<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------------- -----------------
Commission file number (Under the Securities Act of 1933) 33-37977
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
--------------------------------------------------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2726166
- ------------------------------ -----------------------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 PROGRESS PLACE, MIDLAND, MICHIGAN 48640
- --------------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (517) 839-6000
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
<PAGE> 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS AS OF
(In Thousands)
<TABLE>
<CAPTION>
September 30,
1996 December 31,
ASSETS (Unaudited) 1995
- ------ ---------- ----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 133,174 $ 163,953
Restricted cash and cash equivalents 14,052 13,455
Accounts receivable 64,120 64,021
Gas inventory 13,563 14,396
Unamortized property taxes 5,971 -
Prepaid expenses and other 4,568 1,053
---------- ----------
Total current assets 235,448 256,878
---------- ----------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,386,830 2,357,881
Pipeline 21,222 21,410
---------- ----------
Total property, plant and equipment 2,408,052 2,379,291
Accumulated depreciation (509,787) (431,749)
---------- ----------
Net property, plant and equipment 1,898,265 1,947,542
---------- ----------
OTHER ASSETS:
Restricted non-current cash and cash equivalents 141,954 139,852
Deferred financing costs, net of accumulated amortization
of $7,938 and $7,059, respectively 10,639 11,518
Materials, supplies and other 5,824 4,740
---------- ----------
Total other assets 158,417 156,110
---------- ----------
TOTAL ASSETS $2,292,130 $2,360,530
========== ==========
LIABILITIES AND PARTNERS' EQUITY
- --------------------------------
CURRENT LIABILITIES:
Accounts payable, accrued and other liabilities $ 55,430 $ 54,390
Interest payable 43,848 91,840
Current portion of long-term debt 78,574 72,190
---------- ----------
Total current liabilities 177,852 218,420
---------- ----------
NON-CURRENT LIABILITIES:
Long-term debt 1,929,241 2,007,815
Other 411 335
---------- ----------
Total non-current liabilities 1,929,652 2,008,150
---------- ----------
CONTINGENCIES
TOTAL LIABILITIES 2,107,504 2,226,570
---------- ----------
PARTNERS' EQUITY 184,626 133,960
---------- ----------
TOTAL LIABILITIES AND PARTNERS' EQUITY $2,292,130 $2,360,530
========== ==========
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-1-
<PAGE> 3
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING REVENUES:
Capacity $101,859 $100,364 $293,433 $300,495
Electric 56,821 48,235 164,985 144,511
Steam and other 6,594 6,207 20,851 20,060
-------- -------- -------- --------
Total operating revenues 165,274 154,806 479,269 465,066
-------- -------- -------- --------
OPERATING EXPENSES:
Fuel costs (Note 5) 50,061 59,017 180,785 171,487
Depreciation 25,915 23,415 78,284 70,284
Operations 3,708 3,385 11,560 10,138
Maintenance 2,760 2,898 10,281 9,052
Property and single business taxes 6,480 6,231 19,653 19,457
Administrative, selling and general 1,849 1,892 6,049 6,397
-------- -------- -------- --------
Total operating expenses 90,773 96,838 306,612 286,815
-------- -------- -------- --------
OPERATING INCOME 74,501 57,968 172,657 178,251
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest and other income (Note 5) 5,539 3,680 13,620 11,344
Interest expense (44,206) (45,803) (135,611) (140,256)
-------- -------- -------- --------
Total other income (expense), net (38,667) (42,123) (121,991) (128,912)
-------- -------- -------- --------
NET INCOME $ 35,834 $ 15,845 $ 50,666 $ 49,339
======== ======== ======== ========
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-2-
<PAGE> 4
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1996
----------------------------
General Limited
Partners Partners Total
-------- -------- --------
<S> <C> <C> <C>
BALANCE, BEGINNING OF PERIOD $105,264 $28,696 $133,960
Net income 44,112 6,554 50,666
-------- ------- --------
BALANCE, END OF PERIOD $149,376 $35,250 $184,626
======== ======= ========
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-3-
<PAGE> 5
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
1996 1995
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 50,666 $ 49,339
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 79,163 71,194
(Increase) decrease in accounts receivable (99) 4,205
Decrease (increase) in gas inventory 833 (1,638)
Increase in unamortized property taxes (5,971) (5,941)
Increase in prepaid expenses and other (3,515) (1,275)
Increase in materials, supplies and other (1,084) (1,460)
Increase (decrease) in accounts payable, accrued and other liabilities 1,040 (10,023)
Decrease in interest payable (47,992) (49,324)
Increase (decrease) in other non-current liabilities 76 (333)
-------- --------
Net cash provided by operating activities 73,117 54,744
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (29,007) (19,717)
-------- --------
Net cash used in investing activities (29,007) (19,717)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (72,190) (65,881)
(Increase) decrease in restricted non-current cash and cash equivalents (2,102) 323
-------- --------
Net cash used in financing activities (74,292) (65,558)
-------- --------
NET DECREASE IN CASH, CASH EQUIVALENTS AND
RESTRICTED CASH -- CURRENT (30,182) (30,531)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -- CURRENT,
AT BEGINNING OF PERIOD 177,408 132,980
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -- CURRENT,
-------- --------
AT END OF PERIOD $147,226 $102,449
======== ========
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-4-
<PAGE> 6
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
These consolidated financial statements and condensed notes should be read along
with the audited financial statements and notes as contained in the Annual
Report on Form 10-K for the year ended December 31, 1995 of Midland Cogeneration
Venture Limited Partnership ("MCV") which includes the Report of Independent
Public Accountants. In the opinion of management, the unaudited information
herein reflects all adjustments (which include only normal recurring
adjustments) necessary to assure the fair presentation of financial position,
results of operations and cash flows for the periods presented. Prior period
amounts have been reclassified for comparative purposes. These
reclassifications had no effect on net income. The consolidated financial
statements include the accounts of MCV and its wholly owned subsidiaries. All
material transactions and balances among entities which comprise MCV have been
eliminated in the consolidated financial statements.
(1) THE PARTNERSHIP AND ASSOCIATED RISKS
MCV was organized to construct, own and operate a combined-cycle, gas-fired
cogeneration facility (the "Facility") located in Midland, Michigan. MCV
was formed on January 27, 1987, and the Facility entered into commercial
operation in 1990.
In February 1992, MCV acquired the outstanding common stock of PVCO Corp.,
a previously inactive company. MCV and PVCO Corp. entered into a
partnership agreement to form MCV Gas Acquisition General Partnership for
the purpose of buying and selling natural gas on the spot market and other
transactions involving natural gas activities.
The Facility is designed to provide approximately 1,370 megawatts ("MW") of
electricity and a maximum of 1.5 million pounds of process steam per hour.
MCV has contracted to supply up to 1,240 MW of electric capacity to
Consumers Power Company ("Consumers") for resale to its customers, to
supply electricity and steam to The Dow Chemical Company ("Dow") under the
Steam and Electric Power Agreement ("SEPA") and to supply steam to Dow
Corning Corporation ("DCC") which commenced in July 1996, under the Steam
Purchase Agreement ("SPA"). Results of operations are primarily dependent
on successfully operating the Facility at or near contractual capacity
levels and on Consumers' honoring its obligations under the Power Purchase
Agreement ("PPA") with MCV. Sales pursuant to the PPA are expected to
account for over 90% of MCV's revenue over the next ten years.
The Facility is a qualifying cogeneration facility ("QF") certified by the
Federal Energy Regulatory Commission ("FERC") under the Public Utility
Regulatory Policies Act of 1978, as amended ("PURPA"). In order to
maintain QF status, certain operating and efficiency standards must be
maintained on a calendar-year basis. In the case of a topping-cycle
generating plant such as the Facility, the applicable operating standard
requires that the portion of total energy output that is put to some useful
purpose other than facilitating the production of power (the "Thermal
Percentage") be at least 5%. In addition, the Facility must achieve a
PURPA efficiency standard (the sum of the useful power output plus one-half
of the useful thermal energy output, divided by the energy input (the
"Efficiency Percentage")) of at least 45%. If the Facility maintains a
Thermal Percentage of 15% or higher, the required Efficiency Percentage is
reduced to 42.5%. Since 1990, the Facility has achieved the applicable
Thermal and Efficiency Percentages. For the nine months ended September 30,
1996, the Facility has achieved a Thermal Percentage of 14.5% and a PURPA
Efficiency Percentage of 45.4%. The loss of QF status could, among other
things, cause the Facility to lose its rights under PURPA to sell power to
Consumers at Consumers' "avoided cost" and subject the Facility to
additional federal and state regulatory requirements. MCV believes that,
given projected levels of steam and electricity sales, coupled with
continued diligent operating practices, the Facility will meet the required
Thermal and the corresponding Efficiency Percentages in 1996.
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<PAGE> 7
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The Facility is wholly dependent upon natural gas for its fuel supply and a
substantial portion of the Facility's operating expenses will consist of
the costs of obtaining natural gas. MCV recognizes that its existing gas
contracts are not sufficient to satisfy the anticipated gas needs over the
term of the PPA and, as such, no assurance can be given as to the
availability or price of natural gas after the expiration of the existing
gas contracts. In addition, to the extent that the costs associated with
production of electricity rise faster than the energy charge payments,
MCV's financial performance will be negatively affected. The amount of
such impact will depend upon the amount of the average energy charge
payable under the PPA, which is based upon costs incurred at Consumers'
coal-fired plants and upon the amount of energy scheduled by Consumers for
delivery under the PPA. However, given the unpredictability of these
factors, the overall economic impact upon MCV of changes in future fuel
costs under new or existing contracts cannot accurately be predicted.
(2) RESTRICTED CASH AND CASH EQUIVALENTS
Current and non-current restricted cash and cash equivalents consist of the
following as of (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
-------- --------
<S> <C> <C>
Current:
-------
Funds restricted for plant modifications $ 14,052 $ 13,455
======== ========
Non-current:
-----------
Funds restricted for rental payments pursuant
to the Overall Lease Transaction $141,572 $139,546
Funds restricted for management non-qualified plans 382 306
-------- --------
$141,954 $139,852
======== ========
</TABLE>
(3) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following as of
(in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
Accounts payable
Related parties $14,856 $11,652
Trade creditors 24,710 26,956
Property and single business taxes 13,982 13,675
Other 1,882 2,107
------- -------
Total $55,430 $54,390
======= =======
</TABLE>
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<PAGE> 8
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(4) LONG-TERM DEBT
Long-term debt consists of the following as of (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
Financing obligation, maturing through 2015,
effective interest rate of approximately 8.7%,
payable in semi-annual installments of principal
and interest, secured by property, plant and equipment $2,007,815 $2,080,005
Less current portion (78,574) (72,190)
---------- ----------
Total long-term debt $1,929,241 $2,007,815
========== ==========
</TABLE>
Financing Obligation
In 1990, MCV obtained permanent financing for the Facility by entering into
sale and leaseback agreements ("Overall Lease Transaction") with a lessor
group ("Owner Participants"), related to substantially all of MCV's fixed
assets. Proceeds of the financing were used to retire borrowings
outstanding under existing loan commitments, make a capital distribution to
the Partners and retire a portion of the notes issued by MCV to MEC
Development Corporation ("MDC") in connection with the transfer of certain
assets by MDC to MCV. In accordance with SFAS No. 98, "Accounting For
Leases," the sale and leaseback transaction has been accounted for as a
financing arrangement.
Interest and fees incurred related to long-term debt arrangements during
the nine months ended September 30, 1996 and 1995 were $134.7 million and
$139.3 million, respectively. Interest and fees paid for the nine months
ended September 30, 1996 and 1995 were $182.8 million and $188.7 million,
respectively.
(5) CONTINGENCIES
PPA - 25 MW Regulatory Disallowance, Fixed Energy Payments for Deliveries
Above the Caps
On February 23, 1995, the Michigan Public Service Commission ("MPSC") in
Case No. U-10155-R (the 1993 power supply cost recovery reconciliation
proceeding conducted by the MPSC to reconcile actual costs incurred by
Consumers in 1993 in providing power supply to its customers with actual
revenues it collected that same year), ruled that Consumers could not
recover the full 915 MW of MCV capacity and fixed energy charges provided
under the terms of the 1993 revised settlement proposal approved by the
MPSC in Case Nos. U-10127 and U-8871 et al. Instead, the MPSC "allocated"
approximately 25 MW of MCV capacity to "non-jurisdictional" customers (i.e.
customers not subject to PSCR rates), resulting in a disallowance to
Consumers of approximately $7.4 million of which approximately $.7 million
relates to fixed energy charges. In addition, the MPSC ruled in this case
that Consumers could not recover approximately $.6 million of fixed energy
charges payable to MCV for energy delivered above the off-peak cap of 732
MW. (Consumers has paid into escrow approximately $.4 million of this sum
and the balance was paid to MCV.)
Under the "regulatory out" provision of the PPA Consumers may, under
certain conditions, be relieved of paying energy charges to MCV to the
extent the MPSC does not allow Consumers to recover such charges from its
customers. Consumers is not permitted for the first 17 1/2 years of the PPA
to reduce capacity payments to MCV below an average rate of 3.77 cents per
kWh for available contract capacity as a result of the regulatory
disallowance described above. On October 19, 1995, Consumers notified MCV
that pursuant to the "regulatory
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<PAGE> 9
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
out" provision of the PPA, it would be increasing the amount being escrowed
each month to reflect its calculation of fixed energy charge payments
related to the 25 MW disallowed by the MPSC described above. In addition,
Consumers requested a refund from MCV of $1.9 million plus interest, for
the calendar years 1993 and 1994 and the first eight months of 1995. On
November 21, 1995, MCV responded to Consumers indicating that MCV would,
pursuant to the PPA, refund the appropriate funds, if any, and determine
the appropriate escrowing of funds, if any, at such time as a final and
non-appealable order disallowing these recoveries is entered. As of
September 30, 1996, MCV has not recognized as operating revenues
approximately $2.7 million for amounts placed in escrow and the potential
refund relating to the 25 MW disallowance. Currently, Consumers is
escrowing approximately $62,000 per month in fixed energy charge payments
from MCV due to this issue.
Consumers and MCV appealed the MPSC February 23, 1995 Order to the Michigan
Court of Appeals and on November 1, 1996 the Michigan Court of Appeals
affirmed the MPSC's decision which "allocated" approximately 25 MW of MCV
capacity to "non-jurisdictional" customers and ruled Consumers could not
recover fixed energy charges for energy delivered above the off peak cap of
732 MW. MCV management is currently assessing the prospects of further
appeal or review and, at this time, cannot predict if such an appeal will
be filed (by MCV, Consumers or any other party) or the outcome of such a
proceeding.
In addition, as part of its order in Consumers' 1994 PSCR Plan proceedings,
the MPSC, ruled that for 1994 Consumers would not be permitted to recover
fixed energy costs during off-peak hours for energy delivered above the
availability "caps" contained in the Settlement Order and below 915 MW.
MCV believes the MPSC order on this issue is erroneous and has filed an
appeal of the MPSC decision. Other PSCR Plan and Reconciliation Cases for
the years 1994 - 1997 are pending before the MPSC at this time. MCV
Management cannot predict the outcome of these proceedings. Consumers has
escrowed approximately $2.1 million for the first nine months of 1996 and
approximately $1.0 million for the years 1995 and 1994, of fixed energy
charges payable to MCV based on this MPSC ruling and continues escrowing
approximately $.2 million per month for this portion of fixed energy
charges. MCV has not recognized these amounts as operating revenues.
Fuel Matters
MCV has entered into long-term gas transportation arrangements with four
U.S. interstate transporters: ANR Pipeline Company, Panhandle Eastern Pipe
Line Company, Trunkline Gas Company and Great Lakes Gas Transmission
Company ("Great Lakes"). The transportation rates from these transporters
are subject to FERC regulation.
In 1990, Great Lakes expanded its interstate pipeline system to accommodate
gas purchases from MCV and other customers. Historically, such capital
costs were "rolled-in" to the rate base, thus combining the capital cost of
common use facility additions with the cost of existing common use
facilities for the purpose of determining the transportation rates to be
charged to all system shippers. In 1991, FERC issued an order that
rejected rolled-in pricing for the MCV-related expansion costs and,
instead, imposed incremental pricing which, for MCV, took effect April 1,
1993. The incremental methodology allocates the capital cost of facility
additions solely to the new shippers who will gain access to the expanded
facilities. FERC's decision was appealed by MCV and others to the United
States Court of Appeals for the District of Columbia Circuit, which held
that FERC had failed to adequately explain the adoption of incremental
rates and remanded the orders to FERC for reconsideration. On July 26,
1995, FERC issued its Order on Remand reversing its prior order and
directed Great Lakes to: (i) implement rolled-in rates prospectively
beginning October 1, 1995, for the expansion facilities including those
applicable to MCV; and (ii) refund to MCV, subject to FERC approval, the
principal amount, excluding interest, paid in excess of rolled-in rates.
MCV had, from April 1, 1993 to October 1, 1995, reflected in current
operating results Great Lakes gas transportation costs associated with
incremental pricing. On April 25, 1996, FERC affirmed its Order on Remand
as it pertains to the MCV issues described above ("Order on Rehearing").
On June 3, 1996, FERC granted rehearing for further consideration.
Rehearing was requested by, among others, MCV for clarification of the
timing of refunds, surcharges and
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<PAGE> 10
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
interest thereon subsequent to October 1, 1995. On July 31, 1996, FERC
clarified its April 25, 1996 order stating that interest on refunds was to
commence October 1, 1995 and otherwise denied the relief requested in the
petitions for rehearing. In August 1996, MCV recognized in its current
operating results approximately $19.0 million (which represented $17.6
million in transportation costs included as a reduction in fuel costs and
$1.4 million of accrued interest subsequent to October 1, 1995) of the
Great Lakes refund. Approximately $6.4 million is attributable to the
period January 1, 1995 to September 30, 1995 and approximately $12.6
million is attributable to the period prior to January 1, 1995. As of
September 30, 1996, 98% of the refund has been paid to MCV. The FERC Order
on Rehearing and its July 31, 1996 order are subject to further
administrative and judicial processes and, MCV and others have filed
appeals to the United States Court of Appeals for the District of Columbia
("Court of Appeals") challenging certain aspects of the Order on Remand.
Management cannot predict the outcome of these proceedings but believes
that the likelihood of a reversal by the Court of Appeals of that portion
of the FERC Order on Rehearing requiring rolled-in rate treatment is
remote.
GTG Equipment Problems
In 1991 and 1992, several gas turbine generators ("GTGs") experienced
cracking in the hot gas casing which, in two cases, caused extensive damage
to the turbine blades. As a result of the cracking problems, modifications
were made on all GTGs and MCV and ABB Power Generation, Inc. ("ABB Power")
implemented a program of hot gas casing inspections for all GTGs. During
1994, ABB Power completed an analysis of cracking problems present in two
of the modified GTG hot gas casings and determined that additional
modifications should be made to the hot gas casings. New hot gas casings
which include these modifications have been installed on ten of the units
and are expected to be installed on the remaining two units by the end of
the first quarter of 1997.
In January 1996, two additional GTGs experienced severe cracking in the hot
gas casing (one of which included the newest hot gas casing modifications),
causing extensive damage to the turbine blades and vanes. MCV immediately
inspected all of the remaining GTG hot gas casings for evidence of cracking
and identified an additional five GTGs which required casing replacements.
During the first quarter of 1996, MCV and ABB Power increased the frequency
of inspections on these units which resulted in additional scheduled and
unscheduled maintenance outages. Extensive analysis and review by MCV and
ABB Power has concluded that crack initiation tended to start in high
stress areas of the hot gas casing and that pulsations were the key factor
in crack propagation in these units. MCV and ABB Power have modified the
burner geometry of the affected turbines which has significantly reduced
pulsations in the hot gas casings. MCV has also installed additional
measuring devices to detect any pulsations which are suspected of
accelerating crack propagation. In addition, MCV and ABB Power continue to
study whether any modifications are needed in the high stress areas of the
hot gas casings. In May 1996, MCV successfully completed its second round
of 800 hour GTG inspections which indicated no additional cracking.
Therefore, MCV has increased its GTG inspections to 2000 hours on certain
units. MCV believes that the burner modifications have resolved the
pulsation problems and there should be no significant future impacts on
plant availability or efficiency, although no assurance can be given that
additional equipment problems will not occur.
The cost of casing replacements and modifications is covered by ABB Power
(with the exception of insurable events) pursuant to the amended Service
Agreement, under which ABB Power is providing hot gas path parts for MCV's
twelve gas turbines for the next three series of major GTG inspections
which are expected to be completed by the year 2002.
MCV's insurance carriers continue to monitor and review all the GTG
inspection findings. At this time, MCV currently maintains property
insurance policies that include the hot gas casing equipment and are in
effect through the first quarter of 1997. Failure to maintain insurance is
an Event of Default under the Overall Lease Transaction.
-9-
<PAGE> 11
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(6) PARTNERS' EQUITY AND RELATED PARTY TRANSACTIONS
The following table summarizes the nature and amount of each of MCV's
Partner's equity interest, interest in profits and losses of MCV at
September 30, 1996, and the nature and amount of related party transactions
or agreements that existed with the Partners or affiliates as of September
30, 1996 and 1995, and for each of the nine month periods ended September 30
(in thousands).
<TABLE>
<CAPTION>
Equity Partner, Type of Partner Equity Related Party Transactions
and Nature of Related Party Interest Interest and Agreements 1996 1995
- ---------------------------------- -------- -------- ---------------------------------------------- -------- --------
<S> <C> <C> <C> <C> <C>
CMS Midland, Inc. $90,467 49.0% Power purchase agreement $443,498 $430,423
General Partner; wholly-owned Power purchase agreement administrative fees 18 18
subsidiary of Consumers Power Purchases under gas transportation agreements 7,111 6,955
Company Purchases under spot gas agreements 1,948 677
Purchases under gas supply agreements 7,349 6,521
Gas storage agreement 1,922 1,922
Land lease/easement agreements 450 450
General construction/service/engineering
agreement 166 96
Facilities agreement - transmission line and
metering facility maintenance 19 13
Accounts receivable 49,987 45,830
Accounts payable 6,693 4,972
Gas exchanges 3,305 6,350
Prepaid land lease -- 150
The Dow Chemical Company 26,834 7.5 Steam and electric power agreement 35,771 34,643
Limited Partner Purchases under demineralized water supply
agreement 4,591 4,036
Rent under office building lease agreement 304 292
Accounts receivable 2,273 2,284
Accounts payable 1,336 993
Standby and backup fees 967 729
Source Midland Limited Partnership 28,052 18.1 Purchases under gas transportation agreements 11,562 10,308
General Partner; affiliate of Purchases under spot gas agreements 3,313 1,242
PanEnergy Corp Accounts payable 1,387 1,432
Gas exchanges 2,082 204
Coastal Midland, Inc. 16,831 10.9 Purchases under gas transportation agreements*** (6,739) 16,535
General Partner; wholly-owned Purchases under spot gas agreement 12,161 8,587
subsidiary of The Coastal Purchases under gas supply agreement 2,872 2,571
Corporation Gas agency agreement 953 656
Deferred reservation charges under gas purchase
agreement 2,955 1,757
Accounts receivable 455 607
Accounts payable 4,276 4,131
Gas exchanges 4,056 1,866
MEI Limited Partnership 14,026 9.1 Gas turbine maintenance and spare parts agreement 22,297 18,425
General Partner; affiliate of Accounts payable 81 296
ASEA Brown Boveri, Inc. Partner cash withdrawal (including accrued
interest)** 4,229 --
Accounts receivable 210 --
Micogen Limited Partnership 7,013 4.5 Maintenance/Engineering agreement -- 243
Limited Partner; affiliate of Computer maintenance software agreement 14 15
Fluor Corporation Partner cash withdrawal (including accrued
interest)** 1,899 --
C-E Midland Energy, Inc. 1,402 .9 Service Agreement 5,167 2,167
Limited Partner; wholly-owned Accounts Payable 1,077 329
subsidiary of Combustion
Engineering, Inc. which is a
wholly-owned subsidiary
of ASEA Brown Boveri, Inc.
Alanna Corporation 1* .00001 Note receivable 1 1
Limited Partner; wholly-owned
Subsidiary of Alanna Holdings
Corporation
</TABLE>
* Alanna's capital stock is pledged to secure MCV's obligation under the lease
and other overall lease transaction documents.
** In exchange for a letter of credit pursuant to the Participation Agreement.
*** 1996 includes the Great Lakes gas transportation refund of $17.6 million.
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<PAGE> 12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A)
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
This MD&A should be read along with the MD&A in the Annual Report on Form 10-K
for the year ended December 31, 1995 of the Midland Cogeneration Venture
Limited Partnership ("MCV").
Results of Operations
Operating Revenue Statistics
The following represents significant operating revenue statistics for the
following periods (dollars in thousands except average rates):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Operating Revenues $ 165,274 $ 154,806 $ 479,269 $ 465,066
Capacity Revenue $ 101,859 $ 100,364 $ 293,433 $ 300,495
PPA Contract Capacity (MW) 1,240 1,240 1,240 1,240
PPA Availability 98.6% 97.2% 95.4% 98.1%
Electric Revenue $ 56,821 $ 48,235 $ 164,985 $ 144,511
Average PPA Variable Energy Rate ($/MWh) $ 16.97 $ 17.07 $ 16.99 $ 17.26
Average PPA Fixed Energy Rate ($/MWh) $ 4.09 $ 4.00 $ 4.06 $ 3.85
PPA Delivery as a Percentage of Contract Capacity 90.9% 75.1% 88.8% 75.9%
PPA and SEPA Electric Deliveries (MWh) 2,632,799 2,193,097 7,649,924 6,565,069
Steam and Other Revenue $ 6,594 $ 6,207 $ 20,851 $ 20,060
Steam Deliveries (Mlbs) 1,104,731 934,890 3,708,281 3,369,810
</TABLE>
Comparison of the Three Months Ended September 30, 1996 and 1995
Overview
For the third quarter of 1996, MCV recorded net income of $35.8 million as
compared with net income of $15.8 million for the third quarter of 1995. The
increase in net income for the third quarter of 1996 as compared to 1995 is
primarily the result of the Great Lakes gas transportation refund and higher
capacity revenue under the PPA, partially offset by higher depreciation expense
and higher natural gas prices.
Operating Revenues
For the third quarter of 1996, MCV's operating revenues increased $10.5 million
from the third quarter of 1995 due primarily to higher electric revenue
generated under the PPA. The increase in 1996 third quarter electric revenue
of
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<PAGE> 13
$8.6 million is primarily the result of Consumers' decision to increase MCV's
electric dispatch in 1996 consistent with the terms of the Proposed Settlement.
(See Part II, Item 1, "Legal Proceedings - MPSC Proceedings Relating to Capacity
and Energy Charges" for definition of Proposed Settlement.) The capacity
revenue increase of $1.5 million is the result of higher capacity payments under
the PPA due to fewer scheduled and unscheduled maintenance outages of the GTG's
during the third quarter of 1996.
Operating Expenses
For the third quarter of 1996, MCV's operating expenses were $90.8 million,
which includes $50.1 million of fuel costs. The fuel costs for the quarter
includes the recognition of the Great Lakes gas transportation refund of
approximately $17.6 million (excluding interest). Excluding the Great Lakes
refund, fuel costs were $67.7 million in which MCV used approximately 24.6
billion cubic feet ("bcf") of natural gas at an average rate of $2.35 per
million British thermal units ("MMBtu"). For the third quarter of 1995,
operating expenses were $96.8 million, which includes $59.0 million of fuel
costs. During this period, MCV used approximately 20.9 bcf of natural gas at an
average fuel rate of $2.28 per MMBtu. The increase in fuel costs of $8.7 million
(excluding the Great Lakes refund) for the third quarter of 1996 compared to
1995 is due primarily to the increase in fuel usage resulting from the higher
Consumers dispatch level and higher natural gas prices in the short term market.
This increase was slightly offset by lower Great Lakes demand charges as a
result of implementing rolled-in rates beginning October 1, 1995.
For the third quarter of 1996, operating expenses other than fuel costs
increased $2.9 million over the third quarter of 1995 due primarily to higher
depreciation expense resulting from the amortization of increased payments for
hot gas path parts. Other expenses incurred in these periods were considered
normal expenditures to achieve the recorded operating revenues.
Other Income (Expense)
The increase in interest and other income for the third quarter of 1996 compared
to the third quarter of 1995 is due primarily to interest received of
approximately $1.4 million on the Great Lakes gas transportation refund.
The decrease in interest expense in the third quarter of 1996 from the third
quarter of 1995 is due to a lower principal balance on MCV's financing
obligation.
Comparison of the Nine Months Ended September 30, 1996 and 1995
Overview
For the first nine months of 1996, MCV recorded net income of $50.7 million as
compared with net income of $49.3 million for the first nine months of 1995. The
increase in net income for the first nine months of 1996 as compared to 1995 is
primarily the result of the Great Lakes gas transportation refund, partially
offset by lower capacity payments under the PPA due to first quarter 1996
equipment problems, higher natural gas prices and higher depreciation expense.
Operating Revenues
For the first nine months of 1996, MCV's operating revenues increased $14.2
million from the first nine months of 1995 due primarily to higher electric
revenue generated under the PPA, which was partially offset by lower capacity
revenue under the PPA. The increase in electric revenue during the first nine
months of 1996 of $20.5 million is primarily the result of Consumers' decision
to increase MCV's electric dispatch in 1996 consistent with the terms of the
Proposed Settlement. The capacity revenue reduction of $7.1 million is the
result of lower capacity payments under the PPA due to additional scheduled and
unscheduled maintenance outages on the hot gas casing equipment during the first
quarter of 1996.
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<PAGE> 14
Operating Expenses
For the first nine months of 1996, MCV's operating expenses were $306.6
million, which includes $180.8 million of fuel costs. The year to date fuel
costs includes the recognition of the Great Lakes gas transportation refund
of approximately $17.6 million (excluding interest). Excluding the Great
Lakes refund, fuel costs were $198.4 million in which MCV used
approximately 72.3 bcf of natural gas at an average rate of $2.35 per
MMBtu. For the first nine months of 1995, operating expenses were $286.8
million, which includes $171.5 million of fuel costs. During this period,
MCV used approximately 63.0 bcf of natural gas at an average fuel rate of
$2.21 per MMBtu. The increase in fuel costs of $26.9 million (excluding the
Great Lakes refund) for the first nine months of 1996 compared to 1995 is
due primarily to an increase in fuel usage resulting from the higher
Consumers dispatch level and to an increase in purchases of more expensive
long-term gas over short-term purchases since there has been a substantial
rise in short-term market prices over the first nine months of 1995. This
increase was slightly offset by lower Great Lakes demand charges as a
result of implementing rolled-in rates beginning October 1, 1995.
For the first nine months of 1996, operating expenses other than fuel costs
increased $10.5 million over the first nine months of 1995 due primarily to
higher depreciation expense resulting from the amortization of increased
payments for hot gas path parts and an allowance for the insurance claims
on the two hot gas casings which experienced severe cracking (and
consequent damage to the turbine blades and vanes). Other expenses
incurred in these periods were considered normal expenditures to achieve
the recorded operating revenues.
Other Income (Expense)
The increase in interest and other income for the first nine months of 1996
compared to the first nine months of 1995 is due primarily to interest
received of approximately $1.4 million on the Great Lakes gas
transportation refund.
The decrease in interest expense in the first nine months of 1996 from the
first nine months of 1995 is due to a lower principal balance on MCV's
financing obligation.
Liquidity and Financial Resources
During the first nine months of 1996 and 1995, net cash generated by MCV's
operations was $73.1 million and $54.7 million, respectively. The primary
use of cash was for the payment of interest and principal on the financing
obligation, fuel costs, maintenance costs and other operating expenses.
MCV's cash and cash equivalents have a normal cycle of collecting six
months of revenues less operating expenses prior to making the semiannual
interest and principal payments of the financing obligation due in January
and July for the next nineteen years. During the first nine months of
1996, and 1995, MCV paid the basic rent requirements of $254.7 million and
$254.4 million, respectively, as required under the Overall Lease
Transaction.
MCV also has arranged for a $50 million working capital line ("Working
Capital Facility") from Bank of Montreal to provide temporary financing, as
necessary, for operations. The Working Capital Facility has been secured
by MCV's natural gas inventory and earned receivables. At any given time,
borrowings and letters of credit are limited by the amount of the borrowing
base, defined as 90% of earned receivables. The borrowing base varies over
the month as receivables are earned, billed and collected. At September
30, 1996, the borrowing base was $47.1 million. The Working Capital
Facility term currently extends to August 31, 1997.
MCV did not utilize the Working Capital Facility during the first nine
months of 1996, except for letters of credit associated with normal
business practices. MCV believes that amounts available to it under the
Working Capital Facility will be sufficient to meet working capital
shortfalls, primarily during months when rent payments are due. In
addition, affiliates of certain MCV Partners have agreed (under certain
conditions and for a limited time) to make loans to MCV in an aggregate
amount not to exceed $10 million to cover working capital expenses, as
appropriate. To date, MCV has not made any borrowings under these
agreements with MCV Partners.
-13-
<PAGE> 15
Since January 1992, MCV has experienced a reduction in the energy charges
it is paid for electricity under the PPA due both to declining coal costs
at Consumers' generating plants and Consumers' ability, under the
"regulatory out" provisions of the PPA, to withhold fixed energy charges
for available but undelivered energy. These circumstances have resulted
in rent coverage ratios (as defined in the Overall Lease Transaction) of
less than 1.11 to 1.00. If there are continued reductions in energy
charges relative to MCV's cost of fuel used in production, there could be a
material adverse impact on MCV's ability to make future rental payments out
of cash flow from operations. For the foreseeable future, MCV expects to
fund current operating expenses, payments under the amended Service
Agreement and rental payments primarily through cash flow from operations.
If necessary, MCV could fund any operating cash flow shortfalls from cash
reserves to the extent available for such purposes. As of September 30,
1996, there was $221.1 million (which includes $35.3 million reserved for
capital improvements and spare parts purchases), including accrued
interest, in available reserves for such purposes.
Outlook
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act
of 1995. The following discussion of the outlook for MCV contains certain
"forward-looking statements" as defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"), including (without limitation)
discussion as to expectations, beliefs, plans, objectives and future
financial performance, or assumptions underlying or concerning matters
discussed reflecting MCV's current expectations of the manner in which the
various factors discussed therein may affect its business in the future.
Any matters that are not historical facts are forward-looking and,
accordingly, involve estimates, assumptions, and uncertainties which could
cause actual results or outcomes to differ materially from those expressed
in the forward-looking statements. Accordingly, this "Safe Harbor"
Statement contains additional information about such factors relating to
the forward-looking statements. There is no assurance that MCV's
expectations will be realized or that unexpected events will not have an
adverse impact on MCV's business.
Some important factors that could cause actual results or outcomes to
differ materially from those discussed in the forward-looking statements
include prevailing governmental policies and regulatory actions (including
those of the Federal Energy Regulatory Commission and the Michigan Public
Service Commission) with respect to cost recovery under the PPA, operation
and construction of plant facilities including natural gas pipeline and
storage facilities, and present or prospective wholesale and retail
competition, among others. The business and profitability of the Company
is also influenced by economic factors, weather conditions, pricing and
transportation of commodities, inflation, among other important factors.
All such factors are difficult to predict, contain uncertainties which may
materially affect actual results, and are beyond the control of MCV.
Results of operations are largely dependent on successfully operating the
Facility at or near contractual capacity levels, the availability of
natural gas, the level of energy rates paid to MCV relative to the cost of
fuel used for generation, Consumers' performance of its obligations under
the PPA, and maintenance of the Facility's QF status.
Operating Outlook. Approximately 70% of PPA revenues are capacity payments
which are based on the Facility's availability. PPA availability was 98.1%
in 1995 and 97.2% in 1994. In future years, PPA availability is expected
to decline from the historically high levels as Contract Capacity is
sustained at the PPA contractual level of 1240 MW. Availability will
depend on the level of scheduled and unscheduled maintenance outages, and
on the sustained level of output from each of the GTGs and the steam
turbine. MCV expects long-term PPA availability to exceed 90%.
In 1991 and 1992, several GTGs experienced cracking in the hot gas casing
which, in two cases, caused extensive damage to the turbine blades. As a
result of the cracking problems, modifications were made on all GTGs and
MCV and ABB Power implemented a program of hot gas casing inspections for
all GTGs. During 1994, ABB Power completed an analysis of cracking problems
present in two of the modified GTG hot gas casings and determined that
additional modifications should be made to the hot gas casings. New hot
gas casings which include these modifications were installed on ten of the
units and are expected to be installed on the remaining two units by the
end of the first quarter of 1997.
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<PAGE> 16
In January 1996, two additional GTGs experienced severe cracking in the hot
gas casing (one of which included the newest hot gas casing modifications),
causing extensive damage to the turbine blades and vanes. MCV immediately
inspected all of the remaining GTG hot gas casings for evidence of cracking
and identified an additional five GTGs which required casing replacements.
During the first quarter of 1996, MCV and ABB Power increased the frequency
of inspections on these units which resulted in additional scheduled and
unscheduled maintenance outages. Extensive analysis and review by MCV and
ABB Power has concluded that crack initiation tended to start in high
stress areas of the hot gas casing and that pulsations were the key factor
in crack propagation in these units. MCV and ABB Power have modified the
burner geometry of the affected turbines which has significantly reduced
pulsations in the hot gas casings. MCV has also installed additional
measuring devices to detect any pulsations which are suspected of
accelerating crack propagation. In addition, MCV and ABB Power continue to
study whether any modifications are needed in the high stress areas of the
hot gas casings. In May 1996, MCV successfully completed its second round
of 800 hour GTG inspections which indicated no additional cracking.
Therefore, MCV has increased its GTG inspections to 2000 hours on certain
units. MCV believes that the burner modifications have resolved the
pulsation problems and there should be no significant future impacts on
plant availability or efficiency, although no assurance can be given that
additional equipment problems will not occur.
The cost of casing replacements and modifications is covered by ABB Power
(with the exception of insurable events) pursuant to the amended Service
Agreement, under which ABB Power is providing hot gas path parts for MCV's
twelve gas turbines for the next three series of major GTG inspections
which are expected to be completed by the year 2002.
MCV's insurance carriers continue to monitor and review all the GTG
inspection findings. At this time, MCV currently maintains property
insurance policies that include the hot gas casing equipment and are in
effect through the first quarter of 1997. Failure to maintain insurance is
an Event of Default under the Overall Lease Transaction.
Natural Gas. The Facility is wholly dependent upon natural gas for its
fuel supply and a substantial portion of the Facility's operating expenses
will consist of the costs of obtaining natural gas. Over the last several
years additional gas contracts have been entered into or amended, extending
the period over which fuel supplies are secured. While MCV will continue
to pursue the acquisition of fuel supply beyond the year 2001, MCV
recognizes that its existing gas contracts are not sufficient to satisfy
the anticipated gas needs over the term of the PPA and, as such, no
assurance can be given as to the availability or price of natural gas after
the expiration of the existing gas contracts.
Energy Rates and Cost of Production. Under the PPA, energy charges are
based on the costs associated with fuel inventory, operations and
maintenance, and administrative and general expenses associated with
certain of Consumers' coal plants. However, MCV's costs of producing
electricity are tied, in large part, to the cost of natural gas. To the
extent that the costs associated with production of electricity with
natural gas rise faster than the energy charge payments, which are based
largely on Consumers' coal plant operation and maintenance costs, MCV's
financial performance would be negatively affected. For the period April
1990 through September 1996, the energy charge (fixed and variable) paid to
MCV has declined by .20 cents per kWh, while the average variable cost of
production, as indicated by the average cost of delivered fuel for the
period 1990 - 1995, has risen by $0.05 per MMBtu.
The divergence between variable revenues and costs will become greater if
the energy charge (based largely on the cost of coal) declines or escalates
more slowly than the contract prices under which MCV purchases fuel
(generally escalated at either the total PPA energy charge or 4% per year).
The difference could be further exacerbated in approximately four years as
MCV's gas contracts begin to expire if the cost of replacement fuel is
materially higher than the prices in the expiring contracts.
Energy Payments Under the PPA. On June 7, 1993, Consumers notified MCV
that, based on its interpretation of the 1993 Settlement Order (see Part
II, Item 1, "Legal Proceedings - MPSC Proceedings Relating to Capacity and
Energy Charges" for definition of Settlement Order), it would be applying
the "regulatory out" provision of the PPA and withholding fixed energy
payments on energy delivered during off-peak periods above the
"availability caps" but below 915 MW. Consumers has escrowed approximately
$2.1 million for the first nine months of 1996 and approximately $1.0
million for the years 1995 and 1994, of fixed energy payments for energy
delivered above the
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<PAGE> 17
availability caps but below 915 MW. MCV has not recognized these amounts
placed in escrow as operating revenues. MCV and Consumers have appealed
the MPSC orders denying recovery of the fixed energy charges for energy
delivered to Consumers. MCV management cannot predict the outcome of these
appeals. (See Part II, Item 1, " Legal Proceedings - MPSC Proceedings
Relating to Capacity and Energy Charges.")
On February 23, 1995, the MPSC applied the Settlement Order to Consumers'
1993 Reconciliation Case and ruled that Consumers could not recover the
full 915 MW of MCV capacity and fixed energy charges provided under the
terms of the 1993 Revised Settlement Proposal approved by the MPSC in the
Settlement Order. Instead, the MPSC "allocated" approximately 25 MW of MCV
capacity to "non-jurisdictional" customers (i.e. customers not subject to
PSCR rates), resulting in a disallowance to Consumers of approximately $7.4
million of which approximately $.7 million relates to fixed energy charges.
In addition, the MPSC ruled in this case that Consumers could not recover
approximately $.6 million of fixed energy charges payable to MCV for energy
delivered above the off-peak cap of 732 MW. (Consumers has paid into
escrow approximately $.4 million of this sum and the balance was paid to
MCV). It is likely that the MPSC will apply these types of disallowances
in future PSCR cases unless the Michigan Court of Appeals or other court
reverses the Order of the MPSC.
On October 19, 1995, Consumers notified MCV that pursuant to the
"regulatory out" provision of the PPA, it would be increasing the amount
being escrowed each month, to reflect its calculation of fixed energy
charge payments related to 25 MW disallowed by the MPSC and Michigan Court
of Appeals in Consumers' 1993 Reconciliation Case. In addition, Consumers
requested a refund from MCV of $1.9 million plus interest, for the calendar
years 1993 and 1994 and the first eight months of 1995. On November 21,
1995, MCV responded to Consumers indicating that MCV would, pursuant to the
PPA, refund the appropriate funds, if any, and determine the appropriate
escrowing of funds, if any, at such time as a final and non-appealable
order disallowing these recoveries is entered. As of September 30, 1996,
MCV has not recognized as operating revenues approximately $2.7 million for
amounts placed in escrow and the potential refund relating to the 25 MW
disallowance. Currently, Consumers is escrowing approximately $62,000 per
month in fixed energy charge payments from MCV due to this issue.
Consumers and MCV appealed the MPSC February 23, 1995 Order to the Michigan
Court of Appeals and on November 1, 1996 the Michigan Court of Appeals
affirmed the MPSC's decision which "allocated" approximately 25 MW of MCV
capacity to "non-jurisdictional" customers and ruled Consumers could not
recover fixed energy charges for energy delivered above the off peak cap of
732 MW. MCV management is currently assessing the prospects of further
appeal or review and, at this time, cannot predict if such an appeal will
be filed (by MCV, Consumers or any other party) or the outcome of such a
proceeding.
On September 8, 1995, Consumers and the MPSC staff filed a motion to create
a consolidated proceeding for the purpose of reviewing a proposed
settlement agreement entered into between the MPSC staff and Consumers
related to three cases: Case No. U-10685, Consumers' electric general rate
case; Case No. U-10787, Consumers' request for approval of a special
competitive services tariff (Rate SCS); and Case No. U-10754, Consumers'
application for approval of revised depreciation rates for electric and
common utility plant. MCV is a party to the consolidated proceeding. The
settlement agreement proposes approving the jurisdictional cost recovery of
an additional 325 MW of capacity purchased from MCV. Cost recovery
approval for the 325 MW of MCV contract capacity would be in addition to
the 915 MW already approved by the MPSC. Recovery would begin January 1,
1996. The initial average capacity charge recovered would be 2.86 cents
per kWh escalating to 3.62 cents per kWh in 2004 and thereafter. On
September 22, 1995, MCV filed a position statement not objecting to the
proposed settlement agreement, but reserving all of its rights and
privileges under the PPA. If the settlement is approved as filed it will
likely result in an increase in dispatch under the PPA. Consumers has, in
fact, increased MCV's dispatch in 1996 on the expectation that the proposed
settlement agreement will be approved. This should have a positive impact
on MCV's cash flow and earnings, assuming current gas prices and energy
rates continue in effect. Management cannot predict the outcome of this
proceeding.
Maintaining QF Status. In the case of a topping-cycle generating plant
such as the Facility, the applicable operating standard requires that the
portion of total energy output that is put to some useful purpose other
than facilitating the production of power (the "Thermal Percentage") be at
least 5%. In addition, the plant must achieve and maintain an average
PURPA efficiency standard (the sum of the useful power output plus one-half
of the useful thermal energy
-16-
<PAGE> 18
output, divided by the energy input (the "Efficiency Percentage")) of at
least 45%. However, if the plant maintains a Thermal Percentage of 15% or
higher, the required Efficiency Percentage is reduced to 42.5%. The tests
are applied on a calendar year basis. The Facility has achieved the
applicable Efficiency Percentage of 42.5% in each year since commercial
operation, while in 1995 the Facility achieved an Efficiency Percentage in
excess of 45%.
The Facility's achievement of a Thermal Percentage of 15% (thereby
requiring compliance with the reduced Efficiency Percentage of 42.5%) is
dependent upon both the amount of Dow and DCC steam purchases and the level
of electricity generated by the Facility. Dow has agreed to take as much
steam as is necessary for the Facility to retain its QF status under the
FERC regulations in effect on November 1, 1986 (which regulations have not
been revised in relevant part in any material respect), subject to an
annual average purchase obligation of no less than approximately 440,000
lbs/hr. of steam (less amounts supplied by the Standby Facilities and less
50% of the amount sold by MCV to other steam customers). The SEPA can be
terminated by Dow under certain circumstances. Such termination would
likely lead to a loss of QF status for the Facility. The amounts of steam
that Dow is obligated to take under the SEPA are expected to be sufficient
to allow the Facility to maintain a Thermal Percentage of 5% (which would
require the Facility to achieve the 45% PURPA Efficiency Percentage) but
will not be sufficient to allow the Facility to maintain a Thermal
Percentage of 15% (which would allow a reduction of the required PURPA
efficiency standard to 42.5%). As a result of Consumers decision to
increase MCV's electric dispatch in 1996 consistent with the terms of the
Proposed Settlement, energy deliveries under the PPA could exceed 90% of
contract capacity for the year 1996. In that event, Dow and DCC steam
purchases must average approximately 600,000 lbs/hour in 1996 and beyond
for the Facility to achieve a 15% Thermal Percentage. Higher levels of
electric energy deliveries will require higher levels of steam purchases in
order to achieve a 15% Thermal Percentage.
Under an agreement signed November 1, 1994, Dow began purchasing steam for
its corporate center in October 1995, which has added an annual average of
approximately 22,000 lbs/hr in steam sales. Under an agreement signed
November 15, 1995, DCC began purchasing steam for its Midland site in July
1996, a use MCV believes will add an annual average of approximately
115,000 lbs/hr in steam sales. From 1991 through 1995 Dow steam purchases
have averaged 504,236 lbs/hr. Dow and DCC steam purchases during the first
nine months of 1996 averaged 563,911 lbs/hr reflecting, in part, the steam
sales to DCC which began in mid July 1996. Actual steam usage has varied
and will vary with product mix, seasonal delivery fluctuations and other
factors which may change over time. Thus, MCV believes annual steam sales
will be sufficient to allow the Facility to exceed the 15% Thermal
Percentage even if electricity deliveries under the PPA exceed 90% of
Contract Capacity.
MCV believes that, given projected levels of steam and electricity sales,
as a result of recent equipment modifications, and through diligent
management of the issue, the Facility will be able to maintain QF
Certification and should be capable of achieving a 45% PURPA Efficiency
Percentage on a long-term basis. However, no assurance can be given that
factors outside MCV's control such as Dow and DCC steam requirements,
Consumers' dispatch of the Facility pursuant to the Settlement Order or the
Proposed Settlement, extended outage of the Unit 1 steam turbine, major
malfunctions of other equipment, or degradation of plant heat rate will not
cause the Facility to fail to satisfy the annual PURPA qualification
requirements and thus lose its QF certification. In 1995, MCV achieved an
Efficiency Percentage of 45.2% and an Operating Percentage of 15.7%.
The loss of QF status could, among other things, cause the Facility to lose
its right under PURPA to sell power to Consumers at Consumers' "avoided
cost" and subject the Facility to additional federal and state regulatory
requirements, including the Federal Power Act (under which FERC has
authority to establish rates for electricity, which may be different than
existing contractual rates). If the Facility were to lose its QF status,
the Partners of MCV, the Owner Participants, the bank acting as the Owner
Trustee and their respective parent companies could become subject to
regulation under the Public Utility Holding Company Act of 1935 (under
which, among other things, the Securities and Exchange Commission has
authority to order divestiture of assets under certain circumstances). The
loss of QF status would not, however, entitle Consumers to terminate the
PPA. Under the PPA, Consumers is obligated to continue purchasing power
from MCV at FERC-approved rates (provided that the FERC-approved rates do
not exceed the existing contractual rates) and MCV, not Consumers, is
entitled to terminate the PPA (which MCV has covenanted not to do under the
Participation Agreements). There can be no assurance that FERC-approved
rates would be the same as the rates currently in effect under the PPA. If
the FERC-
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<PAGE> 19
approved rates are materially less than the rates under the PPA, MCV may
not have sufficient revenue to make rent payments under the Overall Lease
Transaction.
The loss of QF status would constitute an Event of Default under the Lease
(and a corresponding Event of Default under the Indenture) unless, among
other requirements, FERC approves (or accepts for filing) rates under the
PPA or other contracts of MCV for the sale of electricity sufficient to
meet certain target coverage ratios (as defined in the Overall Lease
Transaction).
See Part I, Item 1, "Financial Statements -- Notes 1 and 5 to the Condensed
Notes to Unaudited Consolidated Financial Statements" for a further
discussion of associated risks and contingencies.
-18-
<PAGE> 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
MPSC Proceedings Relating to Capacity and Energy Charges
Background. Michigan law requires Consumers to file on an annual basis a
"Power Supply Cost Recovery Plan" (the "PSCR Plan") describing, among other
things, the anticipated sources of electric power to be purchased during
the upcoming year. The PSCR Plan must be filed at least three months
before the beginning of the 12-month period covered by the plan. If the
MPSC fails to allow the costs of purchased power in the PSCR Plan by the
beginning of the year covered thereby, Consumers may adjust its rates to
recover such costs until the MPSC acts. Actual costs are reconciled with
the costs billed to customers in a subsequent filing (made by March 31 each
year) following the year in which the PSCR Plan was in effect, known as the
"Power Supply Cost Reconciliation Proceeding" ("Reconciliation Case"). By
law, the MPSC must disallow in the Reconciliation Case any capacity charges
associated with power purchases for periods in excess of six months unless
the MPSC has previously approved the capacity charge. Under a Michigan
statute known as Act 81, once a capacity charge in a contract for a
purchase from a QF has been approved by the MPSC, the MPSC may not disallow
recovery by the utility of that capacity charge from its customers for a
17-1/2 year period commencing with commercial operation of the QF.
The PPA. The PPA contains a "regulatory out" provision which permits
Consumers, under certain conditions, to reduce the capacity and energy
charges payable to MCV and/or to receive refunds of capacity and energy
charges paid to MCV under the PPA if the MPSC does not permit Consumers to
recover from its customers the capacity and energy charges specified in the
PPA. For the first 17-1/2 years after the Facility's Commercial Operation
Date, however, the PPA further provides that Consumers may not reduce the
average capacity charge below 3.77 cents per kWh notwithstanding the MPSC's
failure to approve either the amount of capacity Consumers has agreed to
purchase from MCV under the PPA or the capacity charge specified in the PPA
for such purchase.
Energy charges payable by Consumers under the PPA are separate and distinct
from the capacity charge in that no 17-1/2 year protection against the
exercise of the "regulatory out" provision for energy charges is provided
for in the PPA. Although prior approval of energy charges is not required
or provided for under Michigan law, the MPSC has asserted the authority to
disallow Consumers' recovery of a portion of such energy charges paid to
MCV. Any disallowance by the MPSC of Consumers' ability to pass energy
charges through to its customers could, pursuant to the "regulatory out"
provision of the PPA, result in a reduction or refund of the fixed and
variable portions of the energy charge under the PPA.
MPSC Proceedings. In September 1987, in order to comply with the prior
approval requirement for contracts exceeding six months and to obtain the
benefit of the 17-1/2 year rate protection provided by Michigan law, MCV
requested MPSC approval of the 4.15 cents per kWh capacity rate provided
for in the PPA. The MPSC hearing held on the request was consolidated with
numerous dockets involving other qualifying facility projects, and resulted
in a number of MPSC orders. Numerous appeals from the MPSC orders were
taken to the Michigan Court of Appeals and the Michigan Supreme Court by
parties to the MPSC proceedings, including Consumers and MCV. During the
pendency of this matter before the Court of Appeals, Consumers, MPSC staff
and other parties negotiated a Revised Settlement Proposal which was
submitted to the MPSC for approval.
On March 31, 1993, the MPSC issued an order, effective January 1, 1993 (the
"Settlement Order"), which approved with modifications the Revised
Settlement Proposal filed by Consumers, the MPSC staff and ten small power
and cogeneration developers. Although MCV was not a party to the Revised
Settlement Proposal, the MPSC staff required that MCV file a letter of
non-objection to the Revised Settlement Proposal. The Settlement Order
addressed the amount Consumers could recover from its electric customers
for the costs of capacity and energy purchased by it from MCV. Generally,
the Settlement Order approved cost recovery of 915 MW of MCV capacity
subject to certain "availability caps" associated with on-peak and off-peak
periods of time each day and recovery of energy payments based on coal
proxy prices (the formula in the PPA). However, instead of capacity and
fixed
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<PAGE> 21
energy payments being based on "availability" as provided in the PPA, the
Settlement Order provided for recovery of such payments on an energy
"delivered" basis. The MPSC did not order that the PPA be modified to
conform with the cost recovery approved in the Settlement Order. However,
the MPSC found that since the capacity charges approved for recovery under
the PPA would not be reflected in the PPA, approval for the purposes of Act
81 could not be extended to those capacity charges. The MPSC did indicate
in its order, however, that its Settlement Order would be implemented for
rate-making purposes in the PSCR Plan and Reconciliation Case for 1993 and
was intended to be applied in subsequent years if the MPSC deemed it to be
appropriate. Petitions for Rehearing of the Settlement Order filed with the
MPSC by opponents to the Revised Settlement Proposal, including the
Michigan Attorney General, were denied by the MPSC in May 1993. In
accordance with the provisions of the Settlement Order, in August 1993
Consumers and MCV withdrew their remaining appeals relating to MCV cost
recovery issues (from 1990, 1991 and 1992 PSCR Reconciliation Cases)
pending before the Michigan Court of Appeals and the Michigan Supreme
Court. An appeal of the Settlement Order has been filed with the Michigan
Court of Appeals by a group representing some of Consumers' industrial
customers and by the Michigan Attorney General ("Appellants"). On March
19, 1996, the Court of Appeals issued a decision which affirmed the
Settlement Order. The Appellants did not seek further judicial review of
the Court of Appeals' decision and thus the March 19, 1996 decision has
become final.
Because the Settlement Order did not approve the capacity charges
authorized for recovery in the PPA, and thereby denied the protection
provided under Michigan law from reconsideration for a 17-1/2 year period,
Consumers' cost recovery relating to purchases from the MCV is subject to
annual PSCR reviews.
In connection with a dispute between MCV and Consumers regarding the
payment of certain fixed energy charges which stemmed from the Revised
Settlement Proposal, on December 10, 1993, Consumers made a written
irrevocable offer of relief ("Offer of Relief") to MCV. The Offer of
Relief was for the purpose of facilitating the sale of Senior Secured Lease
Obligation Bonds, issued in connection with the financing of the Overall
Lease Transaction and held by Consumers. Pursuant to the Offer of Relief,
which was rendered final and irrevocable on December 28, 1993, Consumers
committed to pay MCV the fixed energy charges on all energy delivered by
MCV from the block of contract capacity above 915 MW. Consumers did not
commit to pay MCV for fixed energy charges on energy delivered above the
"caps" established in the Settlement Order up to 915 MW. The Offer of
Relief represented a "floor" for the arbitration of said dispute below
which payments to MCV of fixed energy charges in dispute could not fall.
Consumers would schedule deliveries of this energy in accordance with the
provisions of the PPA. This unilateral commitment, which became effective
as of January 1, 1993, to pay fixed energy charges on delivered energy from
the block of Contract Capacity above 915 MW will expire on September 15,
2007. This commitment will continue to apply even if the Settlement Order
is later amended.
On June 23, 1993, Consumers exercised its rights under the PPA to obtain a
determination through arbitration proceedings of whether Consumers could
exercise the "regulatory out" provision of the PPA in view of Consumers'
acceptance of the Settlement Order. In a Final Order issued on February
16, 1995, the arbitrator ruled that Consumers may withhold the fixed energy
charges for available but undelivered energy, as well as for energy
delivered between the "caps" contained in the Settlement Order and 915 MW,
subject to completion of appellate review in all regulatory and judicial
proceedings with respect to the Settlement Order and then pending PSCR
cases.
On February 23, 1995, the MPSC applied the Settlement Order to Consumers'
1993 Reconciliation Case and ruled that Consumers could not recover the
full 915 MW of MCV capacity and fixed energy charges provided under the
terms of the 1993 Revised Settlement Proposal approved by the MPSC in the
Settlement Order. Instead, the MPSC "allocated" approximately 25 MW of MCV
capacity to "non-jurisdictional" customers (i.e., customers not subject to
PSCR rates), resulting in a disallowance to Consumers of approximately $7.4
million of which approximately $.7 million relates to fixed energy charges.
In addition, the MPSC ruled in this case that Consumers could not recover
approximately $.6 million of fixed energy charges payable to MCV for energy
delivered above the off-peak cap of 732 MW. (Consumers has paid into
escrow approximately $.4 million of this sum and the balance was paid to
MCV.)
On October 19, 1995, Consumers notified MCV that, pursuant to the
"regulatory out" provision of the PPA, it would be increasing the amount
being escrowed each month to reflect its calculation of fixed energy charge
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<PAGE> 22
payments related to the 25 MW disallowed by the MPSC and Michigan Court of
Appeals described above. In addition, Consumers requested a refund from
MCV of $1.9 million plus interest, for the calendar years 1993 and 1994 and
the first eight months of 1995. On November 21, 1995, MCV responded to
Consumers indicating that MCV would, pursuant to the PPA, refund the
appropriate funds, if any, and determine the appropriate escrowing of
funds, if any, at such time as a final and non-appealable order disallowing
these recoveries is entered. Currently, Consumers is escrowing
approximately $62,000 per month in fixed energy charge payments from MCV
due to this issue.
Consumers and MCV appealed the MPSC February 23, 1995 Order to the Michigan
Court of Appeals and on November 1, 1996 the Michigan Court of Appeals
affirmed the MPSC's decision which "allocated" approximately 25 MW of MCV
capacity to "non-jurisdictional" customers and ruled Consumers could not
recover fixed energy charges for energy delivered above the off peak cap of
732 MW. MCV management is currently assessing the prospects of further
appeal or review and, at this time, cannot predict if such an appeal will
be filed (by MCV, Consumers or any other party) or the outcome of such a
proceeding.
As part of its order in Consumers' 1994 PSCR Plan proceedings, the MPSC, on
August 18, 1994, ruled that for 1994 Consumers would not be permitted to
recover fixed energy costs during off-peak hours for energy delivered
above the availability "caps" contained in the Settlement Order and below
915 MW. MCV believes the MPSC order on this issue is erroneous and has
filed an appeal of the MPSC decision. Other PSCR Plan and Reconciliation
Cases for the years 1994 - 1997 are pending before the MPSC at this time.
MCV Management cannot predict the outcome of these proceedings. Consumers
has escrowed approximately $2.1 million for the first nine months of 1996
and approximately $1.0 million for the years 1995 and 1994, of fixed energy
charges payable to MCV based on this MPSC ruling and continues escrowing
approximately $.2 million per month for this portion of fixed energy
charges.
1995 Settlement Proceedings. On September 8, 1995, Consumers and the MPSC
staff filed a motion to create a consolidated proceeding for the purpose of
reviewing a settlement agreement ("Proposed Settlement") entered into
between the MPSC staff and Consumers related to three cases: Case No.
U-10685, Consumers' electric general rate case; Case No. U-10787,
Consumers' request for approval of a special competitive services tariff
(Rate SCS); and Case No. U-10754, Consumers' application for approval of
revised depreciation rates for electric and common utility plant. MCV is a
party to the consolidated proceeding. The settlement agreement proposes
approving the jurisdictional cost recovery of an additional 325 MW of
capacity purchased from MCV. Cost recovery approval for the 325 MW of MCV
contract capacity would be in addition to the 915 MW already approved by
the MPSC. Recovery would begin January 1, 1996. The initial average
capacity charge recovered would be 2.86 cents per kWh escalating to 3.62
cents per kWh in 2004 and thereafter. On September 22, 1995, MCV filed a
position statement not objecting to the Proposed Settlement, but reserving
all of its rights and privileges under the PPA. If the settlement is
approved as filed it will likely result in an increase in MCV's dispatch
under the PPA. Consumers has, in fact, increased MCV's dispatch in 1996
consistent with the terms of the Proposed Settlement. Based on current gas
prices and energy rates, this should have a positive impact on MCV's cash
flow and earnings, assuming current gas prices and energy rates continue in
effect. Management cannot predict the outcome of this proceeding.
Great Lakes Pricing of Gas Transportation Costs
MCV has entered into long-term gas transportation arrangements with four
U.S. interstate transporters: ANR Pipeline Company, Panhandle Eastern Pipe
Line Company, Trunkline Gas Company and Great Lakes Gas Transmission
Company ("Great Lakes"). The transportation rates from these transporters
are subject to FERC regulation.
In 1990, Great Lakes expanded its interstate pipeline system to accommodate
gas purchases from MCV and other customers. Historically, such capital
costs were "rolled-in" to the rate base, thus combining the capital cost of
common use facility additions with the cost of existing common use
facilities for the purpose of determining the transportation rates to be
charged to all system shippers. In 1991, FERC issued an order that
rejected rolled-in pricing for the MCV-related expansion costs and,
instead, imposed incremental pricing which, for MCV, took effect April 1,
1993. The incremental methodology allocates the capital cost of facility
additions solely to the new shippers who will gain access to the expanded
facilities. FERC's decision was appealed by MCV and others to the
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<PAGE> 23
United States Court of Appeals for the District of Columbia Circuit, which held
that FERC had failed to adequately explain the adoption of incremental rates and
remanded the orders to FERC for reconsideration. On July 26, 1995, FERC issued
its Order on Remand reversing its prior order and directed Great Lakes to: (i)
implement rolled-in rates prospectively beginning October 1, 1995, for the
expansion facilities including those applicable to MCV; and (ii) refund to MCV,
subject to FERC approval, the principal amount, excluding interest, paid in
excess of rolled-in rates. MCV had, from April 1, 1993 to October 1, 1995,
reflected in current operating results Great Lakes gas transportation costs
associated with incremental pricing. On April 25, 1996, FERC affirmed its Order
on Remand as it pertains to the MCV issues described above ("Order on
Rehearing"). On June 3, 1996, FERC granted rehearing for further consideration.
Rehearing was requested by, among others, MCV for clarification of the timing of
refunds, surcharges and interest thereon subsequent to October 1, 1995. On July
31, 1996, FERC clarified its April 25, 1996 order stating that interest on
refunds was to commence October 1, 1995 and otherwise denied the relief
requested in the petitions for rehearing. As of September 30, 1996, 98% of the
refund has been paid to MCV. The FERC Order on Rehearing and its July 31, 1996
order are subject to further administrative and judicial processes and, MCV and
others have filed appeals to the United States Court of Appeals for the District
of Columbia ("Court of Appeals") challenging certain aspects of the Order on
Remand. Management cannot predict the outcome of these proceedings but believes
that the likelihood of a reversal by the Court of Appeals of that portion of the
FERC Order on Rehearing requiring rolled-in rate treatment is remote.
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<PAGE> 24
Item 6. Exhibits and Reports on Form 8-K
a.) List of Exhibits
27 Financial Data Schedule (3rd Quarter 1996)
b.) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter for which this
report is filed.
-23-
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MIDLAND COGENERATION VENTURE
LIMITED PARTNERSHIP
----------------------------
(Registrant)
Dated: November 8, 1996 /s/ James M. Kevra
---------------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: November 8, 1996 /s/ James M. Rajewski
-------------------------------------
James M. Rajewski
Vice President and Controller
(Principal Accounting Officer)
-24-
<PAGE> 26
EXHIBIT INDEX
Exhibit Sequential
Number Page No.
------- ----------
27 Financial Data Schedule (3rd Quarter 1996) 26
-25-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 289,180
<SECURITIES> 0
<RECEIVABLES> 64,120
<ALLOWANCES> 0
<INVENTORY> 13,563
<CURRENT-ASSETS> 235,448
<PP&E> 2,408,052
<DEPRECIATION> 509,787
<TOTAL-ASSETS> 2,292,130
<CURRENT-LIABILITIES> 177,852
<BONDS> 1,929,241
0
0
<COMMON> 0
<OTHER-SE> 184,626
<TOTAL-LIABILITY-AND-EQUITY> 2,292,130
<SALES> 0
<TOTAL-REVENUES> 479,269
<CGS> 0
<TOTAL-COSTS> 306,612
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 135,611
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 50,666
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
