the future results of
operations of Reliant Resources' Wholesale Energy business segment, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of Our

57

Wholesale Energy Operations" in the Reliant Energy Form 10-K/A, which is
incorporated herein by reference.

The following table provides summary data, including EBIT, of Reliant
Resources' Wholesale Energy business segment for the three months and six months
ended June 30, 2001 and 2002:

Reliant Resources' Wholesale Energy business segment's EBIT decreased by
$267 million for the three months ended June 30, 2002 compared to the same
period in 2001. The decline in EBIT is primarily due to decreases in gross
margin (revenues less fuel and cost of gas sold and purchased power), and
increases in operating expenses both of which are discussed, in detail below. In
addition, Reliant Resources' Wholesale Energy business segment's EBIT was
impacted by a $34 million reserve recorded during the three months ended June
30, 2002 for refunds owed by them as a result of a May 15, 2002 Federal Energy
Regulatory Commission (FERC) order which revised the methodology for calculating
refunds for California energy sales. During the same period in 2001, Reliant
Resources' Wholesale Energy business segment recorded a $15 million reserve
related to an earlier FERC order.

Reliant Resources' Wholesale Energy business segment's EBIT decreased by
$382 million for the six months ended June 30, 2002 compared to the same period
in 2001. The decrease in EBIT is primarily due to decreases in gross margin,
increases in operating expenses, and recording of a reserve for potential
refunds in the second quarter of 2002, as discussed above. These decreases in
EBIT were partially offset by changes in the credit provisions related to energy
sales in California. In the six months ended June 30, 2002, $38 million of a
previously accrued credit provision for energy sales in California was reversed.
The reversal resulted from collections of outstanding receivables during the
period coupled with a determination that credit risk had been reduced on the
remaining outstanding receivables as a result of payments in 2002 to the
California Power Exchange. In addition, during the six months ended June 30,
2001, Reliant Resources' Wholesale Energy business segment recorded a $34
million credit provision against receivable balances related to energy sales in
the West and a $15 million reserve for refunds, as discussed above.

Reliant Resources' Wholesale Energy business segment's revenues decreased
by $1.2 billion (15%) in the three months ended June 30, 2002 compared to the
same period in 2001. The decreased revenues were primarily due to decreased
prices for natural gas sales (approximately $1.7 billion) and decreased prices
for power sales (approximately $2.2 billion) compared to the same period in
2001. These decreases in prices were partially offset by increased volumes for
natural gas and power sales of approximately $1.8 billion and $0.9 billion,
respectively. Reliant Resources' Wholesale Energy business segment's fuel and
cost of gas sold and purchased power decreased by $1.1 billion in the three
months ended June 30, 2002, largely due to decreased prices for natural gas and

58

purchased power compared to the same period in 2001. These decreases in fuel and
cost of gas sold and purchased power were partially offset by increased volumes
for natural gas and purchased power, and increased fuel expense due to an 171%
increase in power generation sales volumes largely due to the Orion Power
Holdings, Inc. (Orion Power) acquisition that closed in February 2002.

Reliant Resources' Wholesale Energy business segment's revenues decreased
by $4.0 billion (25%) in the six months ended June 30, 2002 compared to the same
period in 2001. The decreased revenues were primarily due to decreased prices
for natural gas sales (approximately $6.3 billion) and decreased prices for
power sales (approximately $4.6 billion) compared to 2001. These decreases in
revenues were partially offset by increased volumes for natural gas and power
sales of approximately $3.6 billion and $3.2 billion, respectively. Reliant
Resources' Wholesale Energy business segment's fuel and cost of gas sold and
purchased power decreased by $3.8 billion in the six months ended June 30, 2002,
largely due to the same factors discussed above.

Reliant Resources' Wholesale Energy business segment's gross margin
decreased by $105 million in the three months ended June 30, 2002 compared to
the same period in 2001. This decrease was primarily due to lower margins from
both their power generation operations and their trading and marketing
activities, and a $19 million increase in reserves related to potential refunds
related to energy sales in the West region in the second quarter 2002 as
compared to the same period in 2001 as discussed above. Margins on power sales
from their generation facilities decreased by $193 million, partially offset by
$177 million from the Orion Power acquisition that closed in February 2002.
Reliant Resources' Wholesale Energy business segment's gross margin for the
three months ended June 30, 2001 benefited from favorable conditions in the West
caused by a combination of factors including reduction in available
hydroelectric generation resources, increased demand, and decreased electric
imports. The absence of these market conditions over the same period in 2002
resulted in a 65% decrease in prices and 58% decrease in volumes for power sales
in the West. Trading and marketing gross margins decreased $70 million from $119
million in the three months ended June 30, 2001 to $49 million in the three
months ended June 30, 2002 primarily as a result of higher natural gas and power
volatility levels in the three months ended June 30, 2001 which provided for
greater trading opportunities compared to the three months ended June 30, 2002,
particularly in the West.

Reliant Resources' Wholesale Energy business segment's gross margin
decreased by $170 million in the six months ended June 30, 2002 compared to the
same period in 2001. This decrease was primarily due to lower margins from both
their power generation operations and their trading and marketing activities,
and a $19 million increase in reserves related to potential refunds related to
energy sales in the West, as discussed above. These factors were partially
offset by a $72 million change in the credit provisions for California energy
sales, as discussed above. Margins on power sales from Reliant Resources'
generation facilities decreased by $353 million. This decrease was partially
offset by $264 million of margins on power sales from the Orion Power
acquisition that closed in February 2002. Trading and marketing gross margins
decreased $134 million from $231 million in the six months ended June 30, 2001
to $97 million in the six months ended June 30, 2002 primarily as a result of
higher natural gas and power volatility levels in the six months ended June 30,
2001 which provided for greater trading opportunities compared to the six months
ended June 30, 2002.

The following table provides further summary data regarding gross margins
by commodity of Reliant Resources' Wholesale Energy business segment for the
three and six months ended June 30, 2001 and 2002.

59

Operation and maintenance and other operating expenses for Reliant
Resources' Wholesale Energy business segment increased $106 million in the three
months ended June 30, 2002 compared to the same period in 2001, primarily due to
$62 million of operation and maintenance expenses of Reliant Resources' Orion
Power generating plants acquired in February 2002, higher administrative costs
to support growing wholesale commercial activities, including Orion Power, and
increased expenses related to development activities of $28 million, which
includes write-offs of $17 million in previously capitalized costs related to
projects that have been terminated.

Operation and maintenance and other operating expenses for Reliant
Resources' Wholesale Energy business segment increased $141 million in the six
months ended June 30, 2002 compared to the same period in 2001, primarily due to
$95 million of operation and maintenance expenses of Reliant Resources' Orion
Power generating plants, higher administrative costs to support growing
wholesale commercial activities, including Orion Power, and increased expenses
related to development activities of $26 million, which includes write-offs of
$17 million as discussed above.

Depreciation and amortization expense increased by $63 million in the three
months ended June 30, 2002 compared to the same period in 2001 primarily as a
result of depreciation expense related to Reliant Resources' Orion Power plants,
and other generating plants placed into service during the second half of 2001
and a $15 million write-off of a plant which Reliant Resources' expects to close
during the third quarter of 2002. For the three months ended June 30, 2001,
Reliant Resources' Wholesale Energy business segment recorded $1 million in
amortization expense related to goodwill. For information regarding the
cessation of goodwill amortization, please read Note 2(q) to the Reliant Energy
10-K/A Notes, which note is incorporated herein by reference, and Note 6 to our
Interim Financial Statements.

Depreciation and amortization expense increased by $72 million in the six
months ended June 30, 2002 compared to the same period in 2001 primarily as a
result of depreciation expense related to Reliant Resources' Orion Power plants,
other generating plants placed into service during the second half of 2001 and
the plant closure as discussed above, partially offset by a decrease in
amortization of air emissions regulatory allowances of $20 million. For the six
months ended June 30, 2001, Reliant Resources' Wholesale Energy business segment
recorded $2 million in amortization expense related to goodwill.

Reliant Resources' Wholesale Energy business segment reported income from
equity investments for the three and six months ended June 30, 2002 of $6
million and $10 million, respectively, compared to $1 million and $14 million in
the same periods in 2001, respectively. The equity income in both periods
primarily resulted from an investment in an electric generation plant in Boulder
City, Nevada. The equity income related to Reliant Resources' investment in the
plant increased during the three months ended June 30, 2002 compared to the same
period in 2001, primarily due to the receipt of business interruption and other
insurance claims totaling $12 million, partially offset by decreases in margins
due to lower prices realized by the project company in 2002. The equity income
related to Reliant Resources' investment in the plant decreased during the six
months ended June 30, 2002 compared to the same period in 2001, primarily due to
decreases in margins as a result of lower prices realized by the project company
in 2002, partially offset by the insurance claims received during the second
quarter of 2002 as discussed above.

For information regarding the reserve against receivables, FERC refund
methodology and uncertainties in the California wholesale energy market, please
read Notes 13(a) and 13(d) to our Interim Financial Statements, which notes are
incorporated herein by reference.

EUROPEAN ENERGY

Reliant Resources' European Energy business segment generates and sells
power from their generation facilities in the Netherlands and participates in
the emerging wholesale energy trading and power origination industry in
Northwest Europe.

Reliant Resources is in the process of evaluating their trading and power
origination strategies in Europe. In the future, Reliant Resources may reduce
their trading and origination activities in order to concentrate on their core
power generation asset position in the Netherlands.

For information regarding factors that may affect the future results of
operations of Reliant Resources' European Energy business segment, please read
"Management's Discussion and Analysis of Financial Condition and Results

60

of Operations -- Certain Factors Affecting Our Future Earnings -- Factors
Affecting the Results of Our European Energy Operations" in the Reliant Energy
Form 10-K/A, which is incorporated herein by reference.

The following table provides summary data, including EBIT, of Reliant
Resources' European Energy business segment for the three months and six months
ended June 30, 2001 and 2002:

Reliant Resources' European Energy business segment's EBIT increased $43
million and $40 million for the three and six months ended June 30, 2002
compared to the same periods in 2001 due to changes in gross margins (revenues
less fuel and purchased power) as explained below. During the three months ended
June 30, 2002, Reliant Resources' European Energy business segment recognized a
one-time $109 million gain resulting from the amendment of their stranded cost
electricity supply contracts which is recorded as a reduction in purchased power
expense and is included in gross margins. For additional discussion regarding
the amendment of these contracts, please read Note 13(e) to our Interim
Financial Statements, which note is incorporated herein by reference.

Reliant Resources' European Energy business segment's operating revenues
increased $365 million for the three months ended June 30, 2002 compared to the
same period in 2001. Approximately $345 million of the increase was attributable
to increased trading volumes associated with their participation in the Dutch,
German, Austrian, United Kingdom and Nordic power markets, and to a lesser
extent, the increase was due to a 17% increase in volume of electric generation
sales representing an approximate $11 million net increase in sales in the
second quarter of 2002 as compared to the same period in 2001. The increase in
electric sales revenues as a result of increased sales volumes was partially
offset by decreases in power prices of approximately 7% in the second quarter of
2002 as compared to the same period in 2001. The overall increases were also
partially offset by the impact of a $30 million efficiency and energy payment
received during the second quarter of 2001 from NEA, which was the coordinating
body for the Dutch electric generating sector prior to wholesale competition.
Also contributing to the increase in operating revenues was a favorable foreign
exchange effect of approximately $40 million.

Reliant Resources' European Energy business segment's operating revenues
increased $652 million for the six months ended June 30, 2002 compared to the
same period in 2001. Revenues derived from trading volumes associated with their
participation in the Dutch, German, Austrian, United Kingdom and Nordic power
markets, increased approximately $678 million. In addition, but to a lesser
extent, the increase in revenues was due to a 22% increase in volume of electric
generation sales representing an approximate $24 million net increase in sales
for the six months ended June 30, 2002 compared to the same period in 2001. The
increase in electric sales revenues as a result of increased sales volume was
partially offset by decreases in power prices that decreased approximately 10%
in the six months ended June 30, 2002 as compared to the same period in 2001.
The overall increases were also offset by a $30 million efficiency and energy
payment received during the second quarter of 2001 from NEA as described above.
In addition, ancillary services revenues decreased approximately $7 million
period over period. This overall increase in operating revenues was impacted by
an unfavorable foreign exchange effect of approximately $13 million.

61

Fuel and purchased power costs increased $270 million for the three months
ended June 30, 2002 compared to the same period in 2001 primarily due to a $343
million increase in purchased power for trading activities associated with the
growth in Reliant Resources' trading business. Offsetting the increase was a
one-time $109 million gain recognized as a result of the amendment of Reliant
Resources' stranded cost electricity supply contracts which is recorded as a
reduction of purchased power expense. For additional discussion regarding the
amendment of these contracts please read Note 13(e) to our Interim Financial
Statements. The overall increase in fuel and purchased power was impacted by an
unfavorable foreign exchange effect of approximately $37 million.

Fuel and purchased power costs increased $559 million for the six month
period ending June 30, 2002 compared to the same period in 2001 primarily due to
a $693 million increase in purchased power for trading activities associated
with the growth in Reliant Resources' trading business. Offsetting this increase
was a one-time $109 million gain as discussed above and a net $16 million gain
related to changes in the valuation of certain out-of-market contracts in the
first six months of 2002 recorded in fuel expense. For further discussion of
these out-of-market contracts, please read Notes 5 and 14(h) to the Reliant
Energy 10-K/A Notes and Note 13(e) to our Interim Financial Statements. The
overall increase in fuel and purchased power was impacted by a favorable foreign
exchange effect of approximately $11 million.

Gross margin increased $95 million for the three months ended June 30, 2002
compared to the same period in 2001 primarily due to (a) the one-time $109
million gain discussed above, (b) a $2 million increase in trading and power
origination gross margins which increased from $2 million for the three months
ended June 30, 2001 to $4 million for the same period in 2002 due to an increase
in power trading volumes and trading origination transactions, and (c) a $15
million increase in plant margins due to increases in electric sales volumes and
decreased fuel prices. Offsetting the above increases was a $30 million
efficiency and energy payment received during the second quarter of 2001 from
NEA. In addition, in the three months ended June 30, 2002, a net $3 million loss
was recognized related to changes in the valuation of certain out-of-market
contracts.

Gross margin increased $93 million for the six months ended June 30, 2002
compared to the same period in 2001 primarily due to (a) the one-time $109
million gain discussed above, (b) the $16 million net gain recognized in fuel
expense discussed above, (c) a $4 million increase in trading and power
origination gross margins which increased from $3 million for the six months
ended June 30, 2001 to $7 million for the same period in 2002 due to an increase
in power trading volumes and trading origination transactions, and (d) a $5
million increase in plant margins due to increases in electric sales volumes and
decreased fuel prices. Offsetting these increases were the $30 million payment
received during the second quarter of 2001 from NEA, and decreased margins on
ancillary services of $4 million. Further offsetting the increase in gross
margin were unscheduled plant outages at certain of Reliant Resources' electric
generating facilities in the first six months of 2002. Reliant Resources
estimates that these unplanned outages resulted in a net decrease in gross
margin of approximately $7 million.

Operation and maintenance and other expenses increased by $6 million for
the three months ended June 30, 2002 compared to the same period in 2001. The
increase was primarily attributable to increased consulting fees and employee
benefit expenses, as well as increased expenses associated with overall trading
business growth, primarily stemming from Reliant Resources' United Kingdom
operations, which began in July 2001.

Operation and maintenance and other expenses increased by $13 million for
the six months ended June 30, 2002 compared to the same period in 2001. The
increase was primarily attributable to the reasons discussed above plus
increased environmental expenditures of $2 million, and reversal of a reserve
for environmental tax subsidies receivable in 2001 of $4 million.

Depreciation and amortization expenses decreased $5 million during the
second quarter of 2002 compared to the same period in 2001 primarily due to the
cessation of goodwill amortization effective January 1, 2002. During the three
months ended June 30, 2001, Reliant Resources' European Energy business segment
recorded $6 million in amortization expense related to goodwill. For additional
discussion regarding the cessation of goodwill amortization, please read Note
2(q) to Reliant Energy Form 10-K/A Notes and Note 6 to our Interim Financial
Statements. This decrease was partially offset by an increase of $1 million in
depreciation expense during the same period as a result of capital expenditures
in late 2001 associated with Reliant Resources' trading business.

62

Depreciation and amortization expenses decreased $11 million for the six
months ended June 30, 2002 compared to the same period in 2001 primarily due to
the cessation of goodwill amortization effective January 1, 2002. During the six
months ended June 30, 2001, Reliant Resources' European Energy business segment
recorded $13 million in amortization expense related to goodwill. This decrease
was partially offset by an increase of $2 million in depreciation expense during
the same period as a result of capital expenditures in late 2001 associated with
Reliant Resources' trading business.

Other non-operating income decreased $51 million during the three and six
months ended June 30, 2002 compared to the same periods in 2001 due to a $51
million gain recorded in the three months ended June 30, 2001, as equity income
for the preacquisition gain contingency related to the acquisition of REPGB for
the value of its equity investment in NEA. For further discussion of this gain,
please read Note 14(h) to the Reliant Energy 10-K/A Notes and Note 13(e) to our
Interim Financial Statements.

RETAIL ENERGY

Reliant Resources' Retail Energy business segment provides energy products
and services to end-use customers, ranging from residential and small commercial
customers to large commercial, industrial and institutional customers. In
addition, Reliant Resources' Retail Energy business segment provided billing,
customer service, credit and collection services to our Electric Operations
business segment and remittance services to our Electric Operations business
segment and two of the divisions of our Natural Gas Distribution business
segment in 2001. Reliant Resources' Retail Energy business segment charged the
regulated electric and natural gas utilities for these services at cost. Reliant
Resources' Retail Energy business segment acquired approximately 1.7 million
electric retail customers in the Houston metropolitan area when the Texas market
opened to full competition in January 2002. During the first half of 2002, the
Texas electric retail market was largely focused on the extensive efforts
necessary to transition customers from the utilities to the affiliated retail
electric providers.

For information regarding factors that may affect the future results of
operations of Reliant Resources' Retail Energy business segment, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Our Future Earnings -- Factors Affecting
the Results of Our Retail Energy Operations" in the Reliant Energy Form 10-K/A,
which is incorporated herein by reference.

The following table provides summary data, including EBIT, of Reliant
Resources' Retail Energy business segment for the three months and six months
ended June 30, 2001 and 2002:

63

Reliant Resources' Retail Energy business segment's EBIT increased $207
million and $259 million in the three and six months ended June 30, 2002,
respectively, compared to the same period in 2001. The increase in EBIT was
primarily due to increased gross margins (revenues less purchased power) related
to retail electric sales to residential, small commercial and large commercial,
industrial and institutional customers resulting from full competition. The
increases in gross margins were partially offset by increased operating expenses
as further discussed below.

Operating revenues increased $1.4 billion and $2.3 billion in the three and
six months ended June 30, 2002, respectively, compared to the same periods in
2001, due to revenues of $1.0 billion and $1.7 billion, respectively, from
retail electric sales in the Texas retail market which opened to full
competition in January 2002. Revenues related to the managing and optimizing of
electric energy supply contributed approximately $395 million and $630 million,
respectively, of the increase in revenues for the three and six months ended
June 30, 2002 compared to the same periods in 2001. Purchased power expense
increased $1.1 billion and $1.9 billion, respectively, for the three and six
months ended June 30, 2002 due to costs of approximately $765 million and $1.4
billion, respectively, associated with the retail electric sales and $334
million and $568 million, respectively, associated with managing and optimizing
of electric energy supply.

Reliant Resources' Retail Energy business segment's gross margins increased
$290 million and $400 million in the three and six months ended June 30, 2002,
respectively, compared to the same periods in 2001 primarily due to increased
margins of $309 million and $438 million, respectively, from retail electric
sales of which $237 million and $343 million, respectively, was increased gross
margin for electric sales exclusive of contracted energy sales to large
commercial, industrial and institutional customers. Contracted energy sales to
large commercial, industrial and institutional customers are accounted for under
the mark-to-market method of accounting, and are included in the margins
mentioned above. These energy contracts are recorded at fair value in revenues
upon contract execution. The net changes in their market values are recognized
in the income statement in revenues in the period of the change. Realized gains
and losses are included in operating revenues and operating expenses in the
results of operations. During the three and six months ended June 30, 2002,
Reliant Resources' Retail Energy business segment recognized $66 million and $77
million, respectively, of gross margins related to commercial, industrial and
institutional energy contracts compared to $11 million and $15 million,
respectively, in the same periods in 2001, respectively. Included in these
margins are unrealized losses related to these contracts which were $13

64

million and $8 million in the three and six months ended June 30, 2002,
respectively, compared to unrealized gains of $11 million and $15 million,
respectively, in the same periods in 2001. For information regarding the
accounting for contracted energy sales to large commercial, industrial and
institutional customers, please read Notes 2(d) and 5 to the Reliant Energy
10-K/A Notes, which notes are incorporated by reference herein.

In addition, in the three and six months ended June 30, 2001, $11 million
and $24 million, respectively, of revenues were recorded for billing, customer
service, credit and collection and remittance services charged to Reliant
Energy's regulated electric utility and two of its natural gas distribution
divisions. The associated costs are included in operation and maintenance
expenses and other expenses. The service agreement governing these services
terminated on December 31, 2001.

Operations and maintenance expenses and other expenses increased $78
million and $132 million in the three and six months ended June 30, 2002
compared to the same periods in 2001, respectively, primarily due to (a)
increased gross receipts taxes of $19 million and $33 million, respectively, (b)
personnel and employee related costs and other administrative costs of $47
million and $83 million, respectively, due to the Texas retail market opening to
full competition in January 2002, (c) increased bad debt reserves of $14 million
and $24 million, respectively, associated with increased retail electric sales
and (d) increased marketing costs of $6 million and $9 million, respectively,
due to the Texas retail market opening to full competition.

Depreciation and amortization expense increased $4 million and $7 million
in the three and six months ended June 30, 2002, respectively, compared to the
same periods in 2001 primarily due to depreciation of information systems
developed and placed in service to meet the needs of Reliant Resources' retail
businesses. In addition, for the three and six months ended June 30, 2001,
Reliant Resources' Retail Energy business segment recorded $1 million for both
periods for amortization expense related to goodwill. For information regarding
the cessation of goodwill amortization, please read Note 2(q) to the Reliant
Energy 10-K/A Notes and Note 6 to our Interim Financial Statements, which notes
are incorporated herein by reference.

The Electric Reliability Council of Texas (ERCOT) independent system
operator (ERCOT ISO) is responsible for maintaining reliable operations of the
bulk electric power supply system in the ERCOT market. The ERCOT ISO is also
responsible for handling scheduling and settlement for all electricity supply
volumes in the Texas deregulated electricity market. As part of settlement, the
ERCOT ISO communicates the actual volumes delivered compared to the volumes
scheduled. The ERCOT ISO calculates an additional charge or credit based on the
difference between the actual and scheduled volumes, based on a market clearing
price. Settlement charges also include allocated costs such as unaccounted-for
energy. Preliminary settlement information is due from ERCOT within two months
after electricity is delivered. Final settlement information is due from ERCOT
within twelve months after electricity is delivered. As a result, Reliant
Resources records their supply costs using scheduled supply volumes and adjusts
those costs upon receipt of settlement and consumption information.

The ERCOT ISO is also responsible for ensuring that information relating to
a customer's choice of retail electric provider is conveyed in a timely manner
to anyone needing the information. Problems in the flow of information between
the ERCOT ISO, the transmission and distribution utility and the retail electric
providers have resulted in delays in enrolling and billing customers. While the
flow of information is improving, operational problems in the new systems and
processes are still being worked out.

Reliant Resources' Retail Energy business segment is dependent on the local
transmission and distribution utilities for the reading of their customers'
energy meters and is required to rely on the local utility or, in some cases,
the independent transmission system operator, to provide them with their
customers' information regarding energy usage, such as historical usage
patterns, and they may be limited in their ability to confirm the accuracy of
the information. The provision of inaccurate information or delayed provision of
such information by the local utilities or system operators could have a
material negative impact on Reliant Resources' business and results of
operations and cash flows.

The Texas Utility Commission regulations allow Reliant Resources to request
an adjustment to the fuel factor in their price to beat up to twice a year for
their Houston area residential and small commercial customers based on the
percentage change in the price of natural gas or increases in the price of
purchased energy. Reliant Resources' price to beat fuel factor was initially set
by the Texas Utility Commission in December 2001 based on an average forward
12-month natural gas price of $3.11/mmbtu. On May 2, 2002, Reliant Resources
filed a request with the Texas Utility Commission to increase the price to beat
fuel factor based on a 20% increase in the price of natural gas.

65

Commission in December 2001 based on an average forward 12-month natural gas
price of $3.11/mmbtu. Reliant Resources' requested increase was based on an
average forward 12-month natural gas price of $3.73/mmbtu. The requested
increase represents a 5.9% increase in the total bill of a residential customer
using, on average, 1,000 kWh per month. On June 6, 2002 the administrative law
judge recommended to the Texas Utility Commission approval of a 19.9% increase
to the price to beat fuel factor based on application of the Texas Utility
Commission's price to beat rule. On July 5, 2002, the Texas Utility Commission
issued an order delaying Reliant Resources' request as well as the request of
each of the other four affiliated retail electric providers requesting
adjustments to the price to beat fuel factors and remanded the cases to the
administrative law judges requesting additional information in order to validate
the Texas Utility Commission's rule. On July 24, 2002, Reliant Resources filed a
request in the Travis County District Court that the Court declare that the
Texas Utility Commission must apply its current rules to Reliant Resources'
request and grant the fuel factor adjustment in accordance with the formula in
the rule that the Texas Utility Commission had already approved. The other four
affiliated retail electric providers also filed similar requests with the Travis
County District Court. The Court issued an order on August 9, 2002 agreeing with
Reliant Resources that the Texas Utility Commission must follow the existing
rules that govern the adjustment of the price to beat fuel factor. Unless the
Texas Utility Commission convenes a special meeting, the earliest a new price to
beat could go into effect would be after August 23, 2002, the date of the Texas
Utility Commission's next normally scheduled meeting.

OTHER OPERATIONS

Our Other Operations business segment includes the operations of Reliant
Energy Thermal Systems, Inc., Reliant Energy Power Systems, Inc., Reliant
Resources' new ventures businesses, various real estate used in business
operations, remaining operations in Latin America and unallocated corporate
costs. After Restructuring and Distribution, our Other Operations business
segment will consist primarily of Reliant Energy Thermal Systems, Inc., Reliant
Energy Power Systems, Inc., office buildings and other real estate used in our
business operations and unallocated corporate costs.

The following table shows EBIT of our Other Operations business segment for
the three months and six months ended June 30, 2001 and 2002:

Our Other Operations business segment's loss before interest and income
taxes decreased by $9 million and $127 million for the three months and six
months ended June 30, 2002, respectively, compared to the same periods in 2001.
The decline in loss before interest and income taxes for the three months is
primarily due to decreased other operating costs in 2002, partially offset by an
increased non-cash unrealized loss of $13 million on our AOL Time Warner
investment and related indexed debt securities. The decline in loss before
interest and income taxes for the six months is primarily due to a $101 million
pre-tax, non-cash charge related to the redesign of certain of our benefit plans
in anticipation of our separation from Reliant Resources incurred in 2001 and
decreased other operating costs in 2002, partially offset by an increased
non-cash unrealized loss of $30 million on our AOL Time Warner investment and
related indexed debt securities.

TRADING AND MARKETING OPERATIONS

Reliant Energy, primarily through our approximately 83% owned subsidiary,
Reliant Resources, trades and markets power, natural gas and other
energy-related commodities and provides related risk management services to
their customers. Reliant Resources applies mark-to-market accounting for all of
their energy trading, marketing, power origination and risk management services
activities. For information regarding mark-to-market accounting, please read
Notes 2(d) and 5(a) to the Reliant Energy 10-K/A Notes. These trading activities
consist of:

66

o the domestic energy trading, marketing, power origination and risk
management services operations of Reliant Resources' Wholesale Energy
business segment;

o the European energy trading and power origination operations of
Reliant Resources' European Energy business segment; and

o the large commercial, industrial and institutional customers under
retail electricity contracts of Reliant Resources' Retail Energy
business segment.

Reliant Resources' domestic and European energy trading and marketing
operations enter into derivative transactions with goals of optimizing their
current power generation asset position and taking a market position.

Reliant Resources is in the process of evaluating their trading, marketing,
power origination and risk management services strategies. In the future,
Reliant Resources may reduce their trading, marketing and origination
activities, which would likely result in a corresponding decrease in earnings
and cash flows.

Reliant Resources' realized and unrealized trading, marketing and risk
management services margins are as follows:

Below is an analysis of Reliant Resources' net trading and marketing assets
and liabilities for 2002 (in millions):

Fair value of contracts outstanding at December 31, 2001....................................... $ 218
Fair value of new contracts when entered into during the period................................ 46
Contracts realized or settled during the period................................................ (201)
Changes in fair values attributable to changes in valuation techniques and assumptions......... 18
Changes in fair value attributable to market price and other market changes.................... 147
--------------
Fair value of contracts outstanding at June 30, 2002......................................... $ 228
==============

During the six months ended June 30, 2002, Reliant Resources' Retail Energy
business segment entered into contracts with large commercial, industrial and
institutional customers ranging from six months to four years in duration. These
contracts had an aggregate fair value of $35 million at the contract inception
dates. Reliant Resources has entered into energy supply contracts to
substantially economically hedge these contracts. The fair value of these Retail
Energy business segment electric supply contracts was determined by comparing
the contractual pricing to the estimated market price for the retail energy
delivery and applying the estimated volumes under the provisions of these
contracts. This calculation involves estimating the customer's anticipated load
volume, and using the forward ERCOT over-the-counter (OTC) commodity prices,
adjusted for the customer's anticipated load pattern. Load characteristics in
the valuation model include: the customer's expected hourly electricity usage
profile, the potential variability in the electricity usage profile (due to
weather or operational uncertainties), and the electricity usage limits included
in the customer's contract. In addition, estimates include anticipated delivery
costs, such as regulatory and transmission charges, electric line losses, ERCOT
system operator administrative fees and other market interaction charges,
estimated credit risk and administrative costs to serve. The remaining
weighted-average duration of these contracts is approximately eighteen months.

Reliant Resources' Retail Energy business segment also enters into
contracts to supply the contracts entered into with large commercial, industrial
and institutional customers. These contracts had an aggregate fair value of $6
million at the contract inception dates. The fair values of these contracts are
estimated using ERCOT OTC forward price and volatility curves and correlation
among power and fuel prices specific to ERCOT, net of credit risk. A significant
portion of the value of these contracts required utilization of internal models
that yield similar results to externally developed standard industry models. For
the contracts extending beyond June 30, 2002, the remaining weighted-average
duration of these contracts is less than two years.

67

The remaining fair value of new contracts recorded at inception of $5
million primarily relates to natural gas transportation contracts
entered into by Reliant Resources' Wholesale Energy business segment. The fair
values of these Wholesale Energy business segment contracts at inception require
the utilization of a spread option model and are estimated using OTC forward
price and volatility curves and correlation among natural gas prices at
differing locations, net of estimated credit risk. For the contracts extending
beyond June 30, 2002, the remaining weighted-average duration of these contracts
is less than five years.

During the second quarter of 2002, Reliant Resources changed their
methodology for allocating credit reserves between their trading and non-trading
portfolios. Total credit reserves calculated for both the trading and
non-trading portfolios, which are less than the sum of the independently
calculated credit reserves for each portfolio due to common counterparties
between the portfolios, are allocated to the trading and non-trading portfolios
based upon the independently calculated trading and non-trading credit reserves.
Previously, credit reserves were independently calculated for the trading
portfolio while credit reserves for the non-trading portfolio were calculated by
deducting the trading credit reserves from the total credit reserves calculated
for both portfolios. This change in methodology reduced credit reserves relating
to the trading portfolio by $18 million.

Below are the maturities of Reliant Resources' contracts related to their
trading and marketing assets and liabilities as of June 30, 2002 (in millions):

- ----------

(1) Twelve months ended June 30, 2003

(2) The third and fourth quarter of 2003

The "prices actively quoted" category represents Reliant Resources' New
York Mercantile Exchange (NYMEX) futures positions in natural gas and crude oil.
At June 30, 2002, NYMEX had quoted prices for natural gas and crude oil for the
next 72 and 30 months, respectively.

The "prices provided by other external sources" category represents Reliant
Resources' forward positions in natural gas and power at points for which OTC
broker quotes are available. On average, OTC quotes for natural gas and power
extend 72 and 36 months into the future, respectively. Reliant Resources values
these positions against internally developed forward market price curves that
are constantly validated and recalibrated against OTC broker quotes. This
category also includes some transactions whose prices are obtained from external
sources and then modeled to hourly, daily or monthly prices, as appropriate.

The "prices based on models and other valuation methods" category contains
(a) the value of Reliant Resources' valuation adjustments for liquidity, credit
and administrative costs, (b) the value of options not quoted by an exchange or
OTC broker, (c) the value of transactions for which an internally developed
price curve was constructed as a result of the long-dated nature of the
transaction or the illiquidity of the market point, and (d) the value of
structured transactions. In certain instances structured transactions can be
composed and modeled by Reliant Resources as simple forwards and options based
on prices actively quoted. Options are typically valued using Black-Scholes
option valuation models. Although the valuation of the simple structures might
not be different from the valuation of contracts in other categories, the
effective model price for any given period is a combination of prices from two
or more different instruments and therefore has been included in this category
due to the complex nature of these transactions.

The fair values in the above table are subject to significant changes based
on fluctuating market prices and conditions. Changes in the assets and
liabilities from trading, marketing, power origination and price risk management
services result primarily from changes in the valuation of the portfolio of
contracts, newly originated transactions and the timing of settlements. The most
significant parameters impacting the value of Reliant Resources' portfolio of
contracts include natural gas and power forward market prices, volatility and
credit risk. For

68

the Retail Energy business segment's sales discussed above, significant
variables affecting contract values also include the variability in electricity
consumption patterns due to weather and operational uncertainties (within
contract parameters). Market prices assume a normal functioning market with an
adequate number of buyers and sellers providing market liquidity. Insufficient
market liquidity could significantly affect the values that could be obtained
for these contracts, as well as the costs at which these contracts could be
hedged. Please read "Quantitative and Qualitative Disclosures About Market Risk"
in Item 7A of the Reliant Energy Form 10-K/A, which is incorporated herein by
reference, for further discussion and measurement of the market exposure in the
trading and marketing businesses and discussion of credit risk management.

Based on Reliant Resources' analysis, they believe their increased exposure
to non-investment grade or unrated counterparties from December 31, 2001 is not
material to their financial position. In addition, Reliant Resources' increase
in exposure to non-investment grade or unrated counterparties compared to their
total trading and marketing assets and total non-trading derivative assets has
not increased significantly from December 31, 2001. For additional information
regarding Reliant Resources' credit exposure to counterparties, please read
Notes 5 to the Reliant Energy 10-K/A Notes and "Quantitative and Qualitative
Disclosures About Market Risk - Credit Risk" in Item 7A of the Reliant Energy
Form 10-K/A. Although a number of Reliant Resources' counterparties have
experienced downgrades in credit worthiness since December 31, 2001, Reliant
Resources has taken steps to mitigate their credit risk to these counterparties
through position reductions and credit enhancements.

For additional information, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Factors
Affecting Our Future Earnings - Factors Affecting the Results of Our Wholesale
Energy Operations - Price Volatility," and "- Risks Associated with Our Hedging
and Risk Management Activities" in Item 7 of the Reliant Energy Form 10-K/A.

For a description of accounting policies for Reliant Resources' trading and
marketing activities, please read Notes 2(d) and 5 to the Reliant Energy 10-K/A
Notes.

Reliant Resources seeks to monitor and control their trading risk exposures
through a variety of processes and committees. For additional information,
please read "Quantitative and Qualitative Disclosures About Market Risk - Risk
Management Structure" in Item 7A of the Reliant Energy Form 10-K/A.

CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS

For information on other developments, factors and trends that may have an
impact on our future earnings, including information relating to an anticipated
decline in earnings of our electric business segments due to deregulation of the
Texas electric industry, please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Factors Affecting Our
Future Earnings" in the Reliant Energy Form 10-K/A, which is incorporated herein
by reference. For additional information regarding (a) the California wholesale
market and related litigation, please read Notes 13(a) and 13(d) to our Interim
Financial Statements, and (b) the Dutch stranded costs, please read Note 13(e)
to our Interim Financial Statements.

FERC Notice of Proposed Rulemaking. On July 31, 2002, FERC issued a Notice
of Proposed Rulemaking proposing requirements for standardization of basic
market rules in the wholesale electricity markets. The stated intent of FERC's
proposal is to implement standard rules that will provide for more equal access
to electricity markets and more predictability and uniformity in the various
parts of the country. The proposal includes provisions for capacity payments,
market mitigation, independent market monitoring, transmission and congestion
revenue rights, and independent transmission operations and governance. The
new requirements will not take effect until Fall 2004. We generally view the
proposal as beneficial to the extent that it may further open competitive
markets and develop predictable rules that should enhance the stability of our
long-term outlook.

FINANCIAL CONDITION

The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the six months ended June 30,
2001 and 2002:

Net cash provided by operating activities during the six months ended June
30, 2002 decreased $899 million compared to the same period in 2001 primarily
due to (a) increased net accounts receivable and accrued unbilled revenues of
$1.3 billion; (b) a $100 million settlement payment related to certain stranded
cost contracts (please read Note 13(e) to our Interim Financial Statements); (c)
settlement of hedges of Reliant Resources' net investment in foreign
subsidiaries totaling $144 million; (d) decreased operating income from Reliant
Resources' Wholesale Energy business segment; and (e) decreased cash flows from
margin deposits related to Reliant Resources' trading and hedging activities.
These items were partially offset by (a) increased accounts payable; (b) an
increase in recovered fuel costs by our Electric Transmission and Distribution
business segment; (c) $142 million of collateral deposits related to Reliant
Resources' equipment financing structure returned to them in 2002 coupled with
collateral deposits paid in 2001 (please read Note 13(f) to our Interim
Financial Statements, which note is incorporated herein by reference); (d)
reduced lease prepayments related to Reliant Resources' REMA sale-leaseback
agreements (please read Note 13(g) to our Interim Financial Statements, which
note is incorporated herein by reference); (e) $50 million related to the
settlement of four structured transactions in 2002 (please read Note 4 to our
Interim Financial Statements, which note is incorporated herein by reference);
and (f) increased cash flows provided by our Retail Energy business segment for
retail sales in the first six months of 2002 due to the Texas retail market
opening to full competition in January 2002.

69

Net cash used in investing activities increased $2.6 billion during the six
months ended June 30, 2002 compared to the same period in 2001 primarily due to
funding of Reliant Resources' acquisition of Orion Power for $2.9 billion on
February 19, 2002, partially offset by a decrease in capital expenditures
related to the construction of domestic power generation projects during the six
months ended June 30, 2002.

Cash flows provided by financing activities increased $4.2 billion during
the six months ended June 30, 2002 compared to the same period in 2001 primarily
due to an increase in short-term borrowings used to fund Reliant Resources'
acquisition of Orion Power and termination of a customer accounts receivable
factoring agreement and increased balances in cash and temporary investments,
partially offset by $1.7 billion in net proceeds from the initial public
offering of Reliant Resources in 2001.

FUTURE SOURCES AND USES OF CASH

The following discussion regarding future sources and uses of cash over the
next twelve months is presented separately for our regulated businesses and
unregulated businesses consistent with the separate liquidity plans that our
management has developed for CenterPoint Energy and Reliant Resources.

RELIANT ENERGY (TO BECOME CENTERPOINT ENERGY SUBSEQUENT TO THE RESTRUCTURING)

FUTURE SOURCES OF CASH FLOWS

Credit Facilities. As of June 30, 2002, we had credit facilities, including
facilities of Houston Industries FinanceCo LP (FinanceCo) and RERC Corp., that
provided for an aggregate of $5.2 billion in committed credit. As of June 30,
2002, $4.5 billion was outstanding under these facilities including $1.0 billion
of commercial paper supported by the facilities, borrowings of $3.5 billion and
letters of credit of $2.5 million. For a discussion of the repayment,
refinancing and/or amendment of certain of these committed credit facilities and
our liquidity concerns, please read Note 8 to our Interim Financial Statements,
which note is incorporated herein by reference.

Offerings of Securities. The following table lists shelf registration
statements existing at June 30, 2002 for securities expected to be sold in
public offerings.

- ----------

(1) The amount reflects the principal amount of debt securities, the aggregate
liquidation value of trust preferred securities and the estimated market
value of common stock based on the number of shares registered as of June
28, 2002 and the closing market price of Reliant Energy common stock on
that date.

Debt securities having an aggregate principal amount of as much as $1.2
billion are expected to be issued by CenterPoint Energy and/or the transmission
and distribution subsidiary of CenterPoint Energy in 2002 following the
Restructuring. Additional debt offerings are expected to be made by one or both
of these companies in early 2003. Amounts issued in 2002 and 2003 are expected
to be affected by the market's perception of our creditworthiness, market
conditions and factors affecting our industry. Proceeds from the sale of these
debt securities are expected to be used primarily to repay short-term
borrowings. In the event CenterPoint Energy elects in 2002 or 2003 to issue
common equity or a security having equity characteristics, proceeds from such
offering are also expected to be used primarily to repay short-term borrowings.

Excluding the repayments expected to be made on the transition bonds
described in Note 4(a) to the Reliant Energy 10-K/A Notes, which note is
incorporated herein by reference, we have long-term debt maturities of $300
million in November 2002 and $150 million in April 2003. Maturing debt is
expected to be refinanced with borrowings under credit facilities.

70

Money Fund. We have a "money fund" through which we and participating
subsidiaries can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money fund's net funding requirements are generally met with
commercial paper and/or bank loans. Following the Restructuring, we expect that
the terms under which the money fund operates will be modified in accordance
with the requirements set forth for registered public utility holding companies
under the 1935 Act.

FUTURE USES OF CASH FLOWS

Debt Service Requirements. Debt service requirements will be affected by
the overall level of interest rates, credit spreads applicable to the various
issuers of debt, the amount of short-term debt that is refinanced with long-term
debt and/or equity, and the rate established on $175 million of 5.20% pollution
control bonds when such bonds are remarketed in the fourth quarter of 2002. We
expect to have large amounts of short-term floating-rate debt throughout 2002.

At June 30, 2002, we had entered into five-year forward starting interest
rate swaps having an aggregate notional amount of $1.5 billion to hedge the
interest rate on an anticipated offering of five-year notes. The weighted
average rate on the swaps was 5.8%. At June 30, 2002, we also had entered into
interest rate swaps to fix the rate on $750 million of our floating rate debt.
The weighted average rate on these swaps was 3.5% at June 30, 2002 and the swaps
expire in 2003 and 2004. While we have, in some instances, hedged our exposure
to changes in interest rates by entering into interest rate swaps, the swaps
leave us exposed to changes in our credit spread relative to the market indices
reflected in the swaps. In addition, there is a risk that the $1.5 billion
notional amount of hedges relating to anticipated offerings of debt in 2002 may
exceed the principal amount of notes issued in 2002. The requirement that the
forward starting swaps be cash settled on the September 4, 2002 start date of
the swaps could result in large cash payments or receipts. It is estimated that,
at June 30, 2002, the forward starting swaps of $1.5 billion could be terminated
at a cost of approximately $74 million. The cash payment or receipt is
determined just prior to the earlier of the swap termination date or the
mandatory settlement date and may vary significantly depending on interest rate
levels. In the event that the notional amount of terminated swaps exceeds the
principal amount of any notes issued, 2002 earnings could be impacted by the
cash payment or receipt upon the settlement or termination of those swaps that
are unrelated to a note offering.

Credit Ratings. Credit ratings impact Reliant Energy's ability to obtain
short- and long-term financing, the cost of such financings and the execution of
our commercial strategies. For a discussion of our credit ratings and the
related factors affecting our future financial position, results of operations
and cash flows, please read Note 15(d) to our Interim Financial Statements,
which note is incorporated herein by reference.

Zero-Premium Exchangeable Notes due 2029 (ZENS). From July 1, 2002 through
August 9, 2002, holders of approximately 12% of the ZENS outstanding exercised
their right to exchange their ZENS for cash, resulting in aggregate cash
payments by Reliant Energy of $33 million. Holders of ZENS submitted for
exchange are entitled to receive a cash payment equal to 95% of the market value
of the reference shares of AOL Time Warner common stock. There are 1.5 reference
shares of AOL Time Warner common stock for each of the 17.2 million ZENS units
originally issued. The exchange market value is calculated using the average
closing price per share of AOL Time Warner common stock on the New York Stock
Exchange on one or more trading days following the notice date. Payment must be
made no later than ten trading days following the notice date. The Company
recorded a gain of $9 million related to the exchanges of the ZENS.

A subsidiary of Reliant Energy owns the reference shares of AOL Time Warner
common stock and has elected to liquidate such holdings in an amount sufficient
to make the cash payments. In connection with exchanges through August 9, 2002,
Reliant Energy received net proceeds of $31 million from the liquidation of 3.1
million shares of AOL Time Warner common stock at an average price of $10 per
share. Deferred taxes of $43 million became current tax obligations as a result
of the ZENS submitted for exchange and the sale of AOL Time Warner common stock.
For additional information on deferred taxes related to ZENS, please read Note
13 to the Reliant Energy 10-K/A Notes, which note is incorporated herein by
reference.

Temporary Investments. At June 30, 2002, we had temporary investments in a
money market fund of $207 million. In July 2002, we liquidated such investments
and used the proceeds to retire short-term debt.

Capital Expenditures. We expect capital requirements to be met with cash
flows from operations as well as proceeds from debt offerings and other
borrowings. We anticipate investing up to $3.3 billion in capital expenditures
between 2002 and 2006, including $477 million expended during the six months
ended June 30, 2002. Of this amount, we anticipate expenditures to be
approximately $900 million and $700 million in 2002 and 2003, respectively.

Environmental Issues. We anticipate investing up to $468 million in capital
and other special project expenditures between 2002 and 2006 for environmental
compliance, including $142 million expended during the six months ended June 30,
2002, and potentially up to an additional $88

71

million by 2007. Of this amount, we anticipate expenditures to be approximately
$205 million and $109 million in 2002 and 2003, respectively. These
environmental compliance expenditures are included in the capital requirements
discussed above. For additional information related to environmental issues,
please read Note 13(b) to our Interim Financial Statements, which note is
incorporated herein by reference.

Distribution of Texas Genco. In 2002, approximately 20% of Texas Genco is
expected to be distributed to holders of CenterPoint Energy common stock. The
value of this publicly traded Texas Genco stock will be used to determine the
value of Texas Genco for purposes of determining stranded costs.

Fuel Filing. Reliant Energy filed its final fuel reconciliation with the
Texas Utility Commission on July 1, 2002. Although previous fuel reconciliation
proceedings have generally covered three year periods, this filing covers $8.6
billion in fuel expense and interest incurred between August 1, 1997 and January
30, 2002. Also included in this amount is an under-recovery of $94 million,
which was the balance as of July 31, 1997. During this period of time, Reliant
Energy collected $8.5 billion in fuel revenues. This results in a current
undercollection, including interest, of $144 million as of June 30, 2002.
Current substantive rules require that the Texas Utility Commission rule on this
case by March 1, 2003. A procedural schedule has been set with a hearing
scheduled to begin November 19, 2002. Under the Texas electric restructuring
law, the final fuel balance found to be reasonable by the Texas Utility
Commission will be reflected in the 2004 true-up proceeding.

Reliant Energy HL&P Rate Matters. An order issued by the Texas Utility
Commission on October 3, 2001 (October 3, 2001 Order) established the
transmission and distribution rates that became effective in January 2002. The
Texas Utility Commission determined that Reliant Energy HL&P had overmitigated
its stranded costs by redirecting transmission and distribution depreciation and
by accelerating depreciation of generation assets as provided under the 1998
transition to competition plan (Transition Plan) and Texas electric
restructuring law. In this final order, Reliant Energy HL&P was required to
reverse the amount of redirected depreciation and accelerated depreciation taken
for regulatory purposes as allowed under the Transition Plan and the Texas
electric restructuring law. Per the October 3, 2001 Order, our Electric
Transmission and Distribution business segment recorded a regulatory liability
to reflect the prospective refund of the accelerated depreciation. Our Electric
Transmission and Distribution business segment began refunding excess mitigation
credits with the January 2002 unbundled bills, to be refunded over a seven year
period. The annual cash flow impact of the reversal of both redirected and
accelerated depreciation is a decrease of approximately $236 million. Under the
Texas electric restructuring law, a final settlement of these stranded costs
will occur in 2004. For further discussion, please read Note 4(a) to the Reliant
Energy 10-K/A Notes.

Treasury Stock Purchases. As of June 30, 2002, we were authorized under our
common stock repurchase program to purchase an additional $271 million of our
common stock. Our purchases under our repurchase program depend on market
conditions, might not be announced in advance and may be made in open market or
privately negotiated transactions. CenterPoint Energy has no current plans to
engage in a significant stock buy-back program, but may seek to repurchase
shares in the open market for use in various benefit and employee compensation
plans, or to maintain a targeted balance of outstanding shares to the extent
that original issue stock is used for such purposes.

Pension and Postretirement Benefits Funding. We make contributions to
achieve adequate funding of company sponsored pension and postretirement
benefits in accordance with applicable regulations and rate orders. Due to the
decline in current market value of the pension plan's assets, the value of the
plan's assets is less than our accumulated pension benefit obligation. As a
result, we may be required to record a minimum pension liability adjustment to
other comprehensive income during the fourth quarter of 2002, which could be
material.

Other Sources/Uses of Cash. Reliant Energy's liquidity and capital
requirements are affected primarily by our results of operations, capital
expenditures, debt service requirements, and working capital needs. We expect
our capital requirements to be met with cash flows from operations, short-term
borrowings and proceeds from debt and equity offerings, and believe that our
current borrowing capability, along with our future anticipated cash flows from
operations and proceeds from anticipated sales of securities in the capital
markets, assuming successful refinancings of credit facilities as they mature,
will be sufficient to meet our cash needs.

RELIANT RESOURCES - UNREGULATED BUSINESSES

FUTURE SOURCES OF CASH FLOWS

Credit Facilities. As of June 30, 2002, Reliant Resources had $8.3 billion
in committed credit facilities of which $1.2 billion remained unused. Credit
facilities aggregating $5.4 billion were unsecured. As of June 30, 2002, letters
of credit outstanding under these facilities aggregated $803 million. As of June
30, 2002, borrowings of $6.3 billion were outstanding under these facilities. As
of June 30, 2002, Reliant Resources had $6.3 billion of committed credit
facilities which will expire by June 30, 2003 of which $2.8 billion will expire
by December 31, 2002. For a discussion of the repayment, refinancing and/or
amendment of certain of these committed credit facilities and Reliant Resources'
liquidity concerns, please read Note 8 to our Interim Financial Statements.

72

Credit Ratings. Credit ratings impact Reliant Resources' ability to obtain
short- and long-term financing, the cost of such financing and the execution of
Reliant Resources' commercial strategies. For a discussion of Reliant Resources'
credit ratings and the related factors affecting their future financial
position, results of operations and cash flows, please read Note 15(d) to our
Interim Financial Statements.

Orion Power and its Subsidiaries Credit Facilities Covenant Waivers. For a
discussion of Orion Power and its subsidiaries covenant waivers during the
second quarter of 2002, please read Note 8 to our Interim Financial Statements.

For additional information regarding Orion Power and its subsidiaries' debt
obligations, please read Note 8 to our Interim Financial Statements.

For a discussion of other factors affecting Reliant Resources' sources of
cash and liquidity, please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources"
in the Reliant Energy Form 10-K/A, which is incorporated herein by reference,
and Note 8 to our Interim Financial Statements.

California Trade Receivables. As of June 30, 2002, Reliant Resources was
owed a total of $239 million, net of a $49 million reserve for refund, by the
Cal ISO, the Cal PX, the California Department of Water Resources, and
California Energy Resources Scheduling for energy sales in the California
wholesale market during the fourth quarter of 2000 through June 30, 2002. From
June 30, 2002 through August 9, 2002, Reliant Resources has collected $1 million
of these receivable balances. As of June 30, 2002, Reliant Resources had a
pre-tax credit provision of $30 million against these receivable balances. For
additional information regarding uncertainties in the California wholesale
market, please read Notes 13(a) and 13(d) to our Interim Financial Statements
and Notes 14(f) and 14(g) to the Reliant Energy 10-K/A Notes, which notes are
incorporated herein by reference.

FUTURE USES OF CASH FLOWS

Generating Projects. As of June 30, 2002, Reliant Resources had one
generating facility under construction. Total estimated costs of constructing
this facility are $496 million. As of June 30, 2002, Reliant Resources had
incurred $212 million of the total projected costs of this project, which was
funded primarily from equity and debt facilities. In addition, in connection
with the acquisition of Orion Power, Reliant Resources acquired contracts to
purchase additional power generation equipment, consisting of steam and
combustion turbines and heat recovery steam generators. Remaining costs under
the contracts are $548 million or Reliant Resources may cancel the contracts for
a total cost of $25 million. Reliant Resources is actively attempting to market
this equipment, having determined that it is in excess of their current needs.
In addition to these facilities, Reliant Resources is constructing facilities as
construction agents under the construction agency agreements, which permit them,
to lease or buy each of these facilities at the conclusion of their
construction.

Construction Agency Agreement and Equipment Financing Structure. In 2001,
Reliant Resources, through several of their subsidiaries, entered into operative
documents with special purpose entities to facilitate the development,
construction, financing and leasing of several power generation projects. These
special purpose entities are not consolidated by Reliant Resources. In addition,
Reliant Resources, through their subsidiary, REPG, has entered into an agreement
with a bank whereby the bank, as owner, entered or will enter into contracts for
the purchase and construction of power generation equipment and REPG, or its
subagent, acts as the bank's agent in connection with administering the
contracts for such equipment. For information regarding these transactions,
please read Note 13(f) to our Interim Financial Statements.

Payment to Reliant Energy. To the extent that Reliant Resources' price for
providing retail electric service to residential and small commercial customers
in Reliant Energy's Houston service territory during 2002 and 2003, which price
is mandated by the Texas electric restructuring law, exceeds the market price of
electricity, Reliant Resources may be required to make a payment to Reliant
Energy in early 2004 unless the Texas Utility Commission determines that, on or
prior to January 1, 2004, 40% or more of the amount of electric power that was
consumed in 2000 by residential or small commercial customers, as applicable,
within Reliant Energy's electric utility's Houston service territory as of
January 1, 2002 is committed to be served by retail electric providers other
than Reliant Resources. Currently, Reliant Resources is unable to estimate the
amount of such payment, if any.

73

Restricted Cash. All of Reliant Resources' operations are conducted by
their subsidiaries. Reliant Resources' cash flow and their ability to service
parent-level indebtedness when due is dependent upon their receipt of cash
dividends, distributions or other transfers from their subsidiaries. The terms
of some of Reliant Resources' subsidiaries' indebtedness restrict their ability
to pay dividends or make restricted payments to Reliant Resources in some
circumstances. Under the credit agreements of certain of Orion Power's
subsidiaries, these subsidiaries are restricted from distributing cash to Orion
Power. In addition, covenants under some indebtedness of Orion Power restrict
its ability to pay dividends to Reliant Resources unless Orion Power meets
certain conditions, including the ability to incur additional indebtedness
without violating the required fixed charge coverage ratio of 2.0 to 1.0. A
credit facility of Orion Power also restricts its ability to pay dividends to
Reliant Resources unless the restrictions contained in certain of its
subsidiaries' credit agreements have terminated and no restrictions remain under
their credit agreements. As of June 30, 2002, Reliant Resources had restricted
cash totaling $374 million related to Orion Power and its subsidiaries.

In addition, the ability of REMA, Reliant Resources' subsidiary that owns
some of the power generation facilities in Reliant Resources' Northeast regional
portfolio, to pay dividends or make payments to Reliant Resources is restricted
under the terms of three lease agreements under which Reliant Resources leases
all or an undivided interest in these generating facilities. These agreements
allow REMA to pay dividends or make restricted payments only if specified
conditions are satisfied, including maintaining specified fixed charge coverage
ratios. As of June 30, 2002, the specified conditions were satisfied.

Counterparty Credit Risk. Reliant Resources is exposed to the risk that
counterparties who owe them money or physical commodities, such as energy or
gas, as a result of market transactions fail to perform their obligations.
Should the counterparties to these arrangements fail to perform, Reliant
Resources might incur losses if Reliant Resources is forced to acquire
alternative hedging arrangements or replace the underlying commitment at
then-current market prices. In addition, Reliant Resources might incur
additional losses to the extent of amounts, if any, already paid to the
defaulting counterparties.

The output of the Liberty Electric Generating Station is contracted under a
tolling agreement (Tolling Agreement) for a term of approximately 14 years, with
an option to extend at the end of the term. Standard & Poor's and Moody's have
downgraded to below investment grade status the senior unsecured debt of PG&E
National Energy Group, Inc., one of the two guarantors of PG&E Energy
Trading-Power, L.P.'s (PGET) obligations under the Tolling Agreement. The
downgrade constitutes an Event of Default by PGET under the Tolling Agreement
unless PGET posts replacement security within ten business days after Liberty
Electric Power, LLC (LEP) notifies PGET of the default. On August 5, LEP
notified PGET of the default. PGET has informed LEP that it will not post the
replacement credit support within the 10 business days period. While LEP could
terminate the Tolling Agreement pursuant to the terms of the Tolling Agreement,
there are certain limitations in the Liberty Credit Agreement on LEP's ability
to take unilateral action in response to a PGET Event of Default.

Generating Capacity Auction Letter of Credit. After the Distribution,
Reliant Resources will be required to post letters of credit to secure the
entitlements to the generation capacity of Reliant Energy's Texas electric
utility generation assets (Texas Genco) that they purchase in the capacity
auctions conducted by Texas Genco. If Reliant Resources was not an affiliate as
of June 30, 2002, they would have been required to post letters of credit to
secure their entitlements to Texas Genco's capacity.

Treasury Stock Purchases. On December 6, 2001, Reliant Resources' Board of
Directors authorized Reliant Resources to purchase up to 10 million additional
shares of their common stock through June 2003. Purchases will be made on a
discretionary basis in the open market or otherwise at times and in amounts as
determined by management subject to market conditions, legal requirements and
other factors. Since the date of this authorization through August 9, 2002,
Reliant Resources has not purchased any shares of their common stock under this
program.

Other Sources/Uses of Cash. Reliant Resources' liquidity and capital
requirements are affected primarily by the results of operations, capital
expenditures, debt service requirements, working capital needs and collateral
requirements. Energy and capital markets permitting, Reliant Resources expect to
grow through the construction of new generation facilities and the acquisition
of generation facilities, and the expansion of their energy retail business.
Reliant Resources expects any resulting capital requirements to be met with cash
flows from operations, and proceeds from debt and equity offerings, project
financings, securitization of assets, other borrowings and off-balance sheet
financings. Additional capital expenditures, some of which may be substantial,
depend to a large extent upon the nature and extent of future project
commitments, which are discretionary. Reliant Resources believes that their
current level of cash and borrowing capability, along with their future
anticipated cash flows from operations and assuming successful refinancings of
credit facilities as they mature, will be sufficient to meet the existing
operational and collateral needs of their business for the next 12 months. If
cash generated from operations is insufficient to satisfy their liquidity
requirements, Reliant Resources may seek to sell either equity or debt
securities, sell assets or obtain additional credit facilities or long-term
financings from financial institutions.

CRITICAL ACCOUNTING POLICIES

A critical accounting policy is one that is both important to the portrayal
of our financial condition and results of operations and requires management to
make difficult, subjective or complex judgments. The circumstances that make
these judgments difficult, subjective and/or complex have to do with the need to
make estimates about the effect of matters that are inherently uncertain.
Estimates and assumptions about future events and their effects cannot be
perceived with certainty. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments. These
estimates may change as new events occur, as more experience is acquired, as
additional information is obtained and as our operating environment changes.

74

We believe the following are the most significant estimates used in the
preparation of our consolidated financial statements.

ACCOUNTING FOR RATE REGULATION

SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
(SFAS No. 71), provides that rate-regulated entities account for and report
assets and liabilities consistent with the recovery of those costs in rates if
the rates established are designed to recover the costs of providing the
regulated service and if the competitive environment makes it probable that such
rates can be charged and collected. Our rate-regulated businesses follow the
accounting and reporting requirements of SFAS No. 71. Certain expenses and
revenues subject to utility regulation or rate determination normally reflected
in income are deferred on the balance sheet and are recognized in income as the
related amounts are included in service rates and recovered from or refunded to
customers. The total amounts of regulatory assets and liabilities reflected in
the Consolidated Balance Sheets are $3.3 billion and $1.4 billion at December
31, 2001, respectively, and $3.4 billion and $1.1 billion at June 30, 2002,
respectively.

Application of SFAS No. 71 to the generation portion of our business was
discontinued as of June 30, 1999. Only the electric transmission and
distribution business, the natural gas distribution companies and one of our
interstate pipelines are subject to SFAS No. 71 after January 1, 2002. We have
recorded regulatory assets and liabilities related to stranded costs associated
with our electric generation operations. Under the Texas electric restructuring
law, a final settlement of these stranded costs will occur in 2004. In the event
that regulation significantly changes the probability for us to recover our
costs in the future, a write-down of all or a portion of our existing regulatory
assets and liabilities could result.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets, which include property, plant and equipment, goodwill
and other intangibles and equity investments comprise a significant amount of
our total assets. We make judgments and estimates in conjunction with the
carrying value of these assets, including amounts to be capitalized,
depreciation and amortization methods and useful lives. Additionally, the
carrying values of these assets are periodically reviewed for impairment or
whenever events or changes in circumstances indicate that the carrying amounts
may not be recoverable. An impairment loss is recorded in the period in which it
is determined that the carrying amount is not recoverable. This requires us to
make long-term forecasts of future revenues and costs related to the assets
subject to review. These forecasts require assumptions about demand for our
products and services, future market conditions and regulatory developments.
Significant and unanticipated changes to these assumptions could require a
provision for impairment in a future period.

UNBILLED ENERGY REVENUES

Revenues related to the sale of energy are generally recorded when service
is rendered or energy is delivered to customers. However, the determination of
the energy sales to individual customers is based on the reading of their meters
which are read on a systematic basis throughout the month. At the end of each
month, amounts of energy delivered to customers since the date of the last meter
reading are estimated and the corresponding unbilled revenue is estimated.
Beginning in January 2002, this unbilled electric revenue is estimated each
month based on daily supply volumes, line losses and applicable customer rates
based on analyses reflecting significant historical trends and experience as
well as related supply costs for Reliant Resources' Retail Energy business
segment. Unbilled natural gas sales are estimated based on estimated purchased
gas volumes, estimated lost and unaccounted for gas and tariffed rates in
effect. Accrued unbilled revenues recorded in the Consolidated Balance Sheet as
of December 31, 2001 were $33 million related to our Electric Transmission and
Distribution business segment, $19 million related to Reliant Resources' Retail
Energy business segment and $188 million related to our Natural Gas Distribution
business segment. Accrued unbilled revenues recorded in the Consolidated Balance
Sheet as of June 30, 2002 were $89 million related to our Electric Transmission
and Distribution business segment, $498 million related to Reliant Resources'
Retail Energy business segment and $22 million related to our Natural Gas
Distribution business segment.

75

ACCOUNTING FOR DERIVATIVES AND HEDGING INSTRUMENTS

SFAS No. 133 established accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires an entity to recognize the
fair value of derivative instruments held as assets or liabilities on the
balance sheet. In accordance with SFAS No. 133, the effective portion of the
change in the fair value of a derivative instrument designated as a cash flow
hedge is reported in other comprehensive income, net of tax. Amounts in
accumulated other comprehensive income are ultimately recognized in earnings
when the related hedged forecasted transaction occurs. The change in the fair
value of the ineffective portion of the derivative instrument designated as a
cash flow hedge is recorded in earnings. Derivative instruments that have not
been designated as hedges are adjusted to fair value through earnings.

We utilize derivative instruments such as futures, physical forward
contracts, swaps and options to mitigate the impact of changes in electricity,
natural gas and fuel prices on our operating results and cash flows. We utilize
cross-currency swaps, forward contracts and options to hedge our net investments
in and cash flows of our foreign subsidiaries, interest rate swaps to mitigate
the impact of changes in interest rates and other financial instruments to
manage various other market risks.

The determination of fair values of trading and marketing assets and
liabilities for our energy trading, marketing and price risk management
operations and non-trading derivative assets and liabilities, including stranded
cost obligations related to Reliant Resources' European Energy operations, are
based on estimates. For further discussion, please read " -- Trading and
Marketing Operations" and "Quantitative and Qualitative Disclosures About Market
Risk" in Item 3 of this Form 10-Q and Note 4 to our Interim Financial
Statements.

NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141 "Business Combinations" (SFAS No. 141). SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting and broadens the criteria for recording intangible
assets separate from goodwill. Recorded goodwill and intangibles will be
evaluated against these new criteria and may result in certain intangibles being
transferred to goodwill, or alternatively, amounts initially recorded as
goodwill may be separately identified and recognized apart from goodwill. We
adopted the provisions of the statement which apply to goodwill and intangible
assets acquired prior to June 30, 2001 on January 1, 2002. The adoption of SFAS
No. 141 did not have a material impact on our historical results of operations
or financial position.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144
provides new guidance on the recognition of impairment losses on long-lived
assets to be held and used or to be disposed of and also broadens the definition
of what constitutes a discontinued operation and how the results of a
discontinued operation are to be measured and presented. SFAS No. 144 supercedes
SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," while retaining many of the requirements of these two
statements. Under SFAS No. 144, assets held for sale that are a component of an
entity will be included in discontinued operations if the operations and cash
flows will be or have been eliminated from the ongoing operations of the entity
and the entity will not have any significant continuing involvement in the
operations prospectively. SFAS No. 144 did not materially change the methods
used by us to measure impairment losses on long-lived assets, but may result in
additional future dispositions being reported as discontinued operations than
was previously permitted. We adopted SFAS No. 144 on January 1, 2002.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a sale-leaseback transaction. The changes related to debt extinguishment will
be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. The Company will apply this guidance prospectively.

76

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The
principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for costs associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with an exit or disposal activity when it is incurred. A
liability is incurred when a transaction or event occurs that leaves an entity
little or no discretion to avoid the future transfer or use of assets to settle
the liability. Under EITF No. 94-3, a liability for an exit cost was recognized
at the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002 with early application encouraged. We will apply the provisions of SFAS No.
146 to all exit or disposal activities initiated after December 31, 2002

See Note 4 to our Interim Financial Statements for a discussion of our
adoption of SFAS No. 133 on January 1, 2001 and adoption of subsequent cleared
guidance. See Note 6 to our Interim Financial Statements for a discussion of our
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets".

In June 2002, the EITF reached a consensus on EITF No. 02-03 that all
mark-to-market gains and losses on energy trading contracts should be shown net
in the income statement whether or not settled physically. An entity should
disclose the gross transaction volumes for those energy trading contracts that
are physically settled. The EITF did not reach a consensus on whether
recognition of dealer profit, or unrealized gains and losses at inception of an
energy trading contract is appropriate in the absence of quoted market prices or
current market transactions for contracts with similar terms. The FASB staff
indicated that until such time as a consensus is reached, the FASB staff will
continue to hold the view that previous EITF consensus do not allow for
recognition of dealer profit, unless evidenced by quoted market prices or other
current market transactions for energy trading contracts with similar terms and
counterparties. The consensus on presenting gains and losses on energy trading
contracts net is effective for financial statements issued for periods ending
after July 15, 2002. Upon application of the consensus, comparative financial
statements for prior periods should be reclassified to conform to the consensus.
We currently report all trading, marketing and risk management services
transactions on a gross basis with such transactions being reported in revenues
and expenses except primarily for financial gas transactions such as swaps.
Beginning with the quarter ended September 30, 2002, we will report all energy
trading and marketing activities on a net basis in the Statements of
Consolidated Income pursuant to EITF No. 02-03. Although we are in the process
of determining the effect of adoption of EITF No. 02-03 on our Statements of
Consolidated Income, we expect the adoption will result in a substantial
reduction in operating revenues, fuel and cost of gas sold, and purchased power.

During the first quarter of 2002, the FASB considered proposed approaches
related to identifying and accounting for special-purpose entities. The current
proposal being considered by the FASB would limit special purpose entities used
by a company for financing and other purposes not being consolidated with its
results of operations. One criterion being considered is to require
consolidation of a special purpose entity if the equity investments held by
third-party owners in the special purpose entity are less than 10% of
capitalization. The FASB likely will not grandfather special purpose entities
existing at the date the final interpretation is issued. Special purpose
entities in existence at the date of adoption of this interpretation will likely
be consolidated by the primary beneficiary. For information regarding special
purpose entities affiliated with Reliant Resources, please read Notes 13(f) and
(g) to our Interim Financial Statements.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

COMMODITY PRICE RISK

We assess the risk of our non-trading derivatives (Energy Derivatives)
using a sensitivity analysis method, and we assess the risk of our trading
derivatives (Trading Derivatives) using the value-at-risk (VAR) method, in order
to maintain our total exposure within management-prescribed limits.

The sensitivity analysis performed on our Energy Derivatives measures the
potential loss based on a hypothetical 10% movement in energy prices. A decrease
of 10% in the market prices of energy commodities from their June 30, 2002
levels would have decreased the fair value of our Energy Derivatives from their
levels on those

77

respective dates by $69 million, excluding non-trading derivative liabilities
associated with Reliant Resources' European Energy business segment's stranded
cost gas contracts.

Reliant Resources' European Energy business segment's stranded cost gas
import contract has exposure to commodity price movements. For information
regarding this contract, please read Notes 4 and 13(e) to our Interim Financial
Statements. A decrease of 10% in market prices of energy commodities from their
June 30, 2002 levels would result in a loss of $73 million.

We utilize the variance/covariance model of VAR, which is a probabilistic
model that measures the estimated risk of loss to earnings in market sensitive
instruments based on historical experience. With respect to Trading Derivatives,
our highest, lowest and average daily VAR were $29 million, $13 million and $17
million, respectively, during the second quarter of 2002 and $29 million, $13
million and $18 million, respectively, during the first six months of 2002 based
on a 95% confidence level and primarily a one day holding period. During the
second quarter of 2001, our highest, lowest and average daily VAR were $16
million, $3 million and $7 million, respectively, and during the first six
months of 2001, our highest, lowest and average monthly VAR were $18 million, $3
million and $8 million, respectively, based on a 95% confidence level and
primarily a one day holding period.

We cannot assure you that market volatility, failure of counterparties to
meet their contractual obligations, transactions entered into after the date of
this Form 10-Q or a failure of risk controls will not lead to significant losses
from our trading, marketing and risk management activities.

INTEREST RATE RISK

We have outstanding long-term debt, bank loans and commercial paper
obligations, mandatory redeemable preferred securities of subsidiary trusts
holding solely our junior subordinated debentures (Trust Preferred Securities),
securities held in our nuclear decommissioning trusts, some lease obligations
and our obligations under the 2.0% Zero-Premium Exchangeable Subordinated Notes
due 2029 (ZENS) that subject us to the risk of loss associated with movements in
market interest rates. We utilize interest-rate swaps in order to hedge portions
of our floating-rate debt and to hedge a portion of the interest rate applicable
to future offerings of long-term debt.

Our floating-rate obligations borrowed from third parties aggregated $10.6
billion at June 30, 2002. If the floating rates were to increase by 10% from
June 30, 2002 rates, our combined interest expense to third parties would
increase by a total of $2.7 million each month in which such increase continued.

At June 30, 2002, we had outstanding fixed-rate debt (excluding indexed
debt securities) and Trust Preferred Securities aggregating $6.8 billion in
principal amount and having a fair value of $6.6 billion. These instruments are
fixed-rate and, therefore, do not expose us to the risk of loss in earnings due
to changes in market interest rates. However, the fair value of these
instruments would increase by approximately $1.1 billion if interest rates were
to decline by 10% from their levels at June 30, 2002. In general, such an
increase in fair value would impact earnings and cash flows only if we were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.

As discussed in Note 14(k) to the Reliant Energy 10-K/A Notes, which note
is incorporated herein by reference, we contributed $14.8 million in 2001 to
trusts established to fund our share of the decommissioning costs for the South
Texas Project. In 2002, we began contributing $2.9 million per year to these
trusts. The securities held by the trusts for decommissioning costs had an
estimated fair value of $169 million as of June 30, 2002, of which approximately
45% were fixed-rate debt securities that subject us to risk of loss of fair
value with movements in market interest rates. If interest rates were to
increase by 10% from their levels at June 30, 2002, the fair value of the
fixed-rate debt securities would decrease by approximately $2 million. In
addition, the risk of an economic loss is mitigated. Any unrealized gains or
losses are accounted for in accordance with SFAS No. 71 as a regulatory
asset/liability because we believe that our future contributions, which are
currently recovered through the ratemaking process, will be adjusted for these
gains and losses. For further discussion regarding the recovery of
decommissioning costs pursuant to the Texas electric restructuring law, please
read Note 4(a) to the Reliant Energy 10-K/A Notes.

As discussed in Note 10(b) to the Reliant Energy 10-K/A Notes, which note
is incorporated herein by reference, RERC Corp.'s $500 million aggregate
principal amount of 6 3/8% Term Enhanced Remarketable Securities include

78

an embedded option to remarket the securities. The option is expected to be
exercised in the event that the ten-year Treasury rate in 2003 is below 5.66%.
At June 30, 2002, we could terminate the option at a cost of $25 million. A
decrease of 10% in the June 30, 2002 level of interest rates would increase the
cost of termination of the option by approximately $13 million.

As discussed in Note 8 to the Reliant Energy 10-K/A Notes, which note is
incorporated herein by reference, upon adoption of SFAS No. 133 effective
January 1, 2001, the ZENS obligation was bifurcated into a debt component of
$122 million and a derivative component of $788 million. The debt component of
$122 million is a fixed-rate obligation and, therefore, does not expose us to
the risk of loss in earnings due to changes in market interest rates. However,
the fair value of the debt component would increase by approximately $18 million
if interest rates were to decline by 10% from levels at June 30, 2002. Changes
in the fair value of the derivative component will be recorded in our Statements
of Consolidated Income and, therefore, we are exposed to changes in the fair
value of the derivative component as a result of changes in the underlying
risk-free interest rate. If the risk-free interest rate were to increase by 10%
from June 30, 2002 levels, the fair value of the derivative component would
increase by approximately $6 million, which would be recorded as a loss in our
Statements of Consolidated Income.

As of June 30, 2002, we have interest rate swaps with an aggregate notional
amount of $2.0 billion that fix the interest rate applicable to floating rate
short-term debt and long-term debt. At June 30, 2002, the swaps relating to
short-term and long-term debt could be terminated at a cost of $28 million. Of
these swaps, $0.8 billion relating to short-term debt do not qualify as cash
flow hedges under SFAS No. 133, and are marked to market in the Company's
Consolidated Balance Sheets with changes reflected in interest expense in the
Statements of Consolidated Income. The remaining $1.2 billion in swaps relating
to both short-term and long-term debt qualify for hedge accounting under SFAS
No. 133 and the periodic settlements are recognized as an adjustment to interest
expense in the Statements of Consolidated Income over the term of the swap
agreements. A decrease of 10% in the June 30, 2002 level of interest rates would
increase the cost of terminating the swaps related to short-term debt and
long-term debt outstanding at June 30, 2002 by $16 million.

As of June 30, 2002, we have entered into forward-starting interest rate
swaps having an aggregate notional amount of $2 billion to hedge the interest
rate on future offerings of long-term fixed-rate notes. At June 30, 2002, these
swaps could be terminated at a cost of $91 million. These swaps qualify as cash
flow hedges under SFAS No. 133. Should the forecasted interest payments no
longer be probable, any deferred amount will be recognized immediately into
income. A decrease of 10% in the June 30, 2002 level of interest rates would
increase the cost of terminating these swaps by $17 million.

FOREIGN CURRENCY EXCHANGE RATE RISK

As of June 30, 2002, we have entered into foreign currency swaps and
foreign exchange forward contracts and have issued Euro-denominated debt to
hedge our net investment in Reliant Resources' European Energy business segment.
Changes in the value of the swaps, forwards and debt are recorded as foreign
currency translation adjustments as a component of accumulated other
comprehensive income (loss) in stockholders' equity. As of June 30, 2002, we
have recorded a $9 million gain in cumulative net translation adjustments. The
cumulative translation adjustments will be realized in earnings and cash flows
only upon the disposition of the related investments.

As of June 30, 2002, Reliant Resources' European Energy business segment
had entered into transactions to purchase approximately $249 million at fixed
exchange rates in order to hedge future fuel purchases payable in U.S. dollars.
As of June 30, 2002, the fair value of these financial instruments was a $7
million liability. An increase in the value of the Euro of 10% compared to the
U.S. dollar from its June 30, 2002 level would result in a loss in the fair
value of these foreign currency financial instruments of $24 million. For
information regarding the accounting for these financial instruments, see Note
5(b) to the Reliant Energy 10-K/A Notes.

Reliant Resources' European Energy business segment's stranded cost gas
contract has foreign currency exposure. An increase of 10% in the U.S. dollar
relative to the Euro from their June 30, 2002 levels would result in a loss of
earnings of $14 million.

79

EQUITY MARKET VALUE RISK

We are exposed to equity market value risk through our ownership of
approximately 26 million shares of AOL Time Warner common stock, which we hold
to facilitate our ability to meet our obligations under the ZENS. Please read
Note 8 to the Reliant Energy 10-K/A Notes for a discussion of the effect of
adoption of SFAS No. 133 on our ZENS obligation and our historical accounting
treatment of our ZENS obligation. Subsequent to adoption of SFAS No. 133, a
decrease of 10% from the June 30, 2002 market value of AOL Time Warner common
stock would result in a net loss of approximately $3 million, which would be
recorded as a loss in our Statements of Consolidated Income.

As discussed above under "-- Interest Rate Risk," we contribute to trusts
established to fund our share of the decommissioning costs for the South Texas
Project, which held debt and equity securities as of June 30, 2002. The equity
securities expose us to losses in fair value. If the market prices of the
individual equity securities were to decrease by 10% from their levels at June
30, 2002, the resulting loss in fair value of these securities would be
approximately $9 million . Currently, the risk of an economic loss is mitigated
as discussed above under "-- Interest Rate Risk."

We have an investment in Itron, Inc. (Itron), which is classified as
"available-for-sale" under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". As of June 30, 2002, the value of the Itron
investment was $7 million. The Itron investment exposes us to losses in the fair
value of Itron common stock. A 10% decline in the market value per share of
Itron common stock from the June 30, 2002 level would decrease the fair value by
less than $1 million.

80

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

For a description of legal proceedings affecting Reliant Energy, please
read Note 13 to our Interim Financial Statements, the discussion under "Our
Business -- Environmental Matters" and Item 3 of the Reliant Energy Form 10-K/A
and Notes 4 and 14 to the Reliant Energy 10-K/A Notes, all of which are
incorporated herein by reference.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

At the annual meeting of Reliant Energy's shareholders held on June 5,
2002, the matters voted upon and the number of votes cast for, against or
withheld, as well as the number of abstentions and broker non-votes as to such
matters (including a separate tabulation with respect to each nominee for
office) were as stated below:

The following nominee for Class III directors was elected to serve a
three-year term expiring 2005 (there were no broker non-votes):

The following directors' terms continued after the meeting and expire when
indicated:

Robert J. Cruikshank (2003),
T. Milton Honea (2003),
Laree E. Perez (2003),
Milton Carroll (2004),
John T. Cater (2004), and
R. Steve Letbetter (2004).

Previous Class III directors James A. Baker, III and Richard E. Balzhiser
retired from the board of directors at the expiration of their terms.

The ratification of the appointment of Deloitte & Touche LLP as independent
accountants and auditors for Reliant Energy for 2002 was approved with
244,915,165 votes for, 15,378,170 votes against, 2,374,925 abstentions and 5,500
broker non-votes.

The shareholder proposal to adopt a policy stating that the public
accounting firm retained by Reliant Energy to provide audit services, or any
affiliated company, should not also be retained to provide non-audit services to
Reliant Energy was not approved with 136,560,646 votes against, 57,683,351 votes
for, 24,625,782 abstentions and 43,803,981 broker non-votes.

The shareholder proposal to require that the board of directors of Reliant
Energy (the "Board") include in future proxy statements a description of the
Board's role in the development and monitoring of Reliant Energy's long-term
strategic plan was not approved with 181,694,663 votes against, 30,173,752 votes
for, 7,001,364 abstentions and 43,803,981 broker non-votes.

ITEM 5. OTHER INFORMATION.

Forward-Looking Statements. From time to time, we make statements
concerning our expectations, beliefs, plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements,
which are not historical facts. These statements are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Actual results may differ materially from those expressed or implied by
these statements. You can generally identify our forward-looking statements by
the words "anticipate," "believe," "continue," "could," "estimate," "expect,"
"intend," "may," "plan," "potential," "predict," "should," "will," "forecast,"
"goal," "objective," "projection," or other similar words.

81

We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.

The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:

o state, federal and international legislative and regulatory
developments, including deregulation; re-regulation and restructuring
of the electric utility industry; and changes in, or application of
environmental, siting and other laws and regulations to which we are
subject;

o timing of the implementation of our business separation plan;

o the effects of competition, including the extent and timing of the
entry of additional competitors in our markets;

o industrial, commercial and residential growth in our service
territories;

o any reduction in our trading, marketing and origination activities;

o our pursuit of potential business strategies, including acquisitions
or dispositions of assets or the development of additional power
generation facilities;

o state, federal and other rate regulations in the United States and in
foreign countries in which we operate or into which we might expand
our operations;

o the timing and extent of changes in commodity prices, particularly
natural gas;

o weather variations and other natural phenomena;

o political, legal and economic conditions and developments in the
United States and in foreign countries in which we operate or into
which we might expand our operations, including the effects of
fluctuations in foreign currency exchange rates;

o financial market conditions and the results of our financing efforts,
including our ability to replace substantial bank credit facilities
that are due to terminate in 2002 and early 2003;

o ramifications from the bankruptcy filing of Enron Corp.;

o any direct or indirect effect on our business resulting from the
September 11, 2001 terrorist attacks or any similar incidents or
responses to such incidents;

o the performance of our projects;

o the outcome of pending securities lawsuits; and

o other factors we discuss in the Reliant Energy Form 10-K/A, including
those outlined in "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our
Future Earnings."

You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statements.

82

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits.

Exhibit 99 Items incorporated by reference from the Reliant Energy
Form 10-K/A: Item 1 "Our Business - RERC Corp.
Restructuring," Item 3 "Legal Proceedings," Item 7
"Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and
Capital Resources" and "- Certain Factors Affecting Our
Future Earnings," Item 7A - Quantitative and
Qualitative Disclosures About Market Risk," and Notes 1
(Background and Basis of Presentation), 2(d)
(Revenues), 2(e) (Long-Lived Assets and Intangibles),
2(f) (Regulatory Assets and Liabilities), 2(l)
(Investment in Debt and Equity Securities), 2(q) (New
Accounting Pronouncements), 3 (Business Acquisitions),
4 (Regulatory Matters), 5 (Derivative Financial
Instruments), 8 (Indexed Debt Securities (ACES and
ZENS) and AOL Time Warner Securities), 10(b) (Long-term
Debt), 11 (Trust Preferred Securities), 13 (Income
Taxes), 14 (Commitments and Contingencies), 21
(Bankruptcy of Enron Corp. and its Affiliates) and 22
(Subsequent Events) of the Reliant Energy 10-K/A Notes.

Exhibit 10.1 First Amendment to $2,500,000,000 Senior A Credit
Agreement dated as of July 12, 2002 among Houston
Industries FinanceCo L.P., Reliant Energy, Incorporated
and the lender thereto.

Exhibit 10.2 First Amendment to $1,800,000,000 Senior B Credit
Agreement dated as of July 12, 2002 among Houston
Industries FinanceCo L.P., Reliant Energy, Incorporated
and the lender parties thereto.

Exhibit 10.3 First Amendment to $400,000,000 Amended and Restated
Revolving Credit and Competitive Advance Facilities
Agreement dated as of July 12, 2002 among Houston
Industries FinanceCo L.P., Reliant Energy, Incorporated
and the banks named therein.

Exhibit 10.4 Fourth Amendment to Houston Industries Incorporated
Long-Term Incentive Compensation Plan, effective
January 1, 2001.

Exhibit 10.5 First Amendment to NorAm Energy Corp. 1994 Incentive
Equity Plan, effective January 1, 2001.

Exhibit 10.6 Reliant Energy, Incorporated 1994 Long-Term Incentive
Compensation Plan, as amended and restated effective
January 1, 2001.

Exhibit 10.7 Form of Stock Option Agreement for non-qualified
options granted under the Reliant Energy, Incorporated
1994 Long-Term Incentive Compensation Plan.

Exhibit 10.8 Reliant Energy, Incorporated Savings Plan, as amended
and restated April 1, 1999 (incorporated by reference
to Exhibit 10(cc)(l) to Reliant Energy's Form 10-K for
the year ended December 31, 1999).

Exhibit 10.9 First Amendment to Reliant Energy, Incorporated Savings
Plan, as amended and restated April 1, 1999, effective
as of the dates specified therein.

Exhibit 10.10 Second Amendment to Reliant Energy, Incorporated
Savings Plan, as amended and restated April 1, 1999,
effective as of the dates specified therein.

Exhibit 10.11 Third Amendment to Reliant Energy, Incorporated Savings
Plan, as amended and restated April 1, 1999, effective
as of the dates specified therein.

Exhibit 10.12 Fourth Amendment to Reliant Energy, Incorporated
Savings Plan, as amended and restated April 1, 1999,
effective as of the dates specified therein.

(b) Reports on Form 8-K.

On April 8, 2002, we filed a Current Report on Form 8-K dated April 5,
2002, announcing the SEC informal inquiry.

On April 29, 2002, we filed a Current Report on Form 8-K dated April 29,
2002, relating to the announcement of first quarter 2002 results.

On July 5, 2002, we filed a Current Report on Form 8-K dated July 5, 2002,
in order to provide updated information regarding certain investigations,
litigation and governmental proceedings involving Reliant Energy and/or its
subsidiaries, including its approximately 83% owned subsidiary Reliant
Resources, Inc.

On July 15, 2002, we filed a Current Report on Form 8-K dated July 12,
2002, announcing the extension of $4.7 billion in credit facilities of Reliant
Energy.

On July 25, 2002, we filed a Current Report on Form 8-K dated July 25,
2002, relating to the announcement of second quarter 2002 results.

On August 1, 2002, we filed a Current Report on Form 8-K dated July 31,
2002 announcing that on July 31, 2002, Moody's Investors Service, Inc. and
Standard & Poor's Rating Services took various actions related to the credit
ratings of Reliant Energy, Incorporated and its subsidiaries. Also on July 31,
2002, Reliant Energy announced that the Internal Revenue Service had issued a
supplemental ruling confirming that the proposed spin-off of Reliant Resources
from Reliant Energy will be tax-free to Reliant Energy and its shareholders.

83

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

RELIANT ENERGY, INCORPORATED
(Registrant)

By: /s/ Mary P. Ricciardello
----------------------------------------------
Mary P. Ricciardello
Senior Vice President and Chief Accounting Officer

Date: August 14, 2002

84