Subject: RE: R.W. Beck Depos
From: [email-masked]
To: <""[email-masked]>, [email-masked], [email-masked]
Cc: [email-masked], [email-masked]
Date: Thu, 24 May 2001 10:03:00 -0700 (PDT)

I expect that if Mel didn't examine these witnesses in their depositions, 
that they will certainly be called at trial.  Also, their testimony is 
consistent with Michael Goldstein's comments to me that I didn't understand 
the implications of the ruling on these facilities.
 Personally, I think that Platte's testimony that he didn't officially 
certify the capacity of the machines in 1998 and, therefore, their capacity 
is unknown, is sort of contrived and made-up sounding in light of the Rev 
Proc.and the miracle of hindsight. The Sempra representations to the IRS that 
the proposed changes would significantly increase production probably didn't 
mean increase it from 105 to 115 tons per hour. Also, Coston is going to have 
to explain what he meant when he made his representations to the IRS and I 
don't think he's going to lie under oath (maybe I'm naive). 
 Regardless of the preceding comments, it sounds like we probably need to 
talk to Tim W. about these issues and also probably need to talk to the K-M 
folks (through their lawyer) about this before the next round of depos. 
 On a related note, I spoke with Michael Goldstein on Tuesday about several 
issues.  First, I told him that if they were interested, we were interested 
in sitting down and talking about resolving things going forward.  I 
questioned whether they would have an open mind toward issues like moving the 
equipment.  He said that this would be up to Mr. Holmes but that he strongly 
doubted that "repricing the deal" or "dramatically changing the economics" of 
the deal would be acceptable.  I also asked whether he thought a mediation 
would be acceptable.  In response, he indicated that although he wouldn't 
rule it out, he thought it was premature. Finally, I mentioned that there had 
been some talk of deposing him.  He said that his only involvement in the 
negotiation phase of the project would be in connection with advice to Sempra 
and, therefore, these communications would be privileged.  He said he only 
met the Enron folks once before the documents were signed in August and this 
was supposedly a pretty casual meeting since he was allegedly busy doing 
other things. He also said that he had no involvement with the IRS PLR's. Let 
me know your thoughts about deposing him in light of this. 
 Finally, George is still out of town but as soon as he returns, I'll get 
with him to get out the letter I know that Greg is anxious that we send out. 
Thanks.  

 -----Original Message-----
From:  "Johnson, Christopher P." <[email-masked]>@ENRON 
[mailto:IMCEANOTES-+22Johnson+2C+20Christopher+20P+2E+22+20+3CCPJohnson+40brob
[email-masked]] 
Sent: Wednesday, May 23, 2001 6:14 PM
To: Markel, Gregory A.; Brownfeld, Gail
Cc: Setton, Ronit; Leit, David ; Zeisler, Aaron M.; Farache, Olivier N.
Subject: R.W. Beck Depos

Greg and Gail:

I've just completed the depositions of R.W. Beck, Sempra's independent
engineers on the Blue Grass/Somerset facilities.  Specifically, I deposed
Keith Platte all day Tuesday and deposed Lance Hardesty Wednesday morning.
The testimony was generally unfavorable to us.  In particular, I think they
require us to rethink our theory that the recent IRS Rev. Proc.'s places
limits on Sempra's "lost tax credit" damage claim.

As you know, IRS Rev. Proc. 2001-30 stated that "a facility ... may be
relocated without affecting the availability of the credit if all essential
components of the facility are retained and the production capacity of the
relocated facility is not significantly increased at the new location."  It
also stated that one of the conditions for obtaining a o 29 ruling is that
"[t]he treated feedstock is subjected to elevated temperature and pressure
that results in briquettes, pellets, or an extruded fuel product, or the
taxpayer represents that the omission of this procedure will not
significantly increase the production output of the facility over the
remainder of the period during which the o 29 credit is allowable."  This
recent ruling from the IRS, of course, was inconsistent with Sempra's May
2000 PLR request, in which Richard Coston stated that "[a]nother consequence
of the use of our emulsion binder is that less pressure is required in the
briquetting phase to produce a synthetic fuel with a significant chemical
change ....  Applying less pressure[s] causes two changes to occur in the
production process.  First a smaller percentage of the synthetic fuel will
be in the form of a briquette.  Second, output capacity can be significantly
increased."

We know from the Enron agreements that Sempra sought to increase the
capacity of the Blue Grass/Somerset facilities combined to 2,000,000
tons/year.  If one assumes 24 hour/day operation for 360 days/year, each
machine would need to have a 115 ton/hour capacity to reach this level.
Keith Martin told us that the "increase in capacity" under Rev. Proc.
2001-30 should be measured against the capacity of the facility when it was
"placed in service" prior to July 1, 1998.  As I told you a couple of weeks
ago, the Sempra Offering Memo contains a certificate from R.W. Beck that the
Blue Grass and Somerset facilities were "placed in service" on June 30,
1998.  In those certificates, Beck "certified" a capacity for each machine
of 50 tons/hour, which, for the 2 machines, means a max of 876,000
tons/year.  I concluded from this that, because Sempra's proposal to
increase Blue Grass/Somerset capacity by reducing the "briquetting" of the
output had been rejected by Rev. Proc. 2001-30, Sempra would not be able to
claim tax credits above those that could be produced at 50 tons/hour, and
that its damage claim would, at the very least, be capped at that level.

Keith Platte (pronounced "Platty"), the lead engineer for Beck, and the guy
who signed the certification, poked a big hole in this conclusion.  Platte
is very personable (particularly for an engineer), appears to know his field
very well and, in my estimation, would make an excellent witness for Sempra,
should he be called.  (Mel did not question Platte.)  Regarding capacity,
Platte did not have a view as to the maximum capacity of the Blue Grass or
Enron facilities.  According to him, the Engineering, Procurement and
Construction ("EPC") contracts pursuant to which the facilities were
constructed said that the facilities were designed to operate at 50
tons/hour.  Platte said that R.W. Beck's job was simply to certify that the
facilities had indeed been constructed by 6/30/98 in accordance with the EPC
contracts, meaning that, as of that date, the facilities had at least that
capacity.  Did they have a capacity of 75 tons/hour on 6/30/98?   He cannot
say, because he was not asked to and did not test that proposition.

I spent some time with Platte establishing that the capacity of a facility
cannot exceed the capacity limit of a particular component piece of
equipment in that facility.  He generally agreed with this fact, and that a
"slow" piece of equipment could act as a "bottleneck."  I then tried to
establish the capacity limits for different pieces of equipment,
particularly the briquetter.  I got nowhere.  He fell back on the
proposition that, if he did not test it, he does not know the capacity
limits.  He said that, if I wanted to know the capacity limit of the
briquetter, I needed to talk to the briquetter manufacturer.  At the
conclusion of the deposition, I decided that that is what I would do.

I may still do that, but, after deposing Lance Hardesty today, I am less
confident that that would be a fruitful course of action.  Hardesty is not
nearly as good a witness as Platte; he has a kind of wimpy, limp-handshake,
dufus quality to him -- the kind of guy who was off in a corner playing with
a slide-rule when God was handing out personality.   Hardesty is, however, a
very knowledgeable engineer.  To cut to the chase, Hardesty 3 weeks ago
"re-certified" the Blue Grass facility as it had been reconstructed back at
Somerset, using the original Somerset design (e.g., no screen before the
crusher, as it was designed at Norfolk).  Hardesty certified that the Blue
Grass facility had a capacity today of at least 105 tons/hour.  Most
significantly, I asked Hardesty -- who participated in the 6/30/98
certification -- to walk through an engineering plan of the facility from
June 1998 and to identify all the changes in facility components between
then and now.  There were not many, and he believes (Holmes will have to
confirm) that the significant components in the synfuel process -- the
mixer, the blender and the briquetter -- are all the same, albeit with some
modifications.  Thus, Sempra's argument will be that, if those components
were capable of producing 105 tons/hour in May 2001, they must have been
capable of doing so in June 1998, the date the facility was "placed in
service."

What about the modifications?  I asked Hardesty to identify all of them.
Holmes and Frank Ikerd told him that the paddles and the internal workings
of the mixer were changed somewhat.  The blender also had replaced some
internal pieces that wore out due to normal use.  (These things do not sound
significant to me, but an engineer or Keith Martin could convince me
otherwise.)  The briquetter is a different story.  Hardesty had earlier
admitted to me that the spacing between the briquetters is one of the things
that can affect the percentage of output that results in a briquette (think
of a piece of charcoal).  Because of significant operational problems in the
summer of 1998 (they kept breaking), the briquetters had to be reconfigured
at the direction of the manufacturer (Komar Industries).  Upon the
completion of these modifications, the briquetter rolls could be adjusted to
achieve spacing between the rolls of anywhere from 0.5" to 1".  (Believe it
or not, I know what this means.)  Hardesty said that, during his visit to
Somerset earlier this month, the briquetter was set at 0.5" spacing and the
facility demonstrated a capacity of 90 tons/hour.  He then ran a capacity
test at 0.75" spacing, and the facility demonstrated a capacity of 105
tons/hour.   I asked him how the capacities over what had been seen in June
1998 were achieved, and he said "Certain improvements were made to the chute
feeding the briquetter and various transition points throughout the process
so that the material would flow better, in avoiding plugging.  But in June
of '98, we never attempted any sort of a maximum test; we merely tested for
the minimum EPC requirements of the EPC contract to install the facility."
We then walked through each of the "improvements."  In short, other than the
changes to the briquetter, none of them struck me as the kind of thing that
would offend the IRS.

Focusing on the briquetter, I asked him why it had been set at 0.5".  He
said that he was told by Holmes and Ikerd that that was the setting the
briquetter had after the modifications were completed in 1998.  (We'll need
to confirm this.)  I asked him whether he ran a test at the full 1" spacing.
He did not.  According to Hardesty, "[w]e discussed it with Richard Holmes,
Frank Ikerd and Richard Coston.  And for conservatism with regards to
maintaining the IRS placed-in-service ruling, three-quarter inch was
selected as a nominal setting for still making briquettes of a similar ...
size as we made on June 30 of 1998," and in roughly the same proportion of
briquettes to non-briquetted fines.  In other words, Sempra will argue to
the IRS that, while it has been able to increase capacity over the capacity
in 6/98, it has done so without omitting the briquetting requirement of Rev.
Proc. 2001-30.  Thus, Sempra's most recent PLR request will likely RETRACT
Coston's May 2000 statement that the increase in capacity comes at the
expense of briquetting.

Obviously, there is still some factual work to be done to see if Sempra's
new argument holds water.  For example, how do they prove what the percent
of briquettes to non-briquetted fines was in June 1998?  Also, we should
inspect the new facility at Somerset with our own engineer (we need to
retain one) so we can draw our own conclusions.  Finally, we will need to
grill Holmes on much of the foregoing, because he continues to be the person
with all the relevant knowledge.

In sum, while the Beck depositions did not generate good testimony, they at
least give us the tools to re-work our analysis on the possibility of using
Rev. Proc. 2001-30 to limit Sempra's lost tax credit damages.

Please let me know if you have any questions.

Thanks,

CPJ (from La Guardia, where I just landed)

Christopher P. Johnson
Brobeck, Phleger & Harrison, LLP
1633 Broadway
New York, New York 10019
(212) 237-2558
(212) 586-7878
[email-masked]

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