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 September 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
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(Exact name of registrant as specified in its charter)
MICHIGAN 38-2726166
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State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 PROGRESS PLACE, MIDLAND, MICHIGAN 48640
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (989) 839-6000
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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
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS AS OF
(In Thousands)
September 30,
2001 December 31,
ASSETS (Unaudited) 2000
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CURRENT ASSETS:
Cash and cash equivalents $ 83,168 $ 205,550
Restricted cash and cash equivalents 772 748
Accounts and notes receivable - related parties 107,901 109,181
Accounts receivable 15,910 75,216
Gas inventory 21,731 14,474
Unamortized property taxes 22,655 16,210
Prepaid expenses and other 35,503 7,785
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Total current assets 287,640 429,164
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PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,437,891 2,433,798
Pipeline 21,396 21,222
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Total property, plant and equipment 2,459,287 2,455,020
Accumulated depreciation (835,758) (783,974)
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Net property, plant and equipment 1,623,529 1,671,046
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OTHER ASSETS:
Restricted investment securities held-to-maturity 141,054 139,876
Deferred financing costs, net of accumulated amortization of
$14,057 and $12,804, respectively 10,908 12,161
Prepaid gas costs, materials and supplies 21,207 22,709
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Total other assets 173,169 174,746
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TOTAL ASSETS $ 2,084,338 $ 2,274,956
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LIABILITIES AND PARTNERS' EQUITY
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CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 81,377 $ 93,010
Interest payable 29,855 67,416
Current portion of long-term debt 186,173 155,632
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Total current liabilities 297,405 316,058
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NON-CURRENT LIABILITIES:
Long-term debt 1,243,060 1,429,233
Other 2,096 1,927
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Total non-current liabilities 1,245,156 1,431,160
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CONTINGENCIES
TOTAL LIABILITIES 1,542,561 1,747,218
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PARTNERS' EQUITY 541,777 527,738
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TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,084,338 $ 2,274,956
================ ==============
The accompanying condensed notes are an integral part of these statements.
-1-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2001 2000 2001 2000
----------- ---------- ----------- ------------
OPERATING REVENUES:
Capacity $ 106,072 $ 106,093 $ 307,847 $ 309,185
Electric 55,825 38,505 134,157 139,712
Steam and other 3,661 3,451 12,180 11,175
----------- ----------- ----------- ------------
Total operating revenues 165,558 148,049 454,184 460,072
----------- ----------- ----------- ------------
OPERATING EXPENSES:
Fuel costs 78,546 57,662 203,124 192,469
Depreciation 22,801 22,465 69,425 71,354
Operations 4,191 3,585 12,002 11,397
Maintenance 3,402 3,368 10,453 10,047
Property and single business taxes 6,896 6,176 19,920 19,117
Administrative, selling and general 9,270 2,249 14,185 7,104
----------- ----------- ----------- ------------
Total operating expenses 125,106 95,505 329,109 311,488
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OPERATING INCOME 40,452 52,544 125,075 148,584
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OTHER INCOME (EXPENSE):
Interest and other income 3,321 7,295 14,001 18,680
Interest expense (30,307) (35,715) (95,356) (112,564)
----------- ----------- ----------- ------------
Total other income (expense), net (26,986) (28,420) (81,355) (93,884)
----------- ----------- ----------- ------------
NET INCOME $ 13,466 $ 24,124 $ 43,720 $ 54,700
=========== =========== =========== ============
The accompanying condensed notes are an integral part of these statements.
-2-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
(In Thousands)
Nine Months Ended
September 30, 2001
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General Limited
Partners Partners Total
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BALANCE, BEGINNING OF PERIOD $ 448,100 $ 79,638 $ 527,738
Comprehensive income:
Net income 38,063 5,657 43,720
Other comprehensive income:
Cumulative effect of accounting change 13,688 2,034 15,722
Unrealized loss on hedging activities (39,864) (5,924) (45,788)
Reclassification adjustments recognized
in net income above 335 50 385
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Total other comprehensive income (25,841) (3,840) (29,681)
Total comprehensive income 12,222 1,817 14,039
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BALANCE, END OF PERIOD $ 460,322 $ 81,455 $ 541,777
========= ======== =========
The accompanying condensed notes are an integral part of these statements.
-3-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
Nine Months Ended
September 30,
--------------------------------
2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 43,720 $ 54,700
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 70,678 72,282
Decrease (increase) in accounts receivable 60,586 (20,394)
Increase in gas inventory (7,257) (2,894)
Increase in unamortized property taxes (6,445) (6,358)
(Increase) decrease in prepaid expenses and other (27,718) 1,982
Decrease in prepaid gas costs, materials and supplies 1,502 335
(Decrease) increase in accounts payable and accrued liabilities (41,314) 14,209
Decrease in interest payable (37,561) (42,512)
Increase in other non-current liabilities 169 156
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Net cash provided by operating activities 56,360 71,506
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CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (21,908) (23,048)
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Net cash used in investing activities (21,908) (23,048)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (155,632) (139,095)
Debt refinancing costs - (6,388)
Maturity of restricted investment securities held-to-maturity 457,220 248,338
Purchase of restricted investment securities held-to-maturity (458,398) (251,446)
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Net cash used in financing activities (156,810) (148,591)
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NET DECEASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT (122,358) (100,133)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT BEGINNING OF
PERIOD 206,298 241,885
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CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT END OF PERIOD
$ 83,940 $ 141,752
========== ==========
The accompanying condensed notes are an integral part of these statements.
-4-
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 nine months ended September 30, 2001, the Facility achieved a Thermal
Percentage of 18.7% and a
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
PURPA Efficiency Percentage of 46.8%. The loss of QF status could, among
other things, cause the Facility to lose its rights under PURPA to sell
power to Consumers at 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 nine months ended September
30, 2001, MCV estimates that this program resulted in net savings of
approximately $8 million, a portion of which will be realized in reduced
maintenance expenditures in future years. 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 in the year 2007 or
beyond by a future MPSC.
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 September 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.
On June 27, 2001, the Financial Accounting Standards Board ("FASB") issued
final guidance extending the normal purchase and sales exception to electric
power purchase or sales agreements that meet specific criteria. MCV believes
that its power supply agreements meet these criteria and as such, does not
record the fair value of these contracts on its balance sheet. On September
19, 2001, the FASB cleared the implementation guidance regarding natural gas
commodity contracts which combine an option component and a forward
component. This guidance requires that either the entire contract is to be
accounted for as a derivative or the components of the combined contract be
legally separated into two discrete contracts. Under the second alternative,
the newly established forward contract could qualify for the normal
purchases and sales exception while the option contract would be treated as
a derivative under SFAS No. 133. This guidance will become effective by
April 1, 2002. As of September 30, 2001, approximately 53.4% of MCV's gas
under contract may not qualify for the normal purchase and sales exception.
MCV is currently studying and quantifying the initial and ongoing impact on
earnings of adoption of this guidance, adoption of which is anticipated to
cause earnings volatility.
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, because 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
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
change and is expected to have an 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 September 30, 2001, MCV had forward
purchase contracts involving Swiss Francs in the notional amount of $10.0
million, which as a hedge is considered highly effective and, therefore,
there is no material gain or loss recognized during the period ended
September 30, 2001. 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, because 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 $30.4 million and
$3.8 million as of September 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 nine
month period ended September 30, 2001, MCV has recognized in other
comprehensive income, an unrealized $45.4 million decrease on the futures
contracts which are hedges of forecasted purchases for plant use of market
priced gas, resulting in a $29.7 million loss balance in other comprehensive
income as of September 30, 2001. In addition, for the nine months ended
September 30, 2001, MCV has recorded a net $2.4 million gain in earnings
from hedging activities and cost mitigation activities.
-8-
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 September 30, 2001
and December 31, 2000.
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 September 30, 2001, MCV did not have any interest rate swap
transactions outstanding which qualified for cash flow hedge accounting,
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 one 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 nine months ended September 30,
2001, MCV recorded a $.9 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):
September 30, December 31,
2001 2000
------------- ------------
Current:
Funds restricted for plant modifications $ 772 $ 748
============= ============
Non-current:
Funds restricted for rental payments pursuant to the Overall
Lease Transaction $ 138,958 $ 137,942
Funds restricted for management non-qualified plans 2,096 1,934
------------- ------------
Total $ 141,054 $ 139,876
============= ============
(4) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following as of (in
thousands):
September 30, December 31,
2001 2000
------------- ------------
Accounts payable
Related parties $ 14,891 $ 18,144
Trade creditors 28,025 41,601
Property and single business taxes 12,489 13,560
Other 25,972 19,705
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Total $ 81,377 $ 93,010
============= ============
-9-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(5) LONG-TERM DEBT
Long-term debt consists of the following as of (in thousands): September 30, December 31,
2001 2000
------------- ------------
Financing obligation, maturing through 2015, payable in
semi-annual installments of principal and interest, secured by
property, plant and equipment $ 1,429,233 $ 1,584,865
Less current portion (186,173) (155,632)
------------- ------------
Total long-term debt $ 1,243,060 $ 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.
The financing obligation utilizes the effective interest rate method, which
is based on the minimum lease payments required through the end of the basic
lease term of 2015 and management's estimate of additional anticipated
obligations after the end of the basic lease term. The effective interest
rate during the remainder of the basic lease term is approximately 9.4%.
Interest and fees incurred related to long-term debt arrangements during the
nine months ended September 30, 2001 and September 30, 2000 were $94.1
million and $108.6 million, respectively. In addition, in June 2000, MCV
expensed approximately $2.8 million of costs associated with MCV's
refinancing of its tax-exempt bonds. Interest and fees paid for the nine
months ended September 30, 2001 and September 30, 2000 were $131.7 million
and $151.2 million, respectively.
-10-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(7) 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
September 30, 2001, and the nature and amount of related party transactions
or agreements that existed with the Partners or affiliates as of September
30, 2001 and 2000, and for each of the nine month periods ended September 30
(in thousands).
Beneficial Owner, Equity Partner, Type Equity
of Partner and Nature of Related Party Interest Interest Transactions and Agreements 2001 2000
- -------------------------------------- -------- -------- --------------------------- -------- ---------
CMS Energy Company
- ------------------
CMS Midland, Inc. $ 265,470 49.0% Power purchase agreements $403,259 $428,185
========= ====== Purchases under gas transportation agreements 18,071 17,533
General Partner; wholly-owned Purchases under spot gas agreements 1,136 3,516
subsidiary of Consumers Energy Purchases under gas supply agreements 7,054 9,137
Company Gas storage agreement 1,922 1,922
Land lease/easement agreements 450 450
Accounts receivable 48,919 44,596
Accounts payable 8,053 9,044
Sales under spot gas agreements 3,891 6,085
El Paso Corporation $ 92,786 18.1%
- -------------------
Source Midland Limited Partnership Purchase under gas transportation agreements 10,300 10,206
("SMLP") General Partner; owned by Purchases under spot gas agreement 41,828 4,520
subsidiaries of El Paso Corporation(1) Purchases under gas supply agreement 3,795 3,664
Gas agency agreement 1,601 1,682
Deferred reservation charges under gas
purchase agreement 7,880 6,895
Accounts receivable -- 2,985
Accounts payable 5,937 3,396
Sales under spot gas agreements 28,183 5,490
Partner cash withdrawal (including accrued
interest)(2) 55,989 50,144
El Paso Midland, Inc. ("El Paso
Midland") 55,671 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 46,395 9.1
Limited Partnership Interest 4,638 .9
Micogen Limited Partnership 23,196 4.5 See related party activity listed under SMLP.
("MLP") Limited Partner, owned
subsidiaries of El Paso Corporation(1)
--------- ------
Total El Paso Corporation $ 222,686 43.5%
========= ======
The Dow Chemical Company
- ------------------------
The Dow Chemical Company $ 53,620 7.5% Steam and electric power agreement 25,358 22,909
========= ======
Limited Partner Steam purchase agreement - Dow Corning Corp
(affiliate) 2,738 2,626
Purchases under demineralized water supply
agreement 5,094 5,033
Accounts receivable 2,986 2,795
Accounts payable 901 502
Standby and backup fees 520 502
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.
-11-
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 Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2001 2000 2001 2000
------------- ------------ ------------- ------------
Operating Revenues $ 165,558 $ 148,049 $ 454,184 $ 460,072
Capacity Revenue $ 106,072 $ 106,093 $ 307,847 $ 309,185
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 $ 55,825 $ 38,505 $ 134,157 $ 139,712
PPA Delivery as a Percentage of Contract Capacity(2) 89.5% 56.3% 71.9% 76.3%
PPA, SEPA and Other Electric Deliveries (MWh) 2,698,006 1,738,464 6,375,311 6,765,745
Average PPA Variable Energy Rate ($/MWh) $ 15.62 $ 15.66 $ 15.58 $ 15.69
Average PPA Fixed Energy Rate ($/MWh) $ 3.80 $ 3.59 $ 3.73 $ 3.56
Steam Revenue $ 3,661 $ 3,451 $ 12,180 $ 11,175
Steam Deliveries (Mlbs) 1,200,810 1,245,330 4,242,250 4,327,250
(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 September 30, 2001 and 2000
Overview
For the third quarter of 2001, MCV recorded net income of $13.5 million as
compared to net income of $24.1 million for the third quarter of 2000. The
decrease for the third quarter of 2001 compared to 2000 is primarily due to
expensed development costs associated with a possible plant expansion, an
increase in the electric dispatch and lower interest income. This decrease was
partially offset by lower interest expense on MCV's financing obligation.
-12-
Operating Revenues
For the third quarter of 2001, MCV's operating revenues increased $17.5 million
from the third quarter of 2000. This increase is due primarily to a higher
electric dispatch under the PPA with Consumers.
Operating Expenses
For the third quarter of 2001, MCV's operating expenses were $125.1 million,
which includes $78.5 million of fuel costs. During this period, MCV purchased
approximately 25.5 billion cubic feet ("bcf") of natural gas, and a net 1.9 bcf
was injected into storage and used for transportation fuel. The average
commodity cost of fuel for the third quarter of 2001 was $2.85 per million
British thermal units ("MMBtu"). For the third quarter of 2000, MCV's operating
expenses were $95.5 million, which includes $57.7 million of fuel costs. During
this period, MCV purchased approximately 18.1 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 third quarter of 2000 was $2.92 per MMBtu. Fuel
costs for the third quarter of 2001 compared to 2000 increased by $20.8 million.
This fuel cost increase was due primarily to a higher gas usage resulting from
the increase in the electric dispatch due to a lower volume of dispatch
reduction transactions entered into with Consumers.
For the third quarter of 2001, operating expenses other than fuel costs
increased $8.8 million from the third quarter of 2000, primarily resulting from
expensing approximately $6.8 million of development costs associated with a
possible plant expansion. 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 third quarter of 2001 compared
to 2000 reflects lower interest rates on MCV's investments and a lower average
invested balance. The decrease in interest expense in the third quarter of 2001
from the third quarter of 2000 is due to a lower principal balance on MCV's
financing obligation.
Comparison of the Nine Months ended September 30, 2001 and 2000
Overview
For the first nine months of 2001, MCV recorded net income of $43.7 million as
compared to net income of $54.7 million for the first nine months of 2000. The
earnings decrease for the first nine months of 2001 compared to 2000 was
primarily due to increased fuel costs resulting from higher natural gas prices
and lower interest income. In addition, MCV expensed development costs
associated with a possible plant expansion. The earnings decrease was partially
offset by lower interest expense on MCV's financing arrangements and by the net
effect of a lower dispatch under the PPA between MCV and Consumers.
Operating Revenues
For the first nine months of 2001, MCV's operating revenues decreased $5.9
million from the first nine months of 2000. This decrease is due primarily 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 and
partially offset by an increase in the steam revenues resulting from an increase
in the steam rates.
Operating Expenses
For the first nine months of 2001, MCV's operating expenses were $329.1 million,
which includes $203.1 million of fuel costs. During this period, MCV purchased
approximately 61.7 bcf of natural gas, and a net 4.2 bcf was injected into
storage and used for transportation fuel. The average commodity cost of fuel for
the first nine months of 2001 was $2.94 per MMBtu. For the first nine months of
2000, MCV's operating expenses were $311.5 million, which includes $192.5
million of fuel costs. During this period, MCV purchased approximately 63.1 bcf
of natural gas, and a net 2.9 bcf was injected into storage and used for
transportation fuel. During this same period, MCV consumed 61.0 bcf, of which .8
bcf of this total was gas provided by Dow. The average commodity cost of fuel
for the first nine months of 2000 was $2.72 per MMBtu. Fuel costs for the first
nine months of 2001 compared to 2000 decreased by $10.7 million. This fuel cost
decrease was due primarily to a lower gas usage resulting from the decrease in
electric dispatch caused primarily by the dispatch reduction transactions
entered into with Consumers and the disposition of natural gas previously hedged
or purchased under contract but not required for electric generation. This fuel
usage decrease was partially offset by a higher average cost of natural gas
under long-term contracts and in the spot market.
-13-
For the first nine months of 2001, operating expenses other than fuel costs
increased $6.9 million as compared to the first nine months of 2000, which
primarily resulted from expensing approximately $6.8 million of development
costs associated with a possible plant expansion. This increase was partially
offset by 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 for the first nine months of 2001
compared to 2000 reflects lower interest rates on MCV's investments and a lower
average invested balance. The decrease in interest expense in the first nine
months of 2001 from the first nine months of 2000 is due to a lower principal
balance on MCV's financing obligation.
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 basic term of 25 years, maturing in 2015, has an
effective interest rate of approximately 9.4%, payable in semi-annual
installments of principal and interest. 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 September 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 maturity. The variable rates presented
are the average of the forward rates for the term of each contract, as valued at
September 30, 2001:
Expected Maturity In
-----------------------------------------------------------------------
Fair
2002 2003 2004 2005 2006 Thereafter Total Value
------ ------ ------ ------ ------ ---------- -------- -----
Debt:
Long-Term Debt Fixed
Rate (in millions) $304.1 $208.9 $242.8 $174.4 $156.0 $1,190.90 $2,277.1 N/A
Avg. Interest Rate 9.4% 9.4% 9.4% 9.4% 9.4% 9.4% 9.4%
Interest Rate Swaps:
Floating to Floating $20.0 $ .5
(in millions)
Avg. Pay Rate 3.03%
Avg. Receive Rate 4.58%
-14-
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 twelve months. The
table presents the carrying amounts and fair values at September 30, 2001:
Expected Maturity in 2001/2002 Fair Value
Futures Contracts:
Contract Volumes (10,000 MMBtu) Long/Buy 1,907 --
Contract Volumes (10,000 MMBtu) Short/Sold 216 --
Weighted Average Price Long (per MMBtu) $4.135 $2.774
Weighted Average Price Short (per MMBtu) $3.925 $2.657
Contract Amount ($US in Millions) $70.4 $47.2
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 September 30,
2001, MCV had forward purchase contracts involving Swiss Francs in the notional
amount of $10.0 million, with a deferred $.6 million gain.
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 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 nine months ended September 30, 2001 and 2000, net cash generated by
MCV's operations was $56.4 million and $71.5 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 2001, and 2000, MCV paid
the basic rent requirements of $287.1 million and $288.6 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 September 30, 2001,
the borrowing base was $46.5 million. The Working Capital Facility term
currently expires on August 31, 2002. MCV did not utilize the Working Capital
Facility during the first nine 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.
-15-
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 September 30, 2001, there was approximately $262 million (which
includes approximately $12 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.
Operating Outlook. During the first nine months of 2001, approximately 72% 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 99.4% for the first nine 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 September 30, 2001 the unit energy charge (fixed
and variable) paid to MCV has declined by 16.5%, while the average unit variable
cost of
-16-
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 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
-17-
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 in the year 2007
or beyond by a future MPSC.
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%.
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 nine months of 2001, MCV achieved an Efficiency
Percentage of 46.8% and a Thermal Percentage of 18.7%.
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).
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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
None
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: November 12, 2001 /s/ James M. Kevra
----------------- -------------------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: November 12, 2001 /s/ James M. Rajewski
----------------- -------------------------------------------
James M. Rajewski
Vice President and Controller
(Principal Accounting Officer)
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