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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]

For the quarterly period ended June 30, 1999, or

[   ]

For the transition period from                     to                     

Commission file number 1-10070

MCN ENERGY GROUP INC.

(Exact name of registrant as specified in its charter)

Michigan

500 Griswold Street, Detroit, Michigan

48226

Registrant’s telephone number, including area code 313-256-5500

No Changes

(Former name, former address and former fiscal year, if changed since last report.)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  [X]             No  [   ]

     Number of shares outstanding of each of the registrant’s classes of common stock, as of July 30, 1999:

Common Stock, par value $.01 per share: 85,655,381

INDEX TO FORM 10-Q

For Quarter Ended June 30, 1999

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MCN ENERGY GROUP INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS

RESULTS OF OPERATIONS

Results lower due to unusual charges, partially offset by earnings from new gas sales program — MCN had a net loss for the 1999 second quarter of $86.3 million or $1.03 per share compared with a net loss of $212.6 million or $2.70 per share in the same 1998 quarter. MCN experienced a net loss in the 1999 six-and twelve-month periods of $.7 million or $.01 per share and $153.4 million or $1.91 per share, respectively, compared with a net loss of $133.7 million or $1.70 per share and $87.6 million or $1.12 per share for the same 1998 periods. As subsequently discussed, the comparability in earnings was affected by non-recurring items consisting of an accounting change and several unusual charges. The unusual charges include losses on the sale of properties, property write-downs, investment losses and restructuring charges.

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Excluding the non-recurring items, MCN had a net loss of $2.9 million for the 1999 quarter and earnings of $85.6 million and $102.0 million for the 1999 six-and twelve-month periods, respectively, resulting in decreases of $10.7 million, $1.1 million and $30.8 million from the corresponding 1998 periods. The comparisons reflect losses in the Diversified Energy group resulting from the decline in earnings in the Exploration & Production (E&P) segment due to the disposition of assets as well as increased financing costs. The decline in Diversified Energy’s results was partially offset by increased contributions from the Gas Distribution segment resulting from its new gas sales program and the favorable impact of more normal weather in the 1999 six-month period. Also affecting the comparability for the six-and twelve-month periods were gains recorded by the Diversified Energy group in 1998 from the sale of certain assets.

As discussed in Note 3 to the Consolidated Financial Statements included herein and in MCN’s 1998 Annual Report on Form 10-K/ A, MCN conducted a special investigation of prior years’ operations of CoEnergy Trading Company, its non-utility energy marketing subsidiary, subsequent to the issuance of its December 31, 1998 financial statements. As a result of the investigation, MCN identified that its internal control systems had been overridden and that certain transactions had not been properly accounted for. The accompanying consolidated financial statements for the 1998 periods have been restated from those originally reported to properly account for the transactions identified. The restatements result in an increase in net loss of $2.5 million or $.03 per share, $4.2 million or $.05 per share and $9.5 million or $.12 per share for the 1998 second quarter, six- and twelve-month periods, respectively. The corrections did not have an impact on the liquidity or cash flows of MCN. The financial information contained in Management’s Discussion and Analysis herein has been revised to reflect the impact of such restatement.

Strategic direction — MCN’s objective is to achieve competitive, long-term returns for its shareholders. Consistent with this objective, MCN announced in August 1999 a significantly revised strategic direction that includes: focusing on the Midwest-to-Northeast region rather than on North America; emphasizing operational efficiencies and growth through the integration of existing businesses rather than building a portfolio of diverse, non-operated energy investments; retaining its natural gas producing properties in Michigan while going forward with the sale of its other exploration and production oil and gas properties; and reducing capital investment levels to approximately $500 million in 1999 and to $300 million in 2000 and 2001.

Unusual charges — MCN recorded several unusual charges in the 1999 second quarter as well as the 1998 second and third quarters, consisting of losses on the sale of properties, property write-downs, investment losses and restructuring charges (Note  2).

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A discussion of each unusual charge by segment follows:

Pipelines & Processing

In the third quarter of 1998, MCN also recorded an impairment loss of $3.9 million pre-tax ($2.5 million net of taxes) relating to an acquired out-of-service pipeline in Michigan. MCN reviewed the business alternatives for this asset and determined that its development is unlikely. Accordingly, MCN recorded an impairment loss equal to the carrying value of this asset.

Electric Power

Exploration & Production

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oil reserves as well as reduced expectations of sales proceeds on unproved acreage. Under the full cost method of accounting as prescribed by the Securities and Exchange Commission, MCN’s capitalized exploration and production costs at June 30, 1999 exceeded the full cost “ceiling,” resulting in the excess being written off to income. The ceiling is the sum of discounted future net cash flows from the production of proved gas and oil reserves, and the lower of cost or estimated fair value of unproved properties, net of related income tax effects.

In the second and third quarters of 1998, MCN recognized write-downs of its gas and oil properties totaling $333.0 million pre-tax ($216.4 million net of taxes) and $83.9 million pre-tax ($54.6 million net of taxes), respectively. The write-downs were also the result of MCN’s capitalized exploration and production costs exceeding the full cost ceiling.

Losses on Sale of Properties: In the second quarter of 1999, MCN recognized losses from the sale of its Western and Midcontinent/ Gulf Coast E&P properties totaling $68.8 million pre-tax ($44.7 million net of taxes).

Loss on Investment: In the second quarter of 1999, MCN recognized a $7.5 million pre-tax ($4.9 million net of taxes) loss from the write-down of an investment in the common stock of an E&P company. MCN had also recognized a $6.1 million pre-tax loss ($4.0 million net of taxes) from the write-down of this investment during the second quarter of 1998. The losses were due to declines in the fair value of the securities that are not considered temporary. MCN has no carrying value in this investment after the write-downs.

Corporate & Other

Gas Distribution

Loss on Investment: In the third quarter of 1998, MCN also recorded an $8.5 million pre-tax loss ($5.5 million net of taxes) from the write-down of an investment in a Missouri gas distribution company that MCN expects to sell in 2000. The write-down represents the amount by which the carrying value exceeded the estimated fair value of the investment.

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Diversified Energy

*  Includes intercompany transactions

Operating and Joint Venture Income

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and $32.8 million, respectively. Results for all 1999 periods reflect reduced contributions from the Pipelines & Processing and E&P segments, partially offset by lower Corporate & Other expenses. The Electric Power segment had reduced contributions in the current quarter and six-month period. Energy Marketing had a larger loss in the current quarter and improved results in the current six-month period.

Pipelines & Processing operating and joint venture results (excluding the write-offs recorded in the 1998 third quarter) decreased by $1.5 million, $6.0 million and $15.9 million for the 1999 quarter, six- and twelve-month periods, respectively. The 1999 quarter reflects start-up expenditures associated with new projects and a decline in the “allowance for funds used during construction” (AFUDC) associated with MCN’s 16%-owned Portland Natural Gas Transmission System, as it was placed in service in the first quarter of 1999. The 1999 six- and twelve-month periods also reflect reduced earnings from MCN’s 25%-owned methanol production business resulting from lower methanol prices as well as lower methanol volumes produced. Earnings from the methanol production business benefited from strong methanol prices during 1997 and early 1998, but prices have since weakened. Pipelines & Processing’s average methanol sales prices declined 22% for the current six-month period and 37% for the 1999 twelve-month period. Methanol production declined 5.4 million gallons for the 1999 six-month period and 6.2 million gallons for the 1999 twelve-month period due primarily to the shutdown of the methanol plant for scheduled maintenance in March 1999. Additionally, Pipelines & Processing results for the 1999 twelve-month period were impacted by $9.1 million of operating losses related to the start-up of the coal fines plants (Note 2a).

Pipelines & Processing operating and joint venture income was also affected by an increase in transportation volumes for all 1999 periods due to new gas gathering ventures and the expansion of existing pipeline projects. Volumes transported increased for the 1999 quarter, six- and twelve-month periods by 10.7 billion cubic feet (Bcf), 16.9 Bcf and 40.6 Bcf, respectively. Pipelines & Processing results were also higher in all 1999 periods due to an increase in gas processed to remove natural gas liquids (NGLs). Gas processed to remove NGLs increased 10.5 Bcf, 9.0 Bcf and 16.9 Bcf in the 1999 quarter, six- and twelve-month periods, respectively, reflecting volumes associated with the acquisition and development of additional processing facilities. Pipelines & Processing operations include an increase in gas processed to remove carbon dioxide (CO₂). The volume of CO₂ gas treated increased 1.7 Bcf, 2.3 Bcf and 8.0 Bcf in the 1999 quarter, six- and twelve-month periods, respectively. However, earnings were not significantly affected by these

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increases, since under the terms of Pipelines & Processing’s CO₂ processing contracts, revenues are not volume sensitive.

*	Includes MCN’s share of joint ventures

Pipelines & Processing has also recorded earnings from certain joint venture investments where it is allocated income based on its share of the ventures’ earnings but not less than a predetermined fixed amount. Joint venture income recorded from these investments through June 1999 was based on the fixed amount. Under the joint venture agreements, the fixed amount will be lowered or eliminated in 2000.

Pipelines & Processing has a 75% interest in an asphalt manufacturing partnership that recently completed construction of a plant designed to produce annually up to 100,000 tons of high-quality asphalt. The plant is experiencing some technical difficulties in producing economical quantities of asphalt. MCN is aggressively working to resolve the technical issues.

In 1998, MCN advanced approximately $18 million to a developer of a natural gas-based fertilizer project in the United Arab Emirates. The advance was structured as an interest bearing loan with the possibility of being converted into an equity investment in the project. Under MCN’s new strategic direction, it is no longer likely that it will make an equity interest in the project. While the advance is due in September 1999, the project is being developed slower than initially anticipated and MCN’s continuing role in the project is under negotiation.

Electric Power operating and joint venture results (excluding the restructuring charges recorded in the 1998 third quarter) decreased by $3.0 million and $1.0 million in the 1999 quarter and six-month period, respectively, and increased by $.3 million in the 1999 twelve-month period. Results for all 1999 periods were unfavorably affected by an uncollectible expense provision associated with a customer in bankruptcy. Additionally, the 1999 periods were impacted by higher start-up expenditures associated with new ventures as well as reduced contributions from MCN’s international power investments, specifically its interest in the Torrent Power Limited (TPL) venture, which holds minority interests in electric distribution companies and power generation facilities in the state of Gujarat, India. In February 1999, MCN reached an agreement to sell its 40% interest in TPL for approximately $130 million. Earnings from TPL for 1999 have been deferred due to the pending sale that is expected to be completed in August 1999. MCN does not expect to incur any significant gains or losses relating to the TPL sale.

Electric Power’s earnings comparison also was impacted by increased contributions from the 1,370 megawatt (MW) Midland Cogeneration Venture (MCV) facility reflecting an increase in MCN’s interest in the MCV partnership from 18% to 23% in June 1998. Earnings from the MCV partnership for the 1999 six-and twelve-month periods include a favorable $2.1 million pre-tax

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adjustment for the resolution of a number of contract issues with the electricity purchaser. Also contributing favorably to the 1999 results were higher earnings from MCN’s 50%-owned, 123 MW Michigan Power cogeneration facility due to higher electricity capacity payments received under its long-term sales contract.

*	Includes MCN’s share of joint ventures

Energy Marketing operating and joint venture results decreased $2.1 million for the 1999 quarter, and improved $2.6 million and $.2 million for the 1999 six-and twelve-month periods, respectively. Results for all 1999 periods were impacted by higher costs for natural gas transportation and storage capacity, higher uncollectible expense as well as costs associated with the June 1999 dissolution of the DTE-CoEnergy joint venture.

The 1999 periods were also affected by improved margins due to an increase in total gas sales and exchange deliveries of 41.1 Bcf, 62.9 Bcf and 115.1 Bcf during the 1999 quarter, six- and twelve-month periods, respectively. The increase in gas sales is due in part to the April 1999 acquisition of existing marketing operations that significantly increased Energy Marketing’s level of sales to large commercial and industrial customers in the Midwest. The comparisons of earnings for all periods were also affected by losses associated with trading activities (Note 3). Additionally, the twelve-month period comparison was impacted by the December 1997 sale of Energy Marketing’s 25% interest in a gas storage project, that contributed $1.0 million of joint venture income in the 1998 twelve-month period.

*	Includes MCN’s share of joint ventures

The Washington 10 storage project, for which MCN markets 100% of the 42 Bcf of storage capacity, was completed and placed into operation in July 1999. Completion of the storage field in time for the 1999-2000 winter heating season enhances Energy Marketing’s ability to offer a reliable gas supply during peak winter months.

Exploration & Production operating and joint venture results (excluding the unusual charges recorded in the 1999 second quarter, 1998 second quarter and the 1998 third quarter) decreased by $7.9 million, $8.7 million and $23.7 million for the 1999 quarter, six- and twelve-month periods, respectively. These results reflect a decline in overall gas and oil production of 7.6 billion cubic feet equivalent (Bcfe) in the 1999 quarter, 10.9 Bcfe in the 1999 six-month period and 17.7 Bcfe in the 1999 twelve-month period. The decrease in gas and oil production is due primarily to the sale of MCN’s Western properties in April 1999. Gas and oil production in future 1999 periods will also be

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lower than the comparable 1998 periods due to the expected sale of other non-Michigan E&P properties by the end of 1999.

E&P results for all 1999 periods were also impacted by an increase in production-related expenses and variations in gas and oil sales prices. Production expenses increased per thousand cubic feet (Mcf) equivalent by $.22, $.09 and $.11 for the 1999 quarter, six- and twelve-month periods, respectively. Gas prices increased by $.19 per Mcf in the 1999 second quarter, by $.16 per Mcf in the current six-month period and by $.13 per Mcf in the 1999 twelve-month period. Oil prices increased by $.55 per barrel (Bbl) in the 1999 quarter, but declined by $1.21 per Bbl and $3.02 per Bbl in the current six- and twelve-month periods, respectively. The impact of fluctuations in natural gas and oil sales prices on E&P operating and joint venture income was mitigated by hedging with swap and futures agreements, as discussed in the “Risk Management Strategy” section that follows.

Risk management strategy — MCN manages commodity price risk by utilizing futures, options and swap contracts to more fully balance its portfolio of gas and oil supply and sales agreements. In late 1998, MCN began entering into offsetting positions for existing hedges of gas and oil production from properties that have been or were expected to be sold in 1999. MCN’s risk management strategy is being revised to reflect the change in its business that will result from its new strategic direction as previously discussed. Additionally, as a result of the special investigation, MCN is taking additional steps to ensure compliance with risk management policies that are periodically reviewed by the Board of Directors.

Corporate & Other operating and joint venture results (excluding the restructuring charges recorded in the 1998 third quarter) improved $3.8 million, $6.9 million and $6.3 million for the 1999 quarter, six- and twelve-month periods, respectively. These improvements reflect adjustments that reduce or eliminate accruals for employee incentive awards that are based on MCN’s operating or stock price performance.

Other Income and Deductions

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include lower interest income due to the collection in March 1998 of a $46 million advance made to a Philippine independent power producer. Other income in the 1999 periods includes a $3.1 million pre-tax gain recorded in the 1999 second quarter from the sale of a pipeline facility. Other income in the 1998 six- and twelve-month periods includes $9.9 million of pre-tax gains recorded in the 1998 first quarter from the sale of certain gas sales contracts and a 50% interest in the 30 MW Ada cogeneration facility. Other income for the 1998 twelve-month period includes a $3.2 million pre-tax gain from the December 1997 sale of Diversified Energy’s 25% interest in a gas storage project.

Income Taxes

Outlook

To achieve the operating efficiencies expected from the new strategic direction, MCN is working to reorganize its Diversified Energy group into the segments detailed below. Financial information beginning by year-end 1999 will be presented based on these new segments.

•	Midstream & Supply develops and manages MCN’s gas producing, gathering, processing, storage and transmission facilities within the Midwest-to-Northeast target region. It also integrates all of MCN’s gas supply functions, including purchasing the commodity itself and aggregating the transportation and storage capacity required to deliver the gas to the Gas Distribution, Energy Marketing and Power segments and other, non-affiliated wholesale customers.
•	Energy Marketing consists of MCN’s non-regulated marketing activities to industrial, commercial and residential customers, both inside and outside the Gas Distribution segment’s service area. Energy Marketing also will provide full-service energy solutions to business customers.
•	Power develops and manages independent electric power projects.
•	Energy Holdings manages and seeks to maximize the value of existing ventures outside MCN’s target region. It primarily consists of gas gathering and processing investments in major U.S. producing basins.

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Gas Distribution