<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, 1997
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
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<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,
1997 December 31,
ASSETS (Unaudited) 1996
- ------ ------------- ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 147,406 $ 209,959
Restricted cash and cash equivalents 13,062 14,041
Accounts receivable 89,387 73,811
Gas inventory 12,251 13,539
Unamortized property taxes 22,509 -
Prepaid expenses and other 6,547 4,078
------------- ------------
Total current assets 291,162 315,428
------------- ------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,432,779 2,403,640
Pipeline 21,222 21,222
------------- ------------
Total property, plant and equipment 2,454,001 2,424,862
Accumulated depreciation (614,017) (535,590)
------------- ------------
Net property, plant and equipment 1,839,984 1,889,272
------------- ------------
OTHER ASSETS:
Restricted non-current cash and cash equivalents 142,384 143,049
Deferred financing costs, net of accumulated amortization
of $9,077 and $8,231, respectively 9,500 10,346
Materials, supplies and other 20,841 5,850
------------- ------------
Total other assets 172,725 159,245
------------- ------------
TOTAL ASSETS $ 2,303,871 $ 2,363,945
============= ============
LIABILITIES AND PARTNERS' EQUITY
- --------------------------------
CURRENT LIABILITIES:
Accounts payable, accrued and other liabilities $ 70,504 $ 67,539
Interest payable 42,132 88,652
Current portion of long-term debt 140,950 78,574
------------- ------------
Total current liabilities 253,586 234,765
------------- ------------
NON-CURRENT LIABILITIES:
Long-term debt 1,788,291 1,929,241
Other 604 455
------------- ------------
Total non-current liabilities 1,788,895 1,929,696
------------- ------------
CONTINGENCIES (Note 7)
TOTAL LIABILITIES 2,042,481 2,164,461
------------- ------------
PARTNERS' EQUITY 261,390 199,484
------------- ------------
TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,303,871 $ 2,363,945
============= ============
</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,
-------------------- --------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
OPERATING REVENUES:
Capacity $ 102,147 $ 101,859 $ 303,140 $ 293,433
Electric 54,546 56,821 163,324 164,985
Steam and other 6,063 6,594 20,848 20,851
--------- --------- --------- ---------
Total operating revenues 162,756 165,274 487,312 479,269
--------- --------- --------- ---------
OPERATING EXPENSES:
Fuel costs (Note 7) 66,868 50,061 198,996 180,785
Depreciation 26,207 25,915 78,544 78,284
Operations 3,876 3,708 12,070 11,560
Maintenance 3,542 2,760 9,747 10,281
Property and single business taxes 5,885 6,480 19,334 19,653
Administrative, selling and general 1,867 1,849 6,050 6,049
--------- --------- --------- ---------
Total operating expenses 108,245 90,773 324,741 306,612
--------- --------- --------- ---------
OPERATING INCOME 54,511 74,501 162,571 172,657
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest and other income (Note 7) 4,807 5,539 14,351 13,620
Interest expense (42,473) (44,206) (130,549) (135,611)
--------- --------- --------- ---------
Total other income (expense), net (37,666) (38,667) (116,198) (121,991)
--------- --------- --------- ---------
INCOME BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 16,845 35,834 46,373 50,666
Cumulative effect on prior years
(to December 31, 1996) of change
in method of accounting for property
taxes (Note 3) - - 15,533 -
--------- --------- --------- ---------
NET INCOME $ 16,845 $ 35,834 $ 61,906 $ 50,666
========= ========= ========= =========
</TABLE>
The accompanying condensed notes are an integral part of these statements.
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<PAGE> 4
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1997
----------------------------
General Limited
Partners Partners Total
-------- -------- --------
<S> <C> <C> <C>
BALANCE, BEGINNING OF PERIOD $162,312 $ 37,172 $199,484
Net income 53,897 8,009 61,906
-------- -------- --------
BALANCE, END OF PERIOD $216,209 $ 45,181 $261,390
======== ======== ========
</TABLE>
The accompanying condensed notes are an integral part of this statement.
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<PAGE> 5
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
1997 1996
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 61,906 $ 50,666
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 79,390 79,163
Increase in accounts receivable (15,576) (99)
Decrease in gas inventory 1,288 833
Increase in unamortized property taxes (22,509) (5,971)
Increase in prepaid expenses and other (2,469) (3,515)
Increase in materials, supplies and other (14,991) (1,084)
Increase in accounts payable, accrued and other liabilities 2,965 1,040
Decrease in interest payable (46,520) (47,992)
Increase in other non-current liabilities 149 76
--------- --------
Net cash provided by operating activities 43,633 73,117
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (29,256) (29,007)
--------- --------
Net cash used in investing activities (29,256) (29,007)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (78,574) (72,190)
Decrease (increase) in restricted non-current cash and cash equivalents 665 (2,102)
--------- --------
Net cash used in financing activities (77,909) (74,292)
--------- --------
NET DECREASE IN CASH, CASH EQUIVALENTS AND
RESTRICTED CASH -- CURRENT (63,532) (30,182)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -- CURRENT,
AT BEGINNING OF PERIOD 224,000 177,408
CASH, CASH EQUIVALENTS AND RESTRICTED CASH -- CURRENT,
--------- --------
AT END OF PERIOD $ 160,468 $147,226
========= ========
</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, 1996 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
("MCV GAGP") for the purpose of buying and selling natural gas on the
spot market and other transactions involving natural gas activities.
Currently, MCV GAGP is not actively engaged in any business activity.
The Facility is designed to provide approximately 1,370 megawatts ("MW")
of electricity and approximately 1.5 million pounds of process steam per
hour. MCV has contracted to supply up to 1,240 MW of electric capacity
("Contract Capacity") to Consumers Energy Company, formerly 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") 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 have historically accounted for over 90%
of MCV's revenues.
The Facility is a qualifying cogeneration facility ("QF") originally
certified by the Federal Energy Regulatory Commission ("FERC") under the
Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"). In
order to maintain QF status, certain operating and efficiency standards
must be maintained on a calendar-year basis and certain ownership
limitations must be met. In the case of a topping-cycle generating plant
such as the Facility, the applicable operating standard requires that the
portion of total energy output that is put to some useful purpose other
than facilitating the production of power (the "Thermal Percentage") be
at least 5%. In addition, the Facility must achieve a PURPA efficiency
standard (the sum of the useful power output plus one-half of the useful
thermal energy output, divided by the energy input (the "Efficiency
Percentage")) of at least 45%. If the Facility maintains a Thermal
Percentage of 15% or higher, the required Efficiency Percentage is
reduced to 42.5%. Since 1990, the Facility has achieved the applicable
Thermal and Efficiency Percentages. For the nine months ended September
30, 1997, the Facility achieved a Thermal Percentage of 15.6% and a PURPA
Efficiency Percentage of 45.6%. 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 1997.
MCV meets the ownership limitations of PURPA.
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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 consist of the
costs of natural gas. MCV recognizes that its existing gas contracts are
not sufficient to satisfy the anticipated gas needs over the term of the
PPA and, as such, no assurance can be given as to the availability or price
of natural gas after the expiration of the existing gas contracts.
Commencing in 1998, MCV must provide at Consumers request, continuing
annual assurances of such capability for each succeeding five-year period.
If MCV is unable to provide these continuing assurances, Consumers is
entitled to withhold in a separate escrow fund a portion of capacity
charges until these assurances are provided. MCV believes that it can meet
the requirement of continuing assurances in 1998. In addition, to the
extent that the costs associated with production of electricity rise faster
than the energy charge payments, MCV's financial performance will be
negatively affected. The amount of such impact will depend upon the amount
of the average energy charge payable under the PPA, which is based upon
costs incurred at Consumers' coal-fired plants and upon the amount of
energy scheduled by Consumers for delivery under the PPA. However, given
the unpredictability of these factors, the overall economic impact upon MCV
of changes in energy charges payable under the PPA and in future fuel costs
under new or existing contracts cannot accurately be predicted.
(2) SIGNIFICANT ACCOUNTING POLICIES
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents approximate fair value
because of the short maturity of these instruments. The unique nature of
the negotiated financing obligation discussed in Note 6 makes it
impractical to estimate the fair value of the lessor group ("Owner
Participants") underlying debt and equity instruments supporting such
financing obligation.
Forward Foreign Exchange Contracts
Under a service agreement (the "Service Agreement") between MCV and ABB
Power Generation ("ABB Power"), ABB Power sold MCV an initial inventory of
spare parts for the GTGs and provides qualified service personnel and
supporting staff to assist MCV, to perform scheduled inspections on the
GTGs, and to repair the GTGs at MCV's request. Effective December 31,
1993, MCV entered into an addendum to the Service Agreement. Under this
addendum to the Service Agreement, ABB Power will provide hot gas path
parts for MCV's twelve gas turbines through the fourth series of major GTG
inspections, which are expected to be completed by year 2002. The payments
due to ABB Power under this addendum to the Service Agreement are adjusted
annually based on the ratio of the U.S. dollar to Swiss franc currency
exchange rate. MCV maintains a foreign currency hedging program to be used
only with respect to MCV payments subject to foreign currency exposure
under the addendum to the Service Agreement.
To manage this currency exchange rate risk and hedge against adverse
currency fluctuations impacting the payments under this addendum to the
Service Agreement, MCV enters into forward purchase contracts for Swiss
francs. The forward foreign currency exchange contracts qualify as hedges
under Statement of Financial Accounting Standards ("SFAS") 52 "Foreign
Currency Translation," since they hedge the identifiable foreign currency
commitment of the addendum to the Service Agreement. The gains and losses
on these transactions, accounted for as hedges, are deferred on the balance
sheet and included in the measurement of the underlying capitalized
maintenance costs when incurred. As of September 30, 1997, MCV had forward
purchase contracts involving Swiss francs in the notional amount of $10.0
million, with a deferred $.2 million gain, recorded in other assets. As of
December 31, 1996, MCV had forward purchase contracts involving Swiss
francs in the notional amount of $15.0 million, with a deferred $1.4
million loss, recorded in other assets.
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<PAGE> 8
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Natural Gas Options and Futures
To manage market risks associated with the volatility of natural gas prices,
MCV maintains a gas hedging program. MCV enters into natural gas option and
futures contracts in order to hedge against unfavorable changes in the
market price of natural gas in future months when gas is expected to be
needed. These financial instruments are being utilized only to secure
anticipated natural gas requirements necessary for projected electric sales
under the PPA at a cost of gas less than that available under MCV's
long-term natural gas contracts and to hedge sales of natural gas previously
obtained in order to optimize MCV's existing gas supply, storage and
transportation arrangements. The natural gas futures contracts qualify as
hedges under SFAS 80, "Accounting for Futures Contracts," since the
contracts cover probable future transactions.
Cash is deposited with the broker in a margin account, at the time future or
option contracts are initiated. The change in market value of these
contracts requires adjustment of the margin account balances. The margin
balance was $2.9 million and $1.7 million as of September 30, 1997 and
December 31, 1996, respectively. MCV's deferred gains and losses on future
and option contracts will be offset by the corresponding underlying physical
transaction and then included in operating expenses as part of fuel cost in
the same period the natural gas is burned to operate the Facility. As of
September 30, 1997, MCV had net open futures and options contracts of .7 Bcf
with a deferred gain of $1.2 million. As of December 31, 1996, MCV had net
open futures contracts of 3.0 Bcf with a deferred gain of $.4 million. In
addition, MCV recorded approximately $3.2 million in net deferred gains on
contracts closed prior to September 30, 1997, related to October 1997
purchase commitments, while MCV recorded approximately $.1 million in net
deferred gains on contracts closed prior to December 31, 1996, related to
January 1997 purchase commitments.
(3) CHANGE IN METHOD OF ACCOUNTING FOR PROPERTY TAXES
Effective January 1, 1997, MCV changed its method of accounting for property
taxes so that such taxes are expensed monthly during the fiscal period of
the taxing authority for which the taxes are levied. This change provides a
better matching of property tax expense with both the payment for services
and those services provided by the taxing authorities. Prior to January 1,
1997, the Partnership expensed property taxes monthly during the year
following the assessment date (December 31). The cumulative effect of this
change in accounting for property taxes increased earnings for the nine
months ended September 30, 1997 by approximately $15.5 million. The pro
forma effect on 1997 and prior years' consolidated net income, including all
interim periods, of retroactively recording property taxes as if the new
method of accounting had been in effect for all periods presented is not
material.
(4) 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,
1997 1996
---- ----
<S> <C> <C>
Current:
- -------
Funds restricted for plant modifications $ 13,062 $ 14,041
======== ========
Non-current:
- -----------
Funds restricted for rental payments pursuant
to the Overall Lease Transaction $141,808 $142,624
Funds restricted for management non-qualified plans 576 425
-------- --------
$142,384 $143,049
======== ========
</TABLE>
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<PAGE> 9
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(5) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following as of
(in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---------------------------
<S> <C> <C>
Accounts payable
Related parties $22,869 $11,743
Trade creditors 28,914 40,076
Property and single business taxes 12,421 11,835
Other 6,300 3,885
------- -------
Total $70,504 $67,539
======= =======
</TABLE>
(6) LONG-TERM DEBT
Long-term debt consists of the following as of (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---------------------------
<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 $1,929,241 $2,007,815
Less current portion (140,950) (78,574)
---------- ----------
Total long-term debt $1,788,291 $1,929,241
========== ==========
</TABLE>
Financing Obligation
--------------------
In 1990, MCV obtained permanent financing for the Facility by entering into
sale and leaseback agreements ("Overall Lease Transaction") with the 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, 1997 and 1996 were $129.7 million and $134.7
million, respectively. Interest and fees paid for the nine months ended
September 30, 1997 and 1996 were $176.2 million and $182.8 million,
respectively.
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<PAGE> 10
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(7) CONTINGENCIES
PPA - "Regulatory Out" Provision
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 a regulatory disallowance.
PPA - 25 MW Regulatory Disallowance
On February 23, 1995, the Michigan Public Service Commission ("MPSC") in
Case No. U-10155-R (the 1993 power supply cost recovery reconciliation
proceeding, "1993 Reconciliation Case" conducted by the MPSC to reconcile
actual costs incurred by Consumers in 1993 in providing power supply to
its retail customers with actual revenues it collected that same year),
ruled that Consumers could not recover from its retail customers the full
915 MW of MCV capacity and fixed energy charges as Consumers contended it
was entitled to 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 MPSC
jurisdiction). In October 1995, Consumers notified MCV that, pursuant to
the "regulatory out" provision of the PPA, it would increase the amount
escrowed each month to reflect its calculation of fixed energy charge
payments allocated to non-jurisdictional customers disallowed by the MPSC
and Michigan Court of Appeals due to the jurisdictional issue. 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. In November 1995, MCV responded to Consumers indicating that MCV
would, pursuant to the PPA, refund the appropriate funds, if any, and
determine the appropriate calculation of the correct escrow amount, if
any, at such time as a final and non-appealable order disallowing these
recoveries is entered. The Michigan Court of Appeals decision involving
the jurisdictional issue has become final. Based on this decision,
Consumers notified MCV that it would continue withholding the fixed energy
charges on the jurisdictional issue (approximately $45,000 per month in
1997). MCV agreed to the release to Consumers of the escrowed funds of
approximately $1.0 million plus interest (covering the period of September
1995 through December 1996), subject to a final resolution between MCV and
Consumers of the energy charge to be paid to MCV, which will be adjusted
with any refund of the $1.9 million (discussed above), as a result of the
finality of the jurisdictional issue. MCV has not recognized any of these
amounts related to this jurisdictional issue as operating revenues.
PPA - Fixed Energy Payments for Deliveries Above the Caps
The MPSC ruled in the 1993, 1994 and 1995 Reconciliation and Plan Cases,
that Consumers would not be permitted to recover from its retail
customers fixed energy costs for energy delivered above the off-peak cap
("the off-peak cap issue") of 732 MW in 1993 and 750.3 MW in 1994 and
1995 . MCV and Consumers appealed the MPSC orders for both the years
1993 and 1994 to the Michigan Court of Appeals, and in the 1993
Reconciliation and 1994 Plan Cases the Michigan Court of Appeals affirmed
the MPSC's decisions. MCV has appealed the 1994 and 1995 MPSC orders to
the Michigan Court of Appeals. MCV believes these rulings are erroneous
and has petitioned the Michigan Supreme Court to review the off-peak cap
issue in the 1993 Reconciliation Case. Other PSCR Plan and
Reconciliation Cases for the years 1996-1998 are pending before the MPSC
at this time which involve this same issue. Consumers escrowed
approximately $2.8 million for 1996 and $1.4 million for the period April
1993 - December 1995 of fixed energy charges payable to MCV based upon
the MPSC rulings. In addition, MCV was paid $.2 million for the period
January - March 1993. MCV has not recognized any of these amounts related
to the off-peak cap issue as operating revenues. MCV Management cannot
predict the outcome of these proceedings.
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<PAGE> 11
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
PPA - Remaining 325 MW
In September 1995, Consumers and the MPSC staff filed a motion to create a
consolidated proceeding for the purpose of reviewing a settlement agreement
("325 MW Proposed Settlement") entered into between the MPSC staff and
Consumers. The settlement agreement proposes approving one-hundred percent
jurisdictional cost recovery of the remaining 325 MW of capacity purchased
from MCV. Cost recovery approval for the 325 MW of MCV Contract Capacity is
in addition to the 915 MW already approved (subject to the jurisdictional
issue) by the MPSC. On November 14, 1996, the MPSC approved, with
modifications, the settlement agreement effective January 1, 1996 ("325 MW
Settlement Order"). The modifications were generally related to issues not
material to MCV, except the jurisdictional issue which the MPSC deferred to
the 1996 PSCR Plan proceeding. Various parties have petitioned the MPSC for
rehearing and on April 10, 1997 the MPSC granted in part and denied in part
those petitions. No issues associated with the 325 MW recovery of MCV's
capacity or energy were part of the grant of rehearing. However, in the
1996 PSCR Plan proceeding, which is subject to further proceedings, the MPSC
ordered, on May 7, 1997, that the 325 MW of additional MCV capacity would be
allocated between jurisdictional and non-jurisdictional customers of
Consumers in the same manner as the original 915 MW. The Attorney General,
among others, has filed an appeal of the 325 MW Settlement Order. As a
result of the approval of the 325 MW Settlement Order, Consumers notified
MCV in February 1997, that it would cease escrowing for the off-peak cap
issue. Consumers released to MCV the 1996 escrowed funds of approximately
$2.8 million discussed in the preceding paragraph and Consumers has paid to
MCV approximately $2.1 million for energy delivered above the off-peak cap
during the first nine months of 1997, subject to a final decision upholding
the 325 MW Settlement Order on this issue. MCV has not recognized these
amounts paid to MCV as operating revenues. MCV Management cannot predict
the outcome of either the 325 MW Settlement Order proceeding or the 1996
PSCR Plan proceeding.
PPA - Other Issues
Recently, Consumers informed MCV of several other potential issues it may
pursue, pursuant to the "regulatory out" provision of the PPA. These issues
relate to Consumers special contract customers, pricing of the energy
delivered during off-peak ramp hours (when MCV adjusts its output to match
Consumers' dispatch) and energy delivered in the band width (energy
delivered above dispatch, within certain limits). In addition, Consumers
notified MCV that it does not believe that MCV can use the approximately 15
MW of generating capacity attributable to the back pressure turbine, which
was placed into service in July 1997, towards available Contract Capacity
under the PPA. Based upon the limited information provided on these
potential issues, at this time, MCV cannot accurately determine the
financial impact of these issues and what specific action will be taken.
MCV management believes, based upon limited information, that these
potential issues will not have a material impact upon MCV's financial
position, if recognized.
GTG Equipment Problems
In 1991 and 1992, several of the gas turbine generators ("GTG's") experienced
cracking in the hot gas casings which, in two cases, caused extensive damage to
the turbine blades and vanes. As a result of these cracking problems,
modifications were made on all GTG's and, MCV and ABB Power Generation, Inc.
("ABB Power") implemented a program of hot gas casing inspections for all GTG's.
In January 1996, two additional GTG's experienced severe cracking in the hot gas
casings causing extensive damage to the turbine blades and vanes. Extensive
analysis and review by MCV and ABB Power 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 all the turbines which has significantly reduced
pulsations in the hot gas casings and installed additional measuring devices to
detect any pulsations which are suspected of accelerating crack propagation. MCV
and ABB Power continue to study whether any modifications are needed in the high
stress areas of the hot gas casings, but MCV believes that the burner
modifications have resolved the pulsation problems and there should be no
significant future impacts on plant
-10-
<PAGE> 12
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
availability or efficiency from pulsations, 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 through the fourth series of major GTG inspections which
are expected to be completed by year end 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 second quarter of 1998. Failure to maintain insurance,
subject to certain exceptions, not currently applicable, is an Event of
Default under the Overall Lease Transaction.
Fuel Matters
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
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. MCV's refund was approximately $5.9 million, $8.0 million and
$3.7 million for each of the years 1995, 1994 and, 1993 and prior
respectively. 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. MCV 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.
-11-
<PAGE> 13
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(8) 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, 1997, and the nature and amount of related party transactions or
agreements that existed with the Partners or affiliates as of September 30,
1997 and 1996, 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
- ------------------------------------- ---------- -------- ---------------------------------------------------------
<S> <C> <C> <C>
CMS Midland, Inc. $128,081 49.0% Power purchase agreement
General Partner; wholly-owned Purchases under gas transportation agreements
subsidiary of Consumers Energy Purchases under spot gas agreements
Company (formerly Consumers Purchases under gas supply agreements
Power Company) Gas storage agreement
Land lease/easement agreements
Accounts receivable
Accounts payable
Gas exchanges
The Dow Chemical Company 32,591 7.5 Steam and electric power agreement
Limited Partner Steam purchase agreement - Dow Corning Corp (affiliate)
Purchases under demineralized water supply agreement
Accounts receivable
Accounts payable
Standby and backup fees
Source Midland Limited Partnership 41,966 18.1 SMLP - Under Ownership of MCNIC Power Company
("SMLP") General Partner; affiliate ---------------------------------------------------------
of MCN Energy Group Inc. (1) Purchases under spot gas agreements
Purchases under gas supply agreements
Accounts payable
Partner cash withdrawal (including accrued interest) (3)
SMLP - Under Ownership of Pan Energy Corp
---------------------------------------------------------
Purchases under gas transportation agreements
Purchases under spot gas agreements
Gas exchanges
Accounts payable
Coastal Midland, Inc. 25,179 10.9 Purchases under gas transportation agreements (2)
General Partner; wholly-owned Purchases under spot gas agreement
subsidiary of The Coastal Purchases under gas supply agreement
Corporation Gas storage agreement
Gas agency agreement
Deferred reservation charges under gas purchase agreement
Accounts receivable
Accounts payable
Gas exchanges
Partner cash withdrawal (including accrued interest) (3)
MEI Limited Partnership 20,983 9.1 Gas turbine maintenance and spare parts agreement
General Partner; affiliate of Accounts payable
ASEA Brown Boveri, Inc. Partner cash withdrawal (including accrued interest) (3)
Micogen Limited Partnership 10,491 4.5 Partner cash withdrawal (including accrued interest) (3)
Limited Partner; affiliate of
Fluor Corporation
C-E Midland Energy, Inc. 2,098 .9 Service Agreement
Limited Partner; affiliate Accounts Payable
of ASEA Brown Boveri, Inc.
Alanna Corporation 1 (4) .00001 Note receivable
Limited Partner; wholly-owned
subsidiary of Alanna Holdings
Corporation
</TABLE>
<TABLE>
<CAPTION>
Equity Partner, Type of Partner
and Nature of Related Party 1997 1996
- ------------------------------------- ---------- --------
<S> <C> <C>
CMS Midland, Inc. $454,721 $443,498
General Partner; wholly-owned 7,270 7,111
subsidiary of Consumers Energy 4,720 1,948
Company (formerly Consumers 7,768 7,349
Power Company) 1,922 1,922
450 450
50,043 49,987
14,192 6,693
1,268 3,305
The Dow Chemical Company 32,587 35,771
Limited Partner 2,294 403
5,540 4,591
1,633 2,273
1,230 1,336
605 967
Source Midland Limited Partnership
("SMLP") General Partner; affiliate 578 --
of MCN Energy Group Inc. (1) 5,384 --
1,284 --
11,753 --
4,648 11,562
911 3,313
50 1,387
-- 2,082
Coastal Midland, Inc. 10,237 (6,739)
General Partner; wholly-owned 4,445 12,161
subsidiary of The Coastal 3,255 2,872
Corporation 203 --
1,121 953
3,940 2,955
891 455
4,490 4,276
1,411 4,056
7,246 --
MEI Limited Partnership 23,503 22,297
General Partner; affiliate of 1,545 81
ASEA Brown Boveri, Inc. -- 4,229
Micogen Limited Partnership 3,102 1,899
Limited Partner; affiliate of
Fluor Corporation
C-E Midland Energy, Inc. 1,538 5,167
Limited Partner; affiliate 129 1,077
of ASEA Brown Boveri, Inc.
Alanna Corporation 1 1
Limited Partner; wholly-owned
subsidiary of Alanna Holdings
Corporation
</TABLE>
(1) On May 16, 1997, MCNIC Power Company acquired all of the partnership
interests in Source Midland Limited Partnership ("SMLP") from PanEnergy
Corp. The SMLP amounts listed Under Ownership of MCNIC Power Company are
as of September 30, 1997 and for the period May 16, 1997 to
September 30, 1997. The SMLP amounts listed Under Ownership of PanEnergy
Corp. are for the period January 1, 1997 to May 15, 1997, and as of
September 30, 1996 and the nine month period ended September 30, 1996.
(2) 1996 includes the Great Lakes gas transportation refund of $17.6 million.
(3) In exchange for a letter of credit pursuant to the Participation Agreement.
(4) Alanna's capital stock is pledged to secure MCV's obligation under the
lease and other overall lease transaction documents.
-12-
<PAGE> 14
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, 1996 of the Midland Cogeneration Venture
Limited Partnership ("MCV").
Results of Operations:
Operating Revenues Statistics
The following represents significant operating revenue statistics for the
following periods (dollars in thousands except average rates):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
1997 1996 1997 1996
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Operating Revenues $ 162,756 $ 165,274 $ 487,312 $ 479,269
Capacity Revenue $ 102,147 $ 101,859 $ 303,140 $ 293,433
PPA Contract Capacity (MW) 1,240 1,240 1,240 1,240
PPA Availability 98.9% 98.6% 98.9% 95.4%
Electric Revenue $ 54,546 $ 56,821 $ 163,324 $ 164,985
PPA Delivery as a Percentage of Contract Capacity 91.2% 90.9% 91.0% 88.8%
PPA and SEPA Electric Deliveries (MWh) 2,641,097 2,632,799 7,810,209 7,649,924
Average PPA Variable Energy Rate ($/MWh) $ 16.87 $ 16.97 $ 16.84 $ 16.99
Average PPA Fixed Energy Rate ($/MWh) $ 3.91 $ 4.09 $ 3.97 $ 4.06
Steam and Other Revenue $ 2,245 $ 2,776 $ 9,395 $ 9,398
Steam Deliveries (Mlbs) 1,163,636 1,104,731 4,164,074 3,708,281
Other Operating Income $ 3,818 $ 3,818 $ 11,453 $ 11,453
</TABLE>
Comparison of the Three Months ended September 30, 1997 and 1996
Overview
For the third quarter of 1997, MCV recorded net income of $16.8 million as
compared with net income of $35.8 million for the third quarter of 1996. The
decrease in net income is primarily the result of the 1996 Great Lakes gas
transportation refund, higher 1997 natural gas prices and lower electric energy
rates under the PPA with Consumers, partially offset by lower interest expense
on MCV's financing obligation.
-13-
<PAGE> 15
Operating Revenues
For the third quarter of 1997, MCV's operating revenues decreased $2.5 million
from the third quarter of 1996 due primarily to lower electric and steam
revenues generated under the SEPA with Dow. The Dow electric and steam
revenues decreased due to the gas tolling credit given to Dow (Dow is entitled
to the credit when Dow exercises its option to provide the gas necessary to
generate Dow's take of steam and electricity, subject to certain limitations
and conditions). Also contributing to the lower electric revenues were lower
energy rates under the PPA with Consumers.
Operating Expenses
For the third quarter of 1997, MCV's operating expenses were $108.2 million,
which includes $66.9 million of fuel costs. During this period MCV purchased
approximately 24.6 billion cubic feet ("bcf") of natural gas, of which 1.5 bcf
was used for transportation fuel and as a net change to gas in storage. During
this same period MCV consumed 23.9 bcf of the natural gas at the plant to
produce energy, of which .8 bcf of this total was gas provided by Dow. The
average commodity cost of fuel for the third quarter of 1997 was $2.43 per
million British thermal units ("MMBtu"). 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 third quarter of 1996 included the 1996 Great
Lakes gas transportation refund of approximately $17.6 million (excluding
interest). Excluding the Great Lakes refund, fuel costs were $67.7 million for
the third quarter of 1996. During this period MCV purchased approximately 27.8
bcf of natural gas, of which 4.3 bcf was used for transportation fuel and as a
net change to gas in storage. During this same period MCV consumed 23.5 bcf of
natural gas at the plant to produce energy. The average commodity cost of fuel
for the third quarter of 1996 was $2.35/MMBtu. The decrease in fuel costs for
the third quarter of 1997 of $.8 million (excluding the Great Lakes refund)
compared to 1996 was primarily due to Dow's providing of gas to generate part
of its take of steam and electricity, partially offset by higher natural gas
prices in the spot market and the escalation of prices in MCV's long term
contracts.
For the third quarter of 1997, operating expenses other than fuel costs
increased $.7 million from the third quarter of 1996 due primarily to an
increase in maintenance material and service costs. Other expenses incurred in
these periods were considered normal expenditures to achieve the recorded
operating revenues.
Other Income (Expense)
The decrease in interest and other income in the third quarter of 1997 compared
to 1996 is due to the 1996 receipt of approximately $1.4 million of interest
income on the Great Lakes gas transportation refund, partially offset by higher
interest income due to maintaining a higher average cash investment balance and
higher interest rates. The decrease in interest expense in the third quarter
of 1997 from the third quarter of 1996 is due to a lower principal balance on
MCV's financing obligation.
Comparison of the Nine Months ended September 30, 1997 and 1996
Overview
For the first nine months of 1997, MCV recorded net income of $61.9 million as
compared with net income of $50.7 million for the first nine months of 1996.
The increase in net income for the first nine months of 1997 as compared to
1996 is primarily the result of the January 1, 1997 change in method of
accounting for property taxes, so that such taxes are expensed monthly during
the fiscal period of the taxing authority for which the taxes are levied. The
cumulative effect of this change in accounting for property taxes increased
earnings by approximately $15.5 million for the first nine months of 1997.
Also contributing to the earnings increase is higher available capacity under
the PPA and lower interest expense on MCV's financing obligation. The earnings
increase was partially offset by the 1996 Great Lakes gas transportation refund
and higher 1997 natural gas prices.
-14-
<PAGE> 16
Operating Revenues
For the first nine months of 1997, MCV's operating revenues increased $8.0
million from the first nine months of 1996 due primarily to higher capacity
revenue generated under the PPA. The capacity revenue increase of $9.7 million
is the result of higher capacity payments under the PPA due to fewer 1997
scheduled and unscheduled maintenance outages. In the first quarter of 1996,
MCV experienced severe cracking in the hot gas casings of several of the gas
turbine generators ("GTG's") which reduced the capacity payments under the PPA,
during that period. Also contributing to the increase in operating revenues
are increases in the Consumers electric dispatch and DCC steam deliveries. The
increase in operating revenues was partially offset by lower Dow electric and
steam revenues due to the credit given to Dow for the tolling of gas.
Operating Expenses
For the first nine months of 1997, MCV's operating expenses were $324.7
million, which includes $199.0 million of fuel costs. During this period MCV
purchased approximately 71.7 bcf of natural gas, of which 2.4 bcf was used
either for transportation fuel or a net change to gas in storage. During this
same period MCV consumed 70.9 bcf of natural gas at the plant to produce
energy, of which 1.6 bcf of this total was gas provided by Dow. The average
commodity cost of fuel for the first nine months of 1997 was $2.41/MMBtu. For
the first nine months of 1996, MCV's operating expenses were $306.6 million,
which includes $180.8 million of fuel costs. The fuel costs for the first nine
months of 1996 include the Great Lakes gas transportation refund of
approximately $17.6 million (excluding interest). Excluding the Great Lakes
refund fuel costs were $198.4 million for the first nine months of 1996.
During this period MCV purchased approximately 72.2 bcf of natural gas, of
which 2.9 bcf was used either for transportation fuel or as a net change to gas
in storage. During this same period MCV consumed 69.3 bcf of natural gas at
the plant to produce energy. The average commodity cost of fuel for the first
nine months of 1996 was $2.35/MMBtu. The increase in fuel costs for the first
nine months of 1997 of $.6 million (excluding the Great Lakes refund) compared
to 1996 is due to an increase in fuel usage resulting from the higher Consumers
dispatch level during the first nine months of 1997 and higher gas prices
primarily due to the escalation of prices in MCV's long-term contracts. This
increase was partially offset by lower fuel costs due to Dow's providing gas to
generate part of its take of steam and electricity.
For the first nine months of 1997, operating expenses other than fuel costs
slightly decreased $.1 million from the first nine months of 1996 due primarily
to the establishment, in 1996, of a provision for the insurance claims on two
gas turbine failures in January 1996. This decrease was partially offset by
increased operating costs due to the increased energy dispatch and higher
maintenance material and service costs. 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 in the first nine months of 1997
compared to 1996 is due to maintaining a higher average cash investment balance
and to higher interest rates. This increase was partially offset by the 1996
receipt of approximately $1.4 million of interest income on the Great Lakes gas
transportation refund. The decrease in interest expense in the first nine
months of 1997 from the first nine months of 1996 is due to a lower principal
balance on MCV's financing obligation.
Liquidity and Financial Resources
During the first nine months of 1997 and 1996, net cash generated by MCV's
operations was $43.6 million and $73.1 million, respectively. The primary use
of net cash was for the payment of principal on the financing obligation and
capital expenditures. MCV's cash and cash equivalents have a normal cycle of
collecting six months of revenues less operating expenses prior to making the
semiannual interest and principal payments of the financing obligation due in
January and July for the next eighteen years. During 1997 and 1996, MCV paid
the basic rent requirements of $254.6 million, and $254.7 million,
respectively, as required under the Overall Lease Transaction.
-15-
<PAGE> 17
MCV also has arranged for a $50 million working capital line ("Working Capital
Facility") from the Bank of Montreal to provide temporary financing, as
necessary, for operations. The Working Capital Facility has been secured by
MCV's natural gas inventory and earned receivables. At any given time,
borrowings and letters of credit are limited by the amount of the borrowing
base, defined as 90% of earned receivables. The borrowing base varies over the
month as receivables are earned, billed and collected. At September 30, 1997,
the borrowing base was $46.7 million. The Working Capital Facility term
currently extends to August 31, 1999. MCV did not utilize the Working Capital
Facility during the first nine months of 1997, 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 any working
capital shortfalls which might occur.
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 a portion of fixed energy charges. 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, 1997, there was $272.0 million (which includes $62.1 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
governmental policies, legislation 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, industry restructuring
or deregulation, 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 MCV is also influenced by economic factors, weather conditions, pricing and
transportation of commodities and 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 65% of PPA revenues are capacity payments
which are based on the Facility's availability. PPA availability was 98.9 %
for the first nine months of 1997, 96.4% in 1996 and 98.1% in 1995.
Availability will depend on the level of scheduled and unscheduled maintenance
outages, and on the sustained level of output from each of the GTGs and the
steam turbines. MCV expects long-term PPA availability to exceed 90%.
-16-
<PAGE> 18
GTG Equipment Problems. In 1991 and 1992, several of the gas turbine
generators ("GTG's") experienced cracking in the hot gas casings which, in two
cases, caused extensive damage to the turbine blades and vanes. As a result of
these cracking problems, modifications were made on all GTG's and, MCV and ABB
Power Generation, Inc. ("ABB Power") implemented a program of hot gas casing
inspections for all GTG's. In January 1996, two additional GTG's experienced
severe cracking in the hot gas casings causing extensive damage to the turbine
blades and vanes. Extensive analysis and review by MCV and ABB Power 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 all the turbines
which has significantly reduced pulsations in the hot gas casings and installed
additional measuring devices to detect any pulsations which are suspected of
accelerating crack propagation. MCV and ABB Power continue to study whether
any modifications are needed in the high stress areas of the hot gas casings,
but MCV believes that the burner modifications have resolved the pulsation
problems and there should be no significant future impacts on plant
availability or efficiency from pulsations, 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 through the fourth series of major GTG inspections which are expected
to be completed by year end 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 second
quarter of 1998. Failure to maintain insurance, subject to certain exceptions,
not currently applicable, 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 consist
of the costs of natural gas. While MCV continues to pursue the acquisition of
fuel supply beyond the year 2002, 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 1997, the energy charge (fixed and
variable) paid to MCV has declined by .23 cents per kWh, while the average
variable cost of delivered fuel for the period 1990 - 1996, has risen by $0.18
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 spot market or contract prices under which MCV purchases fuel
(contract prices generally escalate at either the total PPA energy charge or 4%
per year). The difference could be further exacerbated in approximately three
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
PPA - "Regulatory Out" Provision. 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 a regulatory
disallowance.
-17-
<PAGE> 19
PPA - 25 MW Regulatory Disallowance. On February 23, 1995, the Michigan
Public Service Commission ("MPSC") in Case No. U-10155-R (the 1993 power
supply cost recovery reconciliation proceeding, "1993 Reconciliation Case"
conducted by the MPSC to reconcile actual costs incurred by Consumers in
1993 in providing power supply to its retail customers with actual revenues
it collected that same year), ruled that Consumers could not recover from
its retail customers the full 915 MW of MCV capacity and fixed energy
charges as Consumers contended it was entitled to 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
MPSC jurisdiction). In October 1995, Consumers notified MCV that, pursuant
to the "regulatory out" provision of the PPA, it would increase the amount
escrowed each month to reflect its calculation of fixed energy charge
payments allocated to non-jurisdictional customers disallowed by the MPSC
and Michigan Court of Appeals due to the jurisdictional issue. 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. In
November 1995, MCV responded to Consumers indicating that MCV would,
pursuant to the PPA, refund the appropriate funds, if any, and determine the
appropriate calculation of the correct escrow amount, if any, at such time
as a final and non-appealable order disallowing these recoveries is entered.
The Michigan Court of Appeals decision involving the jurisdictional issue
has become final. Based on this decision, Consumers notified MCV that it
would continue withholding the fixed energy charges on the jurisdictional
issue (approximately $45,000 per month in 1997). MCV agreed to the release
to Consumers of the escrowed funds of approximately $1.0 million plus
interest (covering the period of September 1995 through December 1996),
subject to a final resolution between MCV and Consumers of the energy charge
to be paid to MCV, which will be adjusted with any refund of the $1.9
million (discussed above), as a result of the finality of the jurisdictional
issue. MCV has not recognized any of these amounts related to this
jurisdictional issue as operating revenues.
PPA - Fixed Energy Payments for Deliveries Above the Caps. The MPSC ruled
in the 1993, 1994 and 1995 Reconciliation and Plan Cases, that Consumers
would not be permitted to recover from its retail customers fixed energy
costs for energy delivered above the off-peak cap ("the off-peak cap issue")
of 732 MW in 1993 and 750.3 MW in 1994 and 1995. MCV and Consumers appealed
the MPSC orders for both the years 1993 and 1994 to the Michigan Court of
Appeals, and in the 1993 Reconciliation and 1994 Plan Cases the Michigan
Court of Appeals affirmed the MPSC's decisions. MCV has appealed the 1994
and 1995 MPSC orders to the Michigan Court of Appeals. MCV believes these
rulings are erroneous and has petitioned the Michigan Supreme Court to
review the off-peak cap issue in the 1993 Reconciliation Case. Other PSCR
Plan and Reconciliation Cases for the years 1996-1998 are pending before the
MPSC at this time which involve this same issue. Consumers escrowed
approximately $2.8 million for 1996 and $1.4 million for the period April
1993 - December 1995 of fixed energy charges payable to MCV based upon the
MPSC rulings. In addition, MCV was paid $.2 million for the period January
- March 1993. MCV has not recognized any of these amounts related to the
off-peak cap issue as operating revenues. MCV Management cannot predict the
outcome of these proceedings.
PPA - Remaining 325 MW. In September 1995, Consumers and the MPSC staff
filed a motion to create a consolidated proceeding for the purpose of
reviewing a settlement agreement ("325 MW Proposed Settlement") entered into
between the MPSC staff and Consumers. The settlement agreement proposes
approving one-hundred percent jurisdictional cost recovery of the remaining
325 MW of capacity purchased from MCV. Cost recovery approval for the 325
MW of MCV Contract Capacity is in addition to the 915 MW already approved
(subject to the jurisdictional issue) by the MPSC. On November 14, 1996,
the MPSC approved, with modifications, the settlement agreement effective
January 1, 1996 ("325 MW Settlement Order"). The modifications were
generally related to issues not material to MCV, except the jurisdictional
issue which the MPSC deferred to the 1996 PSCR Plan proceeding . Various
parties have petitioned the MPSC for rehearing and on April 10, 1997 the
MPSC granted in part and denied in part those petitions. No issues
associated with the 325 MW recovery of MCV's capacity or energy were part of
the grant of rehearing. However, in the 1996 PSCR Plan proceeding, which is
subject to further proceedings, the MPSC ordered, on May 7, 1997, that the
325 MW of additional MCV capacity would be allocated between jurisdictional
and non-jurisdictional customers of Consumers in the same manner as the
original 915 MW. The Attorney General, among others, has filed an appeal of
the 325 MW Settlement Order. As a result of the approval of
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the 325 MW Settlement Order, Consumers notified MCV in February 1997, that
it would cease escrowing for the off-peak cap issue. Consumers released to
MCV the 1996 escrowed funds of approximately $2.8 million discussed in the
preceding paragraph and Consumers has paid to MCV approximately $2.1 million
for energy delivered above the off-peak cap during the first nine months of
1997, subject to a final decision upholding the 325 MW Settlement Order on
this issue. MCV has not recognized these amounts paid to MCV as operating
revenues. MCV Management cannot predict the outcome of either the 325 MW
Settlement Order proceeding or the 1996 PSCR Plan proceeding.
PPA - Other Issues. Recently, Consumers informed MCV of several other
potential issues it may pursue, pursuant to the "regulatory out" provision
of the PPA. These issues relate to Consumers special contract customers,
pricing of the energy delivered during off-peak ramp hours (when MCV adjusts
its output to match Consumers' dispatch) and energy delivered in the band
width (energy delivered above dispatch, within certain limits). In
addition, Consumers notified MCV that it does not believe that MCV can use
the approximately 15 MW of generating capacity attributable to the back
pressure turbine, which was placed into service in July 1997, towards
available Contract Capacity under the PPA. Based upon the limited
information provided on these potential issues, at this time, MCV cannot
accurately determine the financial impact of these issues and what specific
action will be taken. MCV management believes, based upon limited
information, that these potential issues will not have a material impact
upon MCV's financial position, if recognized.
Michigan Electric Industry Restructuring Proceedings. On December 20, 1996,
the MPSC initiated a proceeding on its own motion to consider restructuring the
electric industry in Michigan by transitioning to a competitive regime whereby
electric retail customers will be able to chose their power supplier. The MPSC
issued an order on June 5, 1997 (the "June 5, 1997 Order") calling for a
phased-in program (from 1997 through 2001) for this competitive regime, known
as "direct access", whereby all customers (industrial, commercial and
residential) will be eligible to select the electricity supplier of their
choice. The June 5, 1997 Order also addresses many transition issues including
reliability, stranded cost (or transition cost) recovery, rates, and other
issues. The June 5, 1997 Order authorizes recovery by utilities of stranded
costs including energy supply costs (such as purchased power contracts with
qualifying facilities such as MCV) incurred during the regulated era that will
be above market prices during the new competitive regime. However, stranded
cost recovery of above market PPA charges may be limited to the years
1998-2007. MCV has advocated, among other things, full recovery of PPA charges
for the life of the contract. Several parties, including MCV, have filed for
rehearing and/or clarification of the June 5, 1997 Order. The MPSC conducted
further hearings on several aspects of restructuring set forth in its June 5,
1997 Order which could impact MCV and on October 29, 1997, the MPSC issued
orders in these proceedings authorizing a power supply rate freeze and a
true-up process for the recovery of stranded costs. The exact true-up process
for the recovery of stranded costs will be determined after future proceedings
and presentation of additional evidence takes place. MCV is still analyzing
these orders and will likely seek rehearing and/or clarification of these
orders. The Michigan legislature has also begun a hearing process to consider
electric industry restructuring and deregulation. While restructuring could
have a material impact on MCV, MCV Management cannot predict the impact on MCV
or the outcome of these proceedings.
Federal Electric Industry Restructuring. FERC has jurisdiction over wholesale
energy sales in interstate commerce and is moving towards "market" based
pricing of electricity in some circumstances as opposed to traditional
cost-based pricing. In April 1996, FERC issued Order No. 888 requiring all
utilities FERC regulates to file uniform transmission tariffs providing for,
among other things, non-discriminatory "open access" to all wholesale buyers
and sellers, including the transmission owner, on terms and conditions
established by FERC. Order No. 888 also requires utilities to "functionally
unbundle" transmission and separate transmission personnel from those
responsible for marketing generation. In addition, several bills have been
introduced in Congress to require states to permit consumers to choose their
supplier of electricity and manage other issues such as transition cost
recovery and FERC jurisdiction of retail electric sales. MCV Management cannot
predict the impact on MCV or the outcome of these developments.
Maintaining QF Status. In the case of a topping-cycle generating plant such as
the Facility, to maintain QF Status the applicable operating standard requires
that the portion of total energy output that is put to some useful purpose
other than facilitating the production of power (the "Thermal Percentage") be
at least 5%. In addition, the plant
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must achieve and maintain an average PURPA efficiency standard (the sum of the
useful power output plus one-half of the useful thermal energy output, divided
by the energy input (the "Efficiency Percentage")) of at least 45%. However,
if the plant maintains a Thermal Percentage of 15% or higher, the required
Efficiency Percentage is reduced to 42.5%. The tests are applied on a calendar
year basis. The Facility has achieved the applicable Efficiency Percentage of
42.5% in each year since commercial operation, and in 1996 and 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, in 1996, to increase MCV's electric dispatch consistent with the
terms of the 325 MW Settlement Order, energy deliveries under the PPA have
exceeded 90% of Contract Capacity. Due to this increase in dispatch, Dow and
DCC steam purchases must average approximately 600,000 lbs/hour 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. Dow and DCC steam purchases for the first nine months
of 1997 averaged 635,542 lbs/hr. Actual steam usage has varied and will vary
with product mix, seasonal delivery fluctuations and other factors which may
change over time. 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, and
through diligent management of the issue, the Facility will be able to maintain
QF status 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 will not cause the Facility to fail to satisfy the annual PURPA
qualification requirements and thus lose its QF status. In 1996, MCV achieved
an Efficiency Percentage of 45.5% and an Thermal Percentage of 15.0%.
The loss of QF status could, among other things, cause the Facility to lose its
right under PURPA to sell power to Consumers at Consumers' "avoided cost" and
subject the Facility to additional federal and state regulatory requirements,
including the FPA (under which FERC has authority to establish rates for
electricity, which may be different than existing contractual rates). If the
Facility were to lose its QF status, the Partners of MCV, the Owner
Participants, the bank acting as the Owner Trustee and their respective parent
companies could become subject to regulation under the 1935 Act (under which,
among other things, the Securities and Exchange Commission has authority to
order divestiture of assets under certain circumstances). The loss of QF
status would not, however, entitle Consumers to terminate the PPA. Under the
PPA, Consumers is obligated to continue purchasing power from MCV at
FERC-approved rates (provided that the FERC-approved rates do not exceed the
existing contractual rates) and MCV, not Consumers, is entitled to terminate
the PPA (which MCV has covenanted not to do under the Participation
Agreements). There can be no assurance that FERC-approved rates would be the
same as the rates currently in effect under the PPA. If the FERC-approved
rates are materially less than the rates under the PPA, MCV may not have
sufficient revenue to make rent payments under the Overall Lease Transaction.
The loss of QF status would constitute an Event of Default under the Lease (and
a corresponding Event of Default under the Indenture) unless, among other
requirements, FERC approves (or accepts for filing) rates under the PPA or
other contracts of MCV for the sale of electricity sufficient to meet certain
target coverage ratios (as defined in the Overall Lease Transaction).
See Part I, Item 1, "Financial Statements and Supplementary Data -- Notes 1
through 7 to the Condensed Notes to Unaudited Consolidated Financial
Statements" for a further discussion of associated risks and contingencies.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
MPSC and Other 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 or disallow 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, as proposed by Consumers, until the MPSC acts. Actual
costs are reconciled with the costs billed to customers in a subsequent filing
(made by March 31 of the year subsequent to the plan year) 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 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 and Other 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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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 was
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 unsuccessfully sought
further judicial review of the Court of Appeals' decision and that decision has
now 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, certain parties
contend that Consumers' cost recovery relating to purchases from the MCV are
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.
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 from its retail
customers the full 915 MW of MCV capacity and fixed energy charges as Consumers
contended it was entitled to under the terms of the 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 MPSC jurisdiction) resulting in a disallowance of
costs submitted by Consumers of approximately $7.4 million of which
approximately $.7 million relates to fixed energy charges (the "jurisdictional
issue"). 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
allocated to non-jurisdictional customers disallowed by the MPSC and Michigan
Court of Appeals due to the jurisdictional issue. 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
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appropriate funds, if any, and determine the appropriate calculation of the
correct escrow amount, if any, at such time as a final and non-appealable order
disallowing these recoveries is entered. The decision involving the
jurisdictional issue has become final, affirming the MPSC's decision. Based on
this decision, Consumers notified MCV that it would continue withholding the
fixed energy charges on the jurisdictional issue (approximately $45,000 per
month in 1997). MCV agreed to the release to Consumers of the escrowed funds
of approximately $1.0 million plus interest (covering the period of September
1995 through December 1996), subject to a final resolution between MCV and
Consumers of the energy charge to be paid to MCV, which will be adjusted with
any refund of the $1.9 million (discussed above), as a result of the finality
of the jurisdictional issue. MCV has not recognized any of these amounts
related to this jurisdictional issue as operating revenues.
The MPSC also ruled in the 1993 Reconciliation Case that Consumers could not
recover from its retail customers approximately $.6 million of fixed energy
charges payable to MCV for energy delivered above the off-peak cap of 732 MW
(the "off-peak cap issue"). Consumers had paid into escrow approximately $.4
million of this sum and the balance had been paid to MCV. 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. MCV and Consumers filed motions for rehearing of the November 1,
1996 Michigan Court of Appeals Order which were denied on January 27, 1997.
MCV petitioned the Michigan Supreme Court to review the off-peak cap issue.
MCV Management cannot predict the outcome of this proceeding.
In addition, as part of its orders in Consumers' 1994 and 1995 PSCR Plan and
Reconciliation proceedings, the MPSC ruled that Consumers would not be
permitted to recover from its retail customers fixed energy costs for energy
associated with the off-peak cap issue. MCV believed the MPSC orders on this
issue were erroneous and filed appeals of the MPSC decisions. The Michigan
Court of Appeals affirmed the 1994 Plan decision of the MPSC. MCV has
petitioned the court for rehearing. Other PSCR Plan and Reconciliation Cases
for the years 1996 - 1998 are pending before the MPSC at this time. Consumers
has escrowed approximately $2.8 million in 1996 and $1.0 million for the years
1995 and 1994 of fixed energy charges payable to MCV based on the MPSC ruling.
MCV has not recognized any of these amounts related to the off-peak cap issue
as operating revenues. MCV Management cannot predict the outcome of these
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
("325 MW Proposed Settlement") entered into between the MPSC staff and
Consumers. The settlement agreement proposes approving one-hundred percent
jurisdictional cost recovery of the remaining 325 MW of capacity purchased from
MCV. Cost recovery approval for the 325 MW of MCV Contract Capacity is in
addition to the 915 MW already approved (subject to the jurisdictional issue)
by the MPSC. Recovery from Consumers retail customers would begin January 1,
1996. On September 22, 1995, MCV filed a position statement not objecting to
the settlement agreement, but reserving all of its rights and privileges under
the PPA. Consumers increased MCV's dispatch in 1996 consistent with the terms
of the settlement agreement. On November 14, 1996, the MPSC approved, with
modifications, the settlement agreement effective January 1, 1996 ("325 MW
Settlement Order"). The modifications were generally related to issues not
material to MCV, except the jurisdictional issue which the MPSC deferred to the
1996 PSCR Plan proceeding. Various parties have petitioned the MPSC for
rehearing and on April 10, 1997, the MPSC granted in part and denied in part
those petitions. No issues associated with the 325 MW recovery of MCV's
capacity or energy were part of the grant of rehearing. However, in the 1996
PSCR Plan proceeding, which is subject to further proceedings, the MPSC
ordered, on May 7, 1997, that the 325 MW of additional MCV capacity would be
allocated between jurisdictional and non-jurisdictional customers of Consumers
in the same manner as the original 915 MW. The Attorney General, among others,
has filed an appeal of the 325 MW Settlement Order. As a result of the
approval of the 325 MW Settlement Order, Consumers notified MCV in February
1997, that it would cease escrowing for the off-peak cap issue. Consumers
released to MCV the 1996 escrowed funds of approximately $2.8 million discussed
in the preceding paragraph and Consumers has paid to MCV approximately $2.1
million for energy delivered above the off-peak cap during the first nine
months of 1997, subject to a final decision upholding the 325 MW Settlement
Order on this issue. MCV has not recognized these amounts paid to MCV as
operating revenues. MCV Management cannot predict the outcome of either the
325 MW Settlement Order proceeding or the 1996 PSCR Plan proceeding.
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Michigan Electric Industry Restructuring Proceedings
On December 20, 1996, the MPSC initiated a proceeding on its own motion to
consider restructuring the electric industry in Michigan by transitioning to a
competitive regime whereby electric retail customers will be able to chose
their power supplier. The MPSC issued an order on June 5, 1997 (the "June 5,
1997 Order") calling for a phased-in program (from 1997 through 2001) for this
competitive regime, known as "direct access", whereby all customers
(industrial, commercial and residential) will be eligible to select the
electricity supplier of their choice. The June 5, 1997 Order also addresses
many transition issues including reliability, stranded cost (or transition
cost) recovery, rates, and other issues. The June 5, 1997 Order authorizes
recovery by utilities of stranded costs including energy supply costs (such as
purchased power contracts with qualifying facilities such as MCV ) incurred
during the regulated era that will be above market prices during the new
competitive regime. However, stranded cost recovery of above market PPA
charges may be limited to the years 1998 - 2007. MCV has advocated, among
other things, full recovery of PPA charges for the life of the contract.
Several parties, including MCV, have filed for rehearing and/or clarification
of the June 5, 1997 Order. The MPSC conducted further hearings on several
aspects of restructuring set forth in its June 5, 1997 Order which could impact
MCV and on October 29, 1997, the MPSC issued orders in these proceedings
authorizing a power supply rate freeze and a true-up process for the recovery
of stranded costs. The exact true-up process for the recovery of stranded costs
will be determined after future proceedings and presentation of additional
evidence takes place. MCV is still analyzing these orders and will likely seek
rehearing and/or clarification of these orders. The Michigan legislature has
also begun a hearing process to consider electric industry restructuring and
deregulation. While restructuring could have a material impact on MCV, MCV
Management cannot predict the impact on MCV or the outcome of these
proceedings.
Federal Electric Industry Restructuring
FERC has jurisdiction over wholesale energy sales in interstate commerce and is
moving towards "market" based pricing of electricity in some circumstances as
opposed to traditional cost-based pricing. In April 1996, FERC issued Order
No. 888 requiring all utilities FERC regulates to file uniform transmission
tariffs providing for, among other things, non-discriminatory "open access" to
all wholesale buyers and sellers, including the transmission owner, on terms
and conditions established by FERC. Order No. 888 also requires utilities to
"functionally unbundle" transmission and separate transmission personnel from
those responsible for marketing generation. In addition, several bills have
been introduced in Congress to require states to permit consumers to choose
their supplier of electricity, manage other issues such as transition cost
recovery and FERC jurisdiction of retail electric sales. MCV Management cannot
predict the impact on MCV or the outcome of these developments.
Great Lakes Pricing of Gas Transportation Costs
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
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
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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. 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. MCV 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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Item 6. Exhibits and Reports on Form 8-K
a.) List of Exhibits
(18) Letter in regard to change in accounting principle
(27) Financial Data Schedule
b.) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter for which
this report is filed.
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<PAGE> 28
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 10, 1997 /s/ James M. Kevra
-------------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: November 10, 1997 /s/ James M. Rajewski
-------------------------------------
James M. Rajewski
Vice President and Controller
(Principal Accounting Officer)
-27-
<PAGE> 29
EXHIBIT INDEX
Exhibit Sequential
Number Page No.
- ------- ----------
18 Letter In Regard To Change In Accounting Principle
27 Financial Data Schedule
-28-
<PAGE> 1
EXHIBIT 18
(Arthur Andersen Letterhead)
Midland Cogeneration Venture Limited Partnership
100 Progress Place
Midland, MI 48640
Re: Form 10-Q Report for the quarterly period ended September 30, 1997
Gentlemen:
This letter is written to meet the requirements of Regulation S-K calling for a
letter from a registrant's independent accountants whenever there has been a
change in accounting principle or practice.
We have been informed that, as of January 1, 1997, Midland Cogeneration Venture
Limited Partnership (the Partnership), changed its method of accounting for
municipal property taxes to recognize the expense during the fiscal period of
the taxing authority for which the taxes are being levied. According to the
management of the Partnership, this change was made to provide a better
matching of property tax expense with both the payment for services and those
services provided by the municipalities.
A complete coordinated set of financial and reporting standards for determining
the preferability of accounting principles among acceptable alternative
principles has not been established by the accounting profession. Thus, we
cannot make an objective determination of whether the change in accounting
described in the preceding paragraph is to a preferable method. However, we
have reviewed the pertinent factors, including those related to financial
reporting, in this particular case on a subjective basis, and our opinion
stated below is based on our determination made in this manner.
We are of the opinion that the Partnership's change in method of accounting is
to an acceptable alternative method of accounting, which, based upon the
reasons stated for the change and our discussions with you, is also preferable
under the circumstances in this particular case. In arriving at this opinion,
we have relied on the business judgment and business planning of your
management.
We have not audited the application of this change to the financial statements
of any period subsequent to December 31, 1996. Further, we have not examined
and do not express any opinion with respect to your financial statements for
the nine months ended September 30, 1997.
Very truly yours,
Arthur Andersen LLP
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS OF THE
MIDLAND COGENERATION VENTURE FOR THE QUARTER ENDED SEPTEMBER 30, 1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 302,852
<SECURITIES> 0
<RECEIVABLES> 89,387
<ALLOWANCES> 0
<INVENTORY> 12,251
<CURRENT-ASSETS> 291,162
<PP&E> 2,454,001
<DEPRECIATION> 614,017
<TOTAL-ASSETS> 2,303,871
<CURRENT-LIABILITIES> 253,586
<BONDS> 1,788,291
0
0
<COMMON> 0
<OTHER-SE> 261,390
<TOTAL-LIABILITY-AND-EQUITY> 2,303,871
<SALES> 0
<TOTAL-REVENUES> 487,312
<CGS> 0
<TOTAL-COSTS> 324,741
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 130,549
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 46,373
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 15,533
<NET-INCOME> 61,906
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
