1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number (Under the Securities Act of 1933) 33-37977
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
---------------------------------------------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2726166
- --------------------------------------- ---------------------------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 PROGRESS PLACE, MIDLAND, MICHIGAN 48640
- --------------------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (989) 839-6000
------------------
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
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS AS OF
(In Thousands)
June 30,
2001 December 31,
ASSETS (Unaudited) 2000
- ------ --------------- ---------------
CURRENT ASSETS:
Cash and cash equivalents $ 194,144 $ 205,550
Restricted cash and cash equivalents 772 748
Accounts and notes receivable - related parties 106,596 109,181
Accounts receivable 18,298 75,216
Gas inventory 18,704 14,474
Unamortized property taxes 29,523 16,210
Prepaid expenses and other 23,814 7,785
------------- ------------
Total current assets 391,851 429,164
------------- ------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,436,949 2,433,798
Pipeline 21,222 21,222
------------- ------------
Total property, plant and equipment 2,458,171 2,455,020
Accumulated depreciation (817,613) (783,974)
------------- ------------
Net property, plant and equipment 1,640,558 1,671,046
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OTHER ASSETS:
Restricted investment securities held-to-maturity 144,468 139,876
Deferred financing costs, net of accumulated amortization of
$13,659 and $12,804, respectively 11,306 12,161
Prepaid gas costs, materials and supplies 21,863 22,709
------------- ------------
Total other assets 177,637 174,746
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TOTAL ASSETS $ 2,210,046 $ 2,274,956
============= ============
LIABILITIES AND PARTNERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 85,857 $ 93,010
Interest payable 64,078 67,416
Current portion of long-term debt 153,924 155,632
------------- ------------
Total current liabilities 303,859 316,058
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NON-CURRENT LIABILITIES:
Long-term debt 1,363,993 1,429,233
Other 2,096 1,927
------------- ------------
Total non-current liabilities 1,366,089 1,431,160
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CONTINGENCIES
TOTAL LIABILITIES 1,669,948 1,747,218
------------- ------------
PARTNERS' EQUITY 540,098 527,738
------------- ------------
TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,210,046 $ 2,274,956
============= ============
The accompanying condensed notes are an integral part of these statements.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -----------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
OPERATING REVENUES:
Capacity $ 102,197 $ 102,269 $ 201,775 $ 203,092
Electric 40,854 50,279 78,332 101,207
Steam and other 3,768 3,401 8,519 7,724
------------- ------------- ------------- -------------
Total operating revenues 146,819 155,949 288,626 312,023
------------- ------------- ------------- -------------
OPERATING EXPENSES:
Fuel costs 69,704 64,119 124,578 134,807
Depreciation 23,110 24,384 46,624 48,889
Operations 3,899 3,750 7,811 7,812
Maintenance 3,358 3,280 7,051 6,679
Property and single business taxes 6,548 6,467 13,024 12,941
Administrative, selling and general 2,031 2,069 4,915 4,855
------------- ------------- ------------- -------------
Total operating expenses 108,650 104,069 204,003 215,983
------------- ------------- ------------- -------------
OPERATING INCOME 38,169 51,880 84,623 96,040
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest and other income 5,128 6,237 10,680 11,385
Interest expense (32,854) (40,243) (65,049) (76,849)
------------- ------------- ------------- -------------
Total other income (expense), net (27,726) (34,006) (54,369) (65,464)
------------- ------------- ------------- -------------
NET INCOME $ 10,443 $ 17,874 $ 30,254 $ 30,576
============= ============= ============= =============
The accompanying condensed notes are an integral part of these statements.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
(In Thousands)
Six Months Ended
June 30, 2001
----------------------------------------------------
General Limited
Partners Partners Total
-------------- --------------- --------------
BALANCE, BEGINNING OF PERIOD $ 448,100 $ 79,638 $ 527,738
Comprehensive income:
Net income 26,340 3,914 30,254
Other comprehensive income:
Cumulative effect of accounting change 13,688 2,034 15,722
Unrealized loss on hedging activities (26,486) (3,935) (30,421)
Reclassification adjustments recognized
in net income above (2,782) (413) (3,195)
-------------- --------------- --------------
Total other comprehensive income (15,580) (2,314) (17,894)
Total comprehensive income 10,760 1,600 12,360
-------------- --------------- --------------
BALANCE, END OF PERIOD $ 458,860 $ 81,238 $ 540,098
============== =============== ==============
The accompanying condensed notes are an integral part of this statement.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
Six Months Ended
June 30,
--------------------------------------
2001 2000
---------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 30,254 $ 30,576
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 47,479 49,369
Decrease (increase) in accounts receivable 59,523 (7,915)
Increase in gas inventory (4,230) (2,945)
Increase in unamortized property taxes (13,313) (13,228)
Decrease (increase) in prepaid expenses and other (16,029) 1,392
Decrease (increase) in prepaid gas costs, materials and supplies 846 (15)
(Decrease) increase in accounts payable and accrued liabilities (25,067) 21,971
Decrease in interest payable (3,338) (12,089)
Increase in other non-current liabilities 169 168
---------------- -----------------
Net cash provided by operating activities 76,294 67,284
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (16,136) (14,144)
---------------- -----------------
Net cash used in investing activities (16,136) (14,144)
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (66,948) (60,786)
Debt refinancing costs - (5,560)
Maturity of restricted investment securities held-to-maturity 381,470 161,369
Purchase of restricted investment securities held-to-maturity (386,062) (161,574)
---------------- -----------------
Net cash used in financing activities (71,540) (66,551)
---------------- -----------------
NET DECEASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT
(11,382) (13,411)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT BEGINNING OF
PERIOD 206,298 241,885
---------------- -----------------
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT END OF PERIOD
$ 194,916 $ 228,474
================ =================
The accompanying condensed notes are an integral part of these statements.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
These consolidated financial statements and condensed notes should be read along
with the audited financial statements and notes as contained in the Annual
Report on Form 10-K for the year ended December 31, 2000 of Midland Cogeneration
Venture Limited Partnership ("MCV"), which includes the Report of Independent
Public Accountants. In the opinion of management, the unaudited information
herein reflects all adjustments (which include only normal recurring
adjustments) necessary to assure the fair presentation of financial position,
results of operations and cash flows for the periods presented. Prior period
amounts have been reclassified for comparative purposes. These reclassifications
had no effect on net income. The consolidated financial statements include the
accounts of MCV and its wholly-owned subsidiaries. All material transactions and
balances among entities, which comprise MCV, have been eliminated in the
consolidated financial statements.
(1) THE PARTNERSHIP AND ASSOCIATED RISKS
MCV was organized to construct, own and operate a combined-cycle, gas-fired
cogeneration facility (the "Facility") located in Midland, Michigan. MCV was
formed on January 27, 1987, and the Facility entered into commercial
operation in 1990.
In 1992, MCV acquired the outstanding common stock of PVCO Corp., a
previously inactive company. MCV and PVCO Corp. entered into a partnership
agreement to form MCV Gas Acquisition General Partnership ("MCV GAGP") for
the purpose of buying and selling natural gas on the spot market and other
transactions involving natural gas activities. Currently, MCV GAGP is not
actively engaged in any business activity.
The Facility was originally designed to provide approximately 1,370
megawatts ("MW") of electricity and approximately 1.5 million pounds of
process steam per hour. Subsequent improvements to the Facility have
increased net electrical generating capacity to approximately 1,500 MW. MCV
has entered into three principal energy sales agreements. MCV has contracted
to supply up to 1,240 MW of electric capacity ("Contract Capacity") to
Consumers Energy Company ("Consumers") under the Power Purchase Agreement
("PPA"), for resale to its customers, to supply electricity and steam to The
Dow Chemical Company ("Dow") under the Steam and Electric Power Agreement
("SEPA") and to supply steam to Dow Corning Corporation ("DCC") under the
Steam Purchase Agreement ("SPA"). From time to time, MCV enters into other
short-term sales agreements for the sale of excess capacity and/or energy
available above MCV's internal use and obligations under the PPA, SEPA and
SPA. Results of operations are primarily dependent on successfully operating
the Facility at or near contractual capacity levels and on Consumers'
honoring its obligations under the PPA with MCV. Sales pursuant to the PPA
have historically accounted for over 90% of MCV's revenues.
The PPA permits Consumers, under certain conditions, to reduce the capacity
and energy charges payable to MCV and/or to receive refunds of capacity and
energy charges paid to MCV if the Michigan Public Service Commission
("MPSC") does not permit Consumers to recover from its customers the
capacity and energy charges specified in the PPA (the "regulatory-out"
provision). Until September 15, 2007, however, the capacity charge may not
be reduced below an average capacity rate of 3.77 cents per kilowatt hour
for the available Contract Capacity notwithstanding the "regulatory-out"
provision. Consumers and MCV are required to support and defend the terms of
the PPA.
The Facility is a qualifying cogeneration facility ("QF") originally
certified by the Federal Energy Regulatory Commission ("FERC") under the
Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"). In
order to maintain QF status, certain operating and efficiency standards must
be maintained on a calendar-year basis and certain ownership limitations
must be met. In the case of a topping-cycle generating plant such as the
Facility, the applicable operating standard requires that the portion of
total energy output that is put to some useful purpose other than
facilitating the production of power (the "Thermal Percentage") be at least
5%. In addition, the Facility must achieve a PURPA efficiency standard (the
sum of the useful power output plus one-half of the useful thermal energy
output, divided by the energy input (the "Efficiency Percentage")) of at
least 45%. If the Facility maintains a Thermal Percentage of 15% or higher,
the required Efficiency Percentage is reduced to 42.5%. Since 1990, the
Facility has achieved the applicable Thermal and Efficiency Percentages. For
the six months ended June 30, 2001, the Facility achieved a Thermal
Percentage of 22.4% and a PURPA Efficiency Percentage of 47.0%. The loss of
QF status could, among other things, cause the Facility to lose its rights
under PURPA to sell power to Consumers at
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Consumers' "avoided cost" and subject the Facility to additional federal and
state regulatory requirements. MCV believes that the Facility will meet the
required Thermal and the corresponding Efficiency Percentages in 2001 and
beyond.
The Facility is wholly dependent upon natural gas for its fuel supply and a
substantial portion of the Facility's operating expenses consist of the
costs of natural gas. MCV recognizes that its existing gas contracts are not
sufficient to satisfy the anticipated gas needs over the term of the PPA
and, as such, no assurance can be given as to the availability or price of
natural gas after the expiration of the existing gas contracts. In addition,
to the extent that the costs associated with production of electricity rise
faster than the energy charge payments, MCV's financial performance will be
negatively affected. The amount of such impact will depend upon the amount
of the average energy charge payable under the PPA, which is based upon
costs incurred at Consumers' coal-fired plants and upon the amount of energy
scheduled by Consumers for delivery under the PPA. However, given the
unpredictability of these factors, the overall economic impact upon MCV of
changes in energy charges payable under the PPA and in future fuel costs
under new or existing contracts cannot accurately be predicted. In addition,
beginning in July 2000, in response to the rapidly escalating cost of
natural gas, MCV entered into a series of transactions with Consumers
whereby Consumers agreed to reduce the dispatch level of the Facility. In
the event of reduced dispatch, MCV agreed to share the savings realized by
not having to generate the electricity. For the six months ended June 30,
2001, MCV estimates that this program resulted in net savings of
approximately $7.4 million, which were reflected as a component of fuel
costs. MCV anticipates continuing the use of this or similar programs to
mitigate the impacts of high market gas prices.
At both the state and federal level, efforts continue to restructure the
electric industry. One significant issue to MCV is the issue of stranded
assets or transition cost recovery by utilities for PPA charges. At the
state level, the MPSC entered a series of orders from June 1997 through
February 1998 (collectively the "Restructuring Orders"), mandating that
utilities "wheel" third-party power to the utilities' customers, thus
permitting customers to choose their power provider. MCV, as well as others,
filed an appeal in the Michigan Court of Appeals to protect against denial
of recovery by Consumers of PPA charges. The Michigan Court of Appeals found
that the Restructuring Orders do not unequivocally disallow such recovery by
Consumers and, therefore, MCV's issues were not ripe for appellate review
and no actual controversy regarding recovery of costs could occur until
2008, at the earliest. In June 2000, the state of Michigan enacted
legislation which, among other things, states that the Restructuring Orders
(being voluntarily implemented by Consumers) are in compliance with the
legislation and enforceable by the MPSC. The legislation provides that the
rights of parties to existing contracts between utilities (like Consumers)
and QF's (like MCV), including the rights to have the PPA charges recovered
from customers of the utilities, are not abrogated or diminished, and
permitted utilities to securitize certain stranded (transition) costs
including PPA charges.
On July 7, 1999, the U.S. District Court granted summary judgment to MCV
declaring that the Restructuring Orders are preempted by federal law to the
extent they prohibit Consumers from recovering from its customers any charge
for avoided costs (or "stranded costs") to be paid to MCV under PURPA
pursuant to the PPA. In June 2001, the United States Court of Appeals
("Appellate Court") vacated the U.S. District Court's July 7, 1999 summary
judgment and ordered the case dismissed based upon a finding that no actual
case or controversy existed for adjudication between the parties. The
Appellate Court determined that the parties' dispute is hypothetical at this
point in time and the QFs' (including MCV) claims are premised on
speculation about how an order might be interpreted seven years from now by
a future MPSC. MCV has requested rehearing of the Appellate Court's order,
which is subject to further appeal. MCV Management cannot, at this time,
predict the impact or outcome of this proceeding.
MCV continues to monitor and participate in these industry restructuring
matters as appropriate, and to evaluate potential impacts on both cash flows
and recoverability of the carrying value of property, plant and equipment.
MCV Management cannot, at this time, predict the impact or outcome of these
matters.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(2) RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents and short-term investments
approximate fair value because of the short maturity of these instruments.
MCV's short-term investments, which are made up of investment securities
held-to-maturity, as of June 30, 2001 and December 31, 2000, have original
maturity dates of less than one year. The unique nature of the negotiated
financing obligation discussed in Note 5 makes it impractical to estimate
the fair value of the lessor group ("Owner Participants") underlying debt
and equity instruments supporting such financing obligation.
New Accounting Standard
Effective January 1, 2001, MCV adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which was issued in June, 1998 and then amended by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of SFAS No. 133" and SFAS No. 138 "Accounting
for Certain Derivative Instruments and Certain Hedging Activities - An
amendment of FASB Statement No. 133" (collectively referred to as "SFAS No.
133"). SFAS No. 133 establishes accounting and reporting standards requiring
that every derivative instrument be recorded in the balance sheet as either
an asset or liability measured at its fair value. SFAS No. 133 requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges in some cases allows a derivative's gains and losses to
offset related results on the hedged item in the income statement or permits
recognition of the hedge results in other comprehensive income, and requires
that a company formally document, designate, and assess the effectiveness of
transactions that receive hedge accounting.
MCV Management believes that its power supply agreements and long-term
natural gas contracts qualify for the normal purchase and normal sales
exception of SFAS No. 133 and therefore, these contracts are currently not
recognized at fair value on the balance sheet. On June 27, 2001, the
Financial Accounting Standards Board ("FASB") issued final guidance in which
the normal purchase and sales exception was extended to power purchase or
sales agreements that meet specific criteria. MCV believes that its power
supply agreements meet these criteria and as such, will continue to not
record the fair value of these contracts on its balance sheet. In addition,
in May 2001, the Derivative Implementation Group issued tentative guidance
whereby certain natural gas contracts, which include optionality in the
amount of fuel that may be purchased under the contract, would not qualify
for the normal purchase and sales exception of SFAS No. 133. This tentative
guidance, if ultimately ratified by the FASB, would require MCV to recognize
the fair value of certain natural gas contracts on its balance sheet. In
addition, any changes in fair value could potentially be required to be
reported directly in earnings and could cause earnings volatility. At this
time, MCV Management cannot predict the ultimate resolution of this matter.
Forward Foreign Exchange Contracts
An amended service agreement was entered into between MCV and Alstom Power
Company ("Alstom") (the "amended Service Agreement"), under which Alstom
will provide hot gas path parts for MCV's twelve gas turbines through the
sixth series of major GTG inspections, which are expected to be completed by
year-end 2008. The payments due to Alstom under this amended Service
Agreement are adjusted annually based on the U.S. dollar to Swiss franc
currency exchange rate.
To manage this currency exchange rate risk and hedge against adverse
currency fluctuations impacting the payments under this amended Service
Agreement, MCV maintains a foreign currency hedging program. Under this
program, MCV periodically enters into forward purchase contracts for Swiss
francs. Under SFAS No. 133, the forward foreign currency exchange contracts
qualify as fair value hedges, since they hedge the identifiable foreign
currency commitment of the amended Service Agreement. The gains and losses
on these forward contracts as well as the change in value of the firm
commitment are to be recognized currently in earnings. Since the currency,
notional amounts and maturity dates on the hedged transactions and forward
contracts essentially match, the January 1, 2001, adoption of SFAS No. 133
resulted in an immaterial cumulative effect accounting change and is
expected to have an
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
immaterial earnings impact on an ongoing basis. The final gains and losses
on these transactions, accounted for as hedges, will be included in the
measurement of the underlying capitalized major renewal costs when incurred.
As of June 30, 2001, MCV had forward purchase contracts involving Swiss
Francs in the notional amount of $10.0 million, with no material gain or
loss recognized during the period ended June 30, 2001 related to any
ineffectiveness. As of December 31, 2000, MCV had forward purchase contracts
involving Swiss Francs in the notional amount of $10.0 million, with a
deferred $.3 million gain recorded in current liabilities. These contracts
were closed and settled in January 2001.
Natural Gas Futures and Options
To manage market risks associated with the volatility of natural gas prices,
MCV maintains a gas hedging program. MCV enters into natural gas futures and
option contracts in order to hedge against unfavorable changes in the market
price of natural gas in future months when gas is expected to be needed.
These financial instruments are being utilized principally to secure
anticipated natural gas requirements necessary for projected electric and
steam sales and to hedge sales of natural gas previously obtained in order
to optimize MCV's existing gas supply, storage and transportation
arrangements.
These financial instruments are derivatives under SFAS No. 133 and the
contracts that are utilized to secure the anticipated natural gas
requirements necessary for projected electric sales qualify as cash flow
hedges under SFAS No. 133, since they hedge the price risk associated with
the cost of natural gas. MCV also engages in cost mitigation activities to
offset the fixed charges MCV incurs in operating the Facility. These cost
mitigation activities include the use of futures and options contracts to
purchase and/or sell natural gas to maximize the use of the transportation
and storage contracts when it is determined that they will not be needed for
Facility operation. Although these cost mitigation activities do serve to
offset the fixed monthly charges, these cost mitigation activities are not
considered a normal course of business for MCV and as such do not qualify as
hedges under SFAS No. 133, resulting in any gains or losses being flowed
through earnings.
Cash is deposited with the broker in a margin account at the time futures or
options contracts are initiated. The change in market value of these
contracts requires adjustment of the margin account balances. The margin
balance, recorded in "Prepaid expenses and other", was $20.7 million and
$3.8 million as of June 30, 2001 and December 31, 2000, respectively.
Effective January 1, 2001, MCV's gains and losses on futures contracts
qualifying as hedges are recorded as a component of other comprehensive
income and will be offset by the corresponding underlying transaction and
then included in operating expenses in the same period the natural gas is
burned to operate the Facility. MCV's gains and losses on futures and
options contracts that do not qualify as hedges are recognized currently in
earnings with no offsetting physical gas purchase. This could cause
increased earnings volatility when these contracts are adjusted to fair
value in earnings with no offsetting transaction. Under the transition rules
under SFAS No. 133, on January 1, 2001, the cumulative effect accounting
gain related to the fair value of the derivative instruments held for cost
mitigation activities and derivatives that do not qualify for hedge
accounting, has been reflected in other comprehensive income based on
previous hedging relationships. These futures and options totaled 1.9 bcf
with a total fair value loss of $2.2 million. Fair value changes in these
contracts were recognized currently in income and the amount reflected in
other comprehensive income was reclassified to income when the original
underlying transactions occurred during the first quarter of 2001. The
January 1, 2001, adoption of SFAS No. 133 resulted in a total cumulative
effect accounting gain, including cost mitigation activities, of $15.7
million, which was recognized in other comprehensive income. For the six
month period ended June 30, 2001, MCV has recognized in other comprehensive
income, an unrealized $33.6 million decrease on the futures contracts which
are hedges of forecasted purchases for plant use of market priced gas,
resulting in a $17.9 million loss in other comprehensive income as of June
30, 2001. In addition, for the six months ended June 30, 2001, MCV has
recorded a net $4.3 million gain in earnings from hedging activities and
cost mitigation activities.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Interest Rate Swaps
To manage the effects of interest rate volatility on interest income while
maximizing return on permitted investments, MCV established an interest rate
hedging program. The notional amounts of the hedges are tied directly to
MCV's anticipated cash investments, without physically exchanging the
underlying notional amounts. Cash may be deposited with the broker at the
time the interest rate swap transactions are initiated. The change in market
value of these contracts may require further adjustment of the margin
account balance. The margin balance recorded in "Prepaid expenses and
other", was approximately $30,000 and $.4 million as of June 30, 2001 and
December 31, 2000. As of June 30, 2001, MCV had an interest rate swap hedge
with a notional amount of $20 million, with final settlement on the
transaction in July 2001. The difference between the amount received and
paid under the interest rate swap transaction is accrued and recorded as an
adjustment to the interest income over the life of the hedged agreement.
Under SFAS No. 133, this interest rate swap transaction qualifies as a cash
flow hedge. The gains and losses on this type of transaction are recorded
monthly as an adjustment to other comprehensive income and the difference
between the amounts received and paid under interest rate swap transactions
is accrued and recorded as an adjustment to the interest income over the
life of the hedged agreement. The January 1, 2001 adoption of SFAS No. 133
resulted in an immaterial cumulative effect accounting change gain
recognized in other comprehensive income and is expected to have an
immaterial earnings impact on an ongoing basis. As of June 30, 2001, MCV has
an immaterial gain recorded in other comprehensive income for the qualifying
hedge, while for the year ended December 31, 2000 MCV had a net loss of
approximately $.1 million recorded in Prepaid expenses and other.
MCV has an additional interest rate swap, with a notional amount of $20
million and a period of performance that extends until December 1, 2002,
which does not qualify as a hedge under SFAS No. 133. The gains and losses
on this swap are recorded currently in earnings. For the six months ended
June 30, 2001, MCV recorded a $.4 million gain in earnings.
(3) RESTRICTED CASH, CASH EQUIVALENTS AND INVESTMENT SECURITIES HELD-TO-MATURITY
Current and non-current restricted cash and cash equivalents and investment
securities held-to-maturity consist of the following as of (in thousands):
June 30, December 31,
2001 2000
--------------- ----------------
Current:
Funds restricted for plant modifications $ 772 $ 748
=============== ================
Non-current:
Funds restricted for rental payments pursuant to the Overall
$ 142,372 $ 137,942
Lease Transaction
Funds restricted for management non-qualified plans 2,096 1,934
--------------- ----------------
Total $ 144,468 $ 139,876
=============== ================
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(4) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following as of (in
thousands):
June 30, December 31,
2001 2000
----------------- -----------------
Accounts payable
Related parties $ 12,746 $ 18,144
Trade creditors 27,144 41,601
Property and single business taxes 26,802 13,560
Other 19,165 19,705
----------------- -----------------
Total $ 85,857 $ 93,010
================= =================
(5) LONG-TERM DEBT
Long -term debt consists of the following as of (in thousands):
June 30, December 31,
2001 2000
----------------- -----------------
Financing obligation, maturing through 2015, effective interest rate of
approximately 8.3%, payable in semi-annual installments of
principal and interest, secured by property, plant and equipment $ 1,517,917 $ 1,584,865
Less current portion (153,924) (155,632)
----------------- -----------------
Total long-term debt $ 1,363,993 $ 1,429,233
================= =================
Financing Obligation
In 1990, MCV obtained permanent financing for the Facility by entering into
sale and leaseback agreements ("Overall Lease Transaction") with the Owner
Participants, related to substantially all of MCV's fixed assets. Proceeds
of the financing were used to retire borrowings outstanding under existing
loan commitments, make a capital distribution to the Partners and retire a
portion of the notes issued by MCV to MEC Development Corporation ("MDC")
in connection with the transfer of certain assets by MDC to MCV. In
accordance with SFAS No. 98, "Accounting For Leases," the sale and
leaseback transaction has been accounted for as a financing arrangement.
In June 2000, MCV closed on the sale of $200 million of tax-exempt bonds,
the proceeds of which were used on July 24, 2000 to refund a like amount of
previously issued bonds. The refinancing of this portion of the outstanding
debt has lowered MCV's effective interest rate on its long-term debt
arrangement from approximately 8.7% to 8.3%, which is still scheduled to
mature in year 2015.
Interest and fees incurred related to long-term debt arrangements during
the six months ended June 30, 2001 and June 30, 2000 were $64.2 million and
$73.5 million, respectively. Interest and fees paid for the six months
ended June 30, 2001 and June 30, 2000 were $67.5 million and $76.2 million,
respectively.
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(6) PARTNERS' EQUITY AND RELATED PARTY TRANSACTIONS
The following table summarizes the nature and amount of each of MCV's
Partner's equity interest, interest in profits and losses of MCV at June
30, 2001, and the nature and amount of related party transactions or
agreements that existed with the Partners or affiliates as of June 30,
2001 and 2000, and for each of the six month periods ended June 30 (in
thousands).
Beneficial Owner, Equity Partner,
Type of Partner and Nature of Related Equity
Party Interest Interest Related Party Transactions and Agreements 2001 2000
- ----------------------------------------- --------- ----------- ------------------------------------------------ -------- -------
CMS Energy Company
CMS Midland, Inc. $264,647 49.0% Power purchase agreements $247,827 $294,542
======== =======
General Partner; wholly-owned Purchases under gas transportation agreements 12,163 11,668
subsidiary of Consumers Energy Purchases under spot gas agreements 313 2,155
Company Purchases under gas supply agreements 6,294 5,756
Gas storage agreement 1,282 1,282
Land lease/easement agreements 300 300
Accounts receivable 48,667 47,465
Accounts payable 7,537 6,449
Sales under spot gas agreements 3,551 3,586
El Paso Corporation
Source Midland Limited Partnership 92,481 18.1 Purchase under gas transportation agreements 6,957 6,690
("SMLP") General Partner; owned by Purchases under spot gas agreement 39,779 4,520
subsidiaries of El Paso Corporation (1) Purchases under gas supply agreement 3,240 2,082
Gas agency agreement 1,182 1,010
Deferred reservation charges under gas 7,880 6,895
purchase agreement
Accounts payable 4,435 2,678
Sales under spot gas agreements 28,179 2,471
Partner cash withdrawal (including accrued 55,265 46,170
interest) (2)
El Paso Midland, Inc. ("El Paso Midland") 55,489 10.9 See related party activity listed under SMLP.
(formerly known as Coastal Midland,
Inc.) General Partner; wholly-owned
subsidiary of El Paso Corporation (1)
MEI Limited Partnership ("MEI") See related party activity listed under SMLP.
A General and Limited Partner; 50%
interest owned by El Paso Midland, Inc.
and 50% interest owned by SMLP (1)
General Partnership Interest 46,243 9.1
Limited Partnership Interest 4,624 .9
Micogen Limited Partnership 23,119 4.5 See related party activity listed under SMLP.
("MLP") Limited Partner, owned
subsidiaries of El Paso Corporation (1)
------ ------
Total El Paso Corporation 221,956 43.5
======= =======
The Dow Chemical Company
The Dow Chemical Company 53,494 7.5 Steam and electric power agreement 16,374 14,706
======== =======
Limited Partner Steam purchase agreement - Dow Corning Corp 2,030 1,936
(affiliate)
Purchases under demineralized water supply 3,283 3,611
agreement
Accounts receivable 2,899 2,904
Accounts payable 774 571
Standby and backup fees 339 335
Alanna Corporation
Alanna Corporation 1 (3) .00001 Note receivable 1 1
======= ======
Limited Partner; wholly-owned
subsidiary of Alanna Holdings
Corporation
Footnotes to Partners' Equity and Related Party Transactions
(1) On January 29, 2001, El Paso Corporation ("El Paso") announced that it had
completed its merger with The Coastal Corporation ("Coastal"). Coastal was
the previous parent company of El Paso Midland (formerly known as Coastal
Midland, Inc.), SMLP, MLP and, through SMLP, MEI. After the merger, Coastal
became a wholly-owned subsidiary of El Paso and has changed its name to El
Paso CGP Company.
(2) A letter of credit has been issued and recorded as a note receivable from El
Paso Midland, this amount includes their share of cash available, as well
as, cash available to MEI, MLP and SMLP.
(3) Alanna's capital stock is pledged to secure MCV's obligation under the lease
and other overall lease transaction documents.
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A)
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
This MD&A should be read along with the MD&A in the Annual Report on Form 10-K
for the year ended December 31, 2000 of the Midland Cogeneration Venture Limited
Partnership ("MCV").
Results of Operations:
Operating Revenues Statistics
The following represents significant operating revenue statistics for the
following periods (dollars in thousands except average rates):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
2001 2000 2001 2000
------------- ------------ ------------- ------------
Operating Revenues $ 146,819 $ 155,949 $ 288,626 $ 312,023
Capacity Revenue $ 102,197 $ 102,269 $ 201,775 $ 203,092
PPA Contract Capacity (MW) 1,240 1,240 1,240 1,240
Billed PPA Availability (1) 98.5% 98.5% 98.5% 98.5%
Electric Revenue $ 40,854 $ 50,279 $ 78,332 $ 101,207
PPA Delivery as a Percentage of Contract Capacity (2) 63.5% 84.6% 62.9% 86.4%
PPA, SEPA and Other Electric Deliveries (MWh) 1,877,229 2,465,709 3,677,305 5,027,280
Average PPA Variable Energy Rate ($/MWh) $ 15.68 $ 15.71 $ 15.56 $ 15.70
Average PPA Fixed Energy Rate ($/MWh) $ 3.79 $ 3.60 $ 3.69 $ 3.55
Steam Revenue $ 3,768 $ 3,401 $ 8,519 $ 7,724
Steam Deliveries (Mlbs) 1,294,020 1,358,820 3,041,440 3,081,920
(1) As part of a settlement agreement, which became effective January 1, 1999
between MCV and Consumers, among other things, MCV agreed not to bill
Consumers for PPA availability greater than 98.5% in each calendar year.
(2) Beginning in July 2000, in response to the rapidly escalating cost of
natural gas, MCV entered into a series of transactions with Consumers
whereby Consumers agreed to reduce the dispatch level of the Facility. In
the event of reduced dispatch, MCV agreed to share the savings realized by
not having to generate the electricity. MCV anticipates continuing the use
of this or similar programs to mitigate the impacts of high gas market
prices.
Comparison of the Three Months ended June 30, 2001 and 2000
Overview
For the second quarter of 2001, MCV recorded net income of $10.4 million as
compared to net income of $17.9 million for the second quarter of 2000. The
decrease for the second quarter of 2001 compared to 2000 is primarily due to
increased fuel costs resulting from higher natural gas prices, partially offset
by lower interest expense on MCV's financing obligation and the net economic
effect of a lower electric dispatch.
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Operating Revenues
For the second quarter of 2001, MCV's operating revenues decreased $9.1 million
from the second quarter of 2000. This decrease is due primarily to a lower
electric dispatch.
Operating Expenses
For the second quarter of 2001, MCV's operating expenses were $108.6 million,
which includes $69.7 million of fuel costs. During this period, MCV purchased
approximately 20.9 billion cubic feet ("bcf") of natural gas, and a net 3.9 bcf
was injected into storage and used for transportation fuel. The average
commodity cost of fuel for the second quarter of 2001 was $3.41 per million
British thermal units ("MMBtu"). For the second quarter of 2000, MCV's operating
expenses were $104.0 million, which includes $64.1 million of fuel costs. During
this period, MCV purchased approximately 24.8 bcf of natural gas, and a net 3.3
bcf was injected into storage and used for transportation fuel. During this same
period, MCV consumed 21.9 bcf, of which .4 bcf of this total was gas provided by
Dow. The average commodity cost of fuel for the second quarter of 2000 was $2.65
per MMBtu. Fuel costs for the second quarter of 2001 compared to 2000 increased
by $5.6 million. This fuel cost increase was due primarily to a higher average
cost of gas natural in both the long-term and spot markets. This increase was
partially offset by lower gas usage resulting from the decrease in electric
dispatch due in part, to dispatch reduction transactions entered into with
Consumers and disposition of natural gas previously hedged or purchased under
contract but not required for electric generation.
For the second quarter of 2001, operating expenses other than fuel costs
decreased $1.0 million from the second quarter of 2000, primarily resulting from
a revision of the useful lives of the gas turbine generator equipment and
changes to the amortization of payments under the amended Service Agreement. All
other expenses incurred in these periods were considered normal expenditures to
achieve the recorded operating revenues.
Other Income (Expense)
The decrease in interest and other income in the second quarter of 2001 compared
to 2000 reflects lower interest rates on MCV's investments. The decrease in
interest expense in the second quarter of 2001 from the second quarter of 2000
is due to a lower principal balance on MCV's financing obligation and due to the
June 2000 refinancing of MCV's tax-exempt bonds.
Comparison of the Six Months ended June 30, 2001 and 2000
Overview
For the first six months of 2001, MCV recorded net income of $30.3 million as
compared to net income of $30.6 million for the first six months of 2000. The
decrease for the first six months of 2001 compared to 2000 is primarily due to
increased fuel costs resulting from higher natural gas prices, partially offset
by lower interest expense on MCV's financing obligation and the net economic
effect of a lower electric dispatch.
Operating Revenues
For the first six months of 2001, MCV's operating revenues decreased $23.4
million from the first six months of 2000. This decrease is due primarily to due
to a lower electric dispatch. Also contributing to this decrease was lower
capacity payments under the PPA with Consumers due to fewer billing days in
2001.
Operating Expenses
For the first six months of 2001, MCV's operating expenses were $204.0 million,
which includes $124.6 million of fuel costs. During this period, MCV purchased
approximately 36.2 bcf of natural gas, and a net 2.2 bcf was injected into
storage and used for transportation fuel. The average commodity cost of fuel for
the first six months of 2001 was $3.00 per MMBtu. For the first six months of
2000, MCV's operating expenses were $216.0 million, which includes $134.8
million of fuel costs. During this period, MCV purchased approximately 45.0 bcf
of natural gas, and
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15
a net .7 bcf was drawn from gas in storage and used for transportation fuel.
During this same period, MCV consumed 45.1 bcf, of which .8 bcf of this total
was gas provided by Dow. The average commodity cost of fuel for the first six
months of 2000 was $2.64 per MMBtu. Fuel costs for the first six months of 2001
compared to 2000 decreased by $10.2 million. This fuel cost decrease was due
primarily to a lower gas usage resulting from the decrease in electric dispatch
due in part, to dispatch reduction transactions entered into with Consumers and
disposition of natural gas previously hedged or purchased under contract but not
required for electric generation. This fuel cost decrease was partially offset
by a higher average cost of natural gas in both the long-term and spot markets.
For the first six months of 2001, operating expenses other than fuel costs
decreased $1.8 million from the first six months of 2000, primarily resulting
from a revision of the useful lives of the gas turbine generator equipment and
changes to the amortization of payments under the amended Service Agreement. All
other expenses incurred in these periods were considered normal expenditures to
achieve the recorded operating revenues.
Other Income (Expense)
The decrease in interest and other income in the first six months of 2001
compared to 2000 reflects lower interest rates on MCV's investments. The
decrease in interest expense in the first six months of 2001 from the first six
months of 2000 is due to a lower principal balance on MCV's financing obligation
and due to the June 2000 refinancing of MCV's tax-exempt bonds.
Market Risk Sensitivity
Market risks relating to MCV's operations result primarily from changes in
commodity prices, interest rates and foreign exchange rates. To address these
risks, MCV enters into various hedging transactions as described herein. MCV
does not use financial instruments for trading purposes and does not use
leveraged instruments. Fair values included herein have been determined based
upon quoted market prices. The information presented below should be read in
conjunction with Note 2, " Significant Accounting Policies" and Note 5,
"Long-Term Debt" to the Notes to Consolidated Financial Statements of MCV.
Interest Rate Risks. In 1990, MCV obtained permanent financing for the Facility
by entering into sale and leaseback agreements ("Overall Lease Transaction")
with a lessor group, related to substantially all of MCV's fixed assets. In
accordance with SFAS No. 98, "Accounting For Leases," the sale and leaseback
transaction has been accounted for as a financing arrangement. Under the terms
of the Overall Lease Transaction, MCV sold undivided interests in all of the
fixed assets of the Facility for approximately $2.3 billion, to the Owner Trusts
established for the benefit of the Owner Participants. The financing
arrangement, entered into for a term of 25 years, maturing in 2015, had an
effective interest rate of approximately 8.7%, payable in semi-annual
installments of principal and interest. On June 15, 2000, MCV closed on the sale
of $200 million of tax-exempt bonds, the proceeds of which were used on July 24,
2000 to refund a like amount of previously issued bonds. The refinancing of this
portion of the outstanding debt has lowered MCV's effective interest rate on its
long-term debt arrangement from approximately 8.7% to 8.3%, which is still
scheduled to mature in year 2015. Lower interest rates on the recently issued
tax-exempt bonds should result in MCV incurring lower interest payments of
approximately $5.1 million annually through July 2007, with somewhat smaller
savings through the bonds' final maturity in July 2009. Due to the unique nature
of the negotiated financing obligation it is impractical to estimate the fair
value of the Owner Participants' underlying debt and equity instruments
supporting this financing obligation.
In addition, to manage the effects of interest rate volatility on interest
income while maximizing return on permitted investments, MCV has established an
interest rate hedging program. The carrying amounts of MCV's short-term
investments approximate fair value because of the short term maturity of these
instruments. MCV's short-term investments are made up of investment securities
held to maturity and as of June 30, 2001 have original maturity dates of less
than one year.
For MCV's debt obligations, the table below presents principal cash flows and
the related interest rate by expected maturity dates. The interest rate reflects
the fixed effective rate of interest of the financing arrangement. For the
interest rate swap transactions, the table presents the notional amounts and
related interest rates by fiscal year of
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16
maturity. The variable rates presented are the average of the forward rates for
the term of each contract, as valued at June 30, 2001:
Expected Maturity In
------------------------------------------------------------------ Change in
Fair
2001 2002 2003 2004 2005 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
Debt:
Long-Term Debt Fixed
Rate (in millions) $152.8 $304.1 $208.9 $242.8 $174.4 $1,346.9 $2,429.9 N/A
Avg. Interest Rate 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3%
Interest Rate Swaps:
Variable to Fixed $20.0 $ .1
(in millions)
Avg. Pay Rate 4.42%
Avg. Receive Rate 5.93%
Floating to Floating $20.0 $ .3
(in millions)
Avg. Pay Rate 4.27%
Avg. Receive Rate 4.49%
Commodity Risk. MCV is a purchaser of natural gas. MCV enters into natural gas
futures and option contracts in order to hedge against unfavorable changes in
the market price of natural gas in future months when gas is expected to be
needed. These financial instruments are being utilized principally to secure
anticipated natural gas requirements necessary for projected electric sales and
to hedge sales of natural gas previously obtained in order to optimize MCV's
existing gas supply, storage and transportation arrangements.
The following table provides information about MCV's futures and option
contracts that are sensitive to changes in natural gas prices; these futures and
option contracts have maturity dates ranging from two to eighteen months. The
table presents the carrying amounts and fair values at June 30, 2001:
Expected Maturity in 2001/2002 Fair Value
------------------------------ ----------
Futures Contracts:
Contract Volumes (10,000 MMBtu) Long/Buy 1,606 --
Contract Volumes (10,000 MMBtu) Short/Sold 194 --
Weighted Average Price Long (per MMBtu) $4.613 $3.433
Weighted Average Price Short (per MMBtu) $4.517 $3.467
Contract Amount ($US in Millions) $ 65.3 $ 48.4
Foreign Currency Risks. MCV periodically enters into foreign exchange forward
purchase contracts for Swiss Francs to hedge its foreign currency exposure
against adverse currency fluctuations impacting the payments under the amended
Service Agreement with Alstom. The gains and losses on these transactions,
accounted for as hedges, are included in the measurement of the underlying
capitalized major renewal costs when incurred. Forward contracts, which are
entered into, have maturity dates of less than one year. As of June 30, 2001,
MCV had forward purchase contracts involving Swiss Francs in the notional amount
of $10.0 million, with a deferred $.4 million loss.
New Accounting Standards
Effective January 1, 2001, MCV adopted SFAS No. 133, "Accounting for Derivatives
Instruments and Hedging Activities, as amended and interpreted." For a detailed
discussion of the effects of the standard, including earnings volatility, and
the financial impact upon adoption, see Condensed Notes to Unaudited
Consolidated Financial
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Statements -- Note 2 "Risk Management Activities and Derivative Transactions -
New Accounting Standard, Forward Foreign Exchange Contracts, Natural Gas Futures
and Options and Interest Rate Swaps."
Liquidity and Financial Resources
During the six months ended June 30, 2001 and 2000, net cash generated by MCV's
operations was $76.3 million and $67.3 million, respectively. The primary use of
net cash was for the payment of principal on the financing obligation and
capital expenditures. MCV's cash and cash equivalents have a normal cycle of
collecting six months of revenues less operating expenses prior to making the
semiannual interest and principal payments of the financing obligation due in
January and July for the next fourteen years. During January 2001, and 2000, MCV
paid the basic rent requirements of $134.4 million and $136.9 million,
respectively, as required under the Overall Lease Transaction.
MCV also has arranged for a $50 million working capital line ("Working Capital
Facility") from the Bank of Montreal to provide temporary financing, as
necessary, for operations. The Working Capital Facility has been secured by
MCV's natural gas inventory and earned receivables. At any given time,
borrowings and letters of credit are limited by the amount of the borrowing
base, defined as 90% of earned receivables. The borrowing base varies over the
month as receivables are earned, billed and collected. At June 30, 2001, the
borrowing base was $43.1 million. The Working Capital Facility term currently
expires on August 31, 2001, which MCV expects to extend. MCV did not utilize the
Working Capital Facility during the first six months of 2001, except for letters
of credit associated with normal business practices. MCV believes that amounts
available to it under the Working Capital Facility will be sufficient to meet
any working capital shortfalls which might occur.
For the foreseeable future, MCV expects to fund current operating expenses,
payments under the amended Service Agreement and rental payments primarily
through cash flow from operations. If necessary, MCV could fund any operating
cash flow shortfalls from cash reserves to the extent available for such
purposes. As of June 30, 2001, there was approximately $298 million (which
includes approximately $50 million reserved for capital improvements and spare
parts purchases), including accrued interest, in available reserves for such
purposes.
Outlook
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995. The following discussion of the outlook for MCV contains certain
"forward-looking statements" as defined by the Private Securities Litigation
Reform Act of 1995 (the "Act"), including without limitation, discussion as to
expectations, beliefs, plans, objectives and future financial performance, or
assumptions underlying or concerning matters discussed reflecting MCV's current
expectations of the manner in which the various factors discussed therein may
affect its business in the future. Any matters that are not historical facts are
forward-looking and, accordingly, involve estimates, assumptions, and
uncertainties, which could cause actual results or outcomes to differ materially
from those expressed in the forward-looking statements. Accordingly, this "Safe
Harbor" Statement contains additional information about such factors relating to
the forward-looking statements. There is no assurance that MCV's expectations
will be realized or that unexpected events will not have an adverse impact on
MCV's business.
Some important factors that could cause actual results or outcomes to differ
materially from those discussed in the forward-looking statements include
governmental policies, legislation and other regulatory actions (including those
of the Michigan Legislature, Congress, Federal Energy Regulatory Commission and
the Michigan Public Service Commission) with respect to cost recovery under the
PPA, industry restructuring or deregulation, operation and construction of plant
facilities including natural gas pipeline and storage facilities, and present or
prospective wholesale and retail competition, among others. The business and
profitability of MCV is also influenced by other factors such as pricing and
transportation of commodities and environmental legislation/regulation, among
other important factors. All such factors are difficult to predict, contain
uncertainties which may materially affect actual results, and are beyond the
control of MCV.
Results of operations are largely dependent on successfully operating the
Facility at or near contractual capacity levels, the availability of natural
gas, the level of energy rates paid to MCV relative to the cost of fuel used for
generation, Consumers' performance of its obligations under the PPA and
maintenance of the Facility's QF status.
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Operating Outlook. During the first six months of 2001, approximately 75% of PPA
revenues were capacity payments under the PPA, which are billed on availability,
subject to an annual availability cap of 98.5% pursuant to a Settlement
Agreement between MCV and Consumers, which was effective January 1, 1999. Actual
PPA availability was 99.3% for the first six months of 2001, 98.5% for the year
2000 and 99.7% for the year 1999. Availability will depend on the level of
scheduled and unscheduled maintenance outages, and on the sustained level of
output from each of the GTGs and the steam turbines. MCV expects long-term PPA
availability to meet or exceed the capped level of 98.5%, though prolonged
equipment outages could materially reduce the level of availability.
Natural Gas. The Facility is wholly dependent upon natural gas for its fuel
supply and a substantial portion of the Facility's operating expenses consist of
the costs of natural gas. While MCV continues to pursue the acquisition of a
portion of its expected fuel supply requirements in future years, MCV recognizes
that its existing long term gas contracts are not sufficient to satisfy the
anticipated gas needs over the term of the PPA and, as such, no assurance can be
given as to the availability or price of natural gas after the expiration of its
existing fixed price gas contracts or for gas that may be required by the
Facility in excess of the gas that MCV has under contract.
Energy Rates and Cost of Production. Under the PPA, energy charges are based on
the costs associated with fuel inventory, operations and maintenance, and
administrative and general expenses associated with certain of Consumers' coal
plants. However, MCV's costs of producing electricity are tied, in large part,
to the cost of natural gas. To the extent that the costs associated with
production of electricity with natural gas rise faster than the energy charge
payments, which are based largely on Consumers' coal plant operation and
maintenance costs, MCV's financial performance would be negatively affected. For
the period April 1990 through June 30, the unit energy charge (fixed and
variable) paid to MCV has declined by 16.0%, while the average unit variable
cost of delivered fuel for the period 1990 - 2000, has risen by 15.9%. The
divergence between variable revenues and costs will become greater if the energy
charge (based largely on the cost of coal) declines or escalates more slowly
than the spot market or contract prices under which MCV purchases fuel (contract
prices generally escalate at a fixed price, a fixed price with an escalator, an
index based on Consumers' energy charges under the PPA, or a combination
thereof). MCV continues to purchase the majority of its natural gas requirements
under long-term fixed-price contracts, with a smaller portion of gas purchased
on the spot market. MCV has maintained a hedging program to mitigate risk
associated with volatile prices in the spot market and has entered into gas
purchase and hedging arrangements with respect to most of its expected gas needs
for 2001 for requirements not provided for under its long-term contracts. MCV
expects that its purchase and hedging arrangements will mitigate the effects of
rises in natural gas prices for 2001, although high gas prices for an extended
period of time could adversely affect operating results.
Capacity and Energy Payments Under the PPA. The PPA permits Consumers, under
certain conditions, to reduce the capacity and energy charges payable to MCV
and/or to receive refunds of capacity and energy charges paid to MCV if the MPSC
does not permit Consumers to recover from its customers the capacity and energy
charges specified in the PPA (the "regulatory-out" provision). Until September
15, 2007, the capacity charge may not be reduced below an average capacity rate
of 3.77 cents per kWh for the available Contract Capacity notwithstanding the
"regulatory-out" provision. Consumers and MCV are required to support and defend
the terms of the PPA.
Michigan Electric Industry Restructuring Proceedings. The MPSC issued orders on
June 5, 1997, October 29, 1997, January 14, 1998 and February 11, 1998
(collectively the "Restructuring Orders"). The Restructuring Orders provide for
a transition to a competitive regime whereby electric retail customers would be
able to choose their power supplier and pay negotiated or market-based rates for
such power supply. The Restructuring Orders also mandated that utilities "wheel"
third-party power to the utilities' customers. An issue involved in
restructuring, which could significantly impact MCV, is stranded cost recovery.
The Restructuring Orders allow recovery by utilities (including Consumers) of
stranded costs, which include capacity charges from QFs, including MCV,
previously approved by the MPSC, incurred during the regulated era that will be
above market prices during the new competitive regime. However, it appears that
stranded cost recovery of above-market capacity charges in power purchase
contracts (i.e., MCV's PPA) is limited to customers who chose an alternative
power supplier and are only paid for the period 1998 through 2007 (MCV's PPA
expires in 2025). Customers who chose to remain power supply customers of
Consumers will continue to pay capacity charges as part of rates charged by
Consumers, subject
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to MPSC rate regulation. The Restructuring Orders do not otherwise specifically
address the recovery of PPA capacity charges after 2007.
MCV, as well as others, filed appeals in state and federal courts challenging
the Restructuring Orders. The Michigan Court of Appeals found that the
Restructuring Orders do not unequivocally disallow recovery of PPA charges
(capacity and energy) by Consumers and, therefore, MCV's issues were not ripe
for appellate review and no actual controversy regarding recovery of costs could
occur until 2008, at the earliest. In June 1999, the Michigan Supreme Court
issued an opinion in an MPSC "retail wheeling" experiment case holding, among
other things, that the MPSC lacks the statutory authority to mandate that
utilities transmit power of third parties to the utilities' customers ("Michigan
Supreme Court Order"). While the Michigan Supreme Court Order was not directed
at the Restructuring Orders, the MPSC has effectively applied it to them by
entering an order on August 17, 1999, making retail wheeling under the
Restructuring Orders voluntary on the part of the utilities. In September 1999,
Consumers filed a statement with the MPSC stating that it intends to begin
voluntarily implementing the Restructuring Orders. In June 2000, the state of
Michigan enacted legislation which, among other things, states that the
Restructuring Orders (being voluntarily implemented by Consumers) are in
compliance with the legislation and enforceable by the MPSC. The legislation
provides that the rights of parties to existing contracts between utilities
(like Consumers) and QF's (like MCV), including the rights to have the PPA
charges recovered from customers of the utilities, are not abrogated or
diminished, and permitted utilities to securitize certain stranded (transition)
costs including PPA charges.
In MCV's federal court challenge to the Restructuring Orders, on July 7, 1999,
the U.S. District Court granted summary judgment to MCV declaring that the
Restructuring Orders are preempted by federal law to the extent they prohibit
Consumers from recovering from its customers any charge for avoided costs (or
"stranded costs") to be paid to MCV under PURPA pursuant to the PPA. In June
2001, the United States Court of Appeals ("Appellate Court") vacated the U.S.
District Court's July 7, 1999 summary judgment and ordered the case dismissed
based upon a finding that no actual case or controversy existed for adjudication
between the parties. The Appellate Court determined that the parties' dispute is
hypothetical at this point in time and the QFs' (including MCV) claims are
premised on speculation about how an order might be interpreted seven years from
now by a future MPSC. MCV has requested rehearing of the Appellate Court's
order, which is subject to further appeal. MCV Management cannot, at this time,
predict the impact or outcome of this proceeding.
Federal Electric Industry Restructuring. FERC has jurisdiction over wholesale
energy sales and is moving towards "market" based pricing of electricity in some
circumstances as opposed to traditional cost-based pricing. In April 1996, FERC
issued Order No. 888 requiring all utilities FERC regulates to file uniform
transmission tariffs providing for, among other things, non-discriminatory "open
access" to all wholesale buyers and sellers, including the transmission owner,
on terms and conditions established by FERC. Order No. 888 also requires
utilities to "functionally unbundle" transmission and separate transmission
personnel from those responsible for marketing generation. On December 20, 1999,
FERC issued a final rule, Order No. 2000, designed to encourage all owners and
operators of interstate electric transmission lines to join regional
transmission organizations. Order No. 2000 is intended to increase competition
and remedy continuing problems with wholesale transmission access and
reliability. Order No. 2000 does not directly impact MCV since MCV does not own
transmission lines, but could indirectly impact MCV in selling electricity in
the wholesale market. Order No. 2000 and subsequent related orders are pending
before the United States Court of Appeals for the D.C. Circuit. In addition,
several bills have been introduced in Congress to require states to permit
consumers to choose their supplier of electricity and manage other issues such
as transition cost recovery and FERC jurisdiction of retail electric sales. MCV
Management cannot predict the impact on MCV or the outcome of these proceedings.
Maintaining QF Status. In the case of a topping-cycle generating plant such as
the Facility, to maintain QF Status the applicable operating standard requires
that the portion of total energy output that is put to some useful purpose other
than facilitating the production of power (the "Thermal Percentage") be at least
5%. In addition, the plant must achieve and maintain an average PURPA efficiency
standard (the sum of the useful power output plus one-half of the useful thermal
energy output, divided by the energy input (the "Efficiency Percentage")) of at
least 45%. However, if the plant maintains a Thermal Percentage of 15% or
higher, the required Efficiency Percentage is reduced to 42.5%. The tests are
applied on a calendar year basis. The Facility has achieved the applicable
Efficiency Percentage of 42.5% in each year since commercial operation, and in
the years 1995 through 2000 the Facility achieved an Efficiency Percentage in
excess of 45%.
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MCV believes that the Facility will be able to maintain QF status and be capable
of achieving a 45% PURPA Efficiency Percentage on a long-term basis. In
addition, MCV believes annual steam sales will be sufficient to allow the
Facility to exceed the 15% Thermal Percentage. However, no assurance can be
given that factors outside MCV's control will not cause the Facility to fail to
satisfy the annual PURPA qualification requirements and thus lose its QF status.
In 2000, MCV achieved an Efficiency Percentage of 47.3% and a Thermal Percentage
of 19.1%. During the first six months of 2001, MCV achieved an Efficiency
Percentage of 47.0% and a Thermal Percentage of 22.4%.
The loss of QF status could, among other things, cause the Facility to lose its
right under PURPA to sell power to Consumers at Consumers' "avoided cost" and
subject the Facility to additional federal and state regulatory requirements,
including the FPA (under which FERC has authority to establish rates for
electricity, which may be different than existing contractual rates). If the
Facility were to lose its QF status, the Partners of MCV, the Owner
Participants, the Owner Trustee and their respective parent companies could
become subject to regulation under the 1935 Act (under which, among other
things, the Securities and Exchange Commission has authority to order
divestiture of assets under certain circumstances). The loss of QF status would
not, however, entitle Consumers to terminate the PPA. Under the PPA, Consumers
is obligated to continue purchasing power from MCV at FERC-approved rates
(provided that the FERC-approved rates do not exceed the existing contractual
rates) and MCV, not Consumers, is entitled to terminate the PPA (which MCV has
covenanted not to do under the Participation Agreements). There can be no
assurance that FERC-approved rates would be the same as the rates currently in
effect under the PPA. If the FERC-approved rates are materially less than the
rates under the PPA, MCV may not have sufficient revenue to make rent payments
under the Overall Lease Transaction. The loss of QF status would constitute an
Event of Default under the Lease (and a corresponding Event of Default under the
Indenture) unless, among other requirements, FERC approves (or accepts for
filing) rates under the PPA or other contracts of MCV for the sale of
electricity sufficient to meet certain target coverage ratios (as defined in the
Overall Lease Transaction).
See Part I, Item 1, "Financial Statements -- Note 1 to the Condensed Notes to
Unaudited Consolidated Financial Statements" for a further discussion of
associated risks and contingencies.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The discussion below is limited to an update of events or developments that have
occurred in various judicial and administrative proceedings. A complete summary
of all outstanding issues is fully described in MCV's Form 10-K for the year
ended December 31, 2000.
Property Tax Appeal
MCV has filed property tax appeals contesting MCV's property taxes for 1997 and
1998 and the taxable value for 1999 and 2000, which are pending before the
Michigan Tax Tribunal. MCV also appealed its 2001 property taxes. MCV Management
cannot predict the outcome of these proceedings.
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Item 6. Exhibits and Reports on Form 8-K
a.) List of Exhibits
10.01 Long Term Gas Agreement, dated April 12, 2001, between MCV and Engage
Energy America, LLC.
b.) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter for which this
report is filed.
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SIGNATURES
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.
MIDLAND COGENERATION VENTURE
LIMITED PARTNERSHIP
--------------------------------------
(Registrant)
Dated: August 8, 2001 /s/ James M. Kevra
----------------- ---------------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: August 8, 2001 /s/ James M. Rajewski
----------------- ---------------------------------------
James M. Rajewski
Vice President and Controller
(Principal Accounting Officer)
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