AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 21, 2002
REGISTRATION NO. 333-84206
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
---------------------
CEDAR BRAKES II, L.L.C.
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 4911 76-0613853
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of organization) Classification Code Number) Identification No.)
</Table>
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
TEL: (713) 420-2600
(Address, including ZIP code, and telephone number, including area code of
registrant's principal executive offices)
---------------------
PEGGY HEEG
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
TEL: (713) 420-2600
(Name, address, including ZIP code, and telephone number, including area code,
of agent for service)
---------------------
COPIES OF CORRESPONDENCE TO:
A. ROBERT COLBY, ESQ.
CHADBOURNE & PARKE LLP
30 ROCKEFELLER PLAZA
NEW YORK, NEW YORK 10112
TEL.: (212) 408-5100
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: as soon as practicable after the effective date of this registration
statement.
If any of the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(a), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED JUNE 21, 2002
PROSPECTUS
$431,407,000
CEDAR BRAKES II, L.L.C.
OFFER TO EXCHANGE ALL OUTSTANDING 9.875% SERIES A SENIOR SECURED BONDS
DUE 2013 FOR 9.875% SERIES B SENIOR SECURED BONDS DUE 2013
---------------------
We are offering to exchange all of our outstanding 9.875% Series A Senior
Secured Bonds due 2013 for our registered 9.875% Series B Senior Secured Bonds
due 2013. In this prospectus, we will call the original bonds the "Series A
bonds" and the registered bonds the "Series B bonds." The Series A bonds were
issued on December 12, 2001. The terms of the Series B bonds are substantially
identical to the terms of the Series A bonds, except that we have registered the
Series B bonds with the Securities and Exchange Commission. Because we have
registered the Series B bonds, the Series B bonds will not be subject to
transfer restrictions and will not be entitled to registration rights. The
Series A bonds and Series B bonds are collectively referred to in this
prospectus as the "bonds."
THE SERIES B BONDS
- The Series B bonds will mature on September 1, 2013.
- We will pay interest on the Series B bonds semi-annually on March 1 and
September 1 of each year beginning September 1, 2002 at the rate of
9.875% per annum.
- We may redeem the Series B bonds at any time. The redemption prices we
will pay if we do redeem bonds are specified in the prospectus under
"Description of the Bonds and the Indenture -- Redemption at Our Option."
- The Series B bonds are secured obligations and senior to all our current
indebtedness, other than the Series A bonds, and all our future
indebtedness, other than any additional bonds issued under the indenture.
- The Series B bonds will not be listed on any securities exchange or the
NASDAQ Stock Market.
THE EXCHANGE OFFER
- Subject to customary conditions, which we may waive, the exchange offer
is not conditioned upon a minimum aggregate principal amount of Series A
bonds being tendered.
- Our offer to exchange Series A bonds for Series B bonds will be open
until 5:00 p.m., New York City time, on [ ], 2002, unless we extend
the expiration date.
- You should also carefully review the procedures for tendering the Series
A bonds beginning on page 67 of this prospectus.
- You may withdraw your tenders of Series A bonds at any time prior to the
expiration of the exchange offer, unless we have already accepted your
Series A bonds for exchange.
- If you fail to tender your Series A bonds, you will continue to hold
unregistered securities and your ability to transfer them could be
adversely affected.
- The exchange of Series A bonds for Series B bonds in the exchange offer
will not be a taxable event for U.S. federal income tax purposes.
YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS BEGINNING ON PAGE 14 OF THIS
PROSPECTUS BEFORE PARTICIPATING IN THE EXCHANGE OFFER.
NEITHER THE SEC NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR
DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this prospectus is June __, 2002.
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PROSPECTUS SUMMARY.......................................... 1
RISK FACTORS................................................ 14
USE OF PROCEEDS............................................. 19
CAPITALIZATION.............................................. 20
SELECTED FINANCIAL DATA OF THE COMPANY...................... 20
MANAGEMENT.................................................. 21
PUBLIC SERVICE ELECTRIC AND GAS COMPANY AND SUMMARY
FINANCIAL INFORMATION OF PUBLIC SERVICE ELECTRIC AND GAS
COMPANY................................................... 24
EL PASO CORPORATION AND SUMMARY FINANCIAL INFORMATION OF EL
PASO CORPORATION.......................................... 28
EL PASO MERCHANT............................................ 32
LIMESTONE ELECTRON TRUST.................................... 32
MESQUITE AND CHAPARRAL...................................... 32
CHAPARRAL MANAGEMENT........................................ 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 33
FORWARD LOOKING STATEMENTS.................................. 37
REGULATION OF THE ELECTRIC INDUSTRY......................... 38
THE ENERGY SALES TRANSACTIONS............................... 42
SECURITY OWNERSHIP OF OUR OWNER............................. 45
SUMMARY OF OUR TRANSACTION DOCUMENTS........................ 46
AMENDED POWER PURCHASE AGREEMENT............................ 46
MIRROR POWER PURCHASE AGREEMENT............................. 53
ADMINISTRATIVE SERVICES AGREEMENT........................... 61
EL PASO PERFORMANCE GUARANTY................................ 62
RELATIONSHIPS WITH AFFILIATES AND RELATED TRANSACTIONS...... 64
THE EXCHANGE OFFER.......................................... 64
DESCRIPTION OF THE BONDS AND THE INDENTURE.................. 72
DESCRIPTION OF OUR PRINCIPAL FINANCING DOCUMENTS............ 90
U.S. FEDERAL INCOME TAX CONSEQUENCES........................ 90
ERISA CONSIDERATIONS........................................ 94
PLAN OF DISTRIBUTION........................................ 96
LEGAL MATTERS............................................... 97
EXPERTS..................................................... 97
AVAILABLE INFORMATION....................................... 97
INDEX TO FINANCIAL STATEMENTS............................... F-1
ANNEX A -- MIRROR POWER PURCHASE AGREEMENT ASSESSMENT....... A-1
</Table>
---------------------
You may not transfer or resell the Series B bonds except as permitted under
the Securities Act of 1933 and applicable state securities laws.
You should rely only on the information contained in this document or any
supplement. We have not authorized anyone to provide you with any information
that is different. If you receive any unauthorized information, you must not
rely on it. You should disregard anything we said in an earlier document that is
inconsistent with what is in our prospectus.
You should not assume that the information in this prospectus or any
supplement or any of the information incorporated by reference in this
prospectus or any supplement is current as of any date other than the date on
the front page of this prospectus.
This document is not an offer to sell nor is it seeking an offer to buy
these securities in any state or jurisdiction where the offer or sale is not
permitted.
PROSPECTUS SUMMARY
In this prospectus, the words "Company," "we," "our," "ours" and "us' refer
only to Cedar Brakes II, L.L.C. and not to any of our parent or sister companies
or to anyone else. The following summary contains basic information about us and
the exchange offer. It does not contain all of the information that is important
to you. For a more complete understanding of our business and financial status
and the Series B bonds that we are offering, you should read carefully this
entire prospectus and other documents that we will refer you to. The term "El
Paso" refers to El Paso Corporation, a Delaware corporation. For a discussion of
factors to be considered in connection with an investment in the bonds, see
"Risk Factors." For the definitions of some of the terms used throughout this
prospectus, see "Description of the Bonds and the Indenture -- Defined Terms."
THE EXCHANGE OFFER
On December 12, 2001, we completed a private offering of $431,407,000 of
the Series A bonds. In connection with that offering, we entered into a
registration rights agreement with the initial purchasers in the private
offering of the Series A bonds in which we agreed, among other things, to
deliver this prospectus and to complete this exchange offer within 270 days of
the original issuance of the Series A bonds. You are entitled to exchange in
this exchange offer Series A bonds that you hold for registered Series B bonds
with substantially identical terms. You should read the discussion under the
headings "Summary of the Terms of the Series B Bonds" beginning on page 5 and
"Description of the Bonds and the Indenture" beginning on page 72 for further
information regarding the Series B bonds.
We believe that the Series B bonds that will be issued in this exchange
offer may be resold by you without compliance with the registration and
prospectus delivery provisions of the Securities Act. You should read the
discussion under the headings "Summary of the Terms of the Exchange Offer"
beginning on page 3 and "The Exchange Offer" beginning on page 64 for further
information regarding this exchange offer and resale of the Series B bonds.
OUR COMPANY AND BUSINESS
We were formed as a Delaware limited liability company on May 3, 2001
solely to:
- obtain the right, title and interest to two long-term power purchase
agreements;
- sell electric energy and provide electric capacity under an amended and
restated power purchase agreement;
- enter into other related agreements, a bond indenture and related
financing documents and undertake the transactions contemplated
thereunder;
- engage in other activities that are related to or incidental to the above
items; and
- issue the bonds.
Our sole business is the sale of electric energy and the provision of
electric capacity to Public Service Electric and Gas Company, a New Jersey
corporation, under an amended and restated power purchase agreement that we
entered into with Public Service Electric on May 23, 2001, which became
effective upon the consummation of the offering of the Series A bonds. The
amended and restated power purchase agreement combined and superseded two
pre-existing long-term power purchase agreements originally entered into with
Public Service Electric by Cogen Technologies NJ Venture, a New Jersey general
partnership, and Camden Cogen L.P., a Delaware limited partnership, two of our
affiliates. The two pre-existing long-term power purchase agreements provided
for the purchase by Public Service Electric of energy and capacity from gas-
fired, combined-cycle cogeneration facilities located in Bayonne, New Jersey and
Camden, New Jersey. Upon the consummation of the offering of the Series A bonds,
Cogen Technologies and Camden Cogen transferred the pre-existing agreements to
us. In this prospectus, we refer to these pre-existing power purchase agreements
1
as the Bayonne power purchase agreement and the Camden power purchase agreement,
and to our amended and restated power purchase agreement as the amended power
purchase agreement.
We are classified as a public utility subject to regulation by the Federal
Energy Regulatory Commission under the Federal Power Act. We have no employees.
Our material assets are comprised of the amended power purchase agreement,
receivables that are generated or accrue under the amended power purchase
agreement, the proceeds of such receivables, our interest in the amounts held in
our accounts described in this prospectus and the following additional
contracts, which, together with the amended power purchase agreement, we refer
to as our material agreements:
- the mirror power purchase agreement, dated October 1, 2001, with El Paso
Merchant Energy, L.P., a subsidiary of El Paso, as amended on November
26, 2001;
- the administrative services agreement, dated as of December 12, 2001,
with El Paso Merchant;
- the guaranty, dated as of December 12, 2001, by El Paso of El Paso
Merchant's performance under the mirror power purchase agreement and the
administrative services agreement;
- a consent and agreement that we entered into with Public Service Electric
and the trustee on December 12, 2001;
- a consent and agreement that we entered into with El Paso Merchant and
the trustee on December 12, 2001; and
- a consent and agreement that we entered into with El Paso and the trustee
on December 12, 2001.
For more information about our material agreements, see "Summary of Our
Transaction Documents" below.
Our company is owned directly 100% by Mesquite Investors, L.L.C. Mesquite
is owned indirectly by El Paso and Limestone Electron Trust. A wholly-owned
subsidiary of El Paso, El Paso Chaparral Management, L.P., manages the
operations of Mesquite. See "Chaparral Management." Our operations are managed
through our administrative services agreement with El Paso Merchant. Our
principal executive offices are located at 1001 Louisiana Street, Houston, Texas
77002. Our telephone number is (713) 420-2600.
For a more detailed description of our organization and ownership
structure, please see "Management" and the chart on page 21.
RATIO OF EARNINGS TO FIXED CHARGES
For the quarter ended March 31, 2002, our earnings were not adequate to
cover fixed charges by approximately $3.3 million. For the period from May 3,
2001 to December 31, 2001, our ratio of earnings to fixed charges was 98.4 to
1.00. Because we were organized on May 3, 2001, we cannot calculate a ratio of
earnings to fixed charges for any prior periods. For the purposes of calculating
the ratio of earnings available to cover fixed charges:
- earnings consist of income from continuing operations plus fixed charges,
and
- fixed charges consist of interest on borrowings (whether expensed or
capitalized).
All other components of the ratio of earnings to fixed charges were not
applicable since we had no such items. In addition, this ratio includes the
initially recorded market value on our power purchase agreements of $228.2
million for the period from inception (May 3, 2001) to December 31, 2001, which
is not expected to recur. Had this item been excluded for the period from
inception (May 3, 2001) to December 31, 2001, our earnings during the period
would not have covered our fixed charges by $25,000.
2
SUMMARY OF THE TERMS OF THE EXCHANGE OFFER
The Exchange Offer............ We are offering to exchange up to $431,407,000
principal amount of the Series B bonds for up
to $431,407,000 principal amount of the Series
A bonds. As of the date of this prospectus,
Series A bonds representing $431,407,000
aggregate principal amount are outstanding. The
Series B bonds will evidence the same debt as
the Series A bonds, and the Series A bonds and
the Series B bonds will be governed by the same
indenture.
The Series B bonds are described in detail
under the heading "Description of the Bonds and
the Indenture" beginning on page 72 of this
prospectus.
Resale........................ We believe that you will be able to freely
transfer the Series B bonds without
registration or any prospectus delivery
requirement; however, some broker-dealers and
some of our affiliates may be required to
deliver copies of this prospectus if they
resell any Series B bonds.
Expiration Date............... The exchange offer will expire at 5:00 p.m.,
New York City time, [ ], 2002 or a later
date and time if we extend it.
Withdrawal.................... You may withdraw the tender of any Series A
bonds pursuant to the exchange offer at any
time prior to the expiration date. We will
return, as promptly as practicable after the
expiration or termination of the exchange
offer, any Series A bonds not accepted for
exchange for any reason without expense to you.
Interest on the Series B Bonds
and the Series A Bonds........ Interest on the Series B bonds will accrue from
the date of the original issuance of the Series
A bonds or from the date of the last payment of
interest on the Series A bonds, whichever is
later. No additional interest will be paid on
Series A bonds tendered and accepted for
exchange.
Conditions to the Exchange
Offer......................... The exchange offer is not subject to any
conditions other than that it does not violate
applicable law or any applicable interpretation
of the staff of the SEC. See "The Exchange
Offer -- Conditions of the Exchange Offer"
beginning on page 70 of this prospectus.
Procedures for Tendering
Series A Bonds................ If you wish to accept the exchange offer, you
must complete, sign and date the accompanying
letter of transmittal in accordance with the
instructions in the letter of transmittal, and
deliver the letter of transmittal, along with
the Series A bonds and any other required
documentation, to the exchange agent. By
executing the letter of transmittal, you will
represent to us that, among other things:
- any Series B bonds you receive will be
acquired in the ordinary course of business,
- you are not participating, and you have no
arrangement or understanding with any person
to participate, in the distribution of the
Series B bonds, and
- you are not an affiliate of ours or a
broker-dealer tendering Series A bonds
acquired directly from us.
3
If you are not a broker-dealer, you will also
be representing that you are not engaged in and
do not intend to engage in a distribution of
the Series B bonds.
Each broker-dealer receiving Series B bonds for
its own account in exchange for Series A bonds
must acknowledge that it will deliver a
prospectus meeting the requirements of the
Securities Act in connection with any resale of
the Series B bonds. The letter of transmittal
states that, by making this acknowledgement and
by delivering a prospectus, a broker-dealer
will not be deemed to admit that it is an
"underwriter" within the meaning of the
Securities Act. A broker-dealer who acquired
the Series A bonds for its own account as a
result of market-making or other trading
activities may use this prospectus for an offer
to resell, resale or other transfer of the
Series B bonds.
If you hold your Series A bonds through The
Depository Trust Company and wish to
participate in the exchange offer, you may do
so through Depository Trust's Automated Tender
Offer Program. By participating in the exchange
offer, you will agree to be bound by the letter
of transmittal as though you had executed such
letter of transmittal.
We will accept for exchange any and all Series
A bonds which are properly tendered (and not
withdrawn) in the exchange offer prior to the
expiration date. The Series B bonds issued
pursuant to the exchange offer will be
delivered promptly following the expiration
date. See "The Exchange Offer -- Acceptance of
Series A Bonds for Exchange" beginning on page
66 of this prospectus.
Effect of Not Tendering....... Series A bonds that are not tendered or that
are tendered but not accepted will, following
the completion of the exchange offer, continue
to be subject to the existing restrictions upon
transfer thereof. We will have no further
obligation to provide for the registration
under the Securities Act of such Series A
bonds.
Special Procedures for
Beneficial Owners............. If you are a beneficial owner whose Series A
bonds are registered in the name of a broker,
dealer, commercial bank, trust company or other
nominee and wish to tender such Series A bonds
in the exchange offer, please contact the
registered holder as soon as possible and
instruct them to tender on your behalf and
comply with our instructions set forth
elsewhere in this prospectus.
Guaranteed Delivery
Procedures.................... If you wish to tender your Series A bonds, you
may, in some instances, do so according to the
guaranteed delivery procedures set forth
elsewhere in this prospectus under "The
Exchange Offer -- Procedures for Tendering
Series A Bonds -- Guaranteed Delivery"
beginning on page 68 of this prospectus.
Registration Rights
Agreement..................... We sold the Series A bonds on December 12,
2001, to the initial purchaser in a transaction
that was exempt from the SEC's registration
requirements. In connection with the sale, we
entered into a registration rights agreement
with the initial purchaser which grants the
holders of the Series A bonds specified
exchange and registration rights. This exchange
offer satisfies those rights, which
4
terminate upon consummation of the exchange
offer. You will not be entitled to any exchange
or registration rights with respect to the
Series B bonds.
U.S. Federal Income Tax
Considerations................ We believe the exchange of Series A bonds for
Series B bonds pursuant to the exchange offer
will not constitute a sale or an exchange for
federal income tax purposes. See "U.S. Federal
Income Tax Consequences" beginning on page 90
of this prospectus.
Use of Proceeds............... We will not receive any proceeds from the
exchange of bonds pursuant to the exchange
offer.
Exchange Agent................ We have appointed Deutsche Bank Trust Company
Americas as the exchange agent for the exchange
offer. The mailing address and telephone number
of the exchange agent are DB Services
Tennessee, Inc., Reorganization Unit, P.O. Box
292737, Nashville, Tennessee 37229-2737, (615)
835-3572. See "The Exchange Offer -- Exchange
Agent" beginning on page 71 of this prospectus.
SUMMARY OF THE TERMS OF THE SERIES B BONDS
The form and term of the Series B bonds are substantially the same as the
form and term of the Series A bonds, except that the Series B bonds are
registered under the Securities Act. As a result, the Series B bonds will not
bear legends restricting their transfer and will not contain the registration
rights contained in the Series A bonds.
Issuer........................ Cedar Brakes II, L.L.C., a Delaware limited
liability company.
Bonds Offered................. $431,407,000 aggregate principal amount of
9.875% Series B Senior Secured Bonds due
September 1, 2013. The Series B bonds are
secured obligations and senior to all our
current indebtedness, other than the Series A
bonds, and all our future indebtedness, other
than any additional bonds issued under the
indenture.
Additional Bonds.............. Pursuant to the terms of the indenture, we may
issue additional bonds (which will rank pari
passu with the Series A bonds and bonds issued
in this offering) at any time after the initial
offering of the Series A bonds provided that,
after giving effect to such issuance, we
maintain a minimum and average Debt Service
Coverage Ratio of no less than 1.03 to 1.00 and
we obtain a reaffirmation of the initial
ratings of the bonds.
Maturity Date................. September 1, 2013.
Interest Payment Dates........ The first calendar day of each March and
September (or if that day is not a business
day, then the next succeeding business day),
commencing on September 1, 2002. A business day
is a day on which banks are not required or
authorized to close in the City of New York.
Principal Payment Dates and
Amortization.................. We are required to pay principal on the bonds
semi-annually on the first calendar day of each
March and September (or if that day is
5
not a business day, then the next succeeding
business day), commencing on September 1, 2002:
<Table>
<Caption>
PERCENTAGE OF ORIGINAL
PRINCIPAL AMOUNT
PRINCIPAL PAYMENT DATE PAYABLE
---------------------- ----------------------
September 1, 2002.................... 1.35%
March 1, 2003........................ 2.90%
September 1, 2003.................... 2.26%
March 1, 2004........................ 2.70%
September 1, 2004.................... 2.77%
March 1, 2005........................ 3.24%
September 1, 2005.................... 3.33%
March 1, 2006........................ 3.84%
September 1, 2006.................... 3.95%
March 1, 2007........................ 4.50%
September 1, 2007.................... 4.63%
March 1, 2008........................ 5.24%
September 1, 2008.................... 5.50%
March 1, 2009........................ 5.28%
September 1, 2009.................... 4.43%
March 1, 2010........................ 4.96%
September 1, 2010.................... 5.11%
March 1, 2011........................ 5.69%
September 1, 2011.................... 5.87%
March 1, 2012........................ 6.49%
September 1, 2012.................... 6.70%
March 1, 2013........................ 8.09%
September 1, 2013.................... 1.17%
</Table>
Ratings....................... Baa2 by Moody's, BBB- by Standard & Poor's and
BBB by Fitch.
Limited Recourse
Obligations................... The obligations to pay principal, interest and
Make-Whole Premium (if any, with respect to
bonds called for optional redemption) on the
bonds will be solely our obligations. You will
not have any other recourse against any
incorporator, stockholder, member, manager,
officer or director of ours or any of our
members for any failure by us to satisfy
obligations under the bonds.
Collateral.................... We granted to the trustee on the closing date
of the offering of the Series A bonds, on
behalf of and for the benefit of the holders of
bonds, a security interest in all of our right,
title and interest in and to all of our assets,
namely:
- our material agreements;
- our collections and all amounts payable to us
arising out of, attributable to, in respect
of or otherwise in connection with our
collections;
- all other amounts payable to us pursuant to
our material agreements;
6
- all accounts and all funds and all
investments and proceeds on deposit therein
from time to time (other than the proceeds of
additional bonds issued under the indenture);
- all damages and other amounts payable to us
in respect of the foregoing;
- all of our rights, claims, powers, privileges
and remedies with respect to the foregoing;
and
- all present and future claims and demands in
respect of any or all of the foregoing.
In this prospectus, "collections" means all
amounts payable to us from Public Service
Electric pursuant to the amended power purchase
agreement and amounts payable by:
- El Paso Merchant pursuant to Article V(E) and
Article V(F) of the mirror power purchase
agreement to cover any shortfall payments;
- El Paso Merchant pursuant to Article IV(B) of
the mirror power purchase agreement to cover
any excess amounts;
- El Paso pursuant to the El Paso performance
guaranty to cover any shortfall payments and
excess amounts of El Paso Merchant under
Article IV(B), Article V(E) and Article V(F)
of the mirror power purchase agreement; and
- all earnings on permitted investments from
amounts in the collections account and the
liquidity account.
Redemption at Our Option...... We may choose to redeem the bonds, in whole or
in part, at any time, at our option on not less
than 30 nor more than 60 days notice to the
bond holders at a redemption price equal to the
outstanding principal amount of the bonds to be
redeemed, plus accrued interest on these bonds
to the date of the redemption, plus a Make-
Whole Premium, if any. The Make-Whole Premium
is based on the rates of United States Treasury
securities with average lives comparable to the
remaining average lives of the applicable
bonds, plus 50 basis points. A Make-Whole
Premium will not be payable other than in
connection with our optional redemption of the
bonds.
Accounts...................... Pursuant to the indenture, the trustee
established the following accounts: (1) the
collections account, (2) the liquidity account
and (3) the damages and indemnity account. See
"Description of the Bonds and the
Indenture -- The Accounts."
Collections Account........... All collections and all transfer payments from
the liquidity account will be deposited into
the collections account. Amounts on deposit in
the collections account (other than the
proceeds of additional bonds issued under the
indenture) must be used to make payments in
accordance with the priorities set forth in
"Description of the Bonds and the
Indenture -- Withdrawals from the Collections
Account."
Liquidity Account............. On the closing date of the offering of the
Series A bonds, we deposited into the liquidity
account $21.1 million, an amount equal
7
to the liquidity reserve required balance. This
amount was part of the proceeds from the Series
A bonds offering. In the event sufficient funds
are not available in the collections account to
pay the principal or interest on the bonds,
amounts in the liquidity account will be
transferred into the collections account and
used by the trustee to pay this shortfall.
Amounts withdrawn from the liquidity account
will be replenished from the collections
account in accordance with the priority set
forth in "Description of the Bonds and the
Indenture -- Withdrawals from the Collections
Account." The cash on deposit in the liquidity
account may be made available for transfer to
El Paso if El Paso replaces such funds with one
or more acceptable letters of credit from an
acceptable financial institution or an
acceptable guaranty from El Paso equal in
aggregate amount to the amount to be
transferred to El Paso from the liquidity
account. Amounts in excess of the liquidity
reserve required balance on deposit in the
liquidity account on any semi-annual payment
date will be transferred on the next
semi-annual payment date to the collections
account.
Damages and Indemnity
Account....................... All payments to be made by El Paso Merchant
under the mirror power purchase agreement, and
by El Paso, if any, under the El Paso
performance guaranty, to cover:
- damages payable by us to Public Service
Electric as a result of our default under the
amended power purchase agreement;
- indemnity payments payable by us to Public
Service Electric on account of third-party
liability claims under the amended power
purchase agreement; and
- distribution surcharges payable by us to
Public Service Electric on account of the
fact that these distribution surcharges were
not paid to Public Service Electric because
of a statutory exemption under New Jersey
law;
will be made to the damages and indemnity
account and subsequently used to pay such
damages, indemnity payments and distribution
surcharges.
Withdrawals from the
Collections Account........... The trustee must apply amounts in the
collections account (other than proceeds of
additional bonds issued under the indenture) as
follows, and in the following order of
priority:
- monthly, to transfer to the trustee the
amount of the trustee's monthly fees;
- monthly, to pay El Paso Merchant for the
capacity and energy that El Paso Merchant
sold to us under the mirror power purchase
agreement;
- semi-annually, to the payment of interest due
on the bonds;
- semi-annually, to the payment of principal
and, with respect to bonds called for
optional redemption, Make-Whole Premium (if
any), due on the bonds;
8
- semi-annually, to replenish amounts drawn
from the liquidity account so as to maintain
the liquidity reserve required balance;
- semi-annually, to pay El Paso Merchant's fees
and expenses under the administrative
services agreement;
- semi-annually, to us for distribution to our
members; provided that (1) no event of
default (or other event which would with
notice or lapse of time or both become an
event of default) has occurred and is
continuing and (2) the debt service coverage
ratio for the preceding six-month period is
equal to or exceeds 1.03 to 1.00.
Principal Covenants........... The indenture contains a number of covenants on
our part, including:
- restrictions on the incurrence of additional
indebtedness;
- limitations on liens and encumbrances, except
to the extent that failure to comply could
not reasonably be expected to result in a
material adverse effect;
- restrictions on the payments of distributions
to our members or any owner of a beneficial
interest in us;
- limitations on the sale, lease or transfer of
the collateral, except to the extent that
failure to comply could not reasonably be
expected to result in a material adverse
effect, and on mergers, changes in legal form
or other fundamental changes;
- a prohibition on undertaking obligations with
respect to any guaranty;
- a prohibition on terminating any of our
material agreements;
- limitations on transactions entered into with
affiliates;
- limitations on investments in other entities;
- an obligation to maintain the perfection and
priority of the security interest of the
trustee in the collateral;
- an obligation to maintain our legal
existence;
- an obligation to comply with applicable laws,
except to the extent that failure to comply
could not reasonably be expected to result in
a material adverse effect;
- restrictions on our use of the proceeds from
the issuance of the bonds;
- restrictions on our agreeing to the
assignment of the rights or obligations of
any material party to any material agreement;
- limitations on the assignment of our rights
and obligations under any of our material
agreements and the amendment of our material
agreements, and limitations on our entering
into additional contracts, except to the
extent that failure to comply could not
reasonably be expected to result in a
material adverse effect; and
9
- an obligation to schedule and deliver the
annual energy deliveries.
See "Description of the Bonds and the
Indenture -- Covenants in the Indenture."
Events of Default and
Remedies...................... An event of default will occur under the
indenture if:
- we fail to pay any principal or Make-Whole
Premium, if any, with respect to bonds called
for optional redemption, on the bonds when
due and payable and this default continues
for 5 days;
- we fail to pay any interest or any other
amount required to be paid with respect to
the bonds and this default continues for 15
days;
- we, Public Service Electric or El Paso fail
to perform any term, covenant or obligation
contained in any of our material agreements
or any financing document, unless in each
case failure to perform could not reasonably
be expected to result in a material adverse
effect, and such failure continues for 30
days after we are provided notice of such
failure;
- any of our material agreements or financing
documents becomes or is found to be
unenforceable or invalid, and that event
could reasonably be expected to result in a
material adverse effect;
- the trustee's liens on any material portion
of the collateral cease to be valid and
perfected first priority security interests
or any of our other creditors asserts any
right or interest with respect to the
collateral, or our right to receive payments
with respect to the collateral is terminated
or impaired and such assertion of rights or
interests or termination or impairment could
reasonably be expected to result in a
material adverse effect;
- specified events occur related to our
insolvency, such as the commencement of a
liquidation or dissolution proceeding
unstayed for 60 consecutive days or the
filing by us of a voluntary bankruptcy
proceeding;
- it becomes unlawful for us to perform any of
our obligations under the indenture, any
security document or any bond, or any of our
obligations under the indenture, any security
document or any bond ceases to be valid,
binding or enforceable, unless such event or
occurrence could not reasonably be expected
to result in a material adverse effect;
- any of the amended power purchase agreement
or the El Paso performance guaranty
terminates or is abrogated before the end of
its term;
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- one or more judgments or decrees are entered
against us in excess of $15 million in the
aggregate which are not adequately covered by
insurance or vacated, discharged, stayed or
bonded pending appeal within 60 days from the
entry thereof; or
- we fail to observe or perform specified
covenants in the registration rights
agreement with the initial purchaser, and
such failure continues for 30 days after
notice is given to us.
If an event of default (other than an event of
default caused by our bankruptcy) occurs and is
continuing, then the trustee, upon the
direction of the holders of not less than 25%
(for an event of default with respect to
failure to make payments on the bonds) or the
holders of not less than 51% (for any other
event of default) in aggregate principal amount
of the outstanding bonds, must declare the
principal amount of all outstanding bonds to be
immediately due and payable and upon any such
declaration the principal amount, all accrued
and unpaid interest, any Make-Whole Premium
then owed by us in connection with an optional
redemption of the bonds and all other amounts
payable under the bonds will become immediately
due and payable. If a bankruptcy event of
default occurs, the principal amount of,
accrued interest on, Make-Whole Premium then
owed by us in connection with an optional
redemption of the bonds and all other amounts
payable under the bonds will automatically
become immediately due and payable. See
"Description of the Bonds and the
Indenture -- Remedies."
Indenture Trustee............. Deutsche Bank Trust Company Americas (formerly
known as Bankers Trust Company).
Paying Agent, Registrar and
Transfer Agent................ Deutsche Bank Trust Company Americas (formerly
known as Bankers Trust Company).
Governing Law and
Jurisdiction.................. The bonds, the indenture and the other
financing documents are governed by the laws of
the State of New York.
11
SUMMARY OVERVIEW OF OUR ENERGY SALES TRANSACTIONS
The following chart depicts some of our material agreements, the
transaction structure of our energy sales and the relationship to payments on
the bonds:
(GRAPH)
THE TRANSACTIONS
The Bayonne power purchase agreement and the Camden power purchase
agreement were transferred to us from Cogen Technologies and Camden Cogen, two
of our affiliates, upon the consummation of the offering of the Series A bonds.
The amended power purchase agreement combined and superceded the Bayonne power
purchase agreement and Camden power purchase agreement. We expect that interest
and principal on the bonds will be paid solely from payments by Public Service
Electric to us under the amended power purchase agreement (as supplemented, if
revenues from these capacity and energy payments are not available, by funds in
the liquidity account). All scheduled payments of principal and interest on the
bonds have been calculated so as to be paid from the total amount of the
payments that we expect to receive each year from Public Service Electric. We
have entered into the mirror power purchase agreement and an administrative
services agreement with El Paso Merchant in order to have El Paso Merchant
perform all of our obligations and exercise all of our rights under all of our
material agreements and the indenture and the related financing documents under
which the Series A bonds were issued and the Series B bonds will be issued. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations"; "The Energy Sales Transactions"; and "Summary of Our Transaction
Documents."
The energy sales transactions required approval by the Federal Energy
Regulatory Commission of the rates contained in the amended power purchase
agreement and the mirror power purchase agreement and approval by the New Jersey
Board of Public Utilities of the cost recovery by Public Service Electric of the
rates charged under the amended power purchase agreement. In addition, the
issuance of the bonds also required the approval of the Federal Energy
Regulatory Commission. All of these approvals have been obtained and are final
and non-appealable. See "Regulation."
12
MIRROR POWER PURCHASE AGREEMENT ASSESSMENT
Pace Global Energy Services, LLC, an energy consulting firm that
specializes in, among other things, market forecasts in the electric power and
natural gas industries, prepared a mirror power purchase agreement assessment
dated December 7, 2001, included as Annex A to this prospectus. We sought this
analysis by Pace to support our decision to enter into the mirror power purchase
agreement with its "energy-only" fixed contract rate structure and to evaluate
whether the electric power capacity resources in the East Pennsylvania-New
Jersey-Maryland ("East PJM") power market are sufficient to allow El Paso
Merchant to perform its obligations under the mirror power purchase agreement.
Based upon Pace's analysis of the East PJM power market and a review of the
relevant portions of our transaction documents, Pace believes that the contract
rates stipulated in the mirror power purchase agreement reasonably reflect
market prices for the East PJM power market if the energy delivery flexibility
that El Paso Merchant has under the mirror power purchase agreement is taken
into consideration. Specifically, the mirror power purchase agreement structure
grants the supplier volume flexibility to supply more energy in hours when the
prices are expected to be relatively low. This volume flexibility enables El
Paso Merchant to deliver energy at lower prices against the amended power
purchase agreement than the market average, given that the low price hours are
effectively selected to put against the mirror power purchase agreement.
Moreover, Pace believes that the East PJM market offers sufficient power
resources to enable El Paso Merchant to meet its contractual supply obligations
under the mirror power purchase agreement.
Since the date of the mirror power purchase agreement, Pace has not updated
the natural gas prices in that assessment. Since the date on which we entered
into the amended power purchase agreement and the mirror power purchase
agreement, natural gas prices have decreased. Because the prices at which we buy
and sell electric power are fixed by these agreements, changes in the price of
natural gas will not affect our ability to make payments on the bonds, provided
that the other parties to these agreements fulfill their obligations.
The mirror power purchase agreement assessment is meant to be read only in
its entirety and is subject to the restrictions set forth in the legal notice on
its cover page. The mirror power purchase agreement assessment and the legal
notice should be read in their entirety by all prospective investors.
13
RISK FACTORS
An investment in our bonds involves a significant degree of risk, including
the risks described below. You should carefully consider the following
information about these risks, together with the other information in this
prospectus, prior to exchanging your Series A bonds for our Series B bonds.
WE ARE RELYING ON PAYMENTS FROM PUBLIC SERVICE ELECTRIC UNDER THE AMENDED POWER
PURCHASE AGREEMENT FOR OUR PRIMARY SOURCE OF REVENUES.
Public Service Electric is our sole customer for purchases of electric
energy and payments for providing electric generating capacity. Public Service
Electric's payments pursuant to the amended power purchase agreement are
expected to provide 100% of our revenues. We cannot assure you that Public
Service Electric will fulfill its payment obligations under the amended power
purchase agreement. In the event of a bankruptcy of Public Service Electric,
Public Service Electric or the bankruptcy trustee could reject its payment
obligations under the amended power purchase agreement. If Public Service
Electric fails to meet its payment obligations under the amended power purchase
agreement, we will not be able to meet our obligations to make payments of
principal and interest on the bonds. Further, under the amended power purchase
agreement, Public Service Electric may suspend its obligations to accept
delivery of energy if specified events beyond the control of Public Service
Electric occur, such as a system emergency, adverse weather conditions or labor
disputes. Accordingly, we will have no revenues for the duration of these events
and we cannot assure you that we will be able to make payments of principal and
interest on the bonds during the continuance of these events.
IF WE FAIL TO PROVIDE ELECTRIC ENERGY AND CAPACITY TO PUBLIC SERVICE ELECTRIC,
IT COULD RESULT IN TERMINATION OF THE AMENDED POWER PURCHASE AGREEMENT PRIOR TO
THE MATURITY OF THE BONDS.
If we cause or permit to occur an event of default under the amended power
purchase agreement, Public Service Electric may have the right to terminate the
amended power purchase agreement. The amended power purchase agreement expressly
provides that, with respect to defaults that result from our failure to deliver
energy and provide capacity, Public Service Electric shall be entitled to deduct
amounts (determined pursuant to a formula in the amended power purchase
agreement) from payments due to us as liquidated damages. Although the amended
power purchase agreement provides that these liquidated damages are the only
damages that Public Service Electric can claim as a result of any failure by us
to deliver energy or provide capacity, Public Service Electric could take the
position that it is entitled to other remedies provided under applicable law,
such as the right to terminate the power purchase agreement. Therefore, if one
of our defaults has occurred and is continuing, Public Service Electric could
also seek to terminate the amended power purchase agreement.
WE ARE RELYING UPON EL PASO MERCHANT AND EL PASO TO PERFORM OUR OBLIGATIONS
UNDER OUR MATERIAL AGREEMENTS OR, UPON FAILING TO DO SO (WITHOUT EXCUSE), TO
MAKE PAYMENTS TO US.
Under the mirror power purchase agreement and the administrative services
agreement, El Paso Merchant is obligated to exercise our rights and perform all
of our administrative and management obligations under our material agreements,
including exercising our right under the mirror power purchase agreement to
schedule, purchase and have delivered to us the energy that we are required to
deliver and the capacity we are required to provide, and, in the event of an
unexcused failure to make such deliveries, pay to us the amounts that we would
be required to pay to Public Service Electric under the amended power purchase
agreement. If El Paso Merchant fails to perform its obligations under the mirror
power purchase agreement or the administrative services agreement, we will not
be able to perform our obligations to Public Service Electric under the amended
power purchase agreement and our obligations under our other material
agreements. In that situation, unless El Paso Merchant is excused, El Paso
Merchant would be required to make shortfall payments to us for its failure to
schedule and deliver energy under the mirror power purchase agreement or
payments for its failure to perform under the administrative services agreement,
as the case may be. However, we cannot assure you that El Paso Merchant will be
able to make these payments.
14
If El Paso Merchant cannot make these payments, El Paso is required to pay
these amounts pursuant to the El Paso performance guaranty. We cannot assure you
that El Paso will fulfill its obligations under the El Paso performance
guaranty. If, to the extent called upon, El Paso fails to meet its obligations
under the El Paso performance guaranty, we will not be able to meet our
obligations to make payments of interest and principal on the bonds.
Under the mirror power purchase agreement, El Paso Merchant is excused from
its obligation to schedule hourly or seasonal energy deliveries if specified
events beyond the control of El Paso Merchant occur, such as adverse weather
conditions or labor disputes. In this event, neither El Paso Merchant nor El
Paso will be obligated to make shortfall payments. However, except for our
declining to accept energy deliveries because of a potential emergency on the
PJM or on Public Service Electric's system, such events do not excuse or suspend
El Paso Merchant's obligation to make the energy shortfall liquidated damage
payments or the annual energy deliveries.
The obligations of El Paso Merchant under the mirror power purchase
agreement and the administrative services agreement, and of El Paso under the El
Paso performance guaranty, do not constitute a direct or indirect obligation of
El Paso Merchant or El Paso to make any payment on the bonds.
IF THE MIRROR POWER PURCHASE AGREEMENT OR ADMINISTRATIVE SERVICES AGREEMENT
TERMINATES, WE CANNOT ASSURE YOU THAT WE WILL BE ABLE TO OBTAIN EQUIVALENT
REPLACEMENT SERVICES.
Each of the mirror power purchase agreement and the administrative services
agreement provides that it may be terminated prior to its scheduled expiration
date upon the occurrence of events set forth in the agreements, such as a
payment default by us. We are a special purpose entity and we do not have any
employees or our own source of capacity and energy. In the event of a
termination of the mirror power purchase agreement or the administrative
services agreement, we cannot assure you that replacement services can be
obtained on terms as favorable as those under the current agreements. If the
mirror power purchase agreement or the administrative services agreement
terminates, we may not be able to make payments of principal and interest on the
bonds.
OUR REVENUE PROJECTIONS ASSUME THAT CAPACITY RESOURCES WITHIN THE PJM MARKET ARE
SUFFICIENT TO ENSURE THAT EL PASO MERCHANT CAN MEET ITS CONTRACTUAL OBLIGATIONS
UNDER THE MIRROR POWER PURCHASE AGREEMENT.
Based upon the mirror power purchase agreement assessment, we have assumed
that El Paso Merchant will be able to perform its energy delivery and capacity
provision obligations under the mirror power purchase agreement. According to
the mirror power purchase agreement assessment, there may be times when the PJM
electric transmission system may experience disruptions due to system component
failures or act-of-god events. As a result of the occurrence of such events, El
Paso Merchant may not be able to meet its obligations, and we, in turn, may not
be able to sell a sufficient amount of energy to Public Service Electric under
the amended power purchase agreement. While we have provided for energy
shortfall liquidated damage payments from El Paso Merchant, El Paso Merchant may
be excused from making these payments as a result of a system emergency that is
not a force majeure. If this occurs, we will not be able to make payments of
principal and interest on the bonds.
THERE WILL BE CONFLICTS OF INTEREST UNDER OUR AGREEMENTS WITH EL PASO MERCHANT
AND EL PASO.
El Paso Merchant and El Paso are affiliates of each other, and an affiliate
of each of them manages Mesquite, our parent. In negotiating the administrative
services agreement, the mirror power purchase agreement and the El Paso
performance guaranty, we believe that we provided at the time of their consent
terms that are substantially similar to those that might have been obtained from
unaffiliated third parties. However, because the negotiations with respect to
these agreements did not actually involve an unaffiliated third party, we cannot
assure you that those documents actually or that they will continue to meet that
standard.
Furthermore, in carrying out their obligations under our material
agreements to which they are parties, El Paso Merchant and El Paso may face
conflicts of interest in making decisions that affect us. In some situations, El
Paso Merchant may be required under the administrative services agreement to
enforce our
15
rights against itself under the mirror power purchase agreement or against its
ultimate parent, El Paso, under the El Paso performance guaranty. For example,
under the administrative services agreement, El Paso Merchant is required to
exercise our rights under the mirror power purchase agreement, which includes
enforcing our right to receive payments, such as shortfall payments and other
damages, from El Paso Merchant. Although El Paso Merchant and El Paso have
agreed to carry out their obligations to us in a manner that is
nondiscriminatory to us, as a practical matter our ability to monitor compliance
is limited. As a result, we cannot guarantee that El Paso Merchant and El Paso
will carry out their obligations to us in a manner that is nondiscriminatory to
us. If they do not, we may not be able to fulfill our obligations under the
amended power purchase agreement and Public Service Electric may have the right
to terminate the amended power purchase agreement. In the event that Public
Service Electric terminates the amended power purchase agreement due to our
inability to fulfill our obligations under that agreement, we will not be able
to make payments of principal and interest on the bonds.
WE ARE THE ONLY PARTY REQUIRED TO MAKE PAYMENTS ON THE BONDS AND, IF WE DEFAULT
ON THE BONDS, YOUR RECOURSE AND YOUR ABILITY TO ACT MAY BE LIMITED.
We are the only party required to make payments on the bonds. We conduct no
other business, and have no significant assets, other than our rights and
obligations under our material agreements. We have no operating history and no
experience in the purchase or sale of energy. No other entity, including Public
Service Electric, El Paso Merchant or El Paso, and none of our or their
affiliates, shareholders, members, officers, directors or employees, will be
required to make payments on the bonds or will in any way guarantee the payment
of principal, interest or premium (if any) on the bonds.
A number of actions to enforce the rights of the holders, such as
acceleration of the principal, interest and Make-Whole Premium, if any, with
respect to bonds called for optional redemption, on the bonds, may be taken by
the trustee only with the approval of holders of 25% of the outstanding
principal amount of the bonds. A majority of the outstanding principal amount of
the bonds must approve the trustee's actions to enforce the rights of the
holders in the event of all other defaults (other than bankruptcy events). These
requirements of holder approval may limit the ability of the trustee to exercise
specific remedies or prolong the time required for the trustee to act. See
"Description of the Bonds and the Indenture -- Remedies."
OUR BUSINESS IS SUBJECT TO SUBSTANTIAL REGULATIONS AND PERMITTING REQUIREMENTS
AND MAY BE ADVERSELY AFFECTED IF WE ARE UNABLE TO COMPLY WITH EXISTING
REGULATIONS OR REQUIREMENTS OR CHANGES IN APPLICABLE REGULATIONS OR
REQUIREMENTS.
Our business is subject to extensive energy regulation by federal, state
and local authorities, as are the businesses of Public Service Electric, El Paso
Merchant and El Paso. These regulations impose numerous requirements on the
performance of our, Public Service Electric's, El Paso Merchant's and El Paso's
obligations under the amended power purchase agreement, the mirror power
purchase agreement and the El Paso performance guaranty, and failure to comply
with these requirements could prevent the performance of our respective
obligations under these agreements.
The Federal Energy Regulatory Commission currently considers contracts for
the wholesale sale of electric power to be subject to its jurisdiction.
Consequently, the mirror power purchase agreement must be filed with the Federal
Energy Regulatory Commission within 30 days after its effectiveness and any
proposed transfer of either or both the amended power purchase agreement and the
mirror power purchase agreement, including a transfer to the trustee upon
foreclosure, is subject to Federal Energy Regulatory Commission approval, and
any modification of the amended power purchase agreement or the mirror power
purchase agreement would be required to be filed with the Federal Energy
Regulatory Commission and may require Federal Energy Regulatory Commission
approval as well. The Federal Energy Regulatory Commission has pre-approved all
of our currently contemplated future security issuances and assumptions of
liability (including the issuance of the bonds offered hereby). Any further
security issuances and assumptions of liability by us would require pre-approval
by the Federal Energy Regulatory Commission in the event that our power
marketing authorization from the Federal Energy Regulatory Commission is
revoked.
16
The negotiated rates contained in the amended power purchase agreement and
the mirror power purchase agreement require approval by the Federal Energy
Regulatory Commission. Although the Federal Energy Regulatory Commission has
approved the rates to be charged in the amended power purchase agreement and the
mirror power purchase agreement, the Federal Energy Regulatory Commission has
continuing jurisdiction over those rates. The Federal Energy Regulatory
Commission would have to meet a high burden in order to modify the rates, and,
as a matter of practice and policy, the Federal Energy Regulatory Commission has
refused to modify rates after initial approval. We cannot assure you, however,
that the Federal Energy Regulatory Commission will permit those rates to remain
in place for the term of the amended power purchase agreement and the mirror
power purchase agreement, and, in such event, the rates that we are permitted to
charge could be lower, resulting in less cash available for us to make debt
service payments on the bonds.
The marketing of electric power at market-based or negotiated rates
requires a power marketing authorization issued by the Federal Energy Regulatory
Commission based on several criteria, including a showing that the applicant
lacks market power and that there is no opportunity for abusive transactions
involving regulated affiliates of the marketer. Although El Paso Merchant has
received these power marketing authorizations from the Federal Energy Regulatory
Commission, these authorizations could be revoked if El Paso Merchant fails in
the future to satisfy the applicable criteria or if the Federal Energy
Regulatory Commission changes its rate-making policies.
We cannot assure you that the existing laws and regulations will not be
revised or reinterpreted, that new laws and regulations will not be adopted or
become applicable to us or the parties on whom we are relying in this
transaction or that future changes in laws and regulations will not have a
detrimental effect on our or their business. In addition, the structure of
federal and state energy regulation is currently, and may continue to be,
subject to challenges and restructuring proposals. Although not currently
required, additional regulatory approvals may be required in the future due to a
change in laws and regulations or for other reasons. We cannot assure you that
we, Public Service Electric, El Paso Merchant or El Paso will be able to obtain
all required regulatory approvals that may be required in the future, or any
necessary modifications to existing regulatory approvals, or maintain all
required regulatory approvals. Such modifications could result in the loss of
our status as a power marketer and our ability to sell the capacity and energy
to Public Service Electric at the negotiated rates set forth in the amended
power purchase agreement. In this event, we could be required to sell to Public
Service Electric at lower rates.
If there is a change in regulations, or a delay in obtaining any regulatory
approvals or we, Public Service Electric, El Paso Merchant or El Paso fail to
obtain or comply with any required regulatory approvals, then we may not be able
to comply with our obligations under our material agreements and we will be
unable to meet our obligations to make payments of principal and interest on the
bonds.
OUR ABILITY TO MAKE PAYMENT ON THE BONDS MAY BE AFFECTED IN A BANKRUPTCY OF ANY
OF THE COUNTERPARTIES TO OUR MATERIAL AGREEMENTS.
The amended power purchase agreement, mirror power purchase agreement,
administrative services agreement or the El Paso performance guaranty may be
treated as executory contracts by any bankruptcy court having jurisdiction over
them. As a result, in the event of the bankruptcy of Public Service Electric, El
Paso Merchant or El Paso, the bankrupt party or the bankruptcy trustee could
reject any or all of the amended power purchase agreement, mirror power purchase
agreement, administrative services agreement or the El Paso performance guaranty
if they are found to be executory contracts. Rejection of a contract is treated
as a breach of the contract and would result in our having an unsecured claim
against the estate of the debtor for damages as a result of the breach.
IN THE EVENT OF OUR OWN BANKRUPTCY, THE ABILITY OF THE HOLDERS OF THE BONDS TO
FORECLOSE WILL BE AFFECTED BY THE AUTOMATIC STAY IN BANKRUPTCY.
In the event of our own bankruptcy, the holders would have a secured claim
against us for the amounts due under the bonds. The holders' claim would be
secured by their interest in the collateral. Absent relief
17
granted by the bankruptcy judge from the automatic stay in bankruptcy, however,
the holders would not be permitted to foreclose on any of the collateral and,
even following such a foreclosure, there may not be sufficient funds to pay all
amounts due in respect of the bonds.
IT MAY BE DIFFICULT TO REALIZE THE VALUE OF THE COLLATERAL PLEDGED TO SECURE THE
BONDS.
Our obligation to make payments on the bonds is secured only by the
collateral described in this prospectus. The trustee's ability to foreclose on
the collateral on your behalf may be subject to perfection, the consent of third
parties such as Public Service Electric and El Paso Merchant, priority issues
and practical problems associated with the realization of the trustee's security
interest in the collateral. In addition, pursuant to the consent and agreement
with Public Service Electric, in the event that the trustee or any designee and
assignee succeeds to our interests under the amended power purchase agreement,
this successor will assume liability for our obligations under the amended power
purchase agreement, including those obligations arising prior to such
succession. We cannot assure you that foreclosure on the collateral will be
sufficient to make all payments on the bonds.
THERE IS NO EXISTING MARKET FOR THE BONDS AND WE CANNOT ASSURE YOU THAT AN
ACTIVE TRADING MARKET WILL DEVELOP FOR THE BONDS.
We have been informed by the initial purchaser of the Series A bonds that
it intends to make a market in the bonds after the completion of this offering.
However, the initial purchaser is not required to make a market in the bonds,
and it may cease market-making at any time without notice. We cannot assure you
that an active market for the bonds will develop despite the fact that they were
registered. Moreover, even if a market for the bonds does develop, the bonds
could trade at a discount from their face amount. If a market for the bonds does
not develop, you may be unable to resell the bonds for an extended period of
time, if at all. Consequently, you may not be able to liquidate your investment
readily, and lenders may not readily accept the bonds as collateral for loans.
IF YOU DO NOT PROPERLY TENDER YOUR SERIES A BONDS, YOU WILL CONTINUE TO HOLD
UNREGISTERED SERIES A BONDS AND YOUR ABILITY TO TRANSFER SERIES A BONDS WILL BE
ADVERSELY AFFECTED.
We will only issue Series B bonds in exchange for Series A bonds that are
timely received by the exchange agent together with all required documents,
including a properly completed and signed letter of transmittal. Therefore, you
should allow sufficient time to ensure timely delivery of the Series A bonds and
you should carefully follow the instructions on how to tender your Series A
bonds. Neither we nor the exchange agent are required to tell you of any defects
or irregularities with respect to your tender of the Series A bonds. If you do
not tender your Series A bonds or if we do not accept your Series A bonds
because you did not tender your Series A bonds properly, then, after we
consummate the exchange offer, you may continue to hold Series A bonds that are
subject to the existing transfer restrictions. After the exchange offer is
consummated, if you continue to hold any Series A bonds, you may have difficulty
selling them because there will be fewer Series A bonds outstanding.
THE MARKET VALUE OF THE SERIES B BONDS COULD BE MATERIALLY ADVERSELY AFFECTED IF
ONLY A LIMITED NUMBER OF SERIES B BONDS ARE AVAILABLE FOR TRADING.
To the extent that a large amount of the Series A bonds are not tendered or
are tendered and not accepted in the exchange offer, the trading market for the
Series B bonds could be materially adversely affected. Generally, a limited
amount, or "float," of a security could result in less demand to purchase such
security and, as a result, could result in lower prices for such security. We
cannot assure you that a sufficient number of Series A bonds will be exchanged
for Series B bonds so that this does not occur.
HOLDERS OF BENEFICIAL INTERESTS IN GLOBAL BONDS MAY BE UNABLE TO TRANSFER OR
PLEDGE SUCH INTERESTS IF PHYSICAL DELIVERY IS REQUIRED BY APPLICABLE LAW.
Holders may take their interests in the bonds through owning beneficial
interests in global bonds. The laws of some jurisdictions may require that the
holders take physical delivery of bonds in definitive form.
18
Accordingly, the ability to transfer beneficial interests in a global bond to
these persons may be limited. Also, because The Depository Trust Company can
only act on behalf of indirect participants and specific banks, the ability of a
person having a beneficial interest in a global bond to pledge that interest to
persons or entities that do not participate in The Depository Trust Company
system, or otherwise take actions in respect of that interest, may be affected
by the lack of a physical certificate representing that interest.
NONE OF US, ANY OF OUR AFFILIATES OR THE INITIAL PURCHASER OF THE SERIES A BONDS
HAS PERFORMED DUE DILIGENCE ON THE CONSOLIDATED FINANCIAL STATEMENTS OF PUBLIC
SERVICE ELECTRIC.
None of us, any of our affiliates or the initial purchaser of the Series A
bonds, nor any of our or their respective affiliates or representatives, have
performed due diligence on the consolidated financial statements of Public
Service Electric from which the summary financial information provided herein
was transcribed. Accordingly, none of us, any of our affiliates or the initial
purchaser makes any representation as to the truth, completeness or adequacy of
disclosure of such information. In particular, none of us, any of our affiliates
or the initial purchaser of the Series A bonds has reviewed Public Service
Electric's consolidated financial statements to determine (1) the reasonableness
of the assumptions, judgments and methodologies utilized by Public Service
Electric in preparing the consolidated financial statements, (2) whether such
assumptions, judgments and methodologies should be supplemented in any way
through the use of alternative assumptions, judgments and methodologies, or (3)
whether the use of alternative assumptions, judgments and methodologies could
yield results materially different from those generated by Public Service
Electric. Thus, none of us, any of our affiliates or the initial purchaser of
the Series A bonds can assure you that Public Service Electric's consolidated
financial statements or the summary financial information of Public Service
Electric transcribed from such statements fairly present, in all material
respects, the financial position of Public Service Electric.
USE OF PROCEEDS
We will not receive any cash proceeds from the issuance of the Series B
bonds. In consideration for issuing the Series B bonds as contemplated in this
prospectus, we will receive, in exchange, Series A bonds in like principal
amount, which will be cancelled, and as such will not result in any increase in
our indebtedness.
Our net proceeds from the offering of the Series A bonds were approximately
$418.7 million. We used the net proceeds as follows:
(1) to make a payment in the amount of $64.0 million to Public Service
Electric pursuant to the terms of the amended power purchase agreement;
(2) to fund the liquidity account in an amount equal to $21.0 million;
(3) to pay costs, fees and expenses incurred in connection with the
transactions contemplated by the indenture; and
(4) to pay a cash distribution of the remaining proceeds to Mesquite,
our sole member.
19
CAPITALIZATION
The capitalization of our company as of March 31, 2002 consisted of ten
membership interests which had an aggregate balance of approximately $190.3
million and long-term indebtedness of approximately $406.9 million.
SELECTED FINANCIAL DATA OF THE COMPANY
Set forth below is summary financial data of our company. Our summary
historical balance sheet data as of March 31, 2002 and the summary historical
statement of operations for the quarter ended March 31, 2002 are derived from
the unaudited financial statements included elsewhere in this prospectus. Our
summary historical balance sheet data as of December 31, 2001 and the summary
historical statement of income for the period from our formation in May 2001 to
December 31, 2001 are derived from the audited financial statements included
elsewhere in this prospectus. See those financial statements for a further
discussion of the amounts presented below:
<Table>
<Caption>
QUARTER
ENDED PERIOD ENDED
MARCH 31, DECEMBER 31,
2002 2001
--------- ------------
SUMMARY BALANCE SHEET DATA (in thousands):
Total assets.............................................. $651,921 $ 655,394
Long-term liabilities..................................... 420,215 448,221
Member's equity........................................... 190,282 193,581
SUMMARY OPERATING DATA (in thousands):
Operating revenues........................................ $ 26,364 $ 7,019
Operating income.......................................... 7,612 2,299
Other (income) expense.................................... 10,911 (225,894)
Net income (loss)......................................... (3,299) 228,193
</Table>
We engaged in no operations between our formation on May 3, 2001 and
December 12, 2001.
20
MANAGEMENT
We are a wholly-owned direct subsidiary of Mesquite. Mesquite is owned
indirectly by El Paso and Limestone. El Paso Chaparral Management, L.P., a
wholly-owned indirect subsidiary of El Paso, manages the operations of Mesquite.
See "Chaparral Management." Pursuant to our limited liability company agreement,
all management powers of our company are vested in a management committee
comprised of five managers, consisting of three Class A managers and two Class B
managers. The Class A managers are designated by Mesquite. The Class B managers
must be independent and cannot be associated with any of our affiliates. A
voluntary bankruptcy petition cannot be filed by us unless the Class B managers
vote to file this bankruptcy petition. Except for bankruptcy, dissolution and
similar limited matters, the Class B managers do not exercise any power over the
management, conduct or control of the business, operations or affairs of the
company, and the vote of a majority of the Class A managers present at a meeting
constitutes the act of the management committee. Our day-to-day operations are
managed by officers and employees of El Paso Merchant under the administrative
services agreement with us. Our principal executive offices are located at 1001
Louisiana Street, Houston, Texas 77002. Our telephone number is (713) 420-2600.
The following chart sets forth a detailed description of our ownership
structure.
[EL PASO CORP. FLOW GRAPH]
21
The following table sets forth information relating to the business
experience of our executive officers and managers:
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
Clark C. Smith............ 47 President
John L. Harrison.......... 43 Senior Vice President, Chief Financial Officer and Class
A Manager
Cecilia T. Heilmann....... 34 Vice President, Managing Director and Controller
Timothy Sullivan.......... 40 Class A Manager
Kurt Regulski............. 43 Class A Manager
Dean A. Christiansen...... 42 Class B Manager
Henry C. Mustin........... 68 Class B Manager
</Table>
Clark C. Smith is our President. He is also President of El Paso Merchant,
which includes the combined unregulated natural gas and power service businesses
of El Paso. Mr. Smith has over 22 years of industry experience. He has been with
El Paso Merchant since 2000. Mr. Smith was formerly President and Chief
Executive Officer of Engage Energy, Inc., a natural gas power services venture
of The Coastal Corporation, and Westcoast Energy Inc. of Vancouver, British
Columbia. In 1988, Mr. Smith joined The Coastal Corporation as President and
Chief Executive Officer of Coastal Gas Marketing Company, and later assumed
responsibility for the formation of Coastal Gas Marketing Canada and Coastal
Electric Services Company. Mr. Smith began his business career with El Paso
Natural Gas Company in 1978, where he held various positions in regulatory
affairs, systems development and gas accounting. He joined Enron Corp. the next
year as Director of Marketing for Transwestern Pipeline Company. Later, he
became Executive Vice President of Transwestern Pipeline Company's marketing,
gas supply and state regulatory affairs. Mr. Smith earned bachelor's and
master's degrees in business administration from the University of Texas at
Austin.
John L. Harrison is our Senior Vice President, Chief Financial Officer and
a Class A Manager. He is also Senior Managing Director and Chief Financial
Officer of El Paso Merchant. Mr. Harrison has over 20 years of energy industry
experience. He joined El Paso Merchant in 1996. From 1981 until joining El Paso
Merchant, Mr. Harrison was an audit partner and held other positions in the
audit practice of Coopers & Lybrand, LLP, where he specialized in the energy
industry with an emphasis in trading and control environments. Mr. Harrison
received a bachelor's degree in business administration from Texas A&M
University and is a certified public accountant.
Cecilia T. Heilmann is our Vice President, Managing Director and
Controller. She is also Vice President, Managing Director and Controller of El
Paso Merchant. Ms. Heilmann has over eight years of industry experience. Ms.
Heilmann began her business career with El Paso in 1992, where she held various
positions in corporate accounting and strategic planning. In 1998, Ms. Heilmann
became Director of Corporate Planning for El Paso, and, in 1999, she joined El
Paso Merchant as Controller. As Controller for El Paso Merchant, she oversees
accounting, planning and credit activities. Ms. Heilmann received a bachelor's
degree in accounting from the University of Texas at El Paso, and is a certified
public accountant.
Timothy Sullivan, a Class A Manager, is Managing Director of Restructuring
for El Paso Merchant. He has over 18 years of industry experience. Mr. Sullivan
is primarily responsible for El Paso Merchant's financial structuring and
restructuring activities throughout North America. Mr. Sullivan joined El Paso
Merchant in 1998. Mr. Sullivan was previously a Senior Vice President with
Citizens Power in Boston from 1995 to 1997, during which time he participated in
and led financing activities relating to project financings. During 1994, Mr.
Sullivan was a Manager for Enron Power Marketing in Houston, Texas, where he had
responsibility for the marketing of wholesale electric power in the northeast.
Prior to joining Enron, Mr. Sullivan held various positions over a twelve-year
period with Niagara Mohawk Power Corporation in Syracuse, New York, where he was
responsible for negotiating non-utility and wholesale electric power purchase
and sale agreements. Mr. Sullivan holds both a Bachelor of Science and a Master
of Business Administration degree from Syracuse University.
22
Kurt Regulski, a Class A Manager, is responsible for managing El Paso
Merchant's cross-commodity positions, which consist of power and gas positions
related to power plant assets. Mr. Regulski has over 20 years of experience in
the energy industry. Mr. Regulski began in the energy industry as an engineer
for Southern Natural Gas Company, where he worked in a variety of engineering
and technical support positions, including Division Manager and Manager of
Process Reengineering from 1980 to 1994. Mr. Regulski joined Sonat Marketing in
1995 as Manager, Southeast Trading, with responsibilities for managing storage,
basis and physical gas positions in the southeast U.S. He joined Sonat Power
Marketing in 1997 as Director, Power Trading, with management and trading
responsibilities for the term power trading desk. Mr. Regulski joined El Paso
Merchant in 1999, following Sonat's merger with El Paso, Mr. Regulski has a
degree in Mechanical Engineering from Vanderbilt University.
Dean A. Christiansen, a Class B Manager, has been President of Lord
Securities Corporation, a firm specializing in providing services to structured
finance transactions, since October 2000. In his position with Lord, he serves
as an officer, manager, member and/or director of several special purpose
entities. Prior to his employment with Lord, in 1990 Mr. Christiansen founded
Acacia Capital, Inc. a New York City based corporate advisory firm. Mr.
Christiansen is a 1983 graduate of the University of Notre Dame with a degree in
Government.
Vice Admiral Henry C. Mustin (USN, Retired), a Class B Manager, is the
Chairman of the Board of his own consulting company, and serves as a director on
a number of board and committees. Admiral Mustin formed his company in 1992.
From 1989 to 1992, he was the Vice President for International Marketing for the
Kaman Corporation. Admiral Mustin served as an officer in the U.S. Navy for 34
years, during which time he served variously as Deputy Chief of Naval
Operations, Senior Military Representative to the United Nations, a member of
the Joint Chiefs of Staff and a major NATO Commander. Admiral Mustin has a
Bachelor of Arts degree from the U.S. Naval Academy, a Bachelor of Science
degree in electrical engineering from the Naval Post-Graduate Academy in
Monterey, California, a Master of Science in International Affairs from the
George Washington University and is a Distinguished Graduate of the Naval War
College.
All officers have served since May 3, 2001, the date of our formation. Our
Class A Managers and Vice Admiral Mustin have served since December 8, 2001. Mr.
Christiansen has served as a Class B Manager since December 10, 2001. Our Class
A Managers serve until resignation or the next annual meeting of members and
until their respective successors are elected and qualified. Our officers serve
until removal or resignation. Our Class B Managers serve until their successors
are elected and qualified.
Our Class A Managers and our officers are also officers of El Paso or its
affiliates. Such managers and officers may spend a substantial amount of time
managing the business and affairs of El Paso and its affiliates. Since our
day-to-day operations are managed by employees of El Paso Merchant pursuant to
the administrative services agreement, we do not expect that our managers and
officers will face a conflict regarding the allocation of their time between our
interests and the other business interests of El Paso and its affiliates.
Our Class A Managers and officers do not receive any compensation from us.
We do not sponsor any employee benefit plans or arrangements. Our officers and
managers receive compensation from and participate in benefit plans sponsored by
El Paso and its affiliates. The Class B Managers receive a nominal annual fee
for serving on our management committee. El Paso Merchant receives a fee of
$50,000 semi-annually for the services it performs under the Administrative
Services Agreement and is entitled to reimbursement for all expenses other than
internal and overhead costs. El Paso Merchant is responsible for the
compensation of its employees, including our executive officers and Class A
Managers.
23
PUBLIC SERVICE ELECTRIC AND GAS COMPANY AND
SUMMARY FINANCIAL INFORMATION OF
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
PUBLIC SERVICE ELECTRIC
Public Service Electric is an operating public utility company engaged
principally in the transmission, distribution and sale of electric energy and
gas service in the state of New Jersey.
Public Service Electric's senior secured debt is rated A3 by Moody's, A- by
Standard and Poor's, and A by Fitch.
SUMMARY FINANCIAL INFORMATION OF PUBLIC SERVICE ELECTRIC
We present below summary financial information for Public Service Electric
as of and for each of the periods indicated.
Public Service Electric is a public company which files reports, proxy
statements and other information, including financial reports, with the SEC. The
summary financial information of Public Service Electric included in this
prospectus has been derived from its annual report on Form 10-K for the fiscal
year ended December 31, 2001, and quarterly report on Form 10-Q for the
quarterly period ended March 31, 2002. Copies of that report can be obtained
from the SEC. See "Available Information."
We make no representation as to the accuracy or completeness of the summary
financial information of Public Service Electric or that any event has or has
not occurred which would affect the accuracy or completeness thereof.
Public Service Electric has neither guaranteed the payment of principal,
interest or premium (if any) on the bonds nor the performance by us of our
obligations with respect to the bonds. If we fail to pay principal or interest
on the bonds, Public Service Electric will not be obligated to make any such
payments. As a result, the following financial information is neither intended
to indicate, nor should it be construed as an indication, that Public Service
Electric will pay our obligations under the bonds when they become due in the
event we do not make such payments.
24
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
SUMMARY CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT RATIO OF EARNINGS TO FIXED CHARGES)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
-------------------------- --------------------------
2002 2001 2001 2000 1999
----------- ----------- ------ ------ ------
(UNAUDITED) (UNAUDITED)
Operating revenues...................... $ 1,659 $ 1,952 $6,091 $7,359 $7,640
Operating expenses...................... 1,449 1,705 5,409 6,091 6,042
--------- --------- ------ ------ ------
Operating income........................ 210 247 682 1,268 1,598
Other, net.............................. (100) (58) (358) (274) (435)
--------- --------- ------ ------ ------
Income from continuing operations before
income tax expense.................... 110 189 324 994 1,163
Income tax expense...................... (42) (77) (89) (407) (510)
--------- --------- ------ ------ ------
Income before extraordinary item........ 68 112 235 587 653
Extraordinary item, net of income
taxes................................. -- -- -- -- (804)
--------- --------- ------ ------ ------
Net income (loss)....................... 68 112 235 587 (151)
Preferred stock dividends............... (1) (3) (5) (9) (9)
--------- --------- ------ ------ ------
Earnings (loss) available to Public
Service Enterprise Group
Incorporated.......................... $ 67 $ 109 $ 230 $ 578 $ (160)
========= ========= ====== ====== ======
Ratio of earnings to fixed charges...... 2.03x 3.63x 1.83x 3.15x 3.58x
========= ========= ====== ====== ======
</Table>
25
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<Table>
<Caption>
DECEMBER 31,
MARCH 31, -----------------
2002 2001 2000
----------- ------- -------
(UNAUDITED)
ASSETS
Current assets.............................................. $ 1,367 $ 1,549 $ 1,491
Property, plant, and equipment, net......................... 5,837 5,841 5,760
Other noncurrent assets..................................... 5,485 5,573 8,016
------- ------- -------
Total assets................................................ $12,689 $12,963 $15,267
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities......................................... $ 1,798 $ 1,786 $ 2,644
Long-term debt.............................................. 4,797 4,977 3,590
Noncurrent liabilities...................................... 3,574 3,595 3,835
Minority interest........................................... 235 235 683
Stockholders' equity........................................ 2,285 2,370 4,515
------- ------- -------
Total liabilities and stockholders' equity.................. $12,689 $12,963 $15,267
======= ======= =======
</Table>
26
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
SUMMARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
-------------------------- ------------------------
2002 2001 2001 2000 1999
----------- ----------- ------- ----- ------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities
Net income (loss)......................... $ 68 $ 112 $ 235 $ 587 $ (151)
Adjustments to reconcile net income (loss)
to net cash flows from operating
activities............................. 11 4 85 446 1,305
Working capital changes................... 146 60 93 (110) (91)
Other..................................... 87 (26) (2) (26) 87
------- ------- ------- ----- ------
Net cash provided by operating
activities........................ 312 150 411 897 1,150
------- ------- ------- ----- ------
Cash flows from investing activities
Additions to property, plant and
equipment.............................. (80) (63) (398) (401) (479)
Other..................................... (64) (3) (126) (19) (104)
------- ------- ------- ----- ------
Net cash used in investing
activities........................ (144) (66) (524) (420) (583)
------- ------- ------- ----- ------
Cash flows from financing activities
Net change in short-term debt............. -- (1,386) (1,543) 68 625
Net change in long-term debt.............. (24) 2,474 1,955 (32) (423)
Other..................................... (152) (1,118) (236) (647) (638)
------- ------- ------- ----- ------
Net cash provided by (used in)
financing activities.............. (176) (30) 176 (611) (436)
------- ------- ------- ----- ------
Net change in cash and cash equivalents..... (8) 54 63 (134) 131
Cash and cash equivalents at beginning of
period.................................... 102 39 39 173 42
------- ------- ------- ----- ------
Cash and cash equivalents at end of
period.................................... $ 94 $ 93 $ 102 $ 39 $ 173
======= ======= ======= ===== ======
</Table>
27
EL PASO CORPORATION AND
SUMMARY FINANCIAL INFORMATION OF EL PASO CORPORATION
EL PASO
El Paso indirectly owns approximately 20% of the ownership interest in us,
subject to adjustment upon specified events. El Paso is a global energy company
with a significant presence in the rapidly evolving wholesale energy industry.
El Paso's principal operations include: natural gas transportation,
gathering, processing, and storage; energy and energy-related commodity and
products marketing; power generation; petroleum refining; chemicals production;
energy infrastructure facility development and operation; natural gas and oil
exploration, development and production; and coal mining.
El Paso's senior unsecured debt is rated Baa2 by Moody's and BBB by
Standard and Poor's.
SUMMARY FINANCIAL INFORMATION OF EL PASO
We present below summary financial information for El Paso as of and for
each of the periods indicated.
El Paso is a public company which files reports, proxy statements and other
information, including financial reports, with the SEC. The summary financial
information of El Paso included in this prospectus has been derived from its
historical financial statements included in its annual report on Form 10-K for
the fiscal year ended December 31, 2001, and its quarterly report on Form 10-Q
for the quarterly period ended March 31, 2002. Copies of that report can be
obtained from the SEC. See "Available Information."
We make no representation as to the accuracy or completeness of the summary
financial information of El Paso or that any event has or has not occurred which
would affect the accuracy or completeness thereof.
El Paso has neither guaranteed the payment of principal, interest or
Make-Whole Premium (if any) on the bonds nor the performance by us of our
obligations with respect to the bonds. Although El Paso has entered into a
performance guaranty with us pursuant to which El Paso has guaranteed to us the
punctual performance of all of El Paso Merchant's obligations under the mirror
power purchase agreement and the administrative services agreement, such
performance guaranty does not constitute a guaranty by El Paso of payment or
performance on the bonds nor any assurance by El Paso that we will pay principal
or interest on the bonds when such payments become due. Further, if we fail to
pay principal or interest on the bonds, El Paso will not be obligated to make
any such payments. As a result, the following financial information is neither
intended to indicate, nor should it be construed as an indication, that El Paso
will pay our obligations under the bonds when they become due in the event we do
not make such payments.
28
EL PASO CORPORATION
SUMMARY CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT FOR EARNINGS PER SHARE AND RATIO OF EARNINGS TO FIXED
CHARGES DATA)
<Table>
<Caption>
QUARTER ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------------- -------------------------------
2002 2001 2001 2000 1999
----------- ----------- ----------- ------- -------
(UNAUDITED) (UNAUDITED)
Operating revenues.............................. $13,188 $17,762 $ 57,475 $48,915 $27,325
Operating expenses.............................. 12,563 17,974 56,642 46,531 26,615
------- ------- --------- ------- -------
Operating income (loss)......................... 625 (212) 833 2,384 710
Other, net...................................... (288) (213) (584) (610) (360)
------- ------- --------- ------- -------
Income (loss) from continuing operations before
income tax expense............................ 337 (425) 249 1,774 350
Income tax expense (benefit).................... 108 (35) 182 538 93
------- ------- --------- ------- -------
Income (loss) before extraordinary items and
cumulative effect of accounting change........ 229 (390) 67 1,236 257
Extraordinary items, net of income taxes........ -- (10) 26 70 --
Cumulative effect of accounting change, net of
income taxes.................................. 154 -- -- -- (13)
------- ------- --------- ------- -------
Net income (loss) available to common
stockholders.................................. $ 383 $ (400) $ 93 $ 1,306 $ 244
======= ======= ========= ======= =======
Basic earnings per common share
Income (loss) before extraordinary items and
cumulative effect of accounting changes.... $ 0.44 $ (0.78) $ 0.13 $ 2.50 $ 0.52
Extraordinary items, net of income taxes...... -- (0.02) 0.05 0.14 --
Cumulative effect of accounting change, net of
income taxes............................... 0.29 -- -- -- (0.03)
------- ------- --------- ------- -------
Net income (loss) available to common
stockholders............................... $ 0.73 $ (0.80) $ 0.18 $ 2.64 $ 0.49
======= ======= ========= ======= =======
Diluted earnings per common share
Income (loss) before extraordinary items...... $ 0.43 $ (0.78) $ 0.13 $ 2.43 $ 0.52
Extraordinary items, net of income taxes...... -- (0.02) 0.05 0.14 --
Cumulative effect of accounting change, net of
income taxes............................... 0.29 -- -- -- (0.03)
------- ------- --------- ------- -------
Net income (loss) available to common
stockholders............................... $ 0.72 $ (0.80) $ 0.18 $ 2.57 $ 0.49
======= ======= ========= ======= =======
Basic average common shares outstanding......... 527 502 505 494 490
======= ======= ========= ======= =======
Diluted average common shares outstanding....... 538 502 516 513 497
======= ======= ========= ======= =======
Ratio of earnings to fixed charges.............. 2.02x --(1) --(1) 2.15x 1.18x
======= ======= ========= ======= =======
</Table>
- ---------------
(1) Earnings were inadequate to cover fixed charges by $30 million for the year
ended December 31, 2001 and $510 million for the quarter ended March 31,
2001.
29
EL PASO CORPORATION
SUMMARY CONSOLIDATED AND COMBINED BALANCE SHEETS
(IN MILLIONS)
<Table>
<Caption>
DECEMBER 31,
MARCH 31, -----------------
2002 2001 2000
----------- ------- -------
(UNAUDITED)
ASSETS
Current assets.............................................. $12,844 $12,659 $15,124
Property, plant, and equipment, net......................... 24,304 24,591 22,262
Other noncurrent assets..................................... 11,409 10,921 8,934
------- ------- -------
Total assets...................................... $48,557 $48,171 $46,320
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities......................................... $12,326 $13,565 $15,675
Long-term debt.............................................. 14,698 13,184 11,946
Other....................................................... 7,995 8,053 6,873
Minority interest........................................... 4,184 4,013 3,707
Stockholders' equity........................................ 9,354 9,356 8,119
------- ------- -------
Total liabilities and stockholders' equity........ $48,557 $48,171 $46,320
======= ======= =======
</Table>
30
EL PASO CORPORATION
SUMMARY CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<Table>
<Caption>
QUARTER ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------------- ---------------------------
2002 2001 2001 2000 1999
----------- ----------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities
Net income (loss)...................... $ 383 $ (400) $ 93 $ 1,306 $ 244
Adjustments to reconcile net income
(loss) to net cash from operating
activities.......................... 332 923 2,230 1,086 1,494
Working capital changes................ (518) 306 1,993 (2,214) (467)
Other.................................. (111) 226 (196) (79) (4)
------ ------- ------- ------- -------
Net cash provided by operating
activities................... 86 1,055 4,120 99 1,267
------ ------- ------- ------- -------
Cash flows from investing activities
Additions to assets property, plant and
equipment and investment............ (965) (838) (7,017) (5,645) (4,505)
Net proceeds from the sale of assets... 512 181 902 1,141 192
Other.................................. 110 77 1,093 670 (104)
------ ------- ------- ------- -------
Net cash used in investing
activities................... (343) (580) (5,022) (3,834) (4,417)
------ ------- ------- ------- -------
Cash flows from financing activities
Net changes in short-term debt......... 32 (1,145) (783) 391 (125)
Net changes in long-term debt.......... 440 551 1,274 2,337 2,518
Net changes in minority interest....... -- -- 281 995 1,310
Other.................................. (95) (36) 528 191 (199)
------ ------- ------- ------- -------
Net cash provided by (used in)
financing activities......... 377 (630) 1,300 3,914 3,504
------ ------- ------- ------- -------
Increase (decrease) in cash and cash
equivalents............................ 120 (155) 398 179 354
Cash and cash equivalents
Beginning of period.................... 1,139 741 741 562 208
------ ------- ------- ------- -------
End of period.......................... $1,259 $ 586 $ 1,139 $ 741 $ 562
====== ======= ======= ======= =======
</Table>
31
EL PASO MERCHANT
El Paso Merchant is an indirect wholly-owned subsidiary of El Paso that is
involved in a broad range of activities including asset ownership, trading and
risk management and financial services. El Paso Merchant is one of North
America's ten largest wholesale energy commodity marketers and traders, and
buys, sells and trades natural gas, power, crude oil, refined products, coal and
other energy commodities in the U.S. and internationally. El Paso Merchant is
also a significant non-utility owner of electric generating capacity with
ownership interests in 95 facilities in 20 countries. El Paso Merchant's coal
operations produce high-quality, bituminous coal from reserves in Kentucky,
Virginia and West Virginia. Most recently, El Paso Merchant expanded into the
liquefied natural gas business. The financial services businesses of El Paso
Merchant invest in emerging businesses to facilitate growth in energy markets.
LIMESTONE ELECTRON TRUST
Limestone indirectly owns approximately 80% of the ownership interests in
us, subject to adjustment upon specified events. Limestone is a statutory
business trust formed in 1999 under the laws of the State of Delaware pursuant
to the terms of the Limestone Trust Agreement among El Paso, Wilmington Trust
Company in its capacity as trustee, and Limestone, together with a financial
investor. The beneficial ownership interests of Limestone are evidenced by
approximately $150 million of Limestone trust certificates held by institutional
investors. El Paso has voting rights in Limestone with respect to bankruptcy
matters such as the filing of a voluntary bankruptcy petition. Limestone was
formed for the purpose of conducting limited activities, including purchasing a
membership interest in Chaparral, issuing senior notes in an aggregate principal
amount of approximately $1 billion and contributing most of the proceeds of that
issuance to Chaparral.
MESQUITE AND CHAPARRAL
Mesquite is our direct owner. Chaparral Investors, L.L.C. holds the sole
membership interest in Mesquite. Chaparral was formed by El Paso in 1999 to fund
the growth of its unregulated domestic power generation and related businesses.
Chaparral is a Delaware limited liability company, the members of which are El
Paso Chaparral Investor, L.L.C. and El Paso Chaparral Holding II Company, each
of which is a wholly-owned indirect subsidiary of El Paso, and Limestone.
Through Mesquite, Chaparral owns interests in 32 United States power generation
facilities with a total generating capacity of approximately 5,400 gross
megawatts. Chaparral Management, a subsidiary of El Paso Merchant, serves as the
manager of Chaparral and its wholly-owned subsidiary, Mesquite, under a
management agreement which expires in 2006. El Paso Chaparral, a wholly-owned
indirect subsidiary of El Paso, is the managing member of Chaparral and will
make all decisions on behalf of Chaparral (except for actions requiring
unanimous consent of the members).
CHAPARRAL MANAGEMENT
Pursuant to the Chaparral management agreement among the members of
Chaparral, Mesquite and Chaparral Management, Chaparral Management manages the
operations of Chaparral and Mesquite and, subject to the terms of the Chaparral
management agreement, manages the acquisition, operation and disposition of the
assets held by such entities. Chaparral Management is a wholly-owned indirect
subsidiary of El Paso.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements about us.
These statements are based on our current plans and expectations and involve
risks and uncertainties that could cause actual future results to be materially
different from those set forth in the forward-looking statements. Important
factors that could cause actual results to differ include risks set forth in
"Risk Factors" and "Forward-Looking Statements."
GENERAL
Our sole business is to sell electric energy and provide capacity to Public
Service Electric under the amended power purchase agreement with them. We have
no material assets other than our interest in our material agreements and our
accounts, and no material obligations other than those under our bonds, our bond
indenture and our material agreements. We have no employees and rely on El Paso
Merchant under an administrative services agreement to perform our obligations
under our material agreements.
RESULTS OF OPERATIONS
We have included in this prospectus our audited financial statements, which
consist of a balance sheet dated as of December 31, 2001 and statements of
income, cash flows and member's equity from our formation, May 3, 2001, through
December 31, 2001 and our unaudited balance sheet as of March 31, 2002 and our
unaudited statements of operations and cash flows for the quarter ended March
31, 2002. We were formed in May 2001, but did not begin operations until
December 13, 2001, after we obtained the Bayonne power purchase agreement and
the Camden power purchase agreement through a contribution from our member.
Quarter Ended March 31, 2002
For the quarter ended March 31, 2002, we generated operating revenues of
approximately $26.4 million from the sale of approximately 326,000 megawatt
hours of energy, and from capacity provided to Public Service Electric.
Operating expenses totaled approximately $18.8 million, primarily from payments
to El Paso Merchant for purchases of power. Our amended power purchase agreement
and mirror power purchase agreement qualify as derivatives and are, therefore,
required to be recorded at their fair value with changes in their fair value
reported in our statement of operations. Our results during the period reflect a
decrease in the fair value of these agreements from the beginning of the year
through March 31, 2002 in the amount of $8.3 million. Our operating expenses
also include fees to El Paso Merchant under the administrative services
agreement. Interest and debt expense for the period was $11.0 million. Our net
loss during this period was $3.3 million.
Period from Inception (May 3, 2001) to December 31, 2001
From December 13, 2001 to December 31, 2001, we generated operating
revenues of approximately $7.0 million from the sale of approximately 76,000
megawatt hours of energy, and from capacity provided to Public Service Electric.
Operating expenses totaled approximately $4.7 million, primarily from payments
to El Paso Merchant for purchases of power. Our amended power purchase agreement
and mirror power purchase agreement qualify as derivatives and are therefore
required to be recorded at their fair value with changes in their fair value
reported in our statement of income. Our results during the period reflect our
initial adjustment of the carrying value of our contributed power purchase
agreements to their fair value in the amount of $228.2 million, as well as
changes from this initial value to the end of the year in the amount of $2.3
million. Interest and debt expense for the period was $2.3 million. Our net
income during this period was $228.2 million. Our operating expenses also
include fees to El Paso Merchant under the administrative services agreement.
The annual fees to El Paso Merchant under this agreement are $0.1 million. These
fees to El Paso Merchant accrue annually, but are only payable to the extent
that there are amounts on deposit in the collections account after payment of
all current and past due amounts having a payment priority ranking above these
fees. See "Summary of Our Transaction Documents -- Administrative Services
Agreement -- Fee."
33
CRITICAL ACCOUNTING POLICY
The critical accounting policy that will most significantly impact our
financial statements from period to period relates to our accounting for
derivative instruments. Our amended power purchase agreement and our mirror
power purchase agreement qualify as derivatives and are recorded at their fair
value in our balance sheet. Changes in the fair value of these agreements are
reported in our statement of operations as a change in the market value of power
purchase agreements. We estimate the fair value of the agreements based on an
estimate of the cash receipts and payments using anticipated future power prices
compared to the contractual prices under these agreements, discounted at a
risk-adjusted rate commensurate with the term of each contract and the credit
risk of the counterparty. Fluctuations in the credit ratings of our
counterparties, fluctuations in market conditions, or significant changes in
interest rates could change the risk-adjusted rate, which would impact the fair
value of these agreements. The Standard and Poor's downgrade of Public Service
Electric's unsecured credit rating from BBB+ to BBB- has not had a material
impact on the fair value of our amended power purchase agreement. See "Liquidity
and Capital Resources" for further discussion. Our estimates of the timing of
cash receipts and payments are based on the anticipated timing of power
delivered under these agreements. These estimates also consider the minimum and
maximum energy delivery requirements under our agreements. Estimates of the
future prices of power are based on the forward pricing curve of the appropriate
power delivery and receipt points, and this curve is derived from actual prices
observed in the market, price quotes from brokers and extrapolation models that
rely on actively quoted prices and historical information. Changes in these
values in the future, which could be positive or negative, will occur as our
estimates of each of these variables change and as additional market data
becomes available, and these changes could be material from period to period.
However, the pricing of our power purchase agreements is fixed over their term
and, as a result, despite short-term fluctuations in market factors, our long-
term reported results will be more reflective of the terms of these agreements.
Under our amended power purchase agreement and mirror power purchase
agreement, the rates at which we sell energy to Public Service Electric and the
rates at which we purchase energy from El Paso Merchant are fixed for each
calendar year. The following table sets forth the amount of annual energy
quantities delivered and purchased, the rates at which we purchase electricity
from El Paso Merchant and the rates we receive when we sell electricity to
Public Service Electric:
<Table>
<Caption>
CONTRACT RATE CONTRACT RATE
($ PER MWH) ($ PER MWH)
ANNUAL ENERGY PAYABLE BY PUBLIC PAYABLE BY US TO
QUANTITIES DELIVERED SERVICE ELECTRIC TO US EL PASO MERCHANT
AND PURCHASED UNDER AMENDED POWER UNDER MIRROR POWER
CONTRACT YEAR (MWH) PURCHASE AGREEMENT PURCHASE AGREEMENT
- ------------- -------------------- ----------------------- ------------------
2002............................ 1,501,825 $80.88 $32.00
2003............................ 1,501,825 77.75 32.00
2004............................ 1,501,825 80.01 32.00
2005............................ 1,501,825 82.37 32.00
2006............................ 1,501,825 84.82 32.00
2007............................ 1,501,825 87.37 32.00
2008............................ 1,447,524 90.07 32.00
2009............................ 1,171,424 93.08 32.00
2010............................ 1,171,424 95.98 32.00
2011............................ 1,171,424 99.00 32.00
2012............................ 1,171,424 102.15 32.00
2013(1)......................... 205,400 105.42 32.00
</Table>
- ---------------
(1) Through March 5, 2013.
The amount of the annual energy payments to us under the amended power
purchase agreement for any year can be readily determined. Payments to us under
the amended power purchase agreement are determined by multiplying the contract
rate by the amount of energy delivered. The payments by us under the mirror
power purchase agreement can also be readily determined by multiplying the
deliveries we must accept by the contract rate.
Our results of operations in the future will depend primarily on revenues
from the sale of energy and capacity and our costs to purchase energy and other
operating and administrative expenses. There can be no
34
assurance that we can find alternative buyers in the event of the termination of
the amended power purchase agreement, the loss of which would accordingly have a
material affect on our business.
Based solely upon our review of information contained in El Paso's filings
with the SEC, we believe that El Paso Merchant has sufficient access to the
energy and energy capacity markets, as well as adequate financial resources, to
enable it to perform its obligations under the mirror power purchase agreement,
and that El Paso has sufficient financial resources to perform its obligations
under the related performance guaranty in the event that it is required to do
so. We also believe, based solely upon our review of information contained in
Public Service Electric's filings with the SEC and the credit ratings assigned
to Public Service Electric's senior secured debt by Standard and Poor's, Moody's
and Fitch, that Public Service Electric has adequate financial resources to
fulfill its payment obligations under the terms of the amended power purchase
agreement.
RELATED PARTY TRANSACTIONS
Our material agreements include an administrative services agreement and a
mirror power purchase agreement both with El Paso Merchant, our affiliate. Both
contracts were entered into on terms that we believe were based on market rates
at the dates they were negotiated. However, market rates can and do change and
there is no guarantee that the rates we originally agreed to in these contracts
will be indicative of market rates in the future.
LIQUIDITY AND CAPITAL RESOURCES
We have no capital requirements, either in the short or long term. We
believe that cash flows from operations will be sufficient to satisfy our cash
and liquidity requirements, including the payment of interest and principal on
the bonds and the payment of our operating expenses, although we cannot assure
you that this will be the case.
Our primary sources of liquidity and capital resources are the payments to
be made by Public Service Electric under the amended power purchase agreement,
shortfall payments and excess amounts, if any, required to be paid to us by El
Paso Merchant under the mirror power purchase agreement and guaranteed by El
Paso under the El Paso performance guaranty, and amounts on deposit in the
liquidity account or acceptable credit support provided in place of cash
deposits. We are prohibited by the indenture from incurring additional
indebtedness (other than additional bonds issued under the indenture). We would,
therefore, be unable to make up any shortfalls in cash through additional
borrowing to pay amounts due under the bonds. All scheduled payments of
principal and interest on the bonds have been calculated to be paid solely from
the margin created between sales of electric energy and capacity to Public
Service Electric and purchases of electric energy and capacity from El Paso
Merchant, each for the full amount of the required energy deliveries.
In June 2002, Standard and Poor's downgraded our bonds from BBB to BBB-.
The downgrade of our bonds was a result of Standard and Poor's change in Public
Service Electric's unsecured credit rating from BBB+ to BBB- in May 2002. The
downgrade in Public Service Electric's credit rating did not have a significant
impact on the fair value of our amended power purchase agreement. Even with this
ratings action, we believe that Public Service Electric has adequate financial
resources to fulfill its payment obligations under the terms of the amended
power purchase agreement.
The bond indenture allows us to raise additional bonds so long as, among
other things, the initial bonds as well as the additional bonds achieve the
initial credit ratings at the closing of the initial bonds, which were Baa2 by
Moody's, BBB by Standard and Poor's and BBB by Fitch. Therefore, we will be
unable to issue additional debt until Standard and Poor's upgrades the rating of
our bonds to at least BBB and the other ratings agencies at least maintain their
current ratings of our bonds.
Pursuant to the amended power purchase agreement, we have the right to
schedule and deliver the annual energy deliveries for each year. In order to
meet our payments of principal and interest on the bonds, we need to schedule
and deliver (1) 42% of the annual energy deliveries to Public Service Electric
by June 30 of each year and (2) the remaining annual energy deliveries by
December 31 of each year. If El Paso Merchant fails to deliver the energy
deliveries described above, then El Paso Merchant must pay to us an energy
shortfall liquidated damage payment, which will enable us to meet our payments
of principal and interest on the bonds.
35
The annual energy deliveries may be scheduled and delivered at any time
during the calendar year (subject to meeting the minimum energy deliveries
requirements, prior notification provisions and maximum delivery rate limits).
Although our revenues, determined on an annual basis, should remain stable, our
monthly revenues may vary. We receive our last monthly payment from Public
Service Electric for each year on January 31 of the following calendar year.
Principal payments and interest payments are made semi-annually, on March 1 and
September 1 of each year.
Assuming that we schedule and deliver all of the required energy deliveries
each year, the minimum debt service coverage ratio for any payment period is
expected to be 1.07 to 1.00 and the average debt service coverage ratio for any
payment period is expected to be 1.19 to 1.00. The following table sets forth
cash expected to be available for debt service and debt service for the bonds,
which includes interest as well as principal amounts, commencing on September 1,
2002.
<Table>
<Caption>
CASH AVAILABLE
PAYMENT DATE FOR DEBT SERVICE DEBT SERVICE
- ------------ ---------------- ------------
(IN MILLIONS)
September 1, 2002(1)........................................ $ 39.0 $ 36.5
March 1, 2003............................................... $ 37.4 $ 33.5
September 1, 2003........................................... $ 33.4 $ 30.1
March 1, 2004............................................... $ 35.2 $ 31.6
September 1, 2004........................................... $ 35.0 $ 31.3
March 1, 2005............................................... $ 37.0 $ 32.7
September 1, 2005........................................... $ 36.7 $ 32.4
March 1, 2006............................................... $ 38.8 $ 33.9
September 1, 2006........................................... $ 38.5 $ 33.6
March 1, 2007............................................... $ 40.7 $ 35.1
September 1, 2007........................................... $ 40.4 $ 34.7
March 1, 2008............................................... $ 42.6 $ 36.4
September 1, 2008........................................... $ 42.9 $ 36.4
March 1, 2009............................................... $ 40.5 $ 34.2
September 1, 2009........................................... $ 34.7 $ 29.4
March 1, 2010............................................... $ 36.7 $ 30.8
September 1, 2010........................................... $ 36.4 $ 30.4
March 1, 2011............................................... $ 38.4 $ 31.8
September 1, 2011........................................... $ 38.1 $ 31.4
March 1, 2012............................................... $ 40.2 $ 32.8
September 1, 2012........................................... $ 39.9 $ 32.3
March 1, 2013............................................... $ 46.0 $ 36.9
September 1, 2013........................................... $ 9.1 $ 5.3
------ ------
Totals............................................ $857.6 $733.5
====== ======
</Table>
- ---------------
(1) Includes expected payments from Public Service Electric under the amended
power purchase agreement for the period from December 12, 2001 through
December 31, 2001.
Our projection of a minimum debt service coverage ratio of 1.07 to 1.00 is
also based upon the assumptions that (1) El Paso Merchant will pay the energy
shortfall liquidated damage payments that would be required in the event that it
is unable to fulfill its obligations under the mirror power purchase agreement
and (2) that no additional bonds will be issued under the indenture. See
"Summary of Our Transaction Documents -- Mirror Power Purchase Agreement." El
Paso Merchant may be required to make payments to us in the event that it fails
to deliver the minimum energy deliveries, fails to schedule energy deliveries or
fails to deliver energy at the contractually specified delivery point. If, for
example, El Paso Merchant has not met its delivery obligations for that month,
it will be required to pay us an amount determined by reference to Public
Service Electric's cost of replacement energy for that month. See "Summary of
Our Transaction
36
Documents -- Mirror Power Purchase Agreement -- Delivery of Energy and Provision
of Capacity -- Failure to Schedule or Deliver Energy or Provide Capacity." If El
Paso Merchant or El Paso is unable to pay these excess amounts, we may be unable
to pay corresponding amounts that we are required to pay Public Service Electric
under the amended power purchase agreement.
Further, if El Paso Merchant does not schedule and deliver (1) 42% of the
required annual energy deliveries to us by June 30 in any year and (2) the
remaining annual energy deliveries to us in any year, it will be required to pay
to us energy shortfall liquidated damage payments. See "Summary of Our
Transaction Documents -- Mirror Power Purchase Agreement -- Delivery of Energy
and Provision of Capacity -- Energy Shortfall Liquidated Damages Payments."
These shortfall payments are sized so that they are equivalent to the shortfall
between our expected revenues under the amended power purchase agreement for
each semi-annual period assuming the full delivery of the energy described
above, and the actual amount of energy deliveries made during that semi-annual
period. If El Paso Merchant or El Paso is unable to pay shortfall payments, we
may be unable to make payments on the bonds.
We also agreed to fund the liquidity account with the trustee in an amount
equal to the liquidity reserve required balance (which on the closing date of
the offering of the Series A bonds was approximately $21.1 million and which at
all times will be a minimum of $14.25 million) out of the proceeds of the
offering of the Series A bonds. The purpose of the liquidity account is to
provide the trustee with cash if we do not have sufficient funds in the
collections account to make a principal or interest payment. We will be able to
withdraw amounts from the liquidity account to make such payment to the extent
that funds are in the liquidity account. Once funds have been withdrawn from the
liquidity account, those funds will only be replenished out of funds otherwise
available in the collections account. If surplus funds are not available from
the collections account, the liquidity reserve required balance will not be
maintained.
El Paso has the right from time to time to withdraw all or a portion of the
cash on deposit in the liquidity account if El Paso replaces that cash with
acceptable credit support. This is described in "Description of the Bonds and
the Indenture -- The Accounts -- Liquidity Account."
Pursuant to the indenture, payments to the bondholders are given priority
over payments to our members. Under the indenture, we are permitted to make
distributions to our members on March 1 and September 1 of each year, provided
that no default or event of default exists and the debt service coverage test of
1.03 to 1.00 is met and provided further that the proceeds of additional bonds
issued under the indenture may be distributed to our members at any time. We
expect that all excess cash flow (after the payment of debt service, operating
expenses and deposits to the liquidity account) will be distributed
semi-annually to our members, as permitted by the indenture.
FORWARD-LOOKING STATEMENTS
Some statements contained in this prospectus are forward-looking
statements. These forward-looking statements can be identified by the use of
words such as "expect," "intend," "plan," "project," "believe," "estimate" and
similar expressions. We have based these forward-looking statements on our
current expectations, the independent energy consultant's projections about
future events based upon our knowledge of facts as of the date of this
prospectus and the independent energy consultant's assumptions about future
events. These forward-looking statements are subject to various risks and
uncertainties that may be outside our control and that may result in actual
results differing materially from projected results. These risks and
uncertainties, including those described under "Risk Factors," indicate, among
other things:
- market volatility due to world and regional events;
- U.S. and world economic conditions;
- the enforceability of our contracts;
- governmental, statutory or regulatory changes or initiatives affecting us
or our contracts; and
- other unpredictable or unknown factors not discussed.
37
REGULATION OF THE ELECTRIC INDUSTRY
The following is a summary overview of the industry and applicable
regulations and should not be considered a full statement of all issues
pertaining thereto.
Historically, the electric utility industry in the United States was
composed primarily of investor-owned utilities, municipal utilities, rural
electric cooperatives and various federal power agencies, including the
Tennessee Valley Authority. These entities have traditionally been the only
significant providers of electric power to retail and wholesale customers.
Further, traditional electric utilities in the United States were
vertically-integrated businesses that owned generation, transmission and
distribution facilities and whose operations were comprehensively regulated by
federal and state governments using a cost-of-service framework. For many
investor-owned utilities, the generation of electricity has traditionally been
dominant in terms of assets employed, capital invested and revenue generated.
However, the structure and operation of the electric industry is changing as a
result of increasing competition and changing regulation.
TRADITIONAL ELECTRIC UTILITY INDUSTRY REGULATION
Electric utilities have historically been highly regulated by both state
public utility commissions and the Federal Energy Regulatory Commission. State
regulatory authorities exercise their jurisdiction over almost all aspects of
retail operations. The Federal Energy Regulatory Commission regulates wholesale
sales of electric power and the transmission of electricity in interstate
commerce pursuant to the Federal Power Act and regulations promulgated under the
Federal Power Act. Pursuant to its authority under the Federal Power Act, the
Federal Energy Regulatory Commission subjects public utilities to rate and
tariff regulation and accounting and reporting requirements, as well as
oversight of mergers and acquisitions, securities issuances and dispositions of
facilities. A power marketer is considered a public utility under the Federal
Power Act and is subject to Federal Energy Regulatory Commission regulation of
its wholesale power sales, even if it does not own generation, transmission or
distribution facilities.
Under the Public Utility Holding Company Act of 1935 ("PUHCA"), any company
that directly or indirectly owns, controls or holds with the power to vote ten
percent (10%) or more of the outstanding voting securities of a "public utility
company" is a company that is a public utility "holding company" and must
register with the SEC unless it is eligible for an exemption or unless an
appropriate application is filed with, and an order is granted by, the SEC
declaring it not to be a holding company. PUHCA requires registered public
utility holding companies to limit their operations to single integrated utility
systems and to divest any other operations not functionally related to the
operation of the utility system. A registered holding company and its
subsidiaries under PUHCA are subject to financial and organizational regulation,
including SEC approval of their financing transactions. Although the SEC has not
had occasion to consider the treatment of power marketers under PUHCA, the SEC
staff has consistently stated in "no-action" letters that it would not recommend
enforcement action under PUHCA against power marketers that do not own a
physical power plant. Based on such letters, we believe we are not subject to
PUHCA. Since El Paso Merchant and its affiliates do not own physical electric
utility assets (except those that are exempt from PUHCA because of ownership by
Exempt Wholesale Generators or Foreign Utility Companies under sections 32 or 33
of PUHCA, respectively, or because they are Qualifying Facilities under the
Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"), that are
exempt from PUHCA) and do not own other physical assets that would be
jurisdictional under PUHCA, we also do not believe that either El Paso Merchant
or any of our affiliates is subject to PUHCA.
PURPA reduced regulatory constraints and encouraged entities other than
utilities to enter the electric power generation business. Independent power
producers and cogenerators satisfying the Federal Energy Regulatory Commission's
standards as qualifying facilities became exempt from PUHCA, most provisions of
the Federal Power Act and state laws previously applicable relating to rate,
organizational and financial regulation. PURPA also required electric utilities
to purchase electricity generated by qualifying facilities at a price based on
the utility's avoided cost of purchasing electricity or generating electricity
itself, and to sell supplementary, back-up, maintenance and interruptible power
to qualifying facilities on a just and reasonable
38
and non-discriminatory basis. The implementation of PURPA created a new class of
non-utility generating companies and a significant market for electric power
produced by non-utilities.
ELECTRIC INDUSTRY DEREGULATION AND RESTRUCTURING
The Energy Policy Act of 1992 engendered more competition in the electric
industry. The Energy Policy Act permitted independent generation companies that
sold power exclusively on a wholesale basis and that satisfied other
requirements to be eligible for designation as Exempt Wholesale Generators and
thereby avoid becoming subject to PUHCA. As a result of the new market entry
facilitated by the Energy Policy Act, the competition increased among companies
selling power to utilities. The Energy Policy Act also expanded the Federal
Energy Regulatory Commission's authority to increase competition at the
wholesale level by granting the Federal Energy Regulatory Commission the
authority to require utilities to provide access to their transmission lines,
upon request, to specified entities seeking to transmit power to wholesale
purchasers.
Legislation to restructure the electric industry is under active
consideration at the federal level, and nearly half of the states have passed,
or are actively considering, restructuring legislation. Bills have been passed
in the Senate and the House of Representatives that would, among other things,
repeal or significantly modify portions of the PUHCA and PURPA statutes.
In many states, the retail sale of electricity has been deregulated and
opened up to competition. Electricity in several regions is traded as a
commodity, and generators compete primarily in terms of price. Participants in
the growing electricity commodity market include electric utilities, power
marketers, independent power producers and commodity trading firms. Recent
volatility in wholesale power markets and ongoing investigations by the Federal
Energy Regulatory Commission and other government agencies relating to
allegations of price manipulation and other forms of anticompetitive behavior in
California and the Western Systems Coordinating Council may slow the pace of
activity related to industry restructuring.
Many utilities have functionally separated their generation, transmission
and distribution operations (often called "disaggregation" or "unbundling") in
response to the movement toward deregulation of generation. A number of electric
utilities have announced or completed plans to divest their generation assets.
As a result, the participants in the electricity generation market for the
foreseeable future are expected to include captive subsidiaries of
vertically-integrated utilities, non-utility generators with contracts to sell
power to utilities and merchant plants not subject to cost-of-service
regulation, as well as marketers of generation services.
The transmission and distribution of electricity, viewed to be natural
monopoly functions, are expected to remain regulated. In general, it is expected
that the utility regulators in each state will remain responsible for regulating
the distribution of electricity. The Federal Energy Regulatory Commission is
expected to continue its regulation of the transmission of electricity and has
adopted rules to encourage utilities to transfer control over their transmission
assets to Regional Transmission Organizations.
In light of recent legislative and regulatory initiatives, power marketers
have emerged as intermediaries that buy electric energy and/or capacity,
transmission, ancillary services and other commodities and services from
traditional utilities and others and resell these commodities and services at
market-based rates in wholesale markets. Unlike traditional utilities, power
marketers often own neither generation nor transmission facilities and have no
franchised service area. Wholesale power marketers, such as El Paso Merchant,
are subject to Federal Energy Regulatory Commission jurisdiction under the
Federal Power Act regarding rates, terms and conditions of service and specified
reporting requirements. Because the Federal Power Act grants the Federal Energy
Regulatory Commission jurisdiction over wholesale electric sales, a power
marketer that desires to sell electricity on a wholesale basis must have a
tariff accepted for filing by the Federal Energy Regulatory Commission.
Wholesale power marketers with rates on file at the Federal Energy Regulatory
Commission are considered public utilities for the purpose of the Federal Power
Act. A power marketer may receive Federal Energy Regulatory Commission
authorization to make interstate wholesale power sales at market-based rates if
it does not own or control generation or transmission facilities that would
allow it to exercise market power. Power marketers are subject to other
regulatory requirements, such as the filing of quarterly and annual reports with
the Federal Energy Regulatory Commission and notifying the Federal
39
Energy Regulatory Commission of any significant change in ownership or
affiliation with entities that control generation or transmission. They also
must apply for Federal Energy Regulatory Commission approval of a change in
corporate structure, merger or disposition of their jurisdictional assets (i.e.,
their wholesale tariffs and contracts).
A major additional development in the move to a more competitive electric
power industry occurred in 1996 when the Federal Energy Regulatory Commission
issued its Order Nos. 888 and 889, which contained final rules that introduced
competitive reforms into the wholesale power market and increased access to the
electric power grid. At the core of the new rules is a price-regulated
transmission sector that provides service completely separated or "unbundled"
from generation and supply. Under the new rules, all wholesale buyers and
sellers of power, including the utilities themselves, are required to take
transmission service pursuant to the same pro-forma tariff on the same terms and
conditions and at the same prices. Order No. 888 required utilities subject to
the Federal Energy Regulatory Commission's jurisdiction to provide access across
their transmission systems to third parties and allowed them to seek recovery as
"stranded costs" from departing wholesale customers, the revenues that the
utilities expected to receive from those customers. The Federal Energy
Regulatory Commission also imposed reciprocity requirements that compel
non-jurisdictional utilities (e.g., public power, government-owned power
marketing administrations or members of the Electric Reliability Council of
Texas) to offer the same quality of service as a condition to their eligibility
to take advantage of open-access transmission by Federal Energy Regulatory
Commission-regulated utilities. Order No. 888 also required power pools, or
associations of interconnected electric transmission and distribution systems
that have an agreement for integrated and coordinated operations, to provide
open-access transmission. Under Order No. 889, public utilities must provide the
public with an electronic system for buying and selling transmission service in
transactions with the utilities and abide by specific standards of conduct when
using their transmission system to make wholesale sales of power. A federal
appeals court upheld Order Nos. 888 and 889 and the United States Supreme Court
recently affirmed that court's decision.
In 1999, the Federal Energy Regulatory Commission issued Order No. 2000,
which effectively required transmission owning utilities to file plans for
transferring control over their transmission facilities to Regional Transmission
Organizations. The Federal Energy Regulatory Commission's stated objective is to
consolidate the nation's multiple utility-owned and operated transmission
networks into a relatively small number of Regional Transmission Organizations
encompassing large regions. Service would be available from the Regional
Transmission Organization on a uniform and non-discriminatory basis at a
"single-system" rate as compared to having to make multiple requests for service
with separate charges from individual transmission providers under the
traditional scheme. The Federal Energy Regulatory Commission has approved
Regional Transmission Organization arrangements for large portions of the U.S.
(including the Northeast and Midwest) and has ongoing proceedings that will
likely result in Regional Transmission Organizations for the remaining regions
in the near future.
To further enhance competition in wholesale electric markets and broaden
the benefits and cost savings to all wholesale and retail customers, the Federal
Energy Regulatory Commission recently launched several rulemakings to reform
public utilities' transmission tariffs and interconnection agreements to reflect
a standardized wholesale market design. The Federal Energy Regulatory Commission
expects that these initiatives will also provide more choices and improved
services to all wholesale market participants; reduce delivered wholesale
electricity prices through lower transactions costs and wider trade
opportunities; improve reliability through better grid operations and expedited
infrastructure improvements; and increase certainty about market rules to
facilitate investment in much-needed transmission facilities in this crucial
economic sector.
In response to recent volatility in wholesale electric power and natural
gas markets as well as in markets for energy-related financial products, the
Federal Energy Regulatory Commission has proposed a rulemaking to expand its
uniform system of accounting to include financial derivatives and hedging
instruments and other financial transactions. The proposed rulemaking also asks
whether the Federal Energy Regulatory Commission should impose the uniform
system of accounting on power marketers as well as traditional public utilities,
and whether it should approve securities issuances and assumptions of liability
by power marketers on a case-by-case basis rather than by blanket authorization
as it currently does.
40
STATE REGULATION
The New Jersey Board of Public Utilities exercises regulatory jurisdiction
over New Jersey's "public utilities." A "public utility" is defined as including
every individual, corporation, partnership or association and their lessees,
trustees or receivers that own, operate, manage or control within New Jersey any
electricity distribution system for public use.
The New Jersey Board of Public Utilities has jurisdiction over a public
utility to regulate its rates and service, the assumption by it of liabilities
and obligations and the issuance and sale of some of its securities. This
regulatory jurisdiction includes the power to regulate a public utility's
earnings, fix its rates, and authorize it to recover specific costs from its
ratepayers. The New Jersey Board of Public Utilities' jurisdiction over an
electric public utility is limited to prescribing uniform systems of accounts,
conservation and reliability measures, service territory, filing of periodic
reports and, with respect to retail sales, rate structure. The New Jersey Board
of Public Utilities does not have jurisdiction to regulate the earnings or fix
the rates of an electric public utility that is not a public utility.
A New Jersey investor-owned electric utility serving the public at retail,
such as Public Service Electric, is subject to broad New Jersey Board of Public
Utilities regulatory jurisdiction, both as a public utility and as an electric
public utility. By comparison, an entity that supplies electricity on a
wholesale basis only is not subject to New Jersey Board of Public Utilities
regulation as a public utility. These entities, however, may be subject to the
New Jersey Board of Public Utilities' limited regulatory jurisdiction if they
supply electricity on the retail level and fall within the statutory definition
of "electric power supplier."
Since we will not make retail sales of electricity in New Jersey, we will
not be subject to New Jersey Board of Public Utilities regulation as an
"electric power supplier." Since we do not anticipate that we will own, maintain
or operate an electric generation, transmission or distribution system in New
Jersey, we believe that we will not be subject to New Jersey Board of Public
Utilities regulation as an "electric public utility."
THE FEDERAL ENERGY REGULATORY COMMISSION ORDERS
The Federal Energy Regulatory Commission approved our request to sell
electricity at negotiated rates on September 13, 2001, and that approval order
also granted pre-approval for us to issue bonds and assume liabilities after a
notice period that ended October 30, 2001. The Federal Energy Regulatory
Commission order became final and nonappealable on October 13, 2001, and the
notice period expired without intervention.
THE NEW JERSEY BOARD OF PUBLIC UTILITIES ORDER
The amended power purchase agreement amends and restates purchase
agreements that Public Service Electric entered into with the Bayonne facility
and the Camden facility pursuant to PURPA. See "Summary of Our Transaction
Documents -- Amended Power Purchase Agreement." The New Jersey Board of Public
Utilities previously authorized Public Service Electric to recover the costs of
these qualifying facility agreements from its ratepayers. Since the amended
power purchase agreement amends and restates the qualifying facility agreements
under which the New Jersey Board of Public Utilities previously authorized
Public Service Electric's recovery of costs, Public Service Electric filed with
the New Jersey Board of Public Utilities a petition seeking confirmation that
the amended power purchase agreement similarly qualifies for cost recovery under
New Jersey law. The amended power purchase agreement, as a wholesale power sales
agreement, itself is not subject to New Jersey Board of Public Utilities
jurisdiction, and Public Service Electric did not seek New Jersey Board of
Public Utilities' approval of the agreement for any purpose other than to
confirm cost recovery. On July 19, 2001, the New Jersey Board of Public
Utilities approved the amended power purchase agreement for cost recovery
purposes. This order became final and non-appealable on September 14, 2001.
41
THE ENERGY SALES TRANSACTIONS
GENERAL
On the closing date of the offering of the Series A bonds, Cogen
Technologies and Camden Cogen, two of our affiliates, transferred to us two
long-term power purchase agreements, the Bayonne power purchase agreement and
the Camden power purchase agreement. At that time, the amended power purchase
agreement between Public Service Electric and us became effective, which has the
effect of combining and superseding the Bayonne power purchase agreement and the
Camden power purchase agreement. The Bayonne power purchase agreement and the
Camden power purchase agreement each required that the sellers under the
respective agreements source capacity and energy only from their respective
facilities. The amended power purchase agreement eliminated the requirement that
the Bayonne facility and the Camden facility be the only sources of energy
provided under that agreement. The elimination of this requirement is beneficial
to us because we can source energy from anywhere in the PJM market, and the cost
of energy sourced in this way may be less expensive than the cost to produce
such energy at the Bayonne or Camden facilities alone. The benefits of the
amended power purchase agreement also include significantly more flexibility in
scheduling energy deliveries, including a greater degree of daily delivery
flexibility and, from the perspective of Public Service Electric, a benefit in
the form of a payment from us of $64.0 million when the amended power purchase
agreement became effective.
We expect that interest and principal on the bonds will be paid solely from
the margin created between sales of capacity and energy to Public Service
Electric under the amended power purchase agreement and purchases of capacity
and energy from El Paso Merchant under the mirror power purchase agreement. We
have entered into the mirror power purchase agreement with El Paso Merchant in
order to have El Paso Merchant provide to us the energy and capacity that we are
required to provide to Public Service Electric and, if necessary, the payments
that we are required to make, to Public Service Electric for failure to deliver
energy or capacity under the amended power purchase agreement. We have also
entered into the administrative services agreement with El Paso Merchant in
order to have El Paso Merchant administer and perform the management and
administrative obligations we have under our material agreements. Pursuant to
the mirror power purchase agreement and the administrative services agreement,
El Paso Merchant has agreed to perform all of our obligations and exercise all
of our rights under all of our material agreements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
AMENDED POWER PURCHASE AGREEMENT
Under the amended power purchase agreement, which became effective upon the
consummation of the offering of the Series A bonds and which has a term expiring
March 5, 2013, we are required in the summer months of June through September to
deliver to Public Service Electric at least 165 MWh each hour through October
31, 2008 (and 130 MWh each hour thereafter until the end of the term), and an
aggregate of 185 MWh per hour over all of the on-peak hours during the summer
months through October 31, 2008 (and 144 MWh per hour thereafter until the end
of the term). In addition, we are required in the non-summer months to deliver
to Public Service Electric at least 50 MWh each hour through October 31, 2008
(and 39 MWh each hour thereafter until the end of the term), and an aggregate of
460,445 MWh over all of the on-peak hours during the non-summer months through
October 31, 2008 (and 359,000 MWh thereafter until the end of the term).
Further, we may not deliver energy in any calendar year in excess of the annual
energy deliveries, which equal 1,501,825 MWh from 2002-2007, 1,447,524 MWh in
2008, 1,171,424 MWh from 2009-2012, and 205,400 MWh in 2013. In order to meet
our payments of principal and interest on the bonds, we need to schedule and
deliver (1) 42% of the annual energy deliveries to Public Service Electric by
June 30 of each year and (2) the remaining annual energy deliveries by December
31 of each year. If El Paso Merchant fails to deliver the energy deliveries
described above, then El Paso Merchant must pay to us an energy shortfall
liquidated damage payment, which will enable us to meet our payments of
principal and interest on the bonds.
In addition to the minimum energy deliveries, under the amended power
purchase agreement we are required to make electric energy capacity available to
Public Service Electric so as to enable Public Service
42
Electric's account with the PJM to reflect this capacity. We are allowed to
provide Public Service Electric with energy deliveries and capacity credits from
any source of supply, including, but not limited to, the Bayonne facility and
the Camden facility.
The amended power purchase agreement requires Public Service Electric to
pay us each month a combined payment for the capacity and energy provided by us.
The amount of the payment is based, in part, on the amount of energy we actually
deliver. The amount payable to us by Public Service Electric will be reduced by
credits if (1) we fail to schedule and deliver the minimum energy deliveries or
deliver energy as scheduled, (2) we fail to deliver energy at the locations
specified, or (3) we fail to schedule and deliver the annual quantities of
energy specified in the amended power purchase agreement. The amount payable by
Public Service Electric will also be reduced by a credit if we fail to provide
all or part of the capacity to Public Service Electric. See "Summary of Our
Transaction Documents -- Amended Power Purchase Agreement -- Failure to Schedule
or Deliver Energy or Provide Capacity."
MIRROR POWER PURCHASE AGREEMENT
In order to meet our obligations to deliver electric energy and provide
capacity to Public Service Electric under the amended power purchase agreement,
we entered into the mirror power purchase agreement with El Paso Merchant. Both
the mirror power purchase agreement and the amended power purchase agreement
became effective upon the consummation of the offering of the Series A bonds.
Under the mirror power purchase agreement, El Paso Merchant must schedule and
deliver both the minimum hourly energy deliveries and the full amount of the
annual energy deliveries that we are obligated to deliver under the amended
power purchase agreement during each year as we schedule deliveries to Public
Service Electric, and must make available to us capacity credits equal to the
capacity requirements under the amended power purchase agreement. As is the case
with us under the amended power purchase agreement, El Paso Merchant may deliver
energy to us at any point within the PJM market.
In consideration for the energy delivered and capacity provided by El Paso
Merchant, we must make combined energy and capacity payments to El Paso
Merchant. Our payments to El Paso Merchant under the mirror power purchase
agreement will be reduced by credits to us if (1) El Paso Merchant fails to
schedule and deliver the minimum energy deliveries or deliver energy as
scheduled, (2) El Paso Merchant does not deliver energy at the locations
specified in the mirror power purchase agreement or (3) El Paso Merchant fails
to schedule and deliver the required quantities of energy or provide all or part
of the required capacity to us. These credits will be calculated in the same
manner and applied when the corresponding credits are applied to Public Service
Electric under the amended power purchase agreement. If at the end of any
period, the amount of the credits due to us exceeds the total amount that we owe
to El Paso Merchant for that period, El Paso Merchant will be obligated to pay
us in cash for these excess amounts.
In addition to the credits described above, if El Paso Merchant does not
schedule and deliver 42% of the required annual energy deliveries to us by June
30 in any year, or the required annual energy deliveries by December 31 in any
year, El Paso Merchant will be required to pay energy shortfall liquidated
damages to us by August 10 of the same year for the June 30 energy deliveries
and by February 10 of the following year for the December 31 energy deliveries.
In addition to the shortfall payments, El Paso Merchant will also be required to
pay other damages and indemnity payments (such as for third-party liability) and
distribution surcharges that we may be liable for under the amended power
purchase agreement. El Paso Merchant has the right to terminate the mirror power
purchase agreement upon 10 days written notice if we do not pay amounts that we
owe to El Paso Merchant within 30 days of El Paso Merchant's notice to us that
our payment is overdue. Under the consent and agreement to be entered into among
us, El Paso Merchant and the trustee, El Paso Merchant will grant to the trustee
an additional 30 days to cure a payment default by us under the mirror power
purchase agreement prior to terminating the mirror power purchase agreement. We
may terminate the mirror power purchase agreement upon 10 days written notice if
the amended power purchase agreement terminates for any reason.
The other provisions of the amended power purchase agreement and the mirror
power purchase agreement, including the terms during which they are effective,
are substantially similar to each other. For
43
more information about the provisions of the mirror power purchase agreement,
see "Summary of Our Transaction Documents -- Mirror Power Purchase Agreement."
El Paso Merchant expects to procure the energy to be delivered and the
capacity to be provided under the mirror power purchase agreement from the PJM
market. For more information about the East PJM market, see "Independent Energy
Consultant" and Annex A.
ADMINISTRATIVE SERVICES AGREEMENT
We entered into an administrative services agreement with El Paso Merchant
dated as of December 12, 2001. Pursuant to the administrative services
agreement, El Paso Merchant agreed:
- to administer and perform all of our managerial and administrative
obligations under the amended power purchase agreement, exercise all of
our rights under the mirror power purchase agreement and coordinate our
operations under both agreements;
- to administer and perform all of our managerial and administrative
obligations under our other material agreements, the indenture and the
related financing documents; and
- if necessary, to notify El Paso Merchant and El Paso of their payment
obligations under the mirror power purchase agreement and the El Paso
performance guaranty, respectively.
For more detailed information about the administrative services agreement,
see "Summary of Our Transaction Documents -- Administrative Services Agreement."
EL PASO PERFORMANCE GUARANTY
El Paso entered into a performance guaranty dated as of December 12, 2001,
pursuant to which El Paso has agreed to unconditionally guarantee the
obligations (including payment obligations) of El Paso Merchant under the mirror
power purchase agreement and the administrative services agreement.
For more detailed information about the El Paso performance guaranty, see
"Summary of Our Transaction Documents -- El Paso Performance Guaranty."
ACCOUNTS
Payments to us by Public Service Electric under the amended power purchase
agreement, by El Paso Merchant pursuant to the mirror power purchase agreement
for shortfall payments and excess amounts or by El Paso pursuant to the El Paso
performance guaranty and transfer payments from the liquidity account must be
deposited directly into a collections account established by the trustee
pursuant to the indenture. The trustee must disburse funds from the collections
account to pay our expenses (including capacity and energy payments to El Paso
Merchant and principal and interest on the bonds) in a specific order of
priority. In addition, the net proceeds from any additional bonds issued under
the indenture will be distributed into the collections account but will be
immediately distributed to Mesquite. See "Description of the Bonds and the
Indenture -- Withdrawals from the Collections Account."
We have also provided for the establishment and funding of a liquidity
account with the trustee in an amount equal to the liquidity reserve required
balance. The liquidity reserve required balance is an amount equal to the
greater of the maximum amount of interest due on the bonds in any semi-annual
period after September 1, 2002, and during the term of the bonds and $14.25
million. El Paso may substitute a letter of credit or a guaranty from El Paso
for amounts otherwise required to be deposited in the liquidity account if El
Paso or the issuer of a letter of credit, as the case may be, has the required
credit rating. The purpose of the liquidity account is to provide the trustee
with cash if we do not have sufficient funds in the collections account to make
a principal or interest payment. We will be able to withdraw amounts from the
liquidity account to make such payments to the extent that funds are in the
liquidity account. Once funds have been withdrawn from the liquidity account,
those funds will only be replenished out of funds otherwise available in the
collections account. If surplus funds are not available from the collections
account, the liquidity reserve required balance will not be maintained. See
"Description of the Bonds and the Indenture -- The Accounts."
44
If we are required to pay damages to third parties or indemnity amounts
arising under the amended power purchase agreement, El Paso Merchant will be
required to pay us these amounts. Those amounts will be paid into, and the
corresponding payment to Public Service Electric will be paid from, the damages
and indemnity account. See "Description of the Bonds and the Indenture -- The
Accounts."
SECURITY OWNERSHIP OF OUR OWNER
CEDAR BRAKES II, L.L.C.
The following table sets forth information concerning our owner.
<Table>
<Caption>
PERCENT OF
NATURE OF PERCENT OF TOTAL VOTING
NAME AND ADDRESS OWNERSHIP INTEREST OWNERSHIP POWER
- ---------------- ------------------ ---------- ------------
Mesquite Investors, L.L.C.............................. Member 100 100
c/o El Paso Corporation
1001 Louisiana Street
Houston, Texas 77002
</Table>
MESQUITE
Mesquite is indirectly owned by El Paso and Limestone.
45
SUMMARY OF OUR TRANSACTION DOCUMENTS
The following is a summary of selected provisions of some of the principal
documents related to our transaction and should not be considered to be a full
statement of the terms and provisions of those agreements. Accordingly, the
following summaries are qualified by reference to each agreement and are subject
to the terms of the full text of each agreement. Unless otherwise stated, any
reference in this prospectus to any agreement means the agreement described and
all schedules, exhibits and attachments thereto as amended, restated,
supplemented or otherwise modified (including by any consent or agreement
required in connection with the financing contemplated in this prospectus) and
to be in effect as of the date of this prospectus. We encourage you to read
these agreements, copies of which are available for inspection at our principal
executive offices or upon written request of any potential investor.
AMENDED POWER PURCHASE AGREEMENT
We entered into the amended power purchase agreement with Public Service
Electric on May 23, 2001. The amended power purchase agreement amends and
restates two separate power purchase agreements under which Public Service
Electric buys all of the power from the Camden facility and some of the power
from the Bayonne facility, and provides that we must sell energy and provide
capacity credits to Public Service Electric.
TERM
The amended power purchase agreement became effective on December 12, 2001
and remains in effect through and including March 5, 2013, unless terminated
earlier as provided in the amended power purchase agreement
PURCHASE AND SALE OF ENERGY AND CAPACITY
GENERAL CONDITION OF DELIVERY AND ACCEPTANCE OF ENERGY AND PROVISION OF
CAPACITY
We may provide energy and capacity to Public Service Electric at our option
from any source of supply, including the Camden facility, the Bayonne facility,
or other sources.
QUALIFYING FACILITY STATUS
Our obligations and Public Service Electric's obligations under the amended
power purchase agreement to buy and sell capacity and energy are not conditioned
upon our maintenance of qualifying facility status under PURPA of the Camden
facility, the Bayonne facility or any other facility.
PROVISION OF CAPACITY
We are required to arrange for capacity credits to be made available to
Public Service Electric so that Public Service Electric will be credited by PJM
with at least 189 MW of capacity per day through October 31, 2008, and at least
149 MW of capacity per day from November 1, 2008 through the end of the term of
the amended power purchase agreement. We must take all necessary steps for
Public Service Electric's account with PJM to reflect these 189 MW or 149 MW,
respectively, including utilizing PJM's "eCapacity" mechanism, throughout the
applicable periods during the term of the amended power purchase agreement set
forth above. If we are required to provide a different quantity of capacity
credits to Public Service Electric because of a change in the measurement
methodology used by PJM, the new minimum quantity of capacity credits will be
based on the operation of the Camden facility and the Bayonne facility during
the 12 month period from January 1, 1998 through December 31, 1998 or a shorter
period ending as of December 31, 1998 as may be specified in the new measurement
methodology. If Public Service Electric's agreement with the PJM market no
longer requires Public Service Electric to obtain capacity credits, we must
provide capacity to Public Service Electric in an amount equal to the amount
specified in the measurement methodology in effect immediately prior to the
cancellation of this requirement.
46
SALE AND DELIVERY OF ENERGY
We will sell and deliver energy to Public Service Electric at any point on
the PJM system, and Public Service Electric must purchase this energy. The
annual energy deliveries cannot exceed 485,522 MWh for the year 2001 (which will
be prorated since September 5, 2001); 1,501,825 MWh for the years 2002 through
2007; 1,447,524 MWh for the year 2008; 1,171,424 MWh for the years 2009 through
2012; and 205,400 MWh from January 1, 2013 through March 5, 2013.
PURCHASE PRICE AND PAYMENT CONDITIONS
We began receiving the payment for energy and capacity based on our
delivery of energy to Public Service Electric at the contract rate of $92.76/MWh
in 2001. The contract rate then changes on a calendar year basis as follows:
<Table>
<Caption>
CONTRACT
RATE
YEAR PER MWH
- ---- --------
2002........................................................ $80.88
2003........................................................ 77.75
2004........................................................ 80.01
2005........................................................ 82.37
2006........................................................ 84.82
2007........................................................ 87.37
2008........................................................ 90.07
2009........................................................ 93.08
2010........................................................ 95.98
2011........................................................ 99.00
2012........................................................ 102.15
2013........................................................ 105.42
</Table>
DELIVERY OF ENERGY AND PROVISION OF CAPACITY
By no later than three business days prior to each calendar month, we must
provide Public Service Electric with a non-binding schedule of proposed energy
deliveries for each hour of the upcoming month. Subsequently, on the business
day preceding the day of delivery of the energy, we must provide Public Service
Electric with a final schedule for deliveries of energy by no later than one
hour prior to the time that PJM requires submission of final schedules. The
amounts set forth in the daily schedules may vary from each other and may vary
from the amounts set forth in the monthly schedule. If we fail to timely provide
a daily or monthly schedule to Public Service Electric, the amount of energy
scheduled for delivery will be deemed to be the amount that we set in the most
recent monthly schedule that we delivered to Public Service Electric.
We may deliver energy at a rate of up to 200 MWh per hour through October
31, 2008, and 156 MWh per hour thereafter, unless we are also scheduling
"make-up energy" (described below), in which case, we can deliver up to 250 MWh
per hour through October 31, 2008 and 195 MWh per hour thereafter. We must
schedule and deliver energy at the same rate during all on-peak hours in any day
and at the same rate during all off-peak hours in any day. However, the delivery
rate for on-peak hours in a given day may differ from the delivery rate for
off-peak hours in the same day and the delivery rate for on-peak hours can vary
from day to day.
MINIMUM ENERGY DELIVERIES
During the months of June, July, August and September, we must deliver to
Public Service Electric at least 165 MWh per hour through October 31, 2008, and
130 MWh per hour thereafter, which requirement we refer to in this prospectus as
the summer hourly delivery requirement, and 185 MWh per hour on average
47
during the months of June, July, August and September during on-peak hours
through October 31, 2008, and 144 MWh per hour on average during the months of
June, July, August and September during on-peak hours thereafter, which
requirement we refer to in this prospectus as the summer on-peak delivery
requirement. For all other months of the year, we must deliver 50 MWh per hour
through October 31, 2008, and 39 MWh per hour thereafter, which requirement we
refer to in this prospectus as the non-summer hourly delivery requirement, and
460,445 MWh during the on-peak hours through October 31, 2008, and 359,147 MWh
during on-peak hours thereafter, which requirement we refer to in this
prospectus as the non-summer on-peak delivery requirement. The summer hourly
delivery requirement, the summer on-peak delivery requirement, the non-summer
hourly delivery requirement and the non-summer on-peak delivery requirement,
together, are called the minimum energy deliveries.
MAKE-UP ENERGY DELIVERIES
If a force majeure event or a system emergency prevents us from delivering,
or prevents Public Service Electric from accepting, the scheduled amount of
energy, we have the right to reschedule deliveries of make-up quantities during
comparable periods during the remainder of the month in which the inability
occurred. If we are unable to reschedule deliveries of make-up energy due to a
force majeure event or a system emergency in that month, we have the right to
reschedule the delivery of make-up energy during comparable periods in the next
month. If we (1) fail to deliver scheduled quantities of energy or (2) fail to
reschedule and deliver in the immediately following month any make-up
quantities, Public Service Electric may permit us to reschedule any such
quantities of energy in any subsequent month, but is not required to do so.
FAILURE TO SCHEDULE OR DELIVER ENERGY OR PROVIDE CAPACITY
If we fail, for reasons other than a force majeure event or a system
emergency, to deliver all or part of the scheduled energy, Public Service
Electric may permit us to reschedule delivery of the energy. In the event we
fail to deliver all or part of the scheduled energy or fail to schedule
sufficient deliveries to meet the minimum energy deliveries or the annual energy
deliveries, the payment to us with respect to the corresponding billing period
shall be reduced by a credit against the amount payable by Public Service
Electric for succeeding months until such credit is fully used. If the credit
amount is greater than the amount payable by Public Service Electric for a
single month, the excess portion of the credit will be applied to reduce the
amount otherwise payable by Public Service Electric for subsequent months.
Public Service Electric's credit will be calculated as follows:
- if we fail to deliver any scheduled quantities of energy, then the credit
will be determined by multiplying the shortfall by the excess, if any, in
the rate that Public Service Electric had to pay to third parties to
procure energy to replace the energy that we failed to deliver over the
rates payable to us under the amended power purchase agreement;
- if we fail to schedule the summer hourly delivery requirement or the
non-summer hourly delivery requirement for any hour, then the credit will
be determined by multiplying the shortfall by the excess, if any, in the
blended locational marginal price for the applicable hour over the rates
payable to us under the amended power purchase agreement (the "blended
locational marginal price" means (1) until and including October 31,
2008, 78% of the real time locational marginal price at the Camden
delivery point plus 22% of such price at the Bayonne delivery point and
(2) after October 31, 2008, the real-time locational marginal price at
the Camden delivery point);
- if we fail to schedule the summer or non-summer on-peak delivery
requirement for any summer or non-summer on-peak period, respectively,
then the credit will be determined by multiplying the shortfall by the
excess, if any, of the average of the blended locational marginal prices
for the summer or non-summer on-peak period, as applicable, over the
rates payable to us under the amended power purchase agreement; however,
this amount will be reduced by the amount of all hourly shortfall
credits, described immediately above, during the period; or
- if we fail to schedule the annual energy deliveries, then the credit will
be determined by multiplying the shortfall by the excess, if any, of the
average blended locational marginal price for all hours during the
48
calendar year over the rate payable to us under the amended power
purchase agreement; however, this amount will be reduced by the amount of
all hourly shortfalls and all seasonal shortfalls during the year.
If we fail for reasons other than a force majeure or a system emergency,
during any month, to provide all or part of the capacity required to be provided
to Public Service Electric, Public Service Electric must use reasonable
commercial efforts to purchase replacement capacity in the amount of the
shortfall. We must reimburse Public Service Electric for all costs associated
with the replacement. If Public Service Electric is unable to replace this
capacity shortfall, then the payments owed by Public Service Electric for that
month will be reduced by a credit against the amount payable by Public Service
Electric for the next succeeding month in an amount equal to the deficiency
charge, if any, or other charges, as applicable, payable by Public Service
Electric as a direct result of our failure to provide this capacity.
These credits are the only damages that Public Service Electric can claim
as a result of any failure by us to deliver energy or provide capacity as
required by the amended power purchase agreement. The amended power purchase
agreement provides for other remedies if there is an event of default by us. See
"-- Defaults" and "-- Remedies" below.
DAMAGES FOR FAILURE TO ACCEPT DELIVERY OF ENERGY
If Public Service Electric fails to accept deliveries of energy scheduled
by us for reasons other than a force majeure event or a system emergency, Public
Service Electric must pay us an amount equal to the difference, if positive,
between the amount payable by Public Service Electric to us under the amended
power purchase agreement for the scheduled energy which Public Service Electric
failed to accept and the amount that we, using commercially reasonable efforts
under the circumstances, realize through remarketing that energy to persons
other than Public Service Electric. These payments are the only damages that we
can claim as a result of any failure by Public Service Electric to accept
deliveries of energy under the amended power purchase agreement.
FINANCIAL SETTLEMENT
Either Public Service Electric or we may give a notice to the other party,
not later than one hour before PJM's deadline for next-day energy deliveries,
specifying (1) the hour(s) during which energy will not be physically delivered
under the amended power purchase agreement and (2) an amount of energy with
respect to each specified hour, referred to as the financial settlement energy,
which together with the energy delivered during such hour, does not exceed the
maximum delivery rate specified in the amended power purchase agreement for the
specified hours. If the other party agrees, then (1) quantities identified as
financial settlement energy shall not be scheduled or delivered as energy under
the amended power purchase agreement during the hours specified in the notice,
provided that we may in such hour schedule and deliver energy in accordance with
the amended power purchase agreement subject to the maximum delivery rates
specified in the amended power purchase agreement, and (2) all financial
settlement energy shall be deemed to have been scheduled, delivered and accepted
for purposes of calculating credits and maximum delivery rates, with the
financial settlement energy offsetting and thereby reducing the amount of energy
that we are entitled to deliver within such delivery rates. The price for each
MWh of financial settlement energy relating to an hour specified in the notice
shall equal the difference between the contract rate for the hour minus the
blended locational marginal price for the hour. If this price is positive,
Public Service Electric will pay us the price for each MWh of financial
settlement energy in accordance with the price calculation. If this price is
negative, we will pay Public Service Electric an amount equal to the number of
MWh of such financial settlement energy times the calculated price.
TRANSMISSION
We are responsible for arranging transmission of all energy to Public
Service Electric and paying for all related transmission charges and congestion
costs to any delivery point. We may choose any delivery point on the PJM system,
but (1) if we deliver energy to a delivery point other than the Camden delivery
point or, at
49
any time through October 31, 2008, the Bayonne delivery point, or (2) if the
ratio of the quantity of energy delivered to the Camden delivery point during
the hour to the quantity of energy delivered to the Bayonne delivery point
during the same hour is not in the ratio of 78% to 22%, then a delivery point
adjustment shall be used to adjust the amount due for energy delivered during
such hour. This adjustment will equal the difference, if positive, between the
target value of energy delivered during the hour, and the actual value of the
energy delivered during the hour, each as calculated according to a formula in
the amended power purchase agreement.
SYSTEM EMERGENCY EXCEPTION
Public Service Electric is excused from accepting all or a portion of our
energy and capacity in the event of a system emergency if accepting our energy
and capacity would contribute to the system emergency. A "system emergency" is
defined as the existence of a physical or operational condition and/or the
occurrence of an event on Public Service Electric's system (or the PJM system)
which in Public Service Electric's judgment is imminently likely to endanger
life or property, or impairs and/or imminently will impair Public Service
Electric's ability to discharge its statutory obligation to provide safe,
adequate and proper service to its customers and/or the safety and/or
reliability of Public Service Electric's system (or PJM's system).
FORCE MAJEURE
An event of force majeure is an event beyond the reasonable control of the
party claiming force majeure. These events include, without limitation, acts of
God; strikes, lockouts or other similar industrial disturbances; acts of the
public enemy, wars, civil disturbances, blockades, military actions,
insurrections or riots; landslides, floods, washouts, lightning, earthquakes,
tornadoes, hurricanes, blizzards or other storms or storm warnings; explosions,
fires, sabotage or vandalism; mandates, directives, orders or restraints of any
governmental, regulatory or judicial body or agency (other than mandates,
directives, orders or restraints either sought, approved or not contested by the
party asserting force majeure or issued in any bankruptcy or insolvency
proceeding for the relief of the party asserting force majeure); any
catastrophic physical failures or disruptions of the PJM transmission system;
breakage, defects, malfunctioning, or accident to machinery, equipment,
materials or lines of pipe or wires; freezing of machinery, equipment, materials
or lines of pipe or wires; inability or delay in the obtaining of materials or
equipment; and inability to obtain or utilize any permit, approval, easement,
license or right-of-way.
Force majeure events do not include failures of the equipment of the party
claiming force majeure which are due to wear and tear or defects in manufacture,
design or construction; any increase in the cost of electricity supplies or
costs associated with transmission system operation, maintenance or congestion;
unavailability of capacity and/or energy from any source, regardless of price,
for delivery to a delivery point (except in the event of a system emergency);
interruption in service by a transmission provider unless the party contracting
with the transmission provider shall have made arrangements with the
transmission provider for the firm transmission, as defined under the
transmission provider's tariff, of the energy to be delivered, and the
interruption is due to an emergency or to an event of force majeure as defined
under the transmission provider's tariff; and any change in economic conditions
not caused by a force majeure event.
If either party is rendered unable, wholly or in part, by an event of force
majeure, to perform any obligation it has under the amended power purchase
agreement, that party's obligations will be suspended to the extent those
obligations are affected by the event of force majeure for the duration of the
event of force majeure. Neither party is relieved from any obligation to make
any payment to the other during an event of force majeure. The affected party
must use its best efforts to remedy the cause of the force majeure with all
reasonable dispatch.
Neither party will be liable to the other for any claim(s), loss(es),
damages, liability(ies) or expense(s) sustained or incurred, arising out of,
relating to, or resulting from our or Public Service Electric's inability or
incapacity to perform its obligations under the amended power purchase agreement
due to any event of force majeure. The requirement that any event of force
majeure be remedied with all reasonable dispatch will not
50
require the settlement of strikes, lockouts or other similar industrial
disturbances when this course is, in the opinion of the party directly affected,
inadvisable.
LIABILITY
Neither Public Service Electric nor we (including each party's officers,
directors, partners, agents, servants, employees, affiliates, parent,
subsidiaries, or successors or assigns) will be liable to the other for claims
of incidental, special, direct, indirect or consequential damages, whether the
claim is based on warranty, negligence, strict liability, contract, operation of
law or otherwise, except where the claim arises out of the gross negligence of a
party or the willful disregard by a party of its obligations under the amended
power purchase agreement. However, Public Service Electric and we each have the
right to seek to recover from the other party direct damages upon the occurrence
of an event of default under the amended power purchase agreement.
INDEMNIFICATION & WARRANTIES
We and Public Service Electric have each agreed to indemnify and hold
harmless the other (including officers, agents, servants and employees,
successors and assigns) from and against any and all claims, demands and suits,
actions, and liabilities, losses, damages, and/or judgments which may arise
therefrom as well as against any fees, costs, charges or expenses which Public
Service Electric or we, our respective officers, agents, servants and employees,
successors and assigns, incur in the defense of any such claims, suits, actions
or similar such demands made or filed by any third-party, which in any manner
arise out of, relate to, or result from negligence, or strict liability of, or
breach of the amended power purchase agreement by, the other party.
We are obligated to supply energy to the delivery points and provide
capacity free and clear of any liens and/or adverse claims which might attach to
this energy or capacity prior to supply and receipt by Public Service Electric
except with respect to any lien possessed by a lender. We agree to indemnify and
hold harmless Public Service Electric against any and all claims, demands,
suits, actions, costs, liabilities, damages, losses and/or judgments arising out
of, relating to or resulting from any such adverse claim or lien, as well as
against any fees, costs, charges or expenses which Public Service Electric might
incur in the defense of any such claim, suit, action or similar demand made or
filed by the claimant, or its successors or assigns, asserting the adverse
claim.
DEFAULTS
Each of the following would constitute an "event of default" for us:
- We breach or fail to observe or perform any of the material obligations,
covenants, conditions, services or responsibilities under the amended
power purchase agreement, unless, within 30 days after written notice
from Public Service Electric specifying the nature of the breach or
failure, we either cure the breach or failure to act, or, if the cure
cannot be completed within 30 days, provide Public Service Electric with
a plan reasonably acceptable to Public Service Electric to cure the
breach or failure and commence and diligently pursue the plan.
- There is an assignment for the benefit of our creditors, or we are
adjudged a bankrupt, or a petition is filed by or against us under the
provisions of any state insolvency law or under the provisions of the
federal bankruptcy laws, or our business or principal assets are placed
in the hands of a receiver, assignee or trustee, or we are dissolved, or
our existence is terminated, or our business is discontinued. However,
these events will not constitute an event of default or otherwise affect
the validity of the amended power purchase agreement, so long as the
terms, covenants and conditions of the amended power purchase agreement
on our part are performed.
- We take any actions which prevent Public Service Electric from performing
any of its material obligations, covenants, conditions, responsibilities
or services under the amended power purchase agreement, unless, within 30
days after written notice from Public Service Electric specifying the
nature of the action or failure to act, we either cure the action or
failure to act, or, if the cure cannot be
51
completed within 30 days, provide Public Service Electric with a plan
reasonably acceptable to Public Service Electric to cure the breach or
failure and commence and diligently pursue the cure.
- We fail to deliver energy and provide capacity to Public Service Electric
for 240 out of 365 days for any reason other than force majeure or a
system emergency and fail to pay the liquidated damages associated with
the failure when due under the amended purchase power agreement.
Each of the following would constitute an "event of default" for Public
Service Electric:
- Public Service Electric breaches or fails to observe or perform any of
the material obligations, covenants, conditions, services or
responsibilities under the amended power purchase agreement, unless,
within 30 days after written notice from us specifying the nature of the
breach or failure, Public Service Electric either cures the breach or
failure to act, or, if the cure cannot be completed within 30 days,
provides us with a plan reasonably acceptable to us to cure the breach or
failure and commences and diligently pursues the cure.
- Public Service Electric fails to accept deliveries of energy and capacity
for any reason other than a force majeure event or a system emergency,
and the failure continues for a period of 30 days following receipt of
notice of the failure and fails to pay the liquidated damages associated
with the failure as set forth in the amended power purchase agreement.
- There is an assignment for the benefit of Public Service Electric's
creditors, or Public Service Electric is adjudged bankrupt, or a petition
is filed by or against Public Service Electric under the provisions of
any state insolvency law or under the provisions of the federal
bankruptcy law, or the business or principal assets of Public Service
Electric are placed in the hands of a receiver, assignee or trustee, or
Public Service Electric is dissolved, or its existence is terminated, or
its business is discontinued. However, these events will not constitute
an event of default or otherwise affect the validity of the amended power
purchase agreement, so long as the payment for energy and capacity
delivered by us to Public Service Electric as provided under the amended
power purchase agreement continues to be made and the other terms,
covenants and conditions of the amended power purchase agreement on the
part of Public Service Electric are performed.
- Public Service Electric takes any actions which prevent us from
performing any of our material obligations, covenants, conditions,
responsibilities or services under the amended power purchase agreement,
unless within 30 days after written notice from us specifying the nature
of the action or failure to act, Public Service Electric either cures the
action or failure to act, or, if such cure cannot be completed within 30
days, provides us with a plan reasonably acceptable to us to cure the
breach or failure and commences and diligently pursues the cure.
- Public Service Electric fails to pay, when due, the payment under the
amended power purchase agreement, and the failure continues for a period
of 30 days following the receipt by Public Service Electric of notice of
the failure; provided, however, Public Service Electric shall not be
considered in default if (1) it has paid the undisputed portion of any
payment due under the amended power purchase agreement and (2) the
parties are in the process of resolving expeditiously any disputed
portion in accordance with the terms set forth in the amended power
purchase agreement.
CURE BY FINANCIERS
Public Service Electric cannot terminate the amended power purchase
agreement upon our default if, after giving 30 days written notice of our breach
or default, any one or more entities or individuals, referred to in this
prospectus as the "financiers", who provide financing, equity investments or
lease financing to us or entities affiliated with us in respect of the
transactions including and related to the amended power purchase agreement,
have, prior to any effective date of termination (1) cured the condition
precipitating the notice of breach or (2) if the condition is not capable of
being cured prior to the date of termination, commenced in a diligent manner to
cure the condition and for so long as the financiers diligently continue such
efforts.
52
REMEDIES
If either party claims that an event of default has occurred, that party
must provide the other party with a written notice of breach. The parties have
30 days from the date of notice to negotiate a resolution. If the parties are
unable to resolve the dispute by negotiation, each party has the right to submit
the dispute to arbitration or any regulatory body having jurisdiction.
Both parties have the obligation to act in a commercially reasonable manner
to mitigate damages as a result of any event of default. Neither party may
refuse to make, suspend or delay any payment otherwise required under the
amended power purchase agreement or refuse to carry out any of its obligations
under the amended power purchase agreement on account of an alleged breach of
the amended power purchase agreement or event of default.
ARBITRATION AND GOVERNING LAW
Any controversy, dispute or claim between Public Service Electric and us
which is not resolved by negotiation and over which no regulatory body has
jurisdiction, or for which the regulatory body with jurisdiction declines to
initiate proceedings, shall be settled by arbitration in accordance with the
Commercial Arbitration Rules of the American Arbitration Association. Any
controversy, dispute or claim submitted to arbitration shall be settled by
arbitration in Newark, New Jersey in accordance with the laws of the State of
New Jersey.
ASSIGNMENT
We may assign our rights and obligations under the amended power purchase
agreement to El Paso Merchant or any entity controlling, controlled by or under
common control with El Paso Merchant or which has a credit rating at least equal
to Baa3 from Moody's and BBB- from Standard & Poor's or a similar rating from
any other similar independent rating agency. We may also assign our rights and
obligations under the amended power purchase agreement to any financier, as
defined above under "Cure by Financiers", with the consent of Public Service
Electric and provided the terms of the assignment are reasonably acceptable to
Public Service Electric and to us. We may not assign our rights and obligations
under the amended power purchase agreement in any other situation without the
prior written consent of Public Service Electric, which consent will not be
unreasonably withheld or delayed.
Public Service Electric may, on notice to us, assign and transfer its
rights and obligations to any entity controlling, controlled by or under common
control with Public Service Electric if the assignee has a credit rating by each
of Moody's and Standard & Poor's at least equivalent to that of Public Service
Electric. Public Service Electric may not assign its rights and/or obligations
under the amended power purchase agreement in any other situation without our
prior written consent, which consent may not be unreasonably withheld or
delayed.
MIRROR POWER PURCHASE AGREEMENT
We entered into the mirror power purchase agreement with El Paso Merchant
on October 1, 2001. The mirror power purchase agreement was amended on November
26, 2001. Under the mirror power purchase agreement, El Paso Merchant agreed to
sell us energy and provide us capacity credits.
TERM
The term of the mirror power purchase agreement runs from December 12, 2001
until March 5, 2013. We or El Paso Merchant may terminate the mirror power
purchase agreement on 10 days written notice if the amended power purchase
agreement is terminated for any reason, and El Paso Merchant is able to
terminate upon 10 days written notice if we fail to make the required payment
within 30 days after such notice. However, El Paso Merchant does not have the
right to terminate if the reason for the non-payment results directly or
indirectly from El Paso Merchant's failure to perform under the mirror power
purchase agreement.
53
PURCHASE AND SALE OF ENERGY AND CAPACITY
GENERAL CONDITION OF DELIVERY AND ACCEPTANCE OF ENERGY AND PROVISION OF
CAPACITY
El Paso Merchant may provide energy and capacity to us at its option from
any source of supply including but not limited to the Bayonne facility and the
Camden facility.
QUALIFYING FACILITY STATUS
Our obligations and El Paso Merchant's obligations under the mirror power
purchase agreement to buy and sell capacity and energy are not conditioned upon
El Paso Merchant's maintenance of qualifying facility status of the Camden
facility, the Bayonne facility or any other facility.
PROVISION OF CAPACITY
El Paso Merchant must take all necessary steps for our account with PJM to
reflect at least 189 MW of capacity credits per day through October 31, 2008,
and at least 149 MW of capacity credits per day from November 1, 2008 through
the end of the term of the amended power purchase agreement, including utilizing
PJM's "eCapacity" mechanism. If we require a different quantity of capacity
credits because of a change in the measurement methodology used by PJM, El Paso
Merchant will be required to provide us a new minimum quantity of capacity
credits which will be based on the operation of the Camden facility and the
Bayonne facility during the 12 month period from January 1, 1998 through
December 31, 1998, or such shorter period ending as of December 31, 1998, as may
be specified in the new measurement methodology. If we are no longer required by
Public Service Electric's agreement with the PJM market to obtain capacity
credits, El Paso Merchant must provide capacity to us in an amount equal to the
amount specified in the measurement methodology in effect immediately prior to
the cancellation of this requirement.
SALE AND DELIVERY OF ENERGY
El Paso Merchant must sell and deliver energy to us that is scheduled and
delivered by El Paso Merchant at any point on the East PJM system, and we must
purchase the energy at that point. The annual energy deliveries which El Paso
Merchant must schedule and deliver cannot exceed 485,522 MWh for the year 2001
(subject to proration in the event that the mirror power purchase agreement does
not become effective on or before September 5, 2001), 1,501,825 MWh for the
years 2002 through 2007, 1,447,524 MWh for the year 2008, 1,171,424 MWh for the
years 2009 through 2012, and 205,400 MWh from January 1, 2013 through March 5,
2013.
54
PURCHASE PRICE AND PAYMENT CONDITIONS
The contract rate is as follows:
<Table>
<Caption>
CONTRACT RATE
YEAR PER MWH
- ---- -------------
2001........................................................ $32.00
2002........................................................ 32.00
2003........................................................ 32.00
2004........................................................ 32.00
2005........................................................ 32.00
2006........................................................ 32.00
2007........................................................ 32.00
2008........................................................ 32.00
2009........................................................ 32.00
2010........................................................ 32.00
2011........................................................ 32.00
2012........................................................ 32.00
2013........................................................ 32.00
</Table>
DELIVERY OF ENERGY AND PROVISION OF CAPACITY
By no later than seven business days prior to each calendar month, El Paso
Merchant must provide us with a non-binding schedule of proposed energy
deliveries for each hour of the upcoming month. Subsequently, on the business
day preceding the day of delivery of the energy, El Paso Merchant must provide
us with a final schedule for deliveries of energy by no later than two hours
prior to the time that PJM requires submission of final schedules. The amounts
set forth in the daily schedules may vary from each other and may vary from the
amounts set forth in the monthly schedule. If El Paso Merchant fails to timely
provide us a daily or monthly schedule, the amount of energy scheduled for
delivery will be deemed to be the amount that El Paso Merchant set in the most
recent monthly schedule delivered by El Paso Merchant to us.
El Paso Merchant may deliver energy at a rate of up to 200 MWh per hour
through October 31, 2008, and 156 MWh per hour thereafter, unless "make-up
energy" (described below) is also being scheduled, in which case, El Paso
Merchant can deliver up to 250 MWh per hour through October 31, 2008 and 195 MWh
per hour thereafter. El Paso Merchant must schedule and deliver energy at the
same rate during all on-peak hours in any day and at the same rate during all
off-peak hours in any day. However, the delivery rate for on-peak hours in a
given day may differ from the delivery rate for off-peak hours in the same day
and the delivery rate for on-peak hours can vary from day to day.
MINIMUM ENERGY DELIVERIES
During the months of June, July, August and September, El Paso Merchant
must schedule and deliver to us at least 165 MWh per hour through October 31,
2008, and 130 MWh per hour thereafter, which requirement we refer to in this
prospectus as the summer hourly delivery requirement, and 185 MWh per hour on
average during the months of June, July, August and September during on-peak
hours through October 31, 2008, and 144 MWh per hour on average during the
months of June, July, August and September during on-peak hours thereafter,
which requirement we refer to in this prospectus as the summer on-peak delivery
requirement. For all other months of the year, we must deliver 50 MWh per hour
through October 31, 2008, and 39 MWh per hour thereafter, which requirement we
refer to in this prospectus as the non-summer hourly delivery requirement, and
460,445 MWh per hour during the on-peak hours through October 31, 2008, which
requirement we refer to in this prospectus as the non-summer hourly delivery
requirement, and 359,147 MWh during on-peak hours thereafter, which requirement
we refer to in this prospectus as the non-summer on-peak delivery requirement.
The summer hourly delivery requirement, the summer on-peak delivery requirement,
55
the non-summer hourly delivery requirement and the non-summer on-peak delivery
requirement, together, are called the minimum energy deliveries.
MAKE-UP ENERGY DELIVERIES
If a force majeure event or a system emergency prevents El Paso Merchant
from delivering, or prevents us from accepting, the scheduled amount of energy,
El Paso Merchant is obligated to reschedule deliveries of make-up quantities
during comparable periods during the remainder of the month in which the
inability occurred. If El Paso Merchant is unable to reschedule deliveries of
make-up energy due to a force majeure event or a system emergency, El Paso
Merchant has the obligation to reschedule the delivery of make-up energy during
comparable periods in the next month. If El Paso Merchant (1) fails to deliver
scheduled quantities of energy or (2) fails to reschedule and deliver in the
immediately following month any make-up quantities, El Paso Merchant must
reschedule the delivery of any such quantities of energy in any subsequent month
to the extent that we are permitted to reschedule and deliver such make-up
quantities of energy under the amended power purchase agreement.
EL PASO MERCHANT'S FAILURE TO SCHEDULE OR DELIVER ENERGY OR PROVIDE CAPACITY
If El Paso Merchant fails, for reasons other than a force majeure event or
a system emergency, to deliver all or part of the scheduled energy, and Public
Service Electric under the amended power purchase agreement permits us to
reschedule delivery of the energy, El Paso Merchant shall reschedule delivery of
this energy. In the event El Paso Merchant fails to deliver all or part of the
scheduled energy or fails to schedule sufficient deliveries to meet the minimum
energy deliveries, the payment to El Paso Merchant with respect to the
corresponding billing period shall be reduced by a credit against the amount
payable by us for the next succeeding month. If the credit amount is greater
than the amount payable by us for a single month, El Paso Merchant shall pay the
excess portion of the credit by the end of that next succeeding month. These
credits will be calculated in the same manner as the credit due to Public
Service Electric under the amended power purchase agreement and shall be applied
under the mirror power purchase agreement in the same months in which the credit
is applied under the amended power purchase agreement.
If El Paso Merchant fails for reasons other than a force majeure or a
system emergency, during any month, to provide all or part of the capacity
required to be provided to us, we must use reasonable commercial efforts to
purchase replacement capacity in the amount of the shortfall. El Paso Merchant
must reimburse us for all costs associated with the replacement. If we are
unable to replace this capacity shortfall, then the payments owed by us for that
month will be reduced by a credit against the amount payable by us for the next
succeeding month in an amount equal to the deficiency charge, if any, or other
charges, as applicable, payable by us under the amended power purchase agreement
as a direct result of El Paso Merchant's failure to provide this capacity. If
the credit amount is greater than the amount payable by us for a single month,
El Paso Merchant shall pay the excess portion of the credit by the last business
day of that next succeeding month.
These credits and the damages for failure to deliver 42% of the annual
energy deliveries by June 30 in any year and deliver the annual energy
deliveries by December 31 in any year, which are described more fully below, are
the only damages that we can claim as a result of any failure by El Paso
Merchant to deliver energy or provide capacity as required by the mirror power
purchase agreement. The mirror power purchase agreement provides for other
remedies if there is an event of default by El Paso Merchant. See "-- Defaults"
and "-- Remedies" below.
ENERGY SHORTFALL LIQUIDATED DAMAGE PAYMENTS
If El Paso Merchant does not deliver 42% of the annual energy deliveries by
June 30 in any year or deliver the annual energy deliveries by December 31 in
any year, El Paso Merchant must pay us an amount equal to (1) the difference
between (x) 42% of the annual energy deliveries for the relevant year and the
energy actually delivered by El Paso Merchant through June 30, or (y) the annual
energy deliveries for the relevant year and the energy actually delivered by El
Paso Merchant during that year, as applicable, multiplied by (2) the difference
between the liquidated damages rate for that year and the contract rate for that
year, each
56
as set forth in the mirror power purchase agreement. The liquidated damages rate
under the mirror power purchase agreement for each year beginning with 2001 is
set forth below. El Paso Merchant must pay these liquidated damages within five
days after receipt of the invoice from us. We must provide this invoice on or
before the fifth day of February of the succeeding calendar year.
<Table>
<Caption>
LIQUIDATED
DAMAGES
RATE
YEAR PER MWH
- ---- ----------
2001........................................................ $ 92.76
2002........................................................ 80.88
2003........................................................ 77.75
2004........................................................ 80.01
2005........................................................ 82.37
2006........................................................ 84.82
2007........................................................ 87.37
2008........................................................ 90.07
2009........................................................ 93.08
2010........................................................ 95.98
2011........................................................ 99.00
2012........................................................ 102.15
2013........................................................ 105.42
</Table>
FINANCIAL SETTLEMENT
Either El Paso Merchant or we may give a notice to the other party, not
later than two hours before PJM's deadline for next-day energy deliveries,
specifying (1) the hour(s) during which energy will not be physically delivered
under the amended power purchase agreement and (2) an amount of energy with
respect to each specified hour, referred to as the financial settlement energy,
which together with the energy delivered during such hour, does not exceed the
maximum delivery rate specified in the mirror power purchase agreement for the
specified hours. If the other party agrees, then (1) quantities identified as
financial settlement energy shall not be scheduled or delivered as energy under
the mirror power purchase agreement during the hours specified in the notice,
provided that El Paso Merchant may in such hour schedule and deliver energy in
accordance with the mirror power purchase agreement subject to the maximum
delivery rates specified in the mirror power purchase agreement, and (2) all
financial settlement energy shall be deemed to have been scheduled, delivered
and accepted for purposes of calculating credits and maximum delivery rates,
with the financial settlement energy offsetting and thereby reducing the amount
of energy that El Paso Merchant is entitled to deliver within such delivery
rates. The price for each MWh of financial settlement energy relating to an hour
specified in the notice shall equal the difference between the contract rate for
the hour minus the blended locational marginal price for the hour. If this price
is positive, we will pay El Paso Merchant the price for each MWh of financial
settlement energy in accordance with the price calculation. If the price is
negative, El Paso Merchant will pay us an amount equal to the number of MWh of
such financial settlement energy times the calculated price. Neither party may
agree to a financial settlement notice unless we and Public Service Electric
have agreed to such a financial settlement notice under the amended power
purchase agreement.
TRANSMISSION
El Paso Merchant is responsible for arranging transmission of all energy to
us and paying for all related transmission charges and congestion costs to any
delivery point. El Paso Merchant may choose any delivery point on the PJM
system, but (1) if El Paso Merchant delivers energy to a delivery point other
than the Camden delivery point or, at any time through October 31, 2008, the
Bayonne delivery point, or (2) if the ratio of the quantity of energy delivered
to the Camden delivery point during the hour to the quantity of energy
57
delivered to the Bayonne delivery point during the same hour is not in the ratio
of 78% to 22%, then a delivery point adjustment shall be used to adjust the
amount due for energy delivered during such hour. This adjustment will equal the
difference, if positive, between the target value of energy delivered during the
hour, and the actual value of the energy delivered during the hour, each as
calculated according to a formula in the mirror power purchase agreement which
is the same formula set forth in the amended power purchase agreement.
SYSTEM EMERGENCY EXCEPTION
We are excused from accepting all or a portion of El Paso Merchant's energy
and capacity in the event of a system emergency. A "system emergency" is defined
as the existence of a physical or operational condition and/or the occurrence of
an event on Public Service Electric's system (or the PJM system) which in Public
Service Electric's judgment is imminently likely to endanger life or property,
or impairs and/or imminently will impair Public Service Electric's ability to
discharge its statutory obligation to provide safe, adequate and proper service
to its customers and/or the safety and/or reliability of Public Service
Electric's system (or PJM's system).
FORCE MAJEURE
An event of force majeure is an event beyond the reasonable control of the
party claiming force majeure. These events include, without limitation, acts of
God; strikes, lockouts or other similar industrial disturbances; acts of the
public enemy, wars, civil disturbances, blockades, military actions,
insurrections or riots; landslides, floods, washouts, lightning, earthquakes,
tornadoes, hurricanes, blizzards or other storms or storm warnings; explosions,
fires, sabotage or vandalism; mandates, directives, orders or restraints of any
governmental, regulatory or judicial body or agency (other than mandates,
directives, orders or restraints either sought, approved or not contested by the
party asserting force majeure or issued in any bankruptcy or insolvency
proceeding for the relief of the party asserting force majeure); any
catastrophic physical failures or disruptions of the PJM transmission system;
breakage, defects, malfunctioning, or accident to machinery, equipment,
materials or lines of pipe or wires; freezing of machinery, equipment, materials
or lines of pipe or wires; inability or delay in the obtaining of materials or
equipment; and inability to obtain or utilize any permit, approval, easement,
license or right-of-way. However, an event shall be deemed to be an event of
force majeure only to the extent that it is so defined under the amended power
purchase agreement (whether or not the amended power purchase agreement is in
full force and effect).
Force majeure events do not include failures of the equipment of the party
claiming force majeure which are due to wear and tear or defects in manufacture,
design or construction; any increase in the cost of electricity supplies or
costs associated with transmission system operation, maintenance or congestion;
unavailability of capacity and/or energy from any source, regardless of price,
for delivery to a delivery point (except in the event of a system emergency);
interruption in service by a transmission provider unless the party contracting
with the transmission provider shall have made arrangements with the
transmission provider for the firm transmission, as defined under the
transmission provider's tariff, of the energy to be delivered, and the
interruption is due to an emergency or to an event of force majeure as defined
under the transmission provider's tariff; and any change in economic conditions
not caused by a force majeure event.
If either party is rendered unable, wholly or in part, by an event of force
majeure, to perform any obligation it has under the mirror power purchase
agreement, that party's obligations will be suspended to the extent those
obligations are affected by the event of force majeure for the duration of the
event of force majeure, but for no longer than such event has suspended the
parties' obligations under the amended power purchase agreement or, if it is no
longer in effect, would have suspended the parties' obligations under the
amended power purchase agreement if it had remained in effect. Neither party is
relieved from any obligation to make any payment to the other during an event of
force majeure. The affected party must use its best efforts to remedy the cause
of the force majeure with all reasonable dispatch.
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However, nothing in the force majeure provisions will excuse or suspend the
obligations of El Paso Merchant to deliver the annual energy deliveries or to
make the energy shortfall liquidated damage payments under the mirror power
purchase agreement.
Neither party will be liable to the other for any claim(s), loss(es),
damages, liability(ies) or expense(s) sustained or incurred, arising out of,
relating to, or resulting from our or El Paso Merchant's inability or incapacity
to perform its obligations under the mirror power purchase agreement due to any
event of force majeure as defined therein.
LIABILITY
Neither El Paso Merchant nor we (including each party's officers,
directors, partners, agents, servants, employees, affiliates, parent,
subsidiaries, or successors or assigns) will be liable to the other for claims
of incidental, special, direct, indirect or consequential damages, whether the
claim is based on a cause of action in warranty, negligence, strict liability,
contract, operation of law or otherwise (except as otherwise provided for in the
mirror power purchase agreement), except where the claim arises out of the gross
negligence of a party or the willful disregard by a party of its obligations
under the mirror power purchase agreement. However, we have the right to seek to
recover from El Paso Merchant direct damages upon the occurrence of an event of
default under the mirror power purchase agreement and to seek indemnification
payments required to be paid by us to Public Service Electric under the amended
power purchase agreement. In the event of the termination of the amended power
purchase agreement prior to termination of the mirror power purchase agreement,
El Paso Merchant will not be liable to us under the mirror power purchase
agreement unless El Paso Merchant would have been liable under the mirror power
purchase agreement if the amended power purchase agreement were in full force
and effect.
INDEMNIFICATION & WARRANTIES
El Paso Merchant has agreed to indemnify and hold harmless us (including
our officers, agents, servants and employees, our successors and assigns) from
and against any and all claims, demands and suits, actions, and liabilities,
losses, damages, and/or judgments which may arise therefrom as well as against
any fees, costs, charges or expenses which we, our officers, agents, servants
and employees, successors and assigns, incur in the defense of any such claims,
suits, actions or similar such demands made or filed by any third-party, which
in any manner arise out of, relate to, or result from negligence, or strict
liability of, or breach of the mirror power purchase agreement by El Paso
Merchant and against claims, suits, actions or similar demands made or filed by
Public Service Electric against us pursuant to the amended power purchase
agreement.
El Paso Merchant is obligated to supply energy to the delivery points and
provide capacity free and clear of any liens and/or adverse claims which might
attach to this energy or capacity prior to supply and receipt by us except with
respect to any lien possessed by a lender. El Paso Merchant agreed to indemnify
us and hold us harmless against any and all claims, demands, suits, actions,
costs, liabilities, damages, losses and/or judgments arising out of, relating to
or resulting from any such adverse claim or lien, as well as against any fees,
costs, charges or expenses which we might incur in the defense of any such
claim, suit, action or similar demand made or filed by the claimant, or its
successors or assigns, asserting the adverse claim.
DEFAULTS
Each of the following would constitute an "event of default" for El Paso
Merchant:
- El Paso Merchant breaches or fails to observe or perform any of the
material obligations, covenants, conditions, services or responsibilities
under the mirror power purchase agreement, unless, within 25 days after
written notice from us specifying the nature of the breach or failure, El
Paso Merchant either cures the breach or failure or, if the cure cannot
be completed within 25 days, provides us with a plan reasonably
acceptable to us to cure the breach or failure and commences and
diligently pursues the plan.
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- There is an assignment for the benefit of El Paso Merchant's creditors,
or El Paso Merchant is adjudged a bankrupt, or a petition is filed by or
against El Paso Merchant under the provisions of any state insolvency law
or under the provisions of the federal bankruptcy laws, or El Paso
Merchant's business or principal assets are placed in the hands of a
receiver, assignee or trustee, or El Paso Merchant is dissolved, or El
Paso Merchant's existence is terminated, or El Paso Merchant's business
is discontinued. However, these events will not constitute an event of
default or otherwise affect the validity of the mirror power purchase
agreement, so long as the terms, covenants and conditions of the mirror
power purchase agreement on El Paso Merchant's part are performed.
- El Paso Merchant takes any actions which prevent us from performing any
of our material obligations, covenants, conditions, responsibilities or
services under the mirror power purchase agreement, unless, within 25
days after written notice from us specifying the nature of the action or
failure to act, El Paso Merchant either cures the action or failure to
act, or, if the cure cannot be completed within 25 days, provides us with
a plan reasonably acceptable to us to cure the breach or failure and
commences and diligently pursues the cure.
- El Paso Merchant fails to deliver energy and provide capacity to us for
240 out of 365 days for any reason other than force majeure or a system
emergency and fails to pay the liquidated damages associated with the
failure when due or other liquidated damages payments required to be paid
under the mirror power purchase agreement.
REMEDIES
If we claim that an event of default has occurred, we must provide El Paso
Merchant with a written notice of breach. The parties have 25 days from the date
of notice to negotiate a resolution. If the parties are unable to resolve the
dispute by negotiation, each party has the right to submit the dispute to
arbitration or any regulatory body having jurisdiction, such arbitration
proceeding to be joined with any arbitration proceeding initiated under the
amended power purchase agreement with respect to substantially the same dispute
or with respect to another dispute involving substantially the same facts.
We have the obligation to act in a commercially reasonable manner to
mitigate damages as a result of any event of default. Neither party may refuse
to make, suspend or delay any payment otherwise required under the mirror power
purchase agreement or refuse to carry out any of its obligations under the
mirror power purchase agreement on account of an alleged breach of the mirror
power purchase agreement or event of default.
ARBITRATION AND GOVERNING LAW
Any controversy, dispute or claim between El Paso Merchant and us which is
not resolved by negotiation and over which no regulatory body has jurisdiction,
or for which the regulatory body with jurisdiction declines to initiate
proceedings, shall be settled by arbitration in accordance with the Commercial
Arbitration Rules of the American Arbitration Association. Any controversy,
dispute or claim submitted to arbitration shall be settled by arbitration in
Newark, New Jersey in accordance with the laws of the State of New Jersey.
ASSIGNMENT
We may assign our rights in the mirror power purchase agreement to any
lender (including a trustee on behalf of the holders) in connection with any
financing or other financial arrangement without El Paso Merchant's consent. For
any other reason, we may not assign our rights and obligations under the mirror
power purchase agreement without the prior written consent of El Paso Merchant,
which consent will not be unreasonably withheld. El Paso Merchant may not assign
and transfer its rights and obligations under the mirror power purchase
agreement without our prior written consent.
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ADMINISTRATIVE SERVICES AGREEMENT
We entered into the administrative services agreement with El Paso Merchant
on December 12, 2001. Under the administrative services agreement, El Paso
Merchant has agreed to perform all administrative and managerial functions to be
performed by us pursuant to our material agreements, the indenture and the
related financing documents.
TERM
The term of the administrative services agreement commenced upon execution
and ends on September 30, 2013, or, if earlier, upon the early termination of
the mirror power purchase agreement. We have the right to terminate the
administrative services agreement (1) at any time on 60 days written notice to
El Paso Merchant and the payment to El Paso Merchant of all amounts owed El Paso
Merchant under the administrative services agreement or (2) upon El Paso
Merchant's bankruptcy, insolvency or liquidation.
SUPPORT OBLIGATIONS
MANAGEMENT AND ADMINISTRATIVE SERVICES
El Paso Merchant must perform the following management and administrative
services for us: accounting, auditing, financial reporting, budgeting and
forecasting, tax, cash management, review of significant operating and financial
matters, contract administrative services, invoicing, computer and information
services, and such other management, administrative, and regulatory filing
services as directed by us. Specifically, El Paso Merchant must provide the
following services:
- maintaining our books and records in accordance with good business
practice, Internal Revenue Service regulations, applicable law and
generally accepted accounting principles and the retention and oversight
of independent auditors to review these books and records on an annual
basis;
- providing services regarding our cash, including (1) establishing bank
accounts and (2) investing funds in accordance with the financing
documents;
- providing accounting services related to the development and
implementation of our financial controls and systems and the
administering of the financing proceeds;
- exercising all of our rights and administering all of our obligations
under the financing documents, including taking all actions necessary or
desirable to perfect and maintain the perfection and priority of security
interests granted by us to any lender or creditor of ours over any of our
assets;
- administering the amended power purchase agreement, the mirror power
purchase agreement and the other material agreements, and exercising all
of our rights and performing all of our administrative and management
obligations thereunder;
- to the extent that amounts are available from us, paying all of our fees,
debts and obligations;
- providing tax-related services, including, without limitation, paying
from El Paso Merchant's accounts directly to third party payees, upon
demand, taxes or other administrative fees and expenses due and payable
by us;
- making and prosecuting, or causing to be made and prosecuted, such
filings and reports, keeping such records, and taking or causing to be
taken such other actions as may be necessary and lawful to maintain our
existence and good standing and to ensure our compliance with all
applicable laws, regulations, authorizations and orders of government
agencies (including, without limitation, the Federal Energy Regulatory
Commission); and
- doing and performing such other acts as may be mutually agreed to by El
Paso Merchant and us from time to time.
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ASSIGNMENT
We may assign our rights in the administrative services agreement to any
lender (including a trustee on behalf of the holders of the bonds) in connection
with any financing or other financial arrangement or to any person succeeding to
all or substantially all of our assets without El Paso Merchant's consent. For
any other reason, we may not assign our rights and obligations under the
administrative services agreement to any person without El Paso Merchant's prior
written consent, which may not be unreasonably delayed or withheld so long as
the assignee agrees to be bound by, subject to and to comply with the terms and
conditions of the administrative services agreement. El Paso Merchant may not
assign its rights and obligations under the administrative services agreement
without our prior written consent, which shall not be unreasonably withheld or
delayed.
FEE
We will pay El Paso Merchant $50,000 on March 1 and September 1 of each
year under the administrative services agreement. This amount will cover all of
El Paso Merchant's internal and overhead costs. We will reimburse El Paso
Merchant for all expenses other than internal and overhead costs El Paso
Merchant incurs in performing its obligations under the administrative services
agreement on March 1 and September 1 of each year following El Paso Merchant's
delivery of an invoice not less than 30 days prior to each of these dates. The
fees and expenses paid to El Paso Merchant under the administrative services
agreement will be due and payable only to the extent that there are amounts on
deposit in the collections account after payment in accordance with the
indenture of all current and past due amounts ranking prior to the payment of
these fees and expenses.
DEFAULTS
Each of the following constitutes an "event of default" with respect to
either El Paso Merchant or us under the administrative services agreement:
- failure to make, when due, any payment under the administrative services
agreement if the failure is not remedied within 10 business days after
written notice of the failure is given to the defaulting party by the
non-defaulting party;
- any representation or warranty made by a party is false or misleading in
any material respect when made; or
- failure by a party to perform any other material covenant set forth in
the administrative services agreement.
Upon an event of default, the non-defaulting party has the right to
terminate the administrative services agreement.
EL PASO PERFORMANCE GUARANTY
El Paso entered into the performance guaranty on December 12, 2001. Under
the El Paso performance guaranty, El Paso guarantees to us the punctual
performance of all of El Paso Merchant's obligations under the mirror power
purchase agreement and the administrative services agreement.
TERM
The term of the El Paso performance guaranty runs from the date of
execution until all of El Paso Merchant's obligations under the mirror power
purchase agreement and the administrative services agreement have been
performed. The El Paso performance guaranty will remain in full force and effect
or be reinstated if at any time any payment by El Paso Merchant in whole or in
part is rescinded or must otherwise be returned by us upon El Paso Merchant's
insolvency, bankruptcy or reorganization.
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GUARANTY
El Paso irrevocably and unconditionally guarantees to us the punctual
performance and payment of all of El Paso Merchant's obligations under the
mirror power purchase agreement and the administrative services agreement.
El Paso will perform its guaranty in full irrespective of any claim,
set-off, or other right it may have at any time against us, El Paso Merchant or
any other entity. The guaranty is a primary obligation of El Paso and El Paso
will perform its guaranty regardless of the validity or enforceability of the
mirror power purchase agreement or the administrative services agreement, any
changes to the mirror power purchase agreement or the administrative services
agreement, or any other circumstance constituting a legal or equitable discharge
or defense of a guarantor.
All payments that El Paso is required to make under the El Paso performance
guaranty are without any set-off, counterclaim or condition. The guaranty is not
affected by El Paso Merchant's change of ownership, insolvency, bankruptcy or
any other change in El Paso Merchant's legal status. If El Paso Merchant's
obligations are stayed or performance is delayed upon insolvency, bankruptcy or
reorganization, El Paso's guaranty will remain in full force and effect and will
be immediately due to the extent required absent the stay or delay.
WAIVERS
El Paso irrevocably waives diligence, promptness, presentment, demand for
payment or performance, protest, and notice of any kind with respect to all of
its obligations under the El Paso performance guaranty. El Paso also waives any
legal or equitable defenses arising out of El Paso Merchant's insolvency,
bankruptcy or other legal disability.
COVENANTS
El Paso will not exercise any right of subrogation or indemnity, or similar
right or remedy, against El Paso Merchant or any of El Paso Merchant's assets or
property in respect of any amount El Paso paid under the El Paso performance
guaranty or file a proof of claim in competition with us for any amount owed by
El Paso Merchant to El Paso on any account whatsoever in the event of insolvency
or bankruptcy, until all of El Paso Merchant's obligations under the mirror
power purchase agreement and the administrative services agreement are performed
or paid in full. El Paso covenants that the El Paso performance guaranty will
not be discharged except by complete and final payment and performance of El
Paso Merchant's obligations under the mirror power purchase agreement and the
administrative services agreement.
REMEDY
The rights and remedies set forth in the El Paso performance guaranty are
in addition to and not exclusive of any rights and remedies available to us by
law in respect of the guaranty. If any amount payable by El Paso is not paid to
us under the El Paso performance guaranty when due, we may, without notice or
demand of any kind, set-off and apply the unpaid amount against any indebtedness
then due and payable by us to El Paso.
EXPENSES
El Paso will reimburse us on demand for all reasonable costs and expenses
including attorneys' fees we incur in connection with the enforcement of our
rights under the El Paso performance guaranty.
ASSIGNMENT
The El Paso performance guaranty is binding on El Paso and its successors
and assigns. El Paso may not transfer any of its obligations under the El Paso
performance guaranty without our prior written consent.
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We may transfer, pledge, encumber or assign the El Paso performance
guaranty or the accounts, revenues or proceeds under the El Paso performance
guaranty in connection with any financing and may transfer or assign the El Paso
performance guaranty to any entity succeeding to all or substantially all of our
assets, in each case without El Paso's consent.
RELATIONSHIPS WITH AFFILIATES AND RELATED TRANSACTIONS
El Paso Merchant and El Paso are affiliates of each other and an affiliate
of each of them manages us. All of the individuals who perform the day-to-day
financial, administrative, accounting and operational functions for us, as well
as those who are responsible for our direction, are currently employed by El
Paso Merchant. Pursuant to the mirror power purchase agreement, El Paso Merchant
provides reserved capacity and delivers energy on the terms and at the rates set
forth in that agreement. See "Summary of Our Transaction Documents -- Mirror
Power Purchase Agreement." Under the administrative services agreement, El Paso
Merchant is paid a fee of $50,000 semi-annually. See "Summary of Our Transaction
Documents -- Administrative Services Agreement." We believe that the terms of
the mirror power purchase agreement and the administrative services agreement
are commercially reasonable and contain terms that are at least as favorable to
us as we would expect to negotiate with unaffiliated third parties.
THE EXCHANGE OFFER
EXCHANGE TERMS
Series A bonds in an aggregate principal amount of $431,407,000 are
currently issued and outstanding. The maximum aggregate principal amount of
Series B bonds that will be issued in exchange for Series A bonds is
$431,407,000. The terms of the Series B bonds and the Series A bonds are
substantially the same in all material respects, except that the Series B bonds
will be freely transferable by the holders except as provided in this
prospectus.
The Series B bonds will bear interest at a rate of 9.875% per year, payable
semi-annually on March 1 and September 1 of each year, beginning on September 1,
2002. Holders of Series B bonds will receive interest from the date of the
original issuance of the Series A bonds or from the date of the last payment of
interest on the Series A bonds, whichever is later. Holders of Series B bonds
will not receive any interest on Series A bonds tendered and accepted for
exchange. In order to exchange your Series A bonds for transferable Series B
bonds in the exchange offer, you will be required to make the following
representations, which are included in the letter of transmittal:
- any Series B bonds that you receive will be acquired in the ordinary
course of your business;
- you are not participating, and have no arrangement or understanding with
any person or entity to participate, in the distribution of the Series B
bonds;
- you are not our "affiliate," as defined in Rule 405 of the Securities
Act, or a broker-dealer tendering Series A bonds acquired directly from
us; and
- if you are not a broker-dealer, that you are not engaged in and do not
intend to engage in the distribution of the Series B bonds.
Upon the terms and subject to the conditions set forth in this prospectus
and in the letter of transmittal, we will accept for exchange any Series A bonds
properly tendered in the exchange offer, and the exchange agent will deliver the
Series B bonds promptly after the expiration date of the exchange offer.
If you tender your Series A bonds, you will not be required to pay
brokerage commissions or fees or, subject to the instructions in the letter of
transmittal, transfer taxes with respect to the exchange of the Series A bonds
in connection with the exchange offer. We will pay all charges, expenses and
transfer taxes in connection with the exchange offer, other than the taxes
described below under "Transfer Taxes."
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WE MAKE NO RECOMMENDATION TO YOU AS TO WHETHER YOU SHOULD TENDER OR REFRAIN
FROM TENDERING ALL OR ANY PORTION OF YOUR EXISTING SERIES A BONDS INTO THIS
EXCHANGE OFFER. IN ADDITION, NO ONE HAS BEEN AUTHORIZED TO MAKE THIS
RECOMMENDATION. YOU MUST MAKE YOUR OWN DECISION WHETHER TO TENDER INTO THIS
EXCHANGE OFFER AND, IF SO, THE AGGREGATE AMOUNT OF SERIES A BONDS TO TENDER
AFTER READING THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL AND CONSULTING WITH
YOUR ADVISORS, IF ANY, BASED ON YOUR FINANCIAL POSITION AND REQUIREMENTS.
EXPIRATION DATE; EXTENSIONS; TERMINATION; AMENDMENTS
The exchange offer expires at 5:00 p.m., New York City time, on [ ],
2002, unless we extend the exchange offer, in which case the expiration date
will be the latest date and time to which we extend the exchange offer.
We expressly reserve the right, so long as applicable law allows:
- to delay our acceptance of Series A bonds for exchange;
- to terminate the exchange offer if any of the conditions set forth under
"-- Conditions of the Exchange Offer" beginning on page 70 exist;
- to waive any condition to the exchange offer;
- to amend any of the terms of the exchange offer; and
- to extend the expiration date and retain all Series A bonds tendered in
the exchange offer, subject to your right to withdraw your tendered
Series A bonds as described under "-- Withdrawal of Tenders."
Any waiver or amendment to the exchange offer will apply to all Series A
bonds tendered, regardless of when or in what order the Series A bonds were
tendered. If the exchange offer is amended in a manner that we think constitutes
a material change, or if we waive a material condition of the exchange offer, we
will promptly disclose the amendment or waiver by means of a prospectus
supplement that will be distributed to the registered holders of the Series A
bonds, and we will extend the exchange offer to the extent required by Rule
14e-1 under the Exchange Act.
We will promptly follow any delay in acceptance, termination, extension or
amendment by oral or written notice of the event to the exchange agent, followed
promptly by oral or written notice to the registered holders. Should we choose
to delay, extend, amend or terminate the exchange offer, we will have no
obligation to publish, advertise or otherwise communicate this announcement,
other than by making a timely release to an appropriate news agency.
In the event we terminate the exchange offer, all Series A bonds previously
tendered and not accepted for payment will be returned promptly to the tendering
holders.
In the event that the exchange offer is withdrawn or otherwise not
completed, Series B bonds will not be given to holders of Series A bonds who
have validly tendered their Series A bonds.
RESALE OF SERIES B BONDS
Based on interpretations of the SEC staff set forth in no action letters
issued to third parties, we believe that Series B bonds issued under the
exchange offer in exchange for Series A bonds may be offered for resale, resold
and otherwise transferred by you without compliance with the registration and
prospectus delivery requirements of the Securities Act, if:
- you are not our "affiliate" within the meaning of Rule 405 under the
Securities Act;
- you are not participating, and have no arrangement or understanding with
any person to participate, in the distribution of the Series B bonds;
- you are not a broker-dealer who purchased Series A bonds directly from us
for resale pursuant to Rule 144A or any other available exemption under
the Securities Act; and
- you are acquiring Series B bonds in the ordinary course of your business.
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If you tender Series A bonds in the exchange offer with the intention of
participating in any manner in a distribution of the Series B bonds:
- you cannot rely on those interpretations by the SEC staff, and
- you must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction and that such a secondary resale transaction must be covered
by an effective registration statement containing the selling security
holder information required by Item 507 or 508, as applicable, of
Regulation S-K.
Only broker-dealers that acquired the Series A bonds as a result of
market-making activities or other trading activities may participate in the
exchange offer. Each broker-dealer that receives Series B bonds for its own
account in exchange for Series A bonds, where such Series A bonds were acquired
by such broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of the Series B bonds. Please read the section captioned "Plan
of Distribution" beginning on page 96 for more details regarding the transfer of
Series B bonds.
ACCEPTANCE OF SERIES A BONDS FOR EXCHANGE
We will accept for exchange Series A bonds validly tendered pursuant to the
exchange offer, or defectively tendered, if such defect has been waived by us,
after the later of: (1) the expiration date of the exchange offer and (2) the
satisfaction or waiver of the conditions specified below under "Conditions of
the Exchange Offer." We will not accept Series A bonds for exchange subsequent
to the expiration date of the exchange offer. Tenders of Series A bonds will be
accepted only in minimum denominations equal to $100,000 or integral multiples
of $1,000 in excess thereof.
We expressly reserve the right, in our sole discretion, to:
- delay acceptance for exchange of Series A bonds tendered under the
exchange offer, subject to Rule 14e-1 under the Exchange Act, which
requires that an offeror pay the consideration offered or return the
securities deposited by or on behalf of the holders promptly after the
termination or withdrawal of a tender offer, or
- terminate the exchange offer and not accept for exchange any Series A
bonds not theretofore accepted for exchange, if any of the conditions set
forth below under "-- Conditions of the Exchange Offer" have not been
satisfied or waived by us or in order to comply in whole or in part with
any applicable law. In all cases, Series B bonds will be issued only
after timely receipt by the exchange agent of certificates representing
Series A bonds, or confirmation of book-entry transfer, a properly
completed and duly executed letter of transmittal, or a manually signed
facsimile thereof, and any other required documents. For purposes of the
exchange offer, we will be deemed to have accepted for exchange validly
tendered Series A bonds, or defectively tendered Series A bonds with
respect to which we have waived such defect, if, as and when we give
oral, confirmed in writing, or written notice to the exchange agent.
Promptly after the expiration date, we will deposit the Series B bonds
with the exchange agent, who will act as agent for the tendering holders
for the purpose of receiving the Series B bonds and transmitting them to
the holders. The exchange agent will deliver the Series B bonds to
holders of Series A bonds accepted for exchange after the exchange agent
receives the Series B bonds.
If, for any reason, we delay acceptance for exchange of validly tendered
Series A bonds or we are unable to accept for exchange validly tendered Series A
bonds, then the exchange agent may, nevertheless, on our behalf, retain tendered
Series A bonds, without prejudice to our rights described under "-- Expiration
Date; Extensions; Termination; Amendments" beginning on page 65, "-- Conditions
of the Exchange Offer" beginning on page 70 and "-- Withdrawal of Tenders"
beginning on page 69, subject to Rule 14e-1 under the Exchange Act, which
requires that an offeror pay the consideration offered or return the securities
deposited by or on behalf of the holders thereof promptly after the termination
or withdrawal of a tender offer.
If any tendered Series A bonds are not accepted for exchange for any
reason, or if certificates are submitted evidencing more Series A bonds than
those that are tendered, certificates evidencing Series A
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bonds that are not exchanged will be returned, without expense, to the tendering
holder, or, in the case of Series A bonds tendered by book-entry transfer into
the exchange agent's account at a book-entry transfer facility under the
procedure set forth under "-- Procedures for Tendering Series A
Bonds -- Book-Entry Transfer" beginning on page 68, such Series A bonds will be
credited to the account maintained at such book-entry transfer facility from
which such Series A bonds were delivered, unless otherwise requested by such
holder under "Special Delivery Instructions" in the letter of transmittal,
promptly following the exchange date or the termination of the exchange offer.
Tendering holders of Series A bonds exchanged in the exchange offer will
not be obligated to pay brokerage commissions or transfer taxes with respect to
the exchange of their Series A bonds other than as described in "Transfer Taxes"
beginning on page 70 or in Instruction 7 to the letter of transmittal. We will
pay all other charges and expenses in connection with the exchange offer.
PROCEDURES FOR TENDERING SERIES A BONDS
Any beneficial owner whose Series A bonds are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee or held through
a book-entry transfer facility and who wishes to tender Series A bonds should
contact such registered holder promptly and instruct such registered holder to
tender Series A bonds on such beneficial owner's behalf.
TENDER OF SERIES A BONDS HELD THROUGH DEPOSITORY TRUST
The exchange agent and Depository Trust have confirmed that the exchange
offer is eligible for the Depository Trust automated tender offer program.
Accordingly, Depository Trust participants may electronically transmit their
acceptance of the exchange offer by causing Depository Trust to transfer Series
A bonds to the exchange agent in accordance with Depository Trust's automated
tender offer program procedures for transfer. Depository Trust will then send an
agent's message to the exchange agent.
The term "agent's message" means a message transmitted by Depository Trust,
received by the exchange agent and forming part of the book-entry confirmation,
which states that Depository Trust has received an express acknowledgment from
the participant in Depository Trust tendering Series A bonds that are the
subject of that book-entry confirmation that the participant has received and
agrees to be bound by the terms of the letter of transmittal, and that we may
enforce such agreement against such participant. In the case of an agent's
message relating to guaranteed delivery, the term means a message transmitted by
Depository Trust and received by the exchange agent which states that Depository
Trust has received an express acknowledgment from the participant in Depository
Trust tendering Series A bonds that they have received and agree to be bound by
the notice of guaranteed delivery.
TENDER OF SERIES A BONDS HELD IN CERTIFICATED FORM
For a holder to validly tender Series A bonds held in certificated form:
- the exchange agent must receive at its address set forth in this
prospectus a properly completed and validly executed letter of
transmittal, or a manually signed facsimile thereof, together with any
signature guarantees and any other documents required by the instructions
to the letter of transmittal, and
- the exchange agent must receive certificates for tendered Series A bonds
at such address, or such Series A bonds must be transferred pursuant to
the procedures for book-entry transfer described above. A confirmation of
such book-entry transfer must be received by the exchange agent prior to
the expiration date of the exchange offer. A holder who desires to tender
Series A bonds and who cannot comply with the procedures set forth herein
for tender on a timely basis or whose Series A bonds are not immediately
available must comply with the procedures for guaranteed delivery set
forth below.
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LETTERS OF TRANSMITTAL AND SERIES A BONDS SHOULD BE SENT ONLY TO THE
EXCHANGE AGENT, AND NOT TO US OR TO ANY BOOK-ENTRY TRANSFER FACILITY.
THE METHOD OF DELIVERY OF SERIES A BONDS, LETTERS OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF
THE HOLDER TENDERING SERIES A BONDS. DELIVERY OF SUCH DOCUMENTS WILL BE DEEMED
MADE ONLY WHEN ACTUALLY RECEIVED BY THE EXCHANGE AGENT. IF SUCH DELIVERY IS BY
MAIL, WE SUGGEST THAT THE HOLDER USE PROPERTY INSURED, REGISTERED MAIL WITH
RETURN RECEIPT REQUESTED, AND THAT THE MAILING BE MADE SUFFICIENTLY IN ADVANCE
OF THE EXPIRATION DATE OF THE EXCHANGE OFFER TO PERMIT DELIVERY TO THE EXCHANGE
AGENT PRIOR TO SUCH DATE. NO ALTERNATIVE, CONDITIONAL OR CONTINGENT TENDERS OF
SERIES A BONDS WILL BE ACCEPTED.
SIGNATURE GUARANTEE
Signatures on the letter of transmittal must be guaranteed by an eligible
institution unless:
- the letter of transmittal is signed by the registered holder of the
Series A bonds tendered therewith, or by a participant in one of the
book-entry transfer facilities whose name appears on a security position
listing it as the owner of those Series A bonds, or if any Series A bonds
for principal amounts not tendered are to be issued directly to the
holder, or, if tendered by a participant in one of the book-entry
transfer facilities, any Series A bonds for principal amounts not
tendered or not accepted for exchange are to be credited to the
participant's account at the book-entry transfer facility, and neither
the "Special Issuance Instructions" nor the "Special Delivery
Instructions" box on the letter of transmittal has been completed, or
- the Series A bonds are tendered for the account of an eligible
institution.
An eligible institution is a firm that is a participant in the Security
Transfer Agents Medallion program or the Stock Exchange Medallion program, which
is generally a member of a registered national securities exchange, a member of
the National Association of Securities Dealers, Inc., or a commercial bank or
trust company having an office in the United States.
BOOK-ENTRY TRANSFER
The exchange agent will seek to establish a new account or utilize an
existing account with respect to the Series A bonds at Depository Trust promptly
after the date of this prospectus. Any financial institution that is a
participant in the book-entry transfer facility system and whose name appears on
a security position listing it as the owner of the Series A bonds may make
book-entry delivery of Series A bonds by causing the book-entry transfer
facility to transfer such Series A bonds into the exchange agent's account.
HOWEVER, ALTHOUGH DELIVERY OF SERIES A BONDS MAY BE EFFECTED THROUGH BOOK-ENTRY
TRANSFER INTO THE EXCHANGE AGENT'S ACCOUNT AT A BOOK-ENTRY TRANSFER FACILITY, A
PROPERLY COMPLETED AND VALIDLY EXECUTED LETTER OF TRANSMITTAL, OR A MANUALLY
SIGNED FACSIMILE THEREOF, MUST BE RECEIVED BY THE EXCHANGE AGENT AT ONE OF ITS
ADDRESSES SET FORTH IN THIS PROSPECTUS ON OR PRIOR TO THE EXPIRATION DATE OF THE
EXCHANGE OFFER, OR ELSE THE GUARANTEED DELIVERY PROCEDURES DESCRIBED BELOW MUST
BE COMPLIED WITH. The confirmation of a book-entry transfer of Series A bonds
into the exchange agent's account at a book-entry transfer facility is referred
to in this prospectus as a "book-entry confirmation." Delivery of documents to
the book-entry transfer facility in accordance with that book-entry transfer
facility's procedures does not constitute delivery to the exchange agent.
GUARANTEED DELIVERY
If you wish to tender your Series A bonds and:
(1) certificates representing your Series A bonds are not lost but are
not immediately available,
(2) time will not permit your letter of transmittal, certificates
representing your Series A bonds and all other required documents to reach
the exchange agent on or prior to the expiration date of the exchange
offer, or
68
(3) the procedures for book-entry transfer cannot be completed on or
prior to the expiration date of the exchange offer, you may nevertheless
tender if all of the following are complied with:
- your tender is made by or through an eligible institution;
- on or prior to the expiration date of the exchange offer, the exchange
agent has received from the eligible institution a properly completed
and validly executed notice of guaranteed delivery, by manually signed
facsimile transmission, mail or hand delivery, in substantially the
form provided with this prospectus. The notice of guaranteed delivery
must:
(a) set forth your name and address, the registered number(s) of
your Series A bonds and the principal amount of Series A bonds tendered;
(b) state that the tender is being made thereby;
(c) guarantee that, within three New York Stock Exchange trading
days after the date of the notice of guaranteed delivery, the letter of
transmittal or facsimile thereof properly completed and validly
executed, together with certificates representing the Series A bonds, or
a book-entry confirmation, and any other documents required by the
letter of transmittal and the instructions thereto, will be deposited by
the eligible institution with the exchange agent; and
(d) the exchange agent receives the properly completed and validly
executed letter of transmittal or facsimile thereof with any required
signature guarantees, together with certificates for all Series A bonds
in proper form for transfer, or a book-entry confirmation, and any other
required documents, within three New York Stock Exchange trading days
after the date of the notice of guaranteed delivery.
OTHER MATTERS
Series B bonds will be issued in exchange for Series A bonds accepted for
exchange only after timely receipt by the exchange agent of:
- certificates for (or a timely book-entry confirmation with respect to)
your Series A bonds,
- a properly completed and duly executed letter of transmittal or facsimile
thereof with any required signature guarantees, or, in the case of a
book-entry transfer, an agent's message, and
- any other documents required by the letter of transmittal.
We will determine, in our sole discretion, all questions as to the form of
all documents, validity, eligibility, including time of receipt, and acceptance
of all tenders of Series A bonds. Our determination will be final and binding on
all parties. ALTERNATIVE, CONDITIONAL OR CONTINGENT TENDERS OF SERIES A BONDS
WILL NOT BE CONSIDERED VALID. WE RESERVE THE ABSOLUTE RIGHT TO REJECT ANY OR ALL
TENDERS OF SERIES A BONDS THAT ARE NOT IN PROPER FORM OR THE ACCEPTANCE OF
WHICH, IN OUR OPINION, WOULD BE UNLAWFUL. WE ALSO RESERVE THE RIGHT TO WAIVE ANY
DEFECTS, IRREGULARITIES OR CONDITIONS OF TENDER AS TO PARTICULAR SERIES A BONDS.
Our interpretation of the terms and conditions of the exchange offer,
including the instructions in the letter of transmittal, will be final and
binding.
Any defect or irregularity in connection with tenders of Series A bonds
must be cured within the time we determine, unless waived by us. We will not
consider the tender of Series A bonds to have been validly made until all
defects and irregularities have been waived by us or cured. Neither we, the
exchange agent, or any other person will be under any duty to give notice of any
defects or irregularities in tenders of Series A bonds, or will incur any
liability to holders for failure to give any such notice.
WITHDRAWAL OF TENDERS
Except as otherwise provided in this prospectus, you may withdraw your
tender of Series A bonds at any time prior to the expiration date.
69
For a withdrawal to be effective:
- the exchange agent must receive a written notice of withdrawal at one of
the addresses set forth below under "-- Exchange Agent" on page 71, or
- you must comply with the appropriate procedures of Depository Trust's
automated tender offer program system.
Any notice of withdrawal must:
- specify the name of the person who tendered the Series A bonds to be
withdrawn and
- identify the Series A bonds to be withdrawn, including the principal
amount of the Series A bonds.
If Series A bonds have been tendered pursuant to the procedure for
book-entry transfer described above, any notice of withdrawal must specify the
name and number of the account at Depository Trust to be credited with the
withdrawn Series A bonds and otherwise comply with the procedures of Depository
Trust.
We will determine all questions as to validity, form, eligibility and time
of receipt of any withdrawal notices. Our determination will be final and
binding on all parties. We will deem any Series A bonds so withdrawn not to have
been validly tendered for exchange for purposes of the exchange offer.
Any Series A bonds that have been tendered for exchange but that are not
exchanged for any reason will be returned to their holder without cost to the
holder or, in the case of Series A bonds tendered by book-entry transfer into
the exchange agent's account at Depository Trust according to the procedures
described above, such Series A bonds will be credited to an account maintained
with Depository Trust for the Series A bonds. This return or crediting will take
place as soon as practicable after withdrawal, rejection of tender or
termination of the exchange offer. You may retender properly withdrawn Series A
bonds by following one of the procedures described under "-- Procedures for
Tendering Series A Bonds" beginning on page 67 at any time on or prior to the
expiration date.
CONDITIONS OF THE EXCHANGE OFFER
Notwithstanding any other provisions of the exchange offer, we will not be
required to accept for exchange, or to exchange, any Series A bonds tendered. We
may terminate, waive any conditions to or amend the exchange offer or, subject
to Rule 14e-1 under the Exchange Act, which requires that an offeror pay the
consideration offered or return the securities deposited by or on behalf of the
holders thereof promptly after the termination or withdrawal of the exchange
offer, postpone the acceptance for exchange of Series A bonds so tendered if, on
or prior to the expiration date of the exchange offer, we determine that the
exchange offer would violate applicable law or any applicable interpretation of
the staff of the SEC.
TRANSFER TAXES
We will pay all transfer taxes applicable to the transfer and exchange of
Series A bonds pursuant to the exchange offer. If, however:
- delivery of the Series B bonds and/or certificates for Series A bonds for
principal amounts not exchanged, are to be made to any person other than
the record holder of the Series A bonds tendered;
- tendered certificates for Series A bonds are recorded in the name of any
person other than the person signing any letter of transmittal; or
- a transfer tax is imposed for any reason other than the transfer and
exchange of Series A bonds to us or our order,
the amount of any such transfer taxes, whether imposed on the record holder or
any other person, will be payable by the tendering holder prior to the issuance
of the Series B bonds.
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CONSEQUENCES OF FAILING TO EXCHANGE
If you do not exchange your Series A bonds for Series B bonds in the
exchange offer, you will remain subject to the restrictions on transfer of the
Series A bonds:
- as set forth in the legend printed on the bonds as a consequence of the
issuance of the Series A bonds pursuant to the exemptions from, or in
transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws; and
- otherwise set forth in the memorandum distributed in connection with the
private offering of the Series A bonds.
In general, you may not offer or sell the Series A bonds unless they are
registered under the Securities Act, or if the offer or sale is exempt from
registration under the Securities Act and applicable state securities laws.
Except as required by the registration rights agreement, we do not intend to
register resales of the Series A bonds under the Securities Act.
ACCOUNTING TREATMENT
The Series B bonds will be recorded at the same carrying value as the
Series A bonds, as reflected in our accounting records on the date of the
exchange. Accordingly, we will not recognize any gain or loss for accounting
purposes upon the consummation of the exchange offer. We will amortize the
expenses of the exchange offer over the term of the exchange notes.
EXCHANGE AGENT
Deutsche Bank Trust Company Americas has been appointed as exchange agent
for the exchange offer. You should direct questions and requests for assistance,
requests for additional copies of this prospectus, the letter of transmittal or
any other documents to the exchange agent. You should send certificates for
Series A bonds, letters of transmittal and any other required documents to the
exchange agent addressed as follows:
DEUTSCHE BANK TRUST COMPANY AMERICAS
<Table>
By Overnight, By Mail: By Hand in New York:
Registered or Certified Mail DB Services Tennessee, Inc. Deutsche Bank Trust Company
or Overnight Courier: Reorganization Unit Americas
DB Services Tennessee, Inc. P.O. Box 292737 C/O The Depository Trust
Corporate Trust & Agency Nashville, Tennessee 37229-2737 Clearing Corporation
Services By Facsimile: 55 Water Street, 1st Floor
Reorganization Unit (for eligible institutions Jeanette Park Entrance
648 Grassmere Park Road only) New York, New York 10041
Nashville, Tennessee 37211 (615) 835-3701 Information: (800) 735-7777
Confirm by telephone:
(615) 835-3572
</Table>
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DESCRIPTION OF THE BONDS AND THE INDENTURE
The following summaries of material provisions of the bonds and the
indenture do not purport to be complete and are subject to, and are qualified in
their entirety by reference to, all of the provisions of the bonds and the
indenture, including the definitions therein. Copies of the indenture are
available for inspection at the corporate trust office of the trustee. We urge
you to read the bonds and the indenture because they, and not this description,
define your rights as a holder of the bonds. Capitalized terms used herein and
not otherwise defined in this prospectus have the meanings ascribed to them
under "Defined Terms."
We issued the Series A bonds under an indenture dated December 12, 2001,
between us and Bankers Trust Company (now known as Deutsche Bank Trust Company
Americas), as trustee, in a private transaction that was not subject to the
registration requirements of the Securities Act. The Series B bonds will be
issued under the same indenture. Subject to compliance with covenants in the
indenture that restrict our ability to incur additional indebtedness, the
aggregate principal amount of bonds that may be issued under the indenture is
unlimited. Any additional bonds issued under the indenture will rank pari passu
with the Series A bonds and the Series B bonds. The terms of the bonds include
those stated in the indenture and those made part of the indenture by reference
to the Trust Indenture Act.
GENERAL
The Series A bonds, the Series B bonds and any additional bonds issued
under the indenture will constitute a single class of debt securities under the
indenture. If the exchange offer is completed, holders of Series A bonds who do
not exchange their Series A bonds for Series B bonds will vote together with
holders of the Series B bonds and the holders of any additional bonds for all
relevant purposes under the indenture. In that regard, the indenture requires
that a number of actions by holders, including the acceleration following an
event of default, must be taken, and specific rights must be exercised, by
specified minimum percentages of the aggregate principal amount of the
outstanding securities issued under the indenture. In determining whether the
required holders have given any notice, consent or waiver or taken any other
action permitted under the indenture, any Series A bonds that remain outstanding
after the exchange offer will be aggregated with the Series B bonds and any
additional bonds, and the holders of the Series A bonds, the Series B bonds and
any additional bonds will vote together as a single series. All references in
this prospectus to specified percentages in aggregate principal amount of the
bonds means, at any time after the exchange offer is completed, the percentages
in aggregate principal amount of the Series A bonds, the Series B bonds and any
additional bonds then outstanding. The Series B bonds are secured obligations
and senior to all our current indebtedness, other than Series A bonds, and all
our future indebtedness, other than any additional bonds issued under the
indenture.
PRINCIPAL AMOUNT, INTEREST RATE AND STATED MATURITY
The Series A bonds and the Series B bonds will have a maximum aggregate
principal amount of $431,407,000 and will bear interest at the rate of 9.875%
per year. The bonds will mature on September 1, 2013.
Any defaulted principal, Make-Whole Premium, if any, with respect to any
bonds called for optional redemption, or interest, and (to the extent lawful)
interest on such defaulted principal, Make-Whole Premium or interest, will bear
interest at the rate of 9.875% plus 1.0%. If an exchange offer is not
consummated on or prior to the 270th day after the date of the original issue of
the Series A bonds, or if, pursuant to the terms of the registration rights
agreement, it becomes necessary to file a shelf registration statement with
respect to the bonds and such shelf registration statement has not been filed or
declared effective within the time period specified in the registration rights
agreement the annual interest rate on the Series A bonds will be increased by
0.50% until the date on which the exchange offer is consummated or all of the
Series A bonds otherwise become transferable by the holders of the bonds (other
than affiliates of us) without further registration under the Securities Act or
the date on which the shelf registration statement has become effective. We will
pay principal and interest on the bonds semi-annually on March 1 and September 1
or, if that day is not a business day in New York City, then on the next
succeeding business day commencing September 1, 2002, to the
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registered owners thereof at the close of business on the February 15 or August
15 preceding the relevant payment date. Interest will be computed on the basis
of a 360-day year consisting of twelve 30-day months.
PAYMENT OF PRINCIPAL AND INTEREST
We will make all payments (including principal, Make-Whole Premium, if any,
with respect to any bonds called for optional redemption, and interest) on the
bonds at the corporate trust office of the trustee or, at our option, by check
mailed to the address of the person entitled thereto, except for the payment of
the final installment of principal payable with respect to a bond, which we will
make upon presentation and surrender of that bond at the corporate trust office
of the trustee or such other place of payment as is designated pursuant to the
indenture. We will make these payments to the person in whose name the bond (or
one or more predecessor bonds) is registered at the close of business on the
regular record date (the fifteenth business day preceding the relevant payment
date) for the payment. Notwithstanding the foregoing, upon written request, we
will make a payment on the bonds (other than a final payment of principal) by
wire transfer to holders of $1 million or more aggregate principal amount of
bonds. In the case of the global bonds, these payments will be made to
Depository Trust or to any nominee thereof, which will be the holder of record
of the global bonds. See "-- Form and Denomination."
INSTALLMENT PAYMENTS OF PRINCIPAL
Installments of principal on the Series A bonds and the Series B bonds are
payable as follows:
<Table>
<Caption>
PERCENTAGE OF ORIGINAL
PRINCIPAL PAYMENT DATE PRINCIPAL AMOUNT PAYABLE
- ---------------------- ------------------------
September 1, 2002........................................... 1.35%
March 1, 2003............................................... 2.90%
September 1, 2003........................................... 2.26%
March 1, 2004............................................... 2.70%
September 1, 2004........................................... 2.77%
March 1, 2005............................................... 3.24%
September 1, 2005........................................... 3.33%
March 1, 2006............................................... 3.84%
September 1, 2006........................................... 3.95%
March 1, 2007............................................... 4.50%
September 1, 2007........................................... 4.63%
March 1, 2008............................................... 5.24%
September 1, 2008........................................... 5.50%
March 1, 2009............................................... 5.28%
September 1, 2009........................................... 4.43%
March 1, 2010............................................... 4.96%
September 1, 2010........................................... 5.11%
March 1, 2011............................................... 5.69%
September 1, 2011........................................... 5.87%
March 1, 2012............................................... 6.49%
September 1, 2012........................................... 6.70%
March 1, 2013............................................... 8.09%
September 1, 2013........................................... 1.17%
</Table>
73
REDEMPTION AT OUR OPTION
We may at any time redeem all or any portion of the outstanding bonds, in
whole or in part, at a redemption price equal to the principal amount thereof to
be redeemed plus accrued and unpaid interest thereon to the redemption date,
plus the Make-Whole Premium, if any, with respect to any such bonds called for
optional redemption, on a redemption date that we will establish. A Make-Whole
Premium will not be payable in any event other than in connection with our
optional redemption of the bonds.
We will deliver a notice of any such redemption to each holder of a bond
which is to be redeemed (in whole or in part) at that holder's address of record
not less than 30 days nor more than 60 days before the applicable redemption
date. In addition, we will provide a notice of redemption to the trustee in
accordance with the terms of the indenture. On and after any such redemption
date, interest will cease to accrue on the bonds (or portion of the principal
amount thereof) called for redemption.
LIMITATION ON LIABILITY
There is no recourse for the payment of principal of, Make-Whole Premium,
if any, on bonds called for optional redemption, or interest on any bond, or for
any claim based thereon or otherwise in respect thereof, or of the indebtedness
represented thereby, or upon any obligation, covenant or agreement under the
indenture or any bond, against any incorporator, stockholder, member, manager,
officer or director of us or any of our members or any successor thereof and all
such liability is expressly waived and released. Nothing, however, limits the
liability of any person for their fraud, gross negligence or willful misconduct.
FORM AND DENOMINATION
All bonds will be issued in registered form without coupons. The bonds may
be issued in minimum denominations of $100,000 and integral multiples of $1,000
in excess thereof. The bonds, and transfers thereof, will be registered as
provided in the indenture. Any person in whose name a bond is registered may to
the fullest extent permitted by applicable law be treated as the absolute owner
of that bond. The person in whose name a bond is registered is referred to in
this prospectus as the "holder" of a bond.
Except in the limited circumstances described under "-- Certificated Bonds"
below, beneficial interests in the global bonds will only be recorded by
book-entry and owners of beneficial interests in the global bonds will not be
entitled to receive physical delivery of certificates representing the bonds.
Except as set forth below, the bonds will be represented by one permanent
global registered bond in global form without interest coupons, which we refer
to in this prospectus as the "global bonds." The global bonds will be deposited
with, or on behalf of, Depository Trust and registered in the name of Cede & Co.
GLOBAL BONDS
Upon the issuance of the global bonds it is expected that Depository Trust
or its nominee will credit, on its internal system, the respective principal
amounts of the individual beneficial interests represented by those global bonds
to the accounts of persons who have accounts with Depository Trust. These
accounts initially will be designated by or on behalf of the initial purchaser.
Ownership of beneficial interests in a global bond will be limited to persons
who have accounts with Depository Trust ("participants") or persons who hold
interests through participants. Ownership of beneficial interests in the global
bonds will be shown on, and the transfer of that ownership will be effected only
through, records maintained by Depository Trust or its nominee (with respect to
interests of participants) and the records of agent members (with respect to
interests of persons other than participants).
So long as Depository Trust or its nominee is the holder of a global bond,
Depository Trust or its nominee, as the case may be, will be considered the
holder of the bonds represented by that global bond for all purposes under the
indenture and the bonds. No beneficial owner of an interest in a global bond
will be able to transfer that interest except in accordance with Depository
Trust's applicable procedures (in addition to those under the indenture and, if
applicable, those of Euroclear and Clearstream Luxembourg) unless we issue
certificates for the bonds in definitive registered form as described under
"-- Certificated Bonds" below.
74
Payments of the principal of, and interest and Make-Whole Premium, if any,
with respect to bonds called for optional redemption, on the global bonds will
be made to Depository Trust or its nominee, as the holder thereof. None of we,
the initial purchaser or the trustee will have any responsibility or liability
for any aspect of the records relating to or payments made on account of
beneficial ownership interests in the global bonds or for maintaining,
supervising or reviewing any records relating to those beneficial ownership
interests or the transfer thereof.
We expect that Depository Trust or its nominee, upon receipt of any payment
of principal of, or interest on, or Make-Whole Premium, if any, in respect of a
global bond held by it or its nominee, will immediately credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of the global bond as shown on the records of
Depository Trust or its nominee. We also expect that payments by participants to
owners of beneficial interests in that global bond held through the participants
will be governed by standing instructions and customary practices. These
payments will be the responsibility of the participants.
Transfers between participants in Depository Trust will be effected in the
ordinary way in accordance with Depository Trust rules and will be settled in
same-day funds. The laws of some jurisdictions may require that some persons
take physical delivery of bonds in definitive form. Consequently, the ability to
transfer beneficial interests in a global bond to these persons may be limited.
Because Depository Trust can only act on behalf of participants, who in turn act
on behalf of indirect participants and specified banks, the ability of a person
having a beneficial interest in a global bond to pledge that interest to persons
or entities that do not participate in the Depository Trust system, or otherwise
take actions in respect of that interest, may be affected by the lack of a
physical certificate representing that interest. Transfers between participants
in Euroclear and Clearstream Luxembourg will be effected in the ordinary way in
accordance with their respective rules and operating procedures.
Subject to compliance with the transfer restrictions applicable to the
bonds described above and under "Transfer Restrictions," cross-market transfers
between Depository Trust, on the one hand, and directly or indirectly through
Euroclear or Clearstream Luxembourg participants, on the other, will be effected
in Depository Trust in accordance with Depository Trust rules on behalf of
Euroclear or Clearstream Luxembourg, as the case may be, by its respective
depositories; however, these cross-market transactions will require delivery of
instructions to Euroclear or Clearstream Luxembourg, as the case may be, by the
counterparty in such system in accordance with its rules and procedures and
within its established deadlines. Euroclear or Clearstream Luxembourg, as the
case may be, will, if the transaction meets its settlement requirements, deliver
instructions to its respective depositories to take action to effect final
settlement on its behalf by delivering or receiving interests in the global bond
in Depository Trust, and making or receiving payment in accordance with normal
procedures for same-day funds settlement applicable to Depository Trust.
Euroclear and Clearstream Luxembourg participants may not deliver instructions
directly to the depositories for Depository Trust.
Because of time zone differences, the bond account of a Euroclear or
Clearstream Luxembourg participant purchasing an interest in a global bond from
a Depository Trust participant will be credited during the bonds settlement
processing day (which must be a business day for Euroclear or Clearstream
Luxembourg, as the case may be) immediately following the Depository Trust
settlement date, and the credit of any transactions in interests in a global
bond settled during a processing day will be reported to the relevant Depository
Trust participant on that day. Cash received in Euroclear or Clearstream
Luxembourg as a result of sales of interests in a global bond by or through a
Euroclear or Clearstream Luxembourg participant to a Depository Trust
participant will be received on the Depository Trust settlement date, but will
be available in the relevant Euroclear or Clearstream Luxembourg cash account
only as of the business day following settlement in Depository Trust.
We expect that Depository Trust will take any action permitted to be taken
by a holder of bonds (including the presentation of bonds for exchange as
described below) only at the direction of one or more participants to whose
Depository Trust account interests in the global bond are credited, and only in
respect of
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that portion of the aggregate principal amount of the bonds as to which that
participant or those participants has or have given such direction.
Depository Trust is a limited purpose trust company organized under the
laws of the State of New York, a member of the Federal Reserve System, a
"clearing corporation" within the meaning of the New York Uniform Commercial
Code and a "clearing agency" registered pursuant to the provisions of Section
17A of the Securities Exchange Act. Depository Trust was created to hold bonds
for its participants and facilitate the clearance and settlement of bond
transactions between participants through electronic book-entry changes in
accounts of its participants, thereby eliminating the need for physical movement
of certificates. Participants include bond brokers and dealers, banks, trust
companies and clearing corporations and may include other organizations.
Indirect access to the Depository Trust system is available to others such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a Depository Trust participant, either directly or
indirectly.
Although Depository Trust, Euroclear and Clearstream Luxembourg have agreed
to the foregoing procedures in order to facilitate transfers of interests, in
the global bonds among participants of Depository Trust, Euroclear and
Clearstream Luxembourg, they are under no obligation to continue to perform such
procedures and such procedures may be discontinued at any time. None of we, the
initial purchaser or the trustee will have any responsibility for the
performance by Depository Trust, Euroclear or Clearstream Luxembourg or their
respective participants or indirect participants of their respective obligations
under the rules and procedures governing their operations.
CERTIFICATED BONDS
The bonds will be issued in certificated fully registered form (which we
refer to as the individual bonds) to holders or their nominees, rather than as
global bonds, if:
- we notify the trustee in writing that Depository Trust or any successor
depository, as the case may be, is unwilling or unable to continue as a
depository for a global bond or ceases to be a "clearing agency"
registered under the Securities Exchange Act and we do not appoint a
successor depository within 90 days of this notice; or
- we elect to issue individual bonds.
The holder of an individual bond may transfer the bond by surrendering it
at the office or agency maintained by us for such purpose in the Borough of
Manhattan, the City of New York, which initially will be the office of the
trustee.
THE ACCOUNTS
ESTABLISHMENT OF ACCOUNTS
Pursuant to the indenture, the trustee established and maintains the
following accounts and subaccounts in its own name for the benefit of the
holders (collectively, the "accounts"):
- the collections account;
- the liquidity account; and
- the damages and indemnity account.
COLLECTIONS ACCOUNT
We have instructed each person from whom we receive or are entitled to
receive collections to pay those collections (identifying them as such) directly
to the trustee for deposit in the collections account. The trustee must deposit
into the collections account all transfer payments from the liquidity account as
described in the third paragraph of the section entitled "-- Liquidity Account"
and amounts on deposit in the collections account will be withdrawn as described
in "-- Withdrawals from the Collections Account." In addition, the
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net proceeds from any additional bonds issued under the indenture will be
distributed into the collections account but will be immediately distributed to
Mesquite.
LIQUIDITY ACCOUNT
The liquidity account was funded on the closing date of the offering of the
Series A bonds by the transfer to the trustee and the deposit into the liquidity
account of an amount equal to $21.0 million. Following the September 1, 2002
payment, the liquidity account will be funded in an amount equal to the greater
of the maximum amount of interest due on the bonds in any semi-annual period
during the term of the bonds and $14.25 million. We refer to these amounts in
this prospectus as the liquidity reserve required balance. The liquidity account
will also be funded by the transfer by the trustee on each semi-annual payment
date of funds from the collections accounts to the liquidity account as
described under clause fifth of "-- Withdrawals from the Collections Account,"
such that the amount in the liquidity account is equal to the liquidity reserve
required balance.
El Paso may withdraw amounts on deposit in the liquidity account if El Paso
delivers to the trustee for allocation to the liquidity account and to replace
the amount withdrawn, either (1) a guaranty issued by El Paso in the amount
withdrawn, in favor of the trustee for the benefit of the holders of the bonds,
or (2) one or more letters of credit in an aggregate face amount equal to the
amount withdrawn. In order for El Paso to be able to use the guaranty described
in (1), El Paso must have and maintain at least the following ratings: P-1 (or
its equivalent) from Moody's and A-1 (or its equivalent) from Standard & Poor's.
Each letter of credit described in (2) must (A) be from a financial institution
having a combined capital and surplus of at least $500,000,000 or the equivalent
thereof whose long-term unsecured debt is rated at least A2 (or its equivalent)
by Moody's and A (or its equivalent) by Standard & Poor's or, if both such
rating agencies are no longer rating unsecured debt of banks or trust companies,
a comparable rating of another internationally recognized rating agency selected
by us; (B) name the trustee as its sole beneficiary; (C) provide that the
trustee may unconditionally draw, upon presentation of the documentation
required by such letter of credit, under any circumstances that would otherwise
permit withdrawals from the liquidity account or at any time within 30 days
before the expiration of that letter of credit (unless the letter of credit is
replaced with another letter of credit that meets the requirements of the
indenture); and (D) provide that the reimbursement obligation under the letter
of credit is not for our account.
If on any payment date, the aggregate amount of funds on deposit in and
available to be withdrawn from the collections account is insufficient for the
payment of principal or interest then due and payable on the bonds (any such
deficiency, a "Liquidity Deficiency"), the trustee will transfer from the
liquidity account to the collections account an amount equal to the Liquidity
Deficiency. If on any payment date the aggregate amount of funds on deposit in
and available to be withdrawn from the liquidity account exceeds the then-
current liquidity reserve required balance, the excess funds will be transferred
on the next payment date to the collections account. If the excess funds in the
liquidity account are attributable to a letter of credit or guaranty, the
trustee will not draw on the letter of credit or guaranty, but will take such
action on the next payment date as El Paso reasonably directs in writing to the
trustee to reduce the amount available to be drawn under the letter of credit or
guaranty by the amount of the excess.
DAMAGES AND INDEMNITY ACCOUNT
We will instruct El Paso Merchant and El Paso to pay to the trustee for
deposit into the damages and indemnity account all amounts to be paid by El Paso
Merchant under the mirror power purchase agreement and all amounts to be paid by
El Paso under the El Paso performance guaranty to cover:
- damages payable by us to Public Service Electric pursuant to Article XIV
of the amended power purchase agreement;
- indemnity payments payable by us to Public Service Electric pursuant to
Article XII of the amended power purchase agreement; and
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- distribution surcharges payable by us to Public Service Electric pursuant
to Article II(E) of the amended power purchase agreement.
Funds will be withdrawn from the damages and indemnity account from time to
time as needed to pay:
- damages payable by us to Public Service Electric pursuant to Article XIV
of the amended power purchase agreement;
- indemnity payments payable by us to Public Service Electric pursuant to
Article XII of the amended power purchase agreement; and
- distribution surcharges payable by us to Public Service Electric pursuant
to Article II(E) of the amended power purchase agreement.
WITHDRAWALS FROM THE COLLECTIONS ACCOUNT
Except for the net proceeds from additional bonds (which will be
immediately distributed to Mesquite), unless a holder has given notice of an
event of default or a bankruptcy event of default has occurred and is
continuing, the trustee will apply amounts in the collections account on the
following dates and in the following order of priority (if a date is specified
and that date is not a business day in New York City, the payment will be made
on the next business day in New York City):
(1) first, on the first day of each month, to pay to the trustee the
amount of trustee fees due and payable at such time in connection with the
bonds;
(2) second, on the first day of each month, to pay to El Paso Merchant
for energy and capacity provided under the mirror power purchase agreement
for the month prior to the most recently ended month (as specified in our
officer's certificate);
(3) third, semi-annually, to pay, pro rata, to the holders of the
bonds an amount equal to the interest due and payable at that time on the
bonds;
(4) fourth, semi-annually, to pay, pro rata, to the holders of the
bonds an amount equal to the principal and Make-Whole Premium (if any, with
respect to any bonds called for optional redemption) due and payable at
that time on the bonds;
(5) fifth, semi-annually, to transfer to the liquidity account an
amount, if any, necessary to cause the amount on deposit in the liquidity
account to be equal to the liquidity reserve required balance;
(6) sixth, semi-annually, to pay to El Paso Merchant an amount equal
to the accrued and unpaid fees and expenses owed El Paso Merchant under the
administrative services agreement (as specified in our officer's
certificate); and
(7) seventh, semi-annually, provided that (as specified in our
officer's certificate) (A) no event of default or default has occurred and
is continuing on such date and (B) the Debt Service Coverage Ratio
calculated as of that date for the most recently ended six-month period
equals or exceeds 1.03 to 1.00, to us all remaining funds, if any, in the
collections account for distribution to our members.
INVESTMENT OF FUNDS
The trustee will invest the moneys on deposit in the accounts in Permitted
Investments as directed by us. Profits from Permitted Investments will be
deposited into the collections account. Losses on Permitted Investments will be
charged to the applicable account. The trustee has the right to sell or
otherwise liquidate any Permitted Investments to the extent necessary to make
any payment or transfer under the indenture and will have no liability for any
loss incurred in connection with the sale or liquidation.
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COVENANTS IN THE INDENTURE
The indenture contains the following covenants, among others:
MATERIAL AGREEMENTS
We will enforce our rights under each of our material agreements unless the
failure to enforce those rights could not reasonably be expected to result in a
material adverse effect.
PERFORMANCE OF OBLIGATIONS
We may contract with other persons to assist us in performing our
obligations, and, if we do, the performance by that person or those persons will
be treated the same as if we had performed the obligation ourselves. As of the
closing date of the offering of the Series A bonds, pursuant to the
administrative services agreement, we have contracted with El Paso Merchant to
perform our obligations under the indenture and the other financing documents,
so any action taken by El Paso Merchant in performing our duties will be treated
as an action taken by us.
LIENS
We will not create or permit to exist any lien on any of the collateral,
other than the liens created by the indenture and the related security
documents, unless the existence of the lien could not reasonably be expected to
result in a material adverse effect.
INDEBTEDNESS
We will not create or permit to remain outstanding any indebtedness, except
for indebtedness represented by the Series A bonds and the Series B bonds, and
indebtedness represented by additional bonds issued under the indenture after
the closing date of the offering of the Series A bonds. Under the indenture, we
are not be permitted to issue additional bonds after the offering of the Series
A bonds unless, after giving effect to such issuance, we maintain a minimum and
average Debt Service Coverage Ratio of no less than 1.03 to 1.00 and we obtain a
reaffirmation of the initial ratings of the bonds.
GUARANTIES
We will not at any time be or become obligated, contingently or otherwise,
with respect to any guaranty.
TRANSACTIONS WITH AFFILIATES
We will not effect any transaction with any of our affiliates on a basis
more favorable to this affiliate than would at the time be obtainable for a
comparable transaction on an arm's-length dealing with an unrelated third party,
except for (1) our material agreements entered into on or before the closing
date of the offering of the bonds or (2) in connection with any restructuring of
the assets of Mesquite.
INVESTMENTS, LOANS AND ADVANCES
Except for Permitted Investments, we will not acquire any capital stock,
debt securities or other securities of any other person and we will not make
investments in any other person.
MATERIAL AGREEMENTS; ADDITIONAL CONTRACTS
We will not assign any of our rights or obligations under any of our
material agreements or terminate or suffer any termination of, or grant any
waiver of material and timely performance under, or agree to the assignment of
the rights or obligations of any party to, any of our material agreements.
We will not amend or suffer any amendment of any of our material
agreements, except for routine, ministerial and administrative amendments that
could not reasonably be expected to result in a material adverse effect.
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We will not become a party to any contract, lease, agreement or instrument
other than the agreements expressly identified in the definition of our material
agreements and financing documents in the indenture to the extent the action
could reasonably be expected to result in a material adverse effect.
FUNDAMENTAL CHANGE
We will not do any of the following:
- sell, lease, transfer or otherwise dispose of any or all of our right,
title or interest in or to the collateral, unless doing so could not
reasonably be expected to result in a material adverse effect;
- conduct any business or own any assets other than the business and assets
conducted and owned by us as of the closing date of the offering of the
Series A bonds;
- directly or indirectly merge or consolidate with any other person,
liquidate, wind up, terminate, reorganize or dissolve ourselves, or
otherwise wind up;
- change our legal form; or
- establish any subsidiary.
MAINTENANCE OF MARKET-BASED RATE AUTHORITY
We will take all actions necessary to maintain our Federal Energy
Regulatory Commission market-based rate authority and will maintain in effect
all governmental approvals required to conduct our business under our material
agreements and financing documents, unless the failure to do so could not
reasonably be expected to result in a material adverse effect.
RESTRICTED PAYMENTS
Except in accordance with the conditions set forth in clause seventh of
"-- Withdrawals from the Collections Account," we will not, directly or
indirectly:
- make any distribution (by reduction of capital or otherwise), whether in
cash, property, securities or a combination thereof, to our members or
any owner of a beneficial interest in us or otherwise with respect to any
ownership or equity interest or security in or of us (other than the
proceeds of additional bonds issued under the indenture);
- redeem, purchase, retire or otherwise acquire for value any such
ownership or equity interest or security; or
- set aside or otherwise segregate any amounts for any such purpose.
We will not, directly or indirectly, make payments to or distributions from
the collections account except in accordance with the indenture and the
financing documents. See "-- Withdrawals from the Collections Account."
ADDITIONAL COVENANTS
In addition to the covenants described above, the indenture also contains
covenants regarding:
- payment of principal, Make-Whole Premium, if any, with respect to bonds
called for optional redemption, and interest;
- maintenance of an office or agency;
- maintenance of existence and properties;
- payment of taxes and other claims;
- delivery to the trustee of notices, compliance certificates and other
specified information, including notice of the existence of a default or
event of default;
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- taking actions to preserve liens in favor of the trustee under the
financing documents;
- complying with all applicable laws and all of our obligations under each
of our agreements, unless, in each case, the failure to do so could not
reasonably be expected to result in a material adverse effect;
- maintenance of books and records;
- scheduling and delivering the energy deliveries required under the
amended power purchase agreement;
- furnishing to the trustee within 120 days after the end of each fiscal
year an officer's certificate stating that no default has occurred and is
continuing;
- visitation of our premises and examination of our books by the trustee
and the representatives of the trustee during normal business hours upon
reasonable notice;
- providing to the holders of the bonds, any beneficial holder and any
potential holder the information required by Rule 144A under the
Securities Act; and
- further assurances.
EVENTS OF DEFAULT
An event of default will occur under the indenture (an "event of default")
if:
(1) we default in the payment of any principal of or Make-Whole
Premium, if any, with respect to bonds called for optional redemption, on
any of the bonds when the same becomes due and payable, whether by
scheduled maturity or acceleration or otherwise, and such default continues
for a period of five days;
(2) we default in the payment of interest on, or any other amount
(other than principal or Make-Whole Premium) required to be paid with
respect to, any of the bonds in each case when the same becomes due and
payable, and the default continues for a period of 15 days;
(3) we, El Paso, or Public Service Electric fail to observe or perform
any covenant or provision of any of our material agreements or financing
document to which we, El Paso, or Public Service Electric, as the case may
be, are a party, and the failure (a) could reasonably be expected to result
in a material adverse effect and (b) continues for a period of at least 30
days after the date notice thereof has been given to us by the trustee or
the holders of not less than 51% in aggregate principal amount of the
outstanding bonds;
(4) any of our material agreements or financing documents ceases at
any time to be valid and binding and in full force and effect and the
invalidity and unenforceability could reasonably be expected to result in a
material adverse effect;
(5) (A) any grant of a lien contained in the indenture or in any
financing document ceases or otherwise fails to be effective to grant a
lien to the trustee on any material portion of the collateral described
therein, or ceases to be perfected or to be a first priority security
interest, or (B) any creditor of ours (other than the trustee or any bond
holder) asserts any right or interest with respect to the collateral and
the assertion could reasonably be expected to result in a material adverse
effect or (C) our right to receive payments with respect to the collateral
is terminated or impaired and this occurrence could reasonably be expected
to result in a material adverse effect;
(6) specified events occur involving our bankruptcy, insolvency or
receivership, including the commencement of a proceeding seeking our
liquidation or reorganization or the appointment of a trustee or receiver
relating to our bankruptcy or insolvency and such proceeding continues
unstayed for 60 days, as well as the filing by us of a voluntary bankruptcy
proceeding;
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(7) it becomes unlawful for us to perform any of our obligations under
the indenture, any security document or any bond, or any of our obligations
thereunder ceases to be valid, binding and enforceable, unless such event
or occurrence could not reasonably be expected to result in a material
adverse effect;
(8) for any reason the amended power purchase agreement or the El Paso
performance guaranty is terminated or abrogated at any time (prior to its
scheduled expiration);
(9) a judgment or judgments for the payment of money in excess of $15
million in the aggregate, which is not adequately covered by insurance or a
payment or performance bond, are entered against us and the judgment or
judgments have not been vacated, discharged, stayed or bonded pending
appeal within 60 days from the entry thereof; or
(10) we fail to observe or perform any covenant or provision of
Section 3(b) of the registration rights agreement (pursuant to which we are
obligated to use commercially reasonable efforts to continue the
effectiveness of a registration statement) and such failure continues for a
period of at least 30 days after the date notice has been given to us by
the trustee or the holders of not less than 51% in aggregate principal
amount of the outstanding bonds.
REMEDIES
If an event of default (other than events of default specified in
subparagraph (6) of the section "-- Events of Default" above (a "bankruptcy
event of default")) occurs and is continuing, then the trustee, upon the
direction of the holders of not less than 25% in aggregate principle amount of
the outstanding bonds (for an event of default with respect to failure to make
payments on the bonds) or the holders of not less than 51% (for any other event
of default) in aggregate principal amount of the outstanding bonds, must declare
the principal amount of all the bonds to be immediately due and payable, and
upon any such declaration the principal amount, any accrued and unpaid interest,
any Make-Whole Premium then owed by us in connection with an optional redemption
of the bonds and all other amounts payable under the bonds will become
immediately due and payable.
If a bankruptcy event of default occurs, the principal amount of, any
accrued interest on, any Make-Whole Premium then owed by us in connection with
an optional redemption of the bonds and all other amounts payable under the
bonds will become immediately due and payable.
In addition, if one or more of the events of default (other than a
bankruptcy event of default) occurs and is continuing, the trustee may
accelerate the maturity of the bonds notwithstanding the absence of direction
from the holders if in the judgment of the trustee this action is necessary to
protect the interests of the holders.
At any time after the principal of the bonds becomes due and payable upon a
declared acceleration, and before any judgment or decree for the payment of the
money so due, or any portion thereof, is entered, the holders of not less than
51% in aggregate principal amount of the outstanding bonds, by written notice to
us and the trustee, may rescind and annul the declaration and its consequences
if all events of default giving rise to the acceleration have been cured or
waived.
At any time after a declaration of acceleration under the indenture, but
before a judgment or decree for payment of the principal amount of the bonds
then due has been obtained by the trustee, we may, by written notice to a
responsible officer of the trustee, rescind and annul such declaration and its
consequences if we have paid or deposited with the trustee a sum sufficient to
pay:
- all overdue interest on the bonds;
- all unpaid principal of and Make-Whole Premium, if any, on any
outstanding bonds that have become due other than by the declaration of
acceleration and interest thereon at the rate borne by the bonds;
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- to the extent that payment of such interest is lawful, interest upon
overdue interest and overdue principal at the rate borne by the bonds;
and
- all sums paid or advanced by the trustee under the indenture and the
reasonable compensation, expenses, disbursements and advances of the
trustee, its agents and counsel; and
all defaults and events of default, other than the non-payment of amounts of
principal of, Make-Whole Premium, if any, or interest on the bonds that have
become due solely by such declaration of acceleration, have been cured or waived
as provided in the indenture.
Subject to the provisions of the indenture relating to the duties of the
trustee, in case an event of default occurs and is continuing, the trustee is
under no obligation to exercise any of the rights or powers vested in it under
the indenture at the request or direction of any of the holders unless it is
offered security or indemnity reasonably satisfactory to it against costs,
expenses and liabilities.
If any event of default occurs and is continuing and a declaration of
acceleration has occurred, the trustee may and, at the written instruction of
the holders of not less than 51% in aggregate principal amount of the
outstanding bonds, shall, subject to the provisions of the material agreements
and to the provisions of any other law or regulation exercise any or all of the
following rights and remedies:
- collect, receive and appropriate any or all of the collateral and
exercise any of our rights, remedies, powers or privileges under any of
our material agreements;
- set off against all amounts due and payable under the indenture with
funds on deposit in the accounts;
- proceed by suit at law or in equity to seek specific performance of any
obligation of ours;
- take possession of the collateral, in which case we will deliver the
collateral to the trustee or its designee at the time or times and the
place or places as the trustee reasonably specifies;
- sell, lease, assign, give an option or options to purchase or otherwise
dispose of and deliver all or any part of the collateral (or contract to
do so) at one or more public or private sales, at any exchange or,
broker's board or at any of the trustee's offices or elsewhere at the
prices it deems best, for cash or on credit or for future delivery
without assumption of any credit risk; provided that, if the proceeds of
such sale or sales are not sufficient to satisfy all of the outstanding
principal, accrued and unpaid interest, Make-Whole Premium, if any, with
respect to bonds called for optional redemption, and other amounts due
under the bonds, all of the Holders shall have consented to such sale or
sales; and
- proceed by suit at law or in equity to foreclose upon, or appoint a
receiver with respect to, the collateral or exercise any other right or
remedy (including specific performance of our obligations under the
financing documents) available under applicable law.
APPLICATION OF MONEY COLLECTED
Any money collected by the trustee pursuant to its exercise of remedies
under the indenture will be applied in the following order of priority:
- first, to the payment of all amounts due to the trustee and each
predecessor trustee, if any, under the indenture;
- second, to the payment of the amounts due and unpaid for principal of
(and Make-Whole Premium, if any) and interest on the bonds in respect of
which or for the benefit of which the money has been collected, ratably,
without preference or priority of any kind, according to the amounts due
and payable on the bonds for principal (and Make-Whole Premium, if any,
with respect to bonds called for optional redemption) and interest,
respectively;
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- third, to the payment of all amounts due and payable to Public Service
Electric under the amended power purchase agreement and to El Paso
Merchant under the mirror power purchase agreement and the administrative
services agreement, as set forth in our officer's certificate or as
determined by a court of competent jurisdiction; and
- fourth, to us.
AMENDMENTS AND SUPPLEMENTS
Without the consent of the holders of the bonds, we and the trustee may
enter into one or more supplemental indentures for any of the following
purposes:
- to evidence the succession of another person to us and the assumption by
any such successor of our covenants contained in the indenture and in the
bonds;
- to add to our covenants for the benefit of the holders of the bonds or to
surrender any right or power conferred upon us in the indenture;
- to add additional events of default;
- to provide additional security for the bonds;
- to evidence and provide for the acceptance of appointment by a successor
trustee with respect to the bonds and to add to or change any of the
provisions of the indenture as may be necessary to provide for or
facilitate the administration of the trusts thereunder by more than one
trustee;
- to cure any ambiguity, to correct or supplement any provision of the
indenture which may be inconsistent with any other provision therein;
provided that such action may not adversely affect the interests of the
holders of the bonds in any material respect; or
- to supplement any of the provisions of the indenture to the extent
necessary to permit or facilitate the defeasance and discharge of the
bonds; provided that any such action not adversely affect the interests
of the holders of the bonds in any material respect.
With the consent of the holders of not less than 51% in aggregate principal
amount of bonds then outstanding, we and the trustee may enter into an indenture
or indentures supplemental to the indenture for the purpose of adding, changing
or eliminating provisions of the indenture or the bonds, or of modifying in any
manner the rights of the holders of bonds under the indenture; provided, that no
such supplemental indenture may, without the consent of the holder of each
outstanding bond:
- change the stated maturity of the principal of, or any installment of
interest on, any bond;
- reduce the principal amount of any bond or any Make-Whole Premium payable
upon the optional redemption of any bond, or reduce the rate of interest
on any bond, including discharge of repayment of principal of or interest
on any bond;
- reduce the percentage in principal amount of outstanding bonds the
consent of the holders of which is required for the adoption of a
resolution or the quorum required at any meeting of holders at which a
resolution is adopted or the percentage in principal amount of
outstanding bonds the holders of which are entitled to request the
calling of a holders' meeting;
- change the percentage rules established for adopting resolutions at
meetings of holders of the bonds or regarding the quorum necessary to
constitute a meeting;
- modify any of the provisions of the indenture regarding the approval of
supplemental indentures or waivers of past defaults, except to increase
the percentage of holders required for those approvals;
- change the place or coin or currency for payment of principal of,
Make-Whole Premium, if any, with respect to bonds called for optional
redemption, or interest on, any bond;
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- impair the right to institute suit for the enforcement of any payment on
or after the stated maturity thereof or any redemption date or payment
date therefor;
- permit the creation of any lien with respect to all or any substantial
portion of the collateral, release or terminate the lien of the security
documents on all or any substantial portion of the collateral or deprive
any holder of the security afforded by the lien of the security
documents, except to the extent expressly permitted by the indenture or
any of the security documents;
- modify the ranking or priority of the bonds; or
- waive a default in the payment of principal of, Make-Whole Premium, if
any, or interest on, the bonds.
SATISFACTION AND DISCHARGE OF THE INDENTURE
The indenture will cease to be of further effect (except as to any
surviving rights of registration of transfer or exchange of bonds expressly
provided for, and except as otherwise specifically provided, in the indenture)
when:
(1) either
(A) all bonds previously authenticated and delivered (other than (i)
bonds which have been destroyed, lost or stolen and which have been
replaced or paid and (ii) bonds for which payment money has previously been
deposited in trust with the trustee) have been delivered to the trustee for
cancellation; or
(B) all bonds not previously delivered to the trustee for cancellation
(i) have become due and payable;
(ii) will become due and payable at their stated maturity within
one year; or
(iii) if redeemable at our option, are to be called for redemption
within one year under arrangements satisfactory to the trustee for the
giving of notice of redemption by the trustee in our name and at our
expense; and we, in the case of (B)(i), (ii) or (iii) above, have
irrevocably deposited or caused to be deposited with the trustee as
trust funds in trust for the purpose an amount sufficient to pay and
discharge the entire indebtedness on those bonds not previously
delivered to the trustee for principal, Make-Whole Premium, if any,
optional redemption, and interest to the date of the deposit (in the
case of bonds that have become due and payable) or to the stated
maturity or redemption date, as the case may be;
(2) we have paid or caused to be paid all other sums then payable under the
indenture by us; and
(3) we have delivered to the trustee an officer's certificate and an
opinion of counsel, each stating that all conditions precedent relating to the
satisfaction and discharge of the indenture have been complied with.
DEFEASANCE OR COVENANT DEFEASANCE
We may, at our option, elect to be discharged from our obligations with
respect to the outstanding bonds ("defeasance"). This defeasance means that we
will be deemed to have paid and discharged the entire indebtedness represented
by such outstanding bonds and to have satisfied all our other obligations under
those bonds and the indenture insofar as those bonds are concerned, except for
the following which shall survive until otherwise terminated or discharged:
- the rights of holders of the outstanding bonds to receive, solely from
the trust funds, payments in respect of the principal of and interest and
Make-Whole Premium, if any, with respect to bonds called for optional
redemption, on those bonds when those payments are due;
- ministerial obligations with respect to registration, payment and
transfer of the bonds and similar matters;
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- the rights, powers, trusts, duties and immunities of the trustee under
the indenture; and
- the defeasance provisions of the indenture.
In addition, we may also elect to have covenant defeasance apply. In the
event covenant defeasance occurs, (1) we will be released from our covenants
contained in the indenture, except for the covenants concerning the payment of
principal, interest and Make-Whole Premium, if any, with respect to bonds called
for optional redemption, maintenance of office or agency and maintenance of
existence and properties, and (2) thereafter, failure to comply with all
covenants except those listed in clause (1) above will not be deemed to be an
event of default.
In order to exercise either defeasance or covenant defeasance with respect
to any outstanding bonds a number of conditions must be satisfied, including the
following:
- we must irrevocably deposit or cause to be deposited with the trustee,
specifically pledged as security for, and dedicated solely to, the
benefit of the holders of the bonds, an amount sufficient to pay and
discharge the outstanding principal of and unpaid installments of
interest (and Make-Whole Premium, if any, with respect to bonds called
for optional redemption) on the outstanding bonds on the date when those
payments become due;
- we must deliver opinions of counsel and officer's certificates as to
specified matters;
- we must certify that the bonds, if then listed on any securities
exchange, will not be delisted as a result of such deposit;
- no default or event of default with respect to the outstanding bonds will
have occurred and be continuing on the date of the deposit or, insofar as
bankruptcy events of default are concerned, at any time during the period
ending on the 121st day after the date of the deposit;
- the defeasance or covenant defeasance will not result in a breach or
violation of, or constitute a default under, the indenture or any other
material agreement or instrument to which we are a party or by which we
are bound; and
- the defeasance or covenant defeasance will not result in the trust
arising from the deposit constituting an investment company as defined in
the Investment Company Act of 1940, as amended, or the trust will be
qualified under that act or exempt from regulation thereunder.
THE TRUSTEE
Deutsche Bank Trust Company Americas (formerly known as Bankers Trust
Company) is the trustee under the indenture. The trustee's current address is 60
Wall Street, New York, New York 10005, Attention: Corporate Trust Office.
COLLATERAL SECURITY
We granted to the trustee on the closing date of the offering of the Series
A bonds, on behalf of and for the benefit of the holders, all of our right,
title and interest in and to:
- the amended power purchase agreement;
- the mirror power purchase agreement;
- the administrative services agreement;
- our other material agreements;
- the collections and all amounts payable to us arising out of,
attributable to, in respect of or otherwise in connection with the
collections;
- all other amounts payable to us pursuant to our material agreements;
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- the collections account (other than the proceeds of additional bonds
issued under the indenture), the liquidity account and the damages and
indemnity account and all funds and all investments and proceeds on
deposit therein from time to time;
- all our governmental approvals and general intangibles;
- all damages and other amounts payable to us in respect of the foregoing;
- all of our rights, claims, powers, privileges and remedies (whether
mandatory, discretionary or judgmental), whether arising by contract, at
law, in equity or otherwise with respect to the foregoing; and
- all present and future claims and demands in respect of any or all of the
foregoing, insurance proceeds, condemnation awards and all payments and
all proceeds of every kind and nature whatsoever in respect of any or all
of the foregoing (collectively, the "collateral").
REPORTS TO HOLDERS
While we are not required to nor do we intend to send annual reports to the
holders of the bonds, we will be filing the reports required by the Securities
Exchange Act and copies of our filings with the SEC will be provided to the
trustee.
MEETINGS OF HOLDERS
The trustee may call or, in the event the trustee fails to call a meeting
of the holders upon the request of the holders of at least 10% in aggregate
principal amount of the outstanding bonds or our request, we or the holders of
at least 10% in aggregate principal amount of the outstanding bonds may call, a
meeting of the holders at any time and from time to time, to:
- give any notice to us or to the trustee, or give any direction to the
trustee, or waive or consent to the waiving of any default under the
indenture and its consequences, or take any other action authorized to be
taken by holders in connection with the occurrence of an event of
default;
- remove the trustee pursuant to the indenture;
- consent to the execution of a supplemental indenture; or
- take any other action authorized to be taken by or on behalf of the
holders of any specified aggregate principal amount of the bonds under
any other provision of the indenture or under applicable law.
Meetings will be held at such time and at such place in the Borough of
Manhattan, the City of New York, as the trustee or we or the holders of not less
than 10% in aggregate principal amount of the outstanding bonds at the time
determine. Notice of any meeting of holders setting forth the time and the place
of that meeting and in general terms the action proposed to be taken at that
meeting will be given by the trustee not less than 20 days nor more than 120
days prior to the date fixed for the meeting.
Any holder may attend the meeting in person or by proxy.
At any meeting, the presence of persons holding or representing bonds in an
aggregate principal amount sufficient to take action upon the business for the
transaction of which the meeting was called will be necessary to constitute a
quorum; but, if less than a quorum is present, the persons holding or
representing a majority of the bonds represented at the meeting may adjourn the
meeting with the same effect, for all intents and purposes, as though a quorum
had been present. At any meeting, each holder of a bond or a proxy will be
entitled to one vote for each $1,000 principal amount of bonds held or
represented by it.
GOVERNING LAW AND ENFORCEABILITY
The indenture and the bonds are governed by, and construed in accordance
with, the laws of the State of New York.
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We have consented to the non-exclusive jurisdiction of any court of the
State of New York or any United States federal court sitting in the Borough of
Manhattan, New York City, New York, United States, and any appellate court from
any thereof, and have waived any immunity from the jurisdiction of these courts
over any suit, action or proceeding that may be brought in connection with the
indenture, the financing documents or the bonds.
We have appointed CT Corporation System as our authorized agent upon which
all writs, process and summonses may be served in any suit, action or proceeding
brought in connection with the indenture, the financing documents or the bonds
against us in any court of the State of New York or any United States federal
court sitting in the Borough of Manhattan, New York City. This appointment is
irrevocable so long as any of the bonds remain outstanding or until the
irrevocable appointment by us of a successor in New York City as our authorized
agent for such purpose and the acceptance of this appointment by the successor.
DEFINED TERMS
"Debt Service Coverage Ratio" means, for any period, the ratio which is
equal to (a) Net Collections for that period divided by (b) Mandatory Debt
Service for that period. For the purposes of this definition, "Net Collections"
means for any period, the excess, if any, of (a) the sum of the collections and
the transfer payments from the liquidity account to the collections account over
(b) any amount payable during that period pursuant to priorities first and
second in the Section "-- Withdrawals from the Collections Account" and
"Mandatory Debt Service" means, for any period, all scheduled interest and
principal payments and fees payable during that period in respect of the bonds
and any additional bonds issued under the indenture.
"Independent Investment Banker" means Credit Suisse First Boston
Corporation or its successor.
"Make-Whole Premium" means an amount equal to the Discounted Present Value
calculated for any bond called for optional redemption (and only such bonds)
less the unpaid principal amount of that bond; provided that the Make-Whole
Premium shall not be less than zero. A Make-Whole Premium shall not be due for
any reason, or result from any event, other than in connection with an optional
redemption of the bonds pursuant to the indenture. For purposes of this
definition, the "Discounted Present Value" of any bond subject to redemption
shall be equal to the discounted present value of all principal and interest
payments scheduled to become due in respect of that bond after the date of this
redemption, calculated by the Independent Investment Banker using a discount
rate equal to the sum of (1) the yield to maturity on the United States treasury
security having an average life equal to the remaining average life of that bond
and trading in the secondary market at the price closest to par and (2) 50 basis
points; provided, however, that, if there is no United States treasury security
having an average life equal to the remaining average life of that bond, this
discount rate shall be calculated using a yield to maturity interpolated or
extrapolated on a straight-line basis (rounding to the nearest month, if
necessary) from the yields to maturity for two United States treasury securities
having average lives most closely corresponding to the remaining average life of
that bond and trading in the secondary market at the price closest to par.
"Moody's" means Moody's Investors Service, Inc.
"Permitted Investments" means the following investments maturing, in each
case, not less than one business day before the payment date next following the
date such investment is made; provided, however, that in the case of any
investment pursuant to clause (b) of this definition which is made with the
trustee, such investment may mature on such payment date:
(a) any direct obligations of, or obligations fully and
unconditionally guaranteed by, the United States of America, or any agency
or instrumentality of the United States of America, the obligations of
which are fully and unconditionally backed by the full faith and credit of
the United States of America;
(b) demand and time deposits in, certificates of deposit of, bankers'
acceptances issued by, or federal funds sold by any depository institution
or trust company incorporated under the laws of the United States of
America or any state thereof and subject to supervision and examination by
federal and/or state authorities, or incorporated under the laws of any
other jurisdiction, so long as at the time of such investment or
contractual commitment providing for such investment the unsecured
commercial
88
paper or other unsecured short-term debt obligations of such depository
institution or trust company have at least the Required Credit Rating from
Moody's and Standard & Poor's;
(c) repurchase obligations with respect to any security described in
clauses (a) or (b) above, in each case entered into with either (i) a
depository institution or trust company (acting as principal) which in
respect of its short-term unsecured debt has at least the Required Credit
Rating from Moody's and Standard & Poor's or (ii) a money market fund
maintained by a broker which in respect of its short-term unsecured debt
has at least the Required Credit Rating from Moody's and Standard & Poor's;
(d) unsecured debt securities bearing interest or sold at a discount
issued by any corporation incorporated under the laws of the United States
of America, or any state thereof, which have at the time of such investment
at least the Required Credit Rating from Moody's and Standard & Poor's;
(e) unsecured commercial paper which has at the time of such
investment at least the Required Credit Rating from Moody's and Standard &
Poor's; and
(f) investments in money market funds or money market mutual funds
which have at the time of such investment at least the Required Credit
Rating from Moody's and Standard & Poor's (including such funds for which
the trustee or any of its affiliates is investment manager or advisor and
for which the trustee or any of its affiliates may receive a fee).
"Required Credit Rating" means P-l (or its equivalent) or higher from
Moody's and A-l (or its equivalent) or higher from Standard & Poor's.
"Standard & Poor's" means Standard & Poor's Rating Services.
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DESCRIPTION OF OUR PRINCIPAL FINANCING DOCUMENTS
The following summaries of material provisions of the financing documents
(other than the indenture and the bonds, which are described in "Description of
the Bonds and the Indenture") do not purport to be complete. Copies of such
financing documents are available for inspection at the corporate trust office
of the trustee. We urge you to read such financing documents because they, and
not this description, will define your rights as a holder of the bonds.
SECURITY DOCUMENTS
CONSENTS
Each of El Paso, El Paso Merchant and Public Service Electric entered into
a consent and agreement with the trustee and us whereby such party, among other
things, consented to the assignment to the trustee of all of our right, title,
interest and obligations under our material agreements to which it is a party
and agreed:
- to provide specified notifications to the trustee; and
- not to suspend or terminate the applicable agreement without providing
the trustee or its designee the opportunity to cure any default within 60
days (or within 30 days with respect to a payment default or in the case
of the amended power purchase agreement) after the last day of the cure
period in the applicable agreement.
Public Service Electric may not assign its rights under the amended power
purchase agreement without our consent unless the assignee is controlling,
controlled by or under common control with Public Service Electric and has a
credit rating at least equivalent to Public Service Electric's rating from both
Moody's and Standard & Poor's. In addition, pursuant to the consent and
agreement with Public Service Electric, in the event that the trustee or any
designee or assignee succeeds to our interests under the amended power purchase
agreement, this successor will assume liability for our obligations under the
amended power purchase agreement, including those obligations arising prior to
succession.
PERFECTION OF SECURITY INTERESTS
The security interests granted under the financing documents will be
perfected to the extent that perfection may be obtained by filing financing
statements under the Uniform Commercial Code and in the case of the securities
entitlements credited to the accounts, through an assignment and security
agreement.
U.S. FEDERAL INCOME TAX CONSEQUENCES
UNITED STATES FEDERAL INCOME TAX
The following summary of federal income tax consequences has been prepared
by Chadbourne & Parke LLP. We urge you to consult your own tax advisors as to
the precise federal, state, local and other tax consequences of the exchange
offer.
The following discussion summarizes and represents the opinion of
Chadbourne & Parke LLP regarding the material United States federal income tax
consequences to beneficial owners arising from the exchange offer. The remainder
of this discussion generally refers to the Series A bonds and the Series B bonds
as the "bonds". The discussion which follows is based on the U.S. Internal
Revenue Code of 1986, as amended (the "Code"), the Treasury regulations
promulgated thereunder, and judicial and administrative interpretations thereof,
all as in effect on the date hereof, and is subject to any changes in these or
other laws occurring after such date, possibly with retroactive effect.
For purposes of this summary, the term "U.S. Holder" means a beneficial
owner of a bond that is, for U.S. federal income tax purposes, (a) an individual
who is a U.S. citizen or resident, (b) a corporation or partnership created or
organized under the laws of the United States or any political subdivision
thereof, or (c) an estate or trust that is otherwise subject to U.S. federal
income tax on a net basis with respect to its
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worldwide income. The term "Non-U.S. Holder" means a beneficial owner of a bond
who is not, for U.S. federal income tax purposes, a U.S. Holder.
The discussion which follows is not intended as tax advice to any
particular investor. This summary is not a complete analysis or listing of all
potential U.S. federal income tax consequences to U.S. Holders and Non-U.S.
Holders relating to the bonds, and does not address the effect of any United
States gift, estate, state or local tax law or foreign tax law on a potential
investor in the bonds.
This summary is generally limited to investors who will hold the bonds as
"capital assets" within the meaning of Section 1221 of the Code and whose
functional currency is the United States dollar. This summary does not address
the tax treatment of U.S. Holders and Non-U.S. Holders that may be subject to
special income tax rules such as insurance companies, tax-exempt organizations,
banks, U.S. Holders subject to the alternative minimum tax, United States
expatriates, holders that are broker-dealers in securities, holders that own
(directly, indirectly or by attribution) 10 percent or more of our equity
interests, or that hold the bonds as a hedge against currency risks, as a
position in a "straddle" for tax purposes, or as part of a conversion or other
integrated transaction.
EXCHANGE OFFER
The exchange of Series A bonds for Series B bonds pursuant to the exchange
offer will not constitute a taxable exchange for U.S. federal income tax
purposes. Accordingly, a U.S. Holder will not recognize gain or loss upon the
receipt of Series B bonds pursuant to the exchange offer, and a U.S. Holder will
be required to include interest on the Series B bonds in gross income in the
manner and to the extent interest income was includable under the Series A
bonds. A U.S. Holder's holding period for the Series B bonds will include the
holding period of the Series A bonds exchanged therefor, and such U.S. Holder's
adjusted basis in the Series B bonds will be the same as the basis of the Series
A bonds exchanged therefor immediately before the exchange.
U.S. Holders
Interest on the Bonds. Interest on a bond will be includable in the gross
income of a U.S. Holder as ordinary interest income at the time such interest is
treated as received or accrued, in accordance with the U.S. Holder's method of
accounting for U.S. federal income tax purposes. We expect that the bonds will
not be considered to be issued with original issue discount for U.S. federal
income tax purposes.
Payments on Registration Default. The bonds provide for the payment of
additional amounts under the circumstances described above under "Description of
the Bonds and the Indenture -- Principal Amount, Interest Rate and Stated
Maturity," and, therefore, are subject to the Treasury regulations that apply to
debt instruments that provide for one or more contingent payments. We believe
that the possible payment of such additional amounts would not cause the bonds
to be treated as having been issued with original issue discount under those
Treasury regulations, because, as of the issue date, the possibility of such
payment is "remote," and would therefore be ignored. In such circumstances, the
rules described above under "-- Interest on the Bonds" would apply. Our
determination that such payments are a remote contingency for these purposes is
binding on a U.S. Holder, unless such U.S. Holder discloses in the proper manner
to the Internal Revenue Service that it is taking a different position.
Market Discount. A U.S. Holder that purchases a bond at a market discount
(as described below) generally will be required to treat any principal payments
on, or any gain on the disposition or maturity of, such bond as ordinary income
to the extent of the accrued market discount (not previously included in income)
at the time of such payment or disposition. In general, market discount is the
amount by which the bond's stated redemption price at maturity exceeds the U.S.
Holder's basis in the bond immediately after the bond is acquired. A bond is not
treated as purchased at a market discount, however, if the market discount is
less than 0.25% of the stated redemption price at maturity of the bond
multiplied by the number of complete years to maturity from the date when the
U.S. Holder acquired the bond. Market discount on a bond will accrue on a
straight-line basis, unless the U.S. Holder elects to accrue such discount on a
constant yield to maturity basis. This election is irrevocable and applies only
to the bond for which it is made. The U.S. Holder
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may also elect to include market discount in income currently as it accrues.
This election, once made, applies to all market discount obligations acquired on
or after the first day of the first taxable year to which the election applies
and may not be revoked without the consent of the Internal Revenue Service.
Generally, if a bond with market discount is transferred in specified
non-taxable transactions (other than a non-recognition transaction described in
Section 1276(c) of the Code), accrued market discount will be includable as
ordinary income to the U.S. Holder as if such U.S. Holder sold the bond at its
fair market value. A U.S. Holder may be required to defer until the maturity of
the bond or, in some circumstances, its earlier disposition, the deduction for
all or a portion of the interest expense attributable to debt incurred or
continued to purchase or carry a bond with market discount, unless an election
to include the market discount on a current basis is made.
Amortizable Bond Premium. A U.S. Holder that purchases a bond for an
amount in excess of its stated principal amount at maturity will generally be
considered to have purchased the bond with "amortizable bond premium." A U.S.
Holder generally may elect to amortize such premium using the constant yield to
maturity method. The amount amortized in any year will generally be treated as a
reduction of the U.S. Holder's interest income on the bond. The premium on a
bond held by a U.S. Holder that does not make such an election will decrease the
gain or increase the loss otherwise recognized on the sale, redemption,
retirement or other disposition of the bond. The election to amortize the
premium on a constant yield to maturity method, once made, applies to all debt
obligations held or subsequently acquired by the electing U.S. Holder on or
after the first day of the first taxable year to which the election applies and
may not be revoked without the consent of the IRS.
Disposition of the Bonds. In general, a U.S. Holder's adjusted tax basis
in a bond will equal the cost of such bond to the U.S. Holder, increased by the
amount of any market discount previously included in the U.S. Holder's income
with respect to the bond, and reduced by (i) the amount of any principal
payments on the bond and (ii) the amortized amount of any amortizable bond
premium on the bond.
A U.S. Holder will generally recognize gain or loss on the sale, retirement
or other disposition of a bond in an amount equal to the difference between (i)
the amount of cash and the fair market value of property received by such U.S.
Holder on such sale, retirement or other disposition (less any amounts
attributable to accrued but unpaid interest which will be taxable as such) and
(ii) the U.S. Holder's adjusted tax basis in the bond (as described above). Gain
or loss upon the sale, retirement or other disposition of a bond will be capital
gain or loss if the bond is a capital asset in the hands of the U.S. Holder and,
in the case of an individual U.S. Holder, will be subject to U.S. federal income
tax at a reduced rate if such bond was owned by such U.S. Holder for more than
one year. Gains on the sale of capital assets held for one year or less are
subject to U.S. federal income tax at ordinary income rates. Some limitations
exist on the deductibility of capital losses by both corporations and individual
taxpayers.
Non-U.S. Holders
A Non-U.S. Holder of a bond generally will not be subject to U.S. federal
income tax by withholding or otherwise on the payment of interest (generally,
including stated interest and market discount, as adjusted by amortizable bond
premium) on a bond provided that the beneficial owner of the bond fulfills the
certification requirements set forth in applicable Treasury regulations unless
(A) such Non-U.S. Holder (i) actually or constructively owns 10% or more of the
total combined voting power of the equity of the issuer entitled to vote, (ii)
is a controlled foreign corporation related, directly or indirectly, to the
issuer through equity ownership or (iii) is a bank receiving interest described
in Section 881(c)(3)(A) of the Code or (B) such interest is effectively
connected with the conduct of a trade or business by the Non-U.S. Holder in the
United States. Under these certification requirements, except as described
below, the last United States payer in the chain of payment prior to payment to
a Non-U.S. Holder (the "withholding agent") must have received in the year in
which a payment of principal, premium or interest occurs, or in either of the
two preceding calendar years, a statement that: (1) is signed by the Non-U.S.
Holder under penalties of perjury; (2) certifies that the holder is a Non-U.S.
Holder; and (3) provides the name and address of the Non-U.S. Holder. The
statement may be made on the appropriate U.S. Treasury Form W-8 (or on a
suitable substitute form), and the Non-U.S. Holder must inform the withholding
agent of any change in the information on the statement within 30 days of such
change. If the bonds are held through a securities clearing organization or some
other types of
92
financial institutions that are not qualified intermediaries, the organization
or institution is required to provide its signed statement to the withholding
agent along with a copy of such Form W-8 (or suitable substitute form) provided
by the Non-U.S. Holder. If the bonds are held through a financial institution
that is a qualified intermediary, the qualified intermediary generally will not
be required to furnish a copy of the Form W-8 (or suitable substitute form)
received from the beneficial owner. A qualified intermediary is a financial
institution that has entered into a withholding agreement with the IRS. If the
bonds are held by a foreign complex trust, the trust is treated as the
beneficial owner. If the bonds are held through a foreign partnership, a foreign
simple trust or a foreign grantor trust, the partner, beneficiary or grantor is
treated as the beneficial owner, and the foreign partnership or foreign trust
must provide its signed statement to the withholding agent along with a copy of
the appropriate Form W-8 (or suitable substitute form) received from the
beneficial owner.
A Non-U.S. Holder generally will not be subject to United States federal
income tax by withholding or otherwise on gain realized on the sale, retirement
or other disposition of a bond, unless (i) such gain is effectively connected
with the conduct by such Non-U.S. Holder of a trade or business within the
United States, or (ii) such gain is realized by an individual Non-U.S. Holder
who is present in the United States for at least 183 days in the taxable year of
the sale, retirement or other disposition, and specified other conditions are
met.
UNITED STATES INFORMATION REPORTING AND BACKUP WITHHOLDING
Payments of principal, premium and interest and the proceeds from the
disposition by some non-corporate holders of bonds may be subject to U.S.
information reporting and backup withholding. A U.S. Holder generally will be
subject to U.S. information reporting and backup withholding unless the U.S.
Holder supplies an accurate taxpayer identification number, as well as other
information, or otherwise establishes, in the manner prescribed by law, an
exemption. U.S. information reporting and backup withholding may also apply to
Non-U.S. Holders that are not "exempt recipients" and that fail to provide
specified information as may be required by U.S. law and applicable regulations.
Any amount withheld under backup withholding is not an additional tax and is
generally allowable as a credit against the beneficial owner's federal income
tax upon furnishing the required information to the IRS.
You should consult your own tax advisors regarding the application of the
U.S. information reporting and backup withholding rules to your particular
situation, including your qualification for exemption therefrom, and the
procedure for obtaining such an exemption, if applicable.
You should also consult your tax advisor as to the tax consequences of the
transaction and of owning the bonds in view of your particular situation.
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ERISA CONSIDERATIONS
If you intend to use plan assets to exchange for any of the Series B bonds
offered by this prospectus, you should consult with counsel on the potential
consequences of your investment under the fiduciary responsibility provisions of
the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and
the prohibited transaction provisions of ERISA. If you intend to use
governmental or church plan assets to exchange for any of the Series B bonds,
you should consult with counsel on the potential consequences of your investment
under similar provisions applicable under laws governing governmental and church
plans.
The following summary is based on the provisions of ERISA and the Code and
related guidance in effect as of the date of this prospectus. This summary does
not attempt to be a complete summary of these considerations. Future
legislation, court decisions, administrative regulations or other guidance will
change the requirements summarized in this section. Any of these changes could
be made retroactively and could apply to transactions entered into before the
change is enacted.
FIDUCIARY RESPONSIBILITIES
ERISA imposes requirements on (1) employee benefit plans subject to ERISA,
(2) entities whose underlying assets include employee benefit plan assets, for
example, collective investment funds and insurance company general accounts, and
(3) fiduciaries of employee benefit plans. Under ERISA, fiduciaries generally
include persons who exercise discretionary authority or control over plan
assets. Before investing any employee benefit plan assets in any bond offered in
connection with this prospectus, you should determine whether the investment:
(1) is permitted under the plan document and other instruments
governing the plan; and
(2) is appropriate for the plan in view of its overall investment
policy and the composition and diversification of its portfolio, taking
into account the limited liquidity of the bonds.
You should consider all factors and circumstances of a particular
investment in the bonds, including, for example, the risk factors discussed in
"Risk Factors" and the fact that in the future there may not be a market in
which you will be able to sell or otherwise dispose of your interest in the
bonds.
We are not making any representation that the sale of any bonds to a plan
meets the fiduciary requirements for investment by plans generally or any
particular plan or that such an investment is appropriate for plans generally or
any particular plan.
PROHIBITED TRANSACTIONS
ERISA and the Code prohibit a wide range of transactions involving (1)
employee benefit plans and arrangements subject to ERISA and/or the Code, and
(2) persons who have specified relationships to the plans. These persons are
called "parties in interest" under ERISA and "disqualified persons" under the
Code. The transactions prohibited by ERISA and the Code are called "prohibited
transactions." If you are a party in interest or disqualified person who engages
in a prohibited transaction, you may be subject to excise taxes and other
penalties and liabilities under ERISA and/or the Code. As a result, if you are
considering using plan assets to invest in any of the bonds offered for sale in
connection with this prospectus, you should consider whether the investment
might be a prohibited transaction under ERISA and/or the Code.
Prohibited transactions may arise, for example, if the bonds are acquired
by a plan with respect to which we, or any of our affiliates, are a party in
interest or a disqualified person. Exemptions from the prohibited transaction
provisions of ERISA and the Code may apply depending in part on the type of plan
fiduciary making the decision to acquire a bond and the circumstances under
which such decision is made. Some of these exemptions include:
(1) Prohibited transaction class exemption or "PTCE" exemptions 75-1
(relating to specified transactions involving employee benefit plans and
broker-dealers, reporting dealers and banks).
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(2) PTCE 84-14 (relating to specified transactions directed by
independent qualified professional asset managers);
(3) PTCE 90-1 (relating to specified transactions involving insurance
company pooled separate accounts);
(4) PTCE 91-38 (relating to specified transactions by bank collective
investment funds);
(5) PTCE 95-60 (relating to specified transactions involving insurance
company general accounts); and
(6) PTCE 96-23 (relating to specified transactions directed by
in-house asset managers);
These exemptions do not, however, provide relief from the self-dealing
prohibitions under ERISA and the Code. In addition, there is no assurance that
any of these class exemptions or other exemption will be available with respect
to any particular transaction involving the bonds.
TREATMENT OF BONDS AS DEBT INSTRUMENTS
Some transactions involving our operation could give rise to prohibited
transactions under ERISA and the Code if our assets were deemed to be plan
assets. Pursuant to Department of Labor Regulations Section 2510.3-101 (which we
refer to as the "plan assets regulations"), in general, when a plan acquires an
"equity interest" in an entity such as Cedar Brakes II, L.L.C., the plan's
assets include both the equity interest and an undivided interest in each of the
underlying assets of the entity unless exceptions set forth in the plan assets
regulations apply.
In general, an "equity interest" is defined under the plan assets
regulations as any interest in an entity other than an instrument which is
treated as indebtedness under applicable local law and which has no substantial
equity features. Although there is very little published authority concerning
the application of this definition, we believe that the bonds should be treated
as debt rather than equity interest under the plan assets regulations because
the bonds (1) should be treated as indebtedness under applicable local law and
debt, rather than equity, for United States tax purposes and (2) should not be
deemed to have any "substantial equity features." However, no assurance can be
given that the bonds will be treated as debt for purposes of ERISA. If the bonds
were to be treated as an equity interest under the plan assets regulations, the
purchase of the bonds using plan assets could cause our assets to become subject
to the fiduciary and prohibited transaction provisions of ERISA and the Code
unless investment in the bonds by "benefit plan investors" is not "significant,"
as determined under the plan assets regulations. We cannot assure you that the
criteria for this exception will be satisfied at any particular time and no
monitoring or other measures will be taken to determine whether such criteria
are met. This means that, if the bonds are treated as equity interests under the
plan asset regulations and investment in the bonds by benefit plan investors is
significant, our assets could be treated as the plan assets subject to ERISA and
a non-exempt prohibited transaction could arise in connection with our operating
activities.
Any insurance company proposing to invest assets of its general account in
the bonds should consider the implications of the U.S. Supreme Court's decision
in John Hancock Mutual Life Insurance Co. v. Harris Trust and Savings Bank, 510
U.S. 86, 114 S. Ct. 517 (1993), which, in some circumstances, treats such
general account as including the assets of a plan that owns a policy or other
contract with such insurance company, as well as the effect of Section 401(c) of
ERISA, as interpreted by regulations proposed by the Department of Labor.
GOVERNMENT AND CHURCH PLANS
Governmental plans and some church plans, while not subject to the
fiduciary responsibility provisions of ERISA or the prohibited transactions
provisions of ERISA or the Code, may be subject to state or other federal laws
that are very similar to the provisions of ERISA and the Code. If you are a
fiduciary of a governmental or church plan, you should consult with counsel
before purchasing any bonds offered for sale in connection with this prospectus.
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FOREIGN INDICIA OF OWNERSHIP
ERISA also prohibits plan fiduciaries from maintaining the indicia of
ownership of any plan assets outside the jurisdiction of the United States
district courts except in specified cases. Before investing in any bond offered
for sale in connection with this prospectus, you should consider whether the
acquisition, holding or disposition of a bond would satisfy such indicia of
ownership rules.
REPRESENTATIONS AND WARRANTIES
If you acquire or accept a bond offered in connection with this prospectus,
you will be deemed to have represented and warranted that either:
(1) you have not used plan assets to acquire such bond; or
(2) your acquisition and holding of a bond (A) is exempt from the
prohibited transaction restrictions of ERISA and the Code under one or more
prohibited transaction class exemptions or does not constitute a prohibited
transaction under ERISA and the Code, and (B) meets the fiduciary
requirements of ERISA.
PLAN OF DISTRIBUTION
Based on interpretations by the staff of the SEC set forth in no action
letters issued to third parties, we believe that you may transfer Series B bonds
issued under the exchange offer in exchange for Series A bonds unless you are:
- our "affiliate" within the meaning of Rule 405 under the Securities Act;
- a broker-dealer that acquired Series A bonds directly from us; or
- a broker-dealer that acquired Series A bonds as a result of market-making
or other trading activities without compliance with the registration and
prospectus delivery provisions of the Securities Act;
provided that you acquire the Series B bonds in the ordinary course of your
business and you are not engaged in, and do not intend to engage in, and have no
arrangement or understanding with any person to participate in, a distribution
of the Series B bonds. Broker-dealers receiving Series B bonds in the exchange
offer will be subject to a prospectus delivery requirement with respect to
resales of the Series B bonds.
To date, the staff of the SEC has taken the position that participating
broker-dealers may fulfill their prospectus delivery requirements with respect
to transactions involving an exchange of securities such as this exchange offer,
other than a resale of an unsold allotment from the original sale of the Series
A bonds, with the prospectus contained in the exchange offer registration
statement.
Pursuant to the Registration Agreement, each broker-dealer that receives
Series B bonds for its own account pursuant to the exchange offer must
acknowledge that it will deliver a prospectus in connection with any resale of
such Series B bonds. This prospectus, as it may be amended or supplemented from
time to time, may be used by a broker-dealer in connection with resales of
Series B bonds received in exchange for Series A bonds where such Series A bonds
were acquired as a result of market-making activities or other trading
activities. We have agreed that, for a period of 180 days after the expiration
date, we will make this prospectus, as amended or supplemented, available to any
broker-dealer for use in connection with any such resale. In addition, until
[ ], 2002, all dealers effecting transactions in the Series B Bonds may be
required to deliver a prospectus.
We will not receive any proceeds from any sale of Series B bonds by
broker-dealers. Series B bonds received by broker-dealers for their own account
pursuant to the exchange offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the Series B bonds or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of
96
commissions or concessions from any such broker-dealer or the purchasers of any
such Series B bonds. Any broker-dealer that resells Series B bonds that were
received by it for its own account pursuant to the exchange offer and any broker
or dealer that participates in a distribution of such Series B bonds may be
deemed to be an "underwriter" within the meaning of the Securities Act and any
profit on any such resale of Series B bonds and any commission or concessions
received by any such persons may be deemed to be underwriting compensation under
the Securities Act. The letter of transmittal states that, by acknowledging that
it will deliver and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the Securities
Act.
For a period of 180 days after the expiration date, we will promptly send
additional copies of this prospectus and any amendment or supplement to this
prospectus to any broker-dealer that requests such documents in the letter of
transmittal. We have agreed to pay all expenses incident to the exchange offer
(including the expenses of one counsel for the holders of the bonds), other than
commissions or concessions of any brokers or dealers, and will indemnify the
holders of the bonds (including any broker-dealers) against specified
liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
Our counsel, Chadbourne & Parke LLP, New York, New York, will issue an
opinion regarding the validity and binding obligation of the bonds and other
specified legal matters.
EXPERTS
The financial statements of Cedar Brakes II, L.L.C. as of December 31, 2001
and for the period from inception (May 3, 2001) to December 31, 2001 included in
this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
Pace prepared the mirror power purchase agreement assessment included as
Annex A to this prospectus. We include the assessment in this prospectus in
reliance upon Pace's authority as a consultant in evaluation of power markets
and related matters. You should read this report in its entirety for information
contained therein with respect to the PJM power market and the related matters
discussed therein.
AVAILABLE INFORMATION
We are filing with the SEC a registration statement on Form S-4 relating to
the Series B bonds. This prospectus is a part of the registration statement, but
the registration statement includes additional information and also includes
exhibits that are referenced in this prospectus. You can review a copy of the
registration statement through the SEC's "EDGAR" System (Electronic Data
Gathering, Analysis and Retrieval) that is available on the SEC's web site
(http://www.sec.gov).
After our registration statement becomes effective, we will be required to
publicly file specified information under the Securities Exchange Act of 1934,
as amended. All our public filings will also be available on EDGAR, including
annual and quarterly reports and other information. You may also read and copy
all of our public filings at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549 or at their facilities in New York and
Chicago. Please call the SEC at (800) 732-0330 for further information on the
operation of the public reference rooms.
While we are not required to nor do we intend to send annual reports to the
holders of the bonds, we will be filing the reports required by the Securities
Exchange Act and copies of our filings with the SEC will be provided to the
trustee.
El Paso and Public Service Electric are subject to the information
requirements of the Securities Exchange Act, and, in accordance therewith, file
periodic reports, proxy statements and other information with the SEC.
97
Reports, proxy statements and other information filed by El Paso and Public
Service Electric with the SEC can be inspected, without charge, and copied at
the public reference facilities maintained by the SEC at 450 Fifth Street, N.W.,
Room 1024, Washington D.C. 20549 and at the SEC's regional offices at Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 233
Broadway, New York, New York 10279. The SEC also maintains a site on the
Internet at http://www.sec.gov that contains reports, proxies and other
information regarding registrants that file electronically with the SEC, and
other filings by El Paso and Public Service Electric are available at that web
site. Copies of such materials also can be obtained from the Public Reference
Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates.
98
ANNEX B
INDEX TO FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
Financial Statements as of December 31, 2001, and for the
period from inception (May 3, 2001) to December 31, 2001:
Report of Independent Accountants......................... F-2
Statement of Income....................................... F-3
Balance Sheet............................................. F-4
Statement of Cash Flows................................... F-5
Statement of Member's Equity.............................. F-6
Notes to the Financial Statements......................... F-7
Financial Statements as of March 31, 2002 and December 31,
2001, and for the quarter ended March 31, 2002:
Condensed Statement of Operations (Unaudited)............. F-13
Condensed Balance Sheets (Unaudited)...................... F-14
Condensed Statement of Cash Flows (Unaudited)............. F-15
Condensed Notes to the Financial Statements (Unaudited)... F-16
</Table>
F-1
CEDAR BRAKES II, L.L.C.
FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2001
AND FOR THE PERIOD FROM INCEPTION (MAY 3, 2001)
TO DECEMBER 31, 2001
REPORT OF INDEPENDENT ACCOUNTANTS
To the Member of Cedar Brakes II, L.L.C.:
In our opinion, the accompanying balance sheet and the related statements
of income, of member's equity and of cash flows present fairly, in all material
respects, the financial position of Cedar Brakes II, L.L.C. (the "Company") at
December 31, 2001, and the results of its operations and its cash flows for the
period from inception (May 3, 2001) to December 31, 2001, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 8, 2002
F-2
CEDAR BRAKES II, L.L.C.
STATEMENT OF INCOME
FOR THE PERIOD FROM INCEPTION (MAY 3, 2001) TO DECEMBER 31, 2001
(IN THOUSANDS)
<Table>
<Caption>
Operating revenues
Electricity sales......................................... $ 7,019
---------
Operating expenses
Electricity purchases from affiliate...................... 2,421
Change in market value of power purchase agreements....... 2,294
Administrative fees to affiliate.......................... 5
---------
4,720
---------
Operating income............................................ 2,299
---------
Other (income) expense
Interest income........................................... (20)
Interest and debt expense................................. 2,344
Initial market gain on power purchase agreements, net..... (228,218)
---------
(225,894)
---------
Net income.................................................. $ 228,193
=========
</Table>
See accompanying notes.
F-3
CEDAR BRAKES II, L.L.C.
BALANCE SHEET
AS OF DECEMBER 31, 2001
(IN THOUSANDS)
<Table>
ASSETS
Current assets
Cash and cash equivalents................................. $ --
Accounts receivable....................................... 7,019
Amended power purchase agreement.......................... 73,741
--------
Total current assets.............................. 80,760
Amended power purchase agreement............................ 547,396
Restricted cash............................................. 21,034
Deferred financing costs, net............................... 6,204
--------
Total assets...................................... $655,394
========
LIABILITIES AND MEMBER'S EQUITY
Current liabilities
Accounts payable -- affiliate............................. $ 2,426
Accrued interest payable.................................. 2,249
Mirror power purchase agreement -- affiliate.............. 3,093
Current maturities of long-term debt...................... 5,824
--------
Total current liabilities......................... 13,592
Mirror power purchase agreement -- affiliate................ 28,997
Long-term debt, less current maturities..................... 419,224
Commitments and contingencies
Member's equity............................................. 193,581
--------
Total liabilities and member's equity............. $655,394
========
</Table>
See accompanying notes.
F-4
CEDAR BRAKES II, L.L.C.
STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM INCEPTION (MAY 3, 2001) TO DECEMBER 31, 2001
(IN THOUSANDS)
<Table>
Cash flows from operating activities
Net income................................................ $228,193
Adjustment to reconcile net income to net cash from
operating activities:
Initial market gain on power agreements................ (228,218)
Change in market value of power purchase agreements,
net................................................... 2,294
Amortization of bond discount.......................... 48
Amortization of deferred financing costs............... 47
Working capital changes:
Accounts receivable.................................. (7,019)
Accounts payable -- affiliate........................ 2,426
Accrued interest payable............................. 2,249
--------
Net cash provided by operating activities......... 20
--------
Cash flows from investing activities
Additional investment in amended power purchase
agreement.............................................. (64,000)
--------
Net cash used in investing activities............. (64,000)
--------
Cash flows from financing activities
Net proceeds from issuance of long-term debt.............. 418,749
Initial contribution...................................... 1
Cash distribution......................................... (333,736)
Increase in restricted cash............................... (21,034)
--------
Net cash provided by financing activities......... 63,980
--------
Net change in cash and cash equivalents..................... --
--------
Cash and cash equivalents
Beginning of period............................... --
End of period..................................... $ --
========
Non-cash transactions
Contribution of power purchase agreements from member..... $299,123
========
</Table>
See accompanying notes.
F-5
CEDAR BRAKES II, L.L.C.
STATEMENT OF MEMBER'S EQUITY
FOR THE PERIOD FROM INCEPTION (MAY 3, 2001) TO DECEMBER 31, 2001
(IN THOUSANDS)
<Table>
Initial contribution on May 3, 2001....................... $ 1
Contribution of power purchase agreements from member..... 299,123
Cash distribution......................................... (333,736)
Net income................................................ 228,193
---------
December 31, 2001......................................... $ 193,581
=========
</Table>
See accompanying notes.
F-6
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS
We are a single member Delaware limited liability company organized in May
2001, under the terms of a limited liability company agreement. We are a wholly
owned direct subsidiary of Mesquite Investors, L.L.C., an entity which is
indirectly owned by the Limestone Electron Trust and El Paso Corporation. El
Paso Chaparral Management, L.P., a wholly owned indirect subsidiary of El Paso
Corporation, manages the operations of Mesquite Investors, L.L.C. Our sole
business is to sell electric energy and provide electric capacity to Public
Service Electric and Gas Company, a New Jersey corporation, under an amended
power purchase agreement that we entered into with Public Service Electric. We
began operating under this amended power purchase agreement on December 13, 2001
when the Cogen Technologies NJ Venture, or Bayonne, power purchase agreement and
the Camden Cogen, L.P., or Camden, power purchase agreement, which had an
aggregate book value of $299.1 million, were contributed to us by our member. We
do not have any employees and our operations are carried out by El Paso Merchant
Energy, L.P., a subsidiary of El Paso Corporation, under an administrative
services agreement (see Note 6). We purchase the electric capacity and electric
energy necessary to meet our obligations under a mirror power purchase agreement
with El Paso Merchant (see Note 5).
2. LIMITED LIABILITY COMPANY
As a limited liability company, our member is not personally obligated for
our debt, obligations or other liabilities simply because they are our member.
These debts, obligations and other liabilities are solely ours.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our financial statements are prepared on the accrual basis of accounting in
accordance with accounting principles generally accepted in the United States.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and disclosure of contingent assets and liabilities that
exist at the date of the financial statements. Actual results may differ from
those estimates.
Cash and Cash Equivalents
We consider short-term investments purchased with an original maturity of
three months or less to be cash equivalents.
Restricted Cash
As required by our bond indenture (see Note 4), we established a restricted
cash fund from the proceeds of our bond issuance equal to the amount of a
semi-annual interest payment. We must maintain this fund through the maturity
date of the bonds. As of December 31, 2001, we had restricted cash of
approximately $21.0 million.
Allowance for Doubtful Accounts
We review collectibility of our accounts receivable on a regular basis
under the specific identification method. At December 31, 2001, no allowance for
doubtful accounts was recorded.
F-7
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Bond Discount
Our bonds were issued at a discount. The bond discount is being amortized
using the effective interest method over the term of the bonds. Amortization of
the bond discount was approximately $48,000 for the period ended December 31,
2001 and is included in our income statement as interest and debt expense.
Deferred Financing Costs
Our deferred financing costs represent the cost to issue our bonds and are
being amortized using the effective interest method over the term of the bonds.
Amortization of deferred financing costs was approximately $47,000 for the
period ended December 31, 2001 and is included in our income statement as
interest and debt expense.
Income Taxes
Since we are a limited liability company, income taxes accrue to our
member. As a result, we have not reflected a provision for income taxes in our
financial statements.
Revenue Recognition
We recognize revenue when we deliver electric energy and provide capacity.
Revenue is based on the quantity of electricity delivered at rates specified in
our amended power purchase agreement.
Accounting for Derivative Instruments
We record all derivative instruments on our balance sheet at their fair
value in accordance with Statement of Financial Accounting Standards (SFAS) No.
133, Accounting for Derivative Instruments and Hedging Activities, as amended by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities. Our amended power purchase agreement and mirror power purchase
agreement qualify as derivative instruments under these standards. As a result,
they are recorded at their fair value in our balance sheet. Changes in the fair
value of these agreements are reported in our income statement as a change in
the market value of power agreements. We estimate the fair value of these
agreements based on an estimate of the cash receipts and payments under these
agreements using anticipated future power prices compared to the contractual
prices under these agreements, discounted at a risk-adjusted rate commensurate
with the term of each contract. Our estimates of the timing of cash receipts and
payments are based on the anticipated timing of power delivered under these
agreements. These estimates also consider the minimum and maximum energy
delivery requirements under those agreements. Estimates of the future prices of
power are based on the forward pricing curve of the appropriate power delivery
and receipt points, and this curve is derived from the actual prices observed in
the market, price quotes from brokers and extrapolation models that rely on
actively, quoted prices and historical information.
As discussed above, our power purchase agreements were contributed to us by
our member and recorded initially at our member's cost of $299.1 million.
Immediately following the transfer, we paid Public Service Electric $64.0
million to amend the power purchase agreements and, among other things, enter
into one amended power purchase agreement. We also entered into the mirror power
purchase agreement with El Paso Merchant. Since these power purchase agreements
qualify as derivatives, our basis was adjusted from their carrying value to
their estimated fair value. We reflected the difference between the carrying
value of these agreements, and their estimated market value as the initial
market gain on power agreements of $228.2 million in our income statement. We
included this amount as other income since this initial market gain was
incidental to the operation and execution of our power purchase agreements. This
initial gain is comprised of the initial value of our amended power purchase
agreement of $262.8 million, less the initial market value of our mirror power
purchase agreement of $34.6 million. Following this initial valuation, changes
in the fair values of these purchase agreements, which were $2.3 million through
December 31, 2001, have been
F-8
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
reflected as a change in market value of power agreements in operating expenses.
These amounts are included in our operating income since changes in the value of
our power agreements result primarily from the execution of our power purchase
agreements. See Note 5 for additional information on the amended power purchase
and mirror power purchase agreements.
RECENT ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
Goodwill and Other Intangible Assets
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, Goodwill and Other Intangible Assets. This statement requires that
goodwill no longer be amortized but intermittently tested for impairment at
least on an annual basis. Other intangible assets are to be amortized over their
useful life and reviewed for impairment in accordance with the provisions of
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to be Disposed of. An intangible asset with an indefinite useful life can
no longer be amortized until its useful life becomes determinable. This
statement has various effective dates, the most significant of which is January
1, 2002. We do not believe the adoption of this standard on January 1, 2002 will
have a material effect on our financial statements.
4. LONG-TERM DEBT
In December 2001, we issued 9.875% Series A Senior Secured Bonds with an
aggregate principal amount of $431.4 million at a discount of $6.4 million. The
bonds mature on September 1, 2013, with principal and interest due semi-annually
on March 1 and September 1 beginning in September 2002. The effective interest
rate of our bonds at December 31, 2001 was 10.173%. The bonds are collateralized
by our assets.
We may choose to redeem the bonds, in whole or part, at any time, on not
less than 30 or more than 60 days notice to the bond holders at a redemption
price equal to the principal amount plus accrued and unpaid interest to the
redemption date, plus a make-whole premium, if any. The make-whole premium is
based on the rates of United States Treasury securities with average lives
comparable to the remaining lives of the applicable bonds, plus 50 basis points.
We will be required to pay an additional 1/2 percent interest on our bonds
if we do not complete an exchange of our current bonds for bonds to be
registered under the rules of the Securities and Exchange Commission within 270
days from their original issuance. El Paso is obligated under a funding
agreement entered into in December 2001 to contribute to us an amount equal to
the additional 1/2 percent interest on our bonds if, on the third business day
prior to any payment date, we do not have sufficient funds to pay the additional
interest due. This agreement terminates upon the consummation of the exchange of
our Series A bonds for bonds registered under the rules of the Securities and
Exchange Commission.
The following are aggregate maturities of the principal amounts of our
bonds for the next five years and thereafter:
<Table>
<Caption>
(IN THOUSANDS)
--------------
2002........................................................ $ 5,824
2003........................................................ 22,260
2004........................................................ 23,598
2005........................................................ 28,343
2006........................................................ 33,607
Thereafter.................................................. 317,775
--------
431,407
Bond discount............................................... (6,359)
--------
Total long-term debt, including current
maturities...................................... $425,048
========
</Table>
F-9
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
As required by our bond indenture, three separate cash accounts were
established from the proceeds of our bond issuance: a collections account, a
liquidity account and a damages and indemnity account. The collections account
was established to receive all payments that we are entitled to receive,
including revenues from energy and energy capacity sales to Public Service
Electric under the amended power purchase agreement. The liquidity account was
established to pay the interest and principal due on the bonds in the event
sufficient funds are not available in the collections account. The amounts we
are required to maintain in this liquidity account is the amount of cash
necessary to make a payment equal to the maximum amount of interest that will be
due on any single subsequent interest payment date. The damages and indemnity
account was established to receive all payments from El Paso Merchant under the
terms of the mirror power purchase agreement (see Note 5) and El Paso under the
terms of the El Paso performance guaranty relating to damages by us to Public
Service Electric. The balance in these accounts is reported as restricted cash
in our balance sheet.
Cash Distributions
Under our limited liability company agreement, cash distributions may be
made to our member semi-annually of all excess cash, provided that no event of
default has occurred, and the debt coverage ratio calculated as of that date for
the most recently ended six-month period equals or exceeds 1.03 to 1.00. For the
period ended December 31, 2001, we distributed $333.7 million to our member.
5. COMMITMENTS AND CONTINGENCIES
Amended Power Purchase Agreement
The amended power purchase agreement combines and supercedes two
pre-existing long-term power purchase agreements originally entered into with
Public Service Electric by Cogen Technologies NJ Venture, a New Jersey general
partnership, and Camden Cogen L.P., a Delaware limited partnership, two of our
affiliates. These pre-existing long-term power purchase agreements provided for
the purchase by Public Service Electric of energy and capacity from gas-fired,
combined-cycle cogeneration facilities located in Bayonne, New Jersey and
Camden, New Jersey. Through a series of transactions, the pre-existing power
purchase agreements were distributed to our member who in turn contributed them
to us. Upon the contribution of the power purchase agreements, we amended their
terms with Public Service Electric, which included a payment to them of $64.0
million by us. Under the amended power purchase agreement, we are required to
arrange for capacity to be made available to Public Service Electric.
Additionally, we will sell and deliver energy at fixed rates to Public Service
Electric at specified delivery points, the annual deliveries of which cannot
exceed thresholds varying from 1,501,825 MWh from 2002 to 2007, 1,447,524 MWh in
2008, 1,171,424 MWh from 2009 to 2012, and 205,400 MWh in 2013. We may deliver
energy at any point within the Pennsylvania-New Jersey-Maryland power system.
For the period ended December 31, 2001, we recorded electricity sales to Public
Service Electric of $7.0 million as operating revenues.
If we fail to deliver all or part of the scheduled energy or fail to
schedule sufficient deliveries to meet the minimum energy deliveries for reasons
other than a force majeure event or a system emergency, Public Service
Electric's payment to us will be reduced by a credit as specified in the amended
power purchase agreement. Generally the credit would equal the excess price
paid, if any, for energy by Public Service Electric over the price as stated in
our amended power purchase agreement.
If we fail to provide all or part of the required capacity for reasons
other than a force majeure event or a system emergency, Public Service Electric
must use reasonable efforts to purchase replacement capacity in the amount of
the shortfall. We must reimburse Public Service Electric for all costs
associated with the replacement capacity. If Public Service Electric is unable
to replace this capacity shortfall, Public Service Electric's payment to us will
be reduced by a credit as specified in the amended power purchase agreement.
F-10
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Generally, the credit would equal the excess of the average market marginal
hourly price, if any, over the price as stated in our amended power purchase
agreement for those hours in which the shortfall occurred.
Mirror Power Purchase Agreement
We entered into a mirror power purchase agreement with El Paso Merchant in
order to have El Paso Merchant (1) deliver to us the energy and capacity that we
are required to deliver to Public Service Electric under the amended power
purchase agreement, (2) pay to us the amounts that we would be required to pay
Public Service Electric in the event of our unexcused failure to deliver energy
or provide capacity under the amended power purchase agreement and (3) pay us
liquidated damages in the event El Paso Merchant fails to deliver (x) 42% of the
required energy deliveries by June 30 or (y) all of the required annual energy
deliveries by December 31.
Under the mirror power purchase agreement, El Paso Merchant must schedule
and deliver both the minimum hourly energy deliveries and the full amount of
energy deliveries that we are obligated to deliver under the amended power
purchase agreement during each year as we schedule deliveries to Public Service
Electric, and must make available to us capacity credits equal to the capacity
requirements under the amended power purchase agreement. If El Paso Merchant
fails to deliver all or part of the scheduled energy to us, for any reason other
than a force majeure event or a system emergency, our payment to El Paso
Merchant will be reduced by a credit calculated in the same manner as the credit
to Public Service Electric described in the amended power purchase agreement. El
Paso Merchant's performance under this agreement has been guaranteed by El Paso
under a performance guaranty (see Note 6).
If El Paso Merchant fails in any month to provide all or part of the
capacity, for any reason other than a force majeure event or a system emergency,
our payment to El Paso Merchant will be reduced by a credit calculated in the
same manner as the credit to Public Service Electric as a direct result of our
failure to provide capacity under the amended power purchase agreement.
6. RELATED PARTY TRANSACTIONS
Mirror Power Purchase Agreement
El Paso Merchant provides power and capacity to us under the mirror power
purchase agreement as discussed above. Expenses under this agreement are based
on market rates at the time the agreement was negotiated. Total purchases for
the period ended December 31, 2001 were $2.4 million and have been reflected as
electricity purchases from affiliate in our income statement. Amounts owed under
the contract are included in our affiliate payable on our balance sheet.
Administrative Services Agreement
In December 2001, we entered into an administrative services agreement with
El Paso Merchant to provide project management, finance and accounting services
to us for a fee of $100,000 per year through 2013. In addition to the base fee,
we are obligated to reimburse El Paso Merchant for certain direct expenses other
than project management, finance and accounting services that may be incurred on
our behalf. Fees and expenses under this agreement are due and payable only to
the extent that we have sufficient cash after paying obligations under our bond
indenture. Our administrative fee expense for the period ended December 31,
2001, was approximately $5,000 and was recorded as an affiliate payable on our
balance sheet.
See Note 5 for additional discussion on commitments with related parties.
F-11
CEDAR BRAKES II, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
El Paso Performance Guaranty
El Paso entered into a performance guaranty with us on December 12, 2001,
which expires on September 1, 2013. Under the performance guaranty, El Paso
guarantees to us the punctual performance of all of El Paso Merchant's
obligations under the mirror power purchase agreement and the administrative
services agreement.
7. CONCENTRATION OF CREDIT RISKS
Our cash and accounts receivable potentially subject us to credit risk.
Major financial institutions hold our cash accounts. Our trade receivables and
revenues are solely from a single customer, Public Service Electric, which
purchases electric energy and capacity from us under a long-term power purchase
agreement.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 2001, the carrying amounts of our financial instruments
including cash, cash equivalents, and trade receivables and payables are
representative of fair value because of their short-term maturity. The fair
value of our long-term debt was $432.0 million at December 31, 2001. The fair
value of our long-term debt has been estimated based on quoted market prices for
the same or similar issues.
F-12
CEDAR BRAKES II, L.L.C.
CONDENSED FINANCIAL STATEMENTS
AS OF MARCH 31, 2002 AND DECEMBER 31, 2001
AND FOR THE QUARTER ENDED MARCH 31, 2002
(UNAUDITED)
CEDAR BRAKES II, L.L.C.
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
QUARTER
ENDED
MARCH 31,
2002
---------
Operating revenues
Electricity sales......................................... $ 26,364
---------
Operating expenses
Electricity purchases from affiliate...................... 10,432
Change in market value of power purchase agreements,
net.................................................... 8,295
Administrative fees to affiliate.......................... 25
---------
18,752
---------
Operating income............................................ 7,612
---------
Other (income) expense
Interest income........................................... (108)
Interest and debt expense................................. 11,019
---------
10,911
---------
Net loss.................................................... $ (3,299)
=========
</Table>
See accompanying notes.
F-13
CEDAR BRAKES II, L.L.C.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2002 2001
----------- ------------
ASSETS
Current assets
Cash and cash equivalents................................. $ 18,625 $ --
Accounts receivable....................................... 8,249 7,019
Amended power purchase agreement.......................... 72,112 73,741
-------- --------
Total current assets.............................. 98,986 80,760
Amended power purchase agreement............................ 525,468 547,396
Restricted cash............................................. 21,365 21,034
Deferred financing costs, net............................... 6,102 6,204
-------- --------
Total assets...................................... $651,921 $655,394
======== ========
LIABILITIES AND MEMBER'S EQUITY
Current liabilities
Accounts payable -- affiliate............................. $ 6,637 $ 2,426
Accrued interest payable.................................. 12,899 2,249
Mirror power purchase agreement -- affiliate.............. 3,553 3,093
Current maturities of long-term debt...................... 18,335 5,824
-------- --------
Total current liabilities......................... 41,424 13,592
Mirror power purchase agreement -- affiliate................ 13,275 28,997
Long-term debt, less current maturities..................... 406,940 419,224
Commitments and contingencies
Member's equity............................................. 190,282 193,581
-------- --------
Total liabilities and member's equity............. $651,921 $655,394
======== ========
</Table>
See accompanying notes.
F-14
CEDAR BRAKES II, L.L.C.
CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
QUARTER
ENDED
MARCH 31,
2002
---------
Cash flows from operating activities
Net loss.................................................. $(3,299)
Adjustment to reconcile net loss to net cash from
operating activities:
Change in market value of power purchase agreements,
net................................................... 8,295
Amortization of bond discount.......................... 227
Amortization of deferred financing costs............... 102
Working capital changes:
Accounts receivable.................................. (1,230)
Accounts payable -- affiliate........................ 4,211
Accrued interest payable............................. 10,650
-------
Net cash provided by operating activities......... 18,956
-------
Cash flows from financing activities
Increase in restricted cash............................... (331)
-------
Net cash used in financing activities............. (331)
-------
Net change in cash and cash equivalents..................... 18,625
-------
Cash and cash equivalents
Beginning of period............................... --
End of period..................................... $18,625
=======
</Table>
See accompanying notes.
F-15
CEDAR BRAKES II, L.L.C.
NOTES TO THE CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
We are a single member Delaware limited liability company organized in May
2001, under the terms of a limited liability company agreement. We are a wholly
owned direct subsidiary of Mesquite Investors, L.L.C., an entity which is
indirectly owned by the Limestone Electron Trust and El Paso Corporation. El
Paso Chaparral Management, L.P., a wholly owned indirect subsidiary of El Paso
Corporation, manages the operations of Mesquite Investors, L.L.C. Our sole
business is to sell electric energy and provide electric capacity to Public
Service Electric and Gas Company, a New Jersey corporation, under an amended
power purchase agreement that we entered into with Public Service Electric. We
began operating under this amended power purchase agreement on December 13, 2001
when the Cogen Technologies NJ Venture, or Bayonne, power purchase agreement and
the Camden Cogen, L.P., or Camden, power purchase agreement were contributed to
us by our member.
Our December 31, 2001 audited financial statements, as presented in this
amendment to the registration statement on Form S-4, include a summary of our
significant accounting policies and other disclosures. You should read those
financial statements in conjunction with these unaudited interim financial
statements. The financial statements as of March 31, 2002, and for the quarter
ended March 31, 2002, are unaudited. The balance sheet as of December 31, 2001,
is derived from our audited financial statements. These financial statements
have been prepared pursuant to the rules and regulations of the United States
Securities and Exchange Commission and do not include all disclosures required
by accounting principles generally accepted in the United States. In our
opinion, we have made all adjustments, all of which are of a normal, recurring
nature, to fairly present our interim period results. Information for interim
periods may not necessarily indicate the results of operations for the entire
year due to the seasonal nature of our business.
Our accounting policies are consistent with those discussed in this
amendment to the registration statement on Form S-4, except as discussed below.
You should refer to our December 31, 2001 financial statements included in this
amendment to the registration statement on Form S-4 for a further discussion of
those policies.
Goodwill and Other Intangible Assets
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets. This statement requires that goodwill no longer be amortized
but intermittently tested for impairment at least on an annual basis. Other
intangible assets are to be amortized over their useful life and reviewed for
impairment in accordance with the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of. An
intangible asset with an indefinite useful life can no longer be amortized until
its useful life becomes determinable. This statement has various effective
dates, the most significant of which is January 1, 2002. The adoption of this
standard on January 1, 2002 did not have a material effect on our financial
statements.
2. COMMITMENTS AND CONTINGENCIES
Amended Power Purchase Agreement
The amended power purchase agreement combines and supercedes two
pre-existing long-term power purchase agreements originally entered into with
Public Service Electric by Cogen Technologies NJ Venture, a New Jersey general
partnership, and Camden Cogen L.P., a Delaware limited partnership, two of our
affiliates. These pre-existing long-term power purchase agreements provided for
the purchase by Public Service Electric of energy and capacity from gas-fired,
combined-cycle cogeneration facilities located in Bayonne, New Jersey and
Camden, New Jersey. Through a series of transactions, the pre-existing power
F-16
CEDAR BRAKES II, L.L.C.
NOTES TO THE CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
purchase agreements were distributed to our member who in turn contributed them
to us. Upon the contribution of the power purchase agreements, we amended their
terms with Public Service Electric, which included a payment to them of $64.0
million by us. Under the amended power purchase agreement, we are required to
arrange for capacity to be made available to Public Service Electric.
Additionally, we will sell and deliver energy at fixed rates to Public Service
Electric at specified delivery points, the annual deliveries of which cannot
exceed thresholds varying from 1,501,825 MWh from 2002 to 2007, 1,447,524 MWh in
2008, 1,171,424 MWh from 2009 to 2012, and 205,400 MWh in 2013. We may deliver
energy at any point within the Pennsylvania-New Jersey-Maryland power system.
For the quarter ended March 31, 2002, we recorded electricity sales to Public
Service Electric of $26.4 million as operating revenues.
If we fail to deliver all or part of the scheduled energy or fail to
schedule sufficient deliveries to meet the minimum energy deliveries for reasons
other than a force majeure event or a system emergency, Public Service
Electric's payment to us will be reduced by a credit as specified in the amended
power purchase agreement. Generally the credit would equal the excess price
paid, if any, for energy by Public Service Electric over the price as stated in
our amended power purchase agreement. No credits were applied during the quarter
ended March 31, 2002.
If we fail to provide all or part of the required capacity for reasons
other than a force majeure event or a system emergency, Public Service Electric
must use reasonable efforts to purchase replacement capacity in the amount of
the shortfall. We must reimburse Public Service Electric for all costs
associated with the replacement capacity. If Public Service Electric is unable
to replace this capacity shortfall, Public Service Electric's payment to us will
be reduced by a credit as specified in the amended power purchase agreement.
Generally, the credit would equal the excess of the average market marginal
hourly price, if any, over the price as stated in our amended power purchase
agreement for those hours in which the shortfall occurred. No credits were
applied during the quarter ended March 31, 2002.
Mirror Power Purchase Agreement
We entered into a mirror power purchase agreement with El Paso Merchant in
order to have El Paso Merchant (1) deliver to us the energy and capacity that we
are required to deliver to Public Service Electric under the amended power
purchase agreement, (2) pay to us the amounts that we would be required to pay
Public Service Electric in the event of our unexcused failure to deliver energy
or provide capacity under the amended power purchase agreement and (3) pay us
liquidated damages in the event El Paso Merchant fails to deliver (x) 42% of the
required energy deliveries by June 30 or (y) all of the required annual energy
deliveries by December 31.
Under the mirror power purchase agreement, El Paso Merchant must schedule
and deliver both the minimum hourly energy deliveries and the full amount of
energy deliveries that we are obligated to deliver under the amended power
purchase agreement during each year as we schedule deliveries to Public Service
Electric, and must make available to us capacity credits equal to the capacity
requirements under the amended power purchase agreement. If El Paso Merchant
fails to deliver all or part of the scheduled energy to us, for any reason other
than a force majeure event or a system emergency, our payment to El Paso
Merchant will be reduced by a credit calculated in the same manner as the credit
to Public Service Electric described in the amended power purchase agreement. No
credits have been taken during the quarter ended March 31, 2002. El Paso
Merchant's performance under this agreement has been guaranteed by El Paso under
a performance guaranty (see Note 3).
If El Paso Merchant fails in any month to provide all or part of the
capacity, for any reason other than a force majeure event or a system emergency,
our payment to El Paso Merchant will be reduced by a credit calculated in the
same manner as the credit to Public Service Electric as a direct result of our
failure to
F-17
CEDAR BRAKES II, L.L.C.
NOTES TO THE CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
provide capacity under the amended power purchase agreement. No credits have
been taken during the quarter ended March 31, 2002.
3. RELATED PARTY TRANSACTIONS
Mirror Power Purchase Agreement
El Paso Merchant provides energy and capacity to us under the mirror power
purchase agreement as discussed above. Expenses under this agreement are based
on market rates at the time the agreement was negotiated. Total purchases for
the quarter ended March 31, 2002 were $10.4 million and have been reflected as
electricity purchases from affiliate in our statement of operations. Amounts
owed under the agreement are included in our affiliate payable on our balance
sheets.
Administrative Services Agreement
We entered into an administrative services agreement with El Paso Merchant
to provide project management, finance and accounting services to us for a fee
of $100,000 per year through 2013. In addition to the base fee, we are obligated
to reimburse El Paso Merchant for direct expenses other than project management,
finance and accounting services that may be incurred on our behalf. Fees and
expenses under this agreement are due and payable only to the extent that we
have sufficient cash after paying obligations under our bond indenture. Our
administrative fee expense for the quarter ended March 31, 2002, was
approximately $25,000 and was recorded as an affiliate payable on our balance
sheet.
See Note 2 for additional discussion on commitments with related parties.
El Paso Corporation Performance Guaranty
El Paso Corporation entered into a performance guaranty with us on December
12, 2001, which expires on September 1, 2013. Under the performance guaranty, El
Paso guarantees to us the punctual performance of all of El Paso Merchant's
obligations under the mirror power purchase agreement and the administrative
services agreement.
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of March 31, 2002 and December 31, 2001, the carrying amounts of our
financial instruments including cash, cash equivalents, and trade receivables
and payables are representative of fair value because of their short-term
nature. The fair value of our long-term debt was $434.0 million at March 31,
2002 and $432.0 million at December 31, 2001. The fair value of our long-term
debt has been estimated based on quoted market prices for the same or similar
issues.
5. SUBSEQUENT EVENTS
In June 2002, Standard and Poor's downgraded our bonds from BBB to BBB-.
The downgrade of our bonds was a result of Standard and Poor's change in Public
Service Electric's, our only customer, unsecured credit rating from BBB+ to BBB-
in May 2002. The downgrade in Public Service Electric's credit rating did not
have a significant impact on the fair value of our amended power purchase
agreement.
The bond indenture allows us to issue additional bonds so long as, among
other things, the initial bonds, as well as the additional bonds, achieve the
initial credit ratings at the closing of the initial bonds, which were Baa2 by
Moody's, BBB by Standard and Poor's and BBB by Fitch. Therefore, we will be
unable to issue additional debt until Standard and Poor's upgrades the rating of
our bonds to at least BBB and the other ratings agencies at least maintain their
current ratings of our bonds.
F-18
(PACE LOGO -- Global Energy Services)
CEDAR BRAKES II, L.L.C.
MIRROR POWER PURCHASE AGREEMENT ASSESSMENT
PREPARED FOR:
MESQUITE INVESTORS, LLC
December 7, 2001
Legal Notice
This Report was produced by Pace Global Energy Services, LLC ("Pace") and is
meant to be read as a whole and in conjunction with this disclaimer. Any use of
this Report other than as a whole and in conjunction with this disclaimer is
forbidden. Any use of this Report outside of its stated purpose without the
prior written consent of Pace is forbidden. Except for its stated purpose, this
Report may not be copied or distributed in whole or in part without Pace's prior
written consent.
This Report and the information and statements herein are based in whole or in
part on information obtained from various sources as of December 7, 2001. While
Pace believes such information to be accurate, it makes no assurances,
endorsements or warranties, express or implied, as to the validity, accuracy or
completeness of any such information, any conclusions based thereon, or any
methods disclosed in this Report. Pace assumes no responsibility for the results
of any actions taken on the basis of this Report. By a party using, acting or
relying on this Report, such party consents and agrees that Pace, its employees,
directors, officers, contractors, advisors, members, affiliates, successors and
agents shall have no liability with respect to such use, actions or reliance.
This Report does contain some forward-looking opinions. Certain unanticipated
factors could cause actual results to differ from the opinions contained herein.
Forward-looking opinions are based on historical and/or current information that
relate to future operations, strategies, financial results or other
developments. Some of the unanticipated factors, among others, that could cause
the actual results to differ include regulatory developments, technological
changes, competitive conditions, new products, general economic conditions,
changes in tax laws, adequacy of reserves, credit and other risks associated
with Cedar Brakes II, L.L.C. and/or other third parties, significant changes in
interest rates and fluctuations in foreign currency exchange rates.
Further, certain statements, findings and conclusions in this Report are based
on Pace's interpretations of various contracts. Interpretations of these
contracts by legal counsel or a jurisdictional body could differ.
(LOGO)
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<Table>
Executive Summary........................................... 1
Transaction Summary...................................... 1
Scope of Work............................................ 1
Summary of option value Analysis......................... 2
Findings and Conclusions................................. 2
Transaction Overview........................................ 5
Transaction Overview..................................... 5
Capacity and Energy Delivery Requirements................ 6
Historical Perspective on the East PJM Power Market......... 8
Volumetric Decision Process................................. 11
East PJM Historical Test................................. 11
Option Value Analysis....................................... 13
Introduction............................................. 13
Methodology.............................................. 13
Option Value Analysis.................................... 14
East PJM Market Price Forecast.............................. 16
Market Clearing Price Forecast Approach.................. 16
Approach................................................. 16
Simulated Base Case Market Price Forecast For East PJM... 18
CEMAS Simulated Market Prices............................ 18
Average System Annual Time of Day Prices................. 18
Wholesale Market Transactions............................ 19
Existing Demand Profile.................................. 20
Base Case Assumptions.................................... 22
Regional Market Definition and Transmission
Interchange.......................................... 22
Regional Demand Forecast.............................. 24
Pace's Independent Load Forecasting Methodology....... 24
Energy Demand Forecast Results........................ 26
Fuel Pricing.......................................... 32
Natural Gas........................................... 33
Commodity Prices...................................... 33
Regional Basis........................................ 34
Fuel Oil.............................................. 37
Coal.................................................. 41
Uranium............................................... 51
Existing Generating Capacity Profiles................. 51
Expansion Generating Capacity......................... 53
</Table>
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL i
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
EXHIBITS
- --------------------------------------------------------------------------------
<Table>
Exhibit 1: Summary of Energy-Only Power Prices ($/ MWh) for the Mirror
PPA, Pace's Market Price Forecast, Pace's Adjusted Market
Price and Pace's Realized Market Price...................... 4
Exhibit 2: Summary of the Cedar Brakes Transaction..................... 6
Exhibit 3: PSE&G Contracted Annual Energy Delivery Requirements in
MWh......................................................... 7
Exhibit 4: Average All-Hour Energy-Only Prices for the East PJM Market
for June 1, 2000 through May 31, 2001....................... 8
Exhibit 5: Average All-Hour Energy-Only Power Price and its Standard
Deviation as a Function of the Total Available Days Per Year
in the East PJM Market...................................... 9
Exhibit 6: Hourly Price Distribution in the East PJM Market for June 1,
2000 through May 31, 2001................................... 10
Exhibit 7: Pace's Projected Monthly Supply Schedule Based on Volumetric
Decision Rule............................................... 11
Exhibit 8: Summary of Volumetric Decision Rule Using East PJM
Historical Test............................................. 12
Exhibit 9: Relationship of Contract Price to Market Price*............. 14
Exhibit 10: Summary of Energy-Only Power Prices ($/ MWh) for the Mirror
PPA, Pace's Market Price Forecast, Pace's Adjusted Market
Price and Pace's Realized Market Price...................... 15
Exhibit 11: Pace CEMAS Methodology...................................... 17
Exhibit 12: PJM Northeast Annual System Time of Day Prices - Base Case
(1998 $/MWh)................................................ 19
Exhibit 13: Power Marketers Volumes Traded in PJM in 1998 and 1999...... 20
Exhibit 14: PJM Demand and Energy Requirements Forecast................. 21
Exhibit 15: PJM Market Demand and Reserve Margin Forecast- Summer....... 21
Exhibit 16: PJM Market Demand and Reserve Margin Forecast- Winter....... 22
Exhibit 17: PJM Sub-Regional Designations............................... 23
Exhibit 18: Assumed PJM Market Area Transmission Constraints............ 24
Exhibit 19: Historic Inter-Regional Transactions........................ 24
Exhibit 20: Pace Load Forecasting Methodology........................... 25
Exhibit 21: Pace Aggregated Energy Demand Forecast (PJM)................ 27
Exhibit 22: Pace PJM Demand Forecast.................................... 28
Exhibit 23: Pace's Sub-Regional Energy Forecast for PJM................. 30
Exhibit 24: Pace Sub-Regional Peak Demand Forecast for PJM - MW......... 31
Exhibit 25: Monthly Fuel Price Adjustment Factors....................... 32
Exhibit 26: Pace Gas Price PJM Subregions............................... 35
Exhibit 27: PJM Natural Gas Price Forecasts (1998 $/MMBtu).............. 36
Exhibit 28: WTI Crude Oil Price Forecast (1998 $/MMBtu)................. 39
Exhibit 29: Pace Oil Price Sub-Regions for PJM.......................... 40
Exhibit 30: PJM Fuel Oil Location Basis (1998 $/MMBtu).................. 40
Exhibit 31: Crude Oil to Refined Product Crack Spreads (1998 $/MMBtu)... 41
Exhibit 32: Fuel Oil Price Forecast by PJM Sub-region (1998 $/MMBtu).... 41
Exhibit 33: PJM Historical Weighted Average & Forecasted FOB Coal Prices
(1998$/MMBtu)............................................... 43
Exhibit 34: Pace FOB Coal Price Forecast for Coal Consumed in PJM
(1998$/MMBtu)............................................... 44
Exhibit 35: Real Transportation Escalation Rates by Mode................ 45
Exhibit 36: PJM Coal Consumption, 1991-2000............................. 46
Exhibit 37: Annual U.S. Coal Supply-Demand Balance...................... 47
Exhibit 38: U.S. Coal Mining Productivity, 1949-1999.................... 48
Exhibit 39: Historical and Projected U.S. Coal Production,
1995 - 2020................................................. 49
Exhibit 40: PJM Nuclear Units........................................... 52
Exhibit 41: PJM Announced Power Projects Included in the Base Case
(MW)........................................................ 53
Exhibit 42: Expansion Unit Characteristics.............................. 54
Exhibit 43: Regional Cost Adjustments................................... 55
</Table>
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL ii
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
EXECUTIVE SUMMARY
- --------------------------------------------------------------------------------
TRANSACTION SUMMARY
Cedar Brakes II, L.L.C. ("Cedar Brakes"), a subsidiary of Mesquite Investors,
L.L.C. ("Mesquite") has entered into an Amended and Restated Power Purchase
Agreement ("Amended Agreement"), dated as of May 23, 2001, with Public Service
Electric and Gas Company of Newark, New Jersey ("PSE&G"), which resulted from a
restructuring of two separate power purchase agreements ("Original PPAs")
between Camden Cogen L.P. ("Camden") and PSE&G and between Cogen Technologies NJ
Venture ("Bayonne") and PSE&G or collectively the Facilities (the "Facilities").
The Amended Agreement, among other things, provides savings to PSE&G in the form
of an upfront payment to PSE&G and provides Cedar Brakes with the flexibility to
meet its energy and capacity delivery obligations to PSE&G from numerous
reliable sources within the Pennsylvania-New Jersey-Maryland ("PJM") power
market.
In order to meet the power supply obligations to PSE&G under the Amended
Agreement, Cedar Brakes entered into a Power Purchase Agreements (the "Mirror
PPA") with El Paso Merchant Energy, L.P. ("EPM"), a wholly-owned subsidiary of
the El Paso Corporation ("EPC"), for the purchase of an equal amount of capacity
and energy as it is obligated to supply under the Amended Agreement, thereby
transferring its energy supply obligations under the Amended Agreement to EPM.
Aside from energy rates, the terms of the Mirror PPA largely mirror those of the
Amended Agreement, thus providing EPM with the flexibility to supply energy and
capacity from numerous sources within the PJM power market for delivery to Cedar
Brakes, and from Cedar Brakes to PSE&G. This flexibility in both the source and
timing of energy delivery creates some option value to EPM. As such, the
effective energy rates in the Mirror PPA, which reflect the deregulated
wholesale marketplace, are lower than the energy rates in the Amended Agreement.
The price differential represents the net revenue stream that will be
securitized in the pending bond offering by Cedar Brakes.
SCOPE OF WORK
Pace Global Energy Services, LLC ("Pace"), an independent energy-consulting
firm, was retained to review the PJM power market and certain provisions of the
Mirror PPA. Specifically, Pace was asked to provide an opinion as to whether (1)
the "energy-only" price schedule under the Mirror PPA reasonably reflects market
pricing in the East PJM power market, adjusted for the energy delivery
flexibility ("option value") that EPM has under the Mirror PPA, and whether (2)
the capacity resources within the East PJM power market are sufficient to ensure
that EPM can meet its contractual obligations under the
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 1
(PACE LOGO -- Global Energy Services)
Mirror PPA(1). Pace's opinions assume that there will be no significant changes
to the East PJM power market with respect to the energy and capacity bidding
processes, the current cap on bid prices and the market structure. Further, the
analysis assumes there are no adverse effects from EPM's other energy trading
activities affecting its ability to perform under the Mirror PPA with Cedar
Brakes.
SUMMARY OF OPTION VALUE ANALYSIS
In order to determine whether the "energy-only" contract prices contained in the
Mirror PPA are reasonable as compared to market prices for energy in the East
PJM, in conjunction with forecasting the East PJM "energy-only" market clearing
prices over the term of the Mirror PPA, Pace has performed an option value
analysis in order to project the anticipated flexibility value embedded in the
Mirror PPA, which would allow EPM to fulfill its obligations under the Mirror
PPA, and in turn, would allow Cedar Brakes to provide power at a lower projected
cost of power supply than contained in the Amended Agreement. The option value
analysis quantifies the market priced put option premiums, whose value is
embedded within the Mirror PPA, associated with a power marketer's reasonable
ability to secure power at prices below the expected price levels. The primary
drivers of such option value include the implied market volatility for power
options traded in the East PJM market and the projected level of market price
relative to the Mirror PPA's price schedule. The potential for downward price
movements in the market allows a power marketer to extract volatility value by
selectively selling (i.e., "putting") energy to the contract at prices below
forecasted market levels. This "price-drop" value has been calculated by
quantifying the monthly put option premium in the East PJM market, relying on a
combination of historical spot and forward price series, adjusted for Pace's
expected path of price volatility and basis risk among adjacent markets.
FINDINGS AND CONCLUSIONS
Certain statements in this Executive Summary are forward-looking and are based
on current assumptions and forecasts, and consequently involve risks and
uncertainties. Accordingly, EPM's actual results could differ materially from
the expectations expressed in the forward-looking statements. While Pace
believes, based on its present knowledge and expertise as of the date of this
Executive Summary, that the assumptions and forecasts relied upon in this
Executive Summary are reasonable, given the uncertainties of energy pricing,
investors' review should include consideration of alternate assumptions and
forecasts.
- ------------------------------------
(1) This Report and the information and statements herein are based in whole or
in part on information obtained from various sources as of December 7, 2001.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 2
(PACE LOGO -- Global Energy Services)
Pace has analyzed the East PJM power market as well as the Mirror PPA contract
prices provided by EPM in conjunction with the analyses described above. Our
analysis focused on whether the contract prices provided by EPM are reasonable
in light of the current market structure, future expectations for the East PJM
power market and the energy delivery flexibility contained in the Mirror PPA.
With respect to the East PJM power market review and the Mirror PPA contract
prices provided by EPM, Pace makes the following observations and conclusions:
1. The PJM power market, including the East PJM region, is a competitive
wholesale energy market and facilitates open access to transmission. PJM
is the largest and most sophisticated, centrally dispatched electric
control area in North America with members from every segment of the
U.S. electric power industry. The PJM market has become one of the most
liquid and active energy markets in the country and the world since its
inception on January 1998.
2. As of 2001, there were 60,300 MW of existing generating capacity present
in the PJM power market. The contract capacity specified in the Mirror
PPA is 189 MW through October 31, 2008 and, thereafter, is reduced to
149 MW through March 5, 2013, representing approximately 0.28% and 0.2%,
respectively, of the total existing capacity in the PJM power market.
The low market share coupled with a well-developed and highly reliable
electrical transmission system, capable of transferring high quantities
of power between generators/sellers and buyers, will allow EPM to access
numerous power purchasers and sellers for capacity and energy sales and
purchases. EPM will therefore have many options to fulfill its on-peak
and off-peak obligations under the Mirror PPA in order to minimize the
cost of energy. There may be times when the PJM electric transmission
system may experience disruptions due to system component failures or
act-of-god events. However, these events are highly unlikely to affect
EPM's overall ability to fulfill its on-peak and off-peak obligations
under the Mirror PPA, given the design and overall size of the PJM
electric transmission system, as well as the makeup energy provisions in
the Mirror PPA.
3. Incremental capacity is needed in the region to match energy demand
growth, which is estimated to increase at an average rate of 1.55% per
year over the term of the 12-year Mirror PPA, based on PJM power market
forecasts and similar power market forecasts conducted by Pace.
4. Camden and Bayonne will enter into agreements with EPM, specifically,
the Camden Capacity Supply Agreement and the Bayonne Capacity Supply
Agreement, upon the effectiveness of the Amended Agreement, which will
transfer the capacity credits associated with the Facilities from the
Facilities to EPM for the sole purpose of fulfilling EPM's capacity
credit obligation under the Mirror PPA.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 3
(PACE LOGO -- Global Energy Services)
5. The Amended Agreement specifies minimum contract quantities that Cedar
Brakes must supply to PSE&G for summer peak, non-summer peak, summer
off-peak, and non-summer off-peak periods, and a maximum annual quantity
that can be supplied. This contract flexibility is passed through to EPM
via the Mirror PPA with Cedar Brakes. The Mirror PPA structure grants
the supplier certain volume flexibility to supply more energy in hours
when the prices are expected to be relatively low. This volume
flexibility will enable EPM to deliver energy at lower prices against
the Amended Agreement than the market average, given that the low price
hours are effectively selected to put against the Mirror PPA.
6. Based upon Pace's analysis of the East PJM power market and a review of
the relevant portions of the Cedar Brakes transaction documents that
have been provided to Pace by Mesquite as of October 12, 2001, we
believe that the contract rates stipulated in the Mirror PPA reasonably
reflect market prices for the East PJM power market, adjusted for the
option value that EPM has under the Mirror PPA, as shown in Exhibit 1 as
"Pace's Realized Market Price". Moreover, we believe that the PJM power
market offers sufficient power resources to enable EPM to meet its
contractual supply obligations under the Mirror PPA.
EXHIBIT 1: SUMMARY OF ENERGY-ONLY POWER PRICES ($/ MWH) FOR THE MIRROR PPA,
PACE'S MARKET PRICE FORECAST, PACE'S ADJUSTED MARKET PRICE AND PACE'S REALIZED
MARKET PRICE
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ---------------------------------------------------------------------------------------
MIRROR PPA PACE'S MARKET PACE'S ADJUSTED PACE'S REALIZED
YEAR PRICE PRICE FORECAST MARKET PRICE(2) MARKET PRICE(3)
- ---------------------------------------------------------------------------------------
2001(1) 32.00 23.89 25.21 24.22
2002 32.00 28.90 30.36 28.87
2003 32.00 24.75 26.34 24.98
2004 32.00 25.52 27.18 25.83
2005 32.00 26.82 28.49 27.11
2006 32.00 27.92 29.53 28.15
2007 32.00 29.73 31.48 30.07
2008 32.00 30.05 31.82 30.38
2009 32.00 31.41 33.27 31.80
2010 32.00 32.50 34.31 32.81
2011 32.00 32.86 34.71 33.16
2012 32.00 34.22 36.06 34.47
2013(1) 32.00 40.18 43.51 41.61
- ---------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
(1) When appropriate, the prices have been adjusted to reflect the
effects of the partial year.
(2) Reflects the sum of negative adjustments for volume flexibility,
netted against positive adjustments for liquidity and basis risk
in forward transactions.
(3) Reflects the negative adjustment for option value associated with
selling put options at the contract price level relative to the
adjusted market price level.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 4
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
TRANSACTION OVERVIEW
- --------------------------------------------------------------------------------
TRANSACTION OVERVIEW
Cedar Brakes has entered into an Amended Agreement with PSE&G on May 23, 2001,
which resulted from a restructuring of two separate power purchase agreements,
the Original PPAs, between Camden and Bayonne and PSE&G. The Amended Agreement
provides savings to PSE&G in the form of an upfront payment to PSE&G and
provides Cedar Brakes with the flexibility to meet its energy and capacity
delivery obligations to PSE&G from any reliable source within the PJM power
market.
Exhibit 2 provides a summary of the Cedar Brakes transaction. The proceeds of
the bond offering will be used to 1) make a payment to PSE&G in the amount of
$64 million pursuant to the terms of the Amended Agreement, 2) fund the
liquidity and collection accounts, 3) pay transaction costs, and 4) make a
distribution of the remaining proceeds to Mesquite. The contract prices under
the Mirror PPA and the Amended Agreement allow Cedar Brakes to realize a spread
on its energy sales in order to service the debt. As depicted, Cedar Brakes
supplies the energy and capacity requirements, as stipulated in the Amended
Agreement, in return for energy and capacity payments from PSE&G. The interest
and principal on the bonds will be paid solely from capacity and energy payments
from PSE&G (as supplemented, under certain circumstances, by funds in a
liquidity account). The scheduled payments of principal and interest on the
bonds have been calculated based on the net annual capacity and energy revenues,
net of the costs of capacity and energy purchased from EPM under the Mirror PPA.
In order to meet its obligations under the Amended Agreement, Cedar Brakes
entered into the Mirror PPA with EPM. Aside from energy rates, the terms of the
Mirror PPA largely mirror those of the Amended Agreement, thus providing EPM
with the flexibility to supply energy and capacity from numerous sources within
the PJM power market for delivery to Cedar Brakes, and from Cedar Brakes to
PSE&G. Under the Mirror PPA, EPM will supply the capacity and energy required by
Cedar Brakes to meet its energy delivery obligations under the Amended
Agreement. The Mirror PPA also provides payment of liquidated damages and
indemnification of Cedar Brakes in the event of failure to meet the capacity and
energy delivery requirements. Cedar Brakes has also entered into an
administrative services agreement ("Administrative Agreement") with EPM pursuant
to which EPM carries out all of Cedar Brakes administrative affairs and
contractual obligations, including those under the Amended Agreement. Lastly,
EPC has provided an unconditional guarantee of all payment and performance
obligations of EPM under the Mirror PPA and Administrative Agreement.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 5
(PACE LOGO -- Global Energy Services)
EXHIBIT 2: SUMMARY OF THE CEDAR BRAKES TRANSACTION
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 2)
CAPACITY AND ENERGY DELIVERY REQUIREMENTS
Presented below are the terms and conditions of the Mirror PPA that were
relevant to Pace's analysis:
a) The Mirror PPA becomes effective on the later of (i) the last date upon
which certain conditions precedent are satisfied or waived and (ii)
November 1, 2001, and remains in effect through and including March 5,
2013 unless terminated earlier as provided in the Mirror PPA.
b) EPM has the option to supply Cedar Brakes' capacity and energy
requirements from any source in the PJM market.
c) EPM is required to take all necessary steps for PSE&G to receive at
least 189 MW per day of capacity credits within the PJM Installed
Capacity market ("ICAP") through October 31, 2008 and at least 149 MW
per day thereafter through contract expiration. EPM may utilize PJM's
"eCapacity" mechanism, throughout the term of the Mirror PPA to meet
this obligation. Based upon Mesquite's representation, Camden and
Bayonne will enter into agreements with EPM, specifically, the Camden
Capacity Supply Agreement and the Bayonne Capacity Supply Agreement,
upon the effectiveness of the Amended Agreement, which will transfer the
capacity credits associated with the Facilities from the Facilities to
EPM, for the sole purpose of fulfilling EPM's capacity credit obligation
under the Mirror PPA.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 6
(PACE LOGO -- Global Energy Services)
EXHIBIT 3: PSE&G CONTRACTED ANNUAL ENERGY DELIVERY REQUIREMENTS IN MWH
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------
ANNUAL
YEAR ENERGY DELIVERIES
- --------------------------------------------------
2001 485,522(1)
2002 1,501,825
2003 1,501,825
2004 1,501,825
2005 1,501,825
2006 1,501,825
2007 1,501,825
2008 1,447,524
2009 1,171,424
2010 1,171,424
2011 1,171,424
2012 1,171,424
2013 205,400
- --------------------------------------------------
</Table>
(1) Prorated from September 5 to actual effective date.
- --------------------------------------------------------------------------------
d) EPM may deliver energy at a rate of up to 200 MWh per hour until and
including October 31, 2008 and 156 MWh per hour thereafter, unless EPM
is also scheduling "make-up energy", in which case EPM may deliver up to
250 MWh per hour until and including October 31, 2008, and 195 MWh per
hour thereafter through the expiration date of the Mirror PPA.
e) EPM must schedule and deliver energy at the same rate during all on-peak
hours in any day and at the same rate during off-peak hours in any day.
However, the delivery rate for on-peak hours in a given day may differ
from the delivery rate for off-peak hours in the same day and the
delivery rate for on-peak and off-peak hours may vary from day to day.
f) During the on-peak hours of the summer period of June, July, August and
September, EPM must deliver to Cedar Brakes a quantity of energy
equivalent to at least 185 MWh through October 31, 2008 and a quantity
of energy equivalent to 144 MWh per hour for on-peak hours, thereafter
through expiration. For the remaining eight months of the year, EPM must
deliver an aggregate of 460,445 MWh during on-peak hours through October
31, 2008 and 359,147 MWh during the non-summer on-peak hours, thereafter
through the expiration date of the Mirror PPA.
g) EPM must deliver certain aggregate energy quantities during the year, as
noted in Exhibit 3.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 7
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
HISTORICAL PERSPECTIVE ON THE EAST PJM POWER MARKET
- --------------------------------------------------------------------------------
Exhibit 4 illustrates the East PJM market price volatility associated with daily
all-hour energy-only power prices for the period June 1, 2000 through May 31,
2001. In general, the summer months possess the greatest price volatility. This
is apparent from the level of summer price spikes as compared to the annual
average energy-only power price.
EXHIBIT 4: AVERAGE ALL-HOUR ENERGY-ONLY PRICES FOR THE EAST PJM MARKET FOR
JUNE 1, 2000 THROUGH MAY 31, 2001
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 4)
- --------------------------------------------------------------------------------
Exhibit 5 illustrates for the period June 1, 2000 through May 31, 2001 the
average annual all-hour energy-only power price and its standard deviation as a
function of the total number of the highest priced days per year included in the
calculation. The X-axis measures the number of days included as a percentage of
the total number of days per year. One hundred percent represents the average
based on 365 days and 80% represents 292 days and so on. The Y-axis measures the
average daily energy-only power prices in dollars per MWh.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 8
(PACE LOGO -- Global Energy Services)
EXHIBIT 5: AVERAGE ALL-HOUR ENERGY-ONLY POWER PRICE AND ITS STANDARD
DEVIATION AS A FUNCTION OF THE TOTAL AVAILABLE DAYS PER YEAR IN THE EAST PJM
MARKET
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 5)
- --------------------------------------------------------------------------------
Based on this analysis, Pace found that on average, market prices were below
$32/MWh in about 58% of the days of a year. For these days, the associated
standard deviation is reduced to $11.77/MWh versus $25.87/MWh for the full
period. Additionally, as shown in Exhibit 6, Pace has analyzed the hourly price
distribution in the East PJM market in order to characterize the possibility of
the market price falling below the $32/MWh Mirror PPA contract price at
different times of the day.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 9
(PACE LOGO -- Global Energy Services)
EXHIBIT 6: HOURLY PRICE DISTRIBUTION IN THE EAST PJM MARKET FOR JUNE 1,
2000 THROUGH MAY 31, 2001
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 6)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 10
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
VOLUMETRIC DECISION PROCESS
- --------------------------------------------------------------------------------
In order to ensure that EPM will meet the contracted annual quantity under the
Mirror PPA and realize the lowest contract supply price possible, EPM, acting in
a prudent manner, would first calculate its monthly supply requirements based on
the expected regional power market's monthly seasonal price patterns. Then EPM
would identify the lowest priced on and off-peak periods to meet the monthly
volume target, or simply hedge these periods by entering into monthly forward
purchase contracts. This process produces peak and off-peak quantities that
fulfill the terms of the Mirror PPA. The realized prices from this methodology
would not be the lowest possible prices, but, EPM would not be exposed to the
liquidated damages provisions contained in the Mirror PPA. In addition, the
monthly volume is readily met, and the use of a monthly volumetric decision rule
enables standard contract commitments to be entered, thereby supporting trading
value enhancement. Moreover, as the supply source is the market, i.e., no
underlying power plant, forced outages do not factor into the volumetric
decision. Based on East PJM market price forecast and the terms of the Mirror
PPA, Pace produced a monthly market supply schedule as shown below in Exhibit 7.
EXHIBIT 7: PACE'S PROJECTED MONTHLY SUPPLY SCHEDULE BASED ON VOLUMETRIC
DECISION RULE
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ----------------------------------------------------------------------------
MONTH JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC
- ----------------------------------------------------------------------------
GWH 114 114 124 112 121 135 139 139 136 124 126 117
- ----------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
EAST PJM HISTORICAL TEST
Pace tested the above volumetric process on the East PJM hourly clearing prices
for three 365-day periods within June 1, 1999 to May 31, 2001. Pace determined
the all-hour average procurement cost of the power in the East PJM region that
would have resulted from this volumetric decision process. We used the monthly
supply schedule shown in Exhibit 7 on all the tested periods, and then
identified the lowest priced periods in that month to meet the contracted
minimum dispatch and scheduled monthly volume. Such a strategy assumes that EPM
operates completely in the day-ahead market, and has reasonable short-term power
price forecasting capability. Since we utilize a "day-ahead" price series to
simulate this volumetric strategy, EPM would require a reasonable understating
of daily versus monthly average prices in order to effectively allocate its
supply to the Mirror PPA among the on and off-peak periods in a given month.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 11
(PACE LOGO -- Global Energy Services)
Based on historical data, it is reasonable to expect that the distribution of on
and off-peak prices will afford EPM opportunities to lower its total cost of
energy deliveries under the Mirror PPA by selectively choosing these periods for
delivery. The amount of delivery flexibility in the Mirror PPA is the highest in
the off-peak and non-summer peak periods, during which time EPM needs to supply
50 MWh per hour through October 31, 2008 and 39 MWh per hour thereafter through
contract expiration. During the on-peak hours of the summer period, EPM must
deliver a quantity of energy equivalent to at least 185 MWh per hour through
October 31, 2008 and a quantity of energy equivalent to 149 MWh per hour for
these hours thereafter through expiration.
Pace calculated the total cost of energy deliveries in East PJM that EPM could
have realized if it had the full benefit of hindsight ("20/20 hindsight") and
handpicked the lowest priced on and off-peak periods during the test years for
minimizing the cost of delivery under the Mirror PPA. The results are provided
in Exhibit 8.
EXHIBIT 8: SUMMARY OF VOLUMETRIC DECISION RULE USING EAST PJM HISTORICAL
TEST
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<Table>
<Caption>
VOLUMETRIC RULE 20/20 HINDSIGHT
PROCUREMENT COST PROCUREMENT COST
TEST PERIOD (AVERAGE $/MWH) (AVERAGE $/MWH)
- --------------------------------------------------------------------------------------------------------
06/01/1999-05/31/2000 28.86 28.82
01/01/2000-12/31/2000 27.13 26.73
06/01/2000-05/31/2001 30.44 30.26
- --------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
In all these sample periods, the 20/20 hindsight rule yielded slightly better
results than the volumetric process, but the results were consistent over time.
Due to the fact that the forecasted seasonal pattern may not exactly match the
actual monthly prices, the realized price from the volumetric process is
slightly higher than the 20/20 hindsight results. Overall, the historical test
results well support the ability to meet the contracted $32/MWh target. However,
given the limitation of the historical numbers and uncertainty in the market
power prices, such result provides no guarantee that the same strategy will
produce similar results in the future.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 12
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
OPTION VALUE ANALYSIS
- --------------------------------------------------------------------------------
INTRODUCTION
In order to further determine whether the contract prices set forth contained in
the Mirror PPA are reasonable, in conjunction with forecasting the East PJM
market clearing prices over the full term of the Mirror PPA, Pace has performed
an option value analysis. The option value analysis quantifies the value to EPM
based upon their ability to extract option value from the Mirror PPA, derived
from the volatility of market price movements around the Mirror PPA contract
price. Specifically, EPM is able to utilize the wholesale power trading markets,
including forwards, futures, and options to purchase power forward or otherwise
sell the downside value embedded in the market's potential price movement below
the Mirror PPA contract price. At times, the projected market-clearing price
will be above the Mirror PPA contract price (i.e., "out-of-the-money") and at
other times the projected market-clearing price will be below the Mirror PPA
price (i.e. "in-the-money"). The East PJM energy-only market clearing price
forecast has been forecasted by Pace using Pace's Capacity & Energy Market
Analysis System ("CEMAS") model. CEMAS is an integrated resource-planning tool
designed to simulate the deregulated power generation market and to project
market-clearing prices for both capacity and energy under a defined set of
assumptions. Pace utilizes the CEMAS projected energy-only market-clearing
prices and compares these with the Mirror PPA contract prices to determine the
degree to which the Mirror PPA prices are expected to be in-the-money or
out-of-the-money.
METHODOLOGY
The option value analysis quantifies the calculated put option premiums
associated with being able to sell power at prices lower than the Mirror PPA
contract price level. The potential for downward price movements in the market
allows the supplier to extract volatility value by selectively selling or
putting power to the contract at prices below forecasted market levels. The
amount assumed to be "put" to the contract equals scheduled monthly supply.
Further, the methodology assumes that EPM sells put options at the Mirror PPA
contract prices, relative to the projected market prices from Pace's CEMAS
Forecast. Central to the put option pricing is the forecast of the implied
volatility in the regional power (East PJM) trading market. Pace's primary
source of implied volatility information is from traded option quotes,
integrated with historical volatility from recent spot, forwards, and futures
trading to quantify expected regional power market implied volatility. Pace also
accounts for the projected regional power market supply-demand balance, reserve
margins, and price levels in preparing its volatility forecast.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 13
(PACE LOGO -- Global Energy Services)
Exhibit 9, shown below, illustrates the general relationship of market price to
the contract price, adjusted for volumetric flexibility and put option premium.
EXHIBIT 9: RELATIONSHIP OF CONTRACT PRICE TO MARKET PRICE*
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 9)
* Option premium based on Pace's forecasted volumetrically adjusted price.
- --------------------------------------------------------------------------------
OPTION VALUE ANALYSIS
The Mirror PPA specifies minimum contract quantities that EPM must supply to
Cedar Brakes for summer peak, non-summer peak, summer off-peak, and non-summer
off-peak periods, and a maximum annual quantity that can be supplied. The Mirror
PPA structure grants EPM certain volume flexibility to dispatch more in months
when the prices are expected to be relatively low. This volume flexibility will
enable EPM to deliver power at lower prices against the Mirror PPA than the
market average. In addition, the EPM supplier can extract option value through
the financial markets to the extent that forward price fluctuations provide the
opportunity to lock in power at prices that can be put to the Mirror PPA. The
monthly volumes put to the Mirror PPA should match the monthly volumes hedged or
purchased to meet the Mirror PPA volume requirements, thereby eliminating any
volumetric risks. By structuring and managing the trading and supply acquisition
positions in spot and forward markets to match its contract positions, the
supplier can lock in option value consistent with its desired price risk
exposure.
Exhibit 10 summarizes the volumetric flexibility and option-adjusted prices.
Pace utilizes CEMAS to forecast spot prices in the future, and then adjusts this
price for fixed volume commitment and volumetric flexibility under the contract
terms, and transaction cost, such as bid ask spread and basis spread between the
Eastern Hub and the more traded Western Hub. The adjusted price becomes the
"strike" price for the EPM to purchase power using forward contracts, then "put"
this power to the Mirror PPA contract, taking advantage of expected price
fluctuation.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 14
(PACE LOGO -- Global Energy Services)
EXHIBIT 10: SUMMARY OF ENERGY-ONLY POWER PRICES ($/ MWH) FOR THE MIRROR
PPA, PACE'S MARKET PRICE FORECAST, PACE'S ADJUSTED MARKET PRICE AND PACE'S
REALIZED MARKET PRICE
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------
MIRROR PPA PACE'S MARKET PACE'S ADJUSTED PACE'S REALIZED
YEAR PRICE PRICE FORECAST MARKET PRICE(2) MARKET PRICE(3)
- ---------------------------------------------------------------------------------------------------------
2001(1) 32.00 23.89 25.21 24.22
2002 32.00 28.90 30.36 28.87
2003 32.00 24.75 26.34 24.98
2004 32.00 25.52 27.18 25.83
2005 32.00 26.82 28.49 27.11
2006 32.00 27.92 29.53 28.15
2007 32.00 29.73 31.48 30.07
2008 32.00 30.05 31.82 30.38
2009 32.00 31.41 33.27 31.80
2010 32.00 32.50 34.31 32.81
2011 32.00 32.86 34.71 33.16
2012 32.00 34.22 36.06 34.47
2013(1) 32.00 40.18 43.51 41.61
- ---------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
(1) When appropriate, the prices have been adjusted to reflect the
effects of the partial year.
(2) Reflects the sum of negative adjustments for volume flexibility,
netted against positive adjustments for liquidity and basis risk
in forward transactions.
(3) Reflects the negative adjustment for option value associated with
selling put options at the contract price level relative to the
adjusted market price level.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 15
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
EAST PJM MARKET PRICE FORECAST
- --------------------------------------------------------------------------------
The following section details the market price forecasting methodology Pace used
in its East PJM Market Price Forecast. This forecast provides the expected level
and distribution (time of day and season) of East PJM power prices, based on
Pace's CEMAS model.
This section also includes Pace's Base Case forecast of market clearing prices
for the period 2001-2013 (the "Study Period"), an assessment of the capacity
resources available within the East PJM region, and key assumptions and
methodology underlying the development of the forecast.
MARKET CLEARING PRICE FORECAST APPROACH
Pace's market-clearing price forecast methodology consists of multiple,
interrelated analytical processes. Pace employed utility-grade computer
simulation models to evaluate the existing supply and demand relationships in
the region, to match future utility operations to demand forecasts, and to
predict the electricity prices resulting from industry deregulation.
APPROACH
Pace conducted a detailed analysis of the East PJM market clearing prices. This
analysis provides in-depth insight into the fundamentals of the PJM power market
and the emerging competitive markets within the region. The analysis is based on
Pace's competitive market vision of a "one-price" market for capacity and
energy. A description of Pace's approach to this analysis is provided below.
Pace's approach incorporates five market analysis tools that provide the
capability to forecast market clearing prices. As illustrated in Exhibit 11,
CEMAS consists of five modules. These modules are:
1. REVENUE REQUIREMENT MODULE: This module compares fixed and variable
costs for all generating units with all-in revenues generated from a
given bidding strategy. It then reports information regarding over or
under-recovery (i.e., stranded costs) to the Bidding Analysis Module.
2. UNIT FUEL PRICING MODULE: This module calculates fuel prices for each
unit and transfers the data to the Revenue Requirement Module. These
fuel-pricing calculations take into account escalation schedules,
transportation costs, fuel quality, and fuel procurement and contractual
constraints.
3. BIDDING ANALYSIS MODULE: Based on the fixed and variable costs of
generating units and over and under-recovery data generated by the
Revenue Requirement Module,
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 16
(PACE LOGO -- Global Energy Services)
this module generates bids for each unit on the system and transfers
those bids to the Market Clearing Price Module for production
simulation.
4. HOURLY LOAD MODULE: The Hourly Load Module aggregates actual utility
hourly loads as reported to the Federal Energy Regulatory Commission
("FERC") to create an integrated system hourly load profile. This module
uses forecasts of peak and energy demand to develop the base system load
profile over the Study Period. The results of the Hourly Load Module are
drawn upon by the Market Clearing Price Module to simulate daily system
demand.
5. MARKET CLEARING PRICE MODULE: This module performs detailed operations
and dispatch simulation based on bid prices generated by the Bidding
Analysis Module and the hourly load data generated by the Hourly Load
Module. For each hour in the Study Period, the module dispatches
generating units according to their bid prices and availabilities. The
Market Clearing Price Module uses a utility grade dispatch model to
model the hourly system constraints of a regional power pool, optimizing
least cost generation choices to match demand fluctuations. The module
then produces hourly market clearing prices, which are passed to the
Revenue Requirement Module to evaluate system operations and market
price stability. Based on this analysis, CEMAS will either produce a new
iteration of optimized bids or, if the market is deemed stable,
summarize market-clearing prices for each Study Period.
EXHIBIT 11: PACE CEMAS METHODOLOGY
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 11)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 17
(PACE LOGO -- Global Energy Services)
CEMAS was designed based on Pace's market experience, showing that clearing
prices of competitive generation markets are a function of the underlying
generation cost structure, supply availability and demand fluctuations, the
bidding strategies that participants adopt and the incremental cost of expansion
units. Pace has sought with CEMAS to integrate these components into a system
capable of accurately projecting market-clearing prices in a competitive market.
SIMULATED BASE CASE MARKET PRICE FORECAST FOR EAST PJM
CEMAS SIMULATED MARKET PRICES
Pace's Base Case market price forecast was founded on our expected assumptions
underlying a competitive market. Specifically, given the cost structure of
generating units, demand, fuel pricing, and other key factors, the CEMAS model
simulated the East PJM system and optimized unit dispatch and bidding to
identify the market pricing and price distribution to allow the system to
recover all fixed and variable costs of generation units except those fixed
costs that are determined above market or "stranded". Additionally, as discussed
previously, bidding strategies are set to achieve a market price within +/- 5%
of the levels which expansion capacity would require to cover their minimum
fixed and variable costs.
AVERAGE SYSTEM ANNUAL TIME OF DAY PRICES
Exhibit 12 shows Pace's forecast of time of day prices for the Study Period. The
time of day designation consists of on-peak, off-peak, and weekend. The peak
period consists of 16-hour blocks during each day of the 5-day work-week, while
the off-peak period represents the remaining 8 hours during each of these 5
days. The weekend designation represents 24-hour blocks for Saturday and Sunday.
Pace's Base Case average price forecasts for the PJM Northeast sub-region (i.e.
East PJM) are between $39.91/MWh and $28.90/MWh (measured in 1998 real dollars)
for the Study Period. Pace expects that electricity prices will remain stable
over the period as sufficient capacity is constructed to meet demand and
efficiency improvements offset a modest natural gas real price increase.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 18
(PACE LOGO -- Global Energy Services)
EXHIBIT 12: PJM NORTHEAST ANNUAL SYSTEM TIME OF DAY PRICES - BASE CASE
(1998 $/MWH)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ---------------------------------------------------------------------
YEAR OFF-PEAK ON-PEAK WEEKEND AVERAGE
- ---------------------------------------------------------------------
2001 17.98 56.00 31.90 39.91
2002 17.58 47.60 27.48 34.58
2003 16.67 38.79 22.96 28.90
2004 16.83 38.95 23.26 29.10
2005 17.12 40.06 23.67 29.81
2006 17.34 40.85 23.79 30.27
2007 17.88 42.00 25.55 31.45
2008 18.01 41.64 24.60 31.04
2009 18.49 42.33 25.24 31.66
2010 18.80 42.98 24.94 31.96
2011 18.95 42.06 24.74 31.50
2012 19.05 42.98 24.90 32.01
2013 19.48 42.97 24.82 32.08
- ---------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
WHOLESALE MARKET TRANSACTIONS
The PJM power market is a highly competitive and maturing wholesale market. The
market's competitiveness is evidenced by the region's large volume of power
transactions. The PJM power market has experienced high wholesale market volumes
of over 163,682 GWh in 1998 and over 240,000 GWh in 1999(2). Due to these high
trading volumes within the PJM market, the region is typically considered a
liquid market. Exhibit 13 displays the trends in power marketer trading activity
in PJM in 1998 and 1999. As shown, power marketer sales in PJM have decreased
from approximately 201,291 GWh in 1998 to approximately 111,600 GWh in 1999.
The high volume of area electricity interchange and the region's proximity to
liquid trading hubs such as the Cinergy trading hub, indicate a strong market
for sales to PJM's neighboring regions. PJM is bordered by the NERC sub-regions
of NYCA, VACAR, and ECAR. Within these areas, power market trading occurs within
three additional spot markets: ComEd, TVA, and Southern. ECAR, on the northern
border of PJM, is host to Cinergy, the most active power trading market to date.
The high volume of area electricity interchange and the liquidity of these
markets indicate a strong market for sales/purchases for power marketers.
- ------------------------------------
(2) Source: RDI. 2000 data is incomplete and has not been provided by RDI.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 19
(PACE LOGO -- Global Energy Services)
EXHIBIT 13: POWER MARKETERS VOLUMES TRADED IN PJM IN 1998 AND 1999
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 13)
Source: RDI PowerDat
- --------------------------------------------------------------------------------
EXISTING DEMAND PROFILE
Pace developed an independent energy demand forecast for the five sub-regions of
PJM for the period 2001 through 2025. Exhibit 14 provides Pace's demand and
energy requirement forecast for the PJM power region between 2001 and 2010. Pace
expects summer peak demand and net energy demand to grow on average at 1.55%
per-year over the next 10 years. Between 2001 and 2010, peak demand is expected
to grow from 52,017 MW to 59,730 MW. Net energy for load is expected to escalate
from a base of approximately 266,296 GWh in 2001 to 305,748 GWh by the year
2010.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 20
(PACE LOGO -- Global Energy Services)
EXHIBIT 14: PJM DEMAND AND ENERGY REQUIREMENTS FORECAST
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
- --------------------------------------------------------------------------------------------------------------------------
Peak Demand Summer (MW) 52,017 52,895 53,788 54,696 55,620 56,418 57,228 58,050 58,884 59,730
Peak Demand Winter (MW) 43,374 44,106 44,850 45,608 46,378 47,044 47,719 48,404 49,100 49,805
Net Energy for Load (GWh) 266,296 270,786 275,354 279,999 284,725 288,808 292,952 297,155 301,421 305,748
System Load Factor 58.44% 58.44% 58.44% 58.44% 58.44% 58.44% 58.44% 58.44% 58.43% 58.43%
Summer Change (MW) 878 893 908 924 798 810 822 834 846
Winter Change (MW) 732 745 757 770 666 675 685 695 706
Energy Change (GWh) 4,490 4,567 4,646 4,725 4,084 4,143 4,204 4,265 4,327
Summer Change % 1.69% 1.69% 1.69% 1.69% 1.44% 1.44% 1.44% 1.44% 1.44%
Winter Change % 1.69% 1.69% 1.69% 1.69% 1.44% 1.44% 1.44% 1.44% 1.44%
Energy Change % 1.69% 1.69% 1.69% 1.69% 1.43% 1.43% 1.43% 1.44% 1.44%
- --------------------------------------------------------------------------------------------------------------------------
Avg. Summer Peak Growth
(2001-2009) 1.55%
Avg. Winter Peak Growth (2001-
2009) 1.55%
Avg. Energy Growth (2001-2009) 1.55%
- --------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
Also shown in Exhibit 14, Pace expects that the PJM market will have an average
load factor of 58.44% between 2001 and 2010.
As it is shown in Exhibit 15, Pace had anticipated an overall system reserve
margin of 16% during the summer months of 2001. With the projected addition of
new merchant projects, reserve margins are expected to increase to approximately
22% in 2003, creating a slight short-term overbuild situation in PJM. After
2003, as rising demand absorbs excess supplies, reserve margins decline
gradually, reaching equilibrium in 2007. Continued demand growth after 2007,
will result in reserve margins declining under 12% by 2010. Pace expects that
after 2010, the reserve margins in PJM will return to equilibrium by 2012-2013.
Pace's winter reserve margin projections for the PJM power market region are
shown in Exhibit 16.
EXHIBIT 15: PJM MARKET DEMAND AND RESERVE MARGIN FORECAST-SUMMER
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
- --------------------------------------------------------------------------------------------------------------------------
Net Peak Demand (MW) 52,017 52,895 53,788 54,696 55,620 56,418 57,228 58,050 58,884 59,730
- --------------------------------------------------------------------------------------------------------------------------
Total Owned Capacity 58,890 60,507 63,959 63,959 63,959 63,959 63,959 63,959 63,959 64,976
Inoperable Capacity 0 0 0 0 0 0 0 0 0 0
Net Operable Capacity 58,890 60,507 63,959 63,959 63,959 63,959 63,959 63,959 63,959 64,976
Capacity Purchases 2,800 2,800 2,800 2,800 2,800 2,800 2,800 2,800 2,800 3,050
Capacity Sales 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200
Planned Capacity Resources 60,490 62,107 65,559 65,559 65,559 65,559 65,559 65,559 65,559 66,826
- --------------------------------------------------------------------------------------------------------------------------
Reserve Margin (MW) 8,473 9,212 11,771 10,863 9,939 9,140 8,330 7,508 6,674 7,095
Reserve Margin (%) 16.29% 17.42% 21.88% 19.86% 17.87% 16.20% 14.56% 12.93% 11.33% 11.88%
- --------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 21
(PACE LOGO -- Global Energy Services)
EXHIBIT 16: PJM MARKET DEMAND AND RESERVE MARGIN FORECAST-WINTER
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
- --------------------------------------------------------------------------------------------------------------------------
Net Peak Demand (MW) 43,374 44,106 44,850 45,608 46,378 47,044 47,719 48,404 49,100 49,805
- --------------------------------------------------------------------------------------------------------------------------
Total Owned Capacity 63,322 65,061 68,773 68,773 68,773 68,773 68,773 68,773 68,773 69,866
Inoperable Capacity 0 0 0 0 0 0 0 0 0 0
Net Operable Capacity 63,322 65,061 68,773 68,773 68,773 68,773 68,773 68,773 68,773 69,866
Capacity Purchases 2,800 2,800 2,800 2,800 2,800 2,800 2,800 2,800 2,800 3,050
Capacity Sales 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200
Planned Capacity Resources 64,922 66,661 70,373 70,373 70,373 70,373 70,373 70,373 70,373 71,716
- --------------------------------------------------------------------------------------------------------------------------
Reserve Margin (MW) 21,548 22,555 25,522 24,765 23,995 23,329 22,654 21,968 21,273 21,911
Reserve Margin (%) 49.68% 51.14% 56.91% 54.30% 51.74% 49.59% 47.47% 45.38% 43.33% 43.99%
- --------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
BASE CASE ASSUMPTIONS
The following presents Pace's major input assumptions used in the integrated
market pricing forecast of PJM. The input assumptions for the forecast are
presented in the following five (5) categories:
- Regional Market Definition and Transmission Interchange
- Demand Forecast
- Fuel Price Forecast
- Existing Generating Capacity Profiles
- Expansion Generating Capacity Profiles
REGIONAL MARKET DEFINITION AND TRANSMISSION INTERCHANGE
Based on the review of existing transmission transfer capabilities and recent
transmission assessment studies, Pace defined the major intra-regional market
areas of PJM as South, Southeast, Northeast, Central, and ACE. Exhibit 17
illustrates the PJM sub-regional designations to be employed in Pace's
simulation.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 22
(PACE LOGO -- Global Energy Services)
EXHIBIT 17: PJM SUB-REGIONAL DESIGNATIONS
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 17)
- --------------------------------------------------------------------------------
Major PJM utility service territories were allocated to sub-regions as follows:
- PJM SOUTH - Baltimore Gas & Electric, Potomac Electric Power Company.
- PJM SOUTHEAST - Delmarva Power & Light Company.
- PJM CENTRAL - Pennsylvania Power & Light Co, Pennsylvania Electric
Company, Metropolitan Edison Company.
- PJM NORTHEAST - PECO Energy Company, Jersey Central Power & Light
Company, Public Service Electric & Gas Company.
- PJM ACE - Atlantic City Electric Company.
Generally, power in PJM flows from West to East, from low cost, low demand areas
in the West to high cost, high demand areas in the East. Such power transfers
tax the system heavily, creating less flexibility for system balance and
emergency response. To slow the region's increasing transmission congestion, the
PJM Interconnection has designed location-based market pricing systems ("LBMP")
to provide market-based incentives to site capacity resources near load centers
and thereby relieve system constraints. Pace's subdivisions were created to
reflect such locational pricing based on regional transmission zones and
inter-regional constraints. Exhibit 18 provides the intra-regional transfer
capability schematic for PJM employed in the simulation.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 23
(PACE LOGO -- Global Energy Services)
EXHIBIT 18: ASSUMED PJM MARKET AREA TRANSMISSION CONSTRAINTS
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 18)
- --------------------------------------------------------------------------------
Pace simulates all resources in PJM including each transmission area's native
load and capacity. Additionally, inter-regional transfers with utilities that
are more than one wheel away from PJM are modeled on a net transaction basis
(i.e., net purchases or sales are simulated, but full resource optimization is
not conducted). Net transactions were developed utilizing historical wholesale
transactions as reported to the FERC for the years 1995 to 1998 and are outlined
in Exhibit 19. These transactions are modeled as available energy to the region
designated at the running system marginal cost.
EXHIBIT 19: HISTORIC INTER-REGIONAL TRANSACTIONS
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -------------------------------------------------
FROM TO MW
- -------------------------------------------------
NYPP PJM 200
MAIN PJM 350
SERC PJM 300
ECAR PJM 800
- -------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
REGIONAL DEMAND FORECAST
Pace developed an independent demand forecast for each of the five sub-regions
in PJM. The following summarizes Pace's demand forecast methodology and results.
PACE'S INDEPENDENT LOAD FORECASTING METHODOLOGY
Pace's independent demand forecast was developed according to the methodology
illustrated in Exhibit 20. This methodology has two primary components. The
first is the use of econometric models to forecast annual energy and peak demand
levels based on changes in
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 24
(PACE LOGO -- Global Energy Services)
population, employment, income, and other relevant economic indicators. The
second component of the methodology is the translation of historical hourly
demand levels and forecasted peak demand to create predicted hourly load for
each forecast year.
Typically, the most accurate means of projecting future demand is not done
solely by analyzing past trends in peak and energy demand, but by analyzing the
underlying factors that drive the consumption of electricity. This approach is
often referred to as a "bottom-up" analytical approach. As shown in Exhibit 20,
the foundation of Pace's load forecasting methodology is a bottom-up analytical
approach.
EXHIBIT 20: PACE LOAD FORECASTING METHODOLOGY
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 20)
- --------------------------------------------------------------------------------
Pace generated its demand forecast based on the historical relationships between
regional demand and multiple historic economic indicators (examples: population,
employment and income) between 1990-1999. To generate this demand forecast,
Pace:
- Established the historical relationship between net energy for load,
population, employment, and disposable income in PJM.
- Forecast a Base demand case based on the historical trends in population,
employment, and personal income.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 25
(PACE LOGO -- Global Energy Services)
- Forecast a Low demand case based on a forecast of these same economic
indicators projected forward at a slowed economic growth rate equal to
3/4 the rate of historic trends.
- Forecast a High demand case based on a nominal increase in population
growth relative to the historical trend.
- Calculated seasonal energy and summer/winter peaks according to
historical usage patterns and load factors.
Other issues considered with respect to Pace's independent forecast include:
- Normal weather conditions are assumed with no factors included to
simulate extreme weather conditions.
- The forecast incorporated all demand and energy reductions from utility
dispatchable and non-dispatchable DSM programs as published in utility
demand forecasts. Pace believes that this is a conservative assumption in
that many DSM programs are aggressive in future years and will likely
fall short of their stated goals.
For purposes of the Base Case, Pace will simulate our base case demand forecast,
which is consistent with future expectations. The low and high demand cases are
developed for comparison and, ultimately, for sensitivity analyses.
ENERGY DEMAND FORECAST RESULTS
Pace's analysis indicates that PJM's historical growth in retail electricity
sales correlated to changes in employment, personal income, and population with
a high degree of reliability. Pace's regression analysis resulted in a
correlation coefficient of 94%. The resulting forecast of PJM system load is
illustrated in Exhibit 21 and provided in tabular form in Exhibit 22. The
summary of the energy forecast results are outlined below:
- Regional electricity demand growth will slow from its historical growth
rate. Historically (1990-1999), the demand has grown at 1.63% per year in
PJM. Pace forecasts annual demand growth to be 1.41% per year over the
forecasting horizon (until 2025) in PJM.
- Pace forecasts a higher annual growth rate than currently filed utility
forecasts in PJM. As shown in Exhibit 21 and Exhibit 22, the region's
utilities in PJM forecast 1.54% annual demand growth from 2000-2009,
while Pace forecasts 1.57% for annual growth over the same time period.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 26
(PACE LOGO -- Global Energy Services)
EXHIBIT 21: PACE AGGREGATED ENERGY DEMAND FORECAST (PJM)
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 21)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 27
(PACE LOGO -- Global Energy Services)
EXHIBIT 22: PACE PJM DEMAND FORECAST
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ----------------------------------------------------------------------------
PACE PJM
PJM UTILITIES' PACE PJM ENERGY
ENERGY ENERGY FORECAST -
DEMAND BACKCAST BASE CASE
(GWH) (GWH) (GWH)
- ----------------------------------------------------------------------------
HISTORIC
- ----------------------------------------------------------------------------
1990 221,099 221,621
1991 228,588 225,445
1992 226,154 231,103
1993 235,980 234,967
1994 238,379 237,729
1995 243,043 240,746
1996 243,328 242,882
1997 243,967 245,972
1998 248,806 250,844
1999 255,741 257,541
- ----------------------------------------------------------------------------
FORECAST
- ----------------------------------------------------------------------------
2000 258,605 261,881
2001 262,257 266,296
2002 266,236 270,786
2003 271,363 275,354
2004 275,981 279,999
2005 280,094 284,725
2006 284,357 288,808
2007 288,493 292,952
2008 292,773 297,155
2009 296,687 301,421
2010 305,748
2011 310,139
2012 314,593
2013 319,113
2014 323,699
2015 328,352
2016 332,517
2017 336,735
2018 341,008
2019 345,336
2020 349,720
2021 353,567
2022 357,457
2023 361,391
- ----------------------------------------------------------------------------
2024 366,483
- ----------------------------------------------------------------------------
2025 371,650
- ----------------------------------------------------------------------------
Growth Rate 1990 - 1999 1.63% 1.68%
- ----------------------------------------------------------------------------
Growth Rate 2000 - 2009 1.54% 1.57%
- ----------------------------------------------------------------------------
Growth Rate 2000 - 2025 1.41%
- ----------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 28
(PACE LOGO -- Global Energy Services)
- --------------------------------------------------------------------------------
The PJM energy forecast shown in Exhibit 23 reflects an aggregation of Pace's
independent view of the sub-regional forecasts for the defined PJM market area:
PJM South, PJM Southeast, PJM Central, PJM Northeast, and PJM ACE. As shown in
Exhibit 23, energy demand in the Northeast is expected to grow at an annual
average rate of 1.35%, in Central is expected to grow at 1.31%, in Southeast is
expected to grow at 2.04%, in the South is expected to grow at 1.40% and in ACE
is expected to grow at 1.58% from 2000 to 2025.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 29
(PACE LOGO -- Global Energy Services)
EXHIBIT 23: PACE'S SUB-REGIONAL ENERGY FORECAST FOR PJM
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------------------
UTILITIES'
ENERGY
PACE'S ENERGY FORECAST - BASE CASE (GWH) FORECAST
- -----------------------------------------------------------------------------------------------------------------
HISTORIC Northeast Central Southeast South ACE Total
- -----------------------------------------------------------------------------------------------------------------
1990 88,777 58,136 14,162 51,831 8,715 221,621 221,099
1991 89,945 59,179 14,525 52,871 8,925 225,445 228,588
1992 92,516 60,747 14,965 53,744 9,131 231,103 226,154
1993 93,776 61,989 15,384 54,439 9,379 234,967 235,980
1994 94,664 62,534 15,814 55,156 9,560 237,729 238,379
1995 96,060 63,035 16,183 55,756 9,711 240,746 243,043
1996 96,805 63,651 16,510 56,025 9,890 242,882 243,328
1997 98,073 64,016 16,830 57,025 10,028 245,972 243,967
1998 100,458 64,680 17,241 58,175 10,289 250,844 248,806
1999 102,529 66,875 17,604 60,209 10,324 257,541 255,741
- -----------------------------------------------------------------------------------------------------------------
FORECAST
- -----------------------------------------------------------------------------------------------------------------
2000 104,183 67,924 18,035 61,220 10,520 261,881 258,605
2001 105,864 68,989 18,476 62,247 10,720 266,296 262,257
2002 107,571 70,071 18,928 63,292 10,923 270,786 266,236
2003 109,307 71,170 19,391 64,355 11,131 275,354 271,363
2004 111,070 72,286 19,866 65,435 11,342 279,999 275,981
2005 112,862 73,420 20,352 66,534 11,558 284,725 280,094
2006 114,408 74,398 20,775 67,483 11,744 288,808 284,357
2007 115,976 75,390 21,206 68,445 11,933 292,952 288,493
2008 117,566 76,395 21,647 69,422 12,126 297,155 292,773
2009 119,177 77,413 22,097 70,412 12,321 301,421 296,687
2010 120,811 78,445 22,556 71,416 12,520 305,748
2011 122,467 79,490 23,025 72,435 12,722 310,139
2012 124,145 80,550 23,503 73,468 12,927 314,593
2013 125,847 81,623 23,991 74,516 13,136 319,113
2014 127,571 82,711 24,490 75,579 13,348 323,699
2015 129,320 83,813 24,999 76,657 13,563 328,352
2016 130,883 84,799 25,457 77,622 13,756 332,517
2017 132,466 85,796 25,923 78,599 13,951 336,735
2018 134,067 86,805 26,398 79,588 14,150 341,008
2019 135,688 87,826 26,882 80,589 14,351 345,336
2020 137,328 88,858 27,374 81,603 14,555 349,720
2021 138,767 89,764 27,809 82,493 14,734 353,567
2022 140,221 90,679 28,250 83,393 14,915 357,457
2023 141,689 91,603 28,698 84,302 15,099 361,391
- -----------------------------------------------------------------------------------------------------------------
2024 143,602 92,803 29,283 85,482 15,313 366,483
- -----------------------------------------------------------------------------------------------------------------
2025 145,540 94,109 29,881 86,679 15,441 371,650
- -----------------------------------------------------------------------------------------------------------------
Growth Rate 1990 - 1999 1.61% 1.57% 2.45% 1.68% 1.90% 1.68% 1.63%
- -----------------------------------------------------------------------------------------------------------------
Growth Rate 2000 - 2009 1.51% 1.46% 2.28% 1.57% 1.77% 1.57% 1.54%
- -----------------------------------------------------------------------------------------------------------------
Growth Rate 2000 - 2025 1.35% 1.31% 2.04% 1.40% 1.58% 1.41%
- -----------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 30
(PACE LOGO -- Global Energy Services)
Pace also developed the summer and winter peak demand for each sub-region based
on each sub-regional energy forecast reflecting historical load factors. Pace's
forecast for winter and summer peak demand for each PJM sub-region along with
utility filed peak forecasts are detailed in Exhibit 24.
EXHIBIT 24: PACE SUB-REGIONAL PEAK DEMAND FORECAST FOR PJM - MW
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------
ACE CENTRAL NORTHEAST SOUTH SOUTHEAST
- -------------------------------------------------------------------------------------------------------------
SUMMER WINTER SUMMER WINTER SUMMER WINTER SUMMER WINTER SUMMER WINTER
- -------------------------------------------------------------------------------------------------------------
HISTORIC
- -------------------------------------------------------------------------------------------------------------
1993
1994
1995
1996
1997
1998
1999
- -------------------------------------------------------------------------------------------------------------
FORECAST
- -------------------------------------------------------------------------------------------------------------
2000 2,326 1,663 12,106 11,519 20,923 16,345 12,295 10,741 3,658 3,275
2001 2,361 1,688 12,240 11,646 21,168 16,536 12,443 10,870 3,726 3,336
2002 2,397 1,713 12,376 11,775 21,416 16,730 12,592 11,000 3,796 3,397
2003 2,433 1,739 12,513 11,906 21,667 16,927 12,743 11,133 3,866 3,461
2004 2,470 1,765 12,651 12,038 21,922 17,125 12,896 11,266 3,938 3,525
2005 2,507 1,792 12,792 12,171 22,179 17,326 13,051 11,402 4,011 3,591
2006 2,544 1,819 12,934 12,306 22,439 17,530 13,208 11,539 4,086 3,658
2007 2,583 1,846 13,077 12,443 22,703 17,735 13,367 11,678 4,162 3,726
2008 2,622 1,874 13,223 12,581 22,969 17,944 13,529 11,819 4,240 3,795
2009 2,661 1,902 13,370 12,722 23,239 18,154 13,692 11,961 4,319 3,866
2010 2,701 1,931 13,519 12,863 23,512 18,368 13,857 12,105 4,400 3,939
2011 2,742 1,960 13,670 13,007 23,788 18,584 14,024 12,251 4,483 4,013
2012 2,783 1,989 13,822 13,152 24,068 18,802 14,193 12,399 4,567 4,088
2013 2,825 2,019 13,977 13,299 24,351 19,023 14,365 12,549 4,652 4,165
- -------------------------------------------------------------------------------------------------------------
<Caption>
- --------- ---------------------------------------
PACE NON- PJM UTILITIES
COINCIDENT PEAK COINCIDENT PEAK
- --------- ---------------------------------------
SUMMER WINTER SUMMER WINTER
---------------------------------------
HISTORIC
- ----------------------------------------------------------------------------------------------------
1993 46,494 41,406
1994 46,019 40,653
1995 48,577 40,790
1996 44,302 40,468
1997 49,464 37,217
1998 48,445 36,532
1999 51,600 38,123
- ------------------------------------------------------------------------------------------------------------- ----------------------
- -----------------
FORECAST
- ------------------------------------------------------------------------------------------------------------- --------------------
- -------------------
2000 51,309 43,543 50,576 43,628
2001 51,938 44,076 51,426 44,264
2002 52,576 44,617 52,238 44,917
2003 53,222 45,165 53,048 45,575
2004 53,877 45,720 53,892 46,247
2005 54,540 46,282 54,769 46,947
2006 55,212 46,852 55,634 47,631
2007 55,893 47,429 56,516 48,321
2008 56,582 48,013 57,381 48,981
2009 57,281 48,606
2010 57,989 49,206
2011 58,707 49,814
2012 59,433 50,431
2013 60,170 51,055
- ------------------------------------------------------------------------------------------------------------- --------------------
- -------------------
</Table>
- --------------------------------------------------------------------------------
Pace used an hourly load module tool to translate annual peak and energy demand
growth factors into future hourly demand for the Study Period. The translation
process is a two-step process:
1) The first step involves aggregating actual utility hourly loads as
reported to the FERC (for each utility under consideration in this
study). This aggregation creates integrated hourly system load profiles,
or base system hourly load files, for each transmission area in the PJM
market.
2) The second step involves applying annual growth factors and seasonal
peak demand forecasts to the base system hourly load file, to create
hourly demand files for each year in the Study Period.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 31
(PACE LOGO -- Global Energy Services)
Pace assumed that the basic historic system load shape as represented by 1998
values would be maintained throughout the Study Period. However, system load
factors do change slightly as the result of applying annual peak and energy
growth factors. As the relationship of peak demand and energy change, the system
load factor and shape will shift.
FUEL PRICING
Pace developed fuel price forecasts for each major fuel (natural gas, #2
distillate fuel oil, #6 residual fuel oil, coal, and uranium) in the PJM market
region. The base year fuel prices and annual escalation rates in the forecast
are based on Pace's analysis of historical price data and the fundamental
factors driving each fuel market. All forecast prices are in 1998 real dollars
and represent a regional benchmark market price.(3)
Pace's forecasting methodology recognizes that actual prices to existing
facilities often vary from the regional benchmark due to
advantages/disadvantages in supply contract terms or transportation rates. To
develop plant-specific fuel forecasts for these facilities, the regional
benchmark price is adjusted to reflect plant-specific cost factors. These
plant-specific cost factors are maintained throughout the forecast.
Pace applies monthly fuel adjustment factors as shown in Exhibit 25 to reflect
monthly fluctuations in fuel prices. For the first three years of the natural
gas forecast, the seasonal factors change each year to reflect a relatively
steep decline in annual prices to the longer term forecast.(4)
EXHIBIT 25: MONTHLY FUEL PRICE ADJUSTMENT FACTORS
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ------------------------------------------------------------------------
GAS GAS
MONTH 2001 2002-25 COAL #2 OIL #6 OIL
- ------------------------------------------------------------------------
JAN 346% 126% 102% 100% 108%
- ------------------------------------------------------------------------
FEB 143% 122% 101% 97% 93%
- ------------------------------------------------------------------------
MAR 99% 110% 99% 96% 92%
- ------------------------------------------------------------------------
APR 103% 94% 95% 98% 95%
- ------------------------------------------------------------------------
MAY 94% 85% 101% 97% 96%
- ------------------------------------------------------------------------
JUN 72% 85% 102% 93% 94%
- ------------------------------------------------------------------------
JUL 65% 85% 102% 95% 97%
- ------------------------------------------------------------------------
AUG 64% 85% 102% 100% 98%
- ------------------------------------------------------------------------
SEP 46% 86% 102% 106% 101%
- ------------------------------------------------------------------------
OCT 49% 94% 94% 109% 108%
- ------------------------------------------------------------------------
NOV 54% 109% 100% 105% 109%
- ------------------------------------------------------------------------
DEC 66% 119% 98% 103% 108%
- ------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
- ------------------------------------
(3) Gas-fired expansion plants are assigned the natural gas regional benchmark
price.
(4) The factors for Jan.-Sep. 2001 reflect actual seasonality.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 32
(PACE LOGO -- Global Energy Services)
The remainder of this section reviews Pace's major conclusions and base case
assumptions regarding fuel pricing.
NATURAL GAS
Pace's independent forecast of delivered natural gas prices in PJM is comprised
of commodity prices, as represented by the price for gas on the New York
Mercantile Exchange ("NYMEX") at the Henry Hub in Louisiana, plus a regional
basis adjustment to reflect price differentials between the Gulf Coast and
various PJM delivered price sub-regions.
COMMODITY PRICES
In general, Pace expects Henry Hub commodity prices to return to towards their
long run mean after peaking in 2001. After 2005, Pace expects a 0.5 percent
annual real price increase throughout the forecast period. Fundamental factors
driving Pace's Henry Hub commodity forecast are:
- Record levels of drilling for natural gas have resulted in new reserve
discoveries and new production that will continue to enter the market for
the next few years. Beginning in the spring of 2001, the industry entered
a cycle of higher production and record storage injections that, coupled
with lower gas demand, lead to a collapse in prices. Pace expects natural
gas prices at the Henry Hub to trade in the $2.00 to $3.00/MMBtu range
for the remainder of 2001, although cash market prices on a given day may
be higher or lower due to short-term technical factors.
- Despite low prices, leading gas supply indicators remain at record
levels, signaling that the rebound in production will continue over the
short to medium term. The U.S. gas-directed rig count stood at over 1,000
in June 2001, compared to a count just above 600 eighteen months
previously. As of September 2001, the rig count was still over 900.
Assuming a six to eighteen month lag between drilling and new production,
and normal summer weather patterns, Pace expects strong production growth
to continue into 2002 and 2003.
- Pace expects that the current slowdown in the U.S. and global economy
will mitigate a recovery in industrial gas consumption due to lower
prices. The chemical industry is by far the largest industrial user of
natural gas, and although gas prices are lower, slow economic growth and
excess capacity will place a cap on near term gas demand from this
industry. Similarly, Pace expects relatively low gas demand from the
metals sectors, the send largest industrial user of natural gas.
- As of September 13, 2001, and since the beginning of the refill season,
the industry had added a record 2,667 Bcf to gas inventories and storage
was over 81 percent full.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 33
(PACE LOGO -- Global Energy Services)
Over the same period last year, the industry had added only 2,258 Bcf and
storage was just 69 percent full. Given the healthy state of inventories
compared to last year and Pace's expectation for storage to rebuild to
near capacity by November 2001, current softness in gas prices should
continue into 2002.
- Pace expects that substantial incremental gas demand from new greenfield
gas-fired power generation during the next three years will offset some
of the downward price pressure exerted by new supply from increased
drilling. Pace estimates that new gas fired generation will add almost
5.4 Bcf/d in incremental natural gas consumption by 2004.
- Expansion of the North American pipeline grid and productive capacity
from the Gulf Coast and the Western Canadian Sedimentary Basin will
increase competition, particularly in the Midwest and Northeast. By 2004,
several new pipeline projects, such as Millennium and Independence should
be completed, which will encourage gas-on-gas competition causing Henry
Hub prices to remain at current levels.
- Over the long term, Pace does not anticipate sustained natural gas
shortfalls in its base case commodity forecast as producers and consumers
respond quickly to market price signals. Higher prices support a greater
and faster expected return on drilling investments, high rig counts, and
future production growth, but also result in lower gas demand.
- Environmental regulations requiring the use of cleaner, more efficient
fuels have shifted consumption preferences to natural gas thereby
contributing to a higher long-term real price escalation rate relative to
other fuels.
- In the long run, technologically driven declines in exploration and
production costs, and increases in finding rates will increase productive
capacity. These supply-side fundamentals will keep real gas prices from
escalating too high relative to other fuels.
REGIONAL BASIS
The delivered gas price forecast incorporates general price differentials and
the cost of transportation to PJM gas price subregions, as depicted in Exhibit
26.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 34
(PACE LOGO -- Global Energy Services)
EXHIBIT 26: PACE GAS PRICE PJM SUBREGIONS
- --------------------------------------------------------------------------------
(GRAPH)
- --------------------------------------------------------------------------------
Each gas price region is defined by its primary liquid supply source, interstate
transporter, and that transporter's applicable market-based transportation
rates. The regional basis from the Henry Hub to these gas price regions is
driven primarily by the following fundamentals:
- Transportation rates in PJM will experience some incremental competition
during the early part of the mid term as projects, such as Millennium,
are built to bring excess Midwestern supply to markets in the Northeast.
- EAST PJM receives supply primarily off of Texas Eastern Transmission
Corporation ("TETCO") and Transcontinental Gas Pipeline Corporation
("Transco"). These pipelines terminate in the New York City ("NYC")
market area, which sets the price for deliveries in this area. Eastern
PJM markets can receive supply just upstream of constraint points heading
into NYC and therefore are priced at a $0.04/ MMBtu discount to delivered
prices in the NY City region.
- On an annual average basis, prices in WESTERN PJM are approximately
$0.08/ MMBtu less than prices in Eastern PJM. This price discrepancy is
attributed to the region's proximity to Appalachian supply and access to
more available pipeline capacity on Columbia Transmission ("TCO") and
Dominion Transmission ("DTI").
- Markets in NORTHERN NEW JERSEY receive supply primarily from Transco and
TETCO. These deliveries are downstream of seasonal constraint points that
cause delivered supply to average approximately $0.04/MMBtu over PJM East
deliveries on an annual average basis.
- Markets located in the DELMARVA Peninsula do not have direct access to
interstate pipeline systems and must therefore use the local distribution
companies to obtain
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 35
(PACE LOGO -- Global Energy Services)
delivery of supply. Pace assumes a transportation charge of $0.25/MMBtu
in addition to PJM East delivered prices.
Exhibit 27 provides a summary of Pace's independent forecast of annual Henry Hub
and delivered prices to each respective PJM fuel sub-region.
EXHIBIT 27: PJM NATURAL GAS PRICE FORECASTS (1998 $/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------------
HENRY N. NEW
YEAR HUB JERSEY E. PJM DEL MARVA W. PJM
- -----------------------------------------------------------------------
2001 3.89 5.28 4.79 5.04 4.71
- -----------------------------------------------------------------------
2002 2.60 3.31 3.28 3.53 3.20
- -----------------------------------------------------------------------
2003 2.32 2.89 2.85 3.10 2.77
- -----------------------------------------------------------------------
2004 2.30 2.87 2.83 3.08 2.75
- -----------------------------------------------------------------------
2005 2.35 2.92 2.88 3.13 2.80
- -----------------------------------------------------------------------
2006 2.36 2.93 2.89 3.14 2.81
- -----------------------------------------------------------------------
2007 2.37 2.94 2.90 3.15 2.82
- -----------------------------------------------------------------------
2008 2.39 2.96 2.92 3.17 2.84
- -----------------------------------------------------------------------
2009 2.40 2.97 2.93 3.18 2.85
- -----------------------------------------------------------------------
2010 2.41 2.98 2.94 3.19 2.86
- -----------------------------------------------------------------------
2011 2.42 2.99 2.95 3.20 2.87
- -----------------------------------------------------------------------
2012 2.44 3.00 2.96 3.21 2.88
- -----------------------------------------------------------------------
2013 2.45 3.02 2.98 3.23 2.90
- -----------------------------------------------------------------------
2014 2.46 3.03 2.99 3.24 2.91
- -----------------------------------------------------------------------
2015 2.47 3.04 3.00 3.25 2.92
- -----------------------------------------------------------------------
2016 2.48 3.05 3.01 3.26 2.93
- -----------------------------------------------------------------------
2017 2.49 3.07 3.03 3.28 2.95
- -----------------------------------------------------------------------
2018 2.51 3.08 3.04 3.29 2.96
- -----------------------------------------------------------------------
2019 2.52 3.09 3.05 3.30 2.97
- -----------------------------------------------------------------------
2020 2.53 3.10 3.06 3.31 2.98
- -----------------------------------------------------------------------
2021 2.55 3.12 3.08 3.33 3.00
- -----------------------------------------------------------------------
2022 2.56 3.13 3.09 3.34 3.01
- -----------------------------------------------------------------------
2023 2.57 3.14 3.10 3.35 3.02
- -----------------------------------------------------------------------
2024 2.58 3.15 3.11 3.36 3.03
- -----------------------------------------------------------------------
2025 2.60 3.17 3.13 3.38 3.05
- -----------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 36
(PACE LOGO -- Global Energy Services)
FUEL OIL
Pace forecasts prices for #2 oil, Low Sulfur #2, #6 1.0%, and #6 0.3% oil for
PJM based on the consumption profile of the generators in the region. The
forecast prices are comprised of the following components, which are detailed in
the remainder of this section:
- Commodity prices as represented by the price for West Texas Intermediate
("WTI") crude oil on the NYMEX in Cushing, Oklahoma,
- Location basis, and
- Crack spreads.
COMMODITY PRICES
The strength of crude oil prices in 2000 can be attributed to low inventory
levels and demand growth stemming from a continued strong U.S. economy and
economic recovery in Asia. Prices were at levels that, if sustained, will
stimulate non-OPEC production and encourage OPEC members to exceed current quota
levels and expand production capacity. Therefore, it is Pace's view that world
prices will eventually fall to levels that are comparable to the average real
price for the five-year period prior to the 1998 price collapse. Pace's WTI
forecast is based on the following key fundamentals:
OPEC PRODUCTION
- The OPEC price-band mechanism that was agreed upon in March 2000 will
remain in effect. The agreement requires OPEC to meet if a basket of OPEC
crude falls below $22.00 or rises above $28.00 per barrel over a 20-day
period. OPEC's largest producer, Saudi Arabia, has voiced its desire for
a $25 per barrel price and aggressively increased production in the
latter half of 2000 to meet that goal. Prices began to soften in late
2000 in response to this increase in supply.
- In spite of bearish price trends during the late fourth quarter of 2000,
the market remains concerned over Middle East tensions, unreliable Iraqi
exports, and possible OPEC production cuts. Therefore, Pace expects the
world price of oil to rise to the upper bounds of OPEC's price band.
However, global crude demand growth, expected to slow during 2001, will
preclude prolonged price spikes over $30.00 per barrel.
- OPEC, led by swing producer Saudi Arabia, will attempt to avoid future
sustained prices above $25.00, which inhibit global economic growth and
lead to increased exploration and production in non-OPEC countries. The
price of crude will be driven toward the long-term equilibrium price of
approximately $21.00.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 37
(PACE LOGO -- Global Energy Services)
- OPEC was producing at nearly its maximum capacity in 2000, and will
undertake relatively ambitious capacity expansion programs in order to
accommodate the projected rise in long term worldwide petroleum demand.
Much of the expansion will occur in the Persian Gulf where the
reserves-to-production ratio already exceeds 80 years.
- OPEC's relative market share will grow from its current level of
approximately 40 percent, but will not surpass the historic high of 53
percent reached in 1973.
NON-OPEC PRODUCTION
- Non-OPEC production was surprisingly resilient in the low price
environment prior to mid-1999, largely due to innovations in exploration
and drilling technologies and investment-friendly government policies.
While the prices in Pace's forecasted range are sufficient not only to
sustain but in some regions expand output by non-OPEC producers, the
relative share of non-OPEC output will fall due to expected strong growth
in OPEC production.
- U.S. crude oil output, which has been declining since 1985 due to a
combination of lower prices and rising production costs, will continue
falling at a rate of about 1 percent annually. The impact of sharply
lower Alaskan oil output, which has historically represented about 25
percent of total U.S. crude oil production, is tempered somewhat by
technological innovations that improve success rates and lower costs for
deepwater exploration and production in the Gulf of Mexico.(5)
- Optimism remains high concerning the long-term resource potential of the
Former Soviet Union (FSU) region, but production growth will be slow
until after 2005 due to the startup delays of many Caspian Basin projects
as well as a generally pessimistic outlook for investment in Russia.
- North Sea production, the largest supply component in the European Union,
is expected to enter a decline phase soon.
OIL DEMAND
- Demand growth in industrialized countries is projected to be flat to
modest due to lower expected GDP growth and a gradual shift away from oil
for non-transportation uses such as power generation and space heating.
- Dramatic demand increases in developing countries are anticipated largely
due to higher assumed rates of GDP growth as well as the greater tendency
in developing
- ------------------------------------
(5) Combined with the expected growth in U.S. oil demand, the decline in U.S.
production implies an increase in U.S. oil imports.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 38
(PACE LOGO -- Global Energy Services)
countries to use oil for a wider variety of applications. GDP growth is
expected to be strongest in the developing economies of Asia, particularly
China.
- FSU and Eastern Europe are projected to have relatively rapid GDP growth,
but the impact on petroleum demand will be modest because the transition
to a market system will lead to offsetting improvements in energy
efficiency.
- In the U.S., a tight natural gas market will lead to some fuel switching
to oil in the industrial and power generation sectors. This will place
upward pressure on oil at times, countering the bearish effects of a
potentially softening economy.
Exhibit 28 shows Pace's crude oil price forecast for WTI for the period of
2001-2025. By 2006, oil prices are expected to settle at their long-term mean
and remain there for the duration of the forecast. It is Pace's view that the
price of oil is mean reverting. While the price does cycle around the mean as
the market moves from surplus to constraint, the cycle is a product of
international political factors as much as supply/demand fundamentals.
EXHIBIT 28: WTI CRUDE OIL PRICE FORECAST (1998 $/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------
YEAR WTI PRICE FORECAST
- -----------------------------------------------
2001 4.76
- -----------------------------------------------
2002 4.52
- -----------------------------------------------
2003 4.28
- -----------------------------------------------
2004 4.04
- -----------------------------------------------
2005 3.80
- -----------------------------------------------
2006-2025 3.60
- -----------------------------------------------
</Table>
- --------------------------------------------------------------------------------
LOCATION BASIS
An adjustment for WTI crude oil prices must be made to reflect the price
differentials between Cushing, Oklahoma, and the oil regions presented in
Exhibit 29. The location adjustment for each region is calculated by reviewing
the differential between prices for oil products in Oklahoma and each oil
sub-regions.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 39
(PACE LOGO -- Global Energy Services)
EXHIBIT 29: PACE OIL PRICE SUB-REGIONS FOR PJM
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 29)
- --------------------------------------------------------------------------------
A local delivery charge is also applied to rack pricing to reflect transport
charges to the plant sites. The final regional Location Basis is presented in
Exhibit 30.
EXHIBIT 30: PJM FUEL OIL LOCATION BASIS (1998 $/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ----------------------------------------------------------------------------
CUSHING, OK TO: LOCATION BASIS
- ----------------------------------------------------------------------------
PJM West 0.18
- ----------------------------------------------------------------------------
PJM South 0.00
- ----------------------------------------------------------------------------
PJM East 0.02
- ----------------------------------------------------------------------------
New York City & Vicinity 0.10
- ----------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
REFINED PRODUCT CRACK SPREADS
Ten years of historical U.S. Gulf Coast and New York Harbor spot prices were
used to determine the average crack spreads between crude oil and #2 fuel oil,
Low Sulfur #2, #6 1.0%, and #6 0.3% oil. The average crack spreads shown in
Exhibit 31 are forecasted to determine the refined product prices in each
region.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 40
(PACE LOGO -- Global Energy Services)
EXHIBIT 31: CRUDE OIL TO REFINED PRODUCT CRACK SPREADS (1998 $/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ------------------------------------------------------------------------
YEAR LS #2 OIL #2 OIL #6 1.0% OIL #6 0.3% OIL
- ------------------------------------------------------------------------
2001 1.22 1.09 (0.70) 0.16
2002 1.10 0.99 (0.68) 0.07
2003 0.98 0.89 (0.66) (0.01)
2004 0.86 0.79 (0.64) (0.09)
2005 0.86 0.79 (0.64) (0.09)
2006-25 0.86 0.79 (0.64) (0.09)
- ------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
DELIVERED OIL PRICE FORECASTS
Exhibit 32 provides Pace's forecast of annual delivered oil prices resulting
from the summation of the components detailed above.
EXHIBIT 32: FUEL OIL PRICE FORECAST BY PJM SUB-REGION (1998 $/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------
WEST PJM SOUTH PJM
-----------------------------------------------------------------------------------------------
<Caption>
YEAR #2 LS #2 #6 1.0% #6 0.3% #2 LS #2 #6 1.0% #6 0.3%
- ----------------------------------------------------------------------------------------------------------------
2001 6.03 6.16 4.24 5.10 5.85 5.98 4.06 4.92
- ----------------------------------------------------------------------------------------------------------------
2002 5.69 5.80 4.02 4.77 5.51 5.62 3.84 4.59
- ----------------------------------------------------------------------------------------------------------------
2003 5.35 5.44 3.80 4.45 5.17 5.26 3.62 4.27
- ----------------------------------------------------------------------------------------------------------------
2004 5.01 5.08 3.58 4.13 4.83 4.90 3.40 3.95
- ----------------------------------------------------------------------------------------------------------------
2005 4.77 4.84 3.34 3.89 4.59 4.66 3.16 3.71
- ----------------------------------------------------------------------------------------------------------------
2006-25 4.57 4.64 3.13 3.68 4.39 4.46 2.95 3.50
- ----------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------
EAST PJM NEW YORK CITY & VICINITY
-----------------------------------------------------------------------------------------------
<Caption>
YEAR #2 LS #2 #6 1.0% #6 0.3% #2 LS #2 #6 1.0% #6 0.3%
- ----------------------------------------------------------------------------------------------------------------
2001 5.87 6.00 4.08 4.94 5.95 6.08 4.15 5.01
- ----------------------------------------------------------------------------------------------------------------
2002 5.53 5.64 3.86 4.61 5.61 5.72 3.93 4.69
- ----------------------------------------------------------------------------------------------------------------
2003 5.19 5.28 3.64 4.29 5.27 5.36 3.72 4.37
- ----------------------------------------------------------------------------------------------------------------
2004 4.85 4.92 3.42 3.97 4.93 5.00 3.50 4.05
- ----------------------------------------------------------------------------------------------------------------
2005 4.61 4.68 3.18 3.73 4.69 4.76 3.26 3.81
- ----------------------------------------------------------------------------------------------------------------
2006-25 4.41 4.48 2.97 3.52 4.49 4.55 3.05 3.60
- ----------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
COAL
Pace forecasts delivered coal prices by adding forecasted transportation costs
to regional free on board ("FOB") basin level coal price forecasts. The basin
level forecasts reflect the market outlook for various grades of coal in the
three major coal-producing regions of the
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 41
(PACE LOGO -- Global Energy Services)
United States: Appalachia (West Virginia, Pennsylvania, Virginia, Eastern
Kentucky, and Ohio), the Interior (Illinois, Indiana, and Western Kentucky), and
the West (Wyoming, Montana, Colorado, Utah, New Mexico, and Arizona). Pace used
the following methodology to generate its coal price forecast:
- Step 1: A coal consumption profile was developed for PJM indicating the
shares of coal consumption by sulfur grade (compliance(6) or
non-compliance) and coal supply region.
- Step 2: National and coal supply region specific trends in supply and
demand were reviewed to forecast an average FOB price for each relevant
coal supply region and sulfur grade.
- Step 3: Trends in the applicable transportation markets were reviewed and
were used to develop escalation rates by mode of transportation,
primarily rail, barge, and truck.
- Step 4: The FOB coal price for each plant was transitioned from the
current price to Pace's forecasted FOB market price by 2004, to reflect a
general movement from long-term above-market contracts to long-term
contracts averaging three to five years in term.
- Finally, the forecasted FOB prices and transportation rates were combined
to generate a delivered coal price forecast.
In the subsequent parts of this section, Pace provides a summary of its FOB
price forecasts and transportation escalation rates, a coal consumption profile
for PJM, an analysis of the national and regional trends influencing the
production basins supplying the region, and a discussion of transportation
trends.
COAL PRICE AND TRANSPORTATION RATE FORECAST SUMMARY
As shown in Exhibit 33, the FOB coal prices paid by electric generators in PJM
for fuel declined in real terms throughout the 1990's. Due to the national and
regional coal supply and demand trends discussed below, Pace forecasts that
electric generators will likely face on average FOB prices that are higher than
those of the past five years for most of the forecast period.
- ------------------------------------
(6) Compliance coal contains less than or equal to 1.2 Lbs SO2/MMBtu, which is
the average emissions rate that electricity generators were required to meet
by January 1, 2000, under the Clean Air Act Amendments of 1990 ("CAAA").
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 42
(PACE LOGO -- Global Energy Services)
EXHIBIT 33: PJM HISTORICAL WEIGHTED AVERAGE & FORECASTED FOB COAL PRICES
(1998$/MMBTU)
- --------------------------------------------------------------------------------
(GRAPH EXHIBIT 33)
Sources: Pace and RDI COALdat.
- --------------------------------------------------------------------------------
Pace projects that FOB coal prices in the supply basins serving PJM will decline
over the forecast period. Exhibit 34 shows Pace's forecast of FOB prices:
Northern Appalachian ("NAPP") Non-Compliance coal; Central Appalachian ("CAPP")
Compliance and Non-Compliance coals; and Illinois Basin ("ILB") coal.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 43
(PACE LOGO -- Global Energy Services)
EXHIBIT 34: PACE FOB COAL PRICE FORECAST FOR COAL CONSUMED IN PJM
(1998$/MMBTU)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
CAPP CAPP NON- NAPP NON- INTERIOR AND
YEAR COMPLIANCE COMPLIANCE COMPLIANCE ILLINOIS BASIN
- --------------------------------------------------------------------------------------------
2001 1.39 1.29 1.29 1.19
2002 1.26 1.17 1.17 1.06
2003 1.23 1.13 1.13 1.02
2004 1.19 1.09 1.09 0.99
2005 1.15 1.05 1.05 0.95
2006 1.14 1.04 1.04 0.94
2007 1.17 1.07 1.07 0.97
2008 1.20 1.10 1.10 1.00
2009 1.22 1.13 1.13 1.02
2010 1.21 1.11 1.11 1.01
2011 1.20 1.10 1.10 1.00
2012 1.19 1.09 1.09 0.98
2013 1.17 1.08 1.08 0.97
2014 1.16 1.07 1.07 0.96
2015 1.15 1.05 1.05 0.95
2016 1.14 1.04 1.04 0.94
2017 1.13 1.03 1.03 0.93
2018 1.12 1.02 1.02 0.92
2019 1.11 1.01 1.01 0.90
2020 1.09 1.00 1.00 0.89
2021-35 1.09 1.00 1.00 0.89
- --------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
In developing plant-level coal price forecasts, Pace examined the coal
purchasing characteristics underlying each PJM coal-fired power plant, as well
as the overall market for steam coal, to determine the likely delivered coal
costs to each plant in the future. Pace reviewed coal deliveries to each of the
facilities as reported by FERC Form 423 and RDI COALdat. The plant-level price
forecasts were based on a combination of projected FOB and transportation prices
as well as an adjustment for "above-market" contract expiration. To account for
"over-market" contracts, Pace transitioned the FOB price for coal priced above
the weighted average price for the relevant coal grade and coal source to the
projected FOB price by 2004.
In order to reflect price trends in transportation, Pace applied the annual real
escalators presented in Exhibit 35 to the applicable modes of coal
transportation within PJM.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 44
(PACE LOGO -- Global Energy Services)
EXHIBIT 35: REAL TRANSPORTATION ESCALATION RATES BY MODE
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------
TRANSPORTATION MODE 2001 2002 2003-08 2009-20 2021-35
- ------------------------------------------------------------------------------------------------------------
RAIL -- PLANT ACCESSED BY MULTIPLE ROADS -2.0% -2.0% -2.0% -2.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
RAIL -- PLANT ACCESSED BY SINGLE ROAD 0.0% 0.0% 0.0% 0.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
INLAND BARGE -1.0% -1.0% 6.5% -1.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
COASTAL BARGE -1.0% -1.0% -1.0% -1.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
OCEAN FREIGHT -2.0% -2.0% -2.0% -2.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
TRUCK -1.0% -1.0% -1.0% -1.0% 0.0%
- ------------------------------------------------------------------------------------------------------------
</Table>
Source: Pace.
- --------------------------------------------------------------------------------
CONSUMPTION PROFILE
NAPP Non-Compliance coal dominates in the region, having accounted for on
average approximately 79 percent of PJM's consumption from 1991-2000 (Exhibit
36). CAPP Compliance coal and NAPP Compliance coal, which represented 13 and 5
percent, respectively, of PJM's total consumption over the period, are the
region's other two major coals.
Due to PJM's heavy reliance upon indigenous NAPP Non-Compliance coal, the sulfur
content of coal consumed in PJM has remained relatively unchanged over the past
decade. Unlike many NERC regions that have registered a gradual but marked
decline during this period, the sulfur content of coal consumed in PJM has
averaged about 2.55 Lbs SO(2)/ MMBtu, deviating only slightly from this level
due to variations in the consumption levels of NAPP Non-Compliance coal.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 45
(PACE LOGO -- Global Energy Services)
EXHIBIT 36: PJM COAL CONSUMPTION, 1991-2000
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 36)
Sources: Pace and RDI COALdat.
- --------------------------------------------------------------------------------
SUPPLY PROFILE
Pace's long-term coal market outlook for the PJM is based on a review of
fundamental market drivers affecting overall domestic coal prices and the
relative values of specific coal grades.
NATIONAL SUPPLY AND DEMAND BALANCE FOR COAL
Due to a combination of declining supply and surging demand, the U.S. coal
market tightened significantly in 2000, resulting in a run up in spot prices.
Pace expects spot coal prices to decline from their peak. However, over the long
term, Pace expects steadily increasing coal demand, coupled with the hesitancy
of the pared-back domestic coal industry to invest in new capacity, to result in
a fundamental shift in coal industry dynamics to higher prices. Therefore, Pace
projects future coal prices will be relatively higher than those of the past
decade.
Domestic coal production has declined for the last three years despite high
levels of coal reserves (exceeding 250 years). Declining supply and supply
flexibility are a direct result of under-investment in coal production
facilities due to low prices during the 1990s. Low
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 46
(PACE LOGO -- Global Energy Services)
prices resulted in consolidation and rationalization throughout the industry,
declining inventories, and an end to the decade-long overhang of production
capacity in both the Eastern and Western United States (Exhibit 37). On the
demand side, colder than normal weather in November and December 2000 and record
high natural gas prices contributed to high coal consumption and coal unit
dispatch in 2000.
EXHIBIT 37: ANNUAL U.S. COAL SUPPLY-DEMAND BALANCE
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 37)
Source: EIA.
- --------------------------------------------------------------------------------
Higher industry productivity was the overriding reason for falling coal prices
during the 1990s. Higher productivity was driven by many factors including:
- Increased average mine size;
- Closure of less productive properties;
- Concentration of productive capacity among fewer large companies; and
- Technological advances in surface mining, long-wall mining and logistics.
Pace does not expect productivity increases to continue at the rates experienced
in the 1990's, as most of the relatively "easy" advances with regards to the
factors listed above have already been made (Exhibit 38). Nevertheless, Pace
expects productivity to continue to be significantly higher in the Western
United States, primarily the Power River Basin ("PRB"), compared to mines east
of the Mississippi.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 47
(PACE LOGO -- Global Energy Services)
EXHIBIT 38: U.S. COAL MINING PRODUCTIVITY, 1949-1999
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 38)
Source: EIA
- --------------------------------------------------------------------------------
Based on Energy Information Agency ("EIA") projections, Pace expects that
domestic coal production will increase at approximately 0.9 percent per year
between 2000 and 2020, with Western coal production, including the PRB,
increasing at approximately 2 percent annually. During the same period, Pace
expects Appalachian and Interior production to decrease by approximately 0.4
percent annually (Exhibit 39).
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 48
(PACE LOGO -- Global Energy Services)
EXHIBIT 39: HISTORICAL AND PROJECTED U.S. COAL PRODUCTION, 1995 - 2020
- --------------------------------------------------------------------------------
(GRAPH - EXHIBIT 39)
Source: EIA.
- --------------------------------------------------------------------------------
Pace expects relatively steady demand growth for coal over the next two decades,
with the dominant market remaining the electric power industry. In 2000, power
generation consumed approximately 91 percent of U.S. coal production, while 51
percent of net generation was met by coal.(7) Future coal demand will rely
largely on increasing capacity utilization at existing coal units due to low
coal-fired capacity additions over the past decade and projections for only
limited additions over the forecast. Pace expects that new natural gas units
will account for most new generation capacity.
The domestic coal market is considerably less liquid than the natural gas or oil
products market. Historically, electricity generators have purchased
approximately 80 percent of their coal under contracts lasting one year or more
in order to ensure security of supply. While it is likely that utilities will
continue to use the spot coal market, Pace expects electricity generators to
continue to opt for a significant proportion of longer term contracts in order
to supply their plant portfolios. Currently, non-spot coal supply contracts have
an average term of three years.
- ------------------------------------
(7) Excludes cogeneration facilities reported in the EIA's industrial and
commercial sectors.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 49
(PACE LOGO -- Global Energy Services)
TRANSPORTATION FORECAST AND TRENDS
Pace's view of market trends over the forecast period for the major modes of
coal transportation--rail, inland and coastal barge, ocean freight, and
truck--are presented in the sections that follow.
- Consolidation is the most significant issue for railroads in the next
twenty to thirty years. Even though the eastern and western markets are
duopolistic, Burlington Northern Santa Fe ("BNSF") and Union Pacific
("UP") in the West and CSX and Norfolk Southern ("NS") in the East, the
railroads tend to compete in each other's service territories.
Consequently, Pace projects that coal rail transportation rates to plants
with access to more than one railroad or transportation mode will decline
by 2 percent per year between 2001-2020. Pace does not expect rates to
plants served by only one railroad to see any decrease without
competition from a second railroad. Technological improvements allowing
for longer trains and more coal on each car have driven productivity
increases and will continue to do so. Improved logistics management is
also expected to continue to reduce cycle times and increase utilization
rates.
- Consolidation is expected to continue in the inland barge industry during
the next three to five years, as significant investments are required to
replace and add to existing fleets. In real terms, Pace expects barge
transportation rates to decline slightly for the next couple of years.
Between 2003 and 2008, Pace expects average rates to increase 6.5 percent
annually to recover higher capital spending requirements. Pace forecasts
that average barge rates will decline by an average 1 percent per year
between 2009-2020, with a commensurate fall in rates for coal
transportation by coastal barge.
- Ocean freight rates are notoriously volatile in the short term but
relatively stable on average over the long term. Average dry bulk freight
rates over the last 20 years have been flat or declining slightly in
nominal terms, equivalent to a decline in real terms. Pace applies an
annual decline of 2% until 2020 to represent the average long-term
behavior of freight rates.
- Coal trucking rates in both the West and East are impacted by two major
cost components: diesel fuel and labor. Because of the ease of market
penetration in the trucking industry, a general surplus of truckers is
usually available. Consequently, most truckers have only a limited
ability to pass on increased costs, such as higher diesel fuel prices.
Since each state has different weight laws for loaded trucks, rates are
different in each state for the same mileage. Assuming unchanged
regulations and law enforcement, Pace expects that coal-trucking rates
will decline by an average 1 percent per year over the forecast.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 50
(PACE LOGO -- Global Energy Services)
URANIUM
Pace expects uranium prices to remain constant in real terms over the next 20
years. Therefore, Pace assumed utility uranium prices would be equal to their
1996 average value (zero percent annual real rate of escalation).
EXISTING GENERATING CAPACITY PROFILES
Pace reviewed and assessed the existing and expected power generation resource
mix, the operational characteristics of capacity in PJM, and the cost profile of
existing units.
EXISTING UNIT COST PROFILE
For characterization of existing capacity, Pace utilized plant and unit specific
data for 1998 as reported to FERC and the EIA detailing variable O&M, fixed O&M,
fuel costs (adjusted for market delivered prices), capital expenditures, heat
rate efficiency, and summer and winter capacity. Given that capital costs are
not reported at the plant level, Pace has developed a methodology for allocating
utility-level embedded costs to each major power plant in the region.
Pace expects that variable and fixed O&M will remain constant over the 20 year
forecast period. Further, in order to maintain a level of conservativeness
underlying the Base Case Pace did not retire any existing units except for
nuclear capacity as detailed in the next section.
NUCLEAR UNIT ASSESSMENT
Accounting for approximately 21% of installed capacity in PJM nuclear capacity
has a significant impact on the regional electric power markets and the expected
need for additional capacity into the future.
The nuclear industry has been subject to much uncertainty regarding future plant
operations. Specifically, the nuclear fleet must address issues associated with
design, cost, and re-licensing in order to establish future availability. While
license renewal remains an uncertainty for several plants in this and other
regions nationwide, the Calvert Cliffs nuclear facility in PJM is the first
nuclear facility in the U.S. to receive license renewal. A final ruling on the
license application was issued by the Nuclear Regulatory Commission ("NRC") on
March 23, 2000 and provides for license extension through 2034 and 2036 for
Units 1 and 2, respectively.
In addition, nuclear asset purchases have enjoyed significant attention from
market participants. Groups particularly active in nuclear tenders include
Entergy, AmerGen (a
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 51
(PACE LOGO -- Global Energy Services)
joint venture of PECO Energy and British Energy), and more recently, Dominion
Resources. Calling upon core competencies in nuclear asset operations, these
firms hope to decrease operating costs, increase plant margins through pooling
multiple nuclear assets, and ultimately, reduce costs associated with
decommissioning. However, it is currently unclear whether these and other
nuclear operators intend to expend significant capital to refurbish and maintain
these units past their license expiration or if they intend to decommission
these units when major investment is required.
Given the uncertainty surrounding the future of nuclear generation, Pace assumes
that all nuclear units in PJM will retire at their license expiration date.
Exhibit 40 provides a list of existing nuclear capacity located in PJM and the
current NRC license expiration date.
EXHIBIT 40: PJM NUCLEAR UNITS
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------------------------
SUMMER YEAR LICENSE
SUB- CAPACITY ORIGINALLY EXPIRATION/
REGION REGION PLANT NAME UNIT # OWNER(S) (MW) CONSTRUCTED RETIREMENT
- ------------------------------------------------------------------------------------------------------------------------------------
MAAC South Calvert Cliffs 1 BG&E 835 1975 2034
MAAC South Calvert Cliffs 2 BG&E 840 1977 2036
MAAC ACE Hope Creek 1 PSE&G and ACE 1,031 1987 2026
MAAC Northeast Limerick 1 PECO Energy Co. 1,155 1986 2024
MAAC Northeast Limerick 2 PECO Energy Co. 1,155 1990 2029
MAAC Northeast Oyster Creek 1 AmerGen Energy (PECO and British 619 1969 2009
Energy)
MAAC Northeast Peach Bottom 2 PECO Energy Co/PSE&G/ACE/ Delmarva 1,093 1974 2013
MAAC Northeast Peach Bottom 3 PECO Energy Co/PSE&G/ACE/ Delmarva 1,093 1974 2014
MAAC Northeast Salem 1 PECO Energy Co/PSE&G/ACE/ Delmarva 1,106 1977 2016
MAAC Northeast Salem 2 PECO Energy Co/PSE&G/ACE/ Delmarva 1,124 1981 2020
MAAC Central Susquehanna 1 PP&L, Inc. and Allegheny Electric 1,090 1983 2022
Coop, Inc.
MAAC Central Susquehanna 2 PP&L, Inc. and Allegheny Electric 1,094 1985 2024
Coop, Inc.
MAAC Central Three Mile 1 AmerGen Energy (PECO and British 786 1974 2014
Island Energy)
- ------------------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 52
(PACE LOGO -- Global Energy Services)
EXPANSION GENERATING CAPACITY
NEW PLANT ANNOUNCEMENT ASSUMPTIONS
Exhibit 41 details the announced projects in PJM included in the Base Case
Forecast.
EXHIBIT 41: PJM ANNOUNCED POWER PROJECTS INCLUDED IN THE BASE CASE (MW)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL
CAPACITY
DEVELOPER PLANT NAME STATE LOCATION MW TYPE FUEL
- --------------------------------------------------------------------------------------------------------------------------------
AES Corp. Warrior Run MD South 180 ST COAL
PEI Power Archbald PA Central 25 CC METHANE
Motiva Enterprises Delaware City Refinery DE Southeast 224 ST COAL
Williams Energy Group Hazleton PA Central 250 CC GAS
AES Corp. Ironwood PA Central 720 CC GAS
Conectiv Wilmington, Phase I DE Southeast 330 CC GAS
AES Corp. Red Oak NJ Northeast 832 CC GAS
Conectiv Wilmington, Phase II DE Southeast 220 CC GAS
East Coast Power/
Tosco Refining, LP Tosco NJ Northeast 170 CT GAS
Orion/Columbia Liberty PA Northeast 568 CC GAS
PECO Energy Muddy Run PA Northeast 104 HY WAT
PEI Power/Cayuga Energy PEI Power II PA Central 45 CT GAS
Calpine Corporation Ontelaunee PA Northeast 563 CC GAS
Conectiv Bethlehem PA Northeast 550 CC GAS
PG&E Generating Mantua Creek NJ Northeast 803 CC GAS
PP&L Global Martins Creek PA Northeast 600 CC GAS
PSEG Power Bergen NJ Northeast 500 CC GAS
PSEG Power Linden NJ Northeast 1,186 CC GAS
- --------------------------------------------------------------------------------------------------------------------------------
Total Announced Capacity Included 7,870
- --------------------------------------------------------------------------------------------------------------------------------
<Caption>
- ---------------------------------------- --------------
ASSUMED
ON-LINE
DEVELOPER YEAR
- ---------------------------------------- --------------
AES Corp. In Operation
PEI Power In Operation
Motiva Enterprises In Operation
Williams Energy Group In Operation
AES Corp. 2001
Conectiv 2001
AES Corp. 2002
Conectiv 2002
East Coast Power/
Tosco Refining, LP 2001
Orion/Columbia 2001
PECO Energy 2001
PEI Power/Cayuga Energy 2001
Calpine Corporation 2002
Conectiv 2003
PG&E Generating 2003
PP&L Global 2003
PSEG Power 2002
PSEG Power 2003
- --------------------------------------------------------------------------------------------------------------------------------
Total Announced Capacity Included
- --------------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
Pace believes that while 679 MW of recently announced projects are already
operational, as much as 7,191 MW has a potential of reaching commercial
operation between 2001 and 2003. Pace made this determination through the review
of trade press, discussions with market participants, and other publicly
available information. Specifically, Pace assesses where the developer is in the
development process (i.e., permitting, financing, or construction), and the
confidence level associated with the developer of the respective facility.
After 2003, Pace expects that further merchant projects will be announced and
built to meet demand. Market price expectations and developer growth strategies
will drive these new project additions.
EXPANSION UNIT CHARACTERISTICS AND COSTS
In evaluating potential generation technologies for meeting future demand
requirements in the region, Pace assessed each technology's maturity level,
operating history, and duty cycle. The region's existing power supply system is
comprised of an abundance of base-load power plants (e.g., coal, nuclear, and
hydro) and abundant intermediate and peaking capabilities.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 53
(PACE LOGO -- Global Energy Services)
Based on Pace's review of available generation technologies and consultation
with equipment manufacturers, three generic types of technologies were
designated as potential candidates for meeting future demand requirements for
purposes of this analysis:
- Pulverized Coal-Fired Capacity--to meet base load requirements.
- Gas-Fired Combined Cycle--to meet base load through intermediate
requirements.
- Gas-Fired Combustion Turbine--to meet peak load requirements.
The characteristics of these standard units are detailed in Exhibit 42. These
expansion unit costs drive the expansion-planning module to determine the
necessary capacity additions to meet projected demand and provide reserves with
the optimum mix of gas-fired combustion turbine, gas-fired combined cycle, and
coal-fired steam turbine capacity.
EXHIBIT 42: EXPANSION UNIT CHARACTERISTICS
- --------------------------------------------------------------------------------
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------
ITEM UNIT CT CC CC COAL
- --------------------------------------------------------------------------------------------------------
MODEL OR TECHNOLOGY F G
- --------------------------------------------------------------------------------------------------------
Assumptions
- --------------------------------------------------------------------------------------------------------
Available Year Year 1999 1999 2005
- --------------------------------------------------------------------------------------------------------
Capacity MW 170 530 530 500
- --------------------------------------------------------------------------------------------------------
Cost $/kW 345 525 536 1,150
- --------------------------------------------------------------------------------------------------------
Variable O&M $/MWh 3.5 1.75 1.75 2.5
- --------------------------------------------------------------------------------------------------------
Fixed O&M $/kW-yr 8.00 14.00 18.20 29.00
- --------------------------------------------------------------------------------------------------------
Heat Rate-Winter Btu/kWh 10,088 7,050 6,850 9,600
- --------------------------------------------------------------------------------------------------------
Heat Rate-Summer Btu/kWh 10,400 7,262 7,056 9,888
- --------------------------------------------------------------------------------------------------------
Forced Outage % 2.5 2.5 2.5 2.5
- --------------------------------------------------------------------------------------------------------
Annual Maintenance Weeks 2.0 3.0 3.5 4.5
- --------------------------------------------------------------------------------------------------------
Percent Equity % 50 40 40 40
- --------------------------------------------------------------------------------------------------------
Interest % 8.5 8.5 8.5 8.5
- --------------------------------------------------------------------------------------------------------
After Tax Return on Equity % 15 15 15 15
- --------------------------------------------------------------------------------------------------------
Debt Term Years 15 15 15 15
- --------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
Pace increases these standard unit costs to account for regional variations in
land values, labor costs, property taxes, and other potential cost adders.
Pace's assumption of the regional costs and their associated adders for the PJM
sub-regions are shown in Exhibit 43. These expansion unit profiles drive the
expansion-planning module to determine the optimum mix of combustion turbine and
combined cycle capacity to meet projected demand and provide reserves.
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 54
(PACE LOGO -- Global Energy Services)
EXHIBIT 43: REGIONAL COST ADJUSTMENTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------------------------
MULTIPLE OF
MODEL STANDARD COST RESULTING FIXED O&M
ZONE ASSUMPTION ($/KW-YR.) RESULTING INSTALLED COST ($/KW)
- -------------------------------------------------------------------------------------------------------------------------------
<Caption>
CT CC CC COAL CT CC CC COAL
- -------------------------------------------------------------------------------------------------------------------------------
<Caption>
F G F G
- -------------------------------------------------------------------------------------------------------------------------------
PJM-East 1.20 9.68 21.84 21.84 34.80 414 630 643 1,380
- -------------------------------------------------------------------------------------------------------------------------------
PJM-South 1.175 9.40 16.80 21.38 34.07 405 617 630 1,351
- -------------------------------------------------------------------------------------------------------------------------------
PJM-West 1.125 9.00 15.75 20.47 32.62 388 591 603 1,294
- -------------------------------------------------------------------------------------------------------------------------------
NYPP-NYC 1.25 10.00 17.50 22.75 36.25 431 656 670 1,438
- -------------------------------------------------------------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROPRIETARY & CONFIDENTIAL 55
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR OTHER PERSON TO GIVE YOU
WRITTEN INFORMATION OTHER THAN THIS PROSPECTUS OR TO MAKE REPRESENTATIONS AS TO
MATTERS NOT STATED IN THIS PROSPECTUS. YOU MUST NOT RELY ON UNAUTHORIZED
INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL THE BONDS OR OUR
SOLICITATION OF YOUR OFFER TO BUY THE BONDS IN ANY JURISDICTION WHERE THAT WOULD
NOT BE PERMITTED OR LEGAL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALES
MADE HEREUNDER AFTER THE DATE OF THIS PROSPECTUS SHALL CREATE AN IMPLICATION
THAT THE INFORMATION CONTAINED HEREIN OR THE AFFAIRS OF THE COMPANY HAVE NOT
CHANGED SINCE THE DATE OF THIS PROSPECTUS.
UNTIL , ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNUSED
ALLOTMENTS OR SUBSCRIPTIONS.
CEDAR BRAKES II, L.L.C.
$431,407,000
OFFER TO EXCHANGE ALL OUTSTANDING
9.875% SERIES A SENIOR SECURED BONDS DUE 2013
FOR
9.875% SERIES B SENIOR SECURED BONDS DUE 2013
-------------------------
PROSPECTUS
-------------------------
, 2002
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART II
INFORMATION REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF MANAGERS AND OFFICERS
Our limited liability company agreement provides that, except to the extent
expressly prohibited by the Delaware Limited Liability Company Act, we must
indemnify each person made or threatened to be made a party to any action or
proceeding, whether civil or criminal, by reason of the fact that the person or
the person's testator or intestate is or was our member or officer, against
judgments, fines (including excise taxes assessed on a person with respect to an
employee benefit plan), penalties, amounts paid in settlement and reasonable
expenses, including attorneys' fees, actually and necessarily incurred in
connection with such action or proceeding, or any appeal from such actions or
proceedings; provided that no indemnification will be made if a judgment or
other final adjudication adverse to the person establishes that his conduct did
not meet the then applicable minimum statutory standards of conduct; and
provided, further, that no indemnification will be required to any settlement or
other non-adjudicated disposition of any threatened or pending action or
proceeding unless we have given our prior consent to such settlement or such
other disposition, which consent will not be unreasonably withheld.
Section 18-108 of the Delaware Limited Liability Company Act states as
follows:
"Subject to such standards and restrictions, if any, as are set forth
in its limited liability company agreement, a limited liability company
may, and shall have the power to, indemnify and hold harmless any member or
manager or other person from and against any and all claims and demands
whatsoever."
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to managers, officers or persons controlling us pursuant to the
foregoing, we have been informed that, in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1* -- Certificate of Formation of Cedar Brakes IV, L.L.C. (now
known as Cedar Brakes II, L.L.C.) dated May 3, 2001
3.1.1* -- Certificate of Amendment to the Certificate of Formation of
Cedar Brakes IV, L.L.C., dated August 1, 2001
3.2* -- Amended and Restated Limited Liability Company Agreement of
Cedar Brakes II, L.L.C. dated December 12, 2001
4.1* -- Indenture dated as of December 12, 2001 between Cedar Brakes
II, L.L.C. and Bankers Trust Company, as Trustee
4.2* -- Form of 9.875% Series B Senior Secured Bonds due September
1, 2013
4.3* -- Assignment and Security Agreement dated as of December 12,
2001 by and among Cedar Brakes II, L.L.C., as Issuer,
Bankers Trust Company, as Trustee, and Bankers Trust
Company, as Accounts Agent
4.4* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., El Paso Corporation and Bankers
Trust Company, as Trustee
4.5* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., El Paso Merchant Energy, L.P. and
Bankers Trust Company, as Trustee
4.6* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., Public Service Electric and Gas
Company and Bankers Trust Company, as Trustee
4.7* -- Registration Rights Agreement dated as of December 7, 2001
between Cedar Brakes II, L.L.C., as Issuer, and Credit
Suisse First Boston Corporation, as Initial Purchaser
</Table>
II-1
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
5.1* -- Opinion of Chadbourne & Parke LLP as to the legality of the
bonds being registered hereby
8.1* -- Opinion of Chadbourne & Parke LLP regarding tax matters
10.1* -- Amended and Restated Power Purchase Agreement dated as of
May 23, 2001 between Cedar Brakes IV, L.L.C. and Public
Service Electric and Gas Company
10.2* -- Power Purchase Agreement dated October 1, 2001 between El
Paso Merchant Energy, L.P. and Cedar Brakes II, L.L.C.
10.2.1* -- Amendment to the Power Purchase Agreement, dated as of
November 26, 2001, by and between El Paso Merchant Energy,
L.P. and Cedar Brakes II, L.L.C.
10.3* -- Administrative Services Agreement dated as of December 12,
2001 between El Paso Merchant Energy, L.P. and Cedar Brakes
II, L.L.C.
10.4* -- Guaranty dated as of December 12, 2001 from El Paso
Corporation of the performance of El Paso Merchant Energy,
L.P. under the Power Purchase Agreement (included as Exhibit
10.2 hereto) and the Administrative Services Agreement
(included as Exhibit 10.3 hereto)
10.5* -- Purchase Agreement dated December 7, 2001 between Cedar
Brakes II, L.L.C., as Issuer, and Credit Suisse First Boston
Corporation, as Initial Purchaser
12.1* -- Statement Regarding Computation of Ratios as of December 31,
2001
12.2 -- Statement Regarding Computation of Ratios as of March 31,
2002
23.1 -- Consent of PricewaterhouseCoopers LLP
23.2* -- Consent of Pace Global Energy Services, LLC
23.3* -- Consent of Chadbourne & Parke LLP (included in Exhibit 8.1
hereto)
24.1* -- Power of Attorney (included on the signature page of this
Registration Statement)
25.1 -- Statement of Eligibility of Trustee dated as of May 20, 2002
by Deutsche Bank Trust Company Americas
99.1* -- Form of Letter of Transmittal for the 9.875% Series A Senior
Secured Bonds Due 2013
99.2* -- Form of Notice of Guaranteed Delivery for the 9.875% Series
A Senior Secured Bonds Due 2013
99.3* -- Form of Letter to Holders
99.4* -- Form of Letter to Clients
99.5* -- Form of Letter to Registered Holders and Depositary Trust
Company Participants
99.6* -- Guidelines for Certification of Taxpayer Identification
Number on Substitute Form W-9
99.7* -- Form of Exchange Agent Agreement
</Table>
- ---------------
* Previously filed
ITEM 22. UNDERTAKINGS
(a) Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended (the "Securities Act"), may be permitted to directors,
officers and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that, in the opinion
of the Securities and Exchange Commission, such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless, in the opinion of its counsel, the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
II-2
(b) The undersigned registrant hereby undertakes:
(1) to file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement;
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) to reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20 percent change
in the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) to include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement;
(2) that, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof;
(3) to remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering;
(4) that prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), the issuer undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other Items
of the applicable form.
(5) that every prospectus (i) that is filed pursuant to paragraph (4)
immediately preceding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Securities Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the registration statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(6) to respond to requests for information that is incorporated by
reference into this prospectus pursuant to Items 4, 10(b), 11 or 13 of this
Form, within one business day of receipt of such request, and to send the
incorporated documents by first class mail or other equally prompt means.
This includes information contained in documents filed subsequent to the
effective date of the registration statement through the date of responding
to the request; and
(7) to supply by means of a post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the registration statement when
it became effective.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Houston,
Texas, on June 21, 2002.
CEDAR BRAKES II, L.L.C.
By: /s/ JOHN L. HARRISON
------------------------------------
John L. Harrison
Senior Vice President, Chief
Financial Officer, Treasurer and
Class A Manager
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
* President June 21, 2002
------------------------------------------------
Clark C. Smith
/s/ JOHN L. HARRISON Senior Vice President, Chief June 21, 2002
------------------------------------------------ Financial Officer, Treasurer and
John L. Harrison Class A Manager
(Principal Financial Officer)
* Vice President, Managing Director June 21, 2002
------------------------------------------------ and Controller
Cecilia T. Heilmann (Principal Accounting Officer)
* Class A Manager June 21, 2002
------------------------------------------------
Timothy Sullivan
/s/ KURT REGULSKI Class A Manager June 21, 2002
------------------------------------------------
Kurt Regulski
*By: /s/ JOHN L. HARRISON
- --------------------------------------------------
John L. Harrison
Attorney-in-fact
</Table>
II-4
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1* -- Certificate of Formation of Cedar Brakes IV, L.L.C. (now
known as Cedar Brakes II, L.L.C.) dated May 3, 2001
3.1.1* -- Certificate of Amendment to the Certificate of Formation of
Cedar Brakes IV, L.L.C., dated August 1, 2001
3.2* -- Amended and Restated Limited Liability Company Agreement of
Cedar Brakes II, L.L.C. dated December 12, 2001
4.1* -- Indenture dated as of December 12, 2001 between Cedar Brakes
II, L.L.C. and Bankers Trust Company, as Trustee
4.2* -- Form of 9.875% Series B Senior Secured Bonds due September
1, 2013
4.3* -- Assignment and Security Agreement dated as of December 12,
2001 by and among Cedar Brakes II, L.L.C., as Issuer,
Bankers Trust Company, as Trustee, and Bankers Trust
Company, as Accounts Agent
4.4* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., El Paso Corporation and Bankers
Trust Company, as Trustee
4.5* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., El Paso Merchant Energy, L.P. and
Bankers Trust Company, as Trustee
4.6* -- Consent and Agreement dated as of December 12, 2001 among
Cedar Brakes II, L.L.C., Public Service Electric and Gas
Company and Bankers Trust Company, as Trustee
4.7* -- Registration Rights Agreement dated as of December 7, 2001
between Cedar Brakes II, L.L.C., as Issuer, and Credit
Suisse First Boston Corporation, as Initial Purchaser
5.1* -- Opinion of Chadbourne & Parke LLP as to the legality of the
bonds being registered hereby
8.1* -- Opinion of Chadbourne & Parke LLP regarding tax matters
10.1* -- Amended and Restated Power Purchase Agreement dated as of
May 23, 2001 between Cedar Brakes IV, L.L.C. and Public
Service Electric and Gas Company
10.2* -- Power Purchase Agreement dated October 1, 2001 between El
Paso Merchant Energy, L.P. and Cedar Brakes II, L.L.C.
10.2.1* -- Amendment to the Power Purchase Agreement, dated as of
November 26, 2001, by and between El Paso Merchant Energy,
L.P. and Cedar Brakes II, L.L.C.
10.3* -- Administrative Services Agreement dated as of December 12,
2001 between El Paso Merchant Energy, L.P. and Cedar Brakes
II, L.L.C.
10.4* -- Guaranty dated as of December 12, 2001 from El Paso
Corporation of the performance of El Paso Merchant Energy,
L.P. under the Power Purchase Agreement (included as Exhibit
10.2 hereto) and the Administrative Services Agreement
(included as Exhibit 10.3 hereto)
10.5* -- Purchase Agreement dated December 7, 2001 between Cedar
Brakes II, L.L.C., as Issuer, and Credit Suisse First Boston
Corporation, as Initial Purchaser
12.1* -- Statement Regarding Computation of Ratios as of December 31,
2001
12.2 -- Statement Regarding Computation of Ratios as of March 31,
2002
23.1 -- Consent of PricewaterhouseCoopers LLP
23.2* -- Consent of Pace Global Energy Services, LLC
23.3* -- Consent of Chadbourne & Parke LLP (included in Exhibit 8.1
hereto)
24.1* -- Power of Attorney (included on the signature page of this
Registration Statement)
25.1 -- Statement of Eligibility of Trustee dated as of May 20, 2002
by Deutsche Bank Trust Company Americas
99.1* -- Form of Letter of Transmittal for the 9.875% Series A Senior
Secured Bonds Due 2013
99.2* -- Form of Notice of Guaranteed Delivery for the 9.875% Series
A Senior Secured Bonds Due 2013
99.3* -- Form of Letter to Holders
99.4* -- Form of Letter to Clients
</Table>
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
99.5* -- Form of Letter to Registered Holders and Depositary Trust
Company Participants
99.6* -- Guidelines for Certification of Taxpayer Identification
Number on Substitute Form W-9
99.7* -- Form of Exchange Agent Agreement
</Table>
- ---------------
* Previously filed