<Page>
EXHIBIT 1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Members
CE Generation, LLC
Omaha, Nebraska
We have audited the accompanying consolidated balance sheet of CE
Generation, LLC and subsidiaries (collectively, the "Company") as of December
31, 2002, and the related consolidated statements of operations and other
comprehensive income, members' equity, and cash flows for the year ended
December 31, 2002. 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 in accordance with auditing standards generally
accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CE Generation, LLC and
subsidiaries as of December 31, 2002 and the results of their operations and
their cash flows for the year ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, in 2002
the Company changed its accounting policy for goodwill and other intangible
assets.
Omaha, Nebraska (Signed) "DELOITTE & TOUCHE LLP"
January 24, 2003 (January 29, 2003 as to Note 11
and September 23, 2003 as to Note 12)
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CE GENERATION, LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 2002
(Amounts in Thousands)
<Table>
<Caption>
DECEMBER 31,
2002
------------
ASSETS
Current assets:
Cash and cash equivalents.................................................................................... $43,706
Restricted cash.............................................................................................. 60,238
Accounts receivable, net of allowance for doubtful accounts of $6,496........................................ 63,554
Prepaid expenses and other assets............................................................................ 9,943
Inventories.................................................................................................. 25,049
------
Total current assets....................................................................................... 202,490
Restricted cash................................................................................................ 14,299
Properties, plants, contracts and equipment, net............................................................... 1,234,408
Excess of cost over fair value of net assets acquired.......................................................... 265,897
Note receivable from related party............................................................................. 137,789
Deferred financing charges and other assets.................................................................... 10,153
------
TOTAL ASSETS................................................................................................... $1,865,036
==========
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities............................................................... $63,103
Due to affiliates............................................................................................ 406
Current portion of long-term debt............................................................................ 86,656
------
Total current liabilities.................................................................................. 150,165
Project loans................................................................................................ 122,573
Salton Sea notes and bonds................................................................................... 463,591
Senior secured bonds......................................................................................... 338,400
Deferred income taxes........................................................................................ 248,033
-------
Total liabilities.......................................................................................... 1,322,762
Minority interest.............................................................................................. 52,379
Commitments and contingencies (Notes 4 and 10)
Members' equity................................................................................................ 499,748
Accumulated other comprehensive loss, net...................................................................... (9,853)
-------
Total members' equity........................................................................................ 489,895
-------
TOTAL LIABILITIES AND MEMBERS' EQUITY.......................................................................... $1,865,036
==========
</Table>
(Signed) "IAN A. BOURNE" (Signed) "TOM COYLE"
Ian A. Bourne Tom Coyle
Director Director
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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CE GENERATION, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED DECEMBER 31, 2002
(Amounts in Thousands)
<Table>
<Caption>
DECEMBER 31,
2002
------------
REVENUE:
Operating revenue.............................................................................................. $500,729
Interest and other income...................................................................................... 9,353
-----
Total revenue................................................................................................ 510,082
COSTS AND EXPENSES:
Fuel........................................................................................................... 121,736
Plant operations............................................................................................... 134,065
General and administrative..................................................................................... 6,899
Depreciation and amortization.................................................................................. 82,055
Interest expense............................................................................................... 76,697
------
Total costs and expenses..................................................................................... 421,452
-------
INCOME BEFORE PROVISION FOR INCOME TAXES....................................................................... 88,630
Provision for income taxes..................................................................................... 9,559
-----
INCOME BEFORE MINORITY INTEREST................................................................................ 79,071
Minority interest.............................................................................................. 20,757
------
NET INCOME..................................................................................................... $58,314
=======
OTHER COMPREHENSIVE INCOME:
Unrealized loss on cash flow hedges, net of tax of $1,438...................................................... (2,157)
------
COMPREHENSIVE INCOME........................................................................................... $56,157
=======
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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CE GENERATION, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF MEMBERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2002
(Amounts in Thousands)
<Table>
<Caption>
MEMBERS' ACCUMULATED OTHER
EQUITY COMPREHENSIVE INCOME TOTAL
-------- -------------------- --------
BALANCE, JANUARY 1, 2002........................................................... $475,073 $(7,696) $467,377
Distributions...................................................................... (33,639) -- (33,639)
Net income......................................................................... 58,314 -- 58,314
Other comprehensive income:
Change in fair value of cash flow hedges......................................... -- (2,157) (2,157)
-------- ------- --------
BALANCE, DECEMBER 31, 2002......................................................... $499,748 $(9,853) $489,895
======== ======= ========
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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CE GENERATION, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2002
(Amounts in Thousands)
<Table>
<Caption>
DECEMBER 31,
2002
------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income..................................................................................................... $58,314
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization................................................................................ 82,055
Provision for deferred income taxes.......................................................................... 10,490
Distributions to minority interest in excess of related income............................................... (5,222)
Changes in other items:
Accounts receivable, net..................................................................................... 65,171
Inventories.................................................................................................. (1,344)
Due from affiliates.......................................................................................... 538
Accounts payable and other accrued liabilities............................................................... (12,397)
Other assets................................................................................................. (58)
-------
Net cash flows from operating activities................................................................... 197,547
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures......................................................................................... (28,640)
Increase in restricted cash.................................................................................. (290)
----
Net cash flows from investing activities................................................................... (28,930)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of Salton Sea notes and bonds...................................................................... (28,572)
Repayment of Senior Secured bonds............................................................................ (20,600)
Proceeds from related party note............................................................................. 2,107
Repayment of project loans................................................................................... (35,864)
Distributions................................................................................................ (33,639)
Increase in restricted cash.................................................................................. (43,213)
-------
Net cash flows from financing activities................................................................... (159,781)
--------
NET INCREASE IN CASH AND CASH EQUIVALENTS...................................................................... 8,836
Cash and cash equivalents at beginning of year................................................................. 34,870
------
CASH AND CASH EQUIVALENTS AT END OF YEAR....................................................................... $43,706
=======
SUPPLEMENTAL DISCLOSURE:
Interest paid, net of interest capitalized................................................................... $74,067
=======
Income taxes paid............................................................................................ $1,199
======
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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CE GENERATION, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS
MidAmerican Energy Holdings Company ("MidAmerican" or "MEHC") completed a
strategic restructuring in conjunction with its acquisition of MHC Inc.
(formerly MidAmerican Energy Holdings Company) in which MEHC's common stock
interests in Magma Power Company, FSRI Holdings, Inc. ("FSRI") and
California Energy Development Corporation, and their subsidiaries (which
own the geothermal and natural gas-fired combined cycle cogeneration
facilities described below), were contributed by MEHC to the newly created
CE Generation, LLC ("CE Generation" or the "Company"). This restructuring
was completed in February 1999.
On March 3, 1999, MEHC closed the sale of 50% of its ownership interests in
CE Generation to El Paso CE Generation Holding Company, which was merged
into El Paso Merchant Energy North America Company on December 31, 2000
("EPME"). EPME is an indirect subsidiary of El Paso Corporation.
BASIS OF PRESENTATION
These consolidated financial statements of CE Generation reflect the
consolidated financial statements of Magma Power Company and subsidiaries
and FSRI and subsidiaries and Yuma Cogeneration Associates, each a
wholly-owned subsidiary. All intercompany transactions and balances have
been eliminated in consolidation.
Based on the nature of the Company's products, the production process,
types of customers and the method used to distribute products; the
regulatory environment and the economic characteristics of its operations,
the Company has determined that it operates in one reportable segment.
GENERAL
CE Generation is engaged in the independent power business. The following
table sets out information concerning CE Generation's projects:
<Table>
<Caption>
FACILITY NET NET MW LOCATION POWER PURCHASE AGREEMENT
OPERATING PROJECT CAPACITY (MW) OWNED EXPIRATION
----------------- ------------- ------ ---------- ------------------------
GEOTHERMAL FACILITIES:
Salton Sea Projects
Salton Sea I....................................... 10 10 California 2017
Salton Sea II...................................... 20 20 California 2020
Salton Sea III..................................... 50 50 California 2019
Salton Sea IV...................................... 40 40 California 2026
Salton Sea V....................................... 49 49 California Year-to-year
Total Salton Sea Projects........................ 169 169
Partnership Projects
Vulcan............................................. 34 34 California 2016
Elmore............................................. 38 38 California 2018
Leathers........................................... 38 38 California 2019
Del Ranch.......................................... 38 38 California 2019
CE Turbo........................................... 10 10 California Year-to-year
Total Partnership Projects....................... 158 158
Total geothermal facilities........................ 327 327
GAS FACILITIES:
Saranac............................................ 240 180 New York 2009
Power Resources.................................... 200 200 Texas 2003
Yuma............................................... 50 50 Arizona 2024
Total gas facilities............................. 490 430
TOTAL OPERATING PROJECTS............................. 817 757
</Table>
<Page>
Salton Sea I, II, III, IV and V are referred as the Salton Sea Projects.
Vulcan, Del Ranch, Elmore, Leathers and CE Turbo are referred to as the
Partnership Projects. The Salton Sea Projects and the Partnership Projects
are collectively referred to as the Imperial Valley Projects. Saranac,
Power Resources and Yuma are referred to as the Gas Projects.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
CE Generation considers all investment instruments purchased with an
original maturity of three months or less to be cash equivalents.
Restricted cash is not considered a cash equivalent.
RESTRICTED CASH
The current restricted cash balance is composed of debt service funds that
are legally restricted as to their use and require the maintenance of
specific minimum balances equal to the next debt service payment. The
non-current restricted cash balance is composed of restricted accounts for
capital expenditures and major maintenance expenditures.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on the Company's assessment of
the collectibility of specific customer accounts and the aging of the
accounts receivable. If there is deterioration of a major customer's credit
worthiness or actual defaults are higher than the Company's historical
experience, estimates of the recoverability of amounts due it could be
adversely affected.
INVENTORIES
Inventories consist of spare parts and supplies and are valued at the lower
of cost or market. Cost for large replacement parts is determined using the
specific identification method. For the remaining supplies, cost is
determined using the weighted average cost method.
WELL COSTS
The cost of drilling and equipping production wells and other direct costs,
are capitalized and amortized on a straight line basis over their estimated
useful lives when production commences. The estimated useful lives of
production wells are twenty years.
PROPERTIES, PLANTS, CONTRACTS, EQUIPMENT AND DEPRECIATION
The cost of major additions and betterments are capitalized, while
replacements, maintenance, and repairs that do not improve or extend the
lives of the respective assets are expensed.
Depreciation of the operating power plant costs, net of salvage value if
applicable, is computed on the straight-line method over the estimated
useful life of 30 years. Depreciation of furniture, fixtures and equipment
is computed on the straight-line method over the estimated useful lives of
the related assets, which range from 3 to 30 years.
Acquired power sales agreements are amortized separately on a straight line
basis over the remaining contract periods which have ranged from 7 to 30
years at the date of acquisition.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company's long-lived assets consist primarily of property, plant and
equipment and intangible assets with useful lives that range from 3 to 40
years. The Company believes the useful lives of its long-lived assets are
reasonable.
<Page>
The Company also evaluates long-lived assets for impairment whenever events
or changes in circumstances indicate the carrying amount of an asset may
not be recoverable. Triggering events include a significant change in the
extent or manner in which long-lived assets are being used or in its
physical condition, in legal factors, or in the business climate that could
affect the value of the long-lived assets, including changes in regulation.
The interpretation of such events requires judgment from management as to
whether such an event has occurred and is required. If an event occurs that
could effect the carrying value of the asset and management does not
identify it as a triggering event, future results of operations could be
significantly affected.
Upon the occurrence of a triggering event, the carrying amount of a
long-lived asset is reviewed to assess whether the recoverable amount has
declined below its carrying amount. The recoverable amount is the estimated
net future cash flows that the Company expects to recover from the future
use of the asset, undiscounted and without interest, plus the asset's
residual value on disposal. Where the recoverable amount of the long-lived
asset is less than the carrying value, an impairment loss would be
recognized to write down the asset to its fair value, which is based on
discounted estimated cash flows from the future use of the asset.
The estimated cash flows arising from future use of the asset that are used
in the impairment analysis requires judgment regarding what the Company
would expect to recover from future use of the asset. Any changes in the
estimates of cash flows arising from future use of the asset or the
residual value of the asset on disposal based on changes in the market
conditions, changes in the use of the assets, management's plans, the
determination of the useful life of the assets and technology change in the
industry could significantly change the calculation of the fair value or
recoverable amount of the asset and the resulting impairment loss, which
could significantly affect the results of operations.
EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED
On January 1, 2002, CE Generation adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), which establishes the accounting for acquired goodwill and other
intangible assets, and provides that goodwill and indefinite-lived
intangible assets will not be amortized, but will be tested for impairment
on an annual basis. CE Generation's related amortization consists solely of
goodwill amortization, which has no income tax effect. In accordance with
SFAS 142, CE Generation completed its initial goodwill impairment test, as
of January 1, 2002, and its annual goodwill impairment test, as of October
31, 2002, during the fourth quarter of 2002, primarily using a discounted
cash flow methodology. No impairment was indicated as a result of the
impairment tests.
INTANGIBLE ASSETS
The following table summarizes the acquired intangible assets as of
December 31 (in thousands):
<Table>
<Caption>
DECEMBER 31, 2002
----------------------------------
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION
-------------- ------------
Amortized Intangible Assets:
Power Purchase Contracts............................................... $338,716 $203,685
Patented Technology.................................................... 46,290 15,385
------ ------
Total................................................................ $385,006 $219,070
======== ========
</Table>
Amortization expense on acquired intangible assets was $18.3 million for
the year ended December 31, 2002. CE Generation expects amortization
expense on acquired intangible assets to be $18.1 million for 2003 and
$14.9 million for each of the four succeeding fiscal years.
<Page>
CAPITALIZATION OF INTEREST AND DEFERRED FINANCING COSTS
Prior to the commencement of operations, interest is capitalized on the
costs of the plants and geothermal resource development to the extent
incurred. Capitalized interest and other deferred charges are amortized on
a straight-line basis over the lives of the related assets.
Deferred financing costs are amortized over the term of the related
financing using the effective interest method.
REVENUE RECOGNITION
Revenues are recorded based upon electricity and steam delivered to the end
of the month. See Note 3 for contractual terms of power sales agreements.
Royalties earned from providing geothermal resources to power plants
operated by other geothermal power producers are recorded when delivered.
INCOME TAXES
CE Generation and its subsidiaries file a consolidated federal tax return.
Deferred tax assets and liabilities are recognized based on the difference
between the financial statement and tax bases of assets and liabilities
using estimated tax rates in effect for the year in which the differences
are expected to reverse.
FINANCIAL INSTRUMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards 133/138, "Accounting for
Derivative Instruments and Hedging Activities", which was delayed by SFAS
137 and amended by SFAS 138. SFAS 133/138 requires an entity to recognize
all of its derivatives as either assets or liabilities in its statement of
financial position and measure those instruments at fair value. CE
Generation adopted SFAS 133/138 effective January 1, 2001. These interest
rate swap agreements are considered cash flow hedges and therefore the
offset is recorded in accumulated other comprehensive income. The adoption
did not have an impact on results or operations or cash flows.
CE Generation utilizes swap agreements to manage market risks and reduce
its exposure resulting from fluctuation in interest rates. For interest
rate swap agreements, the net cash amounts paid or received on the
agreements are accrued and recognized as an adjustment to interest expense.
CE Generation's practice is not to hold or issue financial instruments for
trading purposes. These instruments are either exchange traded or with
counterparties of high credit quality; therefore, the risk of
nonperformance by the counterparties is considered to be negligible.
Fair values of financial instruments are estimated based on quoted market
prices for debt issues actively traded or on market prices of similar
instruments and/or valuation techniques using market assumptions.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB, issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). This statement provides accounting
and disclosure requirements for retirement obligations associated with
long-lived assets and is effective January 1, 2003. This statement requires
that the present value of retirement costs for which the Company has a
legal obligation be recorded as liabilities with an equivalent amount added
to the asset cost and depreciated over an appropriate period. The liability
is then accreted over time by applying an interest
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method of allocation to the liability. Cumulative accretion and accumulated
depreciation will be recognized for the time period from the date the
liability would have been recognized had the provisions of this statement
been in effect, to the date of adoption of this statement. The cumulative
effect of initially applying this statement will be recognized as a
cumulative effect of a change in accounting principle that is expected to
be $2.5 million, net of tax of $1.6 million, in January 2003.
The Company's review identified legal retirement obligations for landfill
and plant abandonment costs. The Company will record liabilities pursuant
to SFAS No. 143 in January 2003. The Company used an expected cash flow
approach to measure the obligations. The following proforma liabilities
reflect amounts as if this statement had been applied during the period (in
thousands):
<Table>
<Caption>
DECEMBER 31,
2002
------------
Plant abandonment............................................ $3,798
Landfill abandonment......................................... 3,663
</Table>
The plant abandonment had no previously recorded liability. The landfill
abandonment had a previously recorded liability of $1.5 million.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the
fair value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective
for financial statements of interim or annual periods ending after December
15, 2002. The Company does not expect the adoption of FIN 45 to have a
material effect on its financial position, results of operations, or cash
flows.
3. PROPERTIES, PLANTS, CONTRACTS AND EQUIPMENT, NET
Properties, plants, contracts and equipment comprise the following at
December 31 (in thousands):
<Table>
<Caption>
DECEMBER 31,
2002
------------
Cost:
Power plants............................................... $1,288,281
Wells and resource development............................. 180,151
Power sales agreements..................................... 338,716
Licenses and equipment..................................... 50,501
------
1,857,649
Accumulated depreciation and amortization.................... (623,241)
--------
$1,234,408
==========
</Table>
SIGNIFICANT CUSTOMERS AND CONTRACTS
CE Generation's sales of electricity from the Imperial Valley Projects,
comprised approximately 37% of 2002 electricity and steam revenues. Of
these sales, approximately 95% were to Southern California Edison
("Edison") in 2002. Sales of electricity from the Saranac Project comprised
approximately 37% of the 2002 electricity and steam revenues. Of these
sales approximately 98% were to New York State Electric and Gas ("NYSEG").
Sales of electricity from the Power Resources Project comprised
approximately 19% of the 2002 electricity and steam revenues. Of these
sales approximately 97% were to TXU Generation Company LP ("TXU"). Accounts
receivable,
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approximately $25.1 million of which are from Edison, approximately $16
million from NYSEG and approximately $8 million from TXU are primarily
uncollateralized receivables from long-term power purchase contracts
described below. If the customers were unable to perform, CE Generation
could incur an accounting loss equal to $63.6 million at December 31, 2002.
IMPERIAL VALLEY PROJECTS
Each of the Imperial Valley Projects, excluding the CE Turbo and Salton Sea
V Projects, sells electricity to Edison pursuant to a separate Standard
Offer No. 4 Agreement ("SO4 Agreement") or a negotiated power purchase
agreement. Each power purchase agreement is independent of the others, and
the performance requirements specified within one such agreement apply only
to the Project, which is subject to the agreement. The power purchase
agreements provide for energy payments, capacity payments and capacity
bonus payments. Edison makes fixed annual capacity payments and capacity
bonus payments to the projects to the extent that capacity factors exceed
certain benchmarks. The price for capacity is fixed for the life of the SO4
Agreements and are significantly higher in the months of June through
September.
Energy payments for the SO4 Agreement were at increasing fixed rates for
the first ten years after firm operation and thereafter at a rate based on
the cost that Edison avoids by purchasing energy from the project instead
of obtaining the energy from other sources ("Avoided Cost of Energy"). In
June and November 2001, the Imperial Valley Projects, excluding the CE
Turbo and Salton Sea V Projects, entered into Agreements Addressing
Renewable Energy Pricing and Payment Issues with Edison ("Settlement
Agreements"). The Settlement Agreements provide for amended energy payments
under the SO4 Agreements. The amendments provide for fixed energy payments
per kWh in lieu of Edison's Avoided Cost of Energy. The fixed energy
payment was 3.25 cents per kWh from December 1, 2001 through April 30, 2002
and 5.37 cents per kWh commencing May 1, 2002 for a five-year period.
Following the five-year period, the energy payments revert back to Edison's
Avoided Cost of Energy.
For the year ended December 31, 2002, Edison's average Avoided Cost of
Energy was 3.5 cents per kWh. Estimates of Edison's future Avoided Cost of
Energy vary substantially from year to year.
The Salton Sea I Project contracts to sell electricity to Edison pursuant
to a 30-year negotiated power purchase agreement that commenced on July 1,
1987, as amended (the "Salton Sea I PPA"). The contract capacity and
contract nameplate are each 10 MW. The capacity payment is based on the
firm capacity price, which adjusts quarterly based on a basket of energy
indices for the term of the Salton Sea I PPA is currently $154.45 per
Kw-year. The capacity payment is approximately $1.1 million per annum. The
energy payment is calculated using a Base Price (defined as the initial
value of the energy payment (4.7 cents per kWh for the second quarter of
1992)), which is subject to quarterly adjustments based on a basket of
indices. The time period weighted average energy payment for Salton Sea I
was 5.8 cents per kWh during 2002. As the Salton Sea I PPA is not an SO4
Agreement, the energy payments do not revert to Edison's Avoided Cost of
Energy.
The Salton Sea II Project contracts to sell electricity to Edison pursuant
to a 30-year modified SO4 Agreement that commenced on April 5, 1990. The
contract capacity and contract nameplate are 15 MW (16.5 MW during on-peak
periods) and 20 MW, respectively. The price for contract capacity and
contract capacity bonus payments are fixed for the life of the modified SO4
Agreement. The annual capacity and bonus payments are approximately $3.3
million. The energy payments for the first ten-year period, which period
expired on April 4, 2000, were levelized at a time period weighted average
of 10.6 cents per kWh. Thereafter, the monthly energy payment was based on
Edison's Avoided Cost of Energy. Edison is entitled to receive, at no cost,
5% of all energy delivered in excess of 80% of contract capacity through
September 30, 2004.
The Salton Sea III Project contracts to sell electricity to Edison pursuant
to a 30-year modified SO4 Agreement that commenced on February 13, 1989.
The contract capacity and the contract nameplate are 47.5 MW and 49.8 MW,
respectively. The price for contract capacity payments and capacity bonus
payments is fixed at $175 per Kw-year. The annual capacity and bonus
payments are approximately $9.7 million. The energy payments for the first
ten-year period, which period expired on February 12, 1999, were levelized
at a time period weighted average of 9.8 cents per kWh. Thereafter, the
energy payment was based on Edison's Avoided Cost of Energy.
<Page>
The Salton Sea IV Project contracts to sell electricity to Edison pursuant
to a modified SO4 Agreement which provides for contract capacity payments
on 34 MW of capacity at two different rates based on the respective
contract capacities deemed attributable to the original Salton Sea I PPA
option (20 MW) and to the original Salton Sea IV SO4 Agreement ("Fish Lake
PPA") (14 MW). The capacity payment price for the 20 MW portion adjusts
quarterly based upon specified indices and the capacity payment price for
the 14 MW portion is a fixed levelized rate. The capacity and bonus
payments in 2002 were approximately $5.5 million. The energy payment (for
deliveries up to a rate of 39.6 MW) is at a base price, adjusted quarterly
based on specified indices, for 55.6% of the total energy delivered by
Salton Sea IV and is based on an energy payment schedule for 44.4% of the
total energy delivered by Salton Sea IV. The contract has a 30-year term
but Edison is not required to purchase the 20 MW of capacity and energy
originally attributable to the Salton Sea I PPA option after September 30,
2017, the original termination date of the Salton Sea I PPA.
The Salton Sea V Project, which commenced operations in the third quarter
of 2000, will sell approximately 22 MW of its output to Minerals pursuant
to a 33-year power sales agreement. The agreement provides for energy
payments based on the market rates available to the Salton Sea V Project,
adjusted for wheeling costs. The Salton Sea V Project sells its remaining
output through other market transactions.
The Vulcan Project contracts to sell electricity to Edison under a 30-year
SO4 Agreement that commenced on February 10, 1986. The Vulcan Project has a
contract capacity and contract nameplate of 29.5 MW and 34 MW,
respectively. The annual capacity and bonus payments are approximately $5.5
million.
The Elmore Project contracts to sell electricity to Edison under a 30-year
SO4 Agreement that commenced on January 1, 1989. The contract capacity and
contract nameplate are 34 MW and 38 MW, respectively. The annual capacity
and bonus payments are approximately $7.9 million.
The Leathers Project contracts to sell electricity to Edison pursuant to a
30-year SO4 Agreement that commenced on January 1, 1990. The contract
capacity and contract nameplate are 34 MW and 38 MW, respectively. The
annual capacity and bonus payments are approximately $7.5 million. The
energy payment is based on Edison's Avoided Cost of Energy.
The Del Ranch Project contracts to sell electricity to Edison under a
30-year SO4 Agreement that commenced on January 2, 1989. The contract
capacity and contract nameplate are 34 MW and 38 MW, respectively. The
annual capacity and bonus payments are approximately $7.9 million.
The CE Turbo Project, which commenced commercial operation in the third
quarter of 2000, sells its output through market transactions. The CE Turbo
Project may sell its output to CalEnergy Minerals LLC ("Minerals"), a zinc
facility owned by a subsidiary of MidAmerican, pursuant to a 33-year power
purchase agreement. The agreement provides for energy payments based on the
market rates available to the CE Turbo Project, adjusted for wheeling
costs.
The Imperial Valley Projects other than the Salton Sea I Project receive
transmission service from the Imperial Irrigation District to deliver
electricity to Edison near Mirage, California. These projects pay a rate
based on the Imperial Irrigation District's cost of service, which was
$1.70 per month per kilowatt of service provided for 2002 and recalculated
annually. The transmission service and interconnection agreements expire in
2015 for the Partnership Projects, 2019 for the Salton Sea III Project,
2020 for the Salton Sea II Project and 2026 for the Salton Sea IV Project.
The Salton Sea V and the CE Turbo Projects have entered into 30-year
agreements with similar terms with the Imperial Irrigation District. The
Salton Sea I Project delivers energy to Edison at the project site and has
no transmission service agreement with the Imperial Irrigation District.
<Page>
ROYALTIES
Royalty expense for the year ended December 31, 2002, which is included in
plant operations in the consolidated statements of operations, comprise the
following (in thousands):
<Table>
<Caption>
DECEMBER 31,
2002
------------
Salton Sea I & II............................................ $772
Salton Sea III............................................... 1,891
Salton Sea IV................................................ 3,965
Salton Sea V................................................. 212
Vulcan....................................................... 689
Elmore....................................................... 906
Leathers..................................................... 1,178
Del Ranch.................................................... 1,169
CE Turbo..................................................... 41
--
Total........................................................ $10,823
=======
</Table>
The Imperial Valley Projects obtain their geothermal resource rights from
Magma Power Company and Magma Land Company I, wholly-owned subsidiaries of
the Company.
The Partnership Projects pay royalties based on both energy revenues and
total electricity revenues. Del Ranch and Leathers pay royalties of
approximately 5% of energy revenues and 1% of total electricity revenue.
Elmore pays royalties of approximately 5% of energy revenues. Vulcan pays
royalties of approximately 4.167% of energy revenues.
The Salton Sea Project's weighted average royalty expense in 2002 was
approximately 9.8%. The royalties are paid to numerous recipients based on
varying percentages of electrical or steam production multiplied by
published indices.
GAS PROJECTS
The Saranac Project sells electricity to NYSEG pursuant to a 15-year
negotiated power purchase agreement (the "Saranac PPA"), which provides for
capacity and energy payments. Capacity payments, which in 2002 total 2.68
cents per kWh are received for electricity produced during "peak hours" as
defined in the Saranac PPA and escalate at approximately 4.1% annually for
the remaining term of the contract. Energy payments, which averaged 7.86
cents per kWh in 2002, escalate at approximately 4.4% annually for the
remaining term of the Saranac PPA. The Saranac PPA expires in June of 2009.
The Saranac Project sells steam to Georgia-Pacific and Tenneco Packaging
under long-term steam sales agreements. CE Generation believes that these
agreements will enable the Saranac Project to sell the minimum annual
quantity of steam necessary for the Saranac Project to maintain its
qualifying facility status under the Public Utility Regulatory Policies Act
of 1978, ("PURPA") for the term of the Saranac PPA.
The Saranac Project purchases natural gas from Coral Energy under a 15-year
gas supply agreement that expires in 2009. The price was $3.24 per million
MMBtu, at December 2002 and escalates at the rate of 4% per year. Coral
Energy delivers the gas to the pipeline owned by the Saranac Project's
subsidiary, North Country Gas Pipeline, which transports the gas to the
Saranac Project.
The Power Resources Project sells electricity to TXU pursuant to a 15-year
negotiated power purchase agreement ("the Power Resources PPA"), which
provides for capacity and energy payments. Capacity payments and energy
payments, which in 2002 are $3.6 million per month and 3.5 cents per kWh,
respectively, escalate at 3.5% annually for the remaining term of the Power
Resources PPA. The Power Resources PPA expires in September 2003. The Power
Resources Project sells steam to Fina Oil and Chemical under a 15-year
agreement. Power Resources has agreed to supply Fina with up to 150,000
pounds per hour of steam. As long as the Power Resources Project meets its
supply obligations, Fina is required to purchase at least the minimum
amount of steam per year required to allow
<Page>
the Power Resources Project to maintain its qualifying facility status
under PURPA.
Fina Oil and Chemical supplies 3,600 MMBtu of refinery fuel gas to the
Power Resources project under an agreement that expires in 2003. The
delivery point is at the Power Resources Project. The price was $3.02 per
MMBtu in 2002 and escalates at 2% per year. Dominion Oklahoma Texas
Exploration and Production, Inc., ("Dominion"), formerly Louis Dreyfus
Natural Gas Corporation, also supplies natural gas for the Power Resources
Project under a gas supply agreement that expires in 2003. The price for
the first 31,200 MMBtu per day under the agreement was $2.48 per MMBtu in
2002 and escalates incrementally to $2.57 per MMBtu in 2003. The price for
the second 3,000 MMBtu per day under the agreement is set at the West Texas
spot price plus $.05 per MMBtu. Additional gas may be purchased under the
agreement at prices that are negotiated with Dominion. Dominion delivers
the gas to Westar Transmission System, which transports the gas for Power
Resources to the project at a rate of $.06 to $.12 per MMBtu depending upon
the point of entry into the Westar Transmission system.
Depending upon several market variables, the Power Resources Project could
continue operation after the expiration of the Power Resources PPA. On
December 30, 2002, Power Resources obtained an exempt wholesale generator
order from the Federal Energy Regulatory Commission.
The Saranac and Power Resources Projects each delivers energy to its
respective power purchaser at or near the site of its project and does not
utilize transmission service provided by any other party. The facilities to
interconnect each of these projects to the system of the power purchaser
were constructed under the terms of its power purchase agreement.
The Yuma Project sells electricity to San Diego Gas & Electric Company
("SDG&E") under an existing 30-year power purchase contract commencing in
May 1994. The energy is sold at SDG&E's Avoided Cost of Energy and the
capacity is sold to SDG&E at a fixed price for the life of the power
purchase contract. The annual capacity payments are approximately $8.4
million. The power is wheeled to SDG&E over transmission lines constructed
and owned by Arizona Public Service Company ("APS"). The Yuma Project sells
steam to Queen Carpet, Inc. pursuant to an agreement that expires on May 1,
2024. Queen Carpet is required to take a minimum of 126,900 MMBtus of steam
per year, which the Yuma Project needs to maintain its qualifying facility
status under PURPA.
The Yuma Project purchases natural gas from Southwest Gas Corporation
("Southwest Gas"). The Yuma Project is entitled to direct Southwest Gas to
purchase gas from any of several gas supply basins and transport it to the
project. The Yuma Project pays a price based on the applicable index for
the relevant basin. The agreement may be terminated by either party, in
which case Southwest Gas would be required to provide gas transportation
service under its transportation tariff to the Yuma Project.
4. PROJECT LOANS
Each of CE Generation's direct or indirect subsidiaries is organized as a
legal entity separate and apart from CE Generation and its other
subsidiaries and MEHC. Pursuant to separate project financing agreements,
the assets of each subsidiary (excluding Yuma) are pledged or encumbered to
support or otherwise provide the security for their own project or
subsidiary debt. It should not be assumed that any asset of any subsidiary
of CE Generation, will be available to satisfy the obligations of CE
Generation or any of its other subsidiaries; provided, however, that
unrestricted cash or other assets which are available for distribution may,
subject to applicable law and the terms of financing arrangements for such
parties, be advanced, loaned, paid as dividends or otherwise distributed or
contributed to CE Generation or affiliates thereof. "Subsidiary" means all
of CE Generation's direct or indirect subsidiaries (1) owning direct or
indirect interests in the Imperial Valley Projects (including the Salton
Sea Projects and the Partnership Projects other than Magma Power Company
and Salton Sea Power Company), or (2) owning direct interests in the
subsidiaries that own interests in the foregoing projects, the Saranac
Project and the Power Resources Project.
The Power Resources Project has project financing debt with a consortium of
banks with interest and principal due quarterly over a 15-year period,
beginning March 31, 1989. The original principal carried a variable
interest rate based on the London Interbank Offer Rate ("LIBOR") with a
.85% interest margin through the 5th anniversary of the
<Page>
loan, a 1.00% interest margin from the 5th anniversary through the 12th
anniversary of the loan and a 1.25% interest margin from the 12th
anniversary through the end of the loan. The loan is collateralized by an
assignment of all revenues received by the Power Resources Project, a lien
on substantially all of its real and personal property and a pledge of its
capital stock.
The outstanding $21.7 million of project financing debt, as of December 31,
2002, is scheduled to be repaid during 2003.
Under the Power Resources Project's term loan agreement, certain covenants
and conditions must be met before cash distributions can be made, the most
significant of which is the maintenance of a historical quarterly debt
service coverage ratio of at least 1.20:1.00 in order to permit all
available cash to be distributed. The Power Resource Project was in
compliance with these requirements at December 31, 2002.
Effective June 5, 1989, the Power Resource Project entered into an interest
rate swap agreement with the lender as a means of hedging floating interest
rate exposure related to its 15-year term loan. The swap agreement was for
initial notional amounts of $55.0 million and $110.0 million, declining in
correspondence with the principal balances, and effectively fixed the
interest rates at 9.385% and 9.625%, respectively, excluding the interest
margin. The swap agreements are settled in cash based on the difference
between a fixed and floating (index based) price for the underlying debt.
The notional values of these financial instruments was $21.7 million at
December 31, 2002. The Power Resource Project would be exposed to credit
loss in the event of nonperformance by the lender under the interest rate
swap agreement. However, the Power Resource Project does not anticipate
nonperformance by the lender. The fair value of the swap as of December 31,
2002 is $1.1 million and is included in accrued liabilities in the balance
sheet.
The interest rate can be increased by payments under a Compensation
Agreement included in the Power Resources' Project term loan. The
Compensation Agreement, which entitles two of the term lenders to receive
quarterly payments equivalent to a percentage of the Power Resources
Project's discretionary cash flow ("DCF") as separately defined in the
agreement, became effective for a 13-year period ending December 31, 2003.
Under certain conditions relating to the amount of the Power Resources
Project cash flow and the restrictions on cash distributions, the Power
Resource Project has the option to replace the payment obligation in a
quarter with a payment to be calculated in a future quarter and added to
the end of the initial term of the agreement. The Compensation Agreement
entitles the lenders to payments totaling 10% of DCF for the first ten
years, 7.5% of DCF for the next three years and 10% of DCF for each quarter
added to the initial term of the agreement. The Power Resource Project
recorded additional interest expense of $1.3 million for the year ended
December 31, 2002 related to amounts owed under the Compensation Agreement.
In October 1994, the Saranac Partnership signed a 14-year note payable
agreement with a lender for an initial principal amount of $204.6 million.
Under the terms of the note payable agreement, interest rate alternatives
include an option to use a Eurodollar rate or the lender's base rate. Each
option includes an interest margin in addition to the applicable rate
selected. The selected interest rate plus interest margin at December 31,
2002 was 2.92313%.
Maturities of the note payable at December 31, 2002 are as follows (in
thousands):
<Table>
<Caption>
AMOUNT
-------
2003......................................................... $18,827
2004......................................................... 22,100
2005......................................................... 26,193
2006......................................................... 31,104
2007......................................................... 34,378
Thereafter................................................... 8,798
-----
Total........................................................ $141,400
========
</Table>
<Page>
The note agreements are collateralized by all of the Saranac Partnership's
assets. The Saranac Partnership is restricted by the terms of the note
payable agreement from making distributions or withdrawing any capital
accounts without the consent of the lender. Under the terms of the note
payable agreement, distributions may be made to the partners in accordance
with the terms of the Saranac Partnership Agreement. The note payable
agreement also requires the Saranac Partnership to maintain certain
covenants. The Saranac Partnership was in compliance with these
requirements at December 31, 2002.
Effective October 7, 1994, the Saranac Partnership entered into an interest
rate swap agreement with the lender as a means of hedging floating interest
rate exposure related to its 14-year note payable. The swap agreement was
an initial notional amount of $204.6 million and effectively fixes the
interest rate at 8.185%, which increased to 8.31% in October 2001 and will
increase to 8.56% in October 2005. The Saranac Partnership is exposed to
credit loss in the event of nonperformance by the lender under the interest
rate swap agreement. However, the Saranac Partnership does not anticipate
nonperformance by the lender. The fair value of the swap as of December 31,
2002 was $19.9 million, and is included in accrued liabilities in the
balance sheet.
The Saranac Partnership has issued an irrevocable letter of credit to its
gas supplier in the amount of $14.8 million. The Saranac Partnership has
approximately $5.7 million available in additional unissued letters of
credit. Annual fees related to these letters of credit are calculated as
1.75% of the issued balance and 0.5% of the unissued balance.
5. SALTON SEA NOTES AND BONDS
The Salton Sea Funding Corporation (the "Funding Corporation"), a
wholly-owned indirect subsidiary of CE Generation, has issued debt
securities as follows (in thousands):
<Table>
<Caption>
SENIOR
ISSUED DATE SECURED SERIES FINAL MATURITY DATE RATE DECEMBER 31, 2002
----------- -------------- ------------------- ---- -----------------
July 21, 1995.................................. B Bonds May 30, 2005 7.37% $56,661
July 21, 1995.................................. C Bonds May 30, 2010 7.84% 109,250
June 20, 1996.................................. E Bonds May 30, 2011 8.30% 46,322
October 13, 1998............................... F Bonds November 30, 2018 7.48% 279,445
--------
$491,678
========
</Table>
Principal and interest payments are made in semi annual installments. The
Salton Sea Notes and Bonds are non-recourse to CE Generation.
The net revenues, equity distributions and royalties from the Partnership
Projects are used to pay principal and interest payments on outstanding
senior secured bonds issued by Funding Corporation, the final series of
which is scheduled to mature in November 2018. Funding Corporation debt is
guaranteed by certain subsidiaries of Magma and secured by the capital
stock of CE Generation. The proceeds of Funding Corporation debt were
loaned by Funding Corporation pursuant to loan agreements and notes (the
"Imperial Valley Project Loans") to certain subsidiaries of Magma and used
for construction of certain Imperial Valley Projects, refinancing of
certain indebtedness and other purposes. Debt service on the Imperial
Valley Project Loans is used to repay debt service on Funding Corporation
debt. The Imperial Valley Project Loans and the guarantees of Funding
Corporation debt are secured by substantially all of the assets of the
guarantors, including the Imperial Valley Projects, and by the equity
interests in the guarantors.
<Page>
5. SALTON SEA NOTES AND BONDS
On October 13, 1998, Funding Corporation completed a sale to institutional
investors of $285 million aggregate amount of 7.475% Senior Secured Series
F Bonds due November 30, 2018. A portion of the proceeds was used to fund
the cost of construction of, and was advanced to, the Zinc Recovery
Project, which is indirectly 100% owned by Salton Sea Minerals Corp., a
MEHC affiliate not owned by CE Generation. The direct and indirect owners
of the Zinc Facility (the "Zinc Guarantors", which include Salton Sea
Minerals Corp. and Minerals) are among the guarantors of the Funding
Corporation debt. In connection with the divestiture, MEHC guaranteed the
payment by the Zinc Guarantors of a specified portion of the scheduled debt
service on the Imperial Valley Project Loans, including the current
principal amount of approximately $137.8 million, which is included in note
receivable to related party in the accompanied consolidated balance sheet
and associated interest.
Pursuant to a depository agreement, Funding Corporation established a debt
service reserve fund in the form of a letter of credit in the amount of
$67.6 million from which scheduled interest and principal payments could
have been made. As a result of the uncertainties related to Edison, the
letter of credit that supports the debt service reserve fund at Salton Sea
Funding Corporation has not been not renewed, and as such cash
distributions are not available to CE Generation until the Salton Sea
Funding Corporation debt service reserve fund of approximately $67.6
million, has been funded or the letter of credit has been renewed or
replaced. The fund has a cash balance of $46.3 million as of December 31,
2002.
Annual repayments of the Salton Sea Notes and Bonds for the years ending
December 31 are as follows (in thousands):
<Table>
<Caption>
AMOUNT
2003............................................................. $ 28,087
2004............................................................. 30,588
2005............................................................. 30,375
2006............................................................. 27,744
2007............................................................. 26,146
Thereafter....................................................... 348,738
--------
Total............................................................ $491,678
========
</Table>
CE Generation's ability to obtain distributions from its investment in the
Salton Sea Projects and Partnership Projects is subject to the following
conditions:
o the depositary accounts for the Salton Sea Notes and Bonds must be
fully funded;
o there cannot have occurred and be continuing any default or event of
default under the Salton Sea Notes and Bonds;
o the historical debt service coverage ratio of Funding Corporation for
the prior four fiscal quarters must be at least 1.4 to 1.0, if the
distribution occurs prior to 2000, or 1.5 to 1.0, if the distribution
occurs during or after 2000; and
o there must be sufficient geothermal resources to operate the Salton
Sea Projects at their required levels.
On July 21, 1995, Funding Corporation obtained a $15 million seven-year
revolving credit agreement between Credit Suisse as bank and agent and
other lenders. Interest rate is at the Adjusted Base Rate plus .375% or at
the LIBOR rate plus 100 basis points. There were no borrowings during the
year ended December 31, 2002.
<Page>
6. SENIOR SECURED BONDS
On March 2, 1999, CE Generation issued $400 million of 7.416% Senior
Secured Bonds due 2018. These securities are senior secured debt which rank
equally in right of payment with CE Generation's other senior secured debt
permitted under the indenture for the Securities, share equally in the
collateral with CE Generation's other senior secured debt permitted under
the indenture for the Securities, and rank senior to any of CE Generation's
subordinated debt permitted under the indenture for the Securities. These
securities are effectively subordinated to the existing project financing
debt and all other debt of CE Generation's consolidated subsidiaries.
The Senior Secured Bonds are primarily secured by the following collateral:
o all available cash flow (as defined);
o a pledge of 99% of the equity interests in Salton Sea Power and all of
CE Generation's equity interests in its other consolidated
subsidiaries;
o a pledge of all of the capital stock of SECI Holding Inc.;
o a grant of a lien on and security interest in the depository accounts;
and
o to the extent possible, a grant of a lien on and security interest in
all of CE Generation's other tangible and intangible property, to the
extent assignable.
CE Generation has issued a debt service reserve letter of credit in the
amount of $24.3 million.
Annual repayments of the Senior Secured Bonds for the years ending December
31 are as follows (in thousands):
<Table>
<Caption>
AMOUNT
--------
2003............................................................. $ 18,000
2004............................................................. 14,600
2005............................................................. 14,800
2006............................................................. 19,200
2007............................................................. 18,000
Thereafter....................................................... 271,800
--------
Total............................................................ $356,400
========
</Table>
<Page>
7. INCOME TAXES
Provision for income tax is comprised of the following at December 31 (in
thousands):
<Table>
<Caption>
DECEMBER 31,
2002
------------
Current:
Federal.................................................... $ (873)
State...................................................... (58)
-------
(931)
-------
Deferred:
Federal.................................................... 8,991
State...................................................... 1,499
-------
10,490
-------
Total provision.............................................. $ 9,559
=======
</Table>
A reconciliation of the federal statutory tax rate to the effective tax
rate applicable to income before provision for income taxes follows:
<Table>
<Caption>
DECEMBER 31,
2002
------------
Federal statutory rate....................................... 35.0%
Increases (reductions) in taxes resulting from:
Percentage depletion....................................... (18.1)
Investment and energy tax credits.......................... (2.3)
Goodwill amortization...................................... --
State taxes, net of federal benefit........................ 3.3
Minority interest.......................................... (8.2)
Other items, net........................................... 1.1
-----
Effective tax rate........................................... 10.8%
=====
</Table>
During 2002, the Company made considerable progress on several significant
income tax examination matters for prior tax years, including percentage of
depletion, which resulted in a decrease in income tax expense of $15.1
million in 2002.
Income tax expense is only provided for the taxable earnings of the
Company, including its partnership interests. No provision for income taxes
is provided in the accompanying consolidated financial statements for the
minority interests share of the partnership earnings.
<Page>
Deferred tax liabilities (assets) comprise the following at December 31 (in
thousands):
<Table>
<Caption>
DECEMBER 31,
2002
------------
Deferred tax liabilities:
Properties, plant, contracts and equipment................ $262,921
Other..................................................... 1,498
--------
Total deferred tax liabilities.......................... 264,419
Deferred tax assets:
Accruals not currently deductible for tax purposes........ (4,919)
General business tax credits.............................. (11,467)
Total deferred tax assets............................... (16,386)
--------
Net deferred tax liabilities................................ $248,033
========
</Table>
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation. Although management
uses its best judgment in estimating the fair value of these financial
instruments, there are inherent limitations in any estimation technique.
Therefore, the fair value estimates presented herein are not necessarily
indicative of the amounts, which CE Generation could realize in a current
transaction.
The fair value of the note receivable from related party is estimated based
on the quoted market price of the corresponding debt issue.
The fair value of all debt issues listed on exchanges, including the note
receivable from related party which is based on a debt issue listed on an
exchange, has been estimated based on the quoted market prices. The project
loans are estimated to have a fair value equal to the carrying values.
The carrying amounts in the table below are included in the consolidated
balance sheets under the indicated captions (in thousands):
<Table>
<Caption>
DECEMBER 31, 2002
----------------------------
CARRYING ESTIMATED FAIR
VALUE VALUE
--------- --------------
Financial Assets:
Note receivable from related parties...................... $137,789 $126,765
Financial Liabilities:
Project loans............................................. 163,142 163,142
Salton Sea notes and bonds................................ 491,678 464,552
Interest rate swaps....................................... 21,023 21,023
Senior secured bonds...................................... 356,400 313,632
</Table>
9. COMMITMENTS AND CONTINGENCIES
EDISON AND THE CALIFORNIA POWER EXCHANGE
Due to reduced liquidity, Edison had failed to pay approximately $119
million owed under the power purchase agreements with the Imperial Valley
Projects (excluding the Salton Sea V and CE Turbo Projects) for power
delivered in the fourth quarter 2000 and the first quarter 2001. Due to
Edison's failure to pay contractual obligations, the Imperial Valley
Projects (excluding the Salton Sea V and CE Turbo Projects) had established
an allowance for doubtful accounts of approximately $21 million as of
December 31, 2001.
<Page>
As a result of uncertainties related to Edison, the letter of credit that
supports the debt service reserve fund at Salton Sea Funding Corporation
has not been extended beyond its current July 2004 expiration date, and as
such, cash distributions are not available to CE Generation until the
Salton Sea Funding Corporation debt service reserve fund of approximately
$67.6 million has been funded or the letter of credit has been extended
beyond its July 2004 expiration date or replaced. The fund has a cash
balance of $46.3 million as of December 31, 2002.
Pursuant to a settlement agreement the final payment by Edison for past due
balances was received March 1, 2002. Following the receipt of Edison's
payment of past due balances, the Imperial Valley Projects released the
remaining allowance for doubtful accounts.
Edison has disputed a portion of the settlement agreement and has failed to
pay approximately $3.9 million of capacity bonus payments for the months
from October 2001 through May 2002. On December 10, 2001 the Imperial
Valley Projects (excluding the Salton Sea I, Salton Sea V and CE Turbo
Projects) filed a lawsuit against Edison in California's Imperial County
Superior Court seeking a court order requiring Edison to make the required
capacity bonus payments under the Power Purchase Agreements. Due to
Edison's failure to pay these contractual obligations, the Imperial Valley
Projects have established an allowance for doubtful accounts of
approximately $2.7 million. The Project entities are vigorously pursuing
collection of the capacity bonus payments.
On March 25, 2002, Salton Sea II's 10 MW turbine went out of service due to
an uncontrollable force event. Such uncontrollable force event ended, and
Salton Sea II returned to service, on December 17, 2002. Edison has failed
to recognize the uncontrollable force event and as such has not paid
amounts otherwise due and owing and has improperly derated Salton Sea II
from 15 MW to 12.5 MW, under the Salton Sea II Power Purchase Agreement.
In January 2001, the California Power Exchange ("PX") declared bankruptcy.
As a result, the Salton Sea V and CE Turbo Projects have not received
payment for power sold under the Transaction Agreements during December
2000 and January 2001 of approximately $3.8 million. The Imperial Valley
Projects have established an allowance for doubtful accounts for the full
amount of this receivable. The Project entities are vigorously pursuing
collection.
OTHER COMMITMENTS
Power Resources has contracted to purchase natural gas for its cogeneration
facility under two separate agreements, an 8-year agreement for up to
40,000 MMBTU per day, which expires in December 2003 and a 15-year
agreement for 3,600 MMBTU per day which expires in June 2003. These
agreements include annual price adjustments, and the 15-year agreement
includes a provision, which allows the seller to terminate the agreement
with a two-year written notice. As of December 31, 2002, the seller had not
elected to terminate this agreement; therefore, the minimum volumes under
the 15-year and 8-year agreements for the year ending December 31, 2003 are
included in the future minimum payments under these contracts of
approximately $24.9 million.
CE Generation's geothermal and cogeneration facilities are qualifying
facilities under and their contracts for the sale of electricity are
subject to regulations under PURPA. In order to promote open competition in
the industry, legislation has been proposed in the U.S. Congress that calls
for either a repeal of PURPA on a prospective basis or the significant
restructuring of the regulations governing the electric industry, including
sections of PURPA. Current federal legislative proposals would not
abrogate, amend, or modify existing contracts with electric utilities. The
ultimate outcome of any proposed legislation is unknown at this time.
<Page>
The Saranac Partnership has a contract to purchase natural gas from a third
party, for its cogeneration facility for a period of 15 years for an amount
up to 51,000 MMBtus per day which expires in 2009. The price for such
deliveries is a stated rate, escalated annually at a rate of 4%. The
minimum volumes under the agreement for the years ending December 31 are
included in the future minimum payments under the contract as follows (in
thousands):
<Table>
<Caption>
AMOUNT
--------
2003........................................................... $ 63,373
2004........................................................... 66,088
2005........................................................... 68,544
2006........................................................... 71,286
2007........................................................... 74,134
Thereafter..................................................... 130,123
--------
Total.......................................................... $473,548
========
</Table>
The Salton Sea V Project is obligated to supply the electricity demands of
the Zinc Recovery Project, which commenced operations in December 2002, at
the market rates available to the Salton Sea V Project, less the wheeling
costs. Salton Sea V Project, which commenced operations in the third
quarter of 2000, expects to sell up to 22 MW of its output to Minerals. The
remainder of the Salton Sea V Project output is sold through other market
transactions.
ENVIRONMENTAL
The Company is subject to numerous legislative and regulatory environmental
protection requirements involving air and water pollution, waste
management, hazardous chemical use, noise abatement, and land use
aesthetics.
State and federal environmental laws and regulations currently have, and
future modifications may have, the effect of (i) increasing the lead time
for the construction of new facilities, (ii) significantly increasing the
total cost of new facilities, (iii) requiring modification of the Company's
existing facilities, (iv) increasing the risk of delay on construction
projects, (v) increasing the Company's cost of waste disposal and (vi)
reducing the reliability of service provided by the Company and the amount
of energy available from the Company's facilities. Any of such items could
have a substantial impact on amounts required to be expended by the Company
in the future. Expenditures for ongoing compliance with environmental
regulations that relate to current operations are expensed or capitalized
as appropriate. Expenditures that relate to an existing condition caused by
past operations, and which do not contribute to current or future revenue
generation, are expensed. Liabilities are recorded when environmental
assessments indicate that remediation efforts are probable and the costs
can be reasonably estimated. Estimates of the liability are based upon
currently available facts, existing technology and presently enacted laws
and regulations taking into consideration the likely effects of inflation
and other social and economic factors, and include estimates of associated
legal costs. These amounts also consider prior experience in remediating
sites, other companies' clean-up experience and data released by the
Environmental Protection Agency or other organizations. These estimated
liabilities are subject to revision in future periods based on actual costs
or new circumstances, and are included in the accompanying balance sheets
at their undiscounted amounts. As of December 31, 2002, the environmental
liabilities recorded on the balance sheet were $5.3 million.
<Page>
10. RELATED PARTY TRANSACTIONS
Pursuant to the Administrative Services Agreement, MEHC provides certain
administrative and management services to CE Generation, and MEHC's
executive, financial, legal, tax and other corporate staff departments
perform certain services for CE Generation. Expenses incurred by MEHC and
allocated to CE Generation were estimated based on the individual services
and expense items provided. There were no allocated expenses in 2002. On
August 1, 2002, the Administrative Services Agreement between MEHC and CE
Generation was amended to provide for a fixed monthly fee in lieu of
certain expenses, which were being allocated. The fixed fee, which was
retroactive to January 1, 2002 and ends December 2004, is $258,333 per
month and is included in general and administrative expense.
The Company participates in multi-employer pension plans sponsored by MEHC.
The Company's contributions to the various plans was approximately $1.8
million in 2002.
On September 29, 2000, Salton Sea Power and CE Turbo entered into an
agreement to sell all available power from the Salton Sea V Project and CE
Turbo Project to EPME. Under the terms of the agreement, EPME purchased and
sold available power on behalf of Salton Sea Power and CE Turbo, into the
California ISO markets. The purchase price for the available power was
equivalent to the value actually received by EPME for the sale of such
power, including renewable premiums.
On January 17, 2001, Salton Sea Power and CE Turbo entered into a
Transaction Agreement to sell available power from the Salton Sea V Project
and CE Turbo Project to EPME. Under the terms of the agreement, at the
option of Salton Sea Power and CE Turbo, EPME purchased all available power
from the Salton Sea V Project and CE Turbo Project based on day ahead price
quotes received from EPME.
On March 27, 2001 and May 1, 2001, the Imperial Valley Projects entered
into Transaction Agreements to sell available power to EPME based on
percentages of the Dow Jones SP-15 Index. On June 22, 2001, the Imperial
Valley Projects (excluding the Salton Sea V Project and CE Turbo Project)
ceased selling available power to EPME and resumed power sales to Edison
under the Power Purchase Agreements ("PPAs"). Effective September 16, 2002
Salton Sea Power and CE Turbo entered into Transaction Agreements to sell
available power to EPME at increased percentages of the Dow Jones SP-15
Index.
Pursuant to these agreements, sales to EPME from the Company totaled $8.9
million in 2002. As of December 31, 2002, accounts receivable from EPME
were $1.4 million.
Pursuant to the November 1, 1998 Amended and Restated Power Sales
Agreements, Salton Sea Power and CE Turbo are to provide Minerals with its
full electrical energy requirements at the market rates available to them,
less wheeling costs.
Effective August 1, 2002, Salton Sea Power and CE Turbo amended their
respective power sale agreements with Minerals to provide for a fixed price
of $31.00 per megawatt hour for all hours of August 1, 2002 through
December 31, 2002. Pursuant to these agreements, sales to Minerals from
Salton Sea Power totaled $0.4 million for the year ended December 31, 2002,
and there were no sales to Minerals from CE Turbo for the year ended
December 31, 2002. There were no material accounts receivable balances at
December 31, 2002.
11. SUBSEQUENT EVENTS
On January 29, 2003, TransAlta USA Inc. ("TransAlta"), a wholly owned
subsidiary of TransAlta Corporation, purchased EPME's 50% interest in CE
Generation. Pursuant to a Transaction Agreement dated January 29, 2003,
Salton Sea Power and CE Turbo began selling available power to TransAlta on
February 12, 2003 based on percentages of the Dow Jones SP-15 Index. Such
agreement will expire on October 15, 2003.
<Page>
12. RECONCILIATION OF UNITED STATES GAAP TO CANADIAN GAAP
On January 29, 2003, TransAlta Corporation, a Canadian company, acquired a
50% interest in CE Generation, LLC from El Paso Merchant Energy North
America Company.
The financial statements of CE Generation, LLC are prepared in accordance
with United States GAAP ("US GAAP") which, in most respects, conforms to
Canadian GAAP. Significant differences between US and Canadian GAAP are as
follows:
There are no differences between US GAAP and Canadian GAAP in amounts
reported as net earnings or cash flows from operating, financing and
investing activities.
Balance sheet items in accordance with Canadian GAAP are as follows:
<Table>
<Caption>
DECEMBER 31, 2002
NOTES US GAAP CANADIAN GAAP
----- ------- -------------
Accounts payable and other accrued liabilities................ (b) $ 63,103 $ 42,080
Deferred income tax liability................................. (c) 248,033 253,503
Minority interest............................................. (d) 52,379 58,079
Members' equity............................................... -- 499,748 499,748
Accumulated other comprehensive loss.......................... (a)(b) (9,853) --
</Table>
RECONCILING ITEMS
(a) COMPREHENSIVE LOSS
Under US GAAP, specific items are required to be recognized as
components of comprehensive income (loss) and reported in a financial
statement that is displayed with the same prominence as other
financial statements, and display the accumulated balance of other
comprehensive income (loss) separately in the equity section of a
statement of financial position. Under Canadian GAAP no such reporting
requirements exist.
(b) INTEREST RATE SWAPS
As a result of the adoption of SFAS 133/138 effective January 1, 2001,
CE Generation recorded the fair value of the interest rate swap
agreements at January 1, 2001. The offset is recorded in accumulated
other comprehensive income.
The changes in the fair value of the interest swap agreements for the
year ended December 31, 2002 are recorded as a charge to comprehensive
income.
Under Canadian GAAP the fair value of the interest rate swap
agreements are not reflected in the financial statements.
(c) DEFERRED INCOME TAX LIABILITY
Income tax effect of changes in the fair value of the interest rate
swap agreements.
(d) MINORITY INTEREST
Adjustment to reflect minority interest's share of the fair value of
the interest rate swap agreements.