UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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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
- ------------------------------- ------------------------------
(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
--- ---
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS AS OF
(In Thousands)
June 30,
2002 December 31,
ASSETS (Unaudited) 2001
- ------ ---------------- -----------------
CURRENT ASSETS:
Cash and cash equivalents $ 214,111 $ 140,630
Restricted cash and cash equivalents -- 787
Accounts and notes receivable - related parties 51,407 108,780
Accounts receivable 24,657 20,490
Gas inventory 18,625 19,699
Unamortized property taxes 30,191 16,625
Derivative assets (Note 2) 79,305 --
Broker margin accounts and prepaid expenses 10,496 34,372
---------------- -----------------
Total current assets 428,792 341,383
---------------- -----------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,444,125 2,439,541
Pipeline 21,432 21,398
---------------- -----------------
Total property, plant and equipment 2,465,557 2,460,939
Accumulated depreciation (884,710) (851,539)
---------------- -----------------
Net property, plant and equipment 1,580,847 1,609,400
---------------- -----------------
OTHER ASSETS:
Restricted investment securities held-to-maturity 141,434 141,467
Deferred financing costs, net of accumulated amortization of
$15,231 and $14,463, respectively 9,734 10,502
Prepaid gas costs, materials and supplies 13,348 14,295
---------------- -----------------
Total other assets 164,516 166,264
---------------- -----------------
TOTAL ASSETS $ 2,174,155 $ 2,117,047
================ =================
LIABILITIES AND PARTNERS' EQUITY
- --------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 69,599 $ 73,596
Interest payable 61,669 60,334
Current portion of long-term debt 116,844 186,173
---------------- -----------------
Total current liabilities 248,112 320,103
---------------- -----------------
NON-CURRENT LIABILITIES:
Long-term debt 1,247,149 1,243,060
Other 2,411 2,172
---------------- -----------------
Total non-current liabilities 1,249,560 1,245,232
---------------- -----------------
COMMITMENTS AND CONTINGENCIES
TOTAL LIABILITIES 1,497,672 1,565,335
---------------- -----------------
PARTNERS' EQUITY 676,483 551,712
---------------- -----------------
TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,174,155 $ 2,117,047
================ =================
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 Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
OPERATING REVENUES:
Capacity $ 100,938 $ 102,197 $ 200,482 $ 201,775
Electric 41,383 40,854 87,323 78,332
Steam and other 3,137 3,768 7,022 8,519
------------- ------------- ------------- -------------
Total operating revenues 145,458 146,819 294,827 288,626
------------- ------------- ------------- -------------
OPERATING EXPENSES:
Fuel costs (Note 2) 50,666 69,704 121,147 124,578
Depreciation 22,227 23,110 44,325 46,624
Operations 3,858 3,899 7,999 7,811
Maintenance 3,134 3,358 6,675 7,051
Property and single business taxes 6,684 6,548 13,369 13,024
Administrative, selling and general 1,932 2,031 3,999 4,915
------------- ------------- ------------- -------------
Total operating expenses 88,501 108,650 197,514 204,003
------------- ------------- ------------- -------------
OPERATING INCOME 56,957 38,169 97,313 84,623
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest and other income 1,561 5,128 3,341 10,680
Interest expense (31,614) (32,854) (62,543) (65,049)
------------- ------------- ------------- -------------
Total other income (expense), net (30,053) (27,726) (59,202) (54,369)
------------- ------------- ------------- -------------
NET INCOME BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 26,904 10,443 38,111 30,254
Cumulative effect of change in method of
accounting for derivative option contracts
(to April 1, 2002) (Note 2) 58,131 - 58,131 -
------------- ------------- ------------- -------------
NET INCOME $ 85,035 $ 10,443 $ 96,242 $ 30,254
============= ============= ============= =============
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)
Three Months Ended
June 30,
---------------------------------------------------------------------------------
2002 2001
------------------------------------- ------------------------------------
General Limited General Limited
Partners Partners Total Partners Partners Total
---------- --------- ---------- ---------- --------- ---------
BALANCE, BEGINNING OF PERIOD $ 497,350 $ 86,958 $ 584,308 $ 470,685 $ 82,994 $553,679
Comprehensive Income:
Net income 74,034 11,001 85,035 9,092 1,351 10,443
Other Comprehensive Income:
Unrealized gain (loss) on hedging
activities since beginning of period 3,410 506 3,916 (15,678) (2,329) (18,007)
Reclassification adjustments
recognized in net income above 2,807 417 3,224 (5,239) (778) (6,017)
---------- --------- ---------- ---------- --------- ---------
Total other comprehensive income change 6,217 923 7,140 (20,917) (3,107) (24,024)
Total Comprehensive Income 80,251 11,924 92,175 (11,825) (1,756) (13,581)
---------- --------- ---------- ---------- --------- ---------
BALANCE, END OF PERIOD $ 577,601 $ 98,882 $ 676,483 $ 458,860 $ 81,238 $540,098
========== ========= ========== ========== ========= =========
Six Months Ended
June 30,
---------------------------------------------------------------------------------
2002 2001
------------------------------------- ------------------------------------
General Limited General Limited
Partners Partners Total Partners Partners Total
---------- --------- ---------- ---------- --------- ---------
BALANCE, BEGINNING OF PERIOD $ 468,972 $ 82,740 $ 551,712 $ 448,100 $ 79,638 $527,738
Comprehensive Income:
Net income 83,791 12,451 96,242 26,340 3,914 30,254
Other Comprehensive Income:
Cumulative effect of accounting change - - - 13,688 2,034 15,722
Unrealized gain (loss) on hedging
activities since beginning of period 16,899 2,511 19,410 (26,486) (3,935) (30,421)
Reclassification adjustments
recognized in net income above 7,939 1,180 9,119 (2,782) (413) (3,195)
---------- --------- ---------- ---------- --------- ---------
Total other comprehensive income charge 24,838 3,691 28,529 (15,580) (2,314) (17,894)
Total Comprehensive Income 108,629 16,142 124,771 10,760 1,600 12,360
---------- --------- ---------- ---------- --------- ---------
BALANCE, END OF PERIOD $ 577,601 $ 98,882 $ 676,483 $ 458,860 $ 81,238 $540,098
========== ========= ========== ========== ========= =========
The accompanying condensed notes are an integral part of this statement.
-3-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
Six Months Ended
June 30,
--------------------------------------
2002 2001
---------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 96,242 $ 30,254
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 45,093 47,479
Cumulative effect of change in accounting principle (58,131) -
Decrease in accounts receivable 53,206 59,523
Decrease (increase) in gas inventory 1,074 (4,230)
Increase in unamortized property taxes (13,566) (13,313)
Decrease (increase) in broker margin accounts and prepaid expenses 23,876 (16,029)
Increase in derivative assets (16,935) -
Decrease in prepaid gas costs, materials and supplies 947 846
Increase (decrease) in accounts payable and accrued liabilities 20,293 (25,067)
Increase (decrease) in interest payable 1,335 (3,338)
Increase in other non-current liabilities 239 169
---------------- -----------------
Net cash provided by operating activities 153,673 76,294
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant equipment (15,772) (16,136)
---------------- -----------------
Net cash used in investing activities (15,772) (16,136)
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (65,240) (66,948)
Maturity of restricted investment securities held-to-maturity 205,034 381,470
Purchase of restricted investment securities held-to-maturity (205,001) (386,062)
---------------- -----------------
Net cash used in financing activities (65,207) (71,540)
---------------- -----------------
NET INCREASE (DECEASE) IN CASH, CASH EQUIVALENTS
AND RESTRICTED CASH - CURRENT 72,694 (11,382)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -
CURRENT, AT BEGINNING OF PERIOD 141,417 206,298
---------------- -----------------
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -
CURRENT, AT END OF PERIOD $ 214,111 $ 194,916
================ =================
The accompanying 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, 2001 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
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' ability to
perform 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, 2002, the Facility achieved a Thermal
Percentage of 19.4% and a PURPA Efficiency Percentage of 47.2%. The loss of
QF status could, among other things, cause the Facility to lose its
-5-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 2002 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 and Consumers agreed to reduce the dispatch level of the
Facility, from time to time. 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, 2002 and 2001, MCV estimates that these
reduced dispatch transactions resulted in net savings of approximately $.9
million and $7.4 million, respectively, a portion of which will be realized
in reduced maintenance expenditures in future years. MCV anticipates using
the same or similar transactions in the future to mitigate the impacts of
high market gas prices, if circumstances warrant such use.
At both the state and federal level, efforts continue to restructure the
electric industry. One significant issue to MCV is the issue of stranded
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 costs including PPA charges.
In 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 2001, the United States Court of Appeals ("Appellate Court")
vacated the U.S. District Court's 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 time and the QFs' (including
MCV) claims are premised on speculation about how an order might be
interpreted 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.
-6-
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, 2002 and December 31, 2001, have original
maturity dates of approximately one year or less. 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.
Accounting for Derivative Instruments and Hedging Activities
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 a 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.
Electric Sales Contracts
On June 27, 2001, and subsequently on December 19, 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 or do not qualify as a derivative
under SFAS No. 133, and as such, does not record the fair value of these
contracts on its balance sheet.
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 the
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 the 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 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,
2002 and December 31, 2001, MCV had forward purchase contracts involving
Swiss Francs in the notional amount of $5.0 million and $10.0 million,
respectively, these hedges are considered highly effective, therefore,
there is no material gain or loss recognized during the periods ended
June 30, 2002 and December 31, 2001.
-7-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Natural Gas Supply Contracts
MCV Management believes that its long-term natural gas contracts, which
do not contain volume optionality, qualify under SFAS No. 133 for the
normal purchases and normal sales exception. Therefore, these contracts
are currently not recognized at fair value on the balance sheet.
The FASB issued implementation guidance, which became effective April
1, 2002, regarding natural gas commodity contracts that combine an option
component and a forward component. This guidance requires either that the
entire contract be accounted for as a derivative or the components of the
contract be separated into two discrete contracts. Under the first
alternative, the entire contract considered together would not qualify
for the normal purchases and sales exception under the revised guidance.
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 with
changes in fair value recorded through earnings. MCV currently has nine
long-term gas contracts that contain both an option and forward
component. As of April 1, 2002, MCV had not separated these contracts. As
such, they are no longer accounted for under the normal purchases and
sales exception and MCV began mark-to-market accounting of these nine
contracts through earnings. Based on the natural gas prices, at the
beginning of April 2002, MCV recorded a $58.1 million gain for the
cumulative effect of this accounting change. As of June 30, 2002, MCV
recorded in "Fuel costs" an additional $15.3 million mark-to-market gain
in earnings, associated with these contracts. For the three months ended
June 30, 2002, MCV has recorded a derivative asset in "Derivative assets"
in the amount of $73.4 million representing the cumulative mark-to-market
gain on these long-term contracts. MCV expects these contracts to cause
future earnings volatility, since changes to this mark-to-market gain
will be recorded on a quarterly basis during the remaining life of
approximately five years for these gas contracts.
Natural Gas Supply 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 lock in sales prices 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 and steam 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 do not qualify as hedges under SFAS No. 133. Therefore, the
resulting mark-to-market gains and losses from cost mitigation activities
are flowed through MCV's 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 as a current asset in "Broker margin accounts and
prepaid expenses," was $10.0 million and $32.0 million as of June 30,
2002 and December 31, 2001, respectively.
Upon the January 1, 2001 adoption of SFAS No. 133, under the transaction
rules, 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, were reflected in
other comprehensive income based on previous hedging relationships. These
futures and options totaled 1.9 Billion cubic feet ("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
-8-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
transactions occurred during the first quarter of 2001. The 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, 2002, MCV has recognized in other
comprehensive income, an unrealized and realized $28.5 million increase
on the futures contracts, which are hedges of forecasted purchases for
plant use of market priced gas, resulting in a net $4.2 million gain
balance in other comprehensive income as of June 30, 2002. This balance
represents natural gas futures and options with maturities ranging from
August 2002 to December 2005 of which $.7 million of this gain is
expected to be reclassified into earnings within the next twelve months.
MCV also has recorded a derivative asset in "Derivative assets" in the
amount of $5.9 million, representing the mark-to-market gain on natural
gas futures for anticipated projected electric and steam sales accounted
for as hedges. In addition, for the six months ended June 30, 2002, MCV
has recorded a net $9.1 million loss in earnings from hedging activities
related to MCV natural gas requirements for Facility operations and a net
of $.3 million gain in earnings from cost mitigation activities. For the
six months ended June 30, 2001, MCV recognized an unrealized and realized
$33.6 million decrease in other comprehensive income 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 recorded a net $4.3 million gain in earnings
from hedging activities and cost mitigation activities.
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 as a current asset in "Broker margin accounts and prepaid
expenses," was approximately $30,000 for both of the periods ending as
of June 30, 2002 and December 31, 2001.
As of June 30, 2002 and December 31, 2001, MCV did not have any interest
rate swap transactions outstanding which qualified for cash flow hedge
accounting. The January 1, 2001 adoption of SFAS No. 133 resulted in an
immaterial cumulative effect accounting change gain recognized in other
comprehensive income, and for the six months ended June 30, 2001, MCV
recorded an immaterial gain in income for the cash flow hedging activity.
MCV has one interest rate swap, with a notional amount of $20 million
with 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, 2002 and 2001, MCV recorded an immaterial gain and a $.6 gain in
earnings, respectively.
-9-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(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,
2002 2001
----------------- -----------------
Current:
-------
Funds restricted for plant modifications $ -- $ 787
================= =================
Non-current:
-----------
Funds restricted for rental payments pursuant to the Overall
Lease Transaction $ 139,141 $ 139,301
Funds restricted for management non-qualified plans 2,293 2,166
----------------- -----------------
Total $ 141,434 $ 141,467
================= =================
(4) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following as of (in
thousands):
June 30, December 31,
2002 2001
----------------- -----------------
Accounts payable
Related parties $ 12,039 $ 10,918
Trade creditors 27,113 24,678
Property and single business taxes 27,837 12,946
Other 2,610 25,054
----------------- -----------------
Total $ 69,599 $ 73,596
================= =================
(5) LONG-TERM DEBT
Long-term debt consists of the following as of (in thousands): June 30, December 31,
2002 2001
----------------- -----------------
Financing obligation, maturing through 2015, payable in
semi-annual installments of principal and interest, secured by
property, plant and equipment $ 1,363,993 $ 1,429,233
Less current portion (116,844) (186,173)
----------------- -----------------
Total long-term debt $ 1,247,149 $ 1,243,060
================= =================
Financing Obligation
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. 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.
-10-
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 MCV 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 six months ended June 30, 2002 and 2001 were $61.8 million and $64.2
million, respectively. Interest and fees paid for the six months ended June
30, 2002 and 2001 were $60.4 million and $67.5 million, respectively.
-11-
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 June 30, 2002, and the
nature and amount of related party transactions or agreements that existed with
the Partners or affiliates as of June 30, 2002 and 2001, and for each of the six
month periods ended June 30 (in thousands).
Beneficial Owner, Equity Partner, Equity
Type of Partner and Nature of Related Party Interest Interest Party Transactions and Agreements 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
CMS Energy Company
- ------------------
CMS Midland, Inc. $331,476 49.0% Power purchase agreements $277,840 $247,827
General Partner; wholly-owned Purchases under gas transportation agreements 11,840 12,163
subsidiary of Consumers Energy Purchases under spot gas agreements 2,821 313
Company Purchases under gas supply agreements 3,707 6,294
Gas storage agreement 1,282 1,282
Land lease/easement agreements 300 300
Accounts receivable 47,706 48,667
Accounts payable 5,145 7,537
Sales under spot gas agreements 1,007 3,551
El Paso Corporation
- -------------------
Source Midland Limited Partnership $117,201 18.1% Purchase under gas transportation agreements 6,462 6,957
("SMLP") General Partner; owned by Purchases under spot gas agreement 7,184 39,779
subsidiaries of El Paso Corporation Purchases under gas supply agreement 21,710 3,240
Gas agency agreement 266 1,182
Deferred reservation charges under gas -- 7,880
purchase agreement
Accounts receivable 569 --
Accounts payable 6,079 4,435
Sales under spot gas agreements 7,013 28,179
Partner cash withdrawal (including accrued -- 55,265
interest) (1)
El Paso Midland, Inc. ("El Paso Midland") 70,321 10.9 See related party activity listed under SMLP.
General Partner; wholly-owned subsidiary
of El Paso Corporation
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
General Partnership Interest 58,603 9.1
Limited Partnership Interest 5,859 .9
Micogen Limited Partnership 29,299 4.5 See related party activity listed under SMLP.
("MLP") Limited Partner, owned
subsidiaries of El Paso Corporation
-------- -------
Total El Paso Corporation $281,283 43.5%
======== =======
The Dow Chemical Company
- ------------------------
The Dow Chemical Company $ 63,723 7.5% Steam and electric power agreement 12,908 16,374
======== =======
Limited Partner Steam purchase agreement - Dow Corning Corp
(affiliate) 2,049 2,030
Purchases under demineralized water supply
agreement 3,361 3,283
Accounts receivable 3,131 2,899
Accounts payable 815 774
Standby and backup fees 363 339
Sales of gas under tolling agreement 4,212 --
Alanna Corporation
- ------------------
Alanna Corporation $ 1 (2) .00001% Note receivable 1 1
-------- -------
Limited Partner; wholly-owned subsidiary
of Alanna Holdings Corporation
Footnotes to Partners' Equity and Related Party Transactions
(1) A letter of credit was issued and recorded as a note receivable from El Paso
Midland, this amount included their share of cash available, as well as,
cash available to MEI, MLP and SMLP.
(2) Alanna's capital stock is pledged to secure MCV's obligation under the lease
and other overall lease transaction documents.
-12-
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, 2001 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,
---------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ -----------
Operating Revenues $ 145,458 $ 146,819 $ 294,827 $ 288,626
Capacity Revenue $ 100,938 $ 102,197 $ 200,482 $ 201,775
PPA Contract Capacity (MW) 1,240 1,240 1,240 1,240
Billed PPA Availability 98.5% 98.5% 98.5% 98.5%
Electric Revenue $ 41,383 $ 40,854 $ 87,323 $ 78,332
PPA Delivery as a Percentage of Contract Capacity (1) 65.9% 63.5% 72.2% 62.9%
PPA, SEPA and Other Electric Deliveries (MWh) 1,921,987 1,877,229 4,151,635 3,677,305
Average PPA Variable Energy Rate ($/MWh) $ 16.00 $ 15.68 $ 15.97 $ 15.56
Average PPA Fixed Energy Rate ($/MWh) $ 3.89 $ 3.79 $ 3.89 $ 3.69
Steam Revenue $ 3,137 $ 3,768 $ 7,022 $ 8,519
Steam Deliveries (Mlbs) 1,247,840 1,294,020 2,868,000 3,041,440
(1) Beginning in July 2000, in response to the rapidly escalating cost of
natural gas, MCV and Consumers agreed to reduce the dispatch level of the
Facility, from time to time. In the event of reduced dispatch, MCV agreed to
share the savings realized by not having to generate the electricity. MCV
anticipates using the same or similar transactions in the future to mitigate
the impacts of high market gas prices, if circumstances warrant such use.
Comparison of the Three Months ended June 30, 2002 and 2001:
Overview:
For the second quarter of 2002, MCV recorded net income of $85.0 million, which
includes the April 1, 2002 change in method of accounting for long-term gas
derivative option contracts. Certain natural gas contracts that contain
optionality are now being marked-to-market through earnings, as required by SFAS
No. 133. The cumulative effect of this accounting change as of April 1, 2002
increased earning by approximately $58.1 million and the additional quarterly
mark-to-market gain recorded at June 30, 2002 in "Fuel costs" resulted in an
additional earning increase of $15.3 million. MCV's recorded net income, without
the effects of the accounting change of $73.4 million, was $11.6 million as
compared to net income of $10.4 million for the second quarter of 2001. The
earnings increase, for the second quarter of 2002 compared to 2001, was
primarily due to lower costs associated with the electric dispatch
-13-
reduction transactions entered into with Consumers, lower interest expense on
MCV's financing arrangements and lower depreciation expense. This increase was
partially offset by lower interest income on MCV's invested cash reserves,
higher natural gas prices under MCV's long-term contracts and lower capacity and
energy revenues under summer option agreements with Consumers.
Operating Revenues:
For the second quarter of 2002, MCV's operating revenues decreased $1.4 million
from the second quarter of 2001. This decrease is due primarily to lower
capacity and energy revenues under summer option agreements with Consumers and
lower energy rates under the SEPA with Dow. This decrease was partially offset
by higher energy rates under the PPA with Consumers.
Operating Expenses:
For the second quarter of 2002, MCV's operating expenses were $88.5 million,
which includes $50.7 million of fuel costs, including a $15.3 million quarterly
mark-to-market gain on the natural gas contracts which contain optionality.
During this period, MCV purchased approximately 18.4 Bcf of natural gas, and a
net 1.7 Bcf was used for transportation fuel and as a net change to gas in
storage. During this same period, MCV consumed 17.3 Bcf of which .6 Bcf of this
total was gas provided by Dow. The average commodity cost of fuel for the second
quarter of 2002 was $3.30 per MMBtu, which includes the effects of the
disposition of excess gas supplies not required for generation. Without the
effects of the disposition of the excess gas supplies, the average commodity
cost of fuel for the second quarter of 2002 would have been $3.55 per MMBtu. 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 Bcf of natural gas, and a net 3.9 Bcf was used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 17.0 Bcf. The average commodity cost of fuel for the first
six months of 2001 was $3.41 per MMBtu, which includes the effects of the
disposition of excess gas supplies not required for generation. Without the
effects of the disposition of the excess gas supplies, the average commodity
cost of fuel for 2001 would have been $3.70 per MMBtu. Fuel costs for the second
quarter of 2002 compared to 2001 decreased by $3.7 million, excluding the $15.3
million quarterly mark-to-market gain. This fuel cost decrease was due to lower
cost associated with electric dispatch reduction transactions entered into with
Consumers and lower gas usage resulting from Dow's election to toll gas in 2002.
This decrease was partially offset by higher natural gas prices under MCV's
long-term gas contracts.
For the second quarter of 2002, operating expenses other than fuel costs
decreased $1.1 million from the second quarter of 2001, primarily resulting from
lower depreciation expense. All other expenses incurred in these periods were
considered normal expenditures to achieve the recorded operating revenues.
Other Income (Expense):
For the second quarter of 2002, interest and other income decreased $3.6 million
compared to 2001, primarily resulting from lower interest rates on MCV's
invested cash and a lower average invested balance. The decrease in interest
expense for the second quarter of 2002 compared to 2001 of $1.2 million is due
to a lower principal balance on MCV's financing obligation.
Comparison of the Six Months ended June 30, 2002 and 2001:
Overview:
For the first six months of 2002, MCV recorded net income of $96.2 million,
which includes the April 1, 2002 change in method of accounting for long-term
gas derivative option contracts. Certain natural gas contracts that contain
optionality are now being marked-to-market through earnings, as required by SFAS
No. 133. The cumulative effect of this accounting change as of April 1, 2002
increased earnings by approximately $58.1 million and the additional quarterly
mark-to-market gain recorded at June 30, 2002 in "Fuel costs" resulted in an
additional earning increase of $15.3 million. MCV's recorded net income, without
the effects of the accounting change of $73.4 million, was $22.8 million as
compared to net income of $30.3 million for the first six months of 2001. The
earnings decrease, for the
-14-
first six months of 2002 compared to 2001, was primarily due to higher natural
gas prices under MCV's long-term contracts, lower interest income on MCV's
invested cash reserves and lower capacity and energy sales under summer option
agreements with Consumers. This decrease was partially offset by lower costs
associated with the electric dispatch reduction transactions entered into with
Consumers, lower interest expense on MCV's financing arrangements and lower
depreciation expense.
Operating Revenues:
For the first six months of 2002, MCV's operating revenues increased $6.2
million from the first six months of 2001. This increase is due primarily to an
increase in the electric dispatch under the PPA and higher energy rates. This
increase was partially offset by lower energy rates under the SEPA with Dow and
lower capacity and energy revenues under summer option agreements with
Consumers.
Operating Expenses:
For the first six months of 2002, MCV's operating expenses were $197.5 million,
which includes $121.1 million of fuel costs, including a $15.3 million quarterly
mark-to-market gain on the natural gas contracts which contain optionality.
During this period, MCV purchased approximately 36.7 Bcf of natural gas, and a
net .7 Bcf was used for transportation fuel and as a net change to gas in
storage. During this same period, MCV consumed 37.4 Bcf of which 1.4 Bcf of this
total was gas provided by Dow. The average commodity cost of fuel for the first
six months of 2002 was $3.19 per MMBtu, which includes the effects of the
disposition of excess gas supplies not required for generation. Without the
effects of the disposition of the excess gas supplies, the average commodity
cost of fuel for the first six months of 2002 would have been $3.33 per MMBtu.
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 used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 34.0 Bcf. The average commodity cost of fuel for the first
six months of 2001 was $3.00 per MMBtu, which includes the effects of the
disposition of excess gas supplies not required for generation. Without the
effects of the disposition of the excess gas supplies, the average commodity
cost of fuel for the first six months of 2001 would have been $3.47 per MMBtu.
Fuel costs for the first six months of 2002 compared to 2001 increased by $11.8
million, excluding the $15.3 million quarterly mark-to-market gain. This fuel
cost increase was due to higher natural gas prices under MCV's long-term gas
contracts and a higher electric dispatch under the PPA. This increase was
partially offset by lower costs associated with the electric dispatch reduction
transaction entered into with Consumers and a lower gas usage resulting from
Dow's election to toll gas.
For the first six months of 2002, operating expenses other than fuel costs
decreased $3.0 million from the first six months of 2001, primarily resulting
from lower depreciation expense. All other expenses incurred in these periods
were considered normal expenditures to achieve the recorded operating revenues.
Other Income (Expense):
For the first six months of 2002, interest and other income decreased $7.3
million compared to 2001, primarily resulting from lower interest rates on MCV's
invested cash and a lower average invested balance. The decrease in interest
expense for the first six months of 2002 compared to 2001 of $2.5 million is due
to a lower principal balance on MCV's financing obligation.
Cumulative Effect of Accounting Change:
Effective April 1, 2002, the FASB issued guidance regarding natural gas
commodity contracts that combine an option component and a forward component.
This guidance requires either that the entire contract be accounted for as a
derivative or the components of the contract be separated into two discrete
contracts. As of April 1, 2002 MCV had nine long-term gas contracts that each
contain both an option and forward component. As such, they are no longer
accounted for under the normal purchases and sales exception and MCV began
mark-to-market accounting of these nine contracts through earnings. Based on the
natural gas prices, at the beginning of April 2002, MCV recorded a $58.1 million
gain for the cumulative effect of this accounting change. MCV expects these
-15-
contracts to cause future earnings volatility, since changes to this
mark-to-market gain will be recorded on a quarterly basis during the remaining
life of the gas contracts, which approximates five years.
Liquidity and Capital Resources
During the six months ended June 30, 2002 and 2001, net cash generated by MCV's
operations was $153.7 million and $76.3 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 thirteen years. During January 2002 and 2001, MCV
paid the basic rent requirements of $125.6 million and $134.4 million,
respectively, as required under the Overall Lease Transaction.
MCV also has arranged for a $45 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. The Working Capital
Facility term currently expires on August 31, 2002; MCV is currently in the
process of renewing its Working Capital Facility and does not anticipate any
delays in completing this renewal prior to the end of August 2002. MCV did not
utilize the Working Capital Facility during the first six months of 2002, except
for letters of credit associated with normal business practices. MCV believes
that amounts available to it under the Working Capital Facility along with
available cash reserves will be sufficient to meet any working capital
shortfalls that might occur.
For the foreseeable future, MCV expects to fund current operating expenses and
payments under the amended Service Agreement primarily through cash flows from
operations. Due to uneven future scheduled rent payments (high summer payment,
low winter payment), MCV anticipates that it will be drawing on its cash
reserves to fund temporary cash flow shortfalls. These cash flow shortfalls are
anticipated to be replenished annually. If necessary, MCV could fund any ongoing
operating cash flow shortfalls from cash reserves to the extent available for
such purposes. As of June 30, 2002, there was approximately $355.5 million of
cash reserves.
Disclosure about Contractual Obligations
MCV has assumed various financial obligations and commitments in the normal
course of its business. These obligations are considered to represent expected
cash payments that MCV is required to make under its existing contractual
arrangements. As of June 30, 2002, MCV has the following contractual financial
obligations and commitments:
Contractual Obligations (In Millions)
---------------------------------------------------------------------------------------------------
(1)
Total 2002 2003 2004 2005 2006 Thereafter
---------------------------------------------------------------------------------------------------
Long-Term Debt (2) $ 2,151.5 $ 178.5 $ 208.9 $ 242.8 $ 174.4 $ 156.0 $ 1,190.9
===================================================================================================
Unconditional Purchase $ 2,717.7 $ 106.5 $ 247.4 $ 268.0 $ 307.7 $ 322.6 $ 1,465.5
Obligations (3)
Other Long-Term
Obligations (4) $ 146.6 $ 12.8 $ 27.4 $ 26.2 $ 27.2 $ 28.2 $ 24.8
---------------------------------------------------------------------------------------------------
Total Contractual Cash
Obligations $ 2,864.3 $ 119.3 $ 274.8 $ 294.2 $ 334.9 $ 350.8 $ 1,490.3
===================================================================================================
(1) Represents obligations from July - December 2002.
(2) Represents expected cash payments including interest.
(3) Represents estimated minimum commitments under current long-term natural gas
contracts, natural gas transportation reservation charges, spare parts
purchases and ground lease agreement.
(4) Represents the cost of current Facility maintenance service agreements.
-16-
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 that 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, Consumers'
ability to perform its obligation under the PPA and present or prospective
wholesale and retail competition, among other factors. The business and
profitability of MCV is also influenced by other factors such as pricing and
transportation of commodities, changes in accounting standards (such as
accounting for derivative instruments and hedging activities) and environmental
legislation/regulation. 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' ability to perform its obligations under the PPA and
maintenance of the Facility's QF status.
Operating Outlook. During the first six months of 2002, 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. Actual PPA availability was 98.5% for the
first six months of 2002, 99.5% for the year 2001 and 98.5% for the year 2000.
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 1999 through June 2002, the unit energy charge (fixed and variable)
paid to MCV has risen by 1.5%, while the average unit variable cost of delivered
fuel for approximately the same period has risen by 19.7%. 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. 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.
-17-
For the year 2002, MCV has entered into gas purchase and hedging arrangements
with respect to most of its expected gas needs 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 2002, 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 in
1997 and 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 (including 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. This order is now final. 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 costs
including PPA charges.
In MCV's federal court challenge to the Restructuring Orders, the U.S. District
Court granted summary judgment to MCV declaring, among other things, 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 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 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 as
opposed to traditional cost-based pricing. In April 1996, FERC issued Order No.
888 requiring all utilities that 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. In December 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 were affirmed by the United States
Court of Appeals for the D.C. Circuit.
-18-
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 2001 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 2001, MCV achieved an Efficiency Percentage of 47.0% and a Thermal Percentage
of 18.3%. During the first six months of 2002, MCV achieved an Efficiency
Percentage of 47.2% and a Thermal Percentage of 19.4%.
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 Trustees and their respective parent companies could
become subject to regulation under the Public Utility Holding Company Act of
1935 (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).
-19-
Critical Accounting Policies
In preparing MCV's financial statements in accordance with accounting principles
generally accepted in the United States, management must make a number of
estimates and assumptions related to the reporting of assets, liabilities,
revenues and expenses. The following areas represent those that management
believes are particularly important to the financial statements and that require
the use of significant estimates and assumptions.
Electric Industry Restructuring. At both the state and federal level, efforts
continue to restructure the electric industry. In 1997 and 1998, the MPSC
entered a series of orders, now final, permitting customers to choose their
power provider over a four-year phase-in period, which started in 1999. In
addition, Michigan enacted restructuring legislation in June 2000. Proposed
restructuring legislation also exists at the federal level. One significant
issue to MCV is the possible future regulatory denial of stranded cost recovery
by Consumers of above-market PPA costs. Over 90% of MCV's revenues come from
sales pursuant to the PPA. To date, restructuring has not negatively impacted
MCV, but if restructuring results in denying stranded cost recovery of
above-market PPA costs, MCV's cash flows may be negatively impacted, especially
in the period after 2007. MCV continues to monitor and participate in these
matters as appropriate, and to evaluate potential impacts on both cash flows and
recoverability of the carrying value of property, plant and equipment. Any
future adjustment to property, plant and equipment, if required, would result in
a one-time negative earnings impact. At this time, MCV management cannot predict
the outcome of these matters or the magnitude of any possible adjustment.
Natural Gas Contracts. Effective January 1, 2001, MCV adopted SFAS No. 133,
which establishes accounting and reporting standards requiring that every
derivative instrument be recorded on 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 MCV's current long-term natural gas contracts
that do not contain volume optionality qualify under SFAS No. 133 for the
normal purchases and sales exception. These long-term gas contracts are
not being marked-to-market with gains or losses recorded in earnings. Should
significant changes in the level of Facility operational dispatch or purchases
of long-term gas occur, MCV would be required to re-evaluate its accounting
treatment for these long-term gas contracts. This re-evaluation may result in
recording mark-to-market activity on some contracts, which could add to earnings
volatility.
Effective April 1, 2002, the FASB issued guidance regarding natural gas
commodity contracts that combine an option component and a forward component.
This guidance requires either that the entire contract be accounted for as a
derivative or that the components of the contract be 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, with changes in
fair value recorded through earnings. MCV currently has nine long-term gas
contracts that each contains both an option and forward component. As of April
1, 2002, MCV has not separated these contracts. As such, they are no longer
accounted for under the normal purchases and sales exception and MCV began
mark-to-market accounting of these contracts through earnings. MCV expects these
contracts to cause future earnings volatility, since these contracts will be
adjusted on a mark-to-market basis and affect future earnings through 2007 (the
expiration date of the last contract).
Property Tax Appeals. MCV currently accrues property taxes on the basis of the
taxable value as assessed by the taxing authorities. MCV has filed property tax
appeals contesting its property taxes for tax years 1997 through 2002. If MCV is
successful in lowering its taxable value for these years, a one-time favorable
earnings adjustment would be recorded. In addition, future property tax expense
would be reduced. At this time, MCV management cannot predict the outcome of
these appeals.
-20-
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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, "Risk Management Activities and Derivative
Transactions" and Note 5, "Long-Term Debt" to the Condensed Notes to Unaudited
Consolidated Financial Statements of MCV.
Interest Rate Risk. 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.
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, 2002, have original maturity dates of approximately
one year or less.
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
June 30, 2002:
Fair
Expected Maturity in Value
-------------------- -----
2002 2003 2004 2005 2006 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
Debt:
- ----
Long-Term Debt Fixed
Rate (in millions) $178.5 $208.9 $242.8 $174.4 $156.0 $1,190.9 $2,151.5 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 $ .3
(in millions)
Avg. Pay Rate 1.74%
Avg. Receive Rate 5.06%
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 lock in sales prices of natural gas previously obtained in order to optimize
MCV's existing gas supply, storage and transportation arrangements.
-21-
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 August 2002 to December 2005.
The table presents the carrying amounts and fair values at June 30, 2002:
Expected Maturity in 2002/2005 Fair Value
------------------------------ ----------
Futures Contracts:
- -----------------
Contract Volumes (10,000 MMBtu) Long/Buy 3,217 --
Contract Volumes (10,000 MMBtu) Short/Sold 36 --
Weighted Average Price Long (per MMBtu) $ 3.542 $ 3.733
Weighted Average Price Short (per MMBtu) $ 3.402 $ 3.245
Contract Amount ($US in Millions) $ 112.7 $ 118.9
Foreign Currency Risk. 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 entered into by
MCV have maturity dates of less than one year. As of June 30, 2002, MCV had
forward purchase contracts involving Swiss Francs in the notional amount of $5.0
million, with a deferred $.8 million gain.
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.
-22-
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 since May 9, 2002. A
complete summary of all outstanding legal proceedings is set forth in MCV's Form
10-K for the year ended December 31, 2001 filed with the Securities and Exchange
Commission on March 25, 2002.
Property Tax Appeal
In June 1997, MCV filed a property tax appeal against the City of Midland at the
Michigan Tax Tribunal contesting MCV's 1997 property taxes. Subsequently, MCV
filed appeals contesting its property taxes for tax years 1998 through 2002 at
the Michigan Tax Tribunal. MCV is seeking reduction of its annual property
taxes on the basis that the City of Midland has over assessed the property's
taxable value for ad valorem property tax purposes. MCV management cannot
predict the outcome of these proceedings.
-23-
Item 6. Exhibits and Reports on Form 8-K
a.) List of Exhibits
99.1 Chief Executive Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Chief Financial Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b.) Reports on Form 8-K
Current report dated May 3, 2002, containing "Item 5, Other Events",
reporting the election of James M. Rajewski as Chief Financial Officer,
Vice President and Controller of MCV and Barbara E. Lawson as Treasurer of
MCV.
Current report dated June 14, 2002, containing "Item 4, Change in
Registrants Certifying Accountant" reporting the engagement of
PricewaterhouseCoopers to serve as MCV's independent public accountants
and "Item 7, Financial Statements, Pro Forma Financial Statements and
Exhibits."
-24-
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 13, 2002 /s/ James M. Kevra
------------------ ---------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: August 13, 2002 /s/ James M. Rajewski
------------------ ----------------------------------
James M. Rajewski
Chief Financial Officer,
Vice President and Controller
-25-
Exhibit Index
Exhibit No. Description
- ----------- -----------
99.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
99.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002